Contents

Investors

Holding up

Change in approach for credit hedge funds

May's 'flash crash' appears to have precipitated a switch in approach for many credit hedge funds. While the market environment hasn't necessarily favoured hedge funds recently, performance in the sector is holding up better than in fixed income more broadly.

Credit has become illiquid in recent months and the flash crash hasn't helped the environment, according to PVE Capital cio Gennaro Pucci. "Most hedge fund strategies in vogue during 2009 have become difficult to execute and - as we expected - 2010 has become all about active trading, while flows are still characterised by yield-chasing activity. It has certainly revealed the weakness of long-only and range-trading strategies because you have to be very careful from a credit perspective," he explains.

Howard Eisen, md at FletcherBennett, says that since the flash crash occurred the market hasn't rewarded individual security selection. Rather, macro events have driven hedge fund managers to seek the right balance between gross and net exposures.

"It's been a traders' market," he explains. "In other words, it is vital to know when to take risk off or put risk on. But it isn't easy to take positions in this environment because of the intra-day momentum of the market."

Nevertheless, while the markets haven't necessarily favoured hedge funds recently, performance in the sector is holding up better than in fixed income more broadly. In particular, credit long/short (which is up by 4.7% year-on-year, according to the Credit Suisse/Tremont Hedge Fund Index), distressed (up by 4.1%) and event-driven (up by 3.4%) have proven to be top hedge fund strategies year-to-date.

"Credit long/short strategies ran nicely in 2009 and remain one of the better performing hedge fund strategies this year," confirms Eisen. "As the global economy continues to improve, spreads continue tightening and issuance remains robust, performance in this space should keep on improving. Certainly there will be opportunities for good managers that employ sound credit analysis."

In terms of distressed strategies, much of the low-hanging fruit in the segment appeared to have been picked in 2009, yet it also remains one of the better-performing strategies this year. Eisen points out that there are still plenty of struggling companies around and high yield issuance has plummeted over the last few months, which could be an indication of a small headwind.

Similarly, event-driven/merger arbitrage is another strategy that's performing well at present because such activity is directly correlated with the pace of M&A and IPOs. "M&A activity has certainly picked up since 2008/2009," Eisen notes.

Pucci observes that sovereign plays also currently provide some interesting opportunities for credit hedge funds. "There are compelling opportunities in the government bond and sovereign CDS sectors, particularly around the volatility that is emerging," he says. "The sovereign confidence/contagion issue is on par, if not greater than, the subprime crisis. It is becoming harder for primary dealers to run their portfolios and so they aren't participating in government bond auctions, which in turn means that it is becoming harder to sustain the market."

Eisen suggests that credit long/short, as well as equity long/short strategies belong in pension funds' core fixed income and equity buckets and not the alternatives bucket. "Long/short strategies are no different from a manager picking good equities and bonds; it's just a variation on a theme. Hedge fund strategies held up better than long-only equity and fixed income, and long/short strategies insulate portfolios from losses due to the ability to hedge against the downside. For example, if pensions had 10% of their core equity in long/short strategies, they could have prevented a sizable portion of their 2008 losses." In 2008 the typical pension's core equity portfolio was down by more than 30%.

There appear to be a few early adopters of this concept. At the same time, the largest institutional investors are increasingly allocating to alternatives and hedge funds in particular - albeit they have recently typically chosen the industry's biggest brands.

"2009 was a net outflow year for hedge funds, but 2010 is proving to be an inflow year - although not yet in big numbers and almost exclusively to big brand names," Eisen concludes. "It's somewhere between 80/20 and 90/10, where the majority of the assets are held by a minority of funds. Institutional investors don't get paid to take career risk and so hiring a big firm feels safer, despite the fact that smaller teams often generate the most uncorrelated returns."

CS

ABS

Still sidelined

Low volumes and wider ABS/MBS spreads causing some pain

Low trading levels and wide spreads continue to characterise the European ABS markets. Those involved note that much of the market is sidelined by sovereign concerns as market participants wait to see whether governments deliver on their plans to alleviate the situation.

One ABS dealer notes that the only part of the market which continues to perform to reasonable levels is the auto loan sector. Auto loan ABS spreads are only slightly wider than usual, which is far better than typical RMBS paper.

"In RMBS, we've moved back in terms of levels from 110-120 to 150 or 160-170 even, depending on the names," says the dealer. "But the main thing is that there are a lot of investors sidelined at the moment. There is not much activity."

A trader points out that although RMBS paper is as much as 50bp off, the higher bid assets are off 2bp-5bp, depending on the name. "We've retraced all of this year's gains and we're back at December 2009 levels or wider," he says.

"It's a bit of a wake-up call for some sellers, who haven't taken the opportunity over the first part of the year while others had. There's a mixed bag of investors and banks who have been left long with a lot of bonds. There's quite a lot of pain on some trading desks if they're particularly long in subprime and CMBS," the trader notes.

The trader adds that a number of banks that are long product have stopped bidding on paper and retrenched their positions. "Some traders hand out a lot of two-way prices, which don't work. This is pretty unhelpful for other people getting trades done at lower levels; it delays the whole process. This is a common complaint from clients," he says.

The trader believes that while the market is unlikely to recover in the near future, there is still room for certain players to improve performance. Sellers who have missed their chance to sell in the earlier part of the year may seize the opportunity to do so as pricing levels bounce based on the performance of other markets, he says.

Furthermore, he notes that while the level of activity is low for the size of the industry, some trades are still being done. "As a trading desk we're still turning over bonds and making some money, so we're not too negative," he says. "But I think the industry as a whole is in worse shape - it needs new issuance to really galvanise the other areas."

Although another £3bn Fosse deal has been issued, the dealer notes that it was privately placed with two or three investors. "A Storm deal went the same way," he says. "A few investors are still able to pick up big blocks, so they're picking up private placements."

Dexia also privately placed two out of the four tranches of its €6bn Belgian RMBS PENAT 2010-3 transaction, with the € 2.25bn triple-A rated 1.85-year class A1 notes pricing at 90bp over three-month Euribor and the €3.2bn triple-A rated 4.06-year class A2s coming at 110bp over. Separately, Bank of America Merrill Lynch disclosed price talk on its Moorgate Funding 2010-1 RMBS, with focus shifting from the senior tranches (which will likely be retained) to the junior/mezz notes that are still being offered (class Bs at 400bp, class Cs at 500bp, class Ds at 700bp and class Es at 900bp).

The dealer confirms that sovereign concerns remain the driving force behind the market slowdown. "A lot of people are a little bit reluctant to step in and would rather see how the sovereign issues develop. When there is a clear path leading out of the uncertainty, then people will come back into the market," he says.

The dealer continues: "Governments have been announcing nice plans. But planning to implement measures is one thing, and having an effect is another thing."

He believes that people are waiting for a resolution, but adds: "On the other hand, the summer has started and - given the current environment - I think people want to start the summer holidays early."

However, the trader notes that the market slowdown is likely to persist long after the end of summer. "I think we'll be at this level, or lower, for the rest of the year," he says.

JA

ABS

Latest Aussie deals tap US dollar demand

Two Australian transactions are currently marketing, each with US dollar-denominated tranches - indicating improved confidence in deals from the jurisdiction among offshore investors. One offering is a lease-backed securitisation (Macquarie Leasing's A$661.1m-equivalent SMART Series 2010-1 US Trust) and the other is an RMBS (Members Equity Bank's A$1.04bn-equivalent SMHL Securitisation Fund 2010-2E).

SMART Series 2010-1 US Trust is a securitisation of a portfolio of Australian novated leases, commercial hire purchase agreements, chattel mortgages and finance leases secured by motor vehicles, originated by Macquarie Leasing. The US$92m class A-1 notes have been provisionally rated P-1, while Aaa ratings have been given to the US$105m class A-2, US$210m class A-3 and US$93m class A-4 notes.

The A$15m class B notes have been rated Aa2, the A$18.2m class Cs rated A2, the A$16.5 class Ds rated Baa2 and the A$16.5m class Es rated Ba2. The A$6.6m seller notes have not been rated.

All of the class A-2, A-3 and A-4 notes will be split into two separate tranches. "Coming shortly after three other Australian ABS transactions, the deal continues the strong revival seen in this sector in recent weeks," says Ilya Serov, Moody's lead analyst for the transaction.

He adds: "It also represents Macquarie Leasing's first visit into the US markets, pointing to the improving confidence of offshore investors in Australian securitisation transactions. In fact, it is the first non-Australian dollar denominated transaction by an Australian ABS issuer since 2008 and the first transaction including US dollar-denominated tranches in recent memory."

Moody's says the SMART Series 2010-1US Trust is broadly similar to previous SMART transactions sponsored by Macquarie. Notable differences include the conservative composition of the receivables pool backing the transaction, the US dollar-denominated senior notes and the pro-rata principal repayment profile.

Meanwhile, the SMHL Securitisation Fund 2010-2E comprises US$282.9m class A1 bonds, A$315m class A2s, A$332.16m class A3s and A$29.12m class ABs - all provisionally rated triple-A. The class B bonds totalling A$18.72m represent 1.8% of the total amount of bonds to be issued and are unrated.

"ME Bank has been a strong issuer of Australian RMBS throughout the crisis and has included a range of features in its transactions, including a US dollar-denominated class of bonds in this transition with scheduled principal repayments," notes Adam Daman, analyst in Fitch's structured finance team. "This feature, which is unique to this transaction, will help make the currency swap more affordable and also give some investors a greater degree of comfort in terms of the timing and size of repayments."

The collateral for the transaction comprises 7,947 full documentation mortgage-backed loans originated by ME Bank under the Superannuation Members Home Loans programme. The portfolio's weighted average loan-to-value ratio is 62.5% and weighted average seasoning is 43.0 months.

CS & JL

CDPCs

Primus portfolio quality 'surprising'

Primus Financial last week publically released details of its credit swap portfolio. The quality of the CDPC's exposures has surprised some in the market.

Bradley Golding, md at Christofferson, Robb and Company, confirms his surprise at the quality of the Primus portfolio, especially in terms of the small amount of monoline and mortgage insurer exposure. The only potential blemish in the portfolio is CIFG North America because of its exposure to US residential mortgages, he notes.

"Primus dodged a lot of bullets: it had exposure to Iceland, AIG, ILFC and RBS," Golding adds. "None of these names suffered credit events, but if they had it would have been a completely different outcome in terms of Primus' portfolio. We can't quite blow the all-clear whistle, but - given the short tenor of the portfolio - much of it will have run off by the end of the year."

Primus reports that, as of 21 June 2010, its consolidated net portfolio of single name credit swaps was US$9.17bn with a weighted average remaining maturity of 1.41 years. Approximately 46% of these single names are denominated in euros, with the remainder denominated in US dollars.

