Contents

ABS

Sukuk potential

Islamic finance ready for new style of issuance

The sukuk market is seen as having huge potential if it can be tapped correctly. Indeed, Islamic finance could become a breeding ground for new structured finance products, with recent innovative issuances and new issuers coming to the market.

Cagamas' Sukuk al-Amanah Li al-Istithmar (Sukuk ALIm - see last issue) is one example of a new breed of Islamic bond. It is the first to totally preclude the concepts of Inah (sale and buyback), Bai' Dayn (trading of debt) and Wa'ad (undertaking). Such issues are of paramount importance in Shari'ah investing, where the ethics of a deal are key.

Khalid Howladar, Moody's vp and senior credit officer, explains: "In Islamic finance, making money from debt is not ethical. The way to invest and make money is to co-invest and share risk and returns and so the principle of equity is core within Islamic finance."

This year Nomura and GE Capital have both diversified into Islamic finance (SCI passim). Debashis Dey, Clifford Chance partner and head of capital markets, believes these developments might mark the start of a new trend.

He says: "The Nomura sukuk was placed internationally. It follows on the heels of the GE Capital deal at the start of the year, which was the first sukuk issued on an international basis by a US corporate. I think this movement is about foreign corporates dipping their toes in the water. Most of their products are not Shari'ah-compliant, so Shari'ah-compliant investors cannot buy into those businesses."

Both deals were, although small, very successful and each was oversubscribed. More importantly, just like the Sukuk ALIm transaction, they mark entry into new territory. Although Islamic finance has history in the Middle East, there are signs that it is becoming more attractive to those from outside the region as well.

"The main advantage for Islamic investors is the fact that sukuk allows them to invest in compliance with the Shari'ah law," says Roula Sleiman, director at BSEC. But increasingly it is not just Muslims looking to invest in Islamic finance.

She continues: "For conventional investors, sukuk is considered as an investment opportunity which yields a rate of return that can be comparable to the return generated by any other investment."

"One complexity of sukuk is that there are lots of Islamic companies or investors that want bonds and there is a big issue of form over substance," says Howladar. "Because companies and investors want debt, we have a whole exercise of making such products look like something equity-linked or asset-backed, when really it is just an unsecured bond."

He adds: "Securitisation is not a perfect fit, but it is closer to Islamic financial ideals than most existing structures because one key principle is that you invest in something tangible in return for your money. ABS is a lot closer to the Islamic ideal than pure bonds or debt, which are opposite to Islamic ideals."

One of the main effects of the credit crisis was to bring to light issues within the sukuk industry, where the issue of 'form over substance' was exposed. Howladar explains: "Some investors thought they had something tangible, but all they had was the debt of a company in distress."

Dey senses that there could be a shift in sukuk away from asset-based to asset-backed transactions, which would be more in line with conventional securitisation and give investors access to something tangible. He believes market appetite is growing for a covered or secured sukuk, with the market retreating from fully limited recourse products to more structured products.

"I consider sukuk to be corporate asset-based instruments. That does not change the fact that they would work very well for a proper asset-backed limited recourse securitisation. That has happened before; for example, with the Abu Dhabi 2008 Sun Finance transaction, which was a Shari'ah-compliant sukuk, with limited recourse to only the assets and the cashflows coming from them," says Dey.

He continues: "One would argue that Islamic finance has exactly that intention in mind, which is that an investor shares both the loss and the gain arising from an asset pool and an investor really should be bearing the risk of the non-performance of assets. So the two go hand-in-hand; it is just that to-date there has not been an appetite amongst both the Islamic-compliant issuers and the Islamic-compliant investors to go all the way to what we are used to with securitisation in the conventional markets."

If the shape of sukuk is to change, then Nomura and GE Capital have first mover advantage. Should their endeavours prove successful, it will not be long before they are joined in the market by others who traditionally operate outside the Islamic market.

Dey says: "I think GE Capital has a big desire to be in the region. They are investing in a lot of projects with Abu Dhabi's domestic sovereign wealth fund. I think, for them, getting GE recognised as an institution which is interested in the Middle East and Islamic finance is a big driver, as well as diversifying their funding."

He adds: "Nomura has a similar attitude. It knows the Middle East is important, but that it does not have much of a visible presence there, so they are tapping new funding but also raising brand awareness. I think others will also do that."

Sleiman agrees that foreign demand will exist for as long as Islamic products remain attractive, even if what attracts them is different to what attracts Shari'ah-compliant parties. She says: "As long as liquidity is available and products are attractive from a risk/return perspective, conventional investors will not have any restrictions to invest in Islamic products - which is not the case the other way round, where Islamic investors cannot invest in conventional products."

Howladar also agrees that there will be demand, but says the market must develop first. He comments: "Fixed income in the Middle East is a young market and is not very mature; nor is it a very large market. Bond markets are younger, more immature, less developed. As a subset, sukuk too is less developed."

The sukuk market is ripe for development and, although it has suffered in the last few years much as the wider economic environment has been impacted, market consensus is that issuance will take-off from the autumn. Dey explains: "Conditions are always made more difficult seasonally because a lot of people go away for August. From mid-July to the end of August a lot of decision makers will be away."

He adds: "Ramadan in the Middle East will fall mid-August to mid-September this year. Most big decision-makers will go away before Ramadan and come back for Ramadan. Things will not be done so quickly during this time, so there will be a stockpile of things to be done in the final quarter."

Sleiman concurs. She says: "I believe that investors are regaining confidence and investment managers are restructuring their risk management and operational models after the crisis. Markets are definitely opening; and autumn would be the best time to go to market since it will be after summer breaks and Ramadan period, notwithstanding all issuances from the previous years that have been put on hold after the credit crisis."

One investor says he expects a sukuk to be issued by the Republic of Indonesia in the autumn and a corporate sukuk to come from the UK, which has been waiting for tax changes to occur and some clarifications on how the instruments will be treated. Changes in who issues sukuk and what those issuances look like could be dramatic and, moreover, they could be very close at hand.

JL

Ratings

Ratings reliance

Staffing developments indicate continued life for the credit rating model

In the last week Kroll Bond Ratings announced its senior management team, while Jefferies named its ratings advisory head (see Job Swaps). The developments underline investors' continued reliance on credit ratings - albeit they may require more information and advice than before.

Mike Nawas, partner at Bishopsfield Capital Partners, says that the pessimism about investors relying less on ratings post-crisis has proved to be overdone. "The rating agencies have obviously tightened their criteria, but few investors will be able to leverage the necessary infrastructure that would make the rating agencies redundant. Investors can be reassured that a triple-A rating still means a lot."

The market doesn't necessarily need more rating agencies, but a more coordinated approach to ratings methodologies, according to Grenadier Capital founder and managing partner John Uhlein. He says he's disappointed that reform efforts in the US didn't do enough to ensure more consistency in terms of ratings and what they mean regarding frequency of loss and severity of loss, for example.

"But having said that, if a new rating agency can do a better job, it will improve the whole industry. It's not a question of there being enough room for another rating agency; it's a question of a new one being credible enough to make a difference," Uhlein comments.

Kroll Bond Ratings says it aims to build a product that "restores trust in ratings". To that end, it says it will not rely solely on information provided by issuers of bonds - looking "under the hood" to identify what goes into each security - and will refuse to participate in ratings shopping.

Further, the firm promises to adopt superior corporate governance principles to ensure that it is run with accountability and that it will make accuracy the cornerstone of its business. This applies not only to initial ratings, but also to the continued monitoring of ratings.

Assuming Kroll Bond Ratings hires 20-30 analysts and it takes three to five years for the firm to establish itself, anecdotal evidence suggests that it will need US$30m-US$50m in capital committed over that period. One way of raising that capital could be to approach all potential participants that would benefit from a new rating agency - in other words, create a consortium of insurance company, pension fund and endowment investors.

An alternative would be to attract a strategic investor; for instance, a lender looking for complementary investments. The recent acquisition of Realpoint by Morningstar (see SCI issue 177) is a recent example of this.

How ever Kroll Bond Ratings capitalises itself, it will need to have identified/attracted a group of key investors and issuers in order to begin rating deals. Uhlein suggests that the firm's strategy could be to enter the market under the new SEC guidelines or begin undertaking unsolicited queries to gain a foothold.

"The type of investigative analysis that Jules Kroll is famous for is forensic rather than credit-based and so rating transactions will require different skills," he adds. "There is a real need for forensic analysis, given the amount of fraud we're seeing at the moment, but robust credit analysis is crucial. The senior hires the firm has made have a ratings background, so perhaps the forensic aspect will be an extension of the traditional credit analysis."

There is scope for different ratings approaches, Uhlein notes - although he warns that it could cause confusion when what investors need is clarity. In addition, Kroll Bond Ratings could focus on discrete areas where the other rating agencies aren't perceived to be so strong; for example, the private RMBS arena. "This makes sense because that's where everything went wrong and so investors might be open to someone doing a better job there," Uhlein concludes.

CS

CMBS

Regeneration required

Changes necessary to see new issuance of Euro CMBS

After a difficult couple of years for European CMBS, another daunting stretch extends before it. If the market is going to survive and be strong enough to start seeing some new issuance, then it must first reinvent itself.

New European CMBS issuance so far in 2010 has been extremely limited: Vesteda launched a privately-placed €350m tap issuance from its Vesteda Residential Funding II programme in April (see SCI issue 181), while Tesco Property Finance 3 - which priced at the mid-point of the year - is not universally considered to be a true CMBS (SCI passim). But the deal may point to a new blueprint for CMBS.

Conor Downey, partner at Paul Hastings, believes the Tesco transaction may be the start of something. He says: "There are rumours that banks are starting to set up again for CMBS and in particular agency CMBS. The rumour is a few banks have been hiring senior people in those areas. We see this as being quite a gradual process and the Tesco deal is an interesting starting point."

The £950m Tesco transaction is a single-loan deal backed by 41 commercial properties, strongly linked to Tesco's credit. While this may present an attractive model, not everybody is convinced that it will become the dominant mode in the market.

"We have seen quasi-CMBS deals such as Tesco, so the return of issuance is happening. It will not be on the same sort of scale, but it will drip through bit by bit," says Faten Bizzari, head of European CRE debt trading for Cantor Fitzgerald.

