Contents

CMBS

Tug of war

Servicers and CMBS holders agree to disagree

The tug of war that exists between commercial mortgage servicers and CMBS bondholders in the US has quieted down from the fury of a few months ago. Though not much has been resolved, servicers are at least being more responsive to bondholders.

Formal discussions between servicers and CMBS bondholders over extensions on commercial mortgage loans have taken place at all levels for the past several months, with even the CRE Finance Council (formerly the CMSA) brokering discussions. While it has been typically in the interest of servicers and junior CMBS bondholders to extend rather than default on troubled property loans, senior CMBS bondholders would rather redeploy and have their investment returned.

"There was probably some more tension a year ago, where they weren't really sure where things were going to fall out, but it seems like in the last year - particularly in the past three months - there's been more willingness to do an extension for a deal that has a potential issue coming up," says Andrew Little, principal at real estate investment banking firm Levy and Co.

"A year ago, it looked like Armageddon was still a possibility, so the senior bondholders just thought 'get me out of this thing'," he adds. Now, he says there's a sentiment that if the senior bondholders cooperate a little bit more, they will find their way out of the worst CMBS situations.

"The current special servicers' predominant strategy is to extend where possible," notes one credit analyst. Servicers confronted with that problem still have the opportunity to either amend the agreement to permit extensions through a noteholder vote or have the ability to offer forbearance - which technically is not an extension, but it is permitted in most of the documents.

But, as one lender puts it: "The latitude given to the servicers in the existing CMBS was probably too great." Borrowers have had to put in a lot more equity than in years past just to get the extensions done.

CMBS loan extensions have been occurring out to about three years from the previous six- to 12-month range. About the longest so far have been three years plus an extension, notes Little. These are still a far cry, however, from the earlier talks between CMBS bondholders and servicers that called for extensions out to about five years.

The somewhat agreeable tone between both sides is likely to continue. "We would expect to see loan extensions continue to increase. We're also going to expect to see more loan sales or payoffs as well," adds the credit analyst.

Not all property loans fit the bill for the discussions, however, since with properties already underwater, there is less desire on either side to do an extension. But those properties that still have some equity are ripe for extensions.

The credit analyst agrees. "Given where we are at in the market cycle, we think in cases where properties are only experiencing marginal difficulties, extensions may make a lot of sense because it pushes the maturity date out into a better portion of the real estate cycle and the financing cycle," he notes.

But some loans that might otherwise be extended are simply refinanced due to attractive interest rates currently, he notes. Loan spreads have tightened considerably from last year's 500bp-600bp range over treasuries to around 250bp currently.

Loans are also just as likely to be kept in special servicing. "Servicers get compensated the longer a loan stays in special servicing. They don't want to write it down," says the lender.

Special servicing is indeed on the rise. Special servicing exposure rose for the 23rd straight month to roughly US$80bn in March 2010, up from US$76bn in February 2010, according to a research report from Realpoint.

Office properties continue to make up the largest percent by balance of loans entering special servicing, note Moody's analysts in a recent report. The analysts say 45% of the new loans in special servicing were office properties.

Delinquencies are part of the problem. Moody's Delinquency Tracker rose 69bp to 6.42% by the end of March, which is the largest one-month jump for the measure in its history.

KFH

Regulation

Lingering concerns

FDIC strikes middle ground with approvals

The FDIC approved two motions at its board meeting yesterday (11 May) that attempt to reform current securitisation practices and to create adequate preparations and contingencies in the event of depository institution insolvencies going forward. However, a number of concerns remain about the proposal as it stands.

One of the approved motions calls for comment on the need for enhanced loan-level data, particularly for residential mortgage loans, as well as better oversight of servicing. FDIC has decided not to require that mortgages be seasoned for 12 months before being securitised. However, RMBS sponsors have to reserve 5% of the cash proceeds for one year to cover any repurchase obligations.

By the end of the comment period on its Advanced Notice of Proposed Rulemaking (ANPR) in February, the FDIC received 37 comment letters on the safe harbour provision from investors, banks, law firms and rating agencies. Several of the comment letters opposing the proposal said the conditions would result in additional costs for participants, as well as disadvantages compared to non-regulated securitisers.

John Dugan, comptroller of the currency, was among the most vocal critics of the proposal at yesterday's meeting. He said there are still a number of legitimate concerns over the proposal as it stands. "Congress is on the verge of passing a provision that addresses the very issues in the NPR ...that would apply to all securitisers, not just bank securitisers."

In addition, he noted: "We ought to defer acting I believe until Congress acts."

He further added: "My concern, however, has always been that in attempting to address these and other securitisation issues to revive the securitisation market, we not make the problem worse by needlessly deterring the use of securitisations in the first instance because securitisation remains a critical important vehicle."

He is also against having disclosure rules that are different from the SEC's disclosure rules. If both the SEC's NPR and the FDIC's NPR are adopted, he cautions that there will be different securitisation disclosure regimes: one for banks, one for non-banks that engage in the type of securities offerings offered by the SEC's proposals and one for non-banks not covered by these proposed rules.

FDIC chair Sheila Bair, however, believes the FDIC is acting in concert with Congress. "I think what we are doing is quite consistent with the direction that Congress wants us to go," she said, commenting that they will consider the SEC rules as a baseline for banks once they become final.

"Reg AB now does not require as much in the way of disclosure as everyone agrees is desirable. We are trying to strike a middle ground here," she added, noting that actual legislation will still take a long time to be implemented.

"We would like to see the securitisation markets come back, but in the right way - not the wrong way," she said. "Risk appetite is coming back... Now is the time to put some prudent controls in place to make sure we don't get into the problems we saw in the past."

Bair said the FDIC filed a comment with the Federal Reserve to tackle the need for enhanced origination standards, such as suggesting that they expand certain requirements for high-cost mortgages to all mortgages.

Compensation practices at rating agencies regarding securitisation transactions were also addressed at the meeting. The FDIC rule requires that no more than 60% of compensation can be paid to rating agencies upfront, with the remainder tied to performance.

The other approved proposal that will be sent out for comment seeks to establish more effective resolution strategies for certain depository institutions and to assist the FDIC with minimising exposure to the deposit insurance fund. The institutions in question collectively have more than US$8trn in assets. They are typically owned by a parent company that has more than US$100bn in consolidated assets.

Included in the proposal are requirements for those institutions to provide detailed plans discussing how depositories may be separated from an affiliate structure in the event of insolvencies. The plan also recognises the various differences and unique structures of the institutions, however.

FDIC director Thomas Curry, who is in support of the proposal, noted: "There is a limited group of depository institutions that present significant risk to the Depository Insurance Fund."

Bair said the rule is an important step towards fixing the 'too big to fail' problem. "It is a very real problem, as we saw during the crisis," she remarked.

The American Securitization Forum (ASF) says it appreciates the FDIC's modification of certain aspects of its previous proposals with respect to its safe harbour, but agrees that the NPR still contains some proposals that would create significant uncertainty for securitisation investors as to whether the safe harbour has been achieved. "Investors need a clear bright line which establishes application of the safe harbour, thereby providing them the certainty to invest in new securitisations and generating sorely needed credit to American businesses and consumers," comments ASF executive director Tom Deutsch.

KFH

Regulation

Help or hindrance?

Market participants divided over SEC rule 17g-5

The US SEC's rule 17g-5 has been met with compliance on the part of rating agencies (SCI passim). However, other market participants remain divided as to its benefits.

Under rule 17g-5, as of 2 June 2010, all registered NSROs will be prohibited from issuing or maintaining ratings on structured finance products unless the arranger makes all information available to one NSRO available to all others through a password-protected site. Both Moody's and Fitch have issued statements detailing their compliance with the new rule.

Ron D'Vari, ceo of NewOak Capital Management, explains the rationale behind the new rule: "The SEC is hoping to reduce conflicts of interest and create greater transparency. This will subsequently result in a more level playing field."

"Essentially, it's all about freedom of information," adds Rob Ford, partner and portfolio manager at TwentyFour Asset Management. "All information that issuers make available to the rating agencies they will also have to make public."

He explains: "So theoretically if, in order for the agency to complete its rating process, an issuer makes more information regarding a new issue available to the rating agency than it would normally make public, then in future they will also have to make that information public. Equally, any information that they continue to make available to the rating agency in order to maintain the ratings, they will have to make public."

Furthermore, Ford points out that should any rating agency that does not rate a particular deal wish to do so, they will have the same information as the public. While in theory this could lead to a more objective opinion from a rating agency that is not paid by the issuer, he remains unconvinced by the argument.

"Why would a rating agency go out of their way to do all of the work to rate someone's deal when they're not being paid to do it?" Ford asks. "As the majority of the deals are rated by the three main rating agencies, any potential new competitors would need to have a big alternative incentive. It might make sense on large Master Trust issues, but far less so on stand-alone deals."

He continues: "What it may end up being is a time-consuming inconvenience for issuers, which ends up having absolutely no effect at all."

A chief concern among market participants is that the inconvenience caused to issuers in complying with rule 17g-5 may deter new issuance altogether. Ford points to the hurried second Fosse RMBS deal of the year - which came to the market soon after the first - as evidence of issuers acting now before the rule's 2 June commencement.

"It is an issue for potential or prospective issuers," he says. "Santander has come back to the market very quickly after its previous deal and there is market speculation that this is partially predicated by the SEC rule."

However, D'Vari disagrees. "Ultimately the rule shouldn't hinder new issuance," he says. "It will build investor confidence as it reduces the previously cavalier approach to securitisation and creates greater accountability."

He adds: "Although some securitisation professionals may feel the new rules slow the process unnecessarily, there are many that feel the added transparency and standardisation will actually help the market to gain more credibility and add to the ultimate liquidity and market expansion."

Ford agrees that from an investor point of view the rule may be beneficial, as it "does give them the opportunity to access information, particularly documents like swap agreements, which are not normally publicly available".

However, he adds: "But, aside from that, both the ECB and the Bank of England are working hard on increasing the amount of information transparency anyway and moreover they're trying to do that in such a way that the information will be far more standardised, which means that comparison will be much easier - that's not something that's covered by 17g-5."

D'Vari also notes the need for a more standardised approach to bringing transparency to the market. "We should have one global system for information," he says. "Investors should know what the data fields are and who has provided them, and how much confidence they can put in it. The SEC, ECB and BoE should coordinate through an industry panel so everybody signs on."

"At the end of the day, if an issuer wants to get an issue done, then they'll get it done," says Ford. "Thus far, we've only had issuance from very big names and they are probably realising that they are going to have to do a lot more work in terms of standardising information and making information available."

He concludes: "In the medium term, they were going to have to do this anyway, but now they'll have to do it sooner rather than later."

JA

ABS

Heads in the sand

European ABS market activity in the week to 6 May

The European ABS market over the past week has experienced a significant decrease in trading activity as a result of increasing concerns regarding sovereign risk and the wait-and-see approach being adopted by dealers. While the secondary market softens, new regulation threatens to hinder new issuance.

