Contents

Listed products

Back to the future?

Support appears to be growing for exchange-traded credit derivatives

Credit index futures and exchange-traded options may be ready for a comeback. The Chicago Board Options Exchange (CBOE) intends to apply to the SEC with modifications to its rule filing for listing credit options and many in the market believe credit index futures may soon become a reality.

CBOE first launched credit derivatives contracts three years ago, before pulling them due to insufficient liquidity. In Europe, Eurex had the world's first credit futures in March 2007, based on iTraxx indices, but that too was short-lived.

"Eurex still lists CDS futures as one of the products it offers, but to my knowledge it started that product and within one week it became clear no-one would use it, so after four weeks it essentially shut the platform. The iTraxx future is still on its website though," says Tim Brunne, structured credit analyst at UniCredit.

UBS analyst Alex Kramm believes dealers now feel more favourably about exchange-traded CDS than they did back in 2007. Dealers were previously unwilling to turn away from OTC trades because exchange bid/offer spreads are characteristically so much tighter, but OTC spreads have come down since the aborted attempts of a few years ago.

The CDX IG bid/ask spread is now typically as low as 1bp and on iTraxx Main bid/offer spreads can trade as tight as 0.25bp. Tight spreads, coupled with regulators demanding more transparency in OTC markets, may well pave the way for exchange trading.

"We have long argued that credit derivatives lend themselves to standardised trading on exchanges. While listed credit products have failed in the past, the current backdrop might finally provide a catalyst for adoption," notes Kramm. "The key to any re-launch will be smaller contract sizes and standardised tenors and supporting documentation."

Farooq Jaffrey, Traccr founder and ceo, agrees that standardisation is an important factor. He says: "I think this is quite positive, given that the market is moving towards further transparency, clearing and standardisation. Listed options may soon be available."

He continues: "More participants are looking to tap into credit derivatives because the volatility of the past couple of years has impacted credit fundamentals. Market participants are increasingly using credit derivatives as a risk management tool."

Jaffrey believes there should be demand for options from smaller participants that occasionally use credit derivatives because they provide an efficient way to hedge without having to engage in OTC documentation, which can become expensive, particularly when purchasing an out-of-the-money option. He says: "I think having credit options listed on exchange makes it much simpler for parties to play the volatility without having to create the underlying trade itself, which can be time-consuming for the average investor. Trading options on exchange would obviously be cleaner and more cost-efficient, particularly for those users that occasionally use credit derivatives. However, it may be less interesting for credit-focused investors that already have access to best execution from the Street."

The move to new listed products, such as credit index futures, would provide another opportunity for growth for exchanges. UBS estimates the potential market for trading and clearing credit index futures could provide annual revenues of around US$250m, which it says could increase with additional market participants becoming involved. Along with CBOE, ICE and CME are both expected to be interested in listing credit derivatives.

Jaffrey says: "I would imagine options can become comparable to an equity or currency option in its versatility, particularly where the reference entity is a liquid CDS. I believe many exchanges are observing the CDS market and the regulatory changes it is undergoing to see how they can add value for their customers. I'm not surprised that those involved in the option market in other financial instruments want to get involved with CDS."

Kramm concedes that CME "is a futures behemoth in the US", with an improving relationship with dealers, while NYX could also come to the table for new listed derivatives, but he suggests that ICE would lead the market. ICE has cleared in excess of US$9trn in notional outstanding and owns Creditex, one of the largest CDS inter-dealer brokers.

"ICE is clearly the front-runner when it comes to CDS," he says. "We also believe clearing both futures and OTC products in the same clearing house is attractive from a capital perspective. ICE would likely need to restructure its current clearing structure in the US; however, we believe the current clearing model is destined to evolve over time anyway."

Brunne also sees the move to exchange trading as a possible progression of the current clearing model. He says: "The European Parliament has said clearly that these kind of OTC derivatives must go through a clearing house, so I can imagine that we are going in that direction; at least taking a big step in that direction."

Options on the CDS indices will most likely be the easiest to launch, in the same manner as indices were the first to clear on exchange, with the CDX in the US and iTraxx in Europe the preferred indices. Jaffrey believes the easiest route into listed derivatives would be to turn these indices into an option product.

Brunne echoes this sentiment. "Exchange-traded CDS would have to be liquid, and the most liquid indices in Europe are iTraxx - both the Main index and also the Crossover," he says.

CBOE expects to submit its filing to the SEC very shortly. If it gets approval, then the floodgates may well be opened for a new wave of credit products. With significant dealer support and such thin bid/offer OTC spreads, the timing may never be better.

JL

RMBS

Calling the shots

Sponsors move to support their transactions

RBS subsidiary Ulster Bank last week provided the European RMBS market with a welcome surprise when it announced that it will call the Celtic 8 deal at par on the interest payment date in August. The move comes after the bank failed to exercise its first call option this month and is expected to encourage other sponsors to follow suit.

One European RMBS investor says he assumes that Ulster Bank's decision was driven by its wish to support its deals. "The bank recognises that securitisation is an important source of funding going forward and so it doesn't want to discourage investors," he explains. "RBS' recent covered bonds came at 125bp over and UK prime RMBS price at around 150bp, for example, which suggests that the bank has realised that securitisation is a sensible approach to funding. Consequently, we may see Irish deals coming next year or the year after."

However, European securitisation analysts at Barclays Capital note that some investors are concerned about the level of uncertainty created by the announcement. They suggest that the market is speculating about: how RBS obtained permission to call the deal, given the European Commission's stance on calls by bailed-out banks; why, if the bank's intention was always to call the transaction, it wasn't called at the first available call date; and what call risk should be assumed for the Irish RMBS due to be called in March 2012. This will mark the start of a seven-month period when almost 90% of outstanding issuance in the sector will reach its first call date.

Senior Celtic paper nonetheless rallied briefly from 81 to over 90 on the back of the announcement. "I think it's a great development for the market and is likely to set a trend. I certainly wouldn't be surprised if issuers in other jurisdictions also move to support their deals in this way," the investor adds.

UK prime RMBS sponsors, such as Lloyds TSB, have consistently stood behind their deals. But it will likely be harder for Irish banks to support their transactions, given that each institution has a degree of government investment in it.

"It is typically harder to call a deal when an institution is being vetted by the EU," the investor agrees. "For example, some subordinated debt coupon payments have recently been deferred by recipients of government aid because they're not allowed to repay debt until they've repaid the government."

He points to Spain as another interesting jurisdiction in terms of whether securitisation sponsors will exercise clean-up calls. "It is likely that the larger banks will, as many have been buying back their own deals at a discount. However, the smaller saving banks may leave their deals to run off as consolidation in the caja sector gathers pace."

Indeed, so far UK non-conforming RMBS stands out as being the only sector where deals have generally not been called. The investor suggests that this is mainly because the sponsors are too weak and have no refinancing capability. "It would only be possible if the sponsors issued a new transaction; otherwise, most deals will be extended."

According to European asset-backed analysts at RBS, the Celtic call was significant because it represents one of the few remaining sizable securitisation programmes sponsored by a major bank that was being priced to maturity. "It therefore has reduced the available opportunities for investors to pick up cheap optionality without resorting to distressed assets or to more esoteric asset classes. It does also illustrate the danger of a binary approach to valuing a security to either first call or maturity, when in reality the call can be exercised on any interest payment date from the first call date onwards," they note.

CS

ABS

Summer slowdown

Outside of CMBS, ABS market volumes take seasonal drop

US ABS markets have shown a significant slowdown in the past few weeks as participants ease into the slower summer months, with lighter trading and limited issuance. However, macro-economic concerns also continue to play a role in the slowing of market activity.

With the exception of CMBS, which has seen some of its best trading volumes over the past few weeks, mortgage and ABS volumes are reportedly down by 10% with light BWIC trading. This can, according to market participants, be explained by the warmer months.

"Mondays and Fridays have been quite slow: summer's here, so activity is only really happening on Tuesdays, Wednesdays and Thursdays," explains a trader.

An analyst adds: "It's to be expected. Summer months are typically pretty light anyway for the ABS markets. But it is unusually more-so the case this summer. This is probably due to the headline risk that's around."

Macro-economic issues involving the wider credit markets continue to be a factor influencing the low trading activity in the ABS markets and the type of investor involved. "Everyone is unsure about what kind of headline risk we're going to see coming out of Europe over the next few months," says the analyst.

"With volatility being high, the main players in the market are hedge funds - we don't see a lot of real money sponsorship in the market right now, which is keeping volumes light," he adds. "Spreads are still reacting in line with what is seen in the equity markets, so there is still a lot of correlation at play."

The trader agrees that concerns over Europe are keeping people on the sidelines, despite the improving sentiment regarding CMBS and mortgage products. "When we did see some opportunities, we saw some really good buying and have since seen some rally off those numbers pretty strongly, which has caused those buyers to disappear."

However, the trader notes that the market has held relatively steady in light of sovereign concerns and no forced-selling has been taking place. "I think the market has been very disciplined, both on the selling and the buying side - we really haven't seen people chase either way," he says.

The analyst confirms that the lack of trading has helped prices to remain steady. "The PrimeX and ABX indices give you a sense of this. They're up maybe a point week-on-week. But over the past few weeks they've been largely unchanged, perhaps moving a point, if that," he says.

The analyst explains that currently the indices are up half a point. "Usually these indices can move a point in a day," he comments. "There's not a lot of cash trading at the moment, so this is probably a reasonable indicator of how the market is doing."

The primary markets are expected to be similarly underwhelming, with new issuance limited due to increased regulation and wider economic concerns. However, the trader notes: "There will potentially be some distressed, non-performing deals, where people who have bought that type of deal are looking to restructure them."

"Everyone is trying to put out resi deals, but it's not clear whether they'll get the execution done," says the analyst. "The main problem is the push-back that they're getting from the rating agencies in terms of the amount of enhancement that is required. The pricing of the subordination just doesn't facilitate doing the securitisation. I think that's the constant challenge."

Moving forward, market participants believe that the general sentiment is towards patience. "We'll take our lead from what happens in Europe over the next couple of weeks until Bastille Day, when everyone's financing is done," says the trader. Within the US, the trader notes that a big concern is corporate earnings, which should give an indication as to the health of the economy generally.

