Contents

Legislation and litigation

Trigger happy?

CDO litigation risk likely to remain stable post-Goldman

The US SEC's complaint against Goldman Sachs appears not to have sparked a dramatic increase in CDO litigation risk - although this may change with any disclosure of evidence. Of all the potential litigation triggers identified in CDO documentation, the implication that the Abacus 2007-AC1 was deliberately structured to fail has surprised the market, however.

One structured credit lawyer says she isn't aware of a dramatic uptick in banks assessing litigation triggers in CDOs they've arranged. She notes that banks have been undertaking due diligence on any structured deal they may need to potentially defend or manage at a steady pace since the beginning of the downturn.

"In any case, rather than take arrangers to court, most investors are asking banks to buy the investment back or restructure it. The uncertainty and expense of litigation tends to put most investors off suing investment banks," the lawyer adds.

However, she points out that a regulatory investigation represents more of a threat in terms of litigation risk. "Regulators have different powers and processes, and are in a stronger position to impose penalties, given the reputation risk involved," she explains. "Of all the potential litigation triggers out there, such as unclear waterfalls, the SEC's focus on Abacus was a surprise. The fact that policymakers are making a big noise about it without any evidence suggests that they're trying to intimidate Goldman into settling with the SEC out of court."

Arguably, the complaint opens the door for other, similarly structured CDOs to be scrutinised by regulators - especially given the popularity of synthetic structured finance CDOs before the crisis hit. But unless any disclosure of evidence proves otherwise, the Abacus investigation is expected to remain an isolated case (see also last issue).

Indeed, it remains difficult to form a view on whether anything improper can be proved unless there's further disclosure by the SEC, according to the lawyer. "Goldman appears to have been left in the dark about what the SEC is basing its allegations on. The motive is questionable: it's only legitimate if the SEC can prove that Goldman deliberately set the deal to fail."

While there is an obvious moral hazard associated with investment banks arranging deals, there are also various mechanisms within securitisation structures that should prevent a transaction from purposely being created to fail; for example, verifications performed by a servicer, trustee or auditor. In any case, the marketing details for Abacus included a disclaimer about Goldman withholding certain private and confidential information. On the flip side, investors in synthetic CDOs are inevitably very sophisticated and should be able to properly assess the risks involved.

Paulson & Co is said to have proposed working with ACA Management on around 120 deals, but the manager only accepted half - indicating that it demonstrated some standards of care and conduct. "I doubt that other CDO managers would have acted any differently in this situation, given the exuberant climate in 2007. Hopefully, this would also be taken into consideration by the courts," the lawyer remarks.

Structured credit strategists at UniCredit point out that conflicting short positions on synthetic CDO exposures are in practise found in other comparable cases as well; for example, with respect to the hedge fund Magnetar. However, the strategy of Magnetar - in contrast to Paulson & Co's - was to co-invest in the equity tranche in order to influence the portfolio composition. At the same time, it purchased protection on a more senior part of the capital structure.

"Such a CDO trading strategy - buy one part of the capital structure and hedge by selling another part - was a frequently used (market-neutral) strategy (and for SF CDOs referencing mezzanine portfolios the only meaningful strategy, as it was clear the default correlation will be very high in such structures)," the strategists explain. "While this itself might again not be a legal issue, the question is whether other investors were informed about the role (and the position) of the hedge fund."

Magnetar is said to have helped launch some 30 structured finance CDOs via this strategy.

A recent Credit Suisse research report underlines the likelihood of litigation risk dragging on and growing in size as it does so. Analysts at the bank suggest that the wave of litigation brought about by the financial crisis is comparable to that brought about by the dot.com crash.

They explain that, for banks which broke out the two categories separately in disclosures, private litigation was nearly twice the cost of regulatory settlement and the total cost of resolution was nearly eight times that of the initial provision for dot.com-related litigation. "Although the dot.com and subprime crises are different both quantitatively and qualitatively, in our opinion this illustrates the tendency of litigation risk to get worse," the analysts comment.

Further, they note that problems - such as those allegedly posed by the Abacus CDO - are rarely confined to one institution. "Once more, the dot.com era shows us that in the wake of a crisis, business practices which were considered normal at the time can look very much worse with the benefit of hindsight and in a legal setting."

To try to gauge banks' exposure to litigation risk as a result of the SEC complaint against Goldman Sachs, the Credit Suisse analysts constructed a 'league table' ranking bookrunners by total deal amount for all arbitrage structured finance CDOs issued between 2005-2008, based on Dealogic data. This was done on the presumption that regulatory and litigation risks are likely to lie with the lead underwriter rather than the issuer, as per the SEC complaint. They also constructed a separate league table for 2007, the year in which the Abacus transaction was structured.

The results indicate that the top-five bookrunners during 2005-2008 were Bank of America Merrill Lynch at US$16.85bn, UBS at US$15.82bn, JPMorgan at US$9.9bn, Citi at US$9.29bn and Morgan Stanley at US$8.26bn. For 2007, the top-five bookrunners were Bank of America Merrill Lynch at US$9.97bn, UBS at US$8.34bn, Citi at US$5.46bn, RBS at US$4.42bn and Barclays Capital at US$2.59bn.

Clearly not every structured finance CDO issued during the period will necessarily be the subject of litigation. For example, the Credit Suisse analysts observe that another risk factor might be whether a bookrunner possesses a material prime brokerage operation, since the SEC complaint refers to a hedge fund client.

They conclude: "However, the reverse implication can probably be made, in our opinion - banks which do not appear on either list are likely to have minimal risk of being brought into the CDO litigation, while banks with only small exposure or which were not involved in the 2007 vintage, would be at considerably less risk."

CS

CMBS

Lending alternatives

REITs to benefit from NAIC reserve increase

The proposal by the National Association of Insurance Commissioners (NAIC) to increase capital reserve requirements for life insurers to 4% from 2.6% could cut a significant piece of commercial real estate lending. However, it is also driving mortgage REITs to pick up the slack.

NAIC's proposal, which was released for comment last month and will be decided on by June, calls for an adjustment to the base factor for insurers' commercial mortgage loans in good standing. A conference call will take place 5 May to discuss the general state of the mortgage market, which will be followed by another call to discuss the comment letters sometime during the month, says a source familiar with the proposals.

After the comment letters are discussed, regulators will decide what action they will take for year-end 2010, he adds. NAIC is also trying to develop a long-term proposal to change the calculation for year-end 2011.

"It remains to be seen whether that long-term proposal will be ready for year-end 2011," the source notes. Already eight comment letters, with at least one representing the American Council of Life Insurers, were submitted to NAIC criticising the proposal.

For life insurers forced to increase their reserves, lending would be a more significant hit against their capital requirement than buying securities. "Going forward, there will be less money available for commercial real estate from the life companies that we've seen in quite some time. This really could be more of a structural change," says attorney Keith Mullen, a shareholder and co-chair of the financial services industry group at Winstead.

"There is some personal concern that this adjustment to a portion of the base calculation is going to resolve in the investment community wanting to put less money into commercial mortgages," he adds.

NAIC's proposal still has to be accepted at the state level once the regulators decide on the formal capital reserve requirement, but most market participants say the states would typically enforce such a move by NAIC. "It is theoretically possible that a state could go against NAIC's decision on this, but it hasn't been done in the past," says the source.

Mortgage REITs, in the meantime, are seen as the next likely group to take up that lending torch. As a group, they are traditional lenders of commercial loans, but Mullen expects that there will be an increase of mortgage REITs looking to take advantage of this.

"There isn't enough money to refinance all the commercial mortgages that are going to mature," he says. "But there's opportunity now for other kinds of lenders to step into that void."

"There are a handful of REITs that could be a logical source of supply of new commercial mortgage capital if insurers pull back," adds Steven Marks, md and head of the US REIT group at Fitch Ratings. But he notes it would likely be a few of the newer mortgage REITs that recently went public, since they have the capital and liquidity to originate loans, whereas many of the pre-existing or legacy mortgage REITs are still addressing issues with their existing portfolio.

Mortgage REIT Apollo Commercial Real Estate Finance, for one, was created last year in part to take advantage of this scenario. "Whether it's insurance companies pulling back, commercial banks pulling back, or CMBS markets shrinking...there's an opportunity for new pools of capital to take advantage of the dislocation in the commercial real estate lending markets and attempt to build a business around basic commercial real estate lending," says Stuart Rothstein, chief financial officer at Apollo. "We continue to see an opportunity there."

However, Marks notes that a lot of the newer REITs have a mandate to invest lower down in the capital stack and not do the traditional plain vanilla lending that many of the insurance companies have typically done.

Still, increased lending capabilities are expected from several notable mortgage REITs. NorthStar Realty Finance Corp, for example, originates and structures both senior and subordinate debt investments. Last month, the company said it had US$1.9bn of real estate debt that it originated, acquired or structured.

"Over the past six months, REITs have been extremely successful in attracting capital," notes Lou Weller, principal at Deloitte Tax. However, he says: "Some of the mortgage REITs have been hard hit as their collateral for their debt has declined in value."

Securitisation has been a prime outlet for that increased lending. Redwood Trust's US$222.378m mortgage pass-through offering last week reawakened the private label RMBS securitisation market.

Prior to that, Developers Diversified Realty (DDR) surfaced last year with a US$400m TALF-eligible CMBS offering, as did Inland Western Retail Real Estate Trust, which came with a non-TALF US$500m CMBS transaction. Since then other REITs have come to market, such as Ramco-Gershenson Properties Trust issuing a US$31.3m CMBS offering.

Apollo will also consider this option in the future. "As we continue to build a portfolio of senior commercial real estate loans, we'll certainly continue the option of financing those investments through the securitisation market as that market comes back, but there's nothing on the horizon just yet," Rothstein concludes.

KFH

ABS

Holding tight

US ABS market activity in the week to 27 April

While spreads in the US ABS secondary market continue to tighten due to a lack of available bonds, investors looking for a higher yield are turning towards more esoteric paper. Although a new issuance pipeline does exist, it is expected that paper will remain in short supply and off-the-run paper will maintain its appeal.

A compression in spreads has been seen across the board this week, particularly in subordinate classes. One trader elaborates: "The market has been strong and that, coupled with the lack of issuance, has seen spreads tighten." He explains that since 2009 investors have been looking to put money to work and that the current market has less and less paper available.

"Everyone is tripping over each other to get the best yield possible," says one investor. "So they spruce up the credit and it seems to look better every day and they buy more. There's just too much money chasing too few investments in fixed income."

Both credit card and auto paper continues to perform well. "Credit cards are doing particularly well," says the investor. "They've probably outperformed most of the other sectors over the last three months or so."

Although auto loan ABS performed well in March off the back of positive reports on repayment rates across the board, the investor explains that trading in the segment has since stalled. "Credit cards, which had underperformed auto, have since caught up," he says. "Spreads just got so tight. They got within 20bp of their all-time tights."

Subordinate card paper reportedly tightened by 10bp and in the week ending 23 April traded at 70bp for two-year single-A paper (for both fixed and floating) and 80bp for three-years and out.

Investors are now gravitating towards more esoteric paper in the hope of yield. "I think off-the-run paper is going to do well going forward," confirms the investor. "For example, in rental car finance, maybe some subordinate tranches can go a little bit further."

The trader adds that aircraft deals are garnering interest. "It's partly due to people chasing yield. But also due to the fact that the government will never let the airlines fail. So the government will somehow support the bonds," he says.

Moving forward, market participants agree that pricing is likely to grind tighter due to the continued lack of supply. "There's a lot of cash in the market, so it's hard for pricing not to keep getting better. I don't think there is enough issuance in the pipeline to alleviate the situation yet, but hopefully down the road there will be," says the trader.