One ABS dealer explains that although pricing has come down over the past week, the impact has been less than in other markets (see also last issue). "The ABS world is showing itself to be relatively stable," he says. "Of course, paper from countries such as Greece and Portugal has seen spreads widening. But in other areas it is stable - going down, but with a limited impact."

Despite the limited impact of the sovereign situation on the ABS market directly, a portfolio manager explains that decisions taken on a dealer management level may have slowed trading activity. "Their management teams are pressing them to either reduce inventory or at least not add to inventory in the current environment market-wide. This is regardless of the fact that ABS should be more insulated from the sovereign problems out there," he says.

"Dealers have put their heads in the sand a little bit," he adds. "It's not ideal, but it's no surprise. When the boss says get your book down, or don't add any new risk, the boss must be obeyed."

Furthermore, the portfolio manager notes that, as a result, "dealers have widened their bid-offer spreads and in doing that what they've actually done is just moved the bids down and left the offers where they were. It's just as difficult to buy any bonds as it is to sell, so I think dealers are reluctant to cheapen up offers to sell them off their books, even though the market is a bit weak. But they are also reluctant to put bids on anything."

On the primary side of the market, one ABS trader believes that activity may slow down due to the introduction of the new SEC rule 17g-5 (SCI passim), which will come into effect on the 2 June. He explains that the rule has "caught wind in Europe and euro market participants are now trying to understand what the impact of that might be".

The portfolio manager believes that the new regulation requiring all documentation for new issues to be made public will definitely be an issue for potential or prospective issuers. He points to Santander's recent return to the market with its second Fosse RMBS as evidence of this. "Santander has come back to the market very quickly after its previous deal and it may well be that that is partially predicated by the SEC rule."

While Fosse paper generally tends to enjoy positive sentiment, current market conditions may dampen its success. "I think it may price with slightly wide levels as some investors might be cautious because of the environment at the moment," explains the dealer. "It might push the spreads a little wider as well. It depends on the appetite of course and whether it can be rescheduled or resized between the different currencies. That will be important."

JA

CLOs

Temporary pause

US CLO market activity in the week to 10 May

The US CLO market has proven not to be immune to the effects of sovereign contagion - spreads have widened in the secondary market and new issuance has been put on the backburner. However, market participants suggest that this pause in activity is a temporary one.

"I think that bids have definitely backed off," says Sal Cincinelli, CDO market specialist at SecondMarket. "This whole Greek situation that has been escalating, as well as the market drop in the US on Thursday, have caused bids to back off considerably."

One CLO asset manager confirms the drop in trading levels, particularly in the lower part of the mezzanine capital stack. "We saw some prices were a little bit below, at two or three or even five points out. But it's all a little bit sketchy because there are no prints to prove that point," he says.

Cincinelli adds: "I was working on one trade that was an equity piece and not trading very high to begin with, and the bid dropped. I was even lucky to get something firm. It was a 25%-30% drop in the price of bids over a couple of days. I don't know if it was quite as drastic across the capital structure, but then again these were US deals and I imagine that Euro deals would have even more of a drop off."

In addition, BWICs traded weaker, according to the asset manager - with between a third and half of the list not trading at all. He estimates that the dealer bid makes up 40%-50% of the bid, while retail continues to selectively participate. However, he points to new money allocations as a good sign that the market is set to improve.

"There has been new money allocation from the insurance pools, so they're not going to turn around and change their minds. Once they have the allocation, they have to fill their buckets," the asset manager says. "I think that while headline risk points come up, people just sometimes pause. I believe that that's what we've had - a pause."

Despite this pause, he is confident about market performance moving forward. "Am I saying that we're back to pre-crisis levels?" he asks. "No. But we're certainly out of the woods. I think we're back to some kind of normalcy starting this week."

Cincinelli agrees: "Triple-As in the secondary market are trading close to par - they're in the mid-90s and people bidding low-90s now aren't getting hit. It also looks like the primary market is coming back."

Despite the Symphony deal being pushed aside, the asset manager believes that this is likely to be a temporary deferral and not necessarily an indication of investor demand for the CLO. "It didn't get the traction that the manager had wanted," he says. "I don't think it is based on demand only; I think it's a function of the loans. The reason they didn't move forward is because loan prices are up to 92, 93 - and they need to fill a bucket of US$300m-US$400m," he explains.

Cincinelli adds: "It's just common sense - prices have widened out, and the deal doesn't make sense at this point. The problem is that triple-As are the largest part of the capital structure, so any small move in spreads on that tranche is going to make a big difference on whether the arbitrage is going to work or not."

Moving forward, Cincinelli believes that an increase in securitisation using new loans is likely. "A lot of what's going to come out will be proper new issuance, like the Symphony deal is - in that they are not just a repack of an existing CLO, but a lot of the loans will be from a portfolio of loans from an older deal that is being refinanced and then they'll add new loans to that in order to top it up," he says. "It'll be maybe a few more months before there is a completely new deal that doesn't have any existing loans from an older deal in the warehouse."

Finally, Cincinelli says that there are at least two or three deals in the works, with managers currently in talks with arrangers. Although the deals are not yet being marketed, he expects them to come to market before the end of the year.

JA

ABS

BoA back in league with upsized card deal

Bank of America Merrill Lynch's upsized credit card offering signals that the bank is back in the mix with other credit card issuers, albeit with some caveats.

The US$900m deal, which was originally US$750m, priced at 30bp over one-month Libor. The triple-A rated A1 class has an average life of three years. Leads on the offering are Bank of America Merrill Lynch, Barclays Capital, Deutsche Bank Securities, JPMorgan Securities and Credit Suisse Securities.

BoA has issued auto ABS deals through the TALF lending programme, which were often sizable in nature, such as a notable US$2bn transaction last August. However, investors have been waiting on the return of the bank as a regular credit card issuer.

According to a syndicate official, the deal went "extremely well" as evidenced by the upsizing.

Spreads on the offering were in line with secondaries, however, and not much better, notes an investor. But the deal is important since it shows BoA is no longer singled out as separate from JPMorgan and Citi in bringing card deals to market.

"It's one and the same now (to other card issuers). It seems like now if Chase and Citi can sell card deals, BoA can sell," says another investor.

"They are in the normal peer group now, assuming that all the trusts are supported - except for Capital One - and that there's not going to be a downgrade, at least in the near term," he adds.

S&P has a negative outlook on Bank of America Corp's single-A counterparty credit rating. The agency said last month it is uncertain if BoA will show sufficient improvement during the next two years to benefit its stand-alone credit profile and narrow the gap between the counterparty credit rating and its stand-alone creditworthiness.

Moody's, meanwhile, has an A2 rating on Bank of America Corp, with a stable outlook. S&P has a triple-B positive rating on Capital One Bank, while Moody's has an A2 rating, with a negative outlook on the bank.

Investors, however, still discriminate between the card deals. "There still is a concession, such as with a BoA deal to a Chase deal," says the second investor. But he notes: "There is still really strong consumer demand for ABS and more seems to be rolling off than they are issuing."

KFH

CLOs

Cash CLO pricing model proposed

Ex-Lehman Brothers analysts Yadong Li and Ziyu Zheng have published a paper proposing a top-down pricing model for cash CLO tranches based on research they undertook between May and September 2008 while both were employed at the bank. The pair say that the risk-neutral model has the potential to facilitate transparency in the cash CLO markets and could also greatly improve the risk management of cash instruments.

The crux of the model is based on using a representative cash CLO deal, whose market price is somewhat transparent, as an 'index' to price other cash CLO deals. "In practice, cash CLO market participants can choose a representative CLO that [is] reasonably liquid as the CLO 'index'," the paper explains. "Once we identified a cash CLO index and its tranche prices, we then can carry out the calibration and mapping procedure for cash CLOs in a similar manner as in the synthetic CLO models."

In other words, a cash CLO trading desk need only mark the prices of a few representative cash CLO deals as the indices for different vintages and deal types, then the rest of the cash CLO tranches in the book can be automatically priced via a cross-entropy mapping method. This allows cash CLO tranches to be priced consistently using the same calibrate-and-mapping procedure as in synthetic CDO, according to Li and Zheng, making it much more difficult to manipulate the price marks and book P&L.

Although the consistency between the value of cash CLO assets and liabilities is not enforced during the calibration because of the lack of a strong arbitrage relationship, the average loan price is a valuable piece of market information and is used by the cross-entropy mapping to adjust for the underlying loan quality difference between cash CLO deals. Consequently, the model can be used to find relative value trading opportunities between cash CLO tranches.

This top-down method also produces a full set of risk measures: it is feasible to attribute the P&L movement of a cash CLO trading book using the change of the average underlying loan prices and the index cash CLO tranche prices. "Even though it is not feasible to hedge CLO tranches by trading individual loans, it is certainly possible to macro hedge the risk of overall loan market movement based on the cash CLO deltas from the top-down model. If the market develops and certain 'index' cash CLO deals becomes easier to short (for example, via TRS), then it is also possible to hedge the correlation risk of a cash CLO book via the tranche risk from the model," the paper explains.

The method is also computationally efficient, since there are only a limited number of scenarios to run for each deal. According to Li and Zheng, the calibration, pricing and risk measures of cash CLO tranches can be computed very efficiently using the the standard Intex tool (an Intex Solutions product), without the need to build a custom cashflow waterfall engine.

"This top-down method is very easy to implement and operate in practice, as most cash CLO market participants already use the Intex tool," they note. "Using this top-down method, different market participants will reach the same CLO tranche prices if they can agree on a standard set of market scenarios ... and if they can establish a poll to determine the prices of a small set of representative 'index' cash CLO tranches. Both of these two steps are well within reach; therefore, this method has the potential to bring much more pricing transparency to the cash CLO market."

CS

Insurance-linked securities

Pre-hurricane season rush continues

Details of two more potential new catastrophe bonds have emerged over the past week, as price guidance was issued on another and one transaction closed. Both the new deals are from established programmes - United Services Automobile Association's (USAA) Residential Re and Allianz's Blue Fin.

The long-awaited multiple US peril Residential Re 2010 has been given preliminary ratings by S&P. The transaction's three rated three-year tranches are as yet unsized, but the Class 1 notes have been awarded a double-B rating, the Class 2s a single-B plus and the Class 3s a single-B minus. Market speculation has the deal at US$500m.

Meanwhile, Swiss Re Capital Markets and Aon Benfield Securities are marketing the third catastrophe bond from Allianz's Blue Fin programme. The US$150m three-year deal references US hurricane and earthquake risks. S&P has assigned preliminary ratings to the series 3 US$100m class A and US$50m class B notes of single-B minus and double-B respectively.

Blue Fin series 3 covers US hurricanes in 31 US states, including Hawaii and the District of Columbia, and earthquakes occurring in the continental US as well as Alaska and Hawaii. The deal's collateral is invested in US Treasury money market funds.