The last single name credit swap in the portfolio is scheduled to mature in September 2013. Total future premiums on this portfolio are expected to be approximately US$61m, assuming the transactions run to full maturity.

Meanwhile, the CDPC's consolidated portfolio of credit swap tranches sold is US$3.8bn with a weighted average remaining maturity of 4.03 years, as of 21 June 2010. It is all denominated in US dollars.

The last tranche transaction is scheduled to mature in December 2014. Total future premiums on this portfolio are expected to be approximately US$57m, assuming the transactions run to full maturity.

Finally, Primus also reported that, as of the June date, its portfolio of ABS CDS was US$23.7m in notional amount, with an expected weighted average remaining maturity of 1.6 years. This portfolio is denominated in US dollars and future premiums are expected to be approximately US$407,000, assuming the transactions run to expected maturity.

Golding suggests that Primus should have released information about its portfolio to equity investors a long time ago. "The fact that bank counterparties have had it for a while and equity investors haven't makes me suspicious about what Primus' motives are. Banks have essentially stopped dealing with Primus and so perhaps things aren't so good for the CDPC, especially with its recent tear-ups done below market. Nevertheless, the dissemination of the portfolio details was effectively insider information before, but now everyone's on a level playing field."

CS

CDS

Dodd/Frank legislation could hinder US CDS

With CDS volumes already dwindling, the latest initiative by members of a House and Senate conference could arrest even more trading - particularly for US banks. The Dodd-Frank Act, named after Senate Banking Committee Chairman Christopher Dodd and House Financial Services Committee Chairman Barney Frank, states banks will have two years to move credit default swaps to a subsidiary that is separately capitalised.

The plan also calls for other activities involving commodities and equity swaps to be traded at the subsidiary level, but allows for interest rate swaps and foreign exchange contracts - which are used as hedging instruments - to remain where they are traded.

"It's definitely better for the bread and butter business that a lot of the banks in the US do," says Matthew Magidson, vice chair of the derivatives practice group at Lowenstein Sandler. But for credit derivative operations, the changes are more far reaching, he says. "It's not exactly clear how that affiliate is going to look like and how that affiliate's going to be capitalised...but that to me is going to be very harmful to those businesses at banks in the US."

According to the Bank for International Settlements, CDS and commodity derivatives both saw their outstanding amounts fall by 9% and 21% respectively in the second half of 2009. "Market values fell by another 36% for single-name CDS and by almost 50% for multi-name contracts," according to a BIS report released this month.

A hedge fund who wants to buy CDS protection may prefer to buy CDS from one of the large foreign banks that have the full strength and balance sheet of a bank behind it than buying it from some derivatives-only affiliate, says Magidson. Hedge funds, he adds, also like to hedge their exposure to banks.

"This affiliate may not have the ability to do that. From that standpoint, it seems like it could really promote moving those businesses to other banks, other institutions that are not based in the US," he says.

The two-year time limit to set up the affiliate could also be a hindrance to market participants. "To me, two years is not very long," Magidson notes. "It could potentially [be] a year before you have the rules out. It seems very hard to me."

Market participants were surprised that the legislation kept a hard-line on the swaps provision, but overall were pleased it did not go as far as Senator Blanche Lincoln had originally proposed. Under her plan, she called for banks that received federal support to be banned from trading swaps altogether.

The Senator still was in favour, however, of the outcome. In comments made last Friday (25 June), she said: "This legislation brings a US$600trn unregulated derivatives market into the light of day, ending the days of Wall Street's backroom deals and putting this money back on Main Street where it belongs. These reforms will get banks back to the business of banking, protect innocent depositors and ensure taxpayers will never again have to foot the bill for risky Wall Street gambling."

Meanwhile, ISDA estimates that US companies could be US$1trn worse off under the Dodd-Frank Act, if it requires initial and variation margin to be posted for all non-cleared OTC derivatives. An exemption for corporate end-users has been removed from the bill.

Of the US$1trn of estimated capital and liquidity requirements, around US$400bn would be needed as collateral posted with dealer counterparties to cover OTC exposures, while additional credit capacity of US$370bn may also have to be maintained to cover future exposure. A return to 2008 market levels would round the figure to US$1trn, ISDA notes.

"The margining requirements for corporate end-users as currently drafted in the bill runs the risk of imposing a significant cost on US companies and could impede their ability to manage their business and financial risks," says Conrad Voldstad, ISDA ceo.

He adds: "These provisions would increase rather than decrease risk. They work against the bill's main purpose, which ISDA clearly supports, of enhancing financial stability and strengthening our financial system."

ISDA used 2009 year-end data from the Office of the Comptroller of the Currency on derivatives exposure and margining. The association says its analysis is based partially on this data and also on assumptions and estimates regarding corporate end-user exposure, required margin levels and other factors.

The notional value of derivatives held by US commercial banks at year-end 2009 totalled US$213trn. ISDA assumes that 10% reflects corporate end-user activity and initial margin would be 1%. This equates to a US$213bn collateral requirement.

As well as US$325bn of margin for dealing with US banks, companies will have to post margin for transactions with non-US banks, which ISDA believes could push the total up US$81bn to US$406bn.

Further, a fund for potential future exposure could total US$370bn, made up of US$296bn for US banks and US$74bn for non-US banks. ISDA believes any market turmoil could mean several hundred billion dollars of additional collateral requirements for end-users, which may bring the final total to US$1trn.

KFH & JL

CMBS

US conduit CMBS loan payoffs examined

Just short of US$11bn in US conduit CMBS loans reached their expected payoff date by the end of May, representing about one-third of 2010's projected total of maturing loans. CMBS analysts at Bank of America Merrill Lynch survey in a new report the timing of these maturities by month, as well as the break-down of the maturing loans by those that have either paid off or been liquidated and those that remain outstanding.

The BAML analysts point out that GGP-related loans dominate the loan extensions in this data set and account for just under 75% (by balance) of loans that were scheduled to mature in the first five months of the year but received an extension.

Their survey indicates that of the US$11bn of loans that have reached their scheduled maturity this year, 48.6% of the loans (by balance) have paid off. About 22% of these (or 11% of the total maturing) paid off after their scheduled maturity.

The other half of the loans (50.3%) that hit their maturity in the first five months of 2010 remain outstanding. A little less than 15% of the total have been officially modified and extended, with the remaining amount simply in default.

The remainder of the maturing loans, 1.1%, have been liquidated at a loss greater than 3%, according to the analysts.

For maturing loans, the biggest factor in determining whether they will pay off appears to be when they were originated. Three specific origination years - 2000, 2004 and 2005 - account for the vast majority (86%) of the maturing loans surveyed.

The analysts note that the difference in performance of maturing loans based on when the loan was originated is unsurprising, as the more seasoned loans tend to be less levered to begin with and have benefited from the longer-term price appreciation of commercial real estate. "While commercial real estate values are arguably below prices from five years ago, they are higher than they were 10 years ago," they explain. "The older loans also generally benefit from a greater amount of amortisation. The combination of these factors makes refinancing these older loans more likely."

Even the 2004 originated loans tend to have a significantly higher payoff percentage than those from 2005 (64% versus 33%) - a distinction that the analysts believe is noteworthy.

"While many characteristics (property type, loan size) don't have discernable patterns, we clearly see that less seasoned loans are facing more difficulty refinancing," they conclude. "This is important not just for the current valuations of deals facing large maturities, but is worthwhile to consider as we get closer to 2011/2012, when a large number of five-year loans from the more poorly underwritten 2006 and 2007 vintages face maturities. On the other hand, a continued improvement in the financing environment could potentially negate some of the problems from the maturing highly levered loans coming due."

Fitch reports that US$9.6bn of fixed rate CMBS loans will mature within the next six months, according to a recent review of its US CMBS portfolio. The largest amount of loans due are expected in December, when 183 mature, totalling US$1.9bn.

In October, 180 loans are due to mature, also totalling US$1.9bn. In July, 148 loans are set to mature, totalling US$1.7bn. More than 100 loans out of the 960 loans set to mature in total are in special servicing.

Fitch does not expect near-term negative rating actions for loans not able to refinance in recent vintage CMBS, however, since its recent prospective ratings review included a refinance test. "While liquidity is slowly returning to the market, the time it takes for borrowers to refinance continues to be a lengthy process," says Adam Fox, senior director at the agency.

Of the 11 loans greater than US$20m scheduled to mature in July, Fitch expects eight loans to default at maturity based on its assumptions. But 133 out of the 148 loans due to mature in July have an average balance of US$8.5m and are current and performing.

CS & KFH

CMBS

Pair of unusual Euro CMBS proposals emerge

Two unusual proposals have emerged in the European CMBS market over the past week. The sponsor of REC 6 is seeking to repurchase of all of the deal's notes, while the proposed restructuring of Titan Europe 2006-4 appears to be extremely generous to investors.

An entity sponsored by certain directors of Alburn Real Estate is considering making a tender offer in respect of all the REC 6 notes presently outstanding, but will only do so if it is likely to acquire at least three-quarters of each class. Chalkhill Partners structured finance strategists suggest that this would allow Alburn to force through redemption on its own terms.

"While we have seen tender offers in relation to other deals, this is the first CMBS we can recall where a sponsor might repurchase all the notes at a discount and collapse the deal," the strategists note. "Other tenders, such as that for GRND 1 have only been partial (and have not necessarily led to the notes being cancelled). It will be interesting to see the reaction from bondholders."

The entity says it will discuss its plans with noteholders over the next few weeks with a view to getting an initial assessment of whether, and at what price, they would be willing to tender their notes. Noteholders are also asked to note that the entity does not currently have any firm funding commitments: the institutions with whom it has been discussing funding needs have given assurances that when they have a strong enough indication that a significant number of notes are likely to be tendered, they will be able to provide a firm commitment.

The Chalkhill strategists point out that the deal is in clear difficulty from an LTV perspective: the most recently reported whole loan LTV was 142.5% (securitised 133.7%) based on the October 2009 valuation. There was also a negative mark-to-market on the swap of £21.8m as at the end of March.

"The tender may prove an attractive exit route for some bondholders, but whether levels that work for the sponsor will be acceptable to bondholders is uncertain," they remark.

Meanwhile, a proposal presented to Titan 06-4 bondholders appears to go far beyond what has been offered in previous Euro CMBS restructurings, suggesting that investors have extracted significant value during the negotiations. The proposed restructuring involves: a two-year loan extension to 3 September 2012; class A1 margin increase from 25bp to 375bp (plus an additional 100bp from January 2012, unless targeted principal reduction has taken place); class A2 margin increase from 38bp to 500bp in cash, plus 250/300bp toggle (plus an additional 100bp from January 2012, unless targeted principal reduction has taken place); legal final maturity on the notes extended by one year to 2014; liquidity facility to be extended or an alternative found; and a fee payable of 0.6% of principal for noteholders agreeing before 16 July, falling to 0.2% for those signing after 16 July but before the date on which notice of the noteholder meeting is given.