Alternatively, he adds that technical factors could cause spreads to widen. He says: "It's all technical. It depends what the government does. I think if we have more scares - more Greek situations - and credit concerns, the market could widen out."

JA

CLOs

Business as usual

European CLO market activity to 23 April

Trading levels and sentiment within the European secondary CLO market appear to have been unaffected by the ongoing Goldman Sachs fraud charge saga. Indeed, prices have continued their upward trend over the past week as volumes remain low and demand high.

A CLO trader explains that the market is showing improvements and appears to be more liquid than in previous weeks. "Generally the market is being better bid this week," he says. "In terms of leveraged loans, appetite is back and things are trading well across the capital structure, so there's a lot more depth to the market."

In particular, the trader notes that as spreads continue to compress, the lower half of the capital structure holds more appeal for investors looking for greater yield. "Junior bonds, mezzanine and equity have traded pretty well and are at least a couple of points up from where they traded a month ago," he says. "Credit funds are looking for distressed opportunities where they can still pick up cheaper paper. There aren't many other asset classes that can offer the kinds of returns that CLO paper can."

While there was talk of potential near-term volatility in CLOs off the back of the Goldman Sachs saga (see last issue), a dealer says that the news has had "absolutely no impact" on trading levels. However, he points out that, moving forward, market participants may think twice before doing business with the bank.

"There is massive awareness of counterparty risk since Lehman Brothers' collapse and people now focus on counterparty risk in a way that they never did before," he explains. "In secondary trading, where you have a whole host of houses to choose from, counterparty risk is one factor that you take into consideration and if everything else is equal, then why do business with the one house that has more risk attached to it?"

He adds that having to justify a decision to do business with Goldman Sachs internally would be difficult, given the stigma surrounding the bank. "It'd probably be more hassle than it's worth," he adds.

Away from the Goldman story, the dealer believes that CLO and loan prices will continue their upward climb due to the short supply of paper in the market. "Everyone is too short on assets," he explains. "Until the primary market does come through with any kind of volume, everyone will remain a bit short and continue to chase what they perceive to be deals that they can feel comfortable with."

The dealer points to the recent trading levels of the Ineos loan as evidence of the escalating prices in the market. "Ineos is trading at par and a quarter. This is a triple-C rated loan - it's just ridiculous," he says. "It's publicly rated for everyone to see and someone is willing to pay par and a quarter for it."

Although market sentiment has improved, 'normality' has not yet returned. "Now that we have a bit of a primary market, we have secondary prices in the 90s where we can buy and sell," says the dealer. "It's still not back to where it was a couple of years ago, but there have been huge strides forward compared to 2008/2009."

JA

ABS

Euro new issue pipeline builds

Next month is - absent a macro shock - shaping up to be a post-crisis milestone in terms of primary European ABS volumes. At least three sizeable transactions are already gaining visibility in the new issue pipeline.

Last week already saw Fortis's €4bn triple-A rated Dolphin RMBS print - noteworthy for being the largest placed deal post-crisis, albeit it was reportedly sold to a single investor. The four-year €2bn A1 tranche priced at 107bp over three-month Euribor, while the six-year A2 notes came at 113bp over. The originator is also said to have enlisted the services of Cohen & Company to place the uncollateralised class E notes (funding the reserve) from the Dolphin programme privately with institutional clients.

"Still, we would note that more broadly based syndications of similarly sized deals are filling the new issue pipeline, which to us looks heavier than at any time in recent memory," asset-backed analysts at RBS remark.

For example, both the Driver Espana One and Arkle Master Issuer Series 2010-1 deals are expected to launch and price this week. Lloyds TSB, Citi and RBS are lead managers for the Arkle transaction, while Citi and VW are arranging Driver Espana, with JPMorgan joining them as lead managers.

Arkle is expected to feature publicly offered sterling-, US dollar- and euro-denominated tranches. The preliminary capital structure for Driver Espana comprises €622.5m triple-A rated (S&P/Fitch) 1.65-year class A notes and €63.75m A/A+ 2.16-year class Bs.

ABS analysts at UniCredit point out that, given Driver Espana One is a debut with respect to Spanish underlying loans and Arkle is being structured without a put option, the successful launch of both transactions can be viewed as a further step forward in terms of the recovery of the European public securitisation market.

The €1.79bn CIF ASSETS 2001-1 tap issuance is also among the other deals in the pipeline. This is a French prime RMBS that should take the total outstanding issued by the vehicle up to €19.45bn.

The RBS analysts observe that the tone in the Euro asset-backed market has been notably resilient to the renewed sell-off in peripheral sovereigns and financials. "With the secondary market continuing to be starved of supply in the face of steady buying, senior spreads have remained firm to only modestly weaker while pricing trends in the mezzanine market continues to decouple with better quality bonds trading higher," they explain.

RBS estimates that there is currently around €550bn of legacy ABS outstanding from a stock of €1.3trn in pre-crisis 2007. While there is still some vulnerability to this overhang, market technicals continue to benefit from seller resistance among the 'bad banks' and other dormant legacy investors, which collectively account for the bulk of this overhang.

CS

CLOs

CLO managers continue to snap up CLOs

Several CLO managers have benefitted from a strategy of investing in other CLO tranches over the past year, with further managers expected to make a similar call. While the prices of secondary CLO tranches have increased substantially since the beginning of 2009, opportunities still exist, with double-A and single-A CLO tranches offering a better relative value opportunity than the underlying loans.

"One category of investors to whom the trade can be particularly appealing is CLO managers," the Citi strategists explain. "Investing in senior tranches would give roughly the same yield while providing cushion from defaults."

Most CLOs are allowed to have 5% or so of their portfolio invested in tranches of other CLOs, though in some cases the basket is significantly higher. In Citi's sample of 586 US CLOs, since the beginning of 2009 through to mid-April 2010, the amount of CLO tranches that are contained in US CLOs has grown from roughly US$3.65bn (the amount that was more or less locked in CLOs at their origination) to US$4.3bn.

"In our view, the usage of a structured credit basket to buy senior CLO bonds is a clear example of managers adding value to transactions. Of course those buying CLO tranches sacrifice some liquidity and current carry, but, from a total return standpoint, senior CLO tranches offer better value than underlying loans," the strategists add. "This is particularly true for those looking to be cautious in view of a possible double-dip scenario. It is surprising though that only some managers seized the opportunity (it's possible some were sleeping at the wheel). The good news though is that the opportunity is still there."

Citi estimates there is still 8-10 points negative arbitrage between loans and CLOs (suggesting tranches are cheap) and senior mezz tranches still offer comparable or even higher yields than loans while offering significant protection from idiosyncratic risk. However, according to Citi's sample, not all managers seized the opportunity to invest in cheap structured credit assets, with 145 transactions by 20 managers - representing only 25% of the CLO universe by deal count - accounting for over 90% of the increase in CLO baskets within CLOs.

The strategists also point out that those managers who bought CLOs can be split into two camps. The first group liked CLO tranches to begin with, although they initially had lower-rated tranches in their portfolios; the second group was managers who chose to start investing in CLO debt in the course of 2009 for their relative value versus loans.

For example, Angelo Gordon - which in the beginning of 2009 had virtually no CLO exposure in its portfolios - has on average increased the CLO basket in its portfolios to 2.05%. Allied Capital too, though considered a middle market manager, bought roughly US$17m of junior triple-A CLOs for one of its two transactions. At the other end of the spectrum, managers such as Apidos, Greywolf and Kingsland - which traditionally liked CLO tranches - took the opportunity to go up-in-quality and buy senior CLO tranches.

"Surprisingly, only a quarter of transactions have increased their structured credit baskets, and many more have space to do so," the strategists comment.

Another aspect that Citi investigates is the time at which managers purchased assets for their CLO baskets. Some managers in Citi's sample - for example, Goldentree and DA Capital - jumped on the opportunity to buy senior CLO tranches really early, in Q209, and by now have even reduced their allocation to triple-As, probably moving to some other opportunities.

Another category of managers, such as Apidos and Alcentra, have been steadily buying CLO tranches (although the pace has slowed somewhat recently). The third category of CLO managers that bought tranches since the beginning of 2009 have been purchasing tranches in 4Q09 and 1Q10. Angelo Gordon and Kingsland are examples of such managers.

Another difference is the seniority of the tranches that managers bought. Some managers focused almost exclusively on triple-As, while more aggressive buyers have been buying mezzanine double- and single-A CLO tranches. And yet some even more aggressive managers have been buying across the board.

"Even when we look at purchases within the same quarter, we see that some managers opted for triple-As, whereas some decided to go lower in the structure to reap extra yield," note the analysts.

In addition, some of the managers are clearly axed to include tranches of their own CLOs in portfolios. For example, the majority of tranches purchased for Babson CLO 07-1, one of the two Babson transactions that has seen a significant increase in its CLO basket, have been predominantly from various Babson transactions.

"Little surprise though, as managers like their own transactions," the strategists conclude.

AC

Operations

Servicing, operational risk in Euro ABS highlighted

The issue of servicing and operational risk in EMEA structured finance transactions is becoming increasingly prevalent. Recent examples have included the back-up servicer in Kazakh MBS 2007-1 refusing to take up its role (see SCI issue 178) and, in the more mainstream ABS market, DSB - originator and servicer on several Dutch MBS and ABS - going bankrupt last year.

Moody's has taken rating action on several EMEA deals because of operational risk, such as Ford German auto ABS deals and Spanish RMBS IM Pastor 3. The rating agency would, however, like to see minimum standards to mitigate these risks to achieve high rating levels and anticipates bringing out a general framework that covers servicing, cash management and liquidity risks. It will shortly send out a request for comment to the market on this topic.

"Servicing and operational risk in European structured finance transactions is something we have become increasingly aware of," says Barbara Rismondo, vp and senior credit officer at Moody's. "We've been analysing counterparty-related risk and the impact on transaction performance. The risks include the effective performance of servicing and cash management functions, failure due to the creditworthiness of a transaction party and failure due to weaknesses in transaction structures and documentation."

According to Rismondo, these primarily impact the timeliness of payments, which can have serious consequences for transactions. "Even if the funds are available, if payments are not timely deals could enter an event of default. Furthermore, there could be a failure to pay swap counterparties, which may then be able to terminate swap agreements. There may also be deterioration in the underlying assets if there is nobody to service them."

She adds: "Despite many deals having back-up servicers, the reality is that arrangements are, in some cases, not always very robust. For example, DSB - which filed for bankruptcy last year - is still servicing its ABS and RMBS deals; one of the reasons being weak arrangements being put in place regarding the transfer to the back-up servicer."

In the case of Kazakh MBS 2007-1, however, the trustee's reluctance to transfer servicing to the stand-by servicer and the back-up servicer's attempts to renege on its obligations are not particularly surprising or unique, according to Fitch, as the migration of any servicing portfolio from one entity to another involves risks that are further exacerbated when the involved parties are resistant to such action. From the trustee's perspective, maintaining the servicing of Kazakh MBS with BTA Ipoteka (BTAI) - a subsidiary of Kazakhstan's second-largest bank, BTA Bank - is preferable to initiating a transfer to an unwilling back-up servicer, such as Halyk Bank of Kazakhstan, particularly given the type of loans in the portfolio which Halyk claims it cannot service.

Fitch believes such issues to be minimal in more advanced economies with well-developed mortgage markets and sophisticated servicing environments. However, while there are some transactions in EMEA markets where the stand-by servicer has a right of refusal following invocation of the stand-by arrangement, such a provision does not exist for Halyk.