The risk modelling is based on AIR's US earthquake model version 11.5 and US hurricane model version 12.0. For the risk analysis, AIR used the notional insurance portfolio of Allianz risks as of 1 July 2009.

The class A notes will cover events above notional modelled losses, giving a notional index value of 62.5 on an occurrence basis, up to a limit of 112.5. The class B notes will cover events with a notional modelled loss above a minimum threshold of 62.5 and above a notional modelled loss of 162.5 on an aggregate basis, up to a limit of 200.0.

Meanwhile, spread guidance has surfaced for Nationwide Mutual's Caelus Re II catastrophe bond offering, which covers hurricane and earthquake exposure in places like Texas and North Carolina (see SCI issue 183). Indicative spreads on the deal are 550bp-620bp, but they are expected to tighten further by the time it prices, according to investors.

The offering is considered a bit more conservative than other hurricane and earthquake cat bonds that include more exposure to Florida. As one fund manager notes, the offering is indeed appealing, since it has very little Florida exposure. But he concedes that other investors may want Florida coverage, since it would generally mean higher coupons.

"This deal is not going to pay double-digit coupons," he explains.

Catastrophe bond spreads collectively are tighter than a year ago, but are considered to be in a healthier state. "We've come to a point where people are comfortable and where it's attractive still for the sponsor," says another ILS investor.

But investors typically do not see much further tightening on the horizon for spreads. "Some deal spreads are coming in because people want to buy as much capacity as they can. But you will see some deals are pricing in the middle of the range as opposed to the tight end; it really depends," one says.

"Generally ILS securities are still probably a tad over the traditional market (reinsurance)," the investor adds. "But you are buying three-years guaranteed price and you're buying collateralised coverage, as opposed to taking counterparty credit risk, and that's got value."

At the same time, US hurricane catastrophe bond Johnston Re (see SCI issue 181) has closed. The offering from ceding reinsurer Munich Re and issuers the North Carolina Joint Underwriters Association and the North Carolina Insurance Underwriters Association was upsized and priced in line with initial guidance.

Johnston Re's double-B minus rated three-year series 2010-1 class A and B notes ended up at US$200m and US$105m, having initially targeted a total face value for the deal of US$200m. Price guidance was 600bp-650bp over Treasury money market funds for each tranche.

However, the Class As priced at 625bp over for the initial annual risk period and 700bp for the second and third annual risk periods. The Class Bs priced at 650bp over.

KFH & MP

RMBS

Fed said to explore portfolio sale options

The US Fed has reportedly been in contact with broker-dealers to gauge the potential impact of selling its MBS portfolio and to solicit ideas on possible approaches. Former Fed governor Frederick Mishkin noted last week at a Deutsche Bank conference that allowing the Fed MBS portfolio to run-off would keep the Fed entangled in the housing market for more than a decade, which he implied would be politically complex. Selling would clearly disentangle it sooner.

Mishkin speculated that the Fed would give the market plenty of guidance about any planned sales, most likely outlining the timing and volume of possible sales well in advance. He added that the Fed would also likely reserve the right to suspend sales if the market became disrupted.

The price of agency MBS has remained fairly stable over the past month, despite the completion of the Federal Reserve's MBS purchase programme. Spreads on current or par coupon MBS over 10-year US Treasuries increased from 68bp on 31 March to just 73bp on 30 April - despite the yield on 10-year US Treasury decreasing from 3.828% to 3.655% during the same period.

Officials at Annaly Capital Management note that MBS should have widened during this period regardless as investors would demand more spread for the increased prepayment risk they are exposed to as a result of the rally. "Certainly the market for agency MBS has been supported by its relative liquidity and attractive yield, as well as increased buying power from the buyout programme and the Fed's accommodative stance. However, it may also be the legacy of the purchase programme itself that is partially aiding MBS."

The firm explains that even though the purchase programme is now complete, the Federal Reserve has not taken delivery or possession of all the US$1.25trn in agency MBS it has purchased. During the programme the Fed purchased MBS for settlement in the 'out' or future months in the 'to-be-announced' or TBA market as origination was insufficient to meet their purchases.

According to Nomura Securities estimates, the Federal Reserve still has to take delivery of roughly US$54bn in agency MBS, primarily in the form of 30-year 4.5s.

"While origination is more than sufficient to satisfy dealer delivery to the Fed, it fails to account for the natural buyers of lower coupons, including the bid for fixed rate collateral from the CMO structured product market," adds Annaly. "CMO issuance increased 5% month-over-month. As a result of these factors, the available supply will decrease, also helping to support the market."

A material drop in the Fed MBS portfolio balance - either from rapid prepayment or outright sales - has posed a clear risk to MBS spreads since the Fed purchase programme ended, ABS analysts at Deutsche Bank agree. They suggest that the lack of spread widening since the Fed purchases ended could accelerate consideration of portfolio sales if the Fed believed private capital could absorb the supply.

"Based on the pattern in option-adjusted spreads after the Fed announced its purchase programme in late 2008, announcement of a sale programme would likely widen spreads within a few weeks to a few months, with actual periodic sales after the announcement having limited added effect," the Deutsche Bank analysts add. "As for the amount of spread widening, some of the better first estimates of the MBS spread impact from Fed purchases pointed to a 30bp in tightening in OAS. That likely makes 30bp of widening the high estimate of how much ground MBS could lose if the Fed did announce sales."

However, they conclude that the supply/demand imbalance for risk assets should buffer the damage from potential Fed sales.

AC & CS

Secondary markets

Investors react to sovereign concerns

Eurozone sovereign contagion concerns finally took their toll on the ABS and CDO markets late last week. Spreads in both Europe and the US came under pressure, before Sunday's extraordinary support package from the EU and ECB restored some semblance of calm.

The European secondary market saw certain senior ABS widening by 60bp-70bp on Friday (7 May) and, despite a more stable outlook this week, certain senior European ABS are still trading at approximately 20bp-30bp wider than they were at the beginning of last week. The primary Euro ABS market was also affected by sovereign concerns, with the already-delayed Driver Espana One ABS (see last issue) being put on hold.

Securitisation analysts at Barclays Capital say the implications for the ABS market, were the situation allowed to have developed unchecked, could have proven potentially negative for the sector. "Widening FRA-EONIA and FRA-OIS spreads indicate rising liquidity constraints and increasing risk levels for banks. Tight liquidity constraints reduce the banks' ability to invest in ABS," they note.

They add: "This, coming at a time when ABS markets are just starting to pick up again, could have been a significant blow. Additionally, increasing systemic risk within the banking sector and the resulting higher spreads on bank paper would most certainly lead to higher spreads on ABS notes, as well on the back of relative value considerations."

Meanwhile, ABS strategists at Deutsche Bank suggest that - as long as the bail-out holds up (both conceptually and in implementation) - the spread widening presents a buying opportunity, given that European ABS paper remains cheap to both US ABS as well as post-rally European senior unsecured paper. "Certain sectors - including Spain, Ireland and Portugal - however could, in our opinion, continue to trade weaker," they say.

US triple-A CLOs were also affected by last week's events, moving out by 15bp to approximately 215bp, while single-As widened by five points to US$70 - although few sellers emerged at those levels and trading was thin (see also separate Market Report).

Euro CLOs also came under closer scrutiny. Speaking last Friday, Paul Roos, portfolio manager at Highland Capital, commented that - given the unclear outlook on Greece, potential contagion into Spain and Portugal, and the possibility that debt issued from those countries may have found their way into CLO portfolios - Highland would want to take a very hard look at any portfolio that potentially has exposure to those countries.

He also noted that negative headlines from the Eurozone have not helped the continued spread divergence between US and European CLOs. "While CLO prices on European and US deals have both rallied, I do not believe we will see much of a convergence between the two in the short term," he said. "There needs to be some clarity over the UK parliament, the bailout of Greece and whether or not Spain and Portugal can support their economies."

Indeed, at some estimates, a single-A tranche of a US deal offering 15% subordination is currently trading at a spread of 650bp over Libor. A similarly-rated European deal with 17%-20% subordination, meanwhile, trades closer to 950bp to 1000bp over Euribor.

JPMorgan's structured credit analysts also commented on Friday that the severe pollution from Europe's sovereign debt crisis would have to ease before they recommend anything more than selective buying of senior CLO tranches.

AC

ABS

Law firm bolsters global presence

Global offshore law firm Walkers has made a series of appointments to strengthen its Hong Kong and Jersey offices. Global head of Walkers' insolvency and corporate recovery group Guy Locke has been appointed as head of Asia in response to what the firm describes as "burgeoning growth" in that area. He specialises in corporate restructuring and contentious insolvency, as well as matters arising from distressed investment vehicles.

"Asia is an important market for Walkers' corporate and financial restructuring group and we have recently expanded our capabilities in this field to maintain the high level of responsiveness and client service on which we have built our reputation," Locke comments. "This coordination between Asia-based practitioners and ourselves is crucial to insolvency related remedies."

Separately, Carol Hall, head of Walkers' investment funds group in Hong Kong, has been named managing partner of the firm's Hong Kong office. She has been based there since 1999 and specialises in hedge funds and private equity funds.

Hall assumes the role from Hugh O'Loughlin, who will head the firm's Jersey office in the summer as part of Walkers' expansion of its European finance and corporate group. The firm says he will leverage his experience in structured finance, asset finance, capital markets and private equity matters.

The firm has also made the lateral appointment of partner Nigel Weston from Mourant du Feu & Jeune to Walkers' Jersey finance and corporate practice, which he will co-head alongside Alexandra Corner. Weston specialises in investment funds, corporate, banking and finance work.

The Jersey office will also be expanded by the addition of Neil McDonald, who comes in as a finance and corporate associate from Slaughter and May. McDonald focuses on corporate and merger and acquisition work, equity capital markets, asset management and private equity.

"Our expansion in Jersey allows us to provide greater support to our clients throughout Europe and around the world who are involved in complex cross-border transactions that require Jersey, Cayman Islands or British Virgin Islands law," O'Loughlin says. "Working hand-in-hand with the other offices of the Walkers Group, the expanded team in Jersey brings significant additional expertise at a time when many organisations and institutions are looking for new options in financing and asset management."

ABS

Aviation practice takes off with new hire

Elizabeth Evans has joined Jones Day as banking and finance partner in the law firm's New York office. She arrives from Weil, Gotshal & Manges, where she was a corporate partner.

Evans' practice focuses on advising banking and finance clients on corporate transactions, such as aviation finance, project finance, satellite finance and equipment leasing. She has also advised clients on structured finance arrangements, private placements of debt and equity, ABS financings and leveraged leasing.

Evans has represented many financial institutions, credit capital corporations, equity investors, export credit agencies and leasing companies. She has experience of FAA and DOT compliance, bankruptcy matters and privatisations.