She adds: "For now, we are going to return to what CMBS deals looked like before the market really took off, so you will see CMBS with large single-borrower deals and large prime assets. Those and fixed-rate products will be the first to return."

A back-to-basics approach may well make the most sense in a market that appears to have lost its way. While Bizzari suggests stripped-back CMBS will make a comeback, she does not say that is how it will stay. Others in the market agree with this outlook.

Charles Roberts, another Paul Hastings partner, says: "Demand from the investor side is for simpler structures and single-tier tranching, but I think it is a little bit premature to say that is how we are going to end up. I do not know if structured credit is going to be absent in the future."

If deals can be structured attractively, then investors will be interested. The trick, of course, is being able to structure them properly.

Michael Cox, principal at Chalkhill Partners, explains: "There will always be demand for fixed-rate CMBS backed by decent assets, amortising from cash from a long lease to a highly-rated tenant. I think there would be investor demand for a new floating-rate CMBS transaction today; however, I think it would probably be uncompetitive from the borrower's perspective."

He adds: "Relative to the bank market, I do not think the CMBS market would finance weaker quality assets or offer more leverage, and I think it would almost certainly be more expensive. I am not convinced there would be greater depth than we see in the bank market, either."

Roberts believes that central banks want securitisation to be an option because alternatives for long-term bank funding are limited. He says: "Securitisation, if it works, is a very good way for banks to access non-bank capital such as insurance companies and pension funds, who say they would be very interested in buying product if it is structured correctly for them."

However, the form of new CMBS ultimately may not be dictated by market demand, but rather by regulators. Market participants do not believe the regulatory scramble is doing them many favours - although, once the dust settles and some calm follows, a workable framework may be achievable.

"The whole industry has been struggling to deal with the sheer volume of new measures coming from the regulators, but I think people are beginning to get their minds around that. Clearly it is going to be more difficult to do securitisations in the future, but that is the environment which we have to live with," says Downey.

He adds: "There will be a different environment when the market resumes and the question is just whether the measures taken are proportionate. There seems to be a bit of an arms race to be the toughest regulator - Germany announced it will impose a 10% retention domestically. Some of the measures look a little bit extreme."

Roberts comments: "I think there is a bit of concern that there was no proper cost assessment done on these regulations. A lot of people think this could end up being quite costly, but then there are plenty out there who think the opposite and do not think the costs will be too substantial."

The additional costs of compliance could quickly add up. Not only does the industry have to consider the 5% (or higher) retention demands, costs of due diligence and extra disclosure requirements, but also the ancillary costs that come. But these costs are not unique to CMBS and they will have to be accommodated because, as Downey says, "the current political environment is very much pro-regulation and the industry understands that and accepts it".

"Regulation will definitely impact all financial markets, especially as governments and regulators at different levels focus on and start to implement stricter rules," says Hans Starrenburg, director at NIBC Bank. "The trend is clear; there will be stricter rules on applying leverage in general, which means stricter solvency rules for banks."

Starrenburg continues: "In the ABS market, specific regulations will be implemented as well - such as retention requirements - and will result in similar de-leveraging effects. In my view, regulators must be very careful with implementing these kinds of measures all at the same time. Coordinated action should prevail over actions from regulators in individual jurisdictions and the effect of all proposed actions must be analysed thoroughly before implemented, including measures like Tobin taxes and establishing bail-out funds."

The final form of CMBS regulation is not known, especially as many suggest it may eventually be modified or even rolled back. While the shape of things to come remains hard to predict, there is far more agreement about when they will come - and the market's answer is 'not soon'.

"New issuance is a while off for CMBS because first you need to see stability in other ABS products, particularly RMBS," explains Roberts. "You cannot properly value CMBS unless there is stability in the pricing of the RMBS market. Also, the current pricing for secondary market CMBS reflects pricing that is too high for the current borrowing market. Long-term views are optimistic, but not short-term. It is still probably a couple of years away."

Cox does "not think we will see multi-loan deals in the near future [because] investors are eager to do their credit work and understand their risk, which means they will look to single-loan deals", while Starrenburg agrees the return of CMBS will be with "less aggressive structures" than those from 2006 and 2007. This slow return - the "drip through" of issuances, as Bizzari termed it - may well see some false dawns along the way.

Whether the 'almost-CMBS' Tesco transaction will prove to be a sign of things to come or a quickly forgotten anomaly remains to be seen, dependent on how the market reacts when the full scope of new regulation is digested. Whatever form CMBS does return in, however, the market is confident that it will return eventually.

"I would expect to see some privately placed CMBS, where a specific product is created for a particular investor. We remain optimistic. The product is too good to be abandoned and it will be back, probably in the medium-term," concludes Downey.

JL

Regulation

Regulatory push

Solvency II to drive more ILS transactions, but could hit use of CLOs

What is widely believed to be the last remaining test of Solvency II, the fifth quantitative impact study (QIS5), is due to wind down this autumn. While some insurers could take a hit from having to meet higher capital requirements, several are likely to gain on their use of derivatives as hedges, particularly with longevity swaps.

Solvency II specifically recognises derivatives as an efficient way to hedge and mitigate risk. Unlike Solvency I, the new regulation would not require reserving large amounts of regulatory capital against derivatives - which many say could boost derivatives usage.

"From a regulatory perspective, Solvency II could be a driver for more transactions in the ILS space or more longevity hedges, etc," says one ILS investor. Initiating longevity swaps as reinsurance contracts has traditionally offered more favourable treatment under Solvency I. But with Solvency II, the investor says, an insurance company could directly do a longevity swap with an end user and not be subject to unfavourable treatment.

Solvency II could actually encourage more use of the swaps, since QIS5 asked for a 25% stress test on longevity assumptions. "This could incentivise insurance companies to manage their longevity more, laying that off more in the market," the investor adds.

"Longevity risk is going to have to be accounted for," notes Dominic Simpson, vp and senior credit officer at Moody's. Under Solvency II, the longevity shock is a 20% decrease in mortality rates for each age and each policy, he adds. Compared to the previous draft QIS5 specifications, the shock has been reduced from 25%.

He further cautions about the risks of the illiquidity premium allowance. "On the one hand, you can include this illiquidity premium in the discount rate applied to your liabilities, as is the current practice for UK players. But the quid pro quo is that for recognising that premium, you have to capture the risks relating to the allowance of it."

An illiquidity premium shock, which is now a 65% fall in the value of the liquidity premium, somewhat negates the widening of the illiquidity criteria, he continues.

Other types of products, such as CLOs, are not likely to see as much interest simply from QIS5. CLOs, in particular, will not be helped by the removal of the 10% floor, according to structured credit analysts at Bank of America Merrill Lynch in their latest research report.

The capital charge, they note, for even the first-pay assets is above the floor already. The stark difference in capital treatment between CLOs and a comparable CSO arises from the look-through foundation itself, where rating and tenure are the primary drivers of loss expectations, the analysts note.

Similarly, Solvency II is likely to restrain demand for mezzanine debt in the longer term, the analysts continue. For example, higher levels of equity capital will be required due to the lower availability of mezzanine financing. But, much like Basel 2 and 3, they believe that these regulatory changes are likely to be phased in over an extended period of time.

The European Commission pushed back the effective date for the regulatory proposals until after 31 December 2012, but QIS5 has insurers already contemplating their preparedness. "Two years is fairly imminent from an insurance/reinsurance perspective," says the investor.

But the amount of preparedness is different among constituents. According to a Deloitte Solvency II Survey undertaken in Q110, life insurers are approaching Solvency II with a greater sense of urgency.

The survey also showed a disparity between life and non-life insurers over total Solvency II budgets. Nearly a third of life insurers in the study stated they have allocated between €5m and €10m, which compares with just over 6% of non-life insurers allocating that amount.

Solvency II is broken down into three pillars: determining the amount of capital an insurer must hold, governing and managing risk of insurers, and disclosure and transparency. Much like Basel 3 is to banks, Solvency II will essentially raise insurers' capital requirements.

But the largest insurers and reinsurers, due to their sheer size, will likely not need to raise capital just due to Solvency II. Diversification is rewarded under Solvency II, notes Simpson.

"From an industry perspective, smaller insurers with little business line diversity might have to raise capital or alter their business or investment mix to meet these new increased capital requirements," he says.

"Solvency II is a risk-based capital regime with insurers required to hold capital against insurance, market, credit and operational risks. This is in stark contrast to the existing Solvency I regime, in which capital requirements focus solely on insurance risk in a somewhat crude fashion," he concludes.

KFH

RMBS

True sale

US RMBS market absorbs SIV bid lists

The central focus of the US RMBS market over last week was two bid lists from liquidating SIV-lite Golden Key. Both were well received, thanks in part to a seemingly more positive market attitude foreshadowed in previous weeks' trading.

The two lists, which included subprime and alt-A paper, "traded remarkably well, given the volatility we have seen over the past few weeks", says one RMBS trader. As a result, pricing levels for liquid deals shifted up one point across the board in the week to 15 July, albeit with smaller-sized and off-the-run transactions still lagging.

Pricing had been firmer without moving in the previous two weeks, which saw reasonably high volumes of bid list activity even in the week ending 9 July, shortened by the US public holiday. Around 75% of list volume is understood to have traded, reflecting an increased willingness of players to step back into the market.

That change in attitude was seen as being connected to the broader rally in equities, with non-agency RMBS market sentiment continuing to reflect stock market sentiment. Despite prices remaining flat in the week to 9 July, dealers suggest that an underlying increase in risk appetite was evident in the increased number of bids on bonds and the firmer support for prices at current levels.

However, it is liquidations of Golden Key and of the Millstone IV CDO - which was being finalised yesterday, 20 July (see separate News Round-up story) - that provide the clearest barometer of market attitude, according to the trader. "These public auctions are true sales and give you a better idea of where the market is and at what price people want to hold paper. Client BWICs give less of an indication as they involve customer relationships and bids are made based on those relationships," he explains.

He adds that Millstone IV provides an additional test of market appetite. "Millstone is going to be very interesting because it won't be traded in blocks, whereas the SIV traded in buckets," he says.