Fitch believes that, should the trustee in the Kazakh MBS example have to enforce the stand-by agreement, Halyk would be contractually obligated to assume the servicing role or face potential legal action. Such action would likely involve noteholders, particularly if a prolonged servicing disruption significantly impacted transaction performance.

"Fitch views back-up servicing arrangements as an appropriate mitigant to servicing disruption events triggered by a servicer default. However, to fully capitalise on the stand-by arrangement, the agreement needs to be legally binding and the back-up servicer needs to be able to effectively service the types of loans included in the relevant transaction," says Edward Register, senior director, EMEA structured finance operational risk group at Fitch.

AC

Secondary markets

Strong interest anticipated for new CDO liquidations

A number of ABS CDOs are due to be liquidated in the coming weeks, creating the largest amount of paper to hit the market at one time since last year's Victoria SIV auction. In particular, the anticipated supply of highly-rated CLO bonds is expected to garner strong interest among investors.

The US$5bn Klio II CDO, for example, was scheduled to liquidate on 27 April. This is the biggest ABS CDO ever created and contains at least US$200m of originally-rated double-A and triple-A CLO paper. Other forthcoming liquidations include McKinley Finding CDO and Quatro CDO, which together add about US$80m and US$40m of triple-As and double-As respectively.

Structured credit strategists at Citi note that the US$200m of original triple-As would be welcome news for market participants, as sourcing triple-A CLO paper - particularly seasoned deals with shorter lives - has become increasingly more difficult recently. They anticipate strong interest in the upcoming liquidations.

CLO paper is not the only type of structured assets expected to come out of ABS CDO liquidations, however. Klio II also contains about US$300m of corporate CSOs, which are also scheduled to be auctioned on 27 April.

"Some of the CSO lots can be of particular interest to investors, as at least US$120m across three positions will mature in 2012 or earlier, offering much sought-after shorter-dated assets," the Citi analysts continue.

Meanwhile, more than US$1bn notional of triple-A rated Trups CDOs are scheduled to trade before the end of April. These bonds are also coming out of the three ABS CDO liquidations and represent roughly 2% of the entire legacy Trups CDO issuance - by far the largest amount of paper hitting the market in a month, let alone in a matter of ten days. The Citi analysts suggest that the Victoria SIV liquidation last year (SCI passim) comes close, though very few bonds of that liquidation have actually traded in the market.

"With yields on senior tranches of other structured products falling, investors - both existing and new - are paying closer attention to senior, originally triple-A rated tranches of Trups CDOs which still offer high single-digit yields," they add. "We have, in fact, recently seen an increasing interest from investors in junior triple-As, which offer mid-teen returns. Though regional banks, crippled by the bad loans, continue to fail (FDIC has seized 50 banks since the beginning of the year), the subordination below the tranches and higher yields will attract investors who feel they have an understanding of the sector."

Finally, for investors willing to look at even more distressed sectors, the liquidations will offer about US$750m of mostly senior tranches of CRE CDOs. "Again the amount is the highest to hit the market since the Victoria SIV liquidation," the analysts conclude. "Overall, it seems that the CDO liquidation story has not been exhausted yet. Further commutation of CDS contracts between dealers and monolines, if and when these happen, can remove obstacles to more vehicle unwinds and provide supply for investors and trading desks."

AC

Legislation and litigation

Sound and fury

Tales told, but little signified

Much has already been written about the appearance of "Goldman Sachs" before the "Senate" in the 18 hours since it actually happened. There may be little to actually come from this very public event, but there were at least a few stand-out moments in the day's seemingly endless proceedings.

While most of the mainstream press had been heralding yesterday's appearance of seven present and former members of Goldman Sachs in front of the Senate Permanent Subcommittee on Investigations (SPSI) as 'the Lloyd Blankfein show', it was clear to many that the real interest would be in the 'gang of four' appearing in Panel 1. The Goldman 'gang' comprised Daniel Sparks, former partner, head of mortgages department; Joshua Birnbaum former md, structured products group trading; Michael Swenson md, structured products group trading; and, of course, Fabrice Tourre, executive director, structured products group trading - most famous for his emails and being the subject of an SEC investigation. Indeed, that turned out to be the case.

As always appears to be the case with these kind of Congress hearings, the first hour was spent testing the levels of people's interest in what was to follow (and perhaps also it was an effort to break the will of witnesses before proceedings truly began). All watching were subjected to an interminable re-cap of the story so far in the honest, yet humble, opinion of the SPSI.

Unclear motive
What still remains unclear is why this hearing was held in the first place. For its part, the SPSI avowed that it was merely the fourth in its series of hearings on the causes and consequences of the financial crisis and that it intended to "focus on the role of investment banks in the crisis, using Goldman Sachs as a case study". Those of a more suspicious nature have suggested a number of alternative aims; notably, an effort to add impetus to the progress of financial reform bill or to force Goldman's hand and encourage a settlement in the SEC case (see also separate News Analysis).

The potential need for the latter was highlighted by the first stand-out moment provided by Tourre's testimony that: "I deny - categorically - the SEC's allegation. And I will defend myself in court against this false claim."

True, we do not yet have the SEC's full evidence for the case. But if part of the gamble was that Tourre would be left hanging out to dry by the bank, it seems for now at least that it won't pay off.

However, it was during the Q&A that things really took off, after some considerable time wasted on the SPSI members' irritation at the witnesses' time-wasting tactics. Though hardly an unusual strategy, it took quite some leap of faith to believe that an institution such as Goldman should ever employ four such slow-on-the-uptake men as these, all of whom appeared cursed with significant memory loss. Mind you, the obtuse nature of some of the questions being asked didn't help.

The first hurdle to sanity in this regard was a whole misguided discussion over morals (note to senators, morality may play well to your audience, but it has nothing to do with money in this context), combined with confusion over the different roles banks have as investment advisers, market makers etc - if only there was a law against such things...

Crying wolf
Once we were through that, there were plenty of accusations and innuendo, but things really got interesting with the introduction of Timberwolf into the conversation. It was alleged that Goldman had sold the RMBS deal to customers, despite internally characterising the transaction in less than complimentary terms. Chairman Levin, in particular, seemed to take great delight in repeating over and over again the scatological description used in an email by Tom Montag, the then co-head of the securities business at Goldman Sachs and now president of global banking and markets at Bank of America Merrill Lynch.

But the real moment came when one of the committee members honed in on the "hedging" activities around the deal and the firm's move into using equity as well as fixed income products. It was pointed out that US$300m had been sold to Bear Stearns and, in addition to shorting the underlying in the RMBS, Goldman had also bought put options on Bear stock. Ouch! A denial of this being a deliberate strategy immediately followed.

However, at this point someone should probably have stood up and said something like: "Fellahs, that may not be your strategy and it may not be illegal, but it looks awful bad to anyone with even the slightest sense of decency." Then, the matter could have been pursued relentlessly; instead, it was allowed to slip by and some other personal agenda taken up instead.

That, inevitably, will be the tombstone for this hearing and the others to come - missed opportunities. Someone needs to decide what is 'on trial'.

Is it capitalism? If so, then go for your lives. But it appears to be more about the spurious idea of bad people doing bad things.

Are investment bankers bad people? Maybe, sometimes. Do they do bad, but legal things to make money? Yes - it's their job.

Doris Marx*

*Doris Marx is a pseudonym and her views are her own and not necessarily those of SCI.

ABS

Guggenheim tapped for aviation securities team

Jefferies has expanded its aviation team with the hire of Nolan Heske, James Palen and Evan Wallach - all previously with Guggenheim Securities - as mds in the high yield fixed income group. They will be responsible for building the firm's trading and sales effort in aviation and transportation-related securities and have prior experience in the trading, structuring and distribution of transactions in the aviation sector, including ETCs, PTCs, EETCs, secured loans of airlines and aircraft and engine securitisations, as well as similar transactions in rail, container and related sectors.

Heske was responsible for trading airline EETCs and ETCs, as well as aircraft and engine securitisation issues during his time with Guggenheim. Previously, he was a vp in fixed income at Piper Jaffray, specialising in the analysis and sales of airline and aircraft-backed securities.

Palen joins Jefferies with 15 years' experience in the transportation financing sector, specialising in the structuring, restructuring and trading of airline, railroad and leasing company debt securities. He was most recently an md at Guggenheim, responsible for the sales, trading and structuring of airline and transportation securities. Previously, he was a director at Credit Suisse, responsible for the execution of secured capital market transactions for transportation clients.

Wallach joins Jefferies with over 25 years of airline and aircraft financing experience in sales, trading and capital markets activities. Previously, he was md at Guggenheim, where he was responsible for sales, trading and structuring of airline and aircraft securities. Prior to that firm, Wallach was in fixed income at Piper Jaffray, responsible for airline/aircraft capital markets and secondary sales.

ABS

Asset securitisation head steps aside

Michael Wade has left his post as Barclays Capital's Americas asset securitisation group head, and Jay Kim and Cory Wishengrad have been promoted to replace him. Barclays has declined to comment on Wade's departure.

Kim joined Barclays in 2001 from Salomon Smith Barney and is promoted from his role leading the automotive, equipment and prime mortgage portions of the bank's asset securitisation team. Wishengrad has been with Barclays since 1999 and was recently put in charge of the esoteric ABS portion of the group.

"We are extremely excited about the breadth of experience that Jay and Cory bring to their new leadership roles and expect their partnership to further advance our world class securitisation franchise," says Larry Wieseneck, head of global finance and risk solutions at BarCap, in an internal memo.

ABS

Advisory takes on SF staff

Valentina Santo has joined StormHarbour Securities as a director, ABS/CLO sales and advisory. She previously held the same role at ICP since January 2009.

Three other ICP structured finance employees are rumoured to be joining StormHarbour, including Jonathan Davis, who left his post as head of European operations and senior md for ICP Capital in late February. StormHarbour declined to comment on the appointments.

ABS

Yorkshire Bank SF official promoted

Yorkshire Bank has promoted Roddy Kilpatrick to area director for its corporate and structured finance (CSF) team in the North West of England. He is based in the bank's Manchester office and will be in charge of acquisition finance within the region. He replaces Andy Taylor, who has become the bank's West England CSF head.

Kilpatrick has nine years of corporate finance experience, first with Ernst & Young and then with Horwath Corporate Finance and BDO Stoy Hayward. He joined Yorkshire's sister bank Clydesdale in 2004.

ABS

ARS settlements completed

FINRA says it has settled charges with HSBC Securities USA and US Bancorp Investments relating to the sale of auction rate securities (ARS) that became illiquid when auctions froze in February 2008.

HSBC was fined US$1.5m. By July 2008 it had repurchased more than 90% of its customers' ARS holdings and offered to repurchase all remaining ARS in October that year. The bank repurchased more than US$562m of ARS and, as part of the FINRA settlement, it has agreed to offer to repurchase additional ARS sold to certain customers who transferred accounts before its previous buy-back and to customers who chose not to participate in its prior offers.

Among the shortcomings, FINRA found that HSBC did not take adequate measures to warn brokers when it realised ARS were becoming riskier, and also sold certain unregistered ARS securities to customers who were not qualified to own them.

US Bancorp, fined US$275,000, has already repurchased more than US$150m of ARS held in customer accounts. FINRA found that the firm used internal marketing materials prepared by other securities firms that did not provide a balanced or adequate disclosure of risks of ARS, and failed to disclose the liquidity risks. Furthermore, FINRA found that ARS were added to the firm's approved product list without first being subjected to the usual due diligence process.