Jones Day head of banking and finance Mark Sisitsky says: "Elizabeth brings a depth of experience in corporate finance to our clients and will be of great value to the expansion of our global aviation practice."

CDS

Bank bolsters US credit trading desk

BNP Paribas has made further credit trading appointments at its New York office. Matt Reid is joining from UBS's Stamford office as an index trader, while Pinak Modi and Sahir Islam both join from Barclays Capital. Modi will trade index tranches and options, while Islam will trade high yield bonds and CDS.

CDS

Credit trader finds new home

Iftikhar Ali has joined Millennium Capital Partners in London. Millennium Management confirms that he started work last week. In his new role he will trade European and Asian credit.

Ali left James Caird in April after just nine months as head of its European credit business. He has previously held posts as head of credit arbitrage trading for Europe and Asia at Bank of America, and head of CDS trading at Citigroup.

CDS

Bank beefs up in Euro credit sales

Morgan Stanley has made a string of hires for its European credit sales and trading business. The bank has made ten appointments in the past two months as it looks to strengthen its credit department.

Remy Kesrouani and Matthias Beck both join from JPMorgan. Kesrouani is an investment grade corporates trader, while structured credit trader Beck will join in June. They will both join Simon Morgan, who left Morgan Stanley for Ondra Partners a year ago but has now returned as head of distressed credit analytics.

Also coming onboard are Matthew Clark from UniCredit and Julien Gurcel from HSBC. Both join Morgan Stanley's leveraged credit sales team. There have been five further hires in credit sales, including Matthew Bond from Goldman Sachs in Italian sales coverage.

CDS

Credit structurer appointed

RBS has appointed Gary Davis as md in its credit and rates structuring team within its global banking and markets division. The bank says he will focus on delivering credit solutions for North American clients and be based in Stamford, Connecticut. Davis will report to Miles Hunt and David Wagner, respective Americas heads of global structuring and rates structuring.

Davis worked at specialist monoline Reformation Group before joining RBS and has previously held posts at MBIA Insurance Corporation and Citigroup, where he was involved in the derivatives and credit derivative businesses in North America and Europe.

CDS

New head of credit strategy hired

Alan Capper has been appointed md and head of credit strategy at Lloyds TSB Corporate Markets. It is a newly-created position responsible for the provision of macro credit strategy research and Capper will report to head of credit trading Paul Lewitt.

Capper has over twenty years of experience in financial markets, having previously led BNP Paribas' quantitative credit research and credit strategy teams, and also served as md responsible for Lehman Brothers' European credit strategy. He joins Lloyds from LV Asset Management, where he was head of asset allocation.

CDS

Asset manager co-founder steps back

Nigel Legge has stepped down from his role as ceo of Liontrust Asset Management and will remain as a consultant until 6 August 2010, having co-founded the company in 1994. Non-executive chairman Adrian Collins will become executive chairman, while head of retail John Ions joins the board as ceo with immediate effect.

CLO Managers

Euro CLO manager resigns

Natixis, the European collateral manager on Marquette US/European CLO, has tendered its resignation. Neuberger Berman Fixed Income is currently lead collateral manager on the transaction and is set to take on European collateral management duties for the deal, subject to noteholder approval.

Neuberger Berman Fixed Income was formerly known as Lehman Brothers Asset Management. The firm acquired Lightpoint Capital Management - the deal's original lead manager - in 2007.

CLOs

Manager adds to MSIM CDO roster

The appointment of Invesco Senior Secured Management as the replacement collateral manager for Morgan Stanley Investment Management (MSIM) Croton and MSIM Peconic Bay has had preliminary rating confirmation from S&P. Invesco will assume Morgan Stanley's collateral management responsibilities once the proposed change is finalised.

Invesco Asset Management assumed collateral management duties for the MSIM Garda and Mezzano CLOs last month.

CMBS

Mortgage REIT adds structurer

Robert Restrick has joined CreXus Investment Corp. He will be responsible for the structuring and placing of the REIT's investment activities in the CRE space.

The existing team at CreXus is predominantly credit-focused and so Restrick's structuring experience is anticipated to be a good fit. He was previously senior md at CWCapital Investments and before that at GMAC.

CMBS

Old hands to provide fresh drive

Four industry veterans have left Cushman & Wakefield to lead Jones Lang LaSalle's New York capital markets business. Richard Baxter, Jon Caplan, Ron Cohen and Scott Latham have over a century of combined real estate capital markets experience and are tasked with expanding the firm's investment sales, debt placement, recapitalisation, note sales and placement of rescue capital and joint venture equity capital.

"Attracting these key leaders to our firm will enable the aggressive growth of our New York City capital markets business," says Jay Koster, the firm's Americas capital markets president. "The global reach of their relationships and their track record also provide an ideal connection point to our well-established capital markets businesses in EMEA and Asia Pacific."

CMBS

New additions to form capital markets practice

Mark Weibel has joined law firm Thompson & Knight's Dallas office as a partner and is joined by four new associates. The five new additions will join with the firm's current real estate, banking and financing expertise to establish a capital markets practice group. They all join from Fulbright & Jaworski, where Weibel led the CRE practice group.

The new associates are Bryan Larson, Bryan Garner, Christopher Neilson and Shannon Fey Stapp. The new team will focus on representing special servicers in the CMBS market and other related loan workout environments, as well as CRE, structured finance and business transactions.

Weibel has more than 20 years of experience representing clients in CRE matters, including serving as lead counsel for originations, workouts, securitisations, REMIC application and interpretation, public/private land development partnerships and large-scale CRE acquisition, disposition, development and leasing projects. "The addition of Mark and his team enhances the depth and experience of our real estate practice, particularly in supporting the growing number of commercial mortgage transactions that involve special servicers and the capital markets," says Thompson & Knight managing partner Jeff Zlotky.

Investors

Asia Pacific hires continue apace

Babson Capital Management has hired Sue-Ellen O'Keeffe in a sales and investor relations role, as the firm becomes more active in the Asia Pacific. She joins the firm's global business development group and is responsible for servicing and maintaining existing client relationships, in addition to business development within Australia and New Zealand. She will be based in Melbourne and report to Sydney-based md Duncan Robertson.

"Sue-Ellen's expertise and experience will be of great value to our Asia Pacific investor base," says Robertson. "She has a background that incorporates both the investor and manager perspective, and can provide a unique view of the market."

O'Keeffe joins from Super Investment Management, where she spent 13 years, most recently as structured credit director. Her appointment follows Babson's recent creation of an eight-member team to source mezzanine debt and private equity investment opportunities in the region (see SCI issue 177).

Investors

Another BarCap credit strategist moves on

Ashish Shah has left Barclays Capital just days after replacing Robert McAdie, who resigned as European head of credit strategy (see last issue). Credit strategist Shah will join AllianceBernstein as co-head of global credit investment, where he is expected to run the credit team with JJ McKoan in New York and report to head of fixed income Doug Peebles.

BarCap says the vacant European post comes under the jurisdiction of Eric Miller, who will oversee it temporarily, but would not comment further until a suitable appointment has been made.

Investors

Asset manager names new recruits

Matrix Group's asset management business has hired Chris Beament as business development manager and Chris Elliott as marketing executive. Beament joins from Legal & General Investment Management, where he distributed its unit trust range, and Elliott joins from Goldman Sachs in Auckland, where he was a private wealth analyst.

Beament will report to Matrix director Luke Reeves, head of retail and institutional business development. He will be responsible for distributing funds, such as single strategy hedge funds, funds of hedge funds and externally managed funds to the institutional, private client and intermediary marketplaces. Elliott will report to Matrix product and marketing manager Ben Fox.

"Their skills and experience will be of major benefit to us as we continue to launch new products and funds," says Matrix ceo Chris Merry. "Matrix now has funds under management of more than £3bn. As we grow, we have continued to strengthen our sales, marketing, operational and risk management teams."

Legislation and litigation

CPDO coding error resurfaces

Moody's disclosed in its latest quarterly 10-Q filing that on 18 March it received a Wells Notice from the US SEC stating that the Commission is considering instituting administrative and cease-and-desist proceedings against it in connection with the rating agency's initial June 2007 application on SEC Form NRSRO to register as a nationally recognised statistical rating organisation under the Credit Rating Agency Reform Act of 2006. SEC officials have informed Moody's that this action is based on the theory that Moody's description of its procedures and principles were rendered false and misleading as of the time the application was filed in light of the violation of a rating committee policy.

The violation in question relates to a coding error in a model used in the rating process for certain CPDOs (see SCI issue 89). Moody's publicly announced on 1 July 2008 the results of an investigation concerning the coding error, which determined that in April 2007 members of a European rating surveillance committee engaged in conduct contrary to the agency's Code of Professional Conduct (see SCI issue 95).

Moody's says it disagrees with the SEC that the violation of a company policy by a company employee renders the policy itself false and misleading and has submitted a response to the Wells Notice, explaining why its initial application was accurate and why it believes an enforcement action is unwarranted.

RMBS

Data service adds MBS analyst

BlackBox Logic has hired Cory Lambert as senior MBS analyst. The data aggregation company says he will be responsible for building collateral analytics using the company's BBx Data service and integrating the data with complementary data sets. Lambert will also oversee the integration of BBx Data with web-based delivery platforms such as the Crystal Logic interface and 1010data.

He spent four years on the trade desk of Braddock Financial, which is the majority-owner of BlackBox, analysing and trading non-agency RMBS before joining the company.

RMBS

Loan servicing firm adds svp

Rudy Orman has joined Residential Credit Solutions as a director and svp, responsible for marketing and business development. He was previously a vp at Marathon Asset Management, involved in purchasing distressed assets, servicing non-performing assets and the firm's securitisation activities.

ABS

Structured credit trading platform prepped

BNY Mellon is preparing a new electronic trading platform called Structured Credit Connections. The service will initially focus on US public deals and is expected to facilitate increased trading activity and volumes.

According to John Spedding, md at BNY Mellon and coo of QSR Management, the platform is at present building up inventory and establishing a number of different auction protocols. "We've developed analytics that combine pricing data with a loan performance tool, so a user can drill down to city level to see the impact on yield. The platform is anonymous and should encourage reverse enquiry, best execution, transparency and liquidity."

As part of the service, BNY Mellon undertakes due diligence on buyers and sellers, taking a transparent fixed spread on any transactions in return.

ABS

ECB extends liquidity, SF pressures remain

The announcement by the European Central Bank (ECB) that it will extend its non-standard liquidity measures conforms to Fitch's expectation that it will continue to support and work to restore market confidence, the agency says. Fitch notes the ECB's measures are not intended to be permanent, so - despite a temporary boost to banks' liquidity - it is concerned that a number of banks were unwilling or unable to take advantage of the measures to implement more rigorous liquidity management procedures.