While the proposal sets a precedent of sorts, there are two key differences from other deals, the Chalkhill analysts note. First, an operating company is undertaking the discussions rather than a pure propco. Hence, it has been possible to access the operating cashflows to support the increased coupons rather than relying on rental income.

Second, significant equitisation of junior debt has already occurred, thereby reducing the ongoing debt servicing costs. "In more typical CMBS deals, there simply would not have been enough cash to make it possible to increase the coupons by this amount," the analysts comment.

Faced with the current backdrop of depressed property values and dearth of available funding, servicers are increasingly incentivised to extend CMBS loans in return for delevering. Where noteholders have been consulted, they have typically demanded a revision to the economics of the loan (upfront fees and increased margins) to better reflect current market conditions.

European asset-backed analysts at RBS point out that only 10 transactions within the European CMBS space, accounting for around 3% of loans by outstanding balance (£2.3bn and €1.2bn), have been subject to a restructuring incorporating loan extension. Of these, the majority (£1.8bn and €1.1bn) were high profile loans backing single-borrower transactions.

"The main driver of loan restructurings has been default/risk of default at maturity, with borrowers/equity behind the loan attempting to secure a restructuring of the loan rather than lose control of the property from an enforcement and sale process," the RBS analysts explain. "Extension terms have varied considerably, ranging from 12 months to four years, with extensions in conduit transactions generally limited by the transaction structure requiring loan maturities to be at least two or three years prior to note legal final."

Separately, FLTST 2 has issued a notice about the discussions between the servicer, other lenders, the borrower (Highstreet) and the preferred bidder for the tenant (Berggruen). The proposed, as yet undisclosed, changes to the master lease agreement will be put to noteholders to vote on. However, the servicer and the ad hoc committee of bondholders rejected a proposal from the borrower for further modifications to the securitised loan.

CS

Regulation

Concerns continue

Risk retention no solution for ABS

The Senate and House bill requirements for securitisers to retain 5% of the credit risk from pools of securities along with the SEC's proposal in April to have firms hold 5% of each class of ABS is still causing debate among industry participants, according to panellists at an IQPC ABS Summit in New York.

The 5% retention requirement made its way through Congress intact, Faten Sabry, svp at NERA Economic Consulting said. The inability to hedge that 5% risk retention is an important condition, she noted.

If risk retention has to be done, it should be catered to be deal-specific, Sabry added. "We as economists do not think there is a one-size-fits-all for structured products when it comes to risk retention."

Recent legislation from the Dodd/Frank bill, however, exempts some high quality mortgages from the risk retention requirements.

The three sets of parties that exist currently in the securitisation markets - such as banks, originators and brokers, investors and finally trustees and servicers - have competing and not necessarily aligned incentives, Sabry continued. "We need to find a way to align these incentives."

The SEC regulations have another 30 days for comments to be accepted regarding shelf-eligibility requirements. "The SEC said the arranger of the deal has to provide loan level data to make available to everyone. You have to provide a programme to help investors calculate the waterfall of these deals and give investors more time between issuance and think through the deal," she explained.

"The question is: is this an appropriate response?" Sabry asked. She further commented: "Is 5% retention risk without hedging and hiring a third party to verify the quality of the deal every quarter or every six months going to help?"

"Risk retention can mitigate the incentive of an issuer to sell poorly underwritten loans, but cannot remedy broad errors in risk management by market participants," noted Adam Ashcraft, vp and head of structured credit at the Federal Reserve Bank of New York. "In a sound securitisation market, investors have adequate time, information and incentives to do serious credit work on transactions."

Investors themselves are also not completely in favour of the risk retention requirement for banks. Some believe the banks will just figure out a way to get their profit first, one panellist suggested.

"Risk retention doesn't solve everything. Risks need to be aligned with the incentives of investors," he said.

Europe has similar 'skin in the game' proposals, noted another panellist at the conference, but key differences exist. In the US, most of the proposals are issuer-focused, whereas in Europe the compliance part of the European proposals is more focused on the buyer side of ABS, he explained.

Europe initially started out with a higher risk retention than 5% and eventually went back to a very flexible system that takes into account different assets, he added. If the US reform legislation is indeed signed in this week, he suggested that there will be "extra innings", referring to the heavy amount of uncertainty that still exists over the legislation.

"In the end, maybe retention won't be such a big deal if it's done properly," the panellist said. He noted that a whole new securitisation market is being built to fix one little piece of it.

The economic backdrop in the US is also not helping appease the risk retention debate either. Despite the various US government relief programmes, delinquencies for prime and subprime loans are at all time highs, NERA's Sabry pointed out. "The same is true with foreclosures," she noted.

KFH

Advisory

Boutique lands senior advisor

Richard Atterbury has joined structured finance boutique AgFe in a senior advisory capacity. He was previously chair of EMEA investment at Nomura Holdings. Before that, he was co-head of European capital markets at Lehman Brothers and an md at Morgan Stanley.

CDO

Manager change for ABS CDO

Moody's says the change of collateral manager for Parkridge Lane Structured Finance Special Opportunities CDO I will not cause note ratings to be reduced or withdrawn. Bernard Capital Funding is being replaced as collateral manager by Parkridge Lane CM.

The new management agreement follows the key terms and provisions of the previous agreement, with the exception that it includes an irrevocable waiver by Parkridge Lane of any collateral management fee. The change received the consent of the majority of the aggregate outstanding amount of the notes.

CDO

Veteran to head up global sales

Aladdin Capital Holdings has hired Keith Innes as global head of sales. He will be based in Stamford and be chiefly responsible for overseeing the firm's global distribution capabilities.

Innes will join the executive committee and report directly to chairman and ceo Amin Aladin and cio Neal Neilinger. He joins from Forum Partners, where he was responsible for sales and marketing.

Innes has over 25 years of experience in institutional sales, having also previously worked for Banque Indosuez and Lehman Brothers. At Indosuez in Hong Kong, he was md and co-head of a 30-strong credit risk team. For Lehman, Innes was an institutional salesperson and later headed the Asian fixed income business.

Neilinger comments: "As Aladdin continues to grow both its investment banking and investment management businesses, it is critical to our success that we have someone in place with a strong management background to oversee the coordination and communication of our global sales and marketing efforts. Keith's experience in managing and leading institutional sales teams will be very valuable."

CDS

IDBs settle CDS pricing manipulation charge

FINRA has imposed fines totalling US$4.3m against Phoenix Derivatives Group of New York and eight brokers - three employed at Phoenix and five at four other interdealer brokerage firms - for improper communications about customers' proposed brokerage rate reductions in the wholesale CDS market.

"These settlements reflect our continued pursuit of conduct that undermines fundamental principles and rules upon which customers and free markets rely for efficient price discovery," says Tom Gira, evp of FINRA's Department of Market Regulation. "FINRA's requirements to observe high standards of commercial honour and just and equitable principles of trade are designed to prevent the types of inter-firm communications that occurred in this case, which threaten the proper function of market forces."

FINRA alleges that Phoenix improperly attempted, through the efforts of its three CDS desk heads, to influence other CDS inter-dealer brokers to reduce brokerage fee rates from 1 July 2005 to 1 December 2006. Phoenix has been censured and fined US$3m.

Of that fine, US$900,000 has been apportioned among the three desk heads. Managing partners Wesley Wang and Marcos Brodsky have agreed to pay US$450,000 and US$350,000 respectively, with former managing partner Jon Lines paying US$100,000. The trio have been suspended from working in the securities industry for two months, one month and three months respectively.

FINRA also alleges that Phoenix's supervisory systems were not reasonably designed to detect such inappropriate behaviour and it failed to enforce supervisory reviews of electronic communications. In addition, the firm is charged with failing to maintain any of its non-Bloomberg instant messages during the review period and for incomplete electronic communications to staff.

Five brokers at other interdealer firms in the CDS market were also fined a total of US$1.3m and issued suspensions as part of FINRA's ongoing review in this area.

Thomas Lewis and Matthew Somers, former brokers and co-managers for the CDS desk at Chapdelaine Corporate Securities & Co, were each fined US$350,000 and suspended from working in the securities industry in all capacities for six months and three months respectively. John Tompkins, a former broker and manager of the CDS desk at CreditTrade, was fined US$100,000 and suspended in all capacities for four months.

Michael Jessop, a former broker and co-manager of the CDS desk at Tullett Liberty, was fined US$250,000 and suspended in all capacities for two months. Finally, Eric Ridder, a former broker for Creditex Group, was fined US$250,000 and suspended in all capacities for two months.

FINRA fined ICAP US$2.8m in June 2009 and fined and suspended a former broker for related misconduct. FINRA says its investigation is continuing.

FINRA found that the eight brokers engaged in communications with personnel at other interdealer brokerage firms that improperly attempted to influence those firms and individuals. These communications generally occurred after individual customer firms sought to renegotiate their CDS brokerage fees, sending schedules of proposed rate reductions separately to a number of individual interdealer brokers.

The communications that the eight brokers engaged in with personnel at other interdealer brokers included reactions to customers' proposed rate reductions and statements concerning actual or contemplated interdealer broker responses or counter-positions to the customers' proposed rate reductions. Certain brokers' communications with other interdealer brokers also included discussions about creating identical, or similar, individual counter-proposals to rate reduction requests.

FINRA also found that while many of the brokers' communications typically involved one-to-one discussions with personnel from other CDS interdealer brokerage firms, certain of those discussions also referred to similar communications about the proposed fee-reduction schedules with additional interdealer brokerage firms.

Phoenix and the eight individuals settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings.

CDS

Co-head of credit to join ex-colleague

Investec Asset Management's global co-head of credit, Jeffrey Burch, will leave the firm at the end of the month to join London-based hedge fund, Millennium Capital Partners, reporting to Iftikhar Ali.

Burch, who joined Investec in June of last year, had previously worked with Ali at Bank of America. Following this, Burch joined BlueMountain Capital, where he ran the hedge fund's European credit operations, while Ali ran the European credit business at James Caird Asset Management.

It is believed that Burch will be replaced at Investec by Theo Stamos, who joined the credit team from BlueMountain in October of last year (SCI passim). Stamos will work alongside co-head, Simon Howie.

CDS

Global credit strategy head hired

BNP Paribas has hired Robert McAdie to fill the newly-created post of global head of credit research and strategy. He will be based in London and starts in August, reporting directly to David Brunner, deputy global head of fixed income at the bank.