"The failure of each of these firms to adequately disclose the risks associated with ARS left customers unprepared for the failure of the auction market," says James Shorris, FINRA evp and executive director of enforcement. "As with our previous ARS settlements, FINRA's first priority has been to ensure investor access to the money frozen in their ARS investments. We are pleased that these firms have completed or agreed to complete offers to buy back frozen ARS from their customers."

FINRA has concluded ARS-related settlements with 14 firms, issuing nearly US$5m in fines (SCI passim). More than US$2bn has been returned to investors through the settlements so far and investigations continue with additional firms.

CDS

Research pact achieves 'important insights'

Rand Merchant Bank (RMB) and Kamakura Corporation say they have achieved promising results from the joint credit risk research pact announced in October (see SCI issue 157). As part of the research pact, RMB has served as a steering committee member on Version 5 of the Kamakura Risk Information Services public firm default models. RMB contributed a number of important insights that have resulted in dramatic increases in long-term predictive power of the KRIS Version 5 models.

According to Kamakura, the dramatic increase in long-term accuracy of the KRIS 5.0 models is very relevant to the proposed Basel 3 use of "downturn" default probabilities from the worst part of the business cycle. The firm believes that the ten-year term structure of default probabilities in version 5.0 of the KRIS models embeds the business cycle evolution of the term structure of default very accurately. This makes the use of default probabilities from only one arbitrarily selected point in time both unnecessary and less accurate than using the full term structure of default based on the previous day's closing inputs.

RMB and Kamakura have agreed to a joint research paper illustrating that this approach most accurately captures the long-term capital needs of a sophisticated financial institution.

RMB and Kamakura also undertook an extensive comparison of alternative techniques for modelling the default risk of industries that have unique industry-specific explanatory variables available. The firms say they reached a productive mutual understanding on the best way to achieve even greater incremental accuracy over the global database by including certain industry insights.

In addition, they conducted an extensive investigation of alternative techniques for constructing the long run term structure of default risk and proper measurement of accuracy over monthly horizons from one month to 10 years.

CLO Managers

Fortress affiliate takes on eight CDOs

RAIT Financial Trust is selling or delegating its collateral management rights and responsibilities relating to eight Taberna securitisations, with approximately US$5.9bn in total assets under management, to Fortress Investment Group's affiliate TP Management for US$16.5m. The move is part of RAIT's ongoing strategy to focus resources on its core commercial real estate platform.

The transactions include Taberna Preferred Funding II, III, IV, V, VI and VII, and Taberna Europe CDO I and Taberna Europe CDO II. The deals are arbitrage cashflow CDOs invested in portfolios of trust preferred securities and subordinated debt issued by subsidiaries of REITs, real estate operating companies, homebuilders and specialty finance companies, as well as senior REIT debt securities and CMBS. They were selected and initially monitored by Taberna Capital Management.

CLOs

Manager swap for Euro CLOs

Invesco Asset Management is set to take on collateral management duties for cashflow CLO Morgan Stanley Investment Management Garda and Morgan Stanley Investment Management Mezzano. The European deals were launched in 2007 and managed by Morgan Stanley Investment Management.

CMBS

CRE investments md hired

NewOak Capital has appointed Carlos Vigon as CRE investments and services md. The firm says he will focus on expanding its CRE principal investments, asset management, private equity and advisory services.

Vigon has over 22 years of CRE experience as an investor, asset manager and trader. In 2000 he founded Wilshire Holdings, a Los Angeles-based real estate private equity firm, and before that held posts at SCI Investments and Realty Consultants Corporation.

"We are pleased to have Carlos join our commercial real estate debt and equity group that is taking advantage of unprecedented opportunities across property, loan and CMBS," says Ron D'Vari, NewOak ceo and co-founder.

CMBS

Bronx suit seeks CMBS borrower liability

A motion has been filed by Legal Services NYC-Bronx, on behalf of tenants living in a portfolio of ten distressed apartment buildings, arguing that once a foreclosure action is initiated and a court-appointed receiver is in place the mortgage holder can be held liable for maintaining building conditions. The rent-stabilised properties have been in decline since their owner, Milbank Real Estate, defaulted on its US$35m mortgage.

In March 2009, the mortgage holder - a US$3bn CMBS trust controlled by Wells Fargo and serviced by LNR Partners - initiated foreclosure proceedings. The foreclosure judge appointed a receiver, but - due to the high number of vacancies in the buildings, along with the already severely distressed conditions in most of the units - the income from rent collection is not adequate to properly maintain the portfolio.

LS-NYC Bronx attorneys say they hope that the legal action will force Wells Fargo and LNR Partners to invest in the portfolio to bring conditions back up to acceptable levels. The case comes at a time when a record number of apartment buildings are heading into foreclosure.

US Congressman Jose Serrano comments: "The tenants of Milbank Houses have a powerful new tool in a recent court decision that allows them to press the lender to ensure that the properties are adequately maintained. And this is the crux of the issue - we cannot have buildings falling apart as legal wrangling takes place over ownership or foreclosure. Tenants are entitled to housing that is safe and decently maintained."

Distressed assets

European distressed trading head hired

Deutsche Bank has appointed Stephen Byrne as European head of distressed trading. He will report to Gavin Colquhoun, European head of the distressed products group, and will be based in London.

Colquhoun says: "Stephen is an important strategic hire for Deutsche Bank. His credit knowledge and market relationships will support the continued leadership and growth of our par, high yield and distressed platform."

Byrne joins the bank after 14 years at Goldman Sachs, where he was most recently co-head of European high yield and public loan trading and spent the previous five years building the bank's leveraged loan trading platform.

Emerging Markets

EM trade finance agreement signed

IFC, a member of the World Bank Group, and Standard Chartered have signed an agreement for a US$1bn unfunded risk participation arrangement, which aims to increase the availability of trade finance in emerging markets.

Under the arrangement, Standard Chartered will originate a portfolio of up to US$1bn in trade finance transactions from banks in emerging markets, with a special focus on the world's poorest countries. These local banks, in turn, will extend trade financing to their importer and exporter clients. IFC will guarantee a mezzanine tranche of this portfolio, providing credit protection and capital relief on the portfolio over three and a half years.

Peter Sands, ceo of Standard Chartered, explains: "This arrangement will help boost trade finance in Asia, Africa and the Middle East, which has been sharply curtailed by the global financial crisis, and will support domestic businesses, job creation and private sector development."

Lars Thunell, IFC evp and ceo, says: "This innovative structure will significantly increase the supply of trade finance in emerging markets and in particular the world's poorest countries where it is needed most and will have the greatest impact. We are expanding our trade finance solutions and Standard Chartered has been a valuable partner in our initiatives."

Investors

New hire to drive asset management activity

David Leone has joined Newtek Asset Management as svp, responsible for expanding the firm's loan servicing and asset management activity. Newtek says Leone is experienced in all aspects of the structured investment process, and is a long-time investor in residential securities and commercial and consumer-related structured products and loans.

Newtek chairman and ceo Barry Sloan says: "Dave's vast experience as a senior portfolio manager at insurance companies, money managers and hedge funds with a deep understanding of raw loan collateral and securitisation is a valuable skill-set in today's markets. The volume of these opportunities is picking up and we are talking to numerous investors with the intent to invest in these undervalued assets. We believe this to be a tremendous adjunct to our loan origination and servicing business."

He continues: "We believe this opportunity can over time increase our servicing portfolio and assets under management from US$250m today to over US$1bn over time."

Investors

Flagship fund improved for investors

Alpstar Capital has launched the Alper European Credit Fund, which it says is a more mainstream and diversified version of its original long-only loan fund, first seeded in early 2008.

"We have decided to tightly focus our flagship product to better meet investor demand for a dedicated European credit fund," comments Bertrand Pinel, partner and ceo at Alpstar. "Diversification of assets, good liquidity and a European focus were at the top of their list."

The fund has European credit as a core focus and includes a 1.5% management fee, a 15% performance fee and monthly liquidity. A quarterly dividend distribution is optional.

Listed products

Permacap tender offer launched

GSO Capital Partners Employee Side by Side Fund and Miguel Ramos-Fuentenebro, md at GSO Capital, have issued a circular to shareholders in Carador relating to their tender offer to purchase up to two million US dollar shares in the permacap vehicle at US$0.50 per share and/or euro shares of up to an equivalent value at €0.37 per share. The tendering parties believe that the current discount to NAV in Carador's shares does not reflect its fundamental value and so they consider the opportunity to purchase shares at a discount to NAV compelling.

Operations

ISDA names new directors

ISDA has elected four new members to its board of directors, three of whom are involved in the fixed income space. Eight directors were re-elected to the board, with 14 others continuing to serve on it.

The four new directors are: Martin Chavez, md at Goldman Sachs; Bill De Leon, evp and global head of portfolio risk management at PIMCO; Yutaka Nakajima, group senior md at Nomura Securities; and Stuart Spodek, md at BlackRock.

Real Estate

CRE head steps down

A spokesman for Deutsche Bank has confirmed that Douglas Smith, head of its CRE financing business in Japan, is stepping down. Smith will leave at the end of the month for personal reasons.

The bank declined to comment further beyond wishing him well in his future endeavours. A successor is yet to be named.

Regulation

Regulatory counsel appointed

Crowell & Moring has appointed Mark Egert as corporate and financial services partner in its New York office. He joins from Cowen Group, where he was md and chief compliance officer. The law firm says his role will be to spearhead its regulatory and compliance practice serving broker-dealers, banks, asset management firms and investment clients.

Egert has 15 years of in-house counsel experience, and is a former vp and associate general counsel of SIFMA and executive director and chief legal officer for North America for ABN AMRO. "Mark brings incredible in-house counsel and industry experience to Crowell & Moring's financial services clients, who are faced with complex regulatory, trading and market issues," comments James Stuart, chair of Crowell & Moring's corporate group.

ABS

Central bank ABS activity analysed

Central bank funding operations once again dominated securitisation markets in 2009.

The ECB's annual report, which was published last week, puts the average amount of collateral (of all types) submitted to the ECB in 2009 at just over €2trn - a 29% increase over 2008. In 2009 borrowing against this collateral averaged just over €750bn, indicating that counterparties over-submitted collateral to create a large buffer against changes in liquidity needs, volatility in valuations and changes to eligibility criteria, according to asset-backed analysts at RBS.

The proportion of ABS in the posted collateral fell to 23% in 2009 from an average of 28% in 2008, while the value of ABS with the ECB increased by around 6% to an estimated €470bn on average. The RBS analysts estimate that this figure is equivalent to approximately 35% of the stock of outstanding retained securitisations, arguably considerably less than is often assumed by market participants. The ECB attributed the decline in proportionate ABS usage to lower valuations (from 2008 levels) and increases in haircuts.

The analysts suggest that retained securitisations were not used by banks to fund new asset growth over the recent crisis. "Rather we believe that most banks structured and retained securitisations over the past couple of years primarily as a means of converting illiquid balance sheet assets into readily repo-able securities, thus creating liquidity buffers which would have helped - among other things - in meeting regulatory stress tests. The recent ECB data show that only around a third of such assets were actually used by banks to draw cash. We think that in some cases retained securitisations were used to roll-over or refinance existing debt, but expect such cases to be limited - certainly post the initiation of government guarantee bank debt programmes in late 2008."

Meanwhile, on a global basis 2009 central bank funding operations kept gross ABS issuance at US$2.86trn, 3% higher than in 2008, according to the annual securitisation report from International Financial Services London (IFSL). Net issuance sold into the market when excluding central bank funding remained depressed at US$584bn, only a quarter of the US$2.1trn total in 2007.