The ECB has reacted to renewed market volatility, particularly with respect to Greece, by providing additional liquidity. The newly-announced non-standard liquidity measures include re-activating US dollar liquidity swap facilities, additional fixed rate tender procedures for three-month longer-term refinancing operations (LTROs), a new six-month LTRO and a new securities markets programme intended to restore liquidity in the debt markets. On 3 May the requirement for all securities issued or guaranteed by the Greek government to have minimum credit ratings was suspended.

Fitch says banks in Greece, Ireland, Spain and the Netherlands are using ECB liquidity more than they did in previous years, possibly indicating that banks in those systems are increasing their reliance on these sources for structural funding needs or as a boost to flagging profitability. Banks in Italy and France have reduced their use compared to pre-crisis levels, and - while German and Belgian banks have also reduced their usage - they remain heavy users when compared to other countries.

The agency believes liquidity pressures remain in the structured finance markets. Banks increased their use of SF securities as eligible collateral for shorter-term repo funding with the ECB when the closure of the SF markets in 2007 created a funding and liquidity gap. The ECB has gradually introduced tighter eligibility criteria for SF collateral in an effort to manage the credit quality of SF collateral delivered to it, and Fitch believes the ECB's SF collateral will not grow significantly as a liquidity source beyond the collateral already within the system.

ABS

Portuguese banks stockpiling assets

Portuguese structured finance transactions have seen increasing signs of declining performance that could lead to negative rating action, says Fitch. The agency rates 24 RMBS, three ABS and two SME CDO transactions in the jurisdiction and says most show a steady increase in defaults and arrears.

"Fitch's expectation for performance deterioration does not warrant downgrades to SME transactions at this time; however, some RMBS transactions are utilising cash reserve funds - indicating growing pressure on available funds. Given the macro-economic strain and planned austerity measures in Portugal, Fitch is closely monitoring the default trend for any significant acceleration," says Jeffery Cromartie, EMEA structured credit surveillance senior director. "While there are no sharp increases in negative performance to date, the declining trend does contrast against a backdrop of broad stabilisation across most other European structured finance transactions."

After significant budget underperformance, Fitch downgraded Portugal to double-A minus, negative outlook on 24 March. It says the downgrade also reflects the potential impact of the global economic crisis on Portugal's economy and public finances over the medium term. The agency has been asked to provide feedback on several new Portuguese SME transaction proposals, which it thinks is a sign the banking sector is actively seeking capital.

"Access to the debt capital markets has become more challenging and expensive for Portuguese banks in the recent months amid increasing market concerns regarding the sovereign creditworthiness of some of the Southern European sovereigns," says Philip Smith, Fitch financial institutions senior director. "In response, Portuguese banks have been accumulating liquid assets eligible for discount at the ECB in case other sources of funding become scarce."

The agency says that with less conservative provisioning mechanisms than other southern European RMBS, Portuguese transactions are building up larger non-performing loan balances before utilising excess spread to provision for losses. If provisioning of existing late-stage delinquencies occurs at the same time as an increase in early stage delinquencies, then available revenue could be squeezed in a number of transactions, which may result in the use of cash reserve funds.

ABS

RFC out on assessing operational risk

Moody's is asking market participants to comment on its proposed approach to assessing operational risk in structured finance transactions. The approach - set out in a new report called Global Structured Finance Operational Risk Request for Comment - discusses the rating agency's fundamental considerations when analysing servicing arrangements.

These include back-up servicer, master servicer, third-party servicer and cash manager/calculation agents when this responsibility is assumed by a third-party unrelated to the servicer and liquidity standards. Moody's notes the proposed guidelines would potentially be subject to adjustments based on characteristics specific to a transaction.

Moody's defines operational risk as the risk posed to securitisations should parties to the transaction fail to perform their administrative duties adequately - and is a topic the agency has become increasingly aware of recently (see SCI issue 182). Late last week the agency downgraded notes in three Portuguese auto ABS due to operational concerns: the senior notes of LTR Finance 6 and LTR Warehouse, as well as the class B notes of LTR Finance 5 were all downgraded to Aa3. This week it downgraded 36 classes of notes across 23 ABS deals and one class from one CDO.

According to the rating agency, the downgrades reflect its assessment that the credit quality of the servicers and the structural features of the transactions make them vulnerable to possible payment disruptions and losses that could result from a failure of the servicers to perform their obligations in a timely manner under a distressed scenario.

Moody's is inviting participants in the structured finance market to review and comment on its approach to operational risk. Comments are welcome until 15 June, with the final report scheduled to be released publicly in July 2010.

ABS

Basis risk impacts student loan ABS

US FFELP student loan ABS is being exposed to significant short-term volatility by basis risk, says Fitch. Most of the volatility is caused by the difference in the spot and average rates and not the difference in the indices.

"Senior FFELP student loan ABS bonds with 3% or more of credit enhancement appear to be well protected against basis risk," says Fitch senior director Aoto Kenmochi. "However, subordinate bonds with minimal or no enhancement that are not benefiting from excess spread accumulation are much more susceptible to this risk and are more at risk for downgrades."

The rating agency has placed triple-A rated subordinate bonds on rating watch negative based on this risk, and says other lower-rated subordinate bonds may also be at risk of downgrade.

ABS

Cash release mechanism amended for card ABS

Shinhan Card Co has amended the cash release mechanism from the portfolio yield reserve account on the Aa1 rated class A secured floating rate notes issued by Credipia 2006 Plus One A International and the A2 rated class B secured floating rate notes issued by Credipia 2006 Plus One B International. The amount in the portfolio yield reserve account will now be released to the originator and the waterfall once the portfolio gross yield has reached 12% on a three-month rolling average basis.

Moody's says it believes that the move will not have an adverse effect on the ratings of the notes. However, it did not express an opinion as to whether the amendments could have other non credit-related effects that investors may or may not view positively.

ABS

Timeshare ABS delinquencies fall

Total US timeshare ABS delinquencies slipped in Q110, according to Fitch's ABS timeshare index. The decline represents an improvement year-over-year, not only the historical seasonal improvement, analysts at the rating agency report.

"Though still above historical norms, US timeshare ABS delinquencies are slowly migrating back to pre-recession levels," says Brad Sohl, a director at Fitch. Due to the expected stable performance and ample credit enhancement levels, the agency's rating outlook for timeshare ABS remains stable.

Total delinquencies for Q110 were 4.64%, down by about 15% from 5.43% in Q109. Following seasonal patterns typically seen in timeshare ABS, delinquencies are down from 4.89% at the end of Q409.

Monthly defaults remained at 0.83% in March 2010, consistent with 0.83% in Q409 and 0.81% for Q109. On an annualised basis (rolling 12 months), defaults were 9.53% for the index in March, higher than the 9.44% observed in Q409. March's annualised default rate was, however, slightly lower than the rate for the prior two months, the analysts say.

The Fitch timeshare performance index summarises average monthly delinquency (over 30 days) and gross default trends tracked in Fitch's database of timeshare ABS dating back to January 1997.

ABS

UK credit card performance 'mixed'

Fitch says the performance of UK credit card trusts showed a mixed trend in Q110. Quarter-on-quarter improvements to delinquencies, payment rates and yield were offset by a further deterioration in average charge-off levels. The agency expects the UK's weak economy to continue to affect asset performance for the rest of the year and says positive developments were largely down to February's low day-count.

The rating agency's charge-off index reached a historical high of 11.7% at the end of Q110, representing an increase of 0.5% over the quarter. The 60-180 day delinquency index fell from its peak value of 5.5% in May 2009 and dropped over the last quarter to 4.4%, which is still above its long-term average.

The yield index increased quarter-on-quarter by 1.8% to 22.9% at the end of Q110. Fitch says the increase in the yield rates from February to March was partly because of March's higher day count and the application of the discount option in the CARDS I and II trusts.

Finally, the monthly payment rate index ended Q110 at 18.3%, having increased by 2.2% since December. The agency says payments in March were enhanced as a result of the catch-up effect of a short month in February and account additions in a number of trusts.

CDO

CDO Evaluator error expunged

S&P has released version 5.1 of its CDO Evaluator credit model, correcting an error in the old version regarding the recovery rates the model assumes for certain sovereign debt held within or referenced by CDO transactions (see SCI issue 183). The error had no impact on any outstanding ratings.

CDS

Peripheral CDS pushed to new highs

CDS levels on 5 May reflected the widespread unease surrounding the Greek bailout. Greek five-year CDS closed the day at an all-time high of 830bp, with Spanish and Portuguese spreads also moving out to new highs of 227bp and 377bp respectively. At the same time, the iTraxx Main widened to 106bp - a level last seen in the summer of last year.

According to credit strategists at BNP Paribas, the lack of conviction is telling as markets do not believe that a) €110bn is enough to fix the Greece problem rather than simply prolonging it; b) Greece can actually meet its new austerity measures, particularly given building civil unrest; c) the German constitutional court may block the deal; d) fear that contagion from other peripherals that have similar characteristics to Greece, such as high budget deficits; and e) concerns of wider European banking contagion if Greece defaults or imposes haircuts on debt.

"Adding to this is the action of the ECB making a U-turn on changing collateral rules for Greek debt - no matter how lowly rated - in an effort to stem the tide has actually been seen by the markets as a sign of desperation that has hurt the credibility of the ECB and been evident by the weakness of the euro to below 1.3 against the dollar," say the strategists. "For now, no matter how much Portugal and Spain are said to be different from Greece - and they are - markets are not discriminating at present. Both Portugal and Spain are suffering from the perception that if they get into trouble, then Germany will not be pulled round to authorising a bailout."

BNP Paribas economists believe EU authorities need to do more to reduce the uncertainty about Spain and Portugal and stem the rapid contagion.

CDS

Positive convexity trades to hedge contagion risk

Sovereign fundamentals point to a prolonged high-volatility environment rather than a quick resolution. Structured credit analysts at Goldman Sachs have consequently put forward two trades to hedge contagion risk - shorting the iTraxx Main seven-year S9 22%-100% versus the index (with a 2:1 ratio) and buying protection on iTraxx Main seven-year S9 12%-22% versus the index (at a 1:1 ratio).

The cost of protection against tail risk has increased sharply over the past few weeks, led by CDX IG and iTraxx Main options and CDX IG tranches. iTraxx Main tranches, by contrast, remain relatively cheap.

"Implied correlation is around 15% lower than it should be, given current levels of systemic risk, according to our macro correlation model," the Goldman Sachs analysts explain. "While this is partly due to the relatively lower liquidity of iTraxx tranches, we think these instruments should eventually reflect the risk present in other similar markets."

They initially suggested the first trade idea in late February as a hedge against unwind risk and the upcoming Basel 2 proposals, but the tranche still has not widened as much as it should have, given the increase in systemic risk. However, further volatility should cause seniors to widen out and catch up with their fair value, according to the analysts.

Similarly, the second trade idea generates positive carry and has a positive convexity profile for large moves in the underlying index. Conversely, it loses from defaults in the index, which the analysts see as a relatively low probability event in iTraxx Main, compared to the probability of large moves in spreads. They suggest that a -1% stop loss and +1% target gain is applied to the 12%-22% tranche strategy.