Brunner comments: "Robert's appointment reinforces BNP Paribas's long-standing commitment to credit research and strategy and will help to ensure that we actively follow all major markets, serving institutional clients around the world. The globalisation of our research teams is an essential part of the growth of our credit business worldwide and will also allow the bank to expand its global franchise with investment managers."

Foremost among McAdie's new responsibilities will be overseeing BNP Paribas' global credit research function, which includes independent credit research and strategy. The bank says he will also be responsible for sector specialists in conjunction with the credit trading desks.

McAdie has more than 15 years of experience in research and strategy. He was global head of credit strategy and European head of credit research at Barclays Capital before leaving last month (see SCI issue 183). Before joining BarCap in 2004, he spent four years leading European credit strategy at Lehman Brothers and six years before that at Salomon Brothers, where he was head of European emerging markets strategy.

The appointment is part of a wider push to expand the bank's global credit business. Christian Mundigo and Benjamin Jacquard were last month appointed global co-heads of credit trading, based in New York and London respectively (see SCI issue 186), while numerous hires have also been made to the US credit platform recently.

CDS

Asian fixed income duo hired

Crédit Agricole CIB has hired two sales and trading personnel to its fixed income markets team for Asia ex-Japan. The bank says the hires will strengthen its distributions and trading capabilities and reaffirm its commitment to the region. The pair will be based in Hong Kong.

Damian Rowe has been hired as executive director and head of credit trading, debt and credit markets. He is joined by Calvin Cheung, director of financial institutions sales for Hong Kong.

Rowe now reports locally to Swaroop Patel, head of debt and credit markets for Asia ex-Japan, and globally to Bruce Whyte, head of emerging market credit trading. He is responsible for overseeing the Asian arm of the bank's emerging markets credit trading platform and he is also integrating the Asian emerging markets products suite with existing platforms in London and New York.

Rowe joins from Citigroup in Hong Kong, where he was director for Asian credit trading. Before that, he was head of Australian credit trading for ABN AMRO.

Calvin Cheung will report to Anna Cheung, head of financial institutional sales for Hong Kong and will be responsible for sales and marketing the bank's fixed income markets products. He joins from Standard Chartered Bank, where he was head of SME sales in Hong Kong. Previously, he worked for Bank of Tokyo-Mitsubishi and Siam Commercial Bank.

CDS

Derivatives partner recruited

Robert McLaughlin has joined Fried, Frank, Harris, Shriver & Jacobson as a partner in its asset management and financial services practices. He was most recently the co-chair of the structured products practice at Katten Muchin Rosenman.

McLaughlin's practice concentrates on financial transactions with an emphasis on OTC derivatives, structured products, synthetic investments and credit extensions, as well as derivatives claim trading. He regularly advises market participants on legislative and regulatory developments. He has extensive experience structuring and executing a wide array of financial derivatives and structured products, as well as synthetic investments in hedge fund interests, commercial loans and other asset classes.

"The derivatives and prime brokerage areas are in a growth mode. Bob's solid expertise in asset management, OTC derivatives and prime brokerage matters enhances our ability to offer our clients a full-service, world-wide derivatives practice that includes derivatives and regulatory lawyers in the US, Europe and Asia," comments Lawrence Barshay, partner and head of Fried Frank's asset management group.

CLOs

Leveraged finance director appointed

GE Capital has hired Dan Matthews as executive director of its European leveraged finance unit. Matthews will join the UK-based origination team and report to Paul Scott, md and head of sponsor coverage. He will be responsible for growing the firm's sponsor lead arranger franchise.

Matthews joins from Barclays Bank's strategic debt finance division, where for five years he sourced, structured and executed private equity-backed transactions, having had coverage responsibility for the UK mid market. Before Barclays, he spent six years generating senior and mezzanine debt opportunities for Rothschild, where he also established its first leveraged loan CLO.

James Fenner, GE Capital EMEA head of capital markets, says: "GE Capital is working hard to further develop its market-leading sponsor lead arranger franchise and Dan's arrival will enable us to further build on the great foundation already laid down this year."

CMBS

CRE advisory relationship agreed

Sorin Capital Management and HFF Securities are joining forces in a strategic advisory relationship in the US CRE space. Under the agreement, Sorin will have access to HFF professionals' sector opinions and capital markets platform.

"We look forward to a long-term relationship with HFF Securities," says Jim Higgins, Sorin founder and ceo. "As we continually seek to maintain Sorin's edge as a leading real estate securities investor, we believe HFF's insight into local markets across the country and ability to provide granular, property-specific information will only strengthen our already robust investment process."

CMBS

Midwest CRE markets leader hired

A10 Capital has hired Greg Cazel as evp, leading the firm's US Midwest markets division. Cazel was most recently regional director for a joint venture by Jones Lang LaSalle and Real Estate Disposition, which sold performing and non-performing notes and loan pools.

"Greg is one of the most respected and productive commercial real estate finance professionals in the Midwest," says Jerry Dunn, A10 ceo. "He will lead our efforts to originate value-add commercial mortgages in this important region."

In his 25-year career Cazel has worked for Dexia Bank, running the Midwest commercial real estate lending office, and led a highly successful CMBS loan production team at JPMorgan Chase.

"Even though more commercial real estate lenders continue to come back into the lending the markets, the 'box' has shrunk considerably from where it was a few years ago," Cazel says. "The majority of life companies and CMBS shops that actually are lending are extremely selective on what will qualify. Many potential transactions that may have passed muster in the past will no longer be supported, given today's strict underwriting standards."

Cazel says A10 can fill the void created by these standards. He explains: "We lend on un-stabilised properties, allow cash-out recapitalisations, make note purchase loans and provide mezzanine and equity capital on good properties that are nearly, but not quite, bankable."

CMBS

Strategic link-up for distressed CMBS

1st Service Solutions has linked up with Reznick Restructuring Solutions (RRS) to provide CMBS loan modification assistance to borrowers. Dallas-based RRS will provide full-service loan restructuring, recapitalisation and tax advisory solutions to asset property owners and developers with distressed properties secured by CMBS debt and those facing cashflow issues when loans come due.

"Borrowers with distressed loans are often confused about when and how to proceed with a loan restructuring or assumption," says Ann Hambly, 1st Service Solutions president and ceo. "By partnering with RRS we can provide a broad range of borrowers with a variety of debt restructuring and loan workouts solutions."

CMBS

German CMBS debt assumed

Corestate Group has announced its acquisition of a €160m residential and commercial real estate portfolio comprising 40 properties in Berlin. The purchase was funded via a conduit CMBS, but neither the affected loan nor transaction has been disclosed.

The portfolio offers slightly lower than market rental levels and assets are mostly located in sought-after micro-locations in Berlin. The portfolio also includes a €35m project development in the city-centre.

Corestate plans to invest significant capex amounts to further improve profitability and the already good asset quality of the properties over the next few years. The portfolio was previously acquired by a foreign investor during the peak cycle of the German real estate market.

This is the fourth transaction that Corestate has realised in 2010. "The complex assumption of securitised CMBS debt is an extreme challenge for all parties involved and offers a good preview for the upcoming years," says Corestate founder Ralph Winter.

RMBS

REIT reveals RMBS investment plans

Chimera Investment Corporation has priced an underwritten public offering of 100 million shares of its common stock for expected gross proceeds of approximately US$365m before expenses. The REIT expects to use the proceeds of this offering to finance the acquisition of RMBS, prime and Alt-A mortgage loans, commercial mortgage loans, CMBS, CDOs and other ABS. It says it may also use the proceeds for other general corporate purposes, such as repayment of outstanding indebtedness, working capital and for liquidity needs.

Chimera has granted the underwriters a thirty-day option to purchase up to an additional 15 million shares of common stock solely to cover overallotments. Credit Suisse Securities is acting as the lead book-running manager for the offering, with Bank of America Merrill Lynch and RCap Securities acting as book-running managers.

Trading

Boutique adds three in sales

The PrinceRidge Group has hired three new team members to its structured products desk in the firm's newly opened Chicago branch.

Tom Connors joins PrinceRidge as an md, structured products sales and the head of its Chicago branch. Connors brings over 25 years of experience to PrinceRidge, where he is responsible for covering institutional clients focusing on structured product sales in mortgages, ABS and CMBS. Prior to joining PrinceRidge, he worked at Credit Suisse in Chicago, where he was an md in structured sales covering insurance companies, money managers and hedge funds.

Todd Arbuckle joins PrinceRidge as an executive director, structured products sales. His responsibilities include delivering MBS, ABS and CMBS to institutional clients. Arbuckle brings over 20 years of experience to PrinceRidge's clients, having previously worked in fixed income sales, global securitisations and distressed loans at RBS/ABN AMRO Bank, Bank of America and Morgan Stanley.

Finally, Janae Winner joins PrinceRidge as a director, structured products sales and is responsible for sourcing and distributing structured products to the firm's institutional client base. Prior to joining PrinceRidge, Winner was at Credit Suisse, where she worked in fixed income sales focusing on structured products.

ABS

1st Financial plans another ABS foray

An ABS deal is in the planning stages for 1st Financial Bank USA for November, marking its second offering in 2010, says the firm's cfo Gregg Silver. The transaction is expected to between US$100m and US$150m, but most likely US$125m.

A launch in the autumn will fit nicely into its maturity schedule, since the borrower prefers to ladder its maturity dates. Its last offering was in April.

1st Financial used to fund most of its credit card portfolio via the securitisation market, but it will be securitising less compared to previous years, says Silver. Time deposits are becoming more attractive on a relative basis, he adds.

ABS

CarMax outlines issuance strategy

Consumer demand for autos is just not back to where it was pre-recession since there is still a lot of uncertainty in all sectors of the market, according to CarMax executives on a conference call last week. The firm is in the market with the US$650m three-tranche CarMax Auto Owner Trust 2010-2.

"There's some nervousness out there. Almost everything we sell requires a loan," says Tom Folliard, president and ceo of CarMax.

Rating agencies are also still relatively conservative in their outlook, according to the CarMax executives. But "when we go to the public market, we don't want to hold a bunch of these sub bonds," adds Folliard.

CarMax utilised the TALF programme last year in bringing several US dollar ABS offerings. A US$735m deal in April of 2009 featured both senior and subordinate tranches. The company also came to market this past February with a US$470m non-TALF deal that included both triple-A tranches and sub pieces.

In conjunction with its agreement with Santander Consumer USA, the bank is purchasing a large portion of the loans that CarMax Auto Finance (CAF) would have originated prior to CAF's tightening of lending standards in 2009. During this quarter, CAF entered into a second warehouse facility that renews in February 2011. Its total capacity remains US$1.2bn.

CarMax also completed its three store openings in Ohio and Georgia that were originally planned. "We haven't changed our expectations of how we expect stores to perform in the long run," says Folliard. Compared to a year ago, a customer today would get a significantly higher offer on car sales just due to the market, he adds.