In the US market - which accounted for 84% of global net issuance - support for mortgage finance has been provided by federal housing agencies, while the US$200bn TALF has facilitated ABS buying. The European market was largely dormant, however, with net issuance more than halving to US$27bn in 2009 from US$67bn in 2008. It stood at US$455bn in 2007.

IFSL points out that securitisation industry groups are working to develop solutions to restore investor confidence. Duncan McKenzie, IFSL director of economics, says: "While the initiatives in Europe have been important, there has so far been little response in the market as the industry itself has indicated that a reduced investor base, availability of cheaper sources of funding and an overhang of retained issuance are preventing a recovery."

ABS

Euro ABS data requirements prepped

The European Central Bank's governing council has confirmed that work will begin to establish loan-by-loan information requirements for European ABS. The ECB and 16 national central banks of the Euro area will proceed immediately with preparatory work to establish loan-level information requirements.

A public consultation on the issue was launched on 23 December 2009 and ended on 26 February, and the ECB says the majority of respondents were supportive. The move is intended to increase transparency, contribute to more informed risk assessments and help restore confidence in ABS markets, according to the central bank.

The ECB expects preparatory work addressing loan-level information requirements and technical implementation aspects to be finished by September. Subject to the governing council's approval, market participants would have 12 months before the obligation to submit loan-level ABS information comes into force.

European securitisation analysts at Deutsche Bank note that during the consultation concerns were raised by issuers around - among other things - providing loan-level data for master trusts (given the large number of loans), certain granular revolving pools (auto and credit card ABS) and legacy deals. Concerns were also expressed regarding bank secrecy/regulatory issues and the timetable for implementation.

Nevertheless, the analysts "continue to believe, in line with the majority of the responses the ECB received, that the improved transparency loan-level data provides will be positive for European ABS".

ABS

New aircraft leasing deal surfaces

Air transport equipment renter Premier Aircraft Leasing (EXIM) 1 Limited is issuing US$188m secured fixed rate notes sponsored by GE Capital Aviation Funding. The deal is guaranteed by Export-Import Bank of the United States.

Ratings are expected to be AAA/Aaa. The deal matures in 2022 and has a six-year average life. Goldman, JPMorgan and Credit Agricole are bookrunners.

The deal refinances a portion of the purchase price of the beneficial interest in two B767-300ER aircraft and two B737-800 aircraft acquired by the lessor.

ABS

ARS debt exchange offers gaining viability

Debt exchange offers appear to be gaining viability as a way to refinance auction rate debt, particularly in the US student loan segment, as auction rate security (ARS) market activity remains limited.

Brazos Student Finance Corp has become the latest issuer to refinance its ARS in this way, with the US$87m Brazos Student Finance Corp Series 2010-1. The 5.92-year triple-A rated single-tranche deal is backed exclusively by FFELP student loans and priced at 90bp over three-month Libor.

Under the transaction, Brazos offered to purchase for cash or exchange US$373.9m of outstanding senior auction rate notes and US$73.4m outstanding subordinate auction rate notes. Existing auction rate notes had been issued from Brazos Student Financing Corp Series 2003-A, 2003-2 and 2007-A.

According to ABS analysts at Deutsche Bank, all notes tendered for cash were to be purchased at a discount to par of 92% for senior notes and 75% for subordinate notes, plus accrued but unpaid interest. All senior auction rate notes that were exchanged for term notes were to be exchanged at par, while subordinate auction rate notes were to be exchanged at a discount to par of 80%. Approximately US$95m of existing senior auction rate notes were tendered for purchase.

For each debt exchange offering, the rating agencies must confirm that the new deal will not adversely affect the ratings or parity level of the existing ARS.

This is the second student loan auction rate debt refinancing for Brazos, following its US$306.7m Brazos Student Finance Corp Series 2009-1 deal from December. In that offering, the lender offered to exchange US$356m of senior auction rate notes issued in 2004 for one of three classes of term notes.

Each holder of senior auction rate notes received a par amount of Series 2009-1 class A notes. Holders of the subordinate auction rate notes that participated in the exchange received either new class A-S term notes at a discount to par of 53.6% or new class B term notes at a discount to par of 29.1%.

ABS

Indian ABS retention requirements mandated

The Reserve Bank of India has announced changes to its securitisation guidelines in line with the moves being taken by regulatory authorities in other jurisdictions.

Among the new guidelines is the stipulation that securitisation issuers must now invest in and continue to hold a minimum 5% stake of the outstanding amount of the security receipts issued under each class of a transaction until they have been redeemed. Additionally, with a view to bringing transparency and market discipline to the country's securitisation sector, additional disclosures related to assets realised during the year, the value of financial assets unresolved as at the end of the year and the value of security receipts pending for redemption have been prescribed.

Other new guidelines include: securitisation issuers can acquire the assets either in their own books or directly in the books of the trusts set up by them; the period for realisation of assets acquired issuers can be extended from five to eight years by, subject to conditions; and any asset/security receipts that remain unresolved/not redeemed as at the end of five years or eight years will now be treated as loss assets.

ABS

Fitch addresses SEC disclosure amendment

Fitch says it cannot rate a new structured finance security using its international credit rating scale, whether issued within or outside of the US, unless it receives the written representations as outlined by the US SEC's amendment to Rule 17g-5. All engagement letters signed and returned by the arranger to Fitch on or after 2 June 2010, the effective date of the amendment, must contain the representations, regardless of where the structured finance transaction is to take place, the rating agency notes.

The amendment requires that arrangers who hire a nationally recognised statistical rating organization (NRSRO) provide written representations to the agency obligating the arrangers to make available to any NRSRO, whether hired by that arranger or not, all information provided to the hired NRSRO.

The new SEC rule applies to all of Fitch's subsidiaries and offices worldwide. But the requirement only applies to new structured finance securities using Fitch's international credit rating scale. Fitch will not be changing any other practices for other forms of securities.

ABS

Greek bailout may bring ABS FX risk

The secondary European ABS market appears to have been insulated from Greece's ongoing funding problems. However, the FX market - which is reacting strongly to the Greek situation - could have an indirect impact on ABS bonds, according to securitisation analysts at Barclays Capital.

The euro rallied sharply following Greece's request for activation of the rescue package. But nervousness related to approvals for the loans in various European parliaments (particularly in Germany, where there are plans to legally challenge the proposed aid in the German constitutional court) remains and concerns about the severity of the required fiscal adjustments continue to linger.

FX strategists at BarCap believe that delays in providing aid to Greece will be negative for the euro as the possibility of debt restructuring in the near term and the resulting contagion effects are currently not included in the risk premium factored into the euro. "While these fears are unlikely to materialise, they could still weigh on the markets. Medium-term financing concerns are also likely to keep the euro weak," warns BarCap. "These points are worth bearing in mind as they could be potentially negative for euro-denominated ABS bonds."

Meanwhile, European corporate markets - which until a few weeks ago were reacting strongly to the negative signals emanating from Greece - are now becoming increasingly decoupled from Greek spread movements. Barclays Capital credit strategists point out that corporates are now showing an increasing correlation with core nation spreads rather than peripheral nation spreads, indicating that focus is beginning to shift away from specific sovereign issues to the general economic conditions in Europe.

Rates strategists at BarCap believe that the activation of the rescue package will result in a re-steepening of the currently inverted Greek yield curve as the front end moves away from pricing default and restructuring risks. However, longer-term solvency issues are expected to remain and markets will continue to be concerned about debt restructuring until Greece can prove that it can cut its fiscal deficits and successfully adjust.

"The process of fiscal contraction is likely to be very painful, given that Greece needs a primary fiscal balance adjustment of about 13% of GDP over the next four to five years. A painful contraction like this could have a potentially negative impact on ABS collateral performance," BarCap adds.

ABS

Wells Fargo creates prime auto ABS indexes

To assess the credit performance of prime auto ABS deals, analysts at Wells Fargo Securities have begun publishing their Prime Auto ABS Indexes. The issuer data represents vintages from 2001 to 2009.

"The shape of a loss curve or a prepayment curve is pretty similar over time as you look at auto deals," says John McElravey, senior analyst at Wells Fargo Securities. "By looking at it on a vintage basis, you can pick up more of the differences in the way credit was performing at those different times than just looking at it sequentially over time."

"Especially as we have gone through the financial crisis, it seems like a useful way of doing it," he adds.

Defaults, net losses, severity, prepayments, cumulative losses on the pools and two measures of delinquencies - such as a percentage of the current balance and a percentage of the original balance of the pool - are some of the credit metrics the analysts measure.

ABS

Auto ABS prepayments spike in April

Most US auto loan ABS deals backed by prime borrowers showed a significant jump in prepayments in April. According to ABS analysts at Wells Fargo, this was unexpected in light of the relatively slow speeds posted to date by the 2007-2009 vintages.

In a recent report for the sector, the analysts conclude that voluntary prepayments, rather than defaults, appear to be responsible for the entire increase in prepayments. "We hypothesise that a number of factors were at work," they explain. "Pent-up demand for vehicles found its way into the sales data for new and used cars. Furthermore, tax refunds coming back to consumers allowed some additional cashflow to be used for car payments."

However, the analysts question how sustained this move in prepayment rates is. They point out that the tightening trend in spreads means that many bonds have meaningful premiums and that faster prepays have an adverse impact on those bonds.

The analysts expect that prepayment rates on prime auto ABS are headed higher, along a trend that has been evident over the past several months. However, they note that the large, one-month jump was probably an anomaly.

In addition, the analysts found that benchmark prime autos still seem rich compared to credit card ABS. They recommend other non-benchmark names, equipment ABS or subordinated bonds as alternatives for investors looking for incremental yield.

ABS

US credit card charge-off rate to peak in Q2

Charge-offs on US credit cards increased marginally in March, finishing at 11.21%, just 13bp above the February rate, according to Moody's latest report for the sector. Although the first-quarter charge-off rate of 11.12% was the highest quarterly rate in the 20-plus year history of Moody's credit card index, the rating agency expects charge-offs to decrease moving forward.

Moody's expects this Q110 rate to mark the peak of the quarterly charge-off rate for the current credit cycle, with the monthly charge-off rate peaking either in this month or the next. Meanwhile, delinquencies in March fell for the fifth consecutive month to 5.79%.

Moody's svp William Black says: "We expect seasonal trends and a nascent consumer recovery to result in lower delinquency rates, which should lead to lower charge-off rates in the months ahead. Another indication that cardholders are more able to pay down their credit card balances is that cardholder payment rates are improving."

Moody's says the small increase in charge-offs in March had been anticipated, given the elevated delinquency rates during last autumn. The drop in delinquencies returned the rate to the levels of last August.

The payment rate surged in March by 134bp to 18.21%. In addition to improved conditions for paying back principal, the size of the gain can also be attributed in part to the greater number of collection days in March as compared to February.

At 23.54%, the yield index is now more than 500bp higher than it was a year ago and at the highest level in the history of the Moody's index. The increase is being driven not only by principal discounting, but also repricing initiatives on the part of issuers and cardholders becoming more able to afford monthly payments.

Finally, at 9.58%, excess spreads continue to receive significant support from issuer discounting and the strong yields.

ABS

Seasonal benefits fuel US auto ABS improvements

US auto loan ABS experienced solid improvements in both delinquencies and annualised net losses (ANL) last month, which Fitch attributes to high recovery rates on repossessed cars and the seasonal benefits of tax refunds. The rating agency's 60-plus days delinquency index dropped by 20% between February and March to 0.64%, and losses improved to 21%, which is their lowest since early 2008.

The subprime auto sector posted similar trends, as delinquencies decreased by 29% from February to 3.42%, which is 6% better than last year. Subprime ANLs decreased by 23% in March over the prior month, for a 20% improvement on 2009.