What type of buyer Millstone attracts remains to be seen, but most of the Golden Key collateral is understood to have gone to US bulge bracket firms that had hitherto been seen lightening their portfolios. Notably, Bank of America is believed to have taken down a large proportion of both lists in relative terms to the size of its normal involvement.

Less involved than in the past were the European banks, which for the most part stayed away from the auction. This reluctance is attributed by some to concerns over increased capital regulation and the impending stress tests, which could still force some banks to at least partially unwind existing portfolios.

The ultimate destination of the Golden Key paper is still unclear. "I'm not sure where it's going to - institutional investors I talk to are still on the sidelines," says the trader.

MP

CDO

Goldman settles Abacus case

Goldman Sachs has settled with the US SEC over charges that it misled investors in the Abacus 2007-AC1 CDO (see SCI issue 181). The firm has agreed to pay US$550m - the SEC's largest-ever penalty paid by a Wall Street firm - and reform its business practices. Goldman also acknowledged that its marketing materials for the product contained incomplete information.

Goldman's stock and CDS spiked after the announcement. "Longer term this is good for GS as it lifts the shadow over the company (although any permanent franchise damage remains to be seen). Furthermore, the settlement is supportive of other firms who could be under scrutiny as more similar mortgage deals are investigated by the SEC, that the GS case has set the ceiling for charges," credit analysts at RBS comment.

In its 16 April complaint, the SEC alleged that Goldman misstated and omitted key facts during the marketing of the synthetic CDO that hinged on the performance of subprime RMBS. It was also charged with failing to disclose to investors vital information about the CDO, particularly the role that hedge fund Paulson & Co played in the portfolio selection process and the fact that Paulson had taken a short position against the CDO.

In settlement papers submitted to the US District Court for the Southern District of New York, Goldman made the following acknowledgement: "Goldman acknowledges that the marketing materials for the Abacus 2007-AC1 transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure."

Lorin Reisner, deputy director of the SEC's division of enforcement, says: "The unmistakable message of this lawsuit and [the] settlement is that half-truths and deception cannot be tolerated and that the integrity of the securities markets depends on all market participants acting with uncompromising adherence to the requirements of truthfulness and honesty."

Goldman agreed to settle the SEC's charges without admitting or denying the allegations by consenting to the entry of a final judgment that provides for a permanent injunction from violations of the antifraud provisions of the Securities Act of 1933. Of the US$550m to be paid by Goldman in the settlement, US$250m will be returned to harmed investors (split between IKB, which has been awarded US$150m, and RBS) through a Fair Fund distribution and US$300m will be paid to the US Treasury.

RBS is reportedly considering legal action against Goldman to recover the full US$841m it lost on ABACUS. IKB has recouped the full amount of its losses through the Fair Fund distribution.

The settlement also requires remedial action by Goldman in its review and approval of offerings of certain mortgage securities. This includes the role and responsibilities of internal legal counsel, compliance personnel and outside counsel in the review of written marketing materials for such offerings.

It also requires additional education and training of Goldman employees in this area of the firm's business. In the settlement, Goldman acknowledged that it is presently conducting a comprehensive, firm-wide review of its business standards, which the SEC has taken into account in connection with the settlement of this matter.

The settlement is subject to approval by the Barbara Jones, US District Judge for the Southern District of New York. The SEC's litigation continues against Goldman vp Fabrice Tourre.

CS

Ratings

Plans to introduce SF rating identifier confirmed

Fitch, Moody's and DBRS have confirmed that they will introduce a structured finance rating identifier '(sf)' over the summer. S&P announced its plans to do the same at the end of June (see SCI issue 191).

Fitch clarified that the modifier will only indicate that a security is a structured finance instrument and will not reflect any other change to the meaning or definitions of its ratings. The agency says its aim is that the long-term default experience of credit rating categories across sectors, including structured finance, is broadly comparable.

The agency views this as the best measure of a default-based ratings scale performance. It does, however, expect short-term default experience, rating volatility and rating migration to differ between sectors, particularly in the lowest rating categories.

Nevertheless, the most senior ratings - especially triple-A - in all sectors are intended to remain stable over time and not generally respond to the evolution of a typical economic cycle. These ratings are therefore intended to demonstrate similar levels of rating stability across sectors.

"Extensive criteria revisions have been made by Fitch over the past two years in the most stressed structured finance sectors, which will help to achieve greater comparability between SF and non-structured finance ratings," says Fitch's group credit officer, Stuart Jennings.

The (sf) indicator will be used to satisfy the requirements under the European Regulation on Credit Rating Agencies. In addition, instruments with the (sf) indicator are the type that rating agencies believe to be "structured finance instruments" within the meaning of the US SEC's Rule 17g-5(a)(3) and (b)(9).

Moody's intends to apply the indicator to ABCP, ABS, MBS, CDO, closed-end fund debt that is invested in structured finance instruments, CLNs/repacks with credit tranching, principal-protected notes secured by structured finance instruments, SIVs and WBS. It does not intend to apply the (sf) indicator to covered bonds, derivative product companies, EETCs, IO and PO strips, and project/corporate infrastructure financings.

The agency says it sought to define "structured finance instrument" as objectively as possible. For instruments that were difficult to categorise, it also considered general market practice.

In general, the key principles that Moody's used for determining whether an instrument is included as a structured finance instrument are:

• Payments depend upon the performance of an exposure/pool of exposures
• The existence of a special purpose entity and whether economic interests are transferred to such special purpose entity
• The instruments are not obligations of or full or substantially full recourse to the originator/sponsor
• The presence of securitisation tranching
• The presence of a guarantee or insurance policy either covering losses on the underlying assets or issued bonds typically would not impact the categorisation of whether an instrument is a structured finance instrument.

Meanwhile, DBRS is to adopt on a global basis the EU Regulation for requirement for a structured finance modifier on 16 August 2010. The agency plans to apply for registration under the EU CRA Regulation by the end of the summer.

DBRS stresses that the (sf) symbol will only indicate that the security is an SF instrument and will not change the meaning or definition of the rating in any other way, nor will it change the risk of any particular SF instrument. Equally, the agency's expectation of the performance of each rated SF instrument is not adjusted in any way by the SF modifier.

DBRS will apply the SF modifier when it rates: ABS, ABCP, RMBS, single- and multi-tranched CDOs and CDS (with the exception of single-name CDS), CMBS, multi-tranched insurance securitisations, SIVs and repackaged instruments where any of the underlying assets is an SF instrument.

CS & LB

Real Estate

Pair of FDIC structured transactions close

The FDIC has closed on two sales of 40% equity interests in two limited liability companies (LLCs) created to hold failed bank assets in receivership.

The first sale involved an unpaid principal balance of approximately US$1.85bn from 22 failed bank receiverships. The winning bidder of the multibank structured transaction is Colony Capital, with a price of approximately 59% of the unpaid principal balance. The Cogsville Group, a minority-owned investor, was Colony's junior equity partner in the transaction.

As an equity participant, the FDIC will retain a 60% stake in the LLC and share in the returns on the assets. The FDIC offered 1:1 leverage financing and has agreed to guarantee purchase money notes issued by the LLC in the original principal amount of US$545m.

The sale was conducted on a competitive basis, with the FDIC receiving a total of six bids from four bidders on either a 40% leveraged ownership interest or a 20% unleveraged ownership interest in the newly formed LLC.

The FDIC as receiver for the failed banks will convey to the LLC a portfolio of approximately 1,660 distressed commercial real estate loans, of which approximately 50% are delinquent. Collectively, the loans have an unpaid principal balance of US$1.85bn. Of the collateral in the portfolio, 73% is located in Nevada, California, Colorado, Arizona and Georgia. As the LLC's managing equity owner, Colony will manage, service and ultimately dispose of the LLC's assets.

The second sale involves approximately US$898m of primarily non-performing residential loan assets out of AmTrust Bank. The winning bidder of the structured transaction is a three-party consortium made up of Residential Credit Solutions, CarVal Investors and RBS Financial Products at a price of approximately 37% of unpaid principal balance.

As an equity participant, the FDIC will retain a 60% stake in the LLC and share in the returns on the assets. It offered 1:1 leverage financing and has agreed to guaranty purchase money notes issued by the LLC of approximately US$169.5m. The sale was conducted on a competitive basis, with the FDIC receiving a total of five bids on either a 40% leveraged ownership interest or a 40% unleveraged ownership interest in the newly-formed LLC.

The FDIC as receiver for the failed bank will convey to the LLC a portfolio of approximately US$898m residential real estate loans, of which approximately 96% are delinquent. 37% of the collateral in the portfolio is located in Florida, 11% in California, 5% in each of Arizona, Nevada and Massachusetts, and the balance in 42 other states.

As the managing member of the LLC's managing equity owner, Residential Credit Solutions will provide the management, servicing and ultimate disposition of the LLC's assets.

AmTrust bank failed on 4 December 2009, where the FDIC immediately entered into a purchase and assumption agreement with New York Community Bank to assume all the deposits and approximately US$9b of the assets. This transaction completes the sale of the majority of the remaining assets of AmTrust Bank.

LB

RMBS

Russian RMBS rated amid stabilising arrears

Loans originated by Russia's Agency for Housing Mortgage Lending (AHML) have been used to back a R13.5bn securitisation. The move comes amid stabilising arrears levels for most Russian and Commonwealth of Independent States (CIS) RMBS transactions.

The AHML loans were originated by a number of regional banks and non-banking entities in 77 regions of the Russian Federation. Moody's has rated two tranches of notes issued by the Closed Joint Stock Company Mortgage Agent of AHML 2010-1 RMBS, assigning the R6.096bn class A1 notes a Baa1 rating and the R6.096bn class A2 notes Baa3. The R1.345bn class B notes have not been rated.

The notes have been issued to refinance the purchase of a portfolio of mortgage certificates with rights to receivables from mortgage loans. The entire issued share capital is held by Stichting Moscow Mortgages V and Stichting Moscow Mortgages VI.

Moody's says its ratings are based on favourable pool characteristics, such as the weighted average current LTV of 48.7% and low geographic concentration of the portfolio. Credit enhancement provided by subordination, excess spread, an AHML obligation to provide financial assistance and AHML's credit quality as the servicer are all other factors influencing the ratings.