CDS

DTCC moves to provide greater transparency

The DTCC has expanded its public release of data in the Trade Information Warehouse's global repository to include a breakout of outstanding CDS contract values in their currencies of denomination. The move is expected to bring greater transparency to the risk exposure of a particular currency to the CDS market.

"Because nearly all credit derivatives transactions are maintained centrally in the Warehouse's global repository, the industry and regulators worldwide are able to get a consolidated view of risk in the market place, which is critical especially in times of crisis," says Stewart Macbeth, DTCC md and head of the Trade Information Warehouse. "The breakout of the data by currency was a request from the OTC Derivatives Regulators Forum, a group that is globally coordinating requirements for regulatory and public data."

The change follows amended Warehouse Trust policy covering the release of data to regulators upon request to include counterparty names (see SCI issue 177). From now on, the DTCC will publish a breakdown of the aggregate total data by currency, whereas previously it only provided the aggregated gross notional value of the total CDS contracts in the warehouse in US dollar-equivalent values.

There are currently four active central counterparties using the Warehouse's services. The total gross notional of the 2.3 million legally confirmed CDS contracts held in the DTCC's Warehouse as of 30 April was US$25.1trn.

CDS

Succession events determined

A couple of succession events have been determined by ISDA's American Determinations Committee. First is in connection with Northwest Airlines, with Delta Air Lines named as the sole successor as of 31 December. Second is with respect to Affiliated Computer Services, where Boulder Acquisition Corp has been named as sole successor as of 5 February.

CDS

CCP, trade repository recommendations issued

The Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization of Securities Commissions (IOSCO) have issued two consultative reports containing proposals aimed at strengthening the OTC derivatives market.

"These two complementary sets of high-level guidance constitute an important response of the CPSS and IOSCO to the recent financial crisis. They also reflect the G20's recommendations for the strengthening of the OTC derivatives market," comment CPSS chair William Dudley and IOSCO Technical Committee chair Kathleen Casey.

The first report, 'Guidance on the application of the 2004 CPSS-IOSCO Recommendations for Central Counterparties (RCCP) to OTC derivatives CCPs', presents guidance for central counterparties (CCPs) that clear OTC derivatives products. The second report, 'Considerations for trade repositories in OTC derivatives markets', presents a set of considerations for trade repositories (TRs) in OTC derivatives markets and for relevant authorities over TRs.

Dudley and Casey continue: "As the greater use of CCPs for OTC derivatives will increase their systemic importance, it is critical that their risk management should be robust and comprehensive. Moreover, because of the complex risk characteristics and market design of OTC derivatives products, clearing them safely and efficiently through a CCP raises more complex issues than the clearing of exchange-traded or cash products does."

These issues were not fully discussed in the 2004 report of the existing RCCP. Consequently, the CPSS and the Technical Committee have identified such issues and developed international guidance tailored to the unique characteristics of OTC derivatives products and markets. The aim is to promote consistent interpretation, understanding and implementation of the RCCP across CCPs that handle OTC derivatives.

In addition, recognising the growing importance of TRs in enhancing market transparency and supporting clearing and settlement arrangements for OTC derivatives transactions, the CPSS and the Technical Committee have developed a set of factors that should be considered by TRs in designing and operating their services and by relevant authorities in regulating and overseeing TRs.

The two reports are being issued as consultation documents, with comments welcome until 25 June 2010. An outreach event with the industry is anticipated as part of the consultation process.

The CPSS and the Technical Committee do not plan to issue finalised reports after the consultation period. Instead, the guidance presented in the reports, as well as the feedback received in the consultation process, will be incorporated in the general review of the international standards for financial market infrastructures that was launched by the CPSS and the Technical Committee in February this year.

CDS

CDS notionals down 9%

The total notional amount of outstanding OTC derivatives increased by 2% in H209 to US$615trn, according to the latest statistics from the Bank for International Settlements (BIS). This increase follows a recovery of 10% in H109. The H2 increase was evenly spread among risk categories, with the exception of commodities and CDS, which fell by 21% and 9% respectively.

Gross market values for all OTC positions declined by 15% after a 22% contraction in H109. CDS gross market values fell by 40% after a 42% drop in H109 - CDS gross market values now stand at 35% of their end-2008 peak.

Overall gross credit exposure decreased by 6% after an 18% reduction in H109.

CDS

Second RFC issued on California CDS

California state treasurer Bill Lockyer has sent a follow-up request for information on muni CDS trading to Bank of America Merrill Lynch, Barclays Capital, Citi, Goldman Sachs, JPMorgan and Morgan Stanley. This follows his receipt of responses from the banks with respect to his questions and concerns over activity in California muni CDS (SCI passim).

After reviewing and analysing these responses, Lockyer requires answers to 10 additional questions about the nature of the municipal CDS market and its participants. He says the answers will help his office determine the best way to deal with the municipal CDS market and its participants going forward.

The questions seek additional details about: the firms' proprietary trading of California state CDS from 1 January 2007 to the present; any past or potential future proprietary net long credit protection positions; the extent to which counterparties took or were recommended to take speculative positions on California state CDS spreads; any income the firms received for market-making state CDS trades; the firms' future plans with respect to making markets for clients who want to take speculative long credit protection positions on state CDS; and whether they believe California taxpayers benefit from speculative trading of state CDS. Responses to the follow-up questions are to be received by Lockyer on 26 May.

CDS

Euro volatility drives global CDS widening

The Euro zone's ongoing fiscal problems resulted in a weekly widening of global CDS spreads not seen since the height of the credit crisis, according to Fitch Solutions in its latest report for the sector. Globally, CDS spreads widened by 19% last week, with much of the spread widening occurring on Thursday.

The overall five-year Probability of Default Index grew by 8%. Credit and equity markets both signalled credit deterioration across all sectors last week, as worries over the Euro zone's debt problems continued to intensify.

Fitch md and author of the report Jonathan Di Giambattista says: "After massive widening at the end of last week, credit markets appear to have regained some footing, as indicated by 6.6% CDS tightening on Monday."

He adds: "Nonetheless, uncertainty surrounding the bail-out plans and fiscal discipline challenges among European countries will likely continue to drive CDS market volatility."

Euro zone banks were among the most affected by market volatility as credit spreads widened by an average of 32% through the week ended 7 May. Italian banks led the widening, as Unicredit, Banca Monte dei Paschi di Sienna and Banca Nazionale all saw spreads widen by 70% or more.

Di Giambattista concludes: "The dramatic spread volatility surrounding European banks demonstrates the increased interdependence between banks and sovereigns since the financial crisis."

CDS

OTC valuation costs analysed

A new Celent study, entitled 'Optimising the OTC Pricing and Valuation Infrastructure', has uncovered significant duplication of analytics across front, middle and back offices. The findings suggest that firms adopting in-house strategies for OTC pricing will require significant investments between US$25m and US$36m alone to build, maintain and enhance a complete derivatives library over a five-year lifecycle.

One key finding of the study is that recent years have seen banks and investment firms build up their own pricing and valuation capabilities to counter an overreliance on broker-dealers to furnish prices for instruments with more complex payout structures. However, despite advances in analytic tools and integration technologies, the deployment of sound pricing and risk capabilities remains a considerable challenge as a result of internal cost pressures and ongoing regulatory and accounting demands.

"The bar is continually being raised to address not merely valuation risks, but also broader systemic and operating risks associated with OTC derivatives operations," the Celent study explains.

Firms pursuing in-house efforts for derivatives analytics require an upfront investment of at least US$9m, according to the study. Moreover, depending on the "aggressiveness" of an institution, recurring annual costs can range between 25% and 50% of initial investment to keep pricing and risk analytics relevant. This translates to US$11m to US$22m over a five-year production lifecycle to enhance and keep libraries current with ongoing market requirements across multiple asset classes.

Despite the significant costs, most organisations are largely unaware of how much they really spend on analytics at a firm-wide level, according to Celent - especially taking into account indirect costs, inefficiencies and integration expenditures. "Looking ahead, as margins become tighter, players will need to achieve scale, improve trading efficiency and compete hard for market share. At the same time, firms need to be mindful of maintaining a lean cost base," the firm concludes.

CLOs

MV CLO gets additional flexibility

Shiprock Finance SPC, acting on behalf of and for the account of market value CLO SF-3 Segregated Portfolio, has entered into an amendment to a variable funding note purchase agreement with Bank of America, National Association (as the variable funding note agent), PNC Bank, National Association (as the variable funding noteholder agent) and the variable funding noteholder.

The amendment: extends the legal final maturity date of the notes to 30 June 2016 from 10 May 2010; shortens the programme maturity date to 30 June 2016 from 9 May 2017; reduces the total commitment amount under the notes to US$105m from US$150m; allows for permanent reduction of the total commitment amount each time a payment is made on the outstanding principal amount of the notes; and amends the interest rate payable in respect of the notes.

In conjunction with the amendment, the first amended and restated collateral agency and security agreement among the issuer, Bank of America (as collateral agent, custodian bank and indenture trustee) and Four Corners Capital Management is amended to primarily prevent the reinvestment of any proceeds from amortisations and sale of credit risk obligations. All of these proceeds will be distributed according to a revised priority of payments, which provides for immediate repayment of interest and principal amounts of the notes on each payment date and at maturity.

Moody's has determined that the amendment and performance of the activities contemplated therein will not adversely affect the current rating of the notes.

CLOs

Most MV CLOs avoided default

Moody's says events of default (EODs) were avoided by the vast majority of market value CLOs, despite enormous stresses as bank loan prices plummeted. None of the transactions that triggered an EOD were forced to liquidate quickly and absorb the severe losses that would have followed, according to the rating agency.

"Events demonstrate that the performance of market value CLOs depends not merely on the market environment, but also on the choices made by the manager and the controlling parties to the transaction in response to a difficult environment," says Arnaud Lasseron, Moody's vp and senior analyst.

The rating agency says that six out of approximately 40 market value CLOs which it monitors experienced EODs during the credit crisis. Assets were sold progressively by four of the six as they chose to avoid immediate liquidation that would have forced heavily-discounted sales, while two came out of default by increasing their overcollateralisation to comply again with their covenants. Lasseron explains: "When an EOD occurred, controlling parties chose to work with the collateral managers to get back the entirety of their funds."

Managers used several techniques to avoid EODs, including maintaining high overcollateralisation levels by reducing the amount of CLO liabilities, injecting additional equity into the transactions and restructuring transactions into cashflow deals. The agency adds that in some cases where overcollateralisation tests were breached a few CLOs received equity injections to make the overcollateralisation levels compliant again.

CMBS

Survey finds US CRE outlook improving

Results from a DLA Piper survey suggest that the US CRE industry remains largely bearish, although the outlook is improving as bullish sentiment gains momentum. Billions of dollars in CRE debt is set to come due, but the law firm says market sentiment indicates that the bottom of the cycle has been reached.