The trader expects current trends to persist throughout the summer. "It seems to me that there is a lot of cash sitting on the sidelines," he says.

JA

RMBS

Holding off

Thin secondary RMBS trading as new deal is delayed

Activity in the European RMBS secondary markets has been quiet over the past week owing in part to the Global ABS conference held in London, as well as continued caution about contagion from the wider financial markets. In addition, issuance has stalled somewhat with the delay of the much-anticipated Moorgate deal.

Last week showed quiet trading activity that has carried over into this week; one trader remarked that dealers seem to be full up on paper at the moment. He says: "While they were previously bidding quite aggressively, they are now not bidding or even trying to sell where they can in order to lighten up on inventory. I think that has been causing spreads to widen out and will probably continue for the rest of June."

However, he also notes that benchmark paper seems to be firmer now than in previous weeks. Whereas Granite had previously traded as low as 91 while the wider markets were selling off, this week it settled at 92.

An RMBS investor agrees that levels seem to have stabilised, but adds that there is also a diversity in pricing between market participants, which he attributes to the differing opinions of where the most liquid names should be trading. "For example, there have been low-100s, but also offers in the 175bp and 200bp region. Today, I saw some Hermes at 185bp, but we have also seen some offered at 125bp. It's just different views of where it should be," he says.

The investor speculates that this diversity in opinion may in part be driven by those wishing to take advantage of arbitrage opportunities, but adds that the market is very 'clubby' at the moment and suggests the trend is therefore unlikely to persist. Aside from the most liquid names, he says, very little trading has occurred.

"It's difficult to trade Portuguese or Spanish RMBS and it's difficult for investors to know what's going on in the markets due to foreclosures," the investor says. He explains that there is very little transparency in analysing the underlying collateral and therefore it holds little appeal for investors who are already cautious.

"It's very difficult to analyse pools of mortgage and collateral in these countries where there's been a lot of new properties coming to market in the past few years. The process is not at all transparent; the foreclosure periods are many years and we can't trust LTVs anymore - no matter where the property is, people just don't want to buy anymore," the investor adds.

In the primary market the Moorgate 2010-1 transaction (SCI passim) is still yet to materialise. Market speculation is that underwriter Bank of America Merrill Lynch is having trouble placing the deal.

"I haven't heard anything from the Moorgate deal, so I assume that that is on hold due to the turbulence," says the investor. "But it would be interesting to see the first print on that, especially given the size of the deal and the amount of collateral."

The trader adds: "The Moorgate deal is a very good deal. But I think that investors are being very cautious at the moment because spreads have widened due to correlation with the wider markets."

Moving forward, the trader expects further Permanent and Arkle deals to come in the next month, despite wider spreads and investor caution. "I think they have to issue; they have such a huge refinancing pipeline that they just have to keep issuing. They're not going to issue at 200bp, but I think they will try to get something done in the 150s just to get another deal done."

He points out that these deals are likely to fare reasonably well due to the structural demand for sterling RMBS from certain accounts. "As long as the deals meet their targets and investors don't feel that the wider markets are going to really sell-off and show huge volatility, then I think there is still some structural demand. I think if investors can get some good execution with a big ticket, then they probably will."

In terms of market sentiment, the investor points out that concerns still exist in reference to new Basel 2 and liquidity rules that have many waiting for a resolution. However, he believes that for the most part the market is stable. "I expect the current situation to continue sideways, with some spikes on days where there is tension," he concludes.

JA

ABS

Credit card, auto ABS deals fill queue

GE Capital is due with a credit card offering dubbed GE Capital Credit Card Master Note Trust Series 2010-3 (GECCCMT). The deal follows two auto ABS offerings already in the market this week.

GECC's US$850m class A tranche is expected to be rated triple-A by Fitch and Moody's. The deal also will include a US$80m class B tranche, which will not be publicly offered at issuance, and an excess collateral amount of US$86.6m. Instead of including a class C tranche, the deal's excess collateral amount has been enlarged to achieve the equivalent credit enhancement for the class A notes.

The notes are backed by a pool of receivables under GE Money Bank private-label and co-brand revolving credit card accounts generated through private-label programs of multiple retailers.

This issuance marks the 18th series outstanding in the master note trust. Five states - Texas, California, Florida, North Carolina and New York - make up more than 34% of the outstanding receivables pool. According to Fitch, GECCCMT compares favourably with the Fitch Retail Credit Card Index on all fronts, except for gross yield, which has been lagging slightly. But the trust has lower delinquencies, lower charge-offs and faster MPRs than those of the index, Fitch says.

In the card space, meanwhile, Ally Auto Receivables Trust 2010-2 is also due to price via Deutsche Bank Securities, RBS Securities and JPMorgan Securities. The US$792.3m deal from the former GMAC Bank includes a US$164m class A1 money market tranche and a US$170m class A2 tripl-A tranche.

The largest tranche is a US$298m class A3 triple-A tranche. The deal also includes a US$118.7m class A4 tranche rated triple-A. Subordinate pieces include a class B US$22.9m tranche and a US$18.7m tranche.

The deal follows a Bank of America Auto Trust 2010-2 deal that also priced this week. The auto loan deal was upsized from talk at US$1.02bn to US$1.252.1bn, according to investors.

The offering featured a US$340m money market tranche that priced flat to interpolated Libor. A US$240m triple-A tranche priced at 15bp over the Eurodollar Synthetic Forward Rate (EDSF), while a US$481m triple-A tranche priced at 20bp over EDSF. A US$191.1m triple-A tranche priced at 30bp over swaps.

KFH

CDS

Liquidity shift noticeable in sovereign CDS

The liquidity of sovereign CDS has shown to be markedly different according to region and even by credit rating. Several weeks before CDS spreads blew out in Greece and Portugal, for example, liquidity in both countries had dropped out of the market, according to analysts at Fitch Solutions.

Germany and the UK are relatively illiquid, says Thomas Aubrey, md at Fitch Solutions, whereas France and Austria are much more liquid. The increase in liquidity in France's CDS forecast some of the widening of yields in that country, he adds. Over the past several weeks, liquidity has fallen out of the market for Spain and Italy as well.

Liquidity risk, however, has not been much in vogue over the past few years and has instead been largely ignored, says Aubrey. "The last time it was discussed widely was when the Russian bond market defaulted overnight and many banks needed to liquidate assets to meet short-term liabilities. Many of the assets they held in reserve were triple-A RMBS," he says. Without many buyers, prices reduced by half, as a result.

Liquidity risk was, indeed, not always a top priority for market participants in the CDS market. It only recently rose to the top since 2008, says Aubrey, quoting a PricewaterhouseCoopers survey. Liquidity risk did not even make the top 30 concerns for market participants in 2007, for example, but climbed to the number one spot for concerns by 2008.

Currency risk is also factored into CDS spreads themselves, which is a big shift. In some cases, if CDS liquidity had been in certain situations, yields might not have jumped so dramatically in certain markets. Sovereign CDS spreads have narrowed since early June, but there is still some regulatory uncertainty, Aubrey notes.

"Credit risk is only part of the story," he says. "Counterparty risk, currency risk, market risk, liquidity risk are all embedded in an aggregate price. Hence knowing these levels are critical from an investment decision-making process."

KFH

CLOs

LBO exposure to provide CLO differentiation

While short-term technical calls may favour riskier segments of the CLO market, long-term allocations to the sector should continue to focus on the overarching themes of quality, low leverage and easy access to private markets financing, according to CLO analysts at Bank of America Merrill Lynch. Such credit selection ensures that investors still benefit from the cheap valuations available in CLOs as a whole, without being too exposed to the still unresolved longer-term risks of the sector.

For example, the ability for LBO issuers to access equity financing is largely determined both by earnings performance and by leverage levels. As risk appetite normalises and more of the upper tier LBO names are able to access equity markets, CLO deals with outsized exposure to these underlying assets will benefit from larger than average prepayments, while transactions with exposure to the most levered issuers in the LBO space will face longer-term risks of debt being forcefully reduced via a debt exchange or a default.

The BAML analysts reviewed the credit statistics of the most prominent LBO names of the past credit cycle versus their total exposure for the CLO sector and note two key takeaways. The first is the very large exposure at the top of the list, with a handful of transactions accounting for single-digit billions of CLO collateral, which suggests that a single positive outcome IPO-wise for those most referenced names will likely have a significant impact on the CLO sector as a whole.

The second is that there doesn't seem to be an obvious link between the size of an LBO name representation within the CLO sector and its leverage or earnings metrics. "This absence of adverse selection is another relatively positive element for the CLO sector as a whole, as it highlights that LBO refinancing risk does not represent a systemic risk to the sector. If anything, we note that the worst performers on the EBITDA target scale are typically associated with [a] relatively small presence in the CLO sector," the analysts explain.

They indicate that such large dispersion in performance across the LBO spectrum, combined with scattered exposure to LBOs throughout the CLO space represents a significant source of differentiation for the coming months. "At the most junior levels especially, where the ability to benefit from larger than average repayments is key in continuing to improve collateral quality and strength of excess cashflow, we would expect deals with sizeable exposure to LBO issuers with IPO potential to outperform on the long run," the analysts conclude.

CS

RMBS

Re-defaults expected for many loan mods

A sizeable amount of HAMP and special servicer loans are expected to default again within a year, despite both HAMP and servicer-specific loan modifications continuing to increase. However, servicer performance will become an increasingly important factor in re-default rates.

Since HAMP was launched early last year, servicers have been making slow but steady progress with modifications under the programme. By balance, approximately 15% of all RMBS loans have received either a HAMP or non-HAMP loan modification through to May 2010 (up from 10% in September 2009). Additionally, almost 35% of RMBS subprime loans have received at least one modification compared to 25% throughout the same time period.

ABS analysts at Barclays Capital suggest that much of the improvement in re-default rates has been driven by a positive macro environment, as has been the case for performance of unmodified borrowers. They note that macroeconomic environment, extent of modifications and borrower pay history at the time of modification will continue to be the biggest drivers of re-defaults. For example, the typical quality of a modified borrower - as measured by number of months delinquent - worsened dramatically post-3Q09, but was compensated somewhat by more aggressive modifications.