CarMax reported a net earnings increase of 252% to US$101.1m, compared with US$28.7m in Q1 of fiscal 2010. CarMax Auto Finance reported income of US$57.5m compared with a loss of US$21.6m in Q109.

ABS

Pair of German auto ABS surface

A couple of German auto ABS transactions hit the market last week. FCE Bank's €502.75m Globaldrive 2010-A priced, while a restructured Cars Alliance deal was marketing.

Globaldrive 2010-A consists of three tranches; the senior one sold and the other junior tranches both retained. Deutsche Bank, HSBC and Royal Bank of Scotland served as joint lead managers.

The €474.45m Aaa/AAA (Moody's/S&P) rated class A notes have a weighted average life of 2.19 years and priced at 160bp over one-month Euribor. The €28.3m 3.7-year A2/A class Bs and €26.786m unrated class Cs priced at 250bp over and 7% respectively. Legal final maturity for all three tranches is April 2018.

The 41,517 German auto loan contracts in the portfolio have an average balance of €12,755 and weighted average seasoning of 4.51 months. Credit enhancement comes from 10.4% note subordination, a reserve account of 3.1% and initial excess spread is 2.59%.

Meanwhile, preliminary credit ratings were assigned to the class A1 and B series 2010-1 notes to be issued by Cars Alliance Auto Loans Germany FCT. An unrated tranche of class C notes will also be issued.

S&P currently rates Cars Alliance's class R notes triple-A and its class S notes single-A. The agency expects to confirm those ratings following the restructuring of the Cars Alliance Auto Loans Germany FCC 2007 transaction and issuance of the new A1, B and C notes.

The German branch of RCI Banque is the originator, with the new transaction refinancing a portfolio of auto loan receivables originated in Germany. In the 2007 transaction the issuer issued a series of medium-term notes that had a revolving period. It also issued short-term revolving notes rolled over on their expected maturity, which was between one and four months.

The 2007 medium-term notes were repaid in October 2008, with the portfolio now fully funded by short-term notes. New medium-term notes will be issued to refinance some of the outstanding short-term notes and fund new assets. Credit enhancement will also increase and the issuer will be transformed into a Fond Commun de Titrisation under the restructuring.

In addition, the priority of payments will change, in particular so that the issuer will only activate the accelerated priority of payments if the coupon on the senior classes of notes is not paid or if there is an issue liquidation event. If it is activated, the class B and S coupons will be completely subordinated to the senior notes principal.

ABS

Student Loan Corp due with FFELP deal

Student Loan Corporation is due with a FFELP offering. It is expected to be rated triple-A by Fitch.

The deal, called SLC Student Loan Trust 2010-1, features class A notes structured as either pass-throughs or three tranches paid in sequential order, notes Fitch. As of the statistical cut-off date, approximately 65.91% of the student loans were originated on or before 1 July 2006. The largest state concentrations of the 2010-1 loan pool are in California and New York, with 11.12% and 10.57% respectively.

The offering, which is expected to be more than US$800m, is to be managed by Citigroup, according to an investor.

ABS

Santander's auto loan purchase 'credit positive'

Santander Consumer USA has agreed to purchase US$3.2bn in auto loans from CitiFinancial and to service US$7.2bn in auto loans retained by its parent Citigroup. The agreement is a credit-positive development for investors in CitiFinancial's outstanding auto loan ABS deal, CitiFinancial Auto Issuance Trust 2009-1 (CAIT 2009-1), according to Moody's in its latest Weekly Credit Outlook.

"CitiFinancial's auto ABS investors should benefit from the servicing transfer," Moody's notes. "Santander's rating is higher than Citigroup's and it has considerable experience in acquisition and servicer transfer. In March, it acquired the auto loan portfolio of HSBC Financial Corp and in November 2009 it purchased Triad Financial. To the extent that Santander can leverage its experience, CitiFinancial's auto ABS investors should benefit."

Citigroup has provided performance guarantees for the timely remittance of monthly collections to the trust and the performance of CitiFinancial's obligations as a servicer. The guarantees remain in place so long as CitiFinancial is the servicer and Citigroup is the majority owner of CitiFinancial or has not divested itself of the business. Wells Fargo Bank has acted as back-up servicer since deal inception and must take over the servicing in the event of a servicer-termination event.

ABS

US credit card performance improvement continues

Moody's says US credit card charge-offs declined for the second consecutive month in May, finishing 20bp below April at 10.71%. The agency says the two-month decline represents a clear break from the rise in charge-off rates experienced during Q110.

"Our base-case expectation that the unemployment rate will plateau at 10.1% in the second half of the year, combined with steady improvement in the delinquency rate and the payment rate throughout the spring, reinforces our view that credit card charge-offs have passed their peak levels of this credit cycle," says Moody's analyst Jeff Hibbs.

The delinquency rate during May fell for the seventh consecutive month to reach 5.26%, its lowest monthly rate since November 2008. The early-stage delinquency rate, for balances 30-59 days delinquent, also continued to decline to end the month at 1.26%, approaching its historically low ranges of 2006-2007.

May also saw the yield index rebound, increasing by 50bp to 22.89%. Trust yields stay at historically high levels due to issuers employing principal discounting and improvement in organic yields as a result of re-pricing by card issuers.

Improving yield and charge-offs led to excess spread widening by 60bp to 9.32% in May. On a three-month average basis, the excess spread index has reached 9.21%, the highest in the history of Moody's credit card index. However, the agency expects these elevated levels of excess spread to wane later in the year.

"We note that the August implementation of [the US Fed's] Credit CARD Act rules limiting penalty fees and the eventual expiration of some issuers' principal discounting initiatives will likely place downward pressure on yields," says Hibbs. "However, the negative effect on excess spread from lower yields should at least be partially mitigated by the positive effects from lower charge-off rates."

ABS

Application of structured finance identifier outlined

S&P has announced the categories of debt instruments whose ratings will have a structured finance identifier, (sf), as required under the new European regulation on credit rating agencies. The agency says it will apply the symbol to all relevant structured finance ratings globally by early September.

In making its decision, S&P says it considered both the definition of 'Structured Finance Instrument' referred to in the regulation and the principles it believes the EU intended to establish in the regulation. The agency deems the following transaction types to be structured finance instruments under the regulation and will therefore apply an identifier to their ratings:

• All ABS;
• All ABCP;
• All CMBS;
• All single and multi-tranched CDOs and credit default swaps CDS, except single-name CDS;
• All RMBS, including debt backed by mortgages issued by the Japan Housing Finance Agency;
• All insurance securitisations with more than one tranche of debt;
• All project financings with more than one tranche of debt;
• All enhanced equipment trust certificates (EETCs) with more than one tranche of debt;
• All corporate securitisations with more than one tranche of debt; and
• All gas prepay transactions with more than one tranche of debt.

The definition of structured finance instrument, as referenced in the regulation, is as follows: "'securitisation' means a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics: (a) payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; and (b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme."

Some instruments to which S&P will apply the identifier may not correspond to commonly-held views of structured finance instruments, the agency warns. In addition, it will not apply the identifier to certain instruments commonly referred to in the market as structured finance. The following are the key principles and assumptions that guided S&P's decision in this regard:

• A proper reading of the regulation requires S&P to place an identifier on all instruments that meet the regulatory definition and only on those instruments.
• S&P believes the definition of 'structured finance' should be an objective definition; for example, only if it believes the instrument falls within the definition set out in the regulation will the agency apply the identifier.
• The definition should not be tied to how S&P's criteria view the instrument's risk, or to commonly-held market perceptions of what does and does not constitute a structured finance instrument.
• The agency has interpreted 'tranche' to refer not just to separate issues of a capital market or loan instrument by the same issuer in respect of the same transaction, but to any form of financial or economic interest in a horizontally-sliced credit exposure, however this is derived. This would include, for example, the use of deferred purchase prices, attachment points, discount sales and other credit-enhancing devices.
• In S&P's view, the definition in the regulation stating that the exposure that is tranched should not be interpreted to refer to the exposure to an issuing corporate entity. Rather, it interprets the regulation to provide that in order to qualify as a structured finance instrument, the transaction must contain two layers of risk, with the rated layer being a means to convey to the investor the credit risk of a second, underlying layer.
• S&P has included wrapped transactions in its interpretation of structured finance instruments under the regulation when what is wrapped is itself a structured finance transaction according to the regulation.

ABS

FFELP student loan ratings reviewed

Fitch is to review its ratings on US FFELP student loan ABS bonds, including subordinated bonds, and apply updated surveillance criteria. A refined basis risk approach will be used and the review will encompass trusts with Libor floater bonds only, while other structures will be reviewed later when the criteria are expanded.

Ratings on subordinate bonds without overcollateralisation from trusts that release excess spread are expected to be most negatively affected, with the resulting ratings ranging between triple-B and double-B. Ratings on bonds that benefit from overcollateralisation and cannot release cash are expected to be assigned ratings between triple-A and triple-B.

Bonds with parity less than 100% are also at risk of downgrade, but senior bonds with parity of 103% or more with a stable or increasing parity trend are expected to remain triple-A.

Fitch says its updated methodology measures each trust's exposure to basis factor volatility - the spread between the spot three-month Libor rate that determines the liability and special allowance prepayment (SAP) rates earned on underlying loans. For loans tied to the commercial paper spot rate, the base-case basis factor assumption applied for single-B is -0.1%, stressed up to -2.3% for triple-A. Loans tied to the Treasury-bill rate have a base case of -0.4% and triple-A stress of -4.2%.

A minimum gross excess spread is projected for each trust based on the predetermined SAP spread over the average rates of CP or T-bill, the bond spread over the Libor spot rate and the trust fees and expenses as a remedy to absorb negative basis factor stress. The levels of projected minimum gross excess spread across different trusts are expected to vary depending on the loan distribution by type and disbursement date, bond pricing and caps on fees and expenses.

As well as analysing the risk to principal loss, liquidity risk will be analysed. The liquidity test will compare the stressed basis factor with spread generated by the trust net of non-cash earning, principal collections and any liquidity reserve accounts.

Non-cash earnings and principal collections for any quarter are assumed to be 0.8% and 1% respectively. Most trusts are expected to pass the liquidity test at the triple-A stress level.

ABS

Greek review parameters updated

After the recent downgrade of the government's bond rating to Ba1, Moody's is reviewing the increased operational risk of Greek structured finance transactions. 27 transactions backed by Greek pools may be downgraded. The agency expects to finish reviewing its Greek ABS, RMBS and CDO transactions soon.