An amortising reserve fund of R²71m was partially funded at closing to the amount of R94.8m and the remainder will be funded by excess spread. The reserve fund may begin to amortise at 2% of the outstanding note balance after two years, down to a floor of R47m.

Should the reserve fund fall below 50% of its target amount, AHML will provide financial assistance that may be used to top up the reserve fund, pay interest or repay the principal under the notes. The initial amount of the financial assistance is R1.35bn and will start amortising at 10% of the outstanding note balance two years after issuance.

The pool contains fixed-rate loans secured by mortgages on 21,435 residential properties located throughout the Russian Federation. The highest concentration is in the Sverdlovsk region, where 5.96% are located.

Meanwhile, Moody's reports in its latest indices for the sector that arrears levels in most Russian and Commonwealth of Independent States (CIS) RMBS transactions have been fairly steady in the 12 months to May 2010. The agency says two exceptions have been the Kazakh MBS 2007-1 and Moscow Stars transactions.

Delinquencies in the Kazakh transaction increased consistently to reach 3.23% in May, having been as low as 0.05% a year before. The Moscow transaction has seen high default levels, with 8.46% of the current pool balance in May more than 90 days in arrears.

Excess spread was used to cure the Moscow transaction's principal deficiency, meaning the reserve fund could not be built up to the required level. That has triggered a doubling of the reserve fund target amount.

Most other CIS RMBS deals have seen outstanding defaults levelling off in the last six months and loss rates have been negligible. That said, Moody's warns that it is difficult to assess performance and compare transactions because of differences in delinquency and default definitions and the practice of originators repurchasing defaulted loans.

The agency says downside risks remain, despite the Russian economy recovering. A stronger rouble threatens the recovery in exports, as the currency has gained around 13% against the euro since December. Moody's expects GDP growth of 3.9% in 2010 and 4.2% in 2011, but also believes the government will scale back spending, which could further jeopardise growth.

Separately, Moody's has taken rating actions on the notes of five Russian RMBS and ABS transactions, where the notes are backed by US dollar-denominated collateral originated in Russia. The agency originally put these notes on review for downgrade on 16 December 2008, due to the increased uncertainty related to the rapid depreciation of the rouble against the US dollar and the resulting low but increased risk, in its opinion, of redenomination of US dollar mortgages and loan agreements into roubles.

Moody's confirmed the ratings of Moscow Stars, Roof Russia, Red & Black Prime Russia MBS No 1 and Russia Mortgage Backed Securities 2006-1. The senior notes of CityMortgage MBS Finance were downgraded due to increased operational and legal risk.

JL

ABS

New rating agency team takes shape

Kroll Bond Ratings has revealed the members of its senior management team. Ceo and chairman Jules Kroll is to be joined by James Nadler, Robert Anselmi, Ellen Coleman, Jerome Fons and Ajay Junnarkar.

Nadler becomes the president and coo of Kroll. He was previously the vp for corporate development at General Re in the new England asset management division. Prior to this, Nadler was evp at Fitch Ratings, after starting his career as a ratings officer at S&P and as senior accountant at PricewaterhouseCoopers.

Anselmi becomes the general counsel and chief compliance officer of Kroll. Before joining the firm, he held positions with industry leaders, including NY Life Investment Management, Lehman Brothers and JPMorgan.

Coleman is the director of underwriting review at Kroll and is responsible for mortgage originator and servicer reviews. She has 20 years of financial services experience, most recently at Countrywide Financial. Prior to this, Coleman spent 10 years as a relationship banker with ABN AMRO Bank, after starting her banking career at Chase Manhattan Bank.

Fons is the evp of strategy for Kroll. He is an economist specialising in credit risk and rating agency issues, having spent 17 years at Moody's - most recently as md. Prior to joining Moody's, Fons was an economic advisor at Chemical Bank and an economist with the Federal Reserve Banks of New York and Cleveland.

Junnarkar is the chief financial and administrative officer of Kroll. He joins the company from Marsh & McLennan, where he served as a senior finance team member. He began his career as a forensic accountant at Kroll.

"These professionals, with their varied and impressive expertise, have the much-needed judgment to refashion the credit ratings industry," says Kroll. "Together, we will provide investors with a reliable and accurate product."

Kroll expects to publish its first ratings during the third quarter of 2010.

ABS

Sales and trading platform expands

RBS Securities has expanded its MBS & ABS sales and trading teams within its global banking and markets division in the Americas.

Sean Whelan and Colin McGahren have joined the firm's MBS and ABS sales team, while Brian Song has joined RBS as head of agency pass-through trading. Based in Stamford, Connecticut, Song will report to David Cannon and Scott Eichel, global co-heads of MBS and ABS trading. Whelan and McGahren will report to Jeffrey DiModica, head of MBS and ABS sales.

Song joins the firm with nearly 10 years of trading MBS experience. During that period, he worked for Credit Suisse, where he specialised in trading agency pass-through securities. Prior to this, he was responsible for heading agency pass-through trading at HSBC.

Whelan is a veteran of the securitisation markets, with more than 20 years of sales experience. He joins RBS from Deutsche Bank, where he was responsible for MBS sales to banks, money managers and hedge funds. Previously, Whelan held senior MBS sales roles at UBS and Lehman Brothers.

McGahren comes to RBS with more than a decade of sales experience in the MBS market. He joins the firm from Nomura, where he was a member of its MBS sales desk, covering institutional clients ranging from banks to hedge funds. Prior to this, he held MBS sales positions at Mizuho and Bank of America Merrill Lynch.

ABS

New fixed income head appointed

Threadneedle has appointed Jim Cielinski as head of its fixed income desk. He will join the company in October 2010 to lead its fixed income team of 38 investment professionals, who manage both institutional and retail funds of £22.6bn AUM in many sectors including ABS. Following the recent hire of Legal & General's Mark Burgess as cio, this appointment completes Threadneedle's senior team.

Cielinski has spent the last 12 years at Goldman Sachs Asset Management, most recently serving as md and head of global investment grade credit. Prior to GSAM, he was head of fixed income at Utah Retirement Systems and held positions at both Brown Brothers Harriman and First Security Investment Management.

Sarah Arkle, the firm's cio, comments: "Jim will play a crucial role in driving Threadneedle through to the next phase of its development as a manager of scale in fixed income. He has an excellent track record of successfully growing assets under management and delivering performance for clients while he was at GSAM."

ABS

Structured products head resurfaces

Jeffrey Mayer has been appointed head of global markets for North America at Deutsche Bank, managing the bank's sales and trading business in the region. He will report to Anshu Jain, head of the corporate and investment bank.

Mayer joins Deutsche's New York office with over 20 years of cross-asset class sales, trading and management experience. Most recently, he was the executive chairman of fixed income, currencies and commodities and head of complex structured products at UBS. Prior to UBS, Mayer spent 19 years at Bear Stearns, most recently as global co-head of fixed income.

Jain says: "I am pleased that Jeff has decided to lead our sales and trading business in North America, a franchise that is vital to our global strategy and one where we have gained significant market share in recent years. Jeff's record of leadership across multiple asset classes will serve our clients well as we build further on these gains."

ABS

SEC staffs up in ABS disclosure, rulemaking

The US SEC has appointed Paula Dubberly as deputy director for policy and capital markets in its corporation finance division. She joins deputy directors Brian Breheny (for legal and regulatory) and Shelley Parratt (disclosure operations).

Dubberly will oversee two of the division's three new specialised offices, created to enhance its disclosure review and policy operations. The new offices will respectively focus on large financial services companies, ABS and other structured finance products, and securities offering trends. Specifically, the ABS office will review disclosure and monitor its impact on the markets, as well as lead rulemaking and interpretive activities related to structured products.

"These changes will help us focus our resources more sharply on critically important institutions and financial products, so we can stay ahead of the curve and better protect investors," says Meredith Cross, director of the SEC's division of corporation finance.

Dubberly joined the division of corporation finance as an attorney in 1992. She has served in many roles in the division, including assistant director for disclosure operations, chief counsel and associate director (legal), overseeing the division's rulemaking efforts and its office of enforcement liaison.

ABS

Permacap progresses with ABS purchase plan

Queen's Walk Investment Ltd (QWIL) reports in its interim management statement for the period from 31 March to 20 July 2010 that it has made substantial progress in its strategy of repaying its financing facility and increasing exposure to ABS. The permacap fully repaid its loan facility on 6 April, which removes all leverage from its balance sheet.

During the quarter ended 31 March, QWIL invested €6.5m in purchasing ABS bonds that accounted for 15.3% by net asset value of the investment portfolio at the end of that quarter. Between 31 March and 30 June, the permacap invested a further €11.3m purchasing ABS bonds, increasing the total nominal value of the ABS bond portfolio to €46.3m. It intends to continue its strategy of purchasing ABS bonds in order to deliver an improved risk/reward profile to investors.

Indeed, the permacap expects the ABS bond portfolio to increase as a percentage of overall assets in coming quarters and for residual income assets to fall as a proportion of overall assets. As at 30 June, the ABS portfolio consisted of 46 bonds at a cost of €26.1m and a nominal value of €46.3m. The weighted average rating of the ABS bond portfolio (based on the invested amount) is approximately double-B plus.

QWIL believes that mezzanine bonds offer strong relative value and expects market volatility over the coming months to create opportunities to purchase further undervalued ABS bonds. It intends to only invest in bonds whose price is considered depressed due to technical and liquidity issues.

ABS

Latin American practice adds ABS counsel

Alejandro Landa has joined law firm Chadbourne & Parke as counsel in its Mexico City office. He was most recently with Thompson & Knight Abogados in Mexico City, where he advised Mexican and foreign companies and financial institutions on the corporate finance components of public bids, mergers and acquisitions, joint ventures, and domestic and cross-border ABS.

"We are pleased to welcome Alejandro to our Mexico City office," says Chadbourne managing partner Charles O'Neill. "We continue to aggressively add attorneys to our Latin America practice, and Alejandro will provide additional support to our clients in Mexico on a range of matters."

ABS

Partner added in New York

Emil Arca has joined Hogan Lovells as partner and will be based in the New York office.