However, the results are falling far short of HAMP's completed modification goals thus far, according to Fitch. In addition, Treasury-imposed changes to HAMP will continue to impact future progress, says Fitch md Diane Pendley.

"With servicers now required by HAMP to re-analyse and re-work borrowers, final determination of the programmme's ultimate effectiveness will continue to be delayed," adds Pendley.

As a result, Fitch maintains its projection that 65%-75% subprime and Alt-A loans that have been modified will default again within a year. The prognosis is slightly lower for prime loans (55%-65%). Approximately 15% of all modified RMBS loans have received at least one additional modification when the first mod failed.

The BarCap analysts expect re-default rates on 2008 modifications to be close to 80%-90%, but 2009 modifications to generally perform much better. In the absence of further material changes to government programmes, they anticipate overall HAMP re-default rates to be 60%-65%. Early HAMP modifications come from a deep delinquent inventory of borrowers and will perform worse versus newly delinquent borrowers that managed to keep paying through 2008-2009.

The analysts also point out that performance differences between servicers will become increasingly important. "We find that SPS, Wilshire and NatCity modifications show lower-than-average re-default rates, whereas Countrywide ones show a higher-than-average rate. At the same time, many servicers are embarking on non-HAMP custom modifications that can have significant ramifications for valuations."

What may help the loan resolution landscape over time are short sales, which have increased gradually since the middle of last year, with half taking place in California. While this strategy has benefits for both borrower and the investor, Pendley points out that "assets in short sale are in competition with other distressed properties and will result in a borrower losing their home".

Looking forward, guidelines and programmes continue to change, while potential new moratoriums are threatened and mandated mediations are becoming more widely required. "Many distressed mortgage loans, including modified loans, will not see a final resolution until well into 2012," concludes Pendley.

CS & JA

SIVs

Large liquidation marked to trade

In contrast to other bid lists making the rounds these days, the US$9.7bn liquidation from Axon Financial Funding is marked "no reserves", implying all of it will trade. Though holders will typically have a bid themselves, other bid lists have not been marked for all of it to trade. Some bid lists have stalled out lately, both due to prices not being attractive enough or a lack of interest in the securities (see SCI issue 187).

The Axon liquidation consists of junior and senior paper from all kinds of CDOs, such as ABS, CMBS, Trups and corporate synthetic CDOs. It also includes corporate CLOs, regular ABS, RMBS, CMBS conduits, CMBS large loans and a host of other securities. The list also contains some rare listings, such as mutual fund fees, container finance, timeshare ABS and whole business securitisations such as from Domino's Pizza and U-Haul.

"Some of the stuff is in the more esoteric realm, which tends to be a bit more opaque without as much liquidity," says an ABS trader, who does not expect the liquidation to impact secondary spreads in any category.

The dearth of supply lately has created an environment in which not many sales, albeit fire sales, are large enough to impact secondary spreads. "The market should absorb it; there's not a lot of sellers," adds an MBS trader. "There aren't a lot of alternatives."

"We're bidding on CDO liquidations every week when it comes across our desk. Some of the pricings are a bit wide right now," he continues.

The RMBS on the list is expected to trade at 30 to 60 cents on the dollar, he adds, noting that the securities could see interest from Public-Private Investment Program (PPIP) funds.

"Distressed mortgages are cheap, but most people are still trying to wait for a dip," he notes. However, the RMBS portion, he says, will all trade.

Adds the first trader: "It's mostly pro rata shares, which is why they will likely show the sub noteholders' prices. This is not the format for getting the best prices."

The list is due to be sold in different pools over different time slots on 30 June, which one investor notes isn't the best of timing, given that it's half-year end and approaching a holiday weekend. Stone Tower Capital controls the Axon SIV.

Another combination bid list totalling US$4.2bn is already marketing, following the Axon auction. The new list is expected to go off this week, however, says one investor.

KFH

Technology

Capital retention

Dan Rosen, ceo and co-founder, and Benoit Fleury, head of financial engineering and products at R² Financial Technologies, answer SCI's questions

Q: How and when did R² Financial Technologies become involved in the structured credit market?
A: We started in this business by conducting groundbreaking research on how to price complex credit derivatives and structured finance assets for one of the largest structurers on Wall Street. That engagement helped us gain a deep understanding of the analytical and infrastructural requirements for large sell-side clients that need to price and risk-profile thousands of structured finance and credit derivative deals on a near real-time basis.

Our main conclusion was that the buy-side would soon need the same level of analytical sophistication, but that the software to do so didn't exist - it needed to be engineered from the outset to handle complex credit products, but it also needed to be packaged, easy-to-deploy and much cheaper to maintain. So in 2006, we began development of NxR², a front-office portfolio construction and risk management solution, and Dan Rosen                                                         R² Credit Capital, a middle-office economic capital management platform.

I think it's a credit to the people we have working for us, and the fit of the solutions they build, that we have achieved such broad commercial success during these tough economic times. We now have clients in North America, Europe, Asia and the Middle- East that include hedge funds, banks, asset managers, investment banks, structurers and regulators.

Q: Do you focus on a broad range of asset classes or only one?
A: R² software applications are designed to perform sophisticated quantitative analysis of credit portfolios in real-time. We cover all credit products, including structured finance assets (ABS, MBS, CMBS, CLOs, CDOs), credit derivatives, credit indices, synthetic CDOs, fixed income, derivatives and equities.

Q: What's your release cycle like?
A: We upgrade our software products every six weeks and automatically migrate all of our clients to the latest version of the software. We're a young, dynamic software firm, so it's important for us to spend time with clients to understand their business needs and ensure that this feedback loops back into our offerings in a timely manner.

Q: What are you working on at the moment?
A: We're working on:

1. Extensions to NAV reporting framework for CLO investors
2. Extensions to simulation capabilities for CMBS investors
Benoit Fleury                                                     3. Integration of additional data sources (Loan Performance, ABSXchange)
4. Extensions to our Monte Carlo pricing and risk profiling capabilities for all structured finance assets. This includes a powerful calibration module
5. Enhancements to our performance attribution module
6. Incorporation of analytics to measure capital requirements for structured finance assets.

On the capital side, we continue to expand our counterparty credit risk profiling capabilities and measurement of incremental risk charge (IRC). The idea is to aggregate counterparty exposures to create a complete picture of a portfolio and the value of its credit risk, as well as how to apportion the exposure across the portfolio. This is being driven by internal requirements to create a more granular picture of which counterparty is contributing to which netting or margining requirement.

We are expecting significant demand for this product as the implementation of the Basel 2 rules gathers momentum. It will initially be applied in the middle office and then probably migrate to the front office.

Q: How do you differentiate yourself from your competitors?
A: What's unique about us is that:

1. Other vendors specialise in certain products, whereas we cover all credit products. But, significantly, we do so at the level of granularity expected by portfolio managers and traders.
2. Most vendors look at one deal at a time; we focus on the portfolio view. We offer sophisticated data management tools to help price and risk-profile large portfolios of securities in a consistent and secure manner.
3. We have superior analytics. For instance, we built Monte-Carlo pricing functions for structured finance assets where baseline default, prepayment, severity and correlation assumptions can be set at the loan, cluster or deal levels. But in the end, MC reports are only useful if they can be employed in the real world. This is why we calibrate our models to observable market prices and distribute the simulations across a computer grid so you get the results back quickly, often in real-time.
4. We are not promoting a given data vendor over another; in fact, we integrate them all. Our clients want us to mix and match data from different sources directly into their analysis. R² makes it easy for them to do so through our generic data loaders and our data cleansing and reconciliation layer.
5. We deliver sophisticated quantitative analysis in an intuitive way. We are all about "advanced analytics, but simple solutions".
6. We deliver business tools, not a software system. Our solution offers specialised business reports to help screen potential investment opportunities, mark portfolios, measure risk, measure performance and control unwanted exposure.
7. We use state-of-the-art technology. We built our products from the ground up using the most recent technology stack. This provides us with greater flexibility, which enables us to deliver more capabilities, faster.

Most importantly, we target some of the industry's most difficult problems, such as:

• How to accurately measure risk in real-time?
• How to run meaningful pre-deal analysis?
• How to mark large portfolios of complex products in an accurate and consistent manner?
• How to measure performance and attribute it to meaningful investment decisions and market movements?
• How to measure and allocate capital consumptions from an economic and regulatory standpoint?
• How to aggregate market, credit and operational risk in a consistent and transparent manner?
• How to effectively communicate investment ideas and decisions to senior management and to external investors?
• How to implement a disciplined, fact-based, risk management culture that empowers portfolio managers?

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: Before the crisis, there was not enough questioning regarding the quality of the models employed, nor around the underlying assumptions made. In fact, many of the models employed were not appropriate, or they weren't applied or calibrated properly.

Few managers understood how sensitive the analytics produced were to the different assumptions made. There was also an overreliance on biased third-party valuations and rating estimates.

Ratings are fine to analyse corporate credits, but they cannot be used to measure risk in a dynamic securitisation structure. A vivid illustration of this is the amount of rating arbitrage done on structured finance deals prior to the crisis.

The crisis, for all its pain, has crystallised the need to analyse deals at a much more granular level, to employ better models that are better calibrated and linked to appropriate data sources. We think this represents a great opportunity for us to implicate and educate portfolio managers and senior managers on the importance of participating in the firm's valuation and risk measurement processes.

Senior managers are increasingly becoming involved in the valuation process and so need to understand the amount of risk associated with the sometimes "heroic" assumptions made in the valuation process. They are also increasingly aware of the need to understand how liquidity may impact their valuation or risk estimates.

We firmly believe that valuation platforms are a key tool with which to attract and retain investor capital. Investors want a more detailed view of risk and liquidity - long gone are the days when investors put money into a fund without asking any questions. A robust valuation tool enables clients to explain to their investors, in a granular, transparent way, how they're creating value and what the key risk drivers and sources of returns are. That's how we've approached the design and development of our products.

Q: What major developments do you need/expect from the market in the future?
A: Our view is that 2010 is a transition year where some markets (e.g. CDOs) will still suffer, while others will start to re-emerge slowly (e.g. CLO, CMBS). In terms of the regulatory reaction, I think the pendulum has swung a little too far.