Moody's believes transactions serviced by Greek banks rated as low as Ba1 could achieve senior ratings in the low single-A range, assuming risk mitigants are in place to ensure timely interest payment. Without such mitigants, transactions are likely to be rated Baa. Transactions serviced by subsidiaries of non-Greek banks will be assessed on a case-by-case basis.

The agency's analysis is based on an assessment of available credit enhancement, considering a variety of loss scenarios and the exposure of the transactions to the banks providing operational services, swaps and liquidity.

Operational risk exposure and liquidity are central considerations for what rating levels Moody's says it will eventually give Greek transactions. In certain situations the agency believes this risk is more significant than the potential losses in the collateral pools.

Moody's will consider the impact of Greek banks' weakened strength on the operational aspects of all Greek transactions, particularly counterparties holding key roles such as servicer, cash manager or swap counterparty. It will also look at the efficiency of structural features in Greek banking to determine the degree of linkage between the structured finance ratings and sponsors' ratings.

The particularly systemic nature of the challenges facing Greek banks presents a special case for considering Greek operational risk mitigants, the agency says. Moody's is therefore concerned that some of the de-linkage features traditionally incorporated in Greek transactions may not sufficiently mitigate operational risk as, for example, having a back-up servicer also domiciled in Greece would not completely remove operational risk.

To maintain ratings higher than the Greek government's Ba1 rating, credit enhancement available to notes must be sufficient to withstand severe collateral losses in stressed scenarios, including those related to a potential government and banking crisis, Moody's says. The agency will consider loss assumptions of 25%-30% for RMBS, 40% for consumer loans ABS, 45%-50% for SME ABS and 50% for CDS transactions in worst-case scenarios. These stress levels are consistent with a single-A rating.

ABS

Korean ABS, Singaporean CMBS outlooks stable

Moody's is changing its sector outlooks for Korean credit card ABS and Singaporean CMBS to stable. The previous negative outlooks had been assigned in February this year.

"Korean credit card ABS have benefited from the country's improving economy and unemployment rate, while credit card delinquency ratios remain low after peaking in Q209. We have therefore revised the outlook," says Marie Lam, Moody's senior credit officer.

She adds: "For Singaporean CMBS, while there is still an abundant supply of office, retail and industrial space, the improving economy and tourism industry should provide stability to the three sectors supporting the transactions. Debt service coverage ratio is strong in all the rated CMBS transactions and refinancing in the second half of 2010 has all been arranged."

Korean RMBS and auto loan ABS remain unchanged at stable outlooks and the agency notes there are no rating implications on outstanding debt arising from the performances of the underlying assets.

Korean RMBS enjoy low LTV ratios for its mortgage loans and the gross default ratio was less than 0.15% of the outstanding pool balance at the end of May. The agency says loan seasoning of at least three years provides a good cushion for property value depreciation, so while the market remains sluggish a stable outlook on loan receivables is maintained.

Auto loan ABS performance stayed stable throughout the credit crisis, which is why its outlook remains as stable.

CDO

CDOs land additional appraisal firm

The indentures of Fortress Credit Funding III and IV have been amended to allow Deloitte Financial Advisory Services to act as an additional approved appraisal firm on the transactions. The addition of Deloitte is intended to further diversify appraisers regarding commercial real estate valuations.

Moody's says it has been informed that the issuer did not receive any objections from a majority of the controlling class with respect to the selection of Deloitte. Further, the agency has determined that the amendments will not cause the current ratings of the notes to be reduced or withdrawn.

CDO

CRE CDO upgraded on correction

Moody's has upgraded five classes of notes issued by G-Star 2002-1, due to a correction in the inputs that it used in its prior analysis of the deal. The agency says the action occurs despite an overall decline in the credit quality of the pool and impacts approximately US$150.5m of securities. The move comes amid Moody's on-going surveillance of CRE CDO transactions.

In connection with Moody's last rating action on the affected notes, certain securities were erroneously classified as defaulted obligations when, in fact, they were credit risk securities as defined in the transaction's legal documents. A credit risk security is a security whose rating has been downgraded by one notch, is on review for possible downgrade or has been withdrawn or qualified.

By reclassifying these securities, the expected loss for the pool has declined. In the agency's current review, there are two defaulted securities (7.7% of the pool balance) and nine credit risk securities (27.7% of the pool balance).

CDO

Criteria update prompts CRE CDO review

S&P has placed 47 ratings from 12 US cashflow CRE CDO transactions and 106 ratings from 46 US synthetic CRE CDO transactions on credit watch negative. This follows an update to the methodology used by the rating agency to derive recovery rate assumptions for CMBS assets held within or referenced by CDO transactions in either cash or synthetic form.

In aggregate, the affected cashflow and hybrid CDO tranches have an issuance amount of US$3.82bn and the affected synthetic CDO tranches have an issuance amount of US$11.58bn. S&P expects to take six weeks to review cashflow CRE CDOs using the new methodology and make the necessary adjustments and two weeks for the synthetic CRE CDOs.

Additionally, the ratings on another 236 tranches from 31 US cashflow and hybrid CRE CDOs (representing US$11.36bn in issuance) and 99 tranches from 33 US synthetic CRE CDOs (representing US$3.450bn in issuance) are already on credit watch negative for performance reasons. S&P affirmed the ratings on 13 senior tranches from 12 cashflow CRE CDO transactions due to the high level of credit enhancement available to support these tranches, which it believes makes it likely that they will be able to maintain their current ratings once the revised recovery criteria is applied.

CDO

Defaults, deferrals prompt Trups CDO downgrades

The ratings of 12 Trups CDO transactions - Alesco Preferred Funding VII, VIII, XI, XIV and XV; Preferred Term Securities VII, X, XIV, XX and XXV; and Trapeza CDO I and IX - have been downgraded by Moody's. The rating actions taken on the notes is the result of a significant increase in the actual and assumed defaults and deferrals of the trust preferred securities held in their portfolios.

Moody's explains that this par loss has resulted in loss of overcollateralisation for the tranches affected and an increase in their expected losses. For the majority of these transactions, the last rating actions occurred in March 2009. Since then, the assumed defaulted amounts have increased significantly, with a large portion of transactions experiencing an increase of the assumed defaulted amount of more than 100%.

Moody's also gave consideration to the event of default (EOD) analysis for Trapeza CDO I. Although Trapeza CDO I has not declared an EOD to date, the agency notes the current class A/B overcollateralisation level is 102.026%.

The transaction would declare an EOD if this level falls below 100%. Since this transaction is close to triggering an EOD, additional modelling scenarios were considered in this case assuming that acceleration has been declared.

The credit deterioration exhibited by these portfolios is a reflection of the continued pressure in the banking sector as the number of bank failures and interest deferrals of trust preferred securities issued by banks has continued to increase. According to FDIC data, 83 US banks have failed to date this year, while 140 banks failed in 2009, as compared to 25 in all of 2008. The opinion of the rating agency is that the banking sector outlook remains negative.

The portfolios of these CDOs are mainly composed of trust preferred securities issued by small to medium-sized US community bank and insurance companies that are generally not publicly rated by the agency. In order to evaluate their credit quality, Moody's derives credit scores for these non-publicly rated assets and evaluates the sensitivity of the rated transactions to their volatility.

Five new bank defaults and an increasing incidence of deferrals transferring to default brought US bank Trups CDO default rates to 13.5%, according to Fitch. The agency's default and deferral index for the sector shows that new defaults last month totalled US$86m, while six banks began deferring interest payments on approximately US$76m of collateral.

"New tender offers or acquisition activity have emerged for a small number of bank Trups issuers that were previously deferring payments," explains Fitch md Kevin Kendra. "Additionally, Fitch was notified of tender offers for two deferring banks in various Trups CDOs."

The five new bank defaults, affecting 11 CDOs, bring the total to 120, with 82 CDOs affected. The 343 banks now deferring are affecting interest payments on US$6.4bn of collateral held by 83 Trups CDOs.

CDS

Guidelines released for tackling 'moral hazard' risks

Financial Stability Board (FSB) chairman Mario Draghi has told the G20 leaders that good progress has been made towards global standards to strengthen bank capital and liquidity. But he called for a significantly higher quality and quantity of capital in the banking system to improve loss absorbency and resiliency.

The authorities, Draghi says, "should provide transition arrangements that enable movement to robust new standards without putting the recovery at risk, rather than allow concerns over the transition to weaken the standards".

The FSB is committed to reducing the moral hazard risks posed by systemically important financial institutions (SIFIs) - the banks 'too big to fail'. The board's new interim report sets out six guidelines for the development of an international policy framework to meet this end.

Under the principles, all jurisdictions should have: a policy framework to reduce moral hazard risks associated with SIFIs; effective resolution tools for resolving financial firms without systemic disruptions or taxpayer losses; the ability to impose proportionate supplementary prudential requirements on firms; the powers to apply different requirements based on different risks; a strong core financial market infrastructure to reduce contagion risk; and an ongoing peer review process by all FSB members to promote effective, consistent policies to address SIFI risks.

Based on those principles, the FSB says it will develop concrete policy recommendations over the coming months to establish an international framework able to address the moral hazard problem. A final report will be ready for the Seoul Summit in November.

The report also covered progress made on improving the OTC derivatives markets, enhancing incentive structures and transparency, and strengthening adherence to international financial standards. The FSB says policy work is proceeding according to - or ahead of - agreed timelines.

CDS

ABX remittances show improvement

The June ABX remittance report indicates that CDRs are generally declining as timelines extend. The 06-1 index continues to buck the trend, however, and has proved the exception to many of the rules this month, according to ABS analysts at Bank of America Merrill Lynch.

CDRs declined anywhere from 1.1 to 2.7 points across the ABX indices and delinquencies declined again month-over-month, with most improvement coming from the 60-plus bucket. REO levels for most of the indices were stable, although the 06-1 index proved an exception by declining slightly.

Countrywide, which the BAML analysts note tends to be slower moving loans through its pipeline, saw an increase in REOs in its 06-2, 07-1 and 07-2 deals. This might be an early indication that it is starting to push through its delinquencies.

Voluntary prepayment rates did not change for most of the indices and remain non-existent. CRRs, excluding negative curtailments, increased slightly for the 06-1 index to move from 1.7% CRR to 2.3%. Including negative curtailments, the 06-2 index had a negative rate of -0.6%. The biggest negative curtailment increase came from BSABS 2006-HE3, which printed a CRR of -4.9%.

Most of the indices saw severities improve, with the exception of 06-1, which experienced a 1.2 point increase. Severity rates for the 06-1, 06-2, 07-1 and 07-2 indices were 71.3%, 72.4%, 77.1% and 77.6% respectively.

The biggest improvement was for the 07-2 index, which saw severities declining by an average of 4.7 points. Within that index, the Countrywide, HEAT and MLMI deals all had significant loss severity reductions.