Record tax refunds helped push prime ANL down to 1.24% in March, from 1.56% a month earlier. It is the lowest loss rate since the first half of 2008 and is 40% lower than March 2009. However, Fitch warns that loss rates will remain under pressure for as long as unemployment stays around 10%.

"Wholesale vehicle values have shown improvements every month this year," says Fitch senior director Hylton Heard. "Stronger collateral characteristics in 2009 transactions are supporting overall performance."

ABS

Shipping loan ABS criteria updated

Moody's has completed its review of the methodology that it uses to rate and monitor ABS transactions backed by shipping loans in EMEA. Following the 90% collapse of the Baltic Dry Bulk Index, the rating agency gathered additional data on the industry over the last several years and used it to update its opinion.

The update of the shipping loan ABS methodology includes a suite of individual models, using Monte Carlo techniques to simulate the specific characteristics of a shipping portfolio. For these types of transactions, the model focus is on two main components - obligor default and recovery following default. The type of charter arrangement determines how the model will analyse default behaviour, Moody's says.

In the case of an event of default being driven by the default of a charter counterparty (applying to long-term charter agreements and guaranteed contracts), most charterers are unrated and hence are assumed to have probabilities of default consistent with Caa ratings. Of note, any charterers with an outstanding Moody's rating would be modelled using such.

Meanwhile, the break-even rate is determined by comparing the revenue earned by a vessel with the stressed operating and debt service expenses associated with each loan. This applies to vessels without a long-term charter in place (spot market). The default probabilities resulting from a typical portfolio are consistent with Caa ratings, according to Moody's.

Moody's emphasises that both quantitative and qualitative factors will form part of the rating committee decision process. Such factors include the transaction type (cash or synthetic), the deal's structural protections, the legal environment, asset-specific protections such as insurance coverage, specific documentation issues and additional information about advance rates.

Due to the relatively high volatility of various aspects of the shipping market - such as charter rates and shipping vessel values, as well as the low credit quality of many ship charterers - the maximum rating that Moody's would assign to a typical shipping loan-backed transaction would be in the low investment grade territory (Baa).

The rating agency explains that although it is not actively rating any ABS shipping securitisations in the EMEA region, the updated methodology will be used to assess the credit quality of cover pools backed by shipping loans and thus may impact future and existing covered bond transactions.

CDO

Goldman's Tourre surprised over ACA

In testimony on Capitol Hill yesterday (27 April), Goldman Sach's trader Fabrice Tourre said he was surprised that CSO investor ACA believed hedge fund operator John Paulson would be an equity investor or be a long investor in Abacus 2007-AC1. He said he told ACA and IKB that he expected Paulson to buy credit protection. He further added that if ACA was confused, it had the opportunity to clarify the issue.

ACA selected the portfolio of securities referenced in the transaction and had sole authority to decide what securities would be referenced, he noted. Neither Paulson nor Goldman could dictate the securities referenced to ACA, but rather Paulson's funds made suggestions to ACA, as did IKB and Goldman.

"The SEC complaint concedes that ACA rejected most of Paulson's suggestions while accepting others, so while Paulson, Goldman Sachs and IKB all had inputs in the reference portfolio for AC1, ACA ultimately analysed and approved each security in the transaction," he said. "Thus, when Goldman represented to investors that ACA selected the reference portfolio, that statement was absolutely correct."

He added: "We held long exposure in the transaction just like ACA and just like IKB. When the securities referenced in AC1 declined in value, we lost money too, including around US$83m with respect to the retained long position."

CDO

Euro CDO outlook still negative

The outlook for European structured credit transactions is still negative despite the pace of corporate credit deterioration slowing, says Fitch. The continuing economic recovery has helped slow the number of corporate loans moving into delinquency or default, but the agency says uncertainty remains about the viability of some companies and their ability to repay debt at maturity.

The SME CLO sector has seen the delinquency rate for Spanish SMEs start stabilising, but a drop in the credit quality of German and Portuguese SMEs continues. Fitch has not rated any Greek SME CLOs. "The stabilisation of Spanish SME delinquency rates can be partly attributed to a stabilisation of the economy and partly to a change in servicing practices at the banks," says Jeremy Carter, Fitch London CDO md.

European leveraged loan CLOs have also benefited as the pace of defaults has slowed and junior over-collateralisation tests are starting to return to compliance in some transactions. Laurent Chane-Kon, London CDO director, says: "The absence of large-scale refinancing opportunities for European leveraged loans continues to impose a negative outlook on the sector. However, the European leveraged loan sector has started to show early signs of stabilisation for high-quality credits."

CDPCs

CDPC rating criteria upgraded

S&P is amending its methodology and assumptions for rating CDPCs, with most of the changes relating to corporate credit risk. The agency says it follows the September update to its CDO criteria which changed corporate default assumptions (see SCI issue 153) and also addresses the credit quality of securitised assets principles.

Under the amendments there are new assumptions for corporate credit defaults; updated assumptions regarding rating transitions that are commensurate with the new assumption for corporate defaults and are used in assessing a CDPS potential obligation for termination payments; and new assumptions for the capital adequacy model rating quantiles commensurate with different rating levels.

The September update is now used as the primary basis for analysing CDPC corporate default risk, including the default and correlation assumptions associated with S&P's CDO Evaluator 5.0 and updated recovery rates that are applied for CDO analysis are also to be incorporated. The amendments also include updated assumptions regarding rating transitions the agency believes commensurate with the new assumptions for corporate defaults and are used in a CDPC's potential obligation for termination payments and updated assumptions regarding the capital adequacy model rating quantiles commensurate with different rating levels in S&P's analysis of a CDPC's issuer credit rating and any liabilities issued by a CDPC.

The new criteria will be effective from 8 June for all new and outstanding CDPCs.

CDS

JAL auction results published

Markit and Creditex have announced the auction results for Japan Airlines Corporation credit default swaps. Fourteen dealers submitted orders and requests during the auction.

The final price was determined to be 20, with the inside market midpoint at 18. Of the inside markets submitted, JPM Securities Japan Co had one of the highest midpoints at 20, while Mitsubishi UFJ Securities Co had one of the lowest at 15.

The deliverable obligations for Japan Airlines Corporation are denominated in Japanese yen.

Separately, the ISDA Americas Determinations Committee ruled on 22 April that a succession event had occurred with respect to Burlington Northern Santa Fe Corporation on 12 February, and that the sole successor is Burlington Northern Santa Fe LLC. The DC also postponed the deadline for voting on whether a succession event has occurred on Northwest Airlines until 7 May.

CDS

California CDS trading volumes revealed

California state treasurer Bill Lockyer has released data showing that since 2007 the top six fee earners among investment banks selling California muni bonds have completed more than US$27.5bn of CDS trades on state general obligation (GO) bonds. This figure includes buys and sells the banks completed for themselves or their clients, and represents 63.2% of the US$43.5bn of GO bonds California has issued since 2007. Clients include hedge funds, broker-dealers, insurance companies and banks.

Lockyer wrote to Bank of America Merrill Lynch, Barclays, Citigroup, Goldman Sachs, JPMorgan and Morgan Stanley - who have been paid a combined US$215m in underwriter fees by California since 2007 - on 29 March to ask for details on their CDS activity (see SCI issue 178). His letter expressed concern at the banks selling state bonds on one hand and betting against, or facilitating bets against, those bonds on the other hand. He also noted that residents have a right to know about the firms' CDS trading activities, as a negative view of California's creditworthiness could harm the state's bond sales and burden taxpayers with higher costs.

Lockyer says that ongoing monitoring of California CDS trading is important, especially if Build America Bonds (BABs) become a permanent part of the municipal bond landscape. BABs are taxable and more like corporate bonds than traditional municipal bonds. The six banks agreed that CDS are likely to gain significance if BABs continue beyond their 2010 sunset date.

CDS

Results published for 2010 ISDA surveys

ISDA has released the results from its 2010 year-end market survey of privately-negotiated derivatives, as well as its margin survey and operations benchmarking survey. The results were released at the association's AGM in San Francisco.

The notional amount of outstanding CDS was US$30.4trn at year-end 2009, down 3% from US$31.2trn at the year's mid-point and down 21% from US$38.6trn at year-end 2008. ISDA attributes this decline to the industry's portfolio compression efforts and says the US$30.4trn was divided fairly equally between bought and sold protection, with the former accounting for approximately US$15.4trn and the latter for US$15trn.

"ISDA continues to develop a strategic vision for the derivatives industry to make derivative processing more scalable, transparent and resilient in all asset classes," says Eraj Shirvani, ISDA chairman. "The lower notional amounts outstanding in this year's survey reflect the industry's steady progress in such key areas as electronic processing, portfolio compression and collateralised portfolio reconciliation."

Meanwhile, ISDA's margin survey indicates that 78% of transactions for large dealers are executed with the support of a collateral agreement, including 97% of credit derivatives trades. Collateral agreements now number almost 172,000 and 83% are two-way collateral obligations. This is up from 75% last year, according to ISDA.

"The need for effective and efficient risk management will continue to drive demand for OTC derivatives," says Conrad Voldstad, ISDA ceo. "Collateralisation remains among the most widely used methods to mitigate counterparty credit risk and, as ISDA's 2010 margin survey demonstrates, market participants have increased their reliance on collateralisation steadily over the years."

About 90% of the survey's respondents say they periodically perform portfolio reconciliations, with the major dealers doing so on a daily basis.

Finally, the operations benchmarking survey shows that 99% of eligible CDS are confirmed electronically, up from 95% last year.

ISDA says infrastructure improvements are also shown by the continuing decrease in confirmations outstanding. Credit derivatives show an average of 1.1 business days' worth of aged outstanding confirmations, down from 3.8 business days in last year's survey.

CDS

CDS spreads signal further euro pressure

The CDS market expects Eurozone government funding pressures to intensify, pushing bond yields higher and bringing further pressure on the euro, according to Fitch Solutions. At the same time, CDS market concerns for the UK have eased dramatically since the start of the year and no further significant increases in UK funding costs are expected.

Fitch says that since 1 January the percentage difference between CDS spreads on euro versus US dollar-denominated German sovereign CDS contracts has increased from 7% to 29%, as at 23 April. "In essence, this shows the value of protection in euros, as expressed by CDS spreads, is 29% lower than in US dollars, reflecting CDS market concerns on both possible financial contagion spreading beyond Southern Europe to the broader Eurozone and on a resulting decline in the value of the euro," says Fitch md Damiano Brigo.

Within the Eurozone, the CDS market is reflecting greatest concerns on the prospects for Italy, Spain and Portugal, whose five-year CDS spreads are at relatively wide levels. On 23 April those levels were 138bp, 175bp and 276bp respectively, and furthermore there was a positive basis of between 77bp and 81bp on these CDS spreads over each country's government bond yields over the risk-free rate. Fitch says approximately two-thirds of this positive basis is explained by CDS investors' expectation of rising bond yields for the three countries.

In contrast, the CDS over bond basis on the UK five-year sovereign CDS has fallen dramatically since the start of this year from 36bp to par, while the UK is also now one of the least liquid European sovereign CDS contracts, trading in the 41st global percentile. "This sharp positive reversal in CDS trends for the UK suggests CDS investors now do not expect any significant increase in UK government bond yields, regardless of the possibility of a hung parliament in early May. Furthermore, whilst the UK CDS still trades considerably wider than that of France or Germany, this difference has narrowed greatly since the beginning of 2010," adds Thomas Aubrey, md at Fitch Solutions.