Most recently, Arca was a partner at Dewey & LeBoeuf in New York. Handling matters in more than 20 countries, particularly in Latin America, he has extensive experience in representing issuers, underwriters, placement agents, investors, borrowers, lenders, insurers and other parties in structured finance, debt capital markets, banking and restructuring transactions in the US and globally.

Lovells finance co-heads, Ben Hammond and David Hudd, comment: "The work handled by Emil is at the high end of the securitisation business and is a very good fit alongside the team based in Europe. We are seeing definite signs of improvement in the securitisation market and this is exactly the right time for the team to be growing its capability in this area."

CDO

Further Callidus deal transferred

GSO/Blackstone Debt Funds Management will replace Callidus Capital Management as collateral manager for yet another CDO, having taken control of nine Callidus transactions earlier this year (see SCI issue 183).

The class A note credit enhancer proposed GSO as the successor manager for Callidus Debt Partners CDO Fund I. Neither the majority in interest of the preference shares nor a majority of the class C notes and class D notes objected within 30 days to the proposal, so all that now remains is for GSO to agree in writing to assume collateral management duties.

CDO

Summary judgment entered against REIT

NorthStar Realty Finance Corp has disclosed that the judge presiding over a lawsuit involving two of the firm's subsidiaries has granted a motion for summary judgment. NorthStar's subsidiaries - NRFC NNN Holdings and NRFC Sub Investor IV - are defendants in a lawsuit filed by GECCMC 2005-CI Plummer Office Limited Partnership (the lender) in the Superior Court of the State of California, relating to a loan on two properties previously owned by NRFC Sub IV that were 100% leased to Washington Mutual Bank.

The lawsuit alleges that the loan provided by the lender to NRFC Sub IV became a recourse obligation of NRFC NNN due to an alleged termination of the lease. The judge is expected to enter a judgment against NRFC NNN in the amount of approximately US$42m.

NRFC NNN says it believes that the lawsuit is without merit and intends to vigorously pursue an appeal of the decision. In connection with such an appeal, it is required to post a bond in an amount equal to 1.5 times the amount of the judgment.

The tenant vacated the buildings, located in Chatsworth, California, on 23 March 2008 and the leases were disaffirmed by the FDIC. The assets were financed with a non-recourse US$42.9m first mortgage loan and a US$9.2m mezzanine loan that was collateral for one of NorthStar's CDO financings.

In Q408, NorthStar took an impairment charge relating to these properties and in the Q309 the lender foreclosed on the property. It filed the complaint against NRFC NNN and NRFC Sub Investor IV on 10 August 2009.

CDS

South Asian capital markets head named

Pankaj Vaish has joined Citi as head of markets for India, Bangladesh and Sri Lanka. He will be responsible for the fixed income, currencies, credit, commodities and equities businesses in the region, reporting to Rodrigo Zorilla, head of global markets at Citi Asia Pacific, and to Pramit Jhaveri, ceo at Citi India.

With over 19 years of capital markets experience, Vaish joins Citi from Nomura Securities, where he was md and head of equities. Prior to that, he worked at Citi in New York, most recently as md, proprietary trading. Earlier in his career with Citi, Vaish's responsibilities included managing credit derivatives trading.

CDS

Structured credit exec promoted

BNY Mellon has appointed Patrick Tadie as global business head for the company's Derivatives360(SM) initiative, a service that assists with managing and trading derivatives transactions.

Tadie, who is an evp, will now oversee the coordination and development of derivatives services across multiple business lines in the company. He was most recently evp in charge of the global structured credit group within BNY Mellon Corporate Trust.

He reports to Art Certosimo, senior evp and head of alternative and broker-dealer services at BNY Mellon.

CLOs

Manager hands over its CLOs

Ares Management has replaced Navigare Partners as collateral manager for two CLOs. Navigare has transferred management duties on Navigare Funding I CLO and Navigare Funding II CLO to Ares, which has subsequently assigned the associated rights and obligations to two of its affiliates.

Navigare had been seeking to transfer its management obligations to Ares for some time (see SCI issue 179). Having now achieved that, Moody's says the transfers will not impact the agency's ratings on either of the CLOs.

Navigare Funding I CLO will now be managed by Ares NF CLO XIII Management, while the successor collateral manager for Navigare Funding II CLO will be Ares NF CLO XIV Management. In both cases requisite noteholders have been given notice and none have raised objections to the manager changes.

CMBS

New York CMBS md recruited

Bank of America has appointed George Kok as md, responsible for conduit lending in New York. He will report to Michael Mazzei, head of commercial real estate debt capital markets at the firm.

Most recently, Kok was head of credit at FundCore Finance in New York. Prior to that, he oversaw conduit lending at Merrill Lynch from 2001 to 2008, after spending five years running the origination and underwriting group for Morgan Stanley's conduit operation.

CMBS

New cio to expand CRE investment footprint

Cole Real Estate Investments has appointed Robert Micera as cio for its office and industrial platform.

Micera has more than 20 years of real estate investment banking, acquisitions, net-lease structuring and dispositions experience. He has served in both principal and advisory capacities, successfully arranging and executing a variety of real estate structured finance solutions representing nearly US$7bn.

Micera was most recently a principal with Cardinal Industrial Real Estate Services. Prior to Cardinal, he was svp and national head of net lease investments for First Industrial Realty Trust.

Investors

President appointed for debt investment group

Gordon Brothers Group has appointed Judy Mencher as president of its debt investment group. Based in the firm's Boston headquarters, Mencher will focus on the firm's debt portfolio.

"Judy's expertise in special situation, distressed and high yield investments will allow us to fully exploit the unique debt investment opportunities that have been created by unprecedented market conditions," states Michael Frieze, ceo of Gordon Brothers.

Prior to joining Gordon Brothers, Mencher was principal at DDJ Capital Management, which she co-founded in 1996 and served as a portfolio manager. Earlier in her career, she served as associate general counsel and then vp at Fidelity Investments in the high yield group, as well as associate and then partner at the law firm Goodwin Procter.

Monolines

Monoline completes remediation plan

Syncora Guarantee has completed its remediation plan to meet its minimum statutory policyholder surplus requirements and address its previously announced liquidity issues. The remediation plan included: purchases of certain guaranteed exposures; monetisation of its illiquid assets; receipt of a partial prepayment of a surplus note from its owned subsidiary Syncora Capital Assurance; and various other loss remediation and restructuring actions.

The monoline also announced that, as required by a supplemental order issued by the New York Insurance Department (NYID) on 17 June, its plan has been approved for the payment of new claims as they become due in the ordinary course of business and for the payment of claims accrued and unpaid since claims payments were suspended on 26 April 2009. In accordance with the plan, Syncora will commence making claim payments on regularly scheduled payment dates occurring on or after 21 July 2010.

The monoline also confirmed that while its loss reserve analysis is still ongoing, it now expects to report statutory surplus as of 30 June 2010 in line with or in excess of the US$104.1m reported.

Ratings

Ratings advisory md named

Paul Sandoli has joined Jefferies as md and head of its ratings advisory group, in a further expansion of the firm's debt capital markets business. Sandoli will be responsible for leading the firm's efforts in providing credit rating and capital structure advice and analysis to corporate clients in connection with their capital raising and acquisition financing decisions.

Sandoli has over 15 years of investment banking experience, including seven years at Bear Stearns, where he was md and led the leveraged finance ratings advisory business. Prior to Bear Stearns, Sandoli spent six years at Goldman Sachs in credit risk management and rating agency advisory.

Benjamin Lorello, global head of investment banking and capital markets at Jefferies, comments: "The addition of Paul to our debt capital markets team is part of our ongoing strategy to expand the breadth of fixed income services we provide to our corporate clients in advising them on their financing, refinancing and acquisition funding decisions."

Real Estate

US real estate group leader hired

Douglas Wisner has joined Clifford Chance as partner in the New York office and will lead the firm's real estate group in the Americas region.

With more than 30 years of experience working on large real estate transactions, Wisner joins Clifford Chance from Mayer Brown, where he was the firm's practice leader in the global real estate group. He has significant experience in representing investment banks, commercial banks and other arrangers of construction, bridge, mezzanine and permanent credit facilities in domestic and cross-border capital markets and leveraged bank transactions.

Regulation

Goldman says some of Basel 3 'not workable'

While it is too early to discuss all of the possible changes that could still take place on the regulatory front, Goldman Sachs said on its conference call yesterday (20 July) that some requirements under Basel 3 are not acceptable in its current form.

"Basel 2.5 has tough requirements that seem to be worked out and are manageable. Basel 3 has some requirements that are not workable for the system," Goldman's cfo David Viniar said on the call.

But some legislation will help Goldman's capital situation. Viniar agreed that the Dodd-Frank Bill will either free up capital or be capital-neutral.

Regarding the 3% limitation of a bank's Tier I capital that can be held in private equity and hedge funds, Viniar said it is likely that Goldman will have less of its capital invested in those funds going forward. "Most of the provisions are either capital enhancing in a way or capital neutral," he noted.

The bank said its Tier I capital ratio under Basel I was 15.2% as of 30 June 2010, while its Tier I common ratio under Basel I was 12.5% as of that date.

The financial regulatory changes taking place are the most sweeping changes for the markets in decades, Viniar added. Derivatives legislation and the restrictions on its proprietary activities are some of its key concerns.

However, it is too early to discuss the costs associated with any possible changes, as well as any impact that could occur on Goldman's derivatives operations themselves and its human capital, Viniar continued.

Goldman settled its Abacus 2007 CDO case with the SEC on 15 July for US$550m without admitting or denying the SEC's allegations, but said it made a mistake including incomplete information in its marketing materials (see separate News story). "We don't think it's going to have any material impact. We think there's nothing new in the settlement," Viniar remarked.

Despite widespread press reports citing a criminal probe into Goldman, the bank said it is not aware of any criminal investigation. "By and large, across the board, our clients were pretty supportive of us," Viniar added.

In trading and principal investments, the firm said its net revenues for Q210 were US$6.55bn, 39% lower than Q209 and 36% lower than Q110. "Macroeconomic uncertainty led to lower customer activity levels and weaker revenues across each major business, particularly credit, interest rates and currencies," he concluded.