CDS

New CDS sector indices launched

S&P has launched a series of CDS sector indices, which seek to track the credit default swap market for a select number of corporate credits in distinct GICS sectors and sub industries and hence increase transparency. The indices may be country-specific or global in nature, offering the independence of the S&P CDS Index Committee and third-party pricing.

Each index is designed with a focus on liquidity, with the goal of supporting investment products, such as index funds, index portfolios and index futures and options. Each series of the S&P CDS Sector Indices has a 5.25-year maturity as measured from its effective date.

The S&P CDS US Sector Indices are equal weighted, with a given number of reference entities and a fixed coupon. Index levels and average CDS spreads for each index are published daily.

"Tracking the more liquid elements of the market, these indices add transparency into how the CDS markets are reacting in the consumer discretionary, consumer staples, energy and health care sectors," says JR Rieger, vp of fixed income indices at S&P Indices.

CDS

Trading revenues rebound in second-strongest quarter

The US Office of the Comptroller of the Currency (OCC) reports that bank trading revenues in the first quarter bounced back from seasonally low fourth-quarter levels, while credit exposure from derivatives continued to decline. Commercial banks reported trading revenues of US$8.3bn.

"We expected to see a sharp rebound in trading revenues from the seasonally weak fourth quarter, as client demand is typically very strong in first quarters," says Kathryn Dick, deputy comptroller for credit and market risk at the OCC.

Dick notes that Q110 trading revenues were the second largest ever, behind only Q109 when intermediation spreads were particularly wide. Credit activity revenues made a large contribution to trading performance as banks reported US$2.7bn in first-quarter credit revenues.

The OCC says that net current credit exposure (NCCE) continues to decline. The OCC's primary metric for measuring credit risk in derivatives activities, NCCE decreased by US$40bn to US$359bn, having previously peaked at US$800bn at the end of 2008.

"The continued decline in credit exposure reflects the more normalised conditions in credit markets that prevailed in the first quarter, when credit spreads continued to decline from crisis peaks," comments Dick.

The notional amount of derivatives held by insured US commercial banks increased by US$3.6trn in Q110 to US$216.5trn. Interest rate contracts increased by US$2.4trn to US$182trn, while FX contracts increased by 6% to US$17.6trn. Banks hold collateral to cover 67% of their NCCE and that collateral is of a high quality, with 83% of it in cash.

The OCC says derivatives contracts are highly concentrated, with five banks holding 97% of the total notional amount of derivatives. CDS is the dominant credit derivatives product and represents 97% of total credit derivatives. Finally, the number of commercial banks holding derivatives increased during Q110 by 20 to reach 1,050.

CDS

France, Greece push sovereign CDS wider

Global CDS spreads are widening once more, says Fitch Solutions. Sovereigns are leading the trend by widening almost 5% last week, while financials widened an average of 2.2%.

Global CDS widened by 2%. Greece finished the week at 904bp, while France was also wide.

"CDS on Greece are at their widest level since the start of the sovereign crisis," says Fitch Solutions md Jonathan Di Giambattista. "CDS on France have been pricing wide of double-A plus levels since the beginning of June."

Brazilian CDS is still outperforming current sovereign market trends. CDS spreads are slightly tight of its triple-B minus CDS-implied rating in light of Fitch Ratings' outlook revision on the sovereign to stable.

CLOs

US CLO default rates continue to decline

US CLO default rates continue to retreat very rapidly. Principal-weighted LTM defaults were at 4.64% at the end of May, down a full percent from end-April and more than 6% since the 10.81% peak in November, according to structured credit analysts at Bank of America Merrill Lynch.

"While we continue to expect the structural default lows for the cycle to be higher than those seen in the past - and particular in 2006-2007 - the short-term trends remain positive and supportive for CLO assets," they note.

For example, the rapid decline in the market share of loans rated triple-C and below has been an important fundamental driver of the move higher in CLO par values over the past few months. "The combination of a lower proportion of assets subject to haircuts and much smaller haircuts for those assets still sitting in excess triple-C territory continue to contribute to a strong recovery in CLO par levels," the BAML analysts add.

They point out that the average headroom over both senior and junior OC tests has now fully retraced the 2009 decline and is back at levels last seen in mid- to late-Q408. "With a more uneven performance in underlying risk assets in May, we expect the pace of improvement to slow down somewhat, but - given the now important pure credit component to this par bounce - we believe that an actual slowdown in macro conditions will be required for a reversal of these now well-entrenched trends."

With junior tests higher across the board, the pass/fail rate of junior OC tests continues to edge higher. It now stands at 84% of BAML's universe of 507 deals, up from 81% last month and from 34% at the lows in H109.

CMBS

CRE reform provisions finalised

The House-Senate Conference Committee on financial reform legislation has finalised several provisions that the CRE Finance Council had made its top priorities. The finalised provisions are based on amendments authored by Senator Mike Crapo and will enable regulators to customise the new risk retention mandate for CRE finance. Another measure was offered by Representative Scott Garrett that requires regulators to consider the combined impact of new reforms and mandates, prior to any rulemaking, and that encourages greater coordination among policymakers.

The provisions enable US regulators to determine how to strengthen the CRE finance market - including through a percent retention, underwriting guidelines and controls, and stronger representations and warranties. Under the provision, regulators must structure reforms by asset class and they have explicit authority to consider allowing a third-party investor to satisfy a potential retention mandate for CMBS, as long as any such third-party investor performs due diligence, purchases a first-loss position and retains this risk in accordance with the statute.

The Conference Committee also adopted a CRE Finance Council-supported amendment offered by Garrett that would require financial regulators to examine and report on the combined impact of new accounting standards and other regulatory changes - such as a retention mandate - on credit availability, prior to any rulemaking.

Under the provision, the Federal Reserve - working with other agencies - would have 90 days to report its findings to Congress with recommendations on statutory and regulatory changes that could be made to lessen the impact on credit availability. The CRE Finance Council says it has been concerned about the totality of legislative, regulatory and accounting reforms, and this provision would ensure greater consideration by, and coordination between, implementing regulators on the growing number of proposals across the various jurisdictions.

CMBS

Fourth Tesco CMBS marketing

Goldman Sachs and HSBC are in the market with Tesco's latest CMBS. Moody's, S&P and Fitch have provisionally assigned A3/A-/A- ratings to the £950.15m Tesco Property Finance 3 transaction.

The deal is a true-sale credit-tenant-linked securitisation of one commercial mortgage loan backed by the long leasehold interest in a portfolio of 41 commercial properties located across the UK. All properties in the portfolio are supermarkets let to Tesco-related entities on long-term leases. The payments under the occupational leases are guaranteed by Tesco.

This transaction is the fourth capital markets sale-and-leaseback CMBS transaction involving Tesco. Tesco Property Finance 2 closed in September 2009, while Tesco Property Finance 1 closed in June 2009 (SCI passim). Tesco's first CMBS - Delamare Finance - closed in April 2004.

The latest transaction is similar to the previous two transactions and especially to Tesco Property Finance 2, considering the issuer and borrower/ownership structure. According to Moody's, the key differences include a slightly lower total leverage (based on expected issuance amount) and a more backloaded amortisation profile of the bonds over the life of the transaction.

In addition, in this deal, the tenant has an option to terminate the occupational leases in September 2020, subject to certain conditions in the lease agreements being fulfilled. Significantly, the tenant can only terminate the leases provided that all amounts owing under the bonds have been repaid by the Issuer.

Index-linked lease payments and payments under the inflation swaps allow for full amortisation of the loan and hence the full amortisation of the bonds by April 2040. The projected debt service coverage ratio for the loan is 1.0x during the entire loan term.

The vacant possession value and market value (MV) of the portfolio are £710.1m and £924m respectively. Based on the day-one rental value of £48.7m, this implies a weighted average net initial yield of 4.99% based on the MV.

CMBS

Balloon risk remains key for German MFH CMBS

Fitch says balloon risk remains the key risk for large German multifamily housing (MFH) CMBS transactions. GRAND, German Residential Funding, Windermere IX (Multifamily) and Immeo Residential Finance No 2 - the four largest CMBS transactions entirely secured by MFH collateral - all have negative outlooks.

The agency says collateral performance remains stable for all the large, institutionally managed portfolios, as shown by flat or slightly improved rental income and controlled cost base. Coverage ratios remain well in excess of their covenants and Fitch expects values to have remained broadly stable over the past year.

Balloon risk remains the key risk because of the continued limited availability of large-ticket funding for real estate portfolios. The exit Fitch LTVs range from 79% to 88%, implying leverage may also make finding alternative debt funding difficult without further equity injections.

Most maturities remain several years away, but the agency's talks with borrowers suggest they are already actively involved in assessing refinancing opportunities. Borrowers identified the large outstanding loan balance, which is over €1bn for each deal, as the main challenge facing an orderly repayment, with the exception of Hallam Finance.

Hallam is part of the Deutsche Annington portfolio, which also includes the collateral for GRAND. The loan balance of €184m is considerably lower than the other transactions, as is its exit Fitch LTV of 67%. The agency expects that these factors will help an orderly repayment at its upcoming maturity date in October 2011 and so has affirmed the notes with a stable outlook.

Ratings

Mid-year outlook released for US SF

S&P has published its mid-year outlook for the US structured finance market. The rating agency believes the positive momentum that began in 2009 should continue in the second half of 2010.

"Tightening credit spreads and stabilising collateral performance for the structured finance assets, with the exception of commercial mortgages and private student loans, along with growing interest in issuance across most structured sectors are good indicators, in our view, of this continuation. However, new or proposed regulations have affected the securitisation market because of various restrictions on sponsors of structured transactions, including higher capital requirements and proposed risk retention requirements, as well as a greater amount of required disclosures," S&P notes in the report.

In the outlook report, the agency says that the volume of new US RMBS issuance has remained low for several years and is expected to remain low through to at least the end of 2010. "This is because most residential mortgages are being issued through the government-sponsored enterprises and this isn't likely to change until Congress determines the fates of Fannie Mae and Freddie Mac. Elevated levels of delinquencies and additional home price declines are also likely to hurt residential collateral performance in the second half."

Market interest in US auto loan ABS appears to be intact, however, even without the TALF programme - including renewed interest in both subprime auto transactions and subordinate bonds. US auto loan collateral continues to benefit from improved credit performance due to the tighter underwriting standards that auto finance companies have implemented since 2008, S&P says.

Its outlook on the US auto lease ABS market remains stable to positive for the remainder of 2010. Collateral performance has stayed relatively strong, with credit and residual losses generally in line with or better than the agency's initial expectations. This mainly reflects an improving economy and the strongest used-vehicle values seen in recent years.