We believe that credit and securitisation are fundamental to the health of the economy. We're unlikely to return to the originate-to-distribute model, but there are more efficient ways of doing this than severe regulation.

We think 2011 will be a good year for structured finance investors. Having the ability to independently price and risk-profile deals and portfolios will quickly become a mandatory component of a firm's investment process and will be key to its ability to attract funds. So we're gearing up heavily in anticipation of this and are very excited about the opportunities it will bring.

ABS

Credit fixed income group launched

Cowen Group has launched a credit fixed income group, appointing Kevin Reynolds head of the group and Leonard Sheer as an md. The pair was recruited from Gleacher & Company and will be primarily responsible for fixed income and credit product origination and execution, including public and private debt placements, exchange offers, consent solicitations and tender offers.

"We are thrilled to launch this new initiative, which we believe will augment our business, provide value for our existing clients and allow us to serve new clients," comments Peter Cohen, chairman and ceo of Cowen Group. "Adding a deeply experienced team to create innovative debt financing solutions allows us to capitalise on a previously identified growth opportunity for Cowen. Kevin and Len each have a stellar track record of meeting client needs; we welcome them to the firm and we look forward to their contributions."

Reynolds was most recently co-head of capital markets origination at Gleacher & Company. He has more than 24 years' experience in the financial services industry focused on credit research, bankruptcy and distressed trading, emerging market debt capital markets and corporate asset-backed securitisations.

Sheer was previously an md at Gleacher & Company and has 14 years of experience in the financial services industry. His background includes private placements of debt and equity and domestic and international merger and acquisition advisory roles in a wide variety of industries.

CDO

CDO manager named in SEC suit

The US SEC has charged an investment adviser and three of his affiliated firms with fraudulently managing investment products tied to the mortgage markets as they came under pressure three years ago. The complaint has been filed in New York.

The SEC alleges that ICP Asset Management defrauded four multi-billion-dollar CDOs at the direction of owner and president Thomas Priore. It says ICP engaged in fraudulent practices and misrepresentations, which lost the CDOs tens of millions of dollars and that Priore and his companies also improperly took tens of millions of dollars in advisory fees and undisclosed profits at the expense of clients and investors.

"ICP and Priore repeatedly put themselves ahead of their clients," says Robert Khuzami, director of the SEC's enforcement division. "Instead of acting as fiduciaries, they took advantage of a distressed market to line their own pockets."

ICP began serving as the collateral manager in 2006 for the Triaxx CDOs, which invested in MBS. ICP's affiliated broker-dealer ICP Securities and its parent Institutional Credit Partners are also charged. It is alleged that ICP and Priore directed more than US$1bn of trades for the Triaxx CDOs at what they knew were inflated prices, repeatedly causing the CDOs to overpay for securities to make money for ICP and protect ICP clients from realising losses.

Prices for Triaxx trades often exceeded market prices by substantial margins. In some cases, ICP caused the CDOs to pay at a substantially higher price than another ICP client had paid for the security on the same day.

George Canellos, director of the SEC's New York office, says: "The CDOs were complex, but the lesson is simple: collateral managers bear the same responsibilities to their clients as every other investment adviser. When they violate their clients' trust, we will hold them accountable."

The SEC's complaint says that ICP and Priore caused the CDOs to make prohibited investments without necessary approvals and later misrepresented those investments to investors and the trustee of the CDOs. Prices were intentionally inflated so ICP could collect millions in advisory fees, while ICP and Priore executed undisclosed cash transfers from a hedge fund they managed to allow another client to meet margin calls. Priore subsequently misrepresented the transfers to the hedge fund's investors.

The defendants are charged with violations of Section 17(a) of the Securities Act 1933, Sections 10(b) and 15(c)(1)(a) of the Securities Exchange Act 1934 and Rules 10b-3 and 10b-5. They are also charged with violating Sections 204, 206(1), 206(2), 206(3) and 206(4) of the Investment Advisers Act 1940 and Rules 204-2, 206(4)-7 and 206(4)-8. The SEC is seeking permanent injunctions barring future violations of the federal securities laws, disgorgement of the defendants' ill-gotten gains with pre-judgement interest and monetary penalties.

CDO

Change of control for Deerfield CDOs

A deemed assignment of the management agreement on the Mayfair Euro CDO I, Mid Ocean CBO 2000-1 and Valeo Investment Grade CDO II transactions has occurred, following Deerfield Capital Corp's acquisition of Columbus Nova Credit Investment Management (SCI passim). The acquisition involved the transfer of US$25m - approximately 40% - of Deerfield stock to Bounty Investments, which constitutes a change of control and thus results in a deemed assignment.

Moody's has determined that the deemed assignments for the three CDOs will not cause the ratings of any class of notes to be reduced or withdrawn. It has been represented to the rating agency that the collateral manager is not assigning the management agreement to another adviser or delegating any of its duties.

Following the acquisition, Deerfield's portfolio management teams are expected to remain intact, including the individuals who are primarily responsible for managing the affected deals. In addition, the manager has represented to Moody's that there will be no change in the investment approach it uses for managing the assets held by the deals.

CDS

Credit investment manager moves on

Geoffrey Jones has joined Tennenbaum Capital Partners (TCP) as principal. His background is in distressed debt and special situations investing and he has spent the last five years as principal responsible for managing credit investments at Kohlberg Kravis Roberts. Jones has previously worked for BNY Mellon, Deloitte, Brown-Forman Corporation and Benesch, Friedlander, Coplan & Aronoff.

CDS

Firm bolsters structured funds practice

Ashurst has hired Nick Terras from Schulte Roth & Zabel International, where he was an investment management partner. He specialises in hedge funds, UCITS funds, exchange-traded funds and related derivatives and joins Ashurst's derivatives products group.

"Nick is widely regarded as a leading adviser in respect of structured funds platforms. He is quite rare in the market in being both an expert in structured funds, their trading strategies and related regulatory and structuring issues as well as in derivatives and their use by funds," says Ashurst head of securities and structured finance, Erica Handling.

CDS

CMA ceo steps aside

CMA has appointed Antoine Kohler as ceo, effective from today (21 June). He succeeds Laurent Paulhac as global head of CMA's business, promoting the growth of the company through its QuoteVision, DataVision and valuations products.

Kohler joins from ICAP, where he was information services md. During a 13-year career at ICAP he also served as head of business development and marketing and director of Intercapital Securities and icap.com.

"I am excited to be taking over the leadership of CMA at this critical time in the growth of the credit markets," says Kohler. "Now more than ever, the need for timely and transparent data is essential to the efficient functioning of both the credit markets and the broader financial system."

Paulhac will now focus full-time on his role as OTC products and services md for CME Group.

CMBS

Fannie Mae DUS entity created

Guggenheim Partners has formed a new CRE entity called Pillar Multifamily. The firm has also acquired certain assets and assumed certain liabilities of Bulls Capital Partners, a Fannie Mae Delegated Underwriting and Servicing (DUS) multifamily lender.

In addition to acquiring Bulls' assets, Pillar has retained most members of the Bulls team, including coo Mark Van Kirk and chief production officer Robert Russell. Anand Gajjar, a senior md at Guggenheim, will be appointed interim ceo of Pillar.

Robert Brennan, head of the CRE finance group at Guggenheim Securities, says: "The Fannie Mae DUS programme is the pre-eminent source of capital for the affordable and market rate multifamily industry. It is a true distinction to be a member of this lending community and the formation of Pillar Multifamily is a major component of the build-out of Guggenheim's commercial real estate finance platform."

CMBS

Veteran CMBS trader joins broker

Amherst Securities Group has hired John Caputo as primary CMBS trader. He joins the New York office, having most recently managed RMBS and CMBS trading at C12 Capital Management. Caputo has almost 20 years of experience and has previously worked for Barclays Capital, Salomon Smith Barney and Citi as a CMBS trader.

Sean Dobson, Amherst chairman and ceo, says: "There is a tremendous opportunity for Amherst to expand its mortgage trading efforts into the CMBS market. We are convinced that John's extensive trading and loan credit background will be critical to our success as we build out this important new platform at Amherst."

Amherst head of CMBS strategy, Darrell Wheeler, adds: "I am confident that the combination of John's credit and trading expertise, Amherst's proprietary analytics and our strategy efforts will enhance Amherst's ability to evaluate and offer CMBS trading opportunities to our clients."

Monolines

Liquidity remediation efforts falling short

Syncora Holdings says its New York financial guarantee subsidiary, Syncora Guarantee, has made progress on its liquidity remediation actions but remains materially short of its remediation plan.

On 17 June the New York Insurance Department (NYID) withdrew an order from 2009 prohibiting Syncora Guarantee from paying claims until it had removed the impairment to its statutorily mandated minimum surplus to policyholders. Syncora Guarantee has also been ordered to provide the NYID with a plan for payment of accrued and unpaid claims and for the payment of new claims as they become due.

Notwithstanding the withdrawal of the 10 April 2009 New York Insurance Law Section 1310 order, Syncora Guarantee says it still needs to complete further significant actions to satisfy its known and anticipated short- and medium-term liquidity needs and resume claims payments. Some required actions are outside Syncora Guarantee's ordinary course of business and will require consent or approval from parties beyond its control, it says.

Since the issuance of the order in 2009, Syncora Guarantee has made progress towards removing the impairment to its statutory capital and restoring it beyond the minimum requirement of US$65m. Its statutory surplus on 31 March was US$104.1m and Q210 estimates suggest continued efforts will have a positive effect on statutory surplus, albeit offset by adverse development in Syncora Guarantee's reserves.

The company says it is continuing to seek to resolve its liquidity issues and will keep evaluating whether it can make sufficient progress towards implementing its ongoing liquidity remediation plan to be able to resume payments.

Should it be unable to resolve its anticipated liquidity needs in order to resume claims payments on time, or cannot provide the NYID with an acceptable plan for the payment of accrued and unpaid claims and new claims as they become due, the NYID may take regulatory action against Syncora Guarantee. Alternatively, the company could submit itself to regulatory action by the NYID, including placing Syncora Guarantee in rehabilitation or liquidation.