RMBS

Amended Countrywide complaint filed

Cohen Milstein Sellers & Toll has filed an amended consolidated class action complaint in its landmark litigation against Countrywide Financial Corporation and 16 other underwriter defendants that it describes as being "prominently involved" in the failure of MBS over the last several years. The other defendants, which underwrote more than US$350bn in Countrywide securities, include JPMorgan, Deutsche Bank, Bear Stearns, UBS, Morgan Stanley, Edward Jones, Citigroup, Goldman Sachs and Credit Suisse.

Cohen Milstein is lead counsel for the class and counsel for the lead plaintiff, the Iowa Public Employees' Retirement System, as well as the Oregon Public Employees' Retirement System and Orange County Employees' Retirement System. The General Board of Pension and Health Benefits of the United Methodist Church is also named as a plaintiff in the litigation.

In the amended complaint, the plaintiffs allege that the defendants published false and misleading offering documents, including registration statements, prospectuses and prospectus supplements. Specifically, these documents misrepresented or failed to disclose that underwriting guidelines for the mortgages backing the securities had been systematically disregarded.

According to the lawsuit, in order to generate a steady flow of mortgage loans to sustain its "mass production" of MBS, Countrywide routinely issued loans to borrowers that otherwise would never have qualified for them - and indeed, did not qualify for the loans they received - through, for example, 'low doc' and 'no doc' loan programmes, often with adjustable interest rates that had been designed for borrowers with higher incomes and better credit.

Over 92% of these securities received triple-A ratings; ultimately, however, 87% were downgraded to junk. Tellingly, one year after the date of the offerings, delinquency and default rates on the underlying mortgages had increased 2,525% from issuance.

The complaint alleges that the defendants' actions violated Sections 11, 12(a)(2) and 15 of the Securities Act of 1933. The case is pending before Judge Mariana Pfaelzer in the US District Court for the Central District of California.

ABS

Fed survey shows increased ABS funding demand

The US Fed has released its findings from the inaugural June 2010 Senior Credit Officer Opinion Survey on Dealer Financing Terms, which collected qualitative information on changes over the previous three months in credit terms and conditions in securities financing and OTC derivatives markets. Overall, responses to the survey pointed to some noteworthy developments with respect to counterparty relationships and securities financing, but little change in the terms and conditions prevalent in OTC derivatives markets.

For example, survey respondents reported that the amount of resources and attention devoted by dealers to management of concentrated credit exposures to dealers and other financial intermediaries had increased. Dealers indicated that they had generally loosened credit terms offered to important groups of clients across the spectrum of securities financing and OTC derivatives transactions. Dealers also noted that efforts by clients to negotiate more-favourable terms had increased in intensity.

With respect to OTC derivatives transactions, respondents reported that non-price terms had changed little across different types of underlyings, including those for both plain vanilla and customised derivatives. Dealers reported that the volume of mark and collateral disputes with clients also remained basically unchanged across counterparty and transaction types.

Meanwhile, responses to questions focused on securities financing suggested an increase in demand for funding high grade corporate bonds, equities, agency RMBS and other ABS. Finally, responses to special questions suggested that current credit terms applicable to all counterparty and transaction types were uniformly more stringent than at the end of 2006, before the onset of the financial crisis.

The survey included a core set of questions that were organised into three groups. The first group of questions covered credit terms applicable to particular types of counterparties across the entire spectrum of transactions.

The second group of questions asked about OTC derivatives trades, differentiating among the underlying asset classes and also between plain vanilla derivatives and those that are more highly customised. The third group of questions was in relation to securities financing trades.

Responses were collated from 20 financial institutions that account for almost all of the dealer financing of dollar-denominated securities to non-dealers and that are the most active intermediaries in OTC derivatives markets. The survey was conducted from 24 May to 4 June 2010. The reference period for the core questions was March through to May.

ABS

BoE updates on ABS transparency initiative

The Bank of England has updated the market on its initiative to require greater information transparency in relation to ABS as part of the eligibility criteria for instruments accepted in its operations. It has also disclosed the results of its recent consultation on broadening the range of collateral eligible in the Discount Window Facility (DWF) to include loan portfolios The bank says it intends to implement both of these initiatives, with further detail on the criteria and timescales to be announced later in the year.

The BoE intends to extend the range of collateral eligible in the DWF to include portfolios of loans to individuals and non-banks. It is expected that this extension will take place during 2011.

In order to be eligible for the bank's operations, meanwhile, a number of additional eligibility requirements for ABS and covered bonds will also be introduced. First is that quarterly loan level information will be made publicly available and within a defined period after the relevant bond payment date for RMBS, covered bonds, CMBS, CLOs and securitisations of auto, consumer, lease and private student loans.

Second, the prospectus - together with the closing transaction documents (excluding legal opinions) - will be made freely and publicly available. Third, a transaction summary in a standardised format for any new issuance will need to be produced and made freely and publicly available.

Fourth, standardised monthly investor reports will have to be provided. Finally, a cashflow model will be made freely and publicly available by or on behalf of the originator/issuer.

The BoE initially envisages that all of this information be placed on a website maintained by the issuer/originator (or by another party on their behalf) and that it be made freely and readily available to interested third parties. The bank says it would not object to a shared infrastructure being developed, but does not intend to mandate this at present.

In comparison, the SEC-mandated issuer disclosure website is said to currently be causing consternation. Issuers are required to maintain the website and potentially have liability for the information contained there, so most will outsource the maintenance to third parties.

"It's not clear what information has to be displayed there," explains John Uhlein, founder and managing partner of Grenadier Capital. "Rating agencies are being encouraged to provide unsolicited opinions on other ratings, but clearly they'll only do this in cases where their rating is lower. Obviously, investors don't want to be in a situation where their investments lose value because of a lower unsolicited rating."

The BoE intends to issue a further market notice later this year setting out full details regarding implementation, including timescales. An implementation period of 12 months will be allowed for each asset class following the publication of detailed requirements.

ABS

Few more FFELP securitisations could be on tap

A couple more loan securisations under the Federal Family Education Loan Program (FFELP) are likely to still squeeze in as student loan issuers look to restructure existing transactions. The government-run programme was eliminated on 1 July.

"We saw a couple of new FFELP securitisations because a lot of issuers want to clean up FFELP loans on their books," says Jingjing Dang, analyst at Moody's, noting that she does not expect the volume of FFELP loan securitisations to continue like this.

According to one MBS investor, a few more securitisations are likely to occur. Last month, the market absorbed FFELP securitisations from Student Loan Corp; Goal Capital, which issued a US$118m deal called GOAL 2010-1; and Educational Funding of the South, which issued a US$228m EFSV 2010-1 offering. An Access deal totalling US$464m featured private student loans.

ABS

RFC issued on Canadian rating oversight

The Canadian Securities Administrators (CSA) has published for comment its proposed National Instrument 25-101 Designated Rating Organisations, which is aimed at introducing securities regulatory oversight of credit rating organisations.

Central to the proposal is the requirement for credit rating organisations to apply to become a designated rating organisation (DRO) to allow their ratings to be used for various purposes within securities legislation. For example, access to the short form prospectus system will only be available for certain debt securities if a credit rating is obtained from a DRO.

Once designated, a rating organisation would be required to have and enforce a code of conduct that is based on the IOSCO code. A DRO would also be required to establish policies and procedures to manage conflicts of interest, prevent inappropriate use of information, appoint a compliance officer and make an annual filing.

"Many investors consider credit ratings as one of the factors in making investment decisions and ratings continue to be referred to within securities legislation, so it is important to develop a formal regulatory regime for the oversight of credit rating organisations," says Jean St-Gelais, chair of CSA and president and ceo of the Autorité des marchés financiers.

He adds: "This CSA initiative is consistent with international developments in addressing the oversight of credit rating agencies, which can have a significant impact upon financial markets."

CSA members who participate in the passport system have proposed that credit rating organisations will be able to rely on this system to apply to their principal regulator to be designated as a DRO, in all passport jurisdictions. As such, the materials include consequential amendments to instruments and the introduction of proposed policies to facilitate use of the passport system.

The CSA is seeking input from all stakeholders on the proposals. The comment period is open until 25 October 2010.

ABS

TALF credit protection reduced in line with outstandings

The Federal Reserve Board says it agrees with the US Treasury that it's appropriate to reduce the credit protection provided for TALF transactions under the Troubled Asset Relief Program (TARP) from US$20bn to US$4.3bn. The Board had initially authorised up to US$200bn in TALF loans, but when the programme closed on 30 June only US$43bn in loans were outstanding.

Although the TALF extended US$70bn in loans overall, many of the loans - which have initial maturities of three or five years - have been repaid early, partly because the interest rates on TALF loans were designed to be higher than market rates in the more normal conditions that have come to prevail in a number of securitisation markets.

Any losses on the TALF programme would first be absorbed by the accumulated excess of the TALF loan interest payments over the Federal Reserve's cost of funds, and then by the TARP funds. To date, the TALF programme has experienced no losses and all outstanding TALF loans remain well collateralised.

ABS

Greek downgrades begin

Moody's has concluded its rating review of 25 Greek structured finance transactions, which resulted in downgrades on 33 ratings and the confirmation of three ratings. The agency maintains ratings on review for downgrade on 12 tranches, pending the implementation of restructurings proposed by the deal sponsors. The action effects €17.2bn of securities.

Senior note ratings of the relevant transactions have been downgraded to A2, A3 or Baa1, depending on the level of credit enhancement and strength of operational risk mitigants. Junior and mezzanine notes have all been lowered to non-investment grade levels.

European asset-backed analysts at RBS note that this latest rating action from Moody's re-establishes a more sensible notching principle for ABS; that is, the agency has allowed for senior performing ABS to retain a rating differential of around four notches above that of the sovereign. "The previous rating action from Moody's - when it downgraded most senior ABS ratings to that of the sovereign - suggested that the agency was taking a far harsher approach to 'distressed' sovereign- or bank-related ABS with an almost one-for-one rating linkage, which we argued at the time defied any structured finance logic," they explain. S&P and Fitch currently allow for a five- or six-notch rating differential for senior performing ABS.