CLOs

Symphony CLO marketing

Symphony CLO VII, which will be managed by Symphony Asset Management, is marketing via Bank of America. The CLO is part of a group of offerings slated to come to market in the coming sessions.

The deal is expected to be US$500m in size, including a triple-A rated US$317m tranche and a Ba2 rated US$113m tranche. To make economic sense, the transaction is likely to price in a range of 150bp to 175bp, says a trader.

Unlike other CLO offerings that graced the market in recent weeks, the deal is not expected to be a pure refinancing. If it does turn out to include a portion of new loans, it would be a positive development for the sector, says an investor.

Until now, the few new issue CLOs that have come to market, including Citi's COA Tempus CLO managed by WCAS Fraser Sullivan Investment Management, were refinancings of prior loans. A true reawakening of the CLO new issue market is not likely to occur until new loans are included in the offerings.

Spreads are considered too wide for a true comeback to occur in the new issue CLO market just yet, however. Levels closer to 125bp at the triple-A senior level would be needed for the arbitrage to work, says the trader. This compares with Citigroup's COA Tempus CLO pricing at 190bp, he adds.

Finding third-party equity interest is also still a tough sell. Some of the recent offerings have offered concessions just to get the deals done, the trader says. The equity returns in the new issue market, which are high single to low double-digit returns, are also not as enticing versus the secondary market currently.

Other deals in the CLO line-up include an offering from Apollo Management and GSO Blackstone.

Interestingly, Moody's notes in its presale report for the Tempus transaction that an agent appointed by the majority of the Class A-1 noteholders will serve as a designated advisor to FS COA Management, overseeing certain trading decisions. On a limited basis the designated advisor will approve purchases during the ramp-up period. After the ramp-up period it will have certain rights related to discretionary sales.

CLOs

Exit loans 'attractive candidates' for CLOs

As the calendar for bankruptcy emergences becomes more visible, exit financing is tipped to be a major component of 2010 loan issuance. Structured credit analysts at Barclays Capital note that, on average, spreads on exit loans have been more than 150bp wide of the general loan new issue, making them attractive candidates for secondary CLOs.

A number of large issuers in this field have emerged in the past few months, including Lear, Idearc, RH Donnelley and Charter. Last week Six Flags' US$770m first- and second- lien loans allocated and traded well in the secondary market. The US$400m first-lien loan has a 400bp over Libor coupon, 2% Libor floor and a 101 soft call premium, while the US$250m second-lien has a 725bp coupon, 2.5% Libor floor and 103, 102, 101 call premiums.

"While the US$19bn current forward calendar does not reflect the potential exit pipeline, we expect the 2010 calendar could include Hawaiian Telcom, Fairpoint, Smurfit Stone, WR Grace, Tronox, Chemtura, Lyondell, AbitibiBowater, Tribune, Visteon and Young Broadcasting," add the BarCap analysts.

CMBS

UK prime CMBS outlook improves

A new Fitch EMEA CMBS report says the UK prime property market, primarily London office properties, has recovered best from the global crisis. Other UK and EMEA sectors remain vulnerable to further weakness and are at risk of further CMBS downgrades.

"The low volume of UK prime properties that have come up for sale over the last 12 months have experienced high levels of demand, causing office yields - particularly in London - to drop back down towards their previous lows," says Fitch European structured finance senior director Euan Gatfield. "Besides weakness in sterling making London property prices per square-foot especially attractive to foreign investors, demand has been fuelled by a freeze in development activity, which reportedly caused new space coming onto the City market to fall to its lowest recorded level, and which is only just beginning to thaw," he adds.

The asset performance and ratings outlooks for this sub-sector have now been changed to stable.

Fitch says yields for non-prime UK markets are set to remain above their historical averages for some time. Transactions are suffering underlying loan payment defaults and many loans will fail to repay on their contractual maturity date.

Mainland European commercial property markets underlying CMBS mostly comprise non-prime properties, many of which are experiencing rising vacancy rates, reduced debt service coverage and defaults. Asset performance outlooks are declining, with rating outlooks for non-prime UK negative and pan-European deals stable/negative.

CMBS

Japanese CMBS collateral prices 'as expected'

Sale prices of collateral property backing Japanese CMBS have generally matched estimated values, says Fitch. After assigning two types of values for each collateral property - revised Fitch values and Fitch stressed-sale values - research concluded last month has found that in many cases actual sale prices achieved are similar to Fitch's revised or stressed-sale values.

The research included CRE transactions of collateral properties backing Fitch-rated Japanese CMBS with sales prices of over Y100m, which were closed between January 2009 and March 2010. There were 158 transactions reported in this time with a total sales price of Y135.2bn and Fitch says the achieved prices indicate a 20% decline compared to initial valuations. Residential and office property types accounted for the largest proportion of the total sales price, with 34% and 48% respectively, while Tokyo accounted for 73% of transactions.

There were 36 properties sold in Q110, with a total sales price of Y32.5bn, exceeding Q409 when 31 transactions were recorded with a total sales price of Y23.7bn.

Fitch says the number of collateral dispositions observed after assigning revised values is 138 with a total sales price of Y115.1bn and transactions at prices higher than the revised Fitch values accounted for 47% of all transactions by sales amount and 33% by number of properties. The agency says this is in line with its estimations.

There were 96 transactions with a total sale price of Y59.3bn related to collateral properties backing loans in default or loans whose maturity dates were within 12 months from the date of sales, and where sale prices were compared to the stressed-sale values. Transactions at prices higher than Fitch stressed-sale values accounted for 73% of all transactions by number and 77% by sales amount, while transactions achieved at prices higher than 90% of Fitch stressed-sale value accounted for 91% by number and 93% by amount, which again the agency says is in line with expectations.

CMBS

US CMBS loan defaults to top 11%

US CMBS loan defaults will continue rising, with an additional 4.4% likely in 2010 and the overall rate for Fitch-rated deals set to exceed 11% by the end of the year, according to the rating agency. New CMBS loan defaults increased more than five-fold last year to 1,464 conduit loans totalling US$17.75bn, with 34% taking place in Q4.

"Fourth-quarter default rates reached their highest ever levels, both in principal balance and number of loans, with no clear signs of stabilisation," says Fitch md Mary MacNeill. She adds that 2009 defaults surpassed the cumulative US$17.74bn from the inception of the CMBS market to the start of that year.

Large loan defaults have also increased, with 56 loans over US$50m defaulting in 2009, compared to just five in 2008. Most of the defaulted loans came from 2006-2008 vintages.

By principal balance, the 2007 vintage accounted for 35.6% of last year's defaults and MacNeill says this is down to aggressive underwriting and higher leverage in the 2007 vintage. She predicts that 10-year cumulative default rates on 2007 Fitch-rated CMBS will reach 27%.

For the first time in five years, multifamily was not the property type with most new defaults, coming second with 22.1%. Retail came first, with 32.3% last year, while office was 20.2% and hotel 17.8%. Fitch expects large default increases for each property type, particularly office and hotel loans.

"Office defaults spiked in the fourth quarter last year, with further rental and net operating income declines likely through next year before a rebound takes place," says Fitch senior director Richard Carlson. "Larger concentrations of hotel loans in recent vintages will translate to higher defaults, particularly among luxury properties, resort destinations and those hotels heavily reliant on group and convention business."

Ratings

Further downgrades for Greek deals

Moody's has taken negative rating actions on 30 structured finance transactions backed by Greek assets. The actions follow the agency's downgrade on 22 April of the Greek government's sovereign debt rating to A3 from A2 and its placement on review for further downgrade. The actions affect €6.9bn of tranches from 11 RMBS, €19.8bn from 16 ABS and €3bn from three CLOs.

The agency has taken rating actions on all senior classes of RMBS notes, with nine classes downgraded by one or two notches and maintained on review for possible downgrade, while two classes have been placed on review for possible downgrade. Seven mezzanine classes rated above the government's rating have been downgraded to A3 and remain on review for possible downgrade.

Rating actions have been taken on ten ABS deals backed by loans or leases to SMEs, four deals backed by consumer assets and two linked to the Greek government. Eight senior classes have been downgraded one notch and maintained on review for possible downgrade and a further eight senior classes were placed on review for possible downgrade.

Moody's has also taken rating actions on three senior CLO classes of notes. One has been downgraded one notch and maintained on review for downgrade while the other two have been placed on review.

Negative rating action was taken on 24 of these 30 affected transactions in March (see SCI issue 179). In line with the previous transactions, Moody's says it has considered an extreme worst-case economic scenario when reviewing the transactions. The agency notes a possible further downgrade of the government's sovereign rating would lead to further downward adjustments of the country's systemic support indicator and, therefore, all ratings above the government's rating remain on review for possible downgrade.

Some of the affected transactions rely on the performance of the National Bank of Greece, EFG Eurobank Ergasias, Alpha Bank AE and Piraeus Bank, or their subsidiaries, Moody's notes.

Ratings

Global SF downgrades moderate

Fitch says the number of negative structured finance (SF) rating actions in Q110 was lower than the previous quarter and there were less downgrades than any quarter since Q407. Downgrades reduced in all sectors in all regions, with the exception of US ABS and CDOs. The rating agency says, however, that downgrades continue to outpace upgrades - a trend that can be expected to continue for some time.

"The mixed rating trends reflect to some degree tentative global economic stabilisation," says Rodney Pelletier, head of US SF surveillance. "However, the data also reflects the fact that fewer major sector reviews were concluded during the first quarter of this year than in recent quarters."

Fitch expects continued dominance of the peak vintage years of 2006 and 2007 in the rating portfolio, where performance can be expected to remain challenged, will continue to weigh on performance expectations.

In the US, RMBS continued to dominate negative rating action as mortgage delinquencies increased for the fifteenth consecutive quarter. All US CDO sectors saw downgrades, with more than half of US CRE loan CDO transactions experiencing action following rating reviews. Fitch says negative action was significant even at the most senior levels.

There were increased ABS downgrades, mainly attributed to student loan rating action where 94 classes of National Collegiate Student Loan Trust transactions were downgraded. Despite continuing rises in unemployment, most prime credit card and auto loan ABS transactions are expected to remain stable. CMBS downgrades were not as bad as in previous quarters, but negative rating action does remain elevated.

In EMEA the pace of downgrade actions declined in all asset classes to the lowest level since Q308 while upgrade rating actions picked up to the highest level since Q408. European SME and CLO transactions continue to account for the majority of downgrades, although the pace of SME downgrades slowed. There were no CDO downgrades in Q110, following 81 in Q409, and CLO downgrade levels were consistent with the previous quarter. Fitch says there has been CMBS performance stabilisation and that RMBS downgrades declined. ABS actions were mixed.

The Asia Pacific region had its highest upgrade to downgrade ratio since Q108 and limited downgrades were spread across countries and sectors. Upgrades were concentrated in two Australian non-conforming RMBS.

Fitch also says rating actions remain limited for Latin American international SF ratings but that a number of ratings were affirmed following a criteria update and review of all future flow ratings.

Ratings

Fitch extends scope of SF IR stresses

Fitch has broadened its recently-updated criteria for stressing interest rate risk with respect to existing and new structured finance transactions. The updated criteria have been extended to transaction cashflows indexed to interest reference rates for Japanese yen (JPY), Swiss franc (CHF), Swedish krona (SEK), Danish krona (DKK) and Norwegian krona (NOK).

Fitch has completed a review of the additional interest rate bases and has defined calibration parameters that are used as inputs to the agency's interest rate stress spreadsheet. The calibration process included an analysis of historical rate movements, a review of the economic outlook and monetary policy regimes of each country, and an evaluation of the appropriateness of the resultant levels of stress produced by applying the interest rate criteria to the proposed calibration parameters. Fitch's analysis and criteria are based upon short-term market interest rates, namely Libor or currency-specific equivalents.