Operations

New FCM formed

BNY Mellon has created a new company to clear futures and derivatives trades on behalf of institutional clients. BNY Mellon Clearing is a registered futures commission merchant and member of the National Futures Association. It plans to become a clearing member on major exchanges and central clearinghouses on a global basis to support its clients' trading activities.

"BNY Mellon Clearing represents a logical extension of our business model," says Gerald Hassell, BNY Mellon president. "With this new company, we will meet the growing needs of clients who trade derivatives and are seeking a global clearing partner with proven operational, financial and risk management expertise."

Sanjay Kannambadi will serve as BNY Mellon Clearing's ceo, reporting to Art Certosimo, senior evp and ceo of alternative and broker-dealer services at thefirm. Kannambadi was previously head of BNY Mellon's office of innovation, leading a team responsible for the development and commercialisation of new products and services.

"BNY Mellon Clearing will provide clients with our extensive operations, technology, risk, finance and compliance capabilities, along with access to exchanges and clearinghouses around the world," says Kannambadi. "The company's formation is designed to anticipate the rapid changes occurring in the clearing and settlement process for derivatives and the need for institutional investors to have a capable, stable partner as the market grows and evolves."

RMBS

TBW chairman charged with securities fraud

The US SEC has charged the former chairman and majority owner of Taylor, Bean & Whitaker Mortgage (TBW) - Lee Farkas - with orchestrating a large-scale securities fraud scheme and attempting to scam the US Treasury's TARP.

The SEC alleges that through TBW Farkas sold more than US$1.5bn worth of fabricated or impaired mortgage loans and securities to Colonial Bank. Those loans and securities were falsely reported to the investing public as high-quality, liquid assets.

In addition, the SEC notes that Farkas was responsible for a bogus equity investment that caused Colonial Bank to misrepresent that it had satisfied a prerequisite necessary to qualify for TARP funds. When Colonial Bank's parent company - Colonial BancGroup - issued a press release announcing it had obtained preliminary approval to receive US$550m in TARP funds, its stock price jumped 54% in the remaining two hours of trading, representing its largest one-day price increase since 1983.

Lorin Reisner, deputy director of the SEC's division of enforcement, says: "As the country's mortgage markets began to falter, Farkas arranged the sale of more than one billion dollars worth of mortgage loans and securities he knew to be fictitious or impaired. Farkas also lied about a sham equity investment he engineered to defraud US taxpayers and the US Treasury's TARP."

According to the SEC's complaint, filed in US District Court for the Eastern District of Virginia, Farkas executed the fraudulent scheme from March 2002 until August 2009, when TBW filed for bankruptcy. TBW was the largest customer of Colonial Bank's mortgage warehouse lending division (MWLD). As TBW generally did not have sufficient capital to internally fund the mortgage loans it originated, it relied on financing arrangements primarily through Colonial Bank's MWLD to fund these mortgage loans.

According to the SEC's complaint, TBW began to experience liquidity problems and overdrew its then-limited warehouse line of credit with Colonial Bank by approximately US$15m each day. The SEC alleges that Farkas pressured an officer at Colonial Bank to assist in concealing TBW's overdraws through a pattern of 'kiting', whereby certain debits to TBW's warehouse line of credit were not entered until after credits due to the warehouse line of credit for the following day were entered. As this kiting activity increased in scope, TBW was overdrawing its accounts with Colonial Bank by approximately US$150m per day.

The SEC alleges that in order to conceal this initial fraudulent conduct, Farkas devised a plan for TBW to create and submit fictitious loan information to Colonial Bank. Farkas also directed the creation of fictitious MBS assembled from the fraudulent loans.

By the end of 2007, the scheme consisted of approximately US$500m in fake residential mortgage loans and approximately US$1bn in severely impaired residential mortgage loans and securities. As a direct result of Farkas's misconduct, these fictitious and impaired loans were misrepresented as high-quality assets on Colonial BancGroup's financial statements.

The SEC alleges that in addition to causing Colonial BancGroup to misrepresent its assets, Farkas caused BancGroup to misstate to investors and TARP officials that it had obtained commitments for a US$300m capital infusion, which would qualify Colonial Bank for TARP funding. Farkas falsely told BancGroup that a foreign-held investment bank had committed to financing TBW's equity investment in Colonial Bank.

Contrary to his representations to BancGroup and the investing public, Farkas never secured financing or sufficient investors to fund the capital infusion. When BancGroup and TBW later mutually announced the termination of their stock purchase agreement, essentially signalling the end of Colonial Bank's pursuit of TARP funds, BancGroup's stock declined by 20%.

The SEC's complaint charges Farkas with violations of the antifraud, reporting, books and records and internal controls provisions of the federal securities laws. The SEC is seeking permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties. The SEC also seeks an officer-and-director bar against Farkas, as well as an equitable order prohibiting him from serving in a senior management or control position at any mortgage-related company or other financial institution and from holding any position involving financial reporting or disclosure at a public company.

RMBS

Boutique names investment strategy head

Braver Stern Securities has hired Scott Buchta as md and head of investment strategy. He has over 23 years of experience developing investment strategies for institutions across various fixed income sectors, with an emphasis on RMBS, CMBS and ABS.

"Scott's proven track record of developing investment strategies and wealth of experience will further bolster the strong mortgage sales and trading team at Braver Stern," says Cliff Sterling, fixed income sales md at the firm.

Buchta's appointment will complement the new Midwest mortgage sales team. The firm says he will add value for clients through regular market updates, which will provide commentary and counsel on market developments. He will also develop trading strategies and serve as a resource on industry trends and analysis.

Buchta was previously md and head of investment strategy at Guggenheim Securities. Prior to that, he spent 20 years at Bear Stearns leading the mortgage products group and serving as senior md in the mortgage analytics group.

RMBS

Distressed assets practice formed

Insurance broker Willis North America has formed a distressed assets practice to advise clients on managing the risks associated with financially distressed, foreclosed or abandoned properties and to provide a range of insurance solutions.

The new unit will be headed by Brian Ruane, national real estate and hotel practice leader for Willis. It will bring together resources and expertise from the firm's real estate and hotel, construction, environmental, executive risks, financial services and mergers & acquisitions practices and its loan protector unit to serve the unique risk management needs of all industry players. These include property owners, developers, investors, lenders, receivers, special servicers and others active in the distressed assets space.

ABS

Basel 2 capital charges clarified

The Basel Committee on Banking Supervision has announced adjustments to the revised market risk framework, which was released in July 2009 (SCI passim). A coordinated start-date of no later than 31 December 2011 for all elements of the July 2009 trading book package has been decided on, to give supervisors additional flexibility.

Two aspects of the framework are impacted by these alterations. The decision that securitisation positions held in the trading book be subject to the Basel 2 securitisation charges and the resolution that correlation trading books be exempted from the full treatment for securitisation products - qualifying either for a revised standardised charge or capital charge based on a comprehensive risk measure - are both affected by the adjustments.

The committee has confirmed the capital charge for non-correlation trading securitisation positions, which will be based on the sum of the capital charges for net long and net short positions. There will be a transition period of two years from the implementation of the revisions.

During the transition period, charges may be based on the larger of the net long and net short capital charges. During this time, the committee says there is a need to ensure that there is not undue recognition of hedging between economically unrelated positions.

The floor for correlation trading securitisation positions is to be set at 8% of the standardised measurement method. As a result of these revisions, market risk capital requirements will increase by an estimated average of three to four times for large, internationally active banks.

Other stipulations from the July 2009 framework are that banks using internal models in the trading book must calculate a stressed value-at-risk based on historical data from a continuous 12-month period of significant financial stress and that banks using internal specific risk models in the trading book must calculate an incremental risk capital charge for credit-sensitive positions, which captures default and migration risk at a longer liquidity horizon.

Deutsche Bank European securitisation analysts describe the Basel Committee's actions as a "watering down of securitisation regulation so minor, it only served to increase our worry over heavy-handed regulatory action". They note that there appears to be a disconnect between policymakers' publicly articulated view of the benefits of restarting securitisation and regulators' current enthusiasm for rules that are likely to delay and impede such a task.

The analysts cite as an example the introduction of banking book risk weights for use in computing the capital charge for securitisation positions held in a trading book unfairly single out securitisation, with the potential to damage liquidity in European mezzanine ABS bonds. They point out that other credit trading portfolios will retain a value-at-risk (VAR) approach.

ABS

Positive US credit card performance continues

Collateral performance of the major US bank credit card trusts was generally positive for the May collection period, with charge-offs mixed but delinquencies, yield and excess spread markedly improving. ABS analysts at Barclays Capital note that they regard more highly the signal from falling delinquencies and believe this month's reports show continued fundamental improvement in credit performance.

At the trust level, most major bank card issuers reported better charge-offs and delinquencies were improved across the board. Higher yields combined with lower charge-offs resulted in rising one-month excess spreads for most trusts.

The BarCap analysts expect charge-offs to decline through the summer, in line with recent delinquency improvements. "We believe credit card default performance has turned the corner and maintain our forecast of 9.75%-10.25% for charge-offs in Q410 (down from 10.8% in Q409)."

Moody's analyses the impact of three events on the North American credit card ABS market in its latest Weekly Credit Outlook - the final set of rules under the US Fed's Credit CARD Act, the expiration of discounting mechanisms on three credit card trusts and CIBC's acquisition of Citibank Canada's credit card business.

The Fed's final credit card rules are scheduled to go into effect on 22 August and include new limits on late fees and over-limit fees, which Moody's expects to put some downward pressure on yield within credit card securitisation trusts. "We expect the incremental drop in portfolio yield, which now averages about 22.4% according to Moody's Credit Card Index, to be no more than 50bp-100bp for bank card trusts and no more than 150bp-250bp for private-label trusts on account of these new rules," Moody's notes. "Mitigating the impact of the new rules is the fact that penalty fees are a small portion of yield in most trusts. Furthermore, card issuers are likely to pursue alternative means of generating yield in order to offset yield lost owing to the new restrictions."