The survey found that 60% of respondents describe themselves as bearish, down from a record high of 90% in September 2008 - just days after the collapse of Lehman Brothers and the sale of Merrill Lynch to Bank of America. Around the same number believe the real estate markets have reached bottom or will reach it this year. Workouts and loan extensions are expected to be the two strategies used most to handle the waves of CRE debt that will come due between now and 2014.

"After the most gruelling downturn the industry has ever seen, there is a genuine sense of stability beginning to return to the marketplace," says Jay Epstien, chair of DLA Piper's US real estate practice. "From this point, the recovery will hinge in large part on workouts and loan extensions, but the real wild card is job growth that would drive renewed real estate demand in virtually every asset class."

Other survey findings were that: two-thirds of respondents believe the federal government's real estate programmes, such as TARP and TALF, have done enough to stabilise the marketplace; 70% don't expect any fresh federal legislation to aid the CRE market; and 60% do not expect the CMBS market to return in time to help refinance the more than US$150bn in CMBS loans coming due in the next two years.

Workouts are not expected to yield deep discounts with lenders and 61% of respondents expect the largest loan write-offs to range between 11% and 30%. Private equity and hedge funds are expected to be the most active investors over the next year by 37%, while 29% believe REITS will be the most active. Finally, multifamily is expected to be the most attractive investment opportunity in the next 12 months.

DLA Piper also reports that respondents do not want regulators to do anything more to stimulate the US CRE market recovery and warn against further interference.

CMBS

Broadgate Financing hit by development proposal

Moody's and S&P have taken rating actions on the junior CMBS notes issued by Broadgate Financing. The move follows the announcement on 4 May that non-binding heads of terms have been agreed between Bluebutton properties (the Blackstone Funds and British Land JV that owns the Broadgate Estate) and UBS to construct a new building for UBS on the site of 4 and 6 Broadgate.

Asset-backed analysts at RBS note that there have been ongoing concerns for the future of the estate, given the break clauses that anchor tenant UBS has in and around 2014, so this news is positive for the overall Broadgate estate. But how this plays out for the securitisation is less clear.

According to the RBS analysts, included among the uncertainties are that 4 and 6 Broadgate are within the securitisation and will presumably have to be removed to facilitate the redevelopment. Additionally, there is a lack of unencumbered available assets for substitution purposes; the deal already sits on considerable cash collateral; and the fact that UBS will undoubtedly undertake significant consolidation may result in the exercise of break clauses at other properties in the transaction (including 100 Liverpool Street).

The 4 and 6 Broadgate properties currently represent nearly 10% of the total lettable space of the securitised property portfolio. In Moody's view, if binding terms are eventually agreed, this would impact the securitisation, both in terms of collateral value and rental cashflows. In particular, the probability that UBS exercises its break options on its existing leases is higher than Moody's initially expected, thereby impacting anticipated future rental cashflows.

The rating agency will conclude the transaction review after it has finalised its assessment of: the value of the property portfolio; the projected future rent roll profile for the remaining years of the transaction; and the default risk of the loan going forward. The ratings of the Class A1, Class A2, Class A3 and Class A4 Broadgate Financing notes are not affected by the rating review action.

S&P, meanwhile, downgraded the Class B, C and D notes, with both Cs and Ds moving to junk - albeit without citing the UBS announcement.

CMBS

EOD for Taurus 4 loan

Investors in UK CMBS Taurus 4 have been notified that the £170m St Katherine's Dock loan referenced by the transaction has entered into an event of default. Following a valuation in February - which was finalised in April - the market value of the property that secured the loan was determined to be £116m. As a result, the borrower has failed to satisfy the requirements of the loan-to-value covenant test applicable to the loan.

According to the latest investor report, published on 5 May, the new LTVs for the securitised loan and the whole loan are 75.66% and 142.91% respectively. However, structured finance strategists at Chalkhill Partners believe that the reported LTV for the securitised loan is incorrect as the securitised loan is only a partial participation in the senior loan. They calculate the true LTV for the securitised loan to be higher at 109.1%.

"The sponsor is REIT Asset Management (now part of F&C REIT Asset Management), which has in the past been keen to undertake further development on the St Katharine's Dock estate," notes Chalkhill. "There is potentially an argument, therefore, that the site has strategic importance, but if one takes the new LTV at face value, the prognosis for the loan does not look good. The loan is due to mature in July this year."

The servicer says it has notified the borrower of the default and will continue to discuss and investigate all possible options.

CMBS

Singapore CMBS liquidity issue resolved

Moody's has today confirmed the triple-A rating on the €186.2m CMBS notes issued by Orion Prime, following their placement on review for possible downgrade on 1 March 2010. The move was prompted by the lack of sufficient liquidity according to Moody's guidelines on the minimum liquidity protection for Singapore CMBS transactions.

The Orion notes are secured by its rights to the underlying assets, which have been mortgaged, assigned and/or charged in its favour by Starhill Global REIT, a Baa2-rated Singapore REIT. The risk of insufficient liquidity arises from the fact that Starhill is an operating entity and is not bankruptcy-remote.

It has other creditors and if it defaults on those obligations, the other parties can bring legal action - including bankruptcy proceedings - against it. If that happens, there may be cashflow disruption upon a mortgage loan event of default, Moody's notes.

To ensure timely payments on CMBS transactions, the agency has published a guideline stating that the minimum level of liquidity protection should be sufficient to cover the senior payment obligations of the CMBS issuer for a period equal to at least six months (SCI passim). Orion's CMBS notes have an expected maturity in September 2010. Starhill has obtained a written commitment from its lenders to provide a facility to fully repay the mortgage loan, and thereby the notes, in September 2010.

In view of the high likelihood that Orion can refinance the CMBS notes in September 2010 and the short timeframe with no other debts maturing before the refinancing date, Moody's concludes that the risk of cashflow disruption is largely alleviated.

CMBS

Special servicers put brakes on delinquency rise

Fitch reports that US CMBS delinquencies rose by 34bp to 7.48% in April because of underperforming properties in states with weak economies. However, the increase is not as great as in previous months, which is attributed to special servicers working through the inventory of defaulted loans. Eight states have delinquency rates in excess of 10%.

"As expected, property market weakness is now emerging in states that were hit hardest during the recession," says Fitch md Mary MacNeill. "The highest loan delinquencies are concentrated in Sun Belt and Rust Belt states characterised by high unemployment, low personal income growth and weak productivity."

The rating agency says there was no significant movement in delinquencies specific to one property type for the month. The current delinquency rate for hotel property is 18.42%, while it is 13.6% for multifamily, 5.83% for retail, 4.6% for industrial and 3.97% for office property.

CMBS

Japanese CRE picture improving

Moody's says that although the Japanese CMBS loan default rate has risen since last year, Y260bn of loans were successfully repaid in Q110. The figure is more than six times the total defaulted loan amount during the same period last year, according to the rating agency.

The agency expects total defaulted loan volume in 2010 to be lower than it forecast earlier this year and notes the volume of matured CMBS underlying loans will peak in 2010, which may concern market participants as many borrowers are still struggling to secure financing and defaults may occur at maturity.

Two new Moody's-rated CMBS issuances were closed in Q110 for funding property acquisitions and several J-REIT bonds were also issued, indicating a return of investor confidence in the Japanese real estate securitisation market. Moody's also says J-REITS are helping the re-emergence of real estate property trade, but adds a collection of defaulted CMBS loans by underlying property sale through special servicing also increased in Q110 and property sales in the special servicing segment might accelerate this year.

Real Estate

Defeasance note-backed deal rated

Deutsche Bank has closed an unusual real estate-related securitisation, backed by three defeasance notes on two properties in New York. Moody's has assigned a triple-A rating to the US$94m single-tranche deal, dubbed Defeased Loan Trust 2010-1.

The defeasance notes are the 11 Madison Avenue B-note, the 11 Madison Avenue D-note and the One Park Avenue D-note. Each of the defeasance notes is secured by a defeasance pledge and security agreement among the borrower, defeasance lender and the securities intermediary that grants the defeasance lender a security interest in obligations backed by the US government.

The rating is based upon the quality of the underlying collateral and the legal structure, and addresses only the credit risks associated with the transaction. Other non-credit risks, such as those associated with the timing of principal prepayments, have not been addressed and may have a significant effect on yield to investors, Moody's notes.

The rating agency applied its US CRE CDO and structured finance CDO methodologies in rating the deal.

Regulation

Financial liability accounting changes proposed

Following the completion of work on the classification and measurement of financial assets, the IASB has published its proposed changes to the accounting for financial liabilities. The IASB proposes limited changes to the accounting for liabilities, with amendments to the fair value option.

David Tweedie, IASB chair, says: "Whilst there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding large profit - especially when investors tell us that such information is often excluded from their financial models."

The IASB says many investors believe volatility in profit or loss resulting from changes in the credit risk of liabilities an entity chooses to measure at fair value is counterintuitive and does not provide useful information. Following feedback from the IASB's introduction of IFRS 9, it concurs that there is an issue with the credit risk of a financial liability that an entity chooses to measure at fair value. Further consultation has led the IASB to the conclusion that volatility in profit or loss resulting from changes in own credit does not provide useful information except to derivatives and liabilities that are held for trading.

The IASB therefore proposes that all gains and losses resulting from changes in own credit for financial liabilities that an entity chooses to measure at fair value should be transferred to other comprehensive income, so changes in own credit will not affect reported profit or loss. No other financial liabilities changes are proposed.

RMBS

Agency MBS prepays meet expectations

April agency RMBS prepayment rates generally met market expectations, according to MBS analysts at Wells Fargo. In the 30-year sector, FNMA prepayment rates increased by 1.3% CPR or 4% month-over-month, while FHLMC 30-year prepayment rates decreased 1.5% CPR or 9% month-over-month.

"We expect FHLMC prepayment rates to be slower in May and FNMA prepayment to be faster in coupons of greater than 5% but less than 6%, reflecting both refinancing trends (FHLMC) and buyout activity (FNMA)," the Wells Fargo analysts note.

Meanwhile, in the 30-year GNMA sector, GNMA I prepayment rates decreased in April by 15% month-over-month to 11.6% CPR and GNMA II prepayment rates by 10% month-over-month to 11.6% CPR. Most coupons exhibited relative slow-down, the analysts add, with the 3.5% and 4% coupons in the GNMA I 30-year sector showing the greatest relative increases at 513% and 208% respectively.

RMBS

NC RMBS arrears improvement slows

Arrears levels in UK non-conforming RMBS transactions are not declining as quickly as in 2009, according to a new report by Fitch, suggesting that arrears may stay at elevated levels. The agency's sector index for Q110 shows the volume of loans three or more months in arrears at 19.7% of the value of outstanding loans, down from 20% in Q409. Before 2007, the index fluctuated between 11% and 13%.