Even so, the RBS analysts point out that Moody's action heightens the risk that Greek senior ABS become ineligible for ECB repo purposes - in most cases, current ratings are at the cusp of losing their eligibility. The dimension of this risk going forward will become more pronounced, should Greece be further downgraded, particularly considering the likely 'de-notching' of senior ABS - and thus a greater convergence with the sovereign rating - as the country's rating moves into the single-B category.

Moody's says the rating actions were prompted by its expectations of significant pool performance deterioration. This is due to the stressed economic environment in Greece, as well as increased operational risk (caused by the weakened financial strength of Greek banks that act as key counterparties in the structured finance deals), reflected in the recent downgrades of Greek bank ratings on 15 June 2010.

The agency took rating action on 21 classes of notes issued in eight out of the nine outstanding Greek RMBS transactions. Eleven ABS and CLO transactions have ratings still under review for downgrade, pending the implementation of the restructuring or early termination proposed by the various sponsors.

ABS

APAC asset performance stabilising

Fitch reports that a total of 16 Asia-Pacific structured finance tranches were downgraded during the second quarter of 2010, while 12 were upgraded. Additionally, 140 tranches were affirmed, accounting for over 10% of all outstanding tranches rated by the agency in the region.

Fitch's Asia Pacific director Helen Wong says: "Fewer APAC SF tranches were downgraded in Q210, compared to Q110, mainly due to stabilising asset performance. All of the downgrades were either to junior classes of Japanese CMBS, which were downgraded to single-B minus or below, as losses look increasingly likely; or to synthetic corporate CDOs, which were downgraded to double-C or below, due to defaults of the underlying corporates."

While downgrades were concentrated in Japanese CMBS and CDOs, upgrades during the quarter were spread across the Asia-Pacific region and across all sectors. Most upgrades were driven by increases in credit enhancement levels, including four tranches from two Korean RMBS transactions, two tranches from an Australian non-conforming RMBS transaction and three second loss credit facilities from three Indian auto loan ABS transactions.

CDO

CDO auction details emerge

Details of the portfolios to be liquidated in next week's Ridgeway Court Funding I and Millstone IV CDO auctions have emerged. The sale of the US$1.93bn Millstone collateral will be held by Bank of New York Mellon on 19 and 20 July, while the US$1.71bn Ridgeway Court sale will be held by Wells Fargo on 22 and 23 July.

The Millstone IV collateral will be sold across six separate auctions, split by asset classes. The US$249.71m CMBS, the US$1.95m agency MBS, the US$118.65m second lien RMBS and US$151.5m ABS CDO portfolios will be auctioned on 19 July. The US$746.23m subprime RMBS and US$657.22m alt-A/prime RMBS portfolios will be auctioned on 20 July.

The Ridgeway Court collateral will be sold in three auctions. Portfolios comprising US$565.3m RMBS and US$567.66m RMBS, floorplan and student loan ABS will be auctioned on 22 July. The third portfolio - containing US$575.74m CDO, CRE CDO, Trup CDO and CLO assets - will be sold on 23 July.

Bidders are invited to provide either bids for individual items of the collateral or a single bid to purchase any of the portfolios of assets on an 'all or none' basis.

CDO

RFC issued on synthetic tranche recovery metrics

S&P is requesting feedback on a proposed set of supplementary analytics that is intended to enable market participants to estimate recoveries on a tranche of corporate synthetic CDOs under varying scenarios. Dubbed Synthetic Tranche Recovery Metrics (STRM), S&P says the tool offers enhanced analytical capabilities and transparency in the corporate SCDO sector.

The STRM framework provides estimates of a corporate SCDO transaction's recovery prospects, given a set of hypothetical future reference portfolio default and recovery assumptions. The framework uses two different sets of metrics: scenario-based metrics, which use a single user-defined stress scenario to generate a portfolio loss metric, tranche exposure and consequent scenario recovery on a specific tranche; and simulation-based metrics, which use a Monte Carlo simulation of many different stress scenarios to generate an expected tranche loss, expected loss given default and expected recovery on a specific tranche.

S&P credit analyst Jimmy Kobylinski says: "While each set of metrics may produce a different recovery estimate for the same tranche, it is our opinion that these analytical tools are complementary and, when used together, provide the market with a more complete understanding of the potential recoveries on a given SCDO transaction."

CDO

Repurchases driving CRE CDO delinquencies

According to Fitch's latest US CREL CDOs delinquency index results, delinquencies rose last month due to US$136.9m in asset manager repurchases of troubled assets. The June 2010 delinquency rate increased to 12.2% from 11.6% in May.

Asset managers continue to actively repurchase defaulted and credit-impaired assets from CDOs. In June, seven whole loans (58bp) were repurchased from three different CDOs, compared to 7bp for May and 25bp for April.

Fitch recently completed reviews of all 35 of its rated CREL CDOs, pursuant to its updated surveillance criteria. In the agency's prospective analysis, the average base-case modelled losses for these CDOs is approximately 34%, while total realised losses to date are approximately 5%.

As real estate fundamentals tend to lag the overall economy, the agency has already reflected the anticipated increase in total delinquencies and realised losses expected over the next several years. In the near term, the CREL delinquency index understates the extent of credit risk assets as managers pursue resolutions and/or trade out potentially troubled assets at losses to par, often prior to actual default.

CDO

Trups CDO defaults continue to increase

According to Fitch's latest default and deferral indices for the sector, three new bank defaults from previously deferring issuers has resulted in another increase of 13.7% on Trups CDO defaults. Last month's new defaults totalled US$72.5m, affecting 10 CDOs.

Additionally, 22 banks began deferring interest payments on roughly US$302.5m of collateral in 23 Trups CDOs. Fitch director Johann Juan says: "Second-quarter acquisition activity resulted in two banks curing their deferrals. The acquiring banks resumed payments in June on the full balance, including accrued interest on the Trups issued by the acquired entities."

Amid increased deferrals in June, the pace of new deferrals continues to slow, however. Fitch senior director Derek Miller says: "Banks that issued between US$20m and US$75m of Trups outstanding in CDOs have been the primary drivers of new default and deferral activity since the beginning of this year."

The indices show that three new bank defaults bring the total to 123. The 362 banks now deferring are affecting interest payments on US$6.5bn of collateral held by 83 Trups CDOs.

CDO

Euro CDO credit quality decline decelerates

The decline in portfolio credit quality for European synthetic CDOs has slowed over the past year, according to an analysis carried out by S&P.

"We have studied the portfolios of more than 1,250 SCDOs we rate - which mostly reference investment grade corporate obligors - and quantified the aggregate deterioration in their credit quality over the past three years," says S&P credit analyst Arnaud Checconi. The agency notes that although the global economic downturn has strongly impacted the creditworthiness of many corporate and financial firms and the structured credit instruments which reference them as obligors, its measure of default risk has recently stabilised as rating migration between corporate obligors underlying synthetic CDOs has slowed.

S&P's analysis also found significant overlap between the portfolios of nominally different synthetic CDOs, with some corporate obligors referenced in more than 60% of transactions. Other findings include that the largest country exposure is to the US, which accounts for 50% of all portfolio references, and that the largest industry exposure for the benchmark index is to financial intermediaries.

CDS

Auction results released, succession event mulled

The CDS auction for Truvo Subsidiary Corp occurred on 15 July. The final price remained unchanged from the initial market midpoint of three.

14 dealers submitted inside markets, physical settlement requests and limit orders to the auction administered by Creditex and Markit. Truvo Subsidiary Corp deliverable obligations are denominated in euros and US dollars.

Separately, Mitsubishi UFJ Morgan Stanley Securities has asked ISDA's Japan Determinations Committee to determine whether a succession event has occurred with respect to The Senshu Bank/Bank of Ikeda. The DC is currently deliberating.

The Senshu Ikeda Bank was established on 1 May 2010 by a merger between The Bank of Ikeda and The Senshu Bank under Senshu Ikeda Holdings.

CDS

OTC standardisation, reporting consultations launched

CESR has launched two consultations on OTC derivatives and announced a public hearing on the consultation on 11 August. The first consultation is in relation to standardisation and exchange-trading of OTC derivatives; the second is with respect to transaction reporting.

The first consultation explores the need for taking regulatory actions in relation to further standardisation for credit, equity, interest rate, commodity and foreign exchange derivatives - both as a means in itself and also in relation to the promotion of trading these derivatives on organised markets. CESR is of the opinion that firms should be able to retain the flexibility to customise aspects - such as standard valuation, payment structures and payment dates - given the role that OTC derivatives and in particular bespoke products play in meeting hedging needs.

Nevertheless, it believes that greater standardisation of OTC derivatives contracts can deliver efficiency benefits to the market. In particular, CESR has identified the use of electronic confirmation systems as one measure that could potentially deliver benefits to the market.

As the degree of standardisation differs by asset class, CESR is keen to solicit views on whether regulators should prioritise their focus on a) a certain element of standardisation and/or b) a particular asset class. It particularly invites market participants to provide information on the potential costs of introducing a mandatory electronic trade confirmation requirement for European trading of OTC derivatives, so that an informed decision can be taken when making final recommendations to the European Commission.

In relation to 'exchange trading' of derivatives currently traded OTC, CESR believes that trading on organised markets could deliver a number of benefits. There are, however, also a number of limitations or prerequisites to exchange trading of derivatives that may explain why the OTC segment of the market remains very large: the need for the contracts to be standardised, the inability to customise contracts according to individual customers' needs and the limited possibility for products innovation.

As a preliminary opinion, CESR is in favour of incentivising the use of organised trading venues but continues to consider whether mandatory usage is desirable, taking into account the discussions currently taking place on this issue in other jurisdictions and international fora.

The second consultation, meanwhile, sets out CESR's proposal for the possible organisation of transaction reporting on OTC derivatives, as well as for the extension of the scope of transaction reporting obligations. CESR's proposal is based on the assumption that all persons not exempted from European Market Infrastructure Legislation (EMIL) would have to report their OTC derivatives transactions to trade repositories (TRs) after these will have been established and registered under EMIL.

However, it proposes that investment firms would retain the possibility of complying with their transaction reporting obligations with respect to OTC derivatives under MiFID provisions. Investment firms reporting their transactions to a TR, supporting MiFID standards, would be exempted from direct reporting when they communicate to the competent authority their decision to report their transactions through a TR.