Meanwhile, the discounting mechanisms for the Chase (CHAIT), Bank of America (BACCT) and American Express trusts are scheduled to expire on 30 June, 30 September and 31 December respectively. But Moody's believes these trusts will withstand the expiry of discounting, given improving collateral performance, recent card rate increases and the gradual manner in which the benefit from discounting phases out for these trusts. Furthermore, if collateral performance takes an unexpected turn for the worse, the resumption of discounting remains a viable and proven option, the agency notes.

Finally, CIBC announced last week that it plans to acquire Citibank Canada's credit card business, which backs the Broadway Credit Card Trust. "We view the purchase of this business and eventual transfer of origination and servicing to CIBC as a credit positive for the outstanding series of Broadway notes because CIBC has greater financial strength, a larger Canadian platform, and superior underwriting and servicing, and because Citi will remove delinquent accounts from Broadway as part of the acquisition," Moody's concludes.

ABS

SLCC I tender offer amended

Student Loan Consolidation Center Student Loan Trust I (SLCC I) has waived the minimum aggregate principal amount of notes to be tendered under its up to US$450m buyback of outstanding auction rate student loan asset-backed notes, Senior Series 2002A and 2002-2A. It has also extended by a week the early tender deadline until 22 June, during which period Route 66 Ventures will pay US$1,500 for each US$50,000 principal amount of notes accepted for purchase.

The tender offer has been amended to provide that up to the first approximately US$45m in tender offer consideration for notes purchased will be funded using funds available from the SLCC I Surplus Fund, while those in excess of approximately US$45m will be funded with the net proceeds from SLCC I's planned offering of its student loan asset-backed notes, Series 2010-2, in one or more series.

ABS

Emerging markets ABS criteria updated

Fitch has published updated criteria for rating asset securitisations in emerging markets, with a particular focus on the relevance of various sovereign ratings to a given transaction. The ratings of emerging market securitisations are capped at a maximum of two to four global scale notches above the relevant country's sovereign ceiling, as ABS in emerging markets are inevitably conditioned by the macroeconomic and political environment in which they are originated.

The agency's criteria detail the relevance of various sovereign ratings when analysing an existing asset securitisation. For the purposes of Fitch's criteria, ABS refers to all types of existing asset securitisations.

Typical ABS risks are exacerbated for emerging market transactions by the increased volatility of the local economic environment, Fitch says. The volatility can significantly impact the probability of default or expected recoveries and increases dramatically when this country enters or approaches default. In this context, the country's sovereign ratings and country ceiling will have a significant influence on the ultimate rating assigned to a securitisation.

Fitch says it has developed a general set of expectations reflecting potential reactions within a jurisdiction to a financial default by the relevant sovereign. The report elaborates on many risks an ABS transaction could be exposed to during a sovereign default.

ABS

Uptick expected for US prime auto losses

Delinquencies and losses on US prime auto loan ABS reached their lowest levels last month since the summer of 2007, mainly due to seasonal factors, according to Fitch. However, the rating agency says this improvement will not last.

Fitch director Ben Tano says: "Performance will come under seasonal pressure during the slower summer months as the effects of tax returns wear off. Although consumer confidence hit a two-year high in May, unemployment and consumer bankruptcies remain high and consumer fundamentals are poor overall."

Fitch's prime annualised net loss (ANL) index improved by 17% to 0.87% in May over the month prior, which represents the fourth consecutive drop. ANL in May were nearly 50% below May 2009 and the lowest rate recorded since August 2007; this was the ninth consecutive month of year-over-year drops in the loss index.

The improvement in losses came in spite of mild softening in used vehicle values in May versus prior months. According to the National Automobile Dealers Association, average used vehicle prices fell by approximately 0.5% from April to May.

Fitch's prime 60+ days delinquency index held steady in May at 0.51%. The index was 29.7% lower than the year prior and the lowest level since June 2007. Delinquencies dropped in recent months driven by seasonality, but with the onset of summer, delinquencies typically rise above levels in the first half of the year following seasonal patterns.

Ratings performance in 2010 is increasingly positive following the performance trends to date. Through May, Fitch has issued 30 upgrades to 15 trusts compared to four upgrades to three trusts during the same period in 2009.

Tano adds: "Auto upgrades are likely to slow due to limited subordinate note issuance in the 2008 and 2009 vintages."

Performance was divided in the subprime sector where 60+ day delinquencies rose by 6.6% in May to 3.05%. Meanwhile, subprime ANL contracted dramatically by 31.4% to 4.50%, also returning to levels last seen in the summer of 2007. Limited subprime issuance in recent years has contributed to volatility in subprime indices as the outstanding transactions season.

Improvements in the 2009 vintage versus prior vintages will continue to play a key role in Fitch indices due to tightened underwriting and stronger collateral characteristics in more recent vintages. In addition to lower loan-to-value ratios, credit bureau scores for the 2009 vintage average 743 points compared to 727 and 715 in the 2008 and 2007 vintages respectively. The stronger collateral mix will serve as a moderating factor to the negative pressure from the greater US economy.

ABS

Greek government-sponsored ABS downgraded

Moody's has downgraded the ratings on two Greek government-sponsored transactions - Ariadne and Titlos - to Ba1 and Ba2 respectively. The move follows Moody's downgrade of the foreign and local currency ratings of the government of Greece to Ba1 from A3 on 14 June and concludes the review for possible downgrade of their ratings that the agency initiated on 27 April.

The ratings of the notes issued by Ariadne are primarily based on the effective guarantee of the Greek government rather than on the value of the lottery receivables backing the notes, Moody's notes. Its rating analysis also considered the benefit of a €10m liquidity reserve, which now accounts for 4.8% of the outstanding notes due to amortisation. This reserve, however, is not sufficient to support a higher rating than that of the Greek government.

The ratings of the notes issued by Titlos, meanwhile, are fully linked to the credit quality of the Greek government and are now also exposed to that of the National Bank of Greece (NBG) in its capacity as swap counterparty, cash manager and account bank. Previously, the rating of the transaction had not been linked to that of NBG because the transaction documents provided for remedial steps to be taken should NBG's rating be downgraded below specific triggers and, in particular, for NBG to be replaced in its various roles in the transaction once its rating fell below certain thresholds.

However, on 16 June 2010, the transaction documents were amended to effectively remove all such obligations, including the required replacement of NBG as account bank, cash manager and hedge counterparty, after Moody's downgraded NBG's senior unsecured debt ratings to Ba1/Not-Prime on 15 June 2010.

ABS

Tobacco bonds under pressure

Some US tobacco settlement ABS bonds are under downgrade pressure due to a significant decline in the master settlement agreement (MSA) payment amount in 2010 from 2009, says Fitch. The rating agency is reviewing all its tobacco settlement ABS transactions.

The agency says some long-term turbo bonds and many capital appreciation bonds are vulnerable to downgrade, generally by one to three notches. The amount of annual MSA payments is affected by the level of tobacco consumption, as well as the inflation rate and state-specific adjustments.

MSA payment has declined by 16.4% in 2010 against the payment in 2009 due to a significant decline in tobacco consumption, as measured by a 10.4% decrease in tobacco shipments. Last year's payment was also boosted by a non-regular release of cash from the disputed payments account.

CDO

CRE CDOs transferred in note redemption

Gramercy Capital Corp has redeemed US$52.5m of junior subordinated notes issued by its operating partnership subsidiary. The transaction was completed by transferring to the noteholders an equivalent par value amount of various classes of bonds issued by the Gramercy Real Estate CDO 2005-1, 2006-1 and 2007-1 deals, previously purchased by the firm in the open market, and cash equivalents of US$5m.

In October 2009, the firm settled an exchange of US$97.5m of junior subordinated notes for an equivalent par amount of CDO bonds. This redemption eliminates the firm's junior subordinated notes from its consolidated financial statements, which had an original balance of US$150m.

CDO

Buyback set to improve CDO's par value ratios

Fortress Investment Group has proposed a partial repurchase of its Duncannon CRE CDO's class A notes. Fitch says that this will not in itself impact the rating of the notes.

The rating agency notes that under the proposed buyback, the repurchase of £30.89m of the class A notes will be undertaken at a discounted purchase price. The notes will subsequently be cancelled, thereby increasing the available credit enhancement to all rated notes. The proposed buyback follows earlier buybacks of class A notes in 2009 and 2010 (SCI passim).

The repurchase will be funded using cash available in the principal collection account. As of June 2010, approximately £22.6m is available in the principal collection account.

The senior, second senior and mezzanine par value tests are currently breaching their limits. Fitch notes that all par value ratios will improve as a result of the repurchase, however. Consequently, the amount of interest required to be diverted on future payment dates to the senior notes to cure the par value tests may be reduced.

CDPCs

Six CDPCs impacted by criteria review

S&P has taken rating actions on six CDPCs, following the scheduled implementation of its updated criteria for rating such vehicles with corporate credit exposure.

The rating agency lowered its long-term issuer credit rating (ICR) and class A and B issue ratings for Channel Capital; and placed its ICR and senior subordinate issue rating for Athilon, as well as its ICRs and issue ratings for Centerline Financial, Invicta and Newlands Financial on credit watch with negative implications. In addition, it affirmed the subordinated and junior subordinated issue ratings for Athilon, the ICR and issue ratings for Koch Financial Products and the short-term ICR and senior capital notes issue rating for Channel Capital.

S&P says it lowered the long-term ICR and class A and B note issue ratings and affirmed the short-term ICR and senior capital notes issue rating for Channel Capital based on the CDPC's updated capital model results, which incorporate our updated criteria. S&P's analyses also considered its view of potential sensitivities relating to various scenarios involving portfolio credit quality, counterparty credit quality and changing portfolio compositions.

The credit watch negative placement of the ICR and senior subordinate issue rating for Athilon and the ICRs and issue ratings for Invicta and Newlands Financial reflect the fact that, as of 21 June 2010, S&P has not received their capital model run results that incorporate the 27 April 2010 CDPC criteria, which became effective on 8 June. "We currently believe that we will likely lower our ratings on these three CDPCs upon the application of our updated criteria. As a result, we are placing our ratings on these CDPCs on credit watch negative," S&P explains.