Meanwhile, US banks' overfunded position and the uncertain effects of regulatory and accounting changes have squeezed credit card ABS issuance to levels not observed since the 1990s. "We've seen an overall improvement in the performance of most credit card ABS collateral, however; as a result, we think our ratings on credit card ABS should remain relatively stable for the remainder of 2010," S&P notes.

Similarly, although FFELP ends on 1 July, the agency's outlook remains stable on FFELP ABS for the remainder of 2010 due to the federal reinsurance of at least 97% on this collateral. At the same time, high unemployment continues to weaken the performance of private student loan collateral, as recent graduates are struggling to find jobs. Therefore, S&P's outlook on private student loan ABS continues to be negative.

High unemployment will also continue to put pressure on commercial real estate fundamentals. As a result, S&P believes vacancies will continue to increase in many markets for the remainder of 2010.

This is likely to keep rents down for the foreseeable future, which - in the agency's view - will result in rising loan delinquencies. New CMBS issuance is likely to remain subdued until fundamentals and loan delinquencies stabilise.

Finally, S&P expects ABCP outstandings to remain relatively flat to slightly down for the remainder of 2010. ABCP sponsors will probably continue the trend that began in early 2010 of cautiously increasing new transaction activity, mostly to replace existing and/or amortising transactions. Nevertheless, the US ABCP market remains stable in an environment where participants continue to grapple with changes in the US regulatory landscape and lower demand for credit.

Ratings

IO, prepayment tranche ratings withdrawn

Fitch has withdrawn the ratings of 91 European structured finance interest-only and prepayment tranches. Of the total, 27 tranches relate to European RMBS transactions and 64 to European CMBS transactions. Fitch-rated European ABS and CDO transactions do not include interest-only or prepayment tranches that would qualify for a withdrawal under the agency's recently revised practice (see last issue).

The rating withdrawal follows Fitch's recent revision of its practice globally for assigning and maintaining structured finance ratings on such securities, and covers all EMEA structured finance tranches that are affected by this revision. Following the revision of its practice, the agency will no longer provide rating or analytical coverage of such structured finance interest-only and prepayment tranches.

RMBS

Fed's coupon swap gives lift to 4.5s

The Federal Reserve Bank of New York Open Market Trading Desk has commenced a limited amount of agency MBS coupon swap operations. It plans to swap unsettled Fannie Mae 30-year 5.5% securities for other agency MBS. The move helps facilitate delivery of about US$9.2bn in unsettled FN 5.5% pools due to the relatively short supply.

The Fed will most likely participate in FN 4.5s since the float is greatest in this coupon, compared to FN 4s or FN 5s, according to Barclays Capital MBS analysts. They note that it does not make sense for a central bank to increase exposure to FN 4s, in particular, since they are the longest coupon outstanding.

On the news, FN 4.5s appreciated by three ticks versus duration hedges, the BarCap analysts add. FN 5.5s have come off by two ticks. The analysts expect the 5.5s to underperform further since they say a logical next step for the Fed would be to offer up bonds for delivery in coupons that have no float, with 5.5s being the prime example.

RMBS

Fannie Mae gets tougher on borrowers

In a new policy change announced on 23 June, Fannie Mae says defaulting borrowers who walk away - even though they had the capacity to pay or did not complete a workout alternative in good faith - will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure. But there may be a few exceptions, the GSE notes.

"We're taking these steps to highlight the importance of working with your servicer," says Terence Edwards, evp for credit portfolio management at Fannie Mae. The GSE says the move is meant to deter the disturbing trend towards strategic defaulting.

Fannie Mae will also take legal action to recoup the outstanding mortgage debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments. Troubled borrowers who work with their servicers and provide information to help the servicer assess their situation can be considered for foreclosure alternatives.

RMBS

HAMP trial modification backlog eases

New HAMP trial modifications started in May declined by 36% from April to just 30,000 borrowers, according to a new report from Bank of America Merrill Lynch. New trials have slowed since their October 2009 peak when more than 158,000 trials were started.

HAMP trial modifications have been offered to nearly 90% of eligible borrowers and BAML MBS analysts expect private modification efforts to now play a more dominant role. Agency mortgages comprise almost 56% of total HAMP modifications outstanding.

Servicers are cutting through the trial modification backlog, with outstanding active modifications dropping by 20% from March to 808,000. The number of permanent modifications started increased by nearly 48,000 to 346,816, but the number converting to permanent status declined 30% last month when more borrowers transitioning out of trial modifications instead cancelled.

Out of the 1.2 million commenced trials, 28% have been made permanent modifications and 35% have been cancelled. Almost half of the cancelled trials are believed to have received a private modification. Of the remaining cancelled borrowers, 26% were still awaiting action, 10% were brought current and 7% moved into foreclosure.

Apart from option ARMs, modification rates have come down after spiking earlier this year. On an annualised basis, jumbo modification rates in February were 3.2% but only 1% in May. Cumulative modification rates were 1.8% for jumbo, 7.3% for alt-A, 6.6% for option ARMs and 29.4% for subprime loans.

The BAML analysts note that the use of principal modifications remains low and concentrated in option ARMs. Option ARM servicers with principal modifications accounting for more than 5% of their total modifications include Countrywide, IndyMac, Aurora and GreenPoint. Differences remain between servicers in the number and type of modifications, with subprime servicers modifying anywhere from 19% to 47% of their total balance outstanding.

Finally, the analysts point out that recidivism rate curves are improving vintage over vintage. Modified subprime loans from the Q209 vintage had a recidivism rate of 43%, a 22% decline on Q408 which had a 56% rate.

RMBS

Freddie Mac buyouts expected to pick up

Freddie Mac's end-of-May delinquency rates suggest that roll rates and delinquency buyouts are likely to reverse their recent slowing trend and start picking up in the August prepayment report.

"Although the 120+ DQs dropped again from last month, the magnitude was much smaller, at only 1%-2% on average," RMBS analysts at Barclays Capital explain. "More importantly, the 90 DQ bucket - which is a leading indicator for 120+ DQs and buyouts - was almost flat month-over-month (compared with a 14% drop in March and 8% in April), while the 90-120 DQ transition rates were up for the first time."

Assuming that the 90-120 transition increases by another 10% in June, the BarCap analysts expect there to be a 5%-10% increase in buyouts in the August report. "The trend has been consistent with our expectation that the recent decline in roll rates is partially attributable to strong seasonals and, as they turn, buyouts should pick up."

RMBS

US RMBS cashflow analysis criteria updated

Fitch has published an updated US RMBS cashflow analysis criteria report. Cashflow modelling criteria remain fundamentally unchanged, but there are enhancements to new issue analysis, including rating resecuritisations to account for potential variability in expected loss timing and prepayment speeds.

Key revisions include the incorporation of a low prepayment scenario, new structured finance interest rate stresses and back-loaded loss timing assumptions for current and delinquent loans.

The agency says these cashflow criteria comprise a subset of the overall US RMBS rating approach and focus only on the structural analysis of the rated securities and cashflow modelling aspect of transactions. The primary risk drivers of the cashflow modelling criteria are default timing assumptions, prepayment rate assumptions and interest rate stresses.

RMBS

French mortgage loss assumptions revised

Fitch has updated its rating criteria assumptions for assessing credit risk in French prime residential mortgage loan pools that are used as collateral for structured finance transactions and covered bonds programmes.

The changes to the agency's French RMBS rating criteria mainly focus on an updated and unique base frequency of foreclosure matrix and a compression of scenario multipliers. It says this reflects expected deal performance deterioration caused by the economic downturn, rising unemployment on mortgage credit behaviour and property market liquidity.

Performance expectations, especially at lower rating levels, are emphasised in the updated criteria. Loss expectations for lower rating levels are likely to be more 'point in time' and vary with changes in Fitch's expectations, as influenced by asset performance. Higher rating scenarios are more remote and are intended to show rating stability through all aspects of an economic cycle.

Lenders' historical foreclosure frequencies (FFs) may differ significantly because of the structure of the French residential lending market, says Fitch. The base frequency of foreclosure matrix would have to be adjusted to account for the characteristics of each lender and loan security type.

Loans originated by specialised lenders normally have higher FFs due to the population they target, such as low-income households or individuals with more complex borrower profiles. The security type - be it cautionnement or mortgage - can also indicate the FF, as for example a cautionnement implies the borrower has passed the underwriting criteria for lender and guarantor.

Secondary markets

RFC issued on enhanced fair value proposal

IASB has published for public comment further enhancements to a disclosure proposal on Level 3 fair value measurements that formed part of its exposure draft, 'Fair Value Measurement', published in May 2009.

In that exposure draft, the IASB proposed a three-level fair value hierarchy that categorises observable and non-observable market data used as inputs for fair value measurements. According to that hierarchy, Level 3 inputs are 'unobservable inputs' used for the fair value measurement of assets or liabilities for which market data are not available.

In response to comments received, the IASB proposes to enhance its original proposal by requiring the measurement uncertainty analysis disclosure to reflect the interdependencies between unobservable inputs used to measure fair value in Level 3. Users of financial statements commented that this information would allow them to assess the effect that the use of different unobservable inputs would have had on the fair value measurement.

The exposure draft, 'Measurement Uncertainty Analysis Disclosure for Fair Value Measurements', is open for comment until 7 September 2010.

SIVs

SIV outlooks revised following error

S&P has revised its outlooks on its issuer credit ratings on four Citibank-sponsored SIVs: Beta Finance Corp, Centauri Corp, Dorada Corp and Five Finance Corp. The rating action corrects an error the agency made in February.

Citibank has an agreement with each vehicle to provide them with funds to meet repayments on the senior debt when it becomes due. In S&P's opinion, the dependency on Citibank means that the SIVs do not merit a rating higher than the current ratings on Citibank.

On 9 February 2010, the agency revised the outlook for Citibank to negative from stable. Due to an error, S&P did not revise its outlooks on these SIVs at that time.

Technology

Evaluated price offerings expanded

Interactive Data has broadened its evaluated pricing offerings for clients. Enhancements include new evaluations coverage, fair value adjusted index information and daily evaluations for fixed-rate reverse MBS (HMBS).

In the past month the firm offered new evaluations coverage for more than 10,000 fixed income instruments. Recent additions to its fixed income evaluation coverage include over 6,300 structured finance securities and 3,600 corporate securities.

As well as a daily fixed income midday market commentary, Interactive Data also now offers monthly market commentary for structured securities. This includes market highlights, representative market colour and month-over-month trends.

"Our evaluated services team continually works with our clients to understand their evolving needs and, as a result, we are able to respond with new and expanded coverage and services for a wide range of securities," says Liz Duggan, evaluations md for Interactive Data's pricing and reference business. "We are also committed to providing clients with increased transparency into our evaluations process, as well as additional insight related to the asset classes for which we produce evaluated prices."