For JPY, Fitch observes that rates had been around or below 1% for the past 15 years. However, Fitch also identified upside interest rate risk resulting from its view that the Japanese economy is not currently in a position of long-term equilibrium and sovereign credit-negative factors (as reflected by the double-A rating).

Consequently, Fitch set interest rate calibration parameters for JPY at levels that are high relative to recent history. Notwithstanding the approach, the JPY stresses remain lower in absolute terms than those applied to other major interest rate bases.

With respect to CHF, Fitch observed that historical rates have been characterised by stability and have tracked consistently below Euribor since its inception and below DEM rates before. The agency notes that Swiss monetary policy features an inflation-targeting regime. It also considers that Swiss interest rates were not immune from external shocks affecting rates in the short term.

The long-term equilibrium rate and upward plateaus were set to reflect the fact that CHF rates has tracked below Euribor. However, a higher short-term stress percentage (relative to Euribor) is applied in order to produce the same short-term triple-A upward plateau.

Historical rates for SEK and DKK, meanwhile, were seen to show a similar trend since the early 1990s and generally consistent with Euribor, with the exception of the stress following the Swedish banking crisis, and a number of short-lived peaks affecting DKK rates. Sweden follows an inflation-targeting monetary policy regime, whereas Denmark formally pegs its currency to the euro. The presence of a currency peg is viewed by Fitch as a potential source of interest rate volatility relative to a floating currency regime.

Long-term calibration parameters for SEK and DKK rates were set in line with the levels applied to Euribor. However, to reflect the volatility risks relative to Euribor, the short-term stress percentage was set higher than Euribor.

Fitch observes that historical NOK rates have tracked above Euribor and SEK and DKK rates. While Norway has a policy of inflation rate-targeting, the commodity intensity of the economy is a source of interest rate volatility, in the agency's opinion.

The long-term equilibrium rate and upward long-term plateaus were both set in excess of Euribor and equal to sterling Libor. The short-term stress percentage was set higher than sterling Libor.

Regulation

Japanese law paints mixed ABS picture

The Japanese government's proposals to mitigate some aspects of its revised Money Lending Business Law will have mixed results for the ABS market, says Moody's. The proposals are expected to include some exceptional rules to reduce the risk of default by allowing lenders to refinance and establish more favourable conditions for obligors' repayments.

Under trust agreements for Japanese ABS, Moody's says cash advances receivables and consumer loan receivables, whose contracts are modified or refinanced, are repurchased by the seller or prepaid. Receivables repurchased by the seller in accordance with the trust agreement are taken out of the underlying pool and the cash equivalent of the outstanding receivables amount is paid to the trustee, so senior beneficial interests under amortising transactions may see their redemptions accelerate, and underlying pools for revolving transactions may improve over the medium term.

Moody's says that if the modified receivables increase dramatically it would negatively impact originators which are mainly dependent on securitisation for funding, and the proposals may prolong the industry's over-paid interest claims problems.

Final government proposals have not been released, but the government has decided to effect the law on 18 June.

RMBS

Redwood Trust RMBS deal prices

The much-anticipated RMBS deal from Redwood Trust launched on 23 April. The US$222.378m offering, called Sequoia Mortgage Trust 2010-H1 (SEMT 10-H1), consists of mortgage pass-through certificates.

The triple-A rated A-1 class has a weighted average life (WAL) of 3.02 years and priced with a coupon of 3.75%. According to its prospectus, the deal has four classes of senior certificates, including one class of interest-only certificates and two classes of residual certificates as well as four classes of subordinate certificates. The two subordinate tranches, the US$5.9m B-1 tranche and the US$2.3m class B-2 tranche, are expected to have an interest rate of 4.545%.

Citi is the lead manager, with JPMorgan as co-manager. CitiMortgage is the originator and servicer, while Sequoia Residential Funding is the depositor.

The certificates represent ownership interest in a pool of hybrid mortgage loans secured by first liens on one-to-two family residential properties, condominiums, cooperative units, planned unit developments and townhouses. The pool has 255 mortgage loans, including 184 interest-only mortgages, with a total stated principal balance of US$237.8m.

While the issuance of the product - which is the first private label US RMBS backed by newly-originated mortgage loans since 2008 - is undoubtedly positive news for the market, the American Securitization Forum (ASF) cautions that the return of the extension of private capital for loans to consumers and small business through securitisations will be a lengthy process. Tom Deutsch, executive director of the ASF, comments: "The transaction signals that the private RMBS market is beginning to return, but it does not signal that RMBS has returned. The market is extremely fragile and we need to be very careful, especially as policymakers consider new regulation, that we act thoughtfully to ensure vitally needed private credit starts flowing again to American consumers."

Almost 90%of new US home mortgages are currently backed by government guarantees through the government sponsored enterprises. The ASF notes it is critical to restart the private label mortgage capital market in order to reduce the housing market's dependency on the federal government.

The ASF points out that it appears the new Redwood security was created using terms and disclosures developed under its Project RESTART, an industry initiative designed by investors and issuers to rebuild investor confidence in mortgage and asset-backed securities (SCI passim).

RMBS

PPIP portfolios analysed

The Office of the Special Inspector General for the Troubled Asset Relief Program (SIG-TARP) last week released its quarterly report to Congress, which contained an update on the US Treasury's PPIP programme. Of the roughly US$25bn in purchasing power available to the PPIP managers as of 31 March, approximately US$10bn had been invested in PPIP-eligible assets.

"The US$15bn of remaining purchasing power should further strengthen demand for hard-to-source assets in this space and adds to the positive technicals that we have been seeing," note ABS analysts at JPMorgan. "Furthermore, seven out of the eight PPIP managers can potentially raise more private-sector capital and multiply this by four times using equity and debt from the Treasury, according to the programme's guidelines."

The current PPIP portfolio composition is split 12% CMBS and 88% RMBS, compared to 13% CMBS and 87% RMBS the previous quarter, despite only US$3.4bn having been invested at that time. The share of prime RMBS has decreased from 42% to 36%, while the other sectors have risen modestly. Option ARMs and subprime together account for 20% of the RMBS portfolio.

The CMBS assets are divided fairly equally between super-senior (US$309m), AM (US$393m) and AJ (US$346m) tranches, with a US$141m investment labelled 'Other CMBS'. The SIG-TARP report shows that super-senior bonds were purchased at prices of 80%-100% of par, while AM bond purchase prices were evenly split across bonds trading between 80%-100% and 60%-80% of par. Finally, AJ bonds were purchased at the lowest prices, with less than half bought at prices between 40%-60% of par.

The JPMorgan analysts suggest that this demonstrates the need for PPIP funds to shift down in credit towards lower price AM and AJ bonds in order to achieve their stated yield hurdles. "In light of the originally lofty yield targets for the funds that were set at the onset of the precipitous credit rally, investors may have to take additional risks for their required returns or lower their return hurdles, which we think is the more likely course of action. We would expect PPIP funds will continue to concentrate on AM and AJ bonds moving forward, as prices on super-senior bonds have now recovered to near or through par and no longer offer enough yield to meet their stated requirements," they conclude.

RMBS

Non-agency RMBS remits surprise to the upside

April non-agency RMBS remits surprised to the upside as net new delinquencies dropped and voluntary prepayment speeds increased. JPMorgan's indices indicate that 30-day delinquencies fell by 57bp across prime RMBS, 69bp across Alt-A, 49bp across option ARMs and 33bp across sub-prime. Combined, delinquencies fell as much as 114bp, even after accounting for liquidations.

Furthermore, six of the 80 ABX deals serviced by Wells Fargo/Countrywide/Saxon exhibited a large drop in their 90+ bucket (by 6%-12% of current balance) and a correspondingly similar increase in their foreclosure inventory. The analysts predict that as servicers start to move the 90+ delinquencies through the pipeline, CDRs will increase down the road.

Meanwhile, the analysts point out that 38% of subprime loans have received a modification, versus about 10% of Alt-A and option ARMs and 3% of prime. Rate reductions were done on 69% of mods, with an average rate cut around 3%. Option ARMs saw more than double the principal mod activity compared to last month, with 13% of mods having an average principal reduction of over US$100,000 while only 7% of sub-prime mods had forgiveness.

JPMorgan analysts note that voluntary speeds increased across the bank's prime indices, reaching around 13 CPR. Sub-prime prepays are now hovering around 0.5%; in more recent vintages and close to half the deals now show 0% voluntary prepays, due to curtailments reducing the limited voluntary prepayments.

In addition, liquidations are running faster, with an increase of nearly 2 CDR across many of JPMorgan's indices. The analysts observe that ACE 07-HE4 posted another high liquidation rate of 36 CDR this month, leading to the complete writedown of the remaining M1 bond and an implied writedown at the triple-A level.

The analysts explain that once subordinates have been depleted, Markit computes ABX.AAA implied writedowns at the Group level. As a result, the ACE triple-A writedowns will be large and will exceed the US$7.4m in period losses, since the Group 2 certificates are undercollateralised by over US$20m. Markit will have a meeting next week to consider whether cross collateralisation cashflows will be used for writedown reimbursements. The analysts note that given ABCDS and ABX are designed to mimic cash bonds as closely as possible, they expect ABX triple-As will benefit from cross collateralisation. However, the analysts note that potential writedown reimbursements will only occur very far in the future.

Finally, severities for most of the indices fell by one to five points, but Prime Fixed 07-1 and 07-2 and Prime ARM 06-1 increased by roughly five points. ABX severities came in between 68% to 72%.

RMBS

US mortgage fraud continues to proliferate

Reported mortgage fraud and misrepresentation by professionals in the US mortgage industry continues to climb, with a survey conducted by the LexisNexis Mortgage Asset Research Institute indicating it increased by 7% from 2008 to 2009. The 2007-2008 increase was 26%.

"While this is a noticeable increase, we believe that mortgage fraud is significantly understated, even during times of massive origination volumes," says Jennifer Butts, LexisNexis Mortgage Asset Research Institute data processing manager, who co-authored the report.

Florida reclaims the dubious honour of ranking top in terms of mortgage fraud, a position it previously held in 2006 and 2007, but was ousted from by Rhode Island. The state has almost three times the expected volume of mortgage fraud and misrepresentation for its origination volume, and Rhode Island fails to make the list only because the state's sample size was too small for the survey.

New York has ranked second for 2009 and the top-ten is rounded off by California, Arizona, Michigan, Maryland, New Jersey, Georgia, Illinois and Virginia. New Jersey and Virginia each make the top-ten for the first time.

Application misrepresentation was the most common type of fraud for the sixth year in a row, accounting for 59%. Frauds related to appraisal and valuation misrepresentation increased to 33% and ranked second. Verifications of deposit, verifications of employment, escrow or closing costs and credit reports all followed.

RMBS

EMEA RMBS to take time to improve

There will be some delay to a general improvement in asset performance for EMEA RMBS, says Fitch, despite a number of macroeconomic indicators pointing to stabilisation.

"The overall reduction in interest rates that continues to benefit borrower affordability in a number of floating-rate mortgage markets throughout the UK and Eurozone is expected to be offset by rising unemployment and declining house prices," says Fitch EMEA RMBS md Gregg Kohansky. "While arrears levels have been showing signs of stabilisation, asset performance deterioration is expected to continue in the short term across the UK and in several euro area countries."

Rating changes are likely to remain focused on junior classes of notes. However, some criteria changes - in particular, for high LTV loans and certain loan characteristics, such as Dutch NHG-backed mortgages - could mean that ratings higher up the rating scale will be affected.