The credit watch negative placement of the ICR and senior loan rating on Centerline Financial, a CDPC that sells credit protection on affordable housing tax credits, reflects the agency's view of potential increased risks associated with its exposure to affordable housing tax credits. S&P currently believes that, given the reported breach of capital model test and the performance of the properties associated with Centerline Financial's CDS portfolio - as indicated by the debt service coverage ratio, loan-to-value ratio and occupancy ratio - amid the challenging tax credit market, it is likely that the ratings on Centerline Financial will be lowered after the ongoing review is completed.

The agency affirmed the ICR and debt ratings for Koch Financial Products after its capital model reports showed that the CDPC passes all of its capital model tests after incorporating S&P's updated criteria. The ratings also reflect S&P's view of potential sensitivities relating to counterparty risk.

CDS

Succession event determined

ISDA's EMEA Determinations Committee has ruled that a succession event occurred with respect to Cable & Wireless PLC on 26 March. Cable & Wireless Limited and Cable & Wireless Worldwide PLC were determined to be the successors.

CDS

Refi risk expected to drive HY CDS returns

A factor analysis of the recent selloff undertaken by credit strategists at Goldman Sachs reveals that refinancing risk has not been a meaningful driver of a cross-section of high yield CDS returns. But this scenario is expected to change as growth in the US loses its momentum.

Goldman Sachs economists forecast that US GDP growth will decline to just 1.5% in the second half of 2010, damaging disproportionately lower-quality credits. To position for the second half of the year, the strategists recommend going short a basket of high yield names with weak capital structures versus the CDX HY index at a 1:1.3 ratio.

"The basket contains Caa and single-B rated companies in our universe, with at least 30% of bonds and loans due in the next two years. The trade is roughly carry-neutral and should benefit from the underperformance of low-quality names," they explain.

CDS

Oil and gas CDS liquidity spikes

A notable spike in CDS liquidity among US oil and gas companies is being caused by the Gulf of Mexico oil spill, says Fitch Solutions. Although global CDS liquidity has rebounded after a brief holiday-related decline earlier in the month, oil and gas companies in the Americas remain under pressure.

Kerr-McGee Corporation is one notable month-to-month mover, with CDS spreads widening by 745%. "Oil rig companies are facing stricter regulations by the US government and are being forced to abate oil excavations in the Gulf of Mexico for six months in light of the ongoing oil spill," says Fitch Solutions md Jonathan Di Giambattista. "Smaller oil riggers like Kerr-McGee will be hit especially hard by the drilling moratorium, likely resulting in losses."

Elsewhere, credit protection on emerging market sovereign debt remains more liquid than CDS for developed market sovereigns. CDS liquidity for developed markets has tapered off since the initial market panic over European sovereign fiscal problems earlier this year. For the last month CDS referencing Brazil have been more liquid than any other sovereign.

CLOs

Euro CLO review completed

S&P has completed its review of 1,371 ratings in 214 European cashflow CLO transactions. These included ratings placed on credit watch negative following the rating agency's corporate CDO criteria update, as well as a substantial number of ratings on (mostly subordinate) CLO tranches that had previously been placed on credit watch negative for performance reasons before the criteria update.

Of these 1,371 ratings, S&P lowered 1,272 (93.28%) after performing a cashflow analysis and a committee review of each of the affected transactions. The affirmations and upgrades of the agency's ratings on the remaining tranches reflect its view that these tranches had adequate credit enhancement to maintain the current ratings under the updated criteria.

S&P says it has released this information in response to market requests for a summary of the effect that the application of its revised criteria for corporate CDOs, as well as deterioration in the creditworthiness of the underlying collateral portfolio, has had on the CLO ratings it has reviewed.

CMBS

Impact multifamily deal prices

Impact Community Capital last week came with its multifamily housing deal called Impact Funding Affordable Multifamily Housing Mortgage Loan Trust 2010-1, say investors. The deal began marketing at the beginning of June (see SCI issue 187).

Barclays was the sole lead on the offering, which totalled US$309m. The deal included a US$235m class A1 tranche, which originally marketed at US$269m. The pass-through certificates are backed by affordable multifamily housing mortgage loans acquired by Impact from Bank of America and California Reinvestment Corporation.

The US$235m tranche priced at 225bp over swaps, while the second US$33.9m tranche - which was retained by the issuer - priced at 230bp over swaps.

The class A tranche is expected to be rated triple-A by S&P.

CMBS

Office building CMBS due in market

A CMBS transaction secured by leases from New York office building One Bryant Park is marketing. The US$650m offering, called OBP Depositor Trust 2010-OBP Commercial Mortgage Pass-Throughs, is to be rated triple-A by Fitch.

Bank of America, the largest tenant in the building, is a part owner of the asset along with the Durst Organization. The building has a 96.9% occupancy rate, according to Fitch.

The US$650m CMBS certificates are secured by a fixed-rate 10-year interest-only loan. The deal also includes US$650m of subordinate non-taxable liberty bonds, which are secured by a fixed-rate 39-year loan that will initially be interest-only for about 30 years. Fitch's LTV is at 40% for the senior certificates and ranges from 61.7% to 80.1% for the subordinated pieces.

CMBS

JPMCC 2010-C1 strengths and risks analysed

As part of its continuing efforts to provide insight to investors on structured finance transactions, S&P has commented on the US$716.3m J.P. Morgan Chase Commercial Mortgage Securities Trust Series 2010-C1 (JPMCC 2010-C1) CMBS (see last issue). The rating agency says it has chosen to comment on this transaction - which appears to be the first conduit/fusion US CMBS since the publication of its new criteria for the sector - because it believes the deal is important to the marketplace and that S&P's views can add value for investors.

S&P has reviewed the information available on the JPMCC 2010-C1 transaction and has formed an opinion with respect to the credit strengths and risk considerations for the deal, which it considered relative to its criteria.

Among the credit strengths cited by S&P, the 13 loans representing 36.7% of the pool balance have what appear to be low-leveraged trust balances, based on the appraisals, with LTVs of 60.0% or less. The pooled trust's LTVs range from 38.5%-73.1% and have an overall weighted average LTV of 61.5%.

The transaction also has a weighted average debt service coverage (DSC) of 1.64x, based on the issuer's net cash flow (NCF) and actual constants for each loan. The DSCs range from 1.26x-3.02x.

In addition, the deal generally prohibits additional debt. Only one loan (4.6% of the pool) has existing mezzanine debt that is secured by a pledge of equity interests in the borrower. Three other loans (8.2% of the pool) that permit future mezzanine debt (or other unsecured debt) are restricted by certain DSC and LTV thresholds and/or rating agency confirmation.

Among the risk considerations cited by S&P is that, in the agency's view, the transaction has significant sponsor concentration with respect to Inland Western Retail Real Estate Trust (IWEST) for 13 loans comprising 42.5% of the trust balance. These loans are not cross-collateralised or cross-defaulted.

The transaction also has loan concentration, as the largest loan - Gateway Salt Lake - represents 14.1% of the pool balance. The Gateway Salt Lake loan is a class A lifestyle centre located in downtown Salt Lake City and faces new competition from City Creek Center. With 43.2% of its occupied space expiring through 2012, the Gateway Salt Lake property will likely be subject to far more competition than has historically been the case in order to retain those expiring tenants, S&P notes.

Further, the pool exhibits geographic concentration in that 44.8% of the assets are located in the top three US states: California (16.1%), Texas (14.5%) and Utah (14.1%). None of the remaining state concentrations exceeds 9.3%.

The pool also exhibits concentration in the retail sector, which comprises 70.9% of the pool balance.

CMBS

Property sales prompt White Tower upgrade

Fitch has upgraded the White Tower 2006-3 class A and B notes from A/B to AA/BB respectively, as well as placed the class A, B and C notes on rating watch positive (RWP). The upgrades reflect the announcement by special servicer CB Richard Ellis Loan Servicing (CBRELS) that two of the underlying properties being marketed as individual assets have been exchanged for sale at prices well in excess of both their June 2009 values and Fitch's own estimate of value. The RWPs indicate the prospect of an upgrade in the coming months if the sale prices of the other assets currently for sale also exceed Fitch's expectations.

Fitch considers CBRELS's sales strategy to be a positive for the transaction as it allows sufficient time to achieve an orderly sale of the assets before the legal final maturity of the bonds in October 2012. It also capitalises on current investor interest in prime London properties. This is especially expected to benefit the Alban Gate property, which is considered prime in nature and one of the strongest in the total portfolio with a lease to JPMorgan Chase Bank until March 2025.

The remainder of the assets being marketed are included in the £466m Thames portfolio. Fitch's key concern for the sale of both this portfolio and the standalone Alban Gate property is the large lot size. Given the continued limited availability of large-ticket bank funding for commercial property acquisitions, it is uncertain whether prospective purchasers will be able to secure funding for such significant amounts.

Should they not be able to do so, the sales prices will be negatively impacted, Fitch says. This was less of a consideration for the two assets sold to date, which traded at £60m and £62m respectively.

CMBS

Stronger underwriting seen in CMBS

The first new US CMBS transaction in two years, JPM 2010-C1 (see last issue), features the strong underwriting emblematic of the early days of the market, according to Fitch. However, the rating agency points out that time will tell if strong underwriting standards remain the case as more deals come to market.

In rating JPM 2010-C1, Fitch found that the transaction reflects stronger issuer underwriting practices, such as in place cashflow, marked-to-market where applicable, with no reliance on pro-forma income - attributes that resembled the norm in the new issue environment between 1995 and 2004. In addition, the agency notes that borrowers are retaining material equity in the properties, with equity contributions generally ranging from 25%-50% based on purchase prices.

This represents a stark contrast to the underwriting in 2007, when collateral was often originated based on expectations that cashflow would continue to rise in a CRE market already experiencing dramatic upward trends, says Fitch. In a recent report for the sector, the agency acknowledges that these standards might not be persist in future deals, however.

Huxley Somerville, Fitch group md and US CMBS group head, says: "If and when underwriting levels do deteriorate, expect to see Fitch raise their credit enhancement levels."

CMBS

CRE prices back on the up

Moody's says US CRE prices increased by 1.7% in April, according to its commercial property price indices. It is the first monthly rise since January. Prices nationally are 41.1% lower than their October 2007 peak, but have come back 4.7% from their low in October 2009.