"UK non-conforming RMBS performance improved during 2009, but recently the pace of improvement in arrears levels has slowed markedly and the sector is certainly not out of the woods yet. It is unclear whether this represents a temporary hiatus in the previous positive arrears trend. Fitch remains concerned that arrears have not fallen further, given the low interest rate environment," says Peter Dossett, RMBS director at Fitch.

The agency expects UK non-conforming transactions to continue to see volatile performance behaviour and to remain under stress for the rest of the year. But it notes that the overall improvement in affordability, due to lower interest rates, has led to an improvement in collection rates within transactions. This has helped keep transaction cashflows stable.

RMBS

Alt-A RMBS delinquencies declining

Fitch says serious delinquencies for US Alt-A RMBS declined for the first time in four years, while subprime late-pays also fell, but that prime RMBS delinquencies increased slightly. The agency says the improvement for Alt-A and subprime delinquencies was caused by higher cure rates and an increased volume of loan modifications, along with improvements in liquidation and roll rates.

"Last month's improvements may be a signal that RMBS performance is beginning to turn the corner," says Fitch md Vincent Barberio. "The next few months will be a better indicator of whether we're witnessing the beginnings of a legitimate turnaround or a short-term seasonal effect of tax-refunds."

Alt-A RMBS delinquencies decreased to 34.1% in April from 34.4% in March, having been 27.4% a year ago. It is the first month-over-month decline since April 2006.

More than half of the Alt-A RMBS loans outstanding are held in California and Florida, with delinquencies for these loans declining from 36.3% to 35.8% month-over-month for the former and holding steady at 51.7% for the latter. Fitch says roll rates also fell from 3.9% to 2.6%, but notes approximately 8.25% of current Alt-A loans are modified and have a substantial risk of re-default, and the same is true of 35% of current subprime loans.

Subprime RMBS delinquencies fell from 46.3% in March to 45.2%, still above the 40.1% rate of a year ago. April's roll rate fell from 4.5% to 3.9%, which is well below the trailing 12-month average of 5.5%.

Prime jumbo RMBS 60-plus days delinquencies rose to 10.2% for April, up from 10.1% a month earlier and 5.4% a year ago. Delinquencies are up 98bp since the beginning of the year. Having reached their highest-ever level of 1.4% in March, roll rates fell back below 1%.

The five states with the highest volume of prime RMBS loans outstanding are California, New York, Florida, Virginia and New Jersey, which together represent two-thirds of the total sector. California accounts for 44% of the US$364bn market, and saw RMBS 60-plus days delinquencies rise from 11.8% in March to 11.9% in April. Over the same period New York stayed steady at 6.7%, Florida nudged up from 17.5% to 17.7%, Virginia decreased from 5.8% to 5.6% and New Jersey climbed from 8.2% to 8.4%.

RMBS

Partnership to provide SF analysis platform

FinCap Financial Services - Computech Corporation and CapitalFusionPartners' joint venture - has announced a strategic joint partnership with MBSData. Data from the latter will be available under the FinCap platform Fin*Fusion, an integrated suite of analytics providing tools for pricing, collateral analysis, portfolio surveillance and asset valuation.

The Fin*Fusion system has been built as a multi-tier portfolio management system designed to keep pace with growing AUM, trading volumes and number of users accessing the system. It is intended to enhance clients' investments in surveillance and investor reporting processes. FinCap says the system has been used by hedge funds to manage structured finance assets.

The MBSData datasets include origination files for all loans that include details such as FICO, payment type, ARM change dates, occupancy, property type, lender names, servicer names and LTV. Historic deal and loan-level performance for non-agency MBS deals is also included, as are monthly and lifetime key indicators such as CPR, CDR, VPR, severity and cumulative loss.

FinCap partner and senior strategy executive John Joshi says: "With our joint venture with MBSData we can even more effectively serve our clients by fully focusing on what they do best: analysing the creditworthiness of each investment. More broadly speaking, our investment in Fin*Fusion also reflects our commitment to grow and develop our technology platform in lockstep with the expansion of FinCap Financial Services business."

Tom Delorenzo, MBSData managing partner, adds: "Our respective teams of technologists and fixed income specialists that created Fin*MBSData combine state-of-the-art technology expertise and industry best MBS loan performance datasets with extensive trading, risk, mortgage origination and portfolio management experience under one roof in order to design the most powerful, flexible product for efficient analysis of structured finance assets."

RMBS

RMBS data product launches

Experian has launched CreditHorizons for Securities, a data-feed product to help determine the creditworthiness of underlying borrowers in mortgage deals. It consists of anonymised US consumer credit profiles, which have been matched to the private-label securitised mortgage deals in the loan-level database from First American CoreLogic/Loan Performance.

The new offering is intended to enable investors to optimise pricing strategies, improve risk management and hedging strategies, and increase confidence in RMBS buy and sell decisions. It has a predefined set of over 50 variables, a relatively small number which Experian says will make it user-friendly and easy to implement.

"Monthly trustee and servicer data sets provide a limited foundation for predicting payment patterns," says Ethan Klemperer, Experian Capital Markets general manager. "To compete profitably in today's market, investors need upgraded valuation methods with increased transparency and predictive power. We're delighted to work with First American CoreLogic to launch CreditHorizons for Securities, providing the critical behavioural data needed to determine the true value and future payment trend of clients' securities."

George Livermore, data and analytics president for The First American Corporation, adds: "By augmenting existing modelling with consumer credit information, investors obtain a holistic view of the underlying collateral and can better predict delinquency and default probabilities for their RMBS portfolios."

SIVs

Ratings-linked SIV obligations downgraded

Moody's has downgraded the senior obligations of the Harrier Finance Funding and Carrera Capital SIVs. The rating actions on Harrier affect US$1.8m and £157m of securities outstanding.

Harrier's Euro and US MTN programmes have been downgraded to A3 from A2. The SIV is managed by Brightwater Capital Management, a wholly owned subsidiary of WestLB.

Moody's explains that the rating actions are the result of WestLB's long-term rating being downgraded to A3 on 4 May 2010. There is a direct linkage between the ratings of Harrier and WestLB due to support by WestLB to provide funding necessary to repay any maturing senior liabilities.

Harrier has no outstanding US or Euro CP. The impacted MTNs have a weighted average maturity of 6.22 years for USMTNs and 6.23 years for EMTNs. The current portfolio size is US$1.429bn, of which US$1.419bn is cash or cash equivalents.

The senior MTN programmes of Carrera Capital, meanwhile, have also been downgraded to A3 from A2. The SIV's Euro and US CP programmes have been affirmed at P-1.

Carrera is managed and sponsored by HSH Nordbank Securities. Moody's explains that the rating action is the result of HSH Nordbank's senior debt rating being downgraded to A3, as well as its short-term rating confirmed at Prime-1 on the 4th May 2010.

There is a direct linkage between the ratings of Carrera Capital and HSH Nordbank, due to the commitment by HSH to support the senior debt obligations of the SIV through the note purchase and liquidity facility agreement, as well as through a committed repo facility, which expire in November 2010. The current liabilities outstanding are limited to the repo and liquidity facility, as currently there are no debt securities outstanding under the Euro and US MTN programmes.

Trading

Trading ideas: un-reach for yield

Tim Backshall, chief strategist at Credit Derivatives Research, looks at a HY-IG decompression pairs trade

The liquidity-fuelled rally of the last fifteen months appears to be stalling as expectations of a linearly extrapolated strong recovery seem a little over-confident. The risk transfer from private to public balance sheets appears to be sloshing back the other way and along with this re-pricing of risk we believe that the turn in the credit cycle that is occurring will slow demand for high yield debt, driving more up-in-quality flows and exaggerating HY-IG decompression.

This trading idea is a combination of a short-term technical 'trade' and a more systemic tactical allocation. We feel the relevering fears that dominate credit chatter currently suggest a rotation in the credit cycle that has impacted IG credit relative to HY for the last 2-3 months. The exuberance of stock markets has been far more correlated with HY and the two have become joined at the hip in terms of rerisking.

This turn-in-the-cycle (which we note could be due to strong recovery-based relevering or another downturn) has triggered some notable events in terms of relative pricing, as insurance companies' seemingly insatiable demand for yield led HY to dramatically outperform IG. The shocks from Europe, however, combined with some sagging growth in domestic (and Asian) economies is forcing some to reconsider current valuations.

We see seven good reasons for a HY-IG decompression trade at this point:

1) Exhibit 1 shows that the two-month rolling beta of HY and IG has dropped below 3x (blue ovals) - for four of these five times, we have seen dramatic decompression soon after;
2) Technically, we are at relatively solid support levels historically (red dotted line), offering an easy reference for stops;
3) The cyclical turn in the credit cycle naturally moves from derisking systemically to an up-in-quality trade (exaggerated by sovereign stress and flight-to-safety);
4) The macro recovery appears less 'growthy' and self-sustaining than equity market expectations believe and, as we enter H210, we believe housing and unemployment will drag once again;
5) A slowing of money flow (demand) triggered by this flight-to-safety (and perhaps refinancing issues) will stall the extend-and-pretend dreams of many HY debt holders;
6) Our MFCI-based model sees considerable weakness at the most distressed end of credit, as well at the crossover segment (with B 'ok'); and
7) Our discussions on through-the-cycle HY total return outperformance from two weeks ago suggest we are in the 'froth' region for HY (relative to IG) and, while the previous cycle took a few months to turn, we feel money is more anxious this time around.

Putting these together, we feel comfortable with this trade from both a macro (top-down) perspective, as well as technically and idiosyncratically (bottom-up).

This is an aggressive position. We are not attempting to reduce our costs via a beta hedge as we would typically do to lower costs and reduce volatility. The reason is two-fold: we want a purer bet on the absolute differential decompressing and we believe that the rally of the last 15 months should have put some money in pockets and unwinding longs to position for this trade seems like a reasonable turn-in-cycle trade.

The HY14 DV01 is around US$3915 (per US$10m) and IG14 at US$4700, implying a 1.2x weighting in HY versus IG to maintain a dollar-based pure on the differential. There is a natural convexity to the position that works modestly against us and traders should consider reweighting as the position moves into the money. Our stop target empirically would lead to a weighting of 1.14x and our final target a weighting of 1.32x (based on DV01s), and so our spot 1.2x ratio seems a good balance.

Position
Sell US$10m notional IG14 5Y protection at 109bp
Buy US$12m notional HY14 5Y protection at 584bp

Upfront US$16.35 (HY US$96.625 /IG US$99.6) plus 592bp carry

Current 475bp
Stop 390bp
Initial target 525bp (raise stop to B/E)
Final target 600bp

For more information and regular updates on this trade idea go to: www.creditresearch.com

Copyright © 2010 Credit Derivatives Research LLC. All Rights Reserved.

Note: This article is intended for general information and use, and does not constitute trading advice from Structured Credit Investor (see also terms and conditions, below, section 12).