"Prices have remained choppy since October," says Moody's md Nick Levidy. "While prices have moved as one would expect at a market bottom, transaction volume has been extremely low, making it difficult to conclude prices have stabilised."

The number of transactions fell in April from 127 repeat sales in March to 114. The total transaction balance also fell to just under US$800m.

Further indices show prices in the US South declined for all property types over the last year, with apartments the worst performer after declining 32.6% from a year earlier. Apartment prices are down 29.9% in Florida from a year ago and have now fallen by over 50% from their peak four years ago.

Finally, San Francisco has seen the smallest one-year decline in prices out of the three major office markets, dropping 10.7%.

Ratings

Agency clarifies use of rating caps

Fitch has issued a new criteria report clarifying which circumstances might cause it to cap a rating when analysing a structured finance transaction. The report is intended to promote transparency and also describes which circumstances would prevent a transaction getting a rating.

"There is a common assumption that, with sufficient credit enhancement, Fitch should be able to assign a triple-A rating to at least some portion of virtually any capital structure. However, this is not the case," says Stuart Jennings, md and Fitch's group credit officer for European structured finance. "If Fitch is unable to develop sufficiently robust assumptions to support a triple-A rating given the specific factors of a transaction, then no portion of the related capital structure can be rated at that level."

Fitch says the criteria report does not contain prescriptive rules to be applied to each transaction because individual deals will have unique characteristics. Instead, the agency says it provides a framework of principles for Fitch's analysts to observe when they assess proposals and whether a rating cap may be needed.

The agency has identified seven key areas that might necessitate a rating cap or prevent a rating from being assigned. These areas are: portfolio and data quality, asset concentration, legal terms and conditions of the notes, excessive market value exposure, sovereign dependency, third-party dependency and the incentives of transaction parties.

The report is not expected to have a material impact on existing ratings because it reflects the agency's current policies and practices. However, certain interest-only and prepayment certificates - where the rating communicates limited information - will be impacted.

Ratings

IO, prepayment rating practices revised

Fitch has revised its global practice for assigning and maintaining structured finance ratings on interest-only securities (IOs) and prepayment certificates. The revised practice affects a variety of security types, including those commonly referred to as Class Ps, Class Rs, Class Xs, Class IOs and MERCs.

IO-related securities are commonly featured in MBS transactions, particularly in the US. They typically provide investors with the right to receive a fixed or variable interest amount from a referenced pool or security. Fitch says the rating of these securities communicates limited information and does not address the risk that notional amount and interest payments could be reduced due to credit losses on the referenced pool or security.

Fitch believes ratings on IO securities have a higher potential to be misinterpreted, misused or misrepresented than a typical structured finance rating, which addresses the likelihood of receiving principal and interest payments in accordance with the terms of the documentation. The agency's revised approach for the future calls for: ratings assigned to IO securities to be directly linked to the credit risk of the referenced tranche or tranches, IOs referencing a single tranche to be rated the same as that tranche, IOs referencing multiple tranches to be rated the same as the lowest tranche and IOs referencing non-rated tranches or the entire or partial pool balance to no longer be assigned new ratings.

To ensure consistency between new and existing ratings, Fitch expects to withdraw ratings on existing IO securities that reference the full or partial pool notional amount or reference non-rated classes. It will also withdraw ratings inconsistent with the new approach. The withdrawal process is to take place over the next 12 months, primarily as transactions come up for evaluation.

A similar practice for rating prepayment certificates and MERCs is also being adopted. Fitch will withdraw the ratings on these certificates as the transactions are reviewed over the course of the year.

Regulation

Accounting survey reveals call for mixed method

PricewaterhouseCoopers (PwC) has surveyed a geographically diverse sample of investors and analysts to better understand their perspectives on accounting and reporting for financial instruments.

The poll intended to discover views on the split between the IASB and FASB on accounting for financial instruments. The two accounting bodies set out jointly in 2008 to solve challenges highlighted by the global crisis, but have reached different conclusions for accounting for financial instruments.

The IASB seeks a new method retaining some of the existing model that combines fair value and amortised cost, depending on the nature of the financial instrument. Rather than this mixed measurement model, the FASB proposes that all financial instruments be reported at fair value, including bank loans and deposits.

Consistent trends that the PwC survey highlighted include:

• Fair value information for financial instruments is considered relevant and valuable by most respondents, but is not necessarily the key consideration in their analysis of an entity. It is rarely used as an indicator of future cashflow generation.
• A majority of respondents prefer a mixed measurement model, with fair value reporting for shorter-life instruments and amortised cost reporting for longer-life instruments when the company intends to hold those instruments for the purpose of collecting the contractual cashflows.
• Respondents favouring the mixed measurement model believe the information better reflects an entity's underlying business and economic reasons for holding an instrument. They also stress the importance of keeping net income free from fair value movements in instruments that are held for long-term cashflow rather than for short-term trading gains.
• Respondents want improved disclosure of fair value information, including detailed information about portfolio composition and risk factors, valuation methods and assumptions and sensitivity analysis for movements in key assumptions.
• There is a lot of support for an impairment model based on expected losses, rather than one based on incurred losses. There is also a desire to define how an expected loss model would be applied. Respondents voiced concern that a loosely defined expected loss model could lead to excessively subjective reserving in order to facilitate earnings management.

Don McGovern, global assurance leader for PwC, says: "The divergence in accounting proposals reflects the breadth of views held by financial statement users, preparers and others. The passion with which these opinions are held is evidenced by the volume and variety of print and television editorials, blogs and articles, as well as comment letters sent to both boards."

RMBS

Non-asset trigger concerns for Aire Valley

Based on the latest report for the trust, the Aire Valley RMBS programme appears to be following the pattern of Granite before its non-asset trigger was breached, according to Ron Thompson, global head of ABS strategy at Knight Libertas. The market's assumption is that there'll be a non-asset trigger for Aire Valley in early 2011, based on the minimum trust size trigger.

"Principal receipts were about £50m a month, which implies - on a straight line basis - there will be 20 payment periods before a breach occurs," Thompson says. "But if CPRs accelerate, this could push the breach further away to mid-2011 or even later. The average over the prior six months was £63m, driven in part by a late-stage jump in payments."

CPR assumptions are typically based on the lowest numbers to be published, which - in some cases - can suggest a relatively dire scenario when bidding for bonds. "This is reflected in the limited amount of paper coming onto the secondary market. Investors may have to rethink their vectors around how CPRs play out: their movement is more granular over a given period of time than is first apparent," Thompson adds.

He cites as an example Paragon, which he believes may see a pick-up in yield as more lenders return to the markets. The Capital Gains Tax changes were better than expected and should help support the market, rather than hurt it, he says.

RMBS

MBS basis 'on the rich side' of fair value

Mortgages are cheap to the consumer and rich to the investor, compared to current 30-year market rates (4.75%), according to MBS analysts at Wells Fargo. They modelled 30-year mortgage rates and determined that current market rates should be between 4.75% and 5.35%.

"We continue to believe that the MBS basis is at 'fair value', albeit on the rich side," the analysts explain. "This conclusion is derived from a quantitative analysis, as well as a distribution analysis that is based on the past 10.5 years of current coupon and swap spreads."

In agency pass-throughs, the Wells Fargo analysts believe that investors should continue to add convexity to their MBS portfolios by adding specified pools with low to moderate pay-ups. "We believe there is relative value in 100% investor pools when compared to TBA deliverables. Our analysis shows that investors may be able to pick up as much as 9bp of carry per month versus TBA."

In REMICs, the analysts suggest that investors should consider short-dated structured PAC-IOs to increase portfolio yield and improve overall relative performance. Their analysis shows that the combination of short-dated PAC and PAC-IOs offers a yield pickup of 90bp over a PAC alone, while maintaining a stable average life profile.

Finally, the analysts indicate that the non-agency sector may not exhibit further deterioration due to delinquencies. "We found that delinquency activity closely follows the unemployment severity index and the index has peaked twice, which may signal a gradual decline and, with it, a decline in delinquency rates," they note. "We also examined ARM payment resets over the next 18 months in each credit cohort. We found that there will likely be anywhere between 5% and 14% in mortgage payment increases."

RMBS

Portuguese transactions on review

Moody's has placed on review for possible downgrade Aaa and Aa ratings on 23 RMBS and three ABS backed by Portuguese asset pools. This review was triggered by its decision on 5 May to place on review for possible downgrade the Aa2 rating on Portugal's government bonds, as well as the ratings of the country's rated banks. The completion of Moody's review of these ABS and RMBS ratings will be driven by the conclusion of the ongoing review of Portugal's sovereign and bank ratings.

Securitised transactions can maintain ratings higher than Portugal's government bond ratings because of two key benefits of EU membership, according to Moody's. First, as a member of the EU, Portugal is unlikely to experience a disruption to its national payment system. Second, membership of the EU also significantly reduces the risk of non-enforceability of contractual agreements and mitigates cross-border legal concerns.

However, Portuguese structured finance transactions could still maintain ratings in the Aaa and Aa categories if they can survive counterparty downgrades and stresses to collateral performance that include adjustments reflecting current circumstances, the agency adds.

RMBS

Mixed performance from EMEA RMBS

EMEA RMBS performance was stable during the first quarter of 2010, according to Fitch, but the agency notes that some performance concerns persist.

Fitch says that loans in arrears by three or more months have been relatively stable for the last two quarters, excluding UK prime and Irish RMBS that continue to deteriorate. However, prepayment rates for EMEA RMBS have continued on a downward trend as European mortgage lenders continue to offer little incentive for existing borrowers to refinance.

Peter Dossett, a director in Fitch's EMEA RMBS surveillance team, says: "Although EMEA RMBS performance in general has seen improvements, the overall picture masks the poor performance of selected deals. Fitch remains concerned that the weak macro-economic environment has not yet fully impacted borrowers and that a further deterioration in performance could occur."

During Q110, Fitch reports that it downgraded 68 and upgraded 10 tranches across EMEA RMBS. The downgrades were related to UK non-conforming and Spanish RMBS.

In addition, the rating agency downgraded all senior bonds in Greek RMBS following its 9 April 2010 downgrade of Greece's sovereign rating to triple-B on outlook negative.