CDS

CDS spreads reflecting credit quality distinctions

According to Fitch Solutions' latest earnings commentary, rising CDS spreads are forcing the market to make greater credit quality distinctions, with Morgan Stanley and other financial firms serving as notable examples.

Underperforming both the broader market and its banking peers over the past three months, Morgan Stanley has established a non-investment grade trading pattern in the CDS market. CDS spreads on Morgan Stanley have widened by 67% over the past quarter, nearly doubling the average spread widening seen on North American financials.

"Concerns over lingering sovereign risks, a double-dip recession and financial reform implications have sent spreads in the North American financial sector wider by 34%," says Fitch md, Jonathan Di Giambattista. Morgan Stanley is an outlier, however, as rivals Goldman Sachs (CDS 32% wider) and Wells Fargo (16% wider) - also reporting this week - have fared better.

Elsewhere, Freeport McMoran Copper & Gold has been among the most active movers in the CDS markets over the past quarter, according to Fitch, with spreads widening by more than 46% to now pricing slightly wide of triple-B spread levels. As speculation mounts over gold prices, liquidity for Freeport has spiked to rank in the top sixth percentile of all CDS market names, up from the 32nd percentile three months ago.

Among technology firms reporting, meanwhile, Xerox and IBM have taken diverging paths as the market appears to be more speculative about Xerox's future credit quality and more certain on IBM's prospects. Signalling market uncertainty, Xerox's liquidity jumped from the 18th percentile to the fifth percentile over the past quarter. Conversely, IBM has moved from the 25th percentile to the 38th, indicating a more stable outlook.

CLOs

Middle market CLO completed

Golub Capital has closed what is believed to be the largest CLO backed primarily by middle-market loans issued in 2010. The proceeds of the US$300m deal, dubbed Golub Capital BDC 2010-1, will be used to refinance the company's existing credit facility.

The transaction was executed through a private offering of US$174m triple-A rated (S&P and Moody's) class A notes that priced at 240bp over Libor. Golub ceo David Golub says: "We are delighted with this new debt facility. It has better pricing, longer term and a more flexible reinvestment period than the financing we described in the IPO prospectus."

The transaction also comprises US$10m Aa2 class B notes, due in 2021.

Golub 2010-1 has a six-month ramp-up period and a three-year reinvestment period that may be extended by an additional two years if certain criteria are met. While the transaction is expected to be collateralised primarily by first-lien senior secured SME corporate loans, there is no restriction on the amount of broadly syndicated corporate loans in the collateral pool (the closing portfolio has in excess of 10% broadly syndicated loans). Up to 5% of the pool may consist of second-lien corporate loans.

Initially, a portion of the portfolio may consist of participations of loans from Golub Capital Master Funding, an unrated affiliate of the issuer. These participations may only be held for a period of up to 60 days from closing. Subsequently, no more than 5% of the pool may consist of participations, which must meet Moody's counterparty criteria.

Golub Capital has the discretion, under limited circumstances, to replace with eligible performing loans collateral loans deemed to be credit-impaired or materially modified. Following such substitution, the collateral pool's coverage tests, collateral quality tests and concentration limitations must be maintained or improved.

The substitute loan must also be of at least the same priority, market value and outstanding principal balance as the loan being substituted. While Golub is not required to effect these par-for-par substitutions, such substitutions may provide additional credit support to the rated notes, Moody's says.

Meanwhile, Bank of America Merrill Lynch is understood to be preparing a US$300m CLO for LCM Asset Management. The transaction, dubbed LCM VIII, is believed to include a US$212m triple-A rated tranche.

CLOs

UK SME CLO closes

Lloyds TSB has priced its Sandown Gold SME CLO, following a last-minute amendment to the structure. The £761.5m-equivalent transaction was preplaced with a number of institutional investors and money managers.

Rated by Moody's and Fitch, the £350m triple-A rated three-year class A1A notes came at 175bp over three-month Libor, the €235m triple-A three-year class A1Bs at 150bp over three-month Euribor and the €60m triple-A 6.9-year EIF-guaranteed class A2s at 50bp over. Only the top two tranches were placed with third-party investors and the remaining notes were retained. The rest of the capital structure comprises £110m Aa3 8.8-year class Bs, £55.7m Baa2 11.4-year class Cs and £98.5m unrated class S notes.

The underlying £807m pool consists of 1733 SME loans of between £25,000-£5.5m made to 1407 UK borrowers. Estimated portfolio WAL is five to six years, with a weighted average seasoning of 2.45 years.

Following a review of the transaction, Moody's discovered an error in its calculations in relation to the capital structure. When calculated correctly, this would have had a negative impact on the originally assigned provisional ratings on both the class B and class C notes.

Lloyds consequently increased the reserve account by £20m, increasing the total reserve account balance to £70m. On the basis of this change to the structure, Moody's was able to affirm its originally assigned ratings.

CLOs

CLO tranche recovery framework completed

S&P has completed its framework for estimating recoveries on CLO tranches under various economic scenarios and has provided those values for the relevant transactions in its US corporate CDO EOD Index.
S&P credit analyst Jaiho Cho says: "Our CLO tranche recovery metric (or CLO TRM) - which we express as a percent of the current balance of the security - reflects a cash flow-based recovery analysis for individual CLO tranches, given a set of hypothetical economic scenarios and certain collateral default and recovery assumptions."

He adds: "A CLO TRM is not a rating - rather, we designed this metric to offer supplementary analytics to market participants who seek additional analytical capabilities and greater transparency in the CLO sector."

The agency says that it expects to provide CLO TRM values for most classes of notes in a given CLO and, considering feedback, will provide CLO TRM values for all classes.

CLO TRM values will initially be published on a nominal basis, with additional measures potentially being published in the future. S&P currently expects to publish CLO TRM values monthly.

CMBS

CMBS loan, note maturity extensions approved

The Mall Funding 1 restructuring proposal has been approved by noteholders (see SCI issue 189). Under the restructuring, the loan maturity will be extended to April 2015 (from April 2012) and the note maturity will be extended to April 2017 (from April 2014).

£50m of the notes will be prepaid on completion of the restructuring, as well as a prepayment from the disposal of four shopping centres that was announced on 25 June (the selling price indicated was £136m). The restructuring also adds hard amortisation commitments, changes to the covenant package and a 50bp increase in the margin on the notes.

Separately, Hatfield Philips reports that it has successfully restructured the €71.2m Berlin Dresden loan. The loan, which is secured on two office buildings in Berlin and Dresden, was transferred to Hatfield earlier this year due to non-repayment at the maturity date.

The restructuring agreement has served to extend the final maturity date until 22 January 2012, with a waiver of the LTV covenant for the extended maturity period. In addition, modification of the relevant clauses allow for: fixed payments to the borrower of €94,000 per quarter as reimbursement for sponsor costs; quarterly interest payments based on three-month Euribor ; a new interest rate cap to be entered into; amortisation based on the original loan balance of €71.2m at the pre-maturity rate of 1.25% per annum; payments to the borrower of €125,000 per quarter; and any additional funds to be applied to either amortisation or capital expenditure at the discretion of the servicer.

The restructuring agreement also included a marketing period of the asset until 30 June, whereby the asset would have been required to be sold if the targeted minimum sales price was obtained. This minimum sales price was not obtained and therefore the loan has been extended based on the agreed terms.

Philip Byun, Hatfield's vp, comments: "As the special servicer, it is our responsibility to maximise the value of the investments, taking into account the prevailing market conditions. We are therefore pleased to announce the successful completion of the restructuring of the loan in such a way that all interested parties have a satisfactory conclusion."

CMBS

Diverging recovery in commercial sector

While most vacancy rates in the commercial real estate sector continued to rise due to the poor absorption experienced in 2009, demand going forward is on the upswing, note Moody's analysts in their 'CMBS: Red-Yellow-Green Update'.

The two office sectors included in their analysis are the only property types that have negative absorption forecasts over the next year. The analysts also note that the pace of growth in vacancy rates should begin to flatten and possibly contract in the coming quarters if the expectations materialise. While commercial real estate in general is looking better than it did a year ago, the sector has further challenges ahead as it continues to work through the effects of the recession.

But a few bright spots emerged in Q210 versus Q110. Specifically, the market with the greatest improvement in the Moody's study was the Miami full-service hotel sector, with a change of +53.

This was followed by the Edison limited-service hotel area, with +51, and the Fort Lauderdale full-service hotel group at +50. The highest overall score in the multifamily sector went to San Jose, Portland and Washington, DC.

However, further deterioration occurred in the Stamford industrial group, with a change of -39 and the El Paso multifamily sector with a mark of -27. The analysts add that although El Paso has a very low vacancy rate, the market's supply-demand relationship moved unfavourably from -2% to -5.5%.

CMBS

Japanese CMBS defaults rising

Fitch reports that the number and balance of defaulted loans backing Fitch-rated Japanese CMBS continues to increase and a number of loans with larger balances are scheduled to mature in Q310. The agency also notes that term defaults of some underlying loans are possible in the near-term due to the under performance of the collateral properties, although most defaults to date have been at loan maturity.

Naoki Saito, director in Fitch's Japanese structured finance team, says: "As of end-June 2010, 51 loans (Y200.6bn) were in default within the Fitch-rated Japanese CMBS universe. The defaulted loan balance is at its highest to date, exceeding the previous peak of Y192.4bn at end-September 2009."

He adds: "Activities in the Japanese real estate finance market remain limited, with many loan maturities upcoming over 2010. Fitch will pay additional attention to the collection activities on loans with balances of more than Y10bn that are scheduled to mature in Q310."

The agency notes that there are a number of loans that may default as a result of failure to make debt service payments, due to deterioration in property cashflows. If this occurs, it would be the first time for an underlying loan backing any Fitch-rated Japanese CMBS to have experienced debt service or term payment default, as opposed to default at maturity.

In its rating analysis, the agency adopts a more stressful value for the collateral properties backing loans set to mature within 12 months, assuming property disposition after loan default. The agency further revises property cashflows as necessary upon each rating review. Therefore, the movement in default rates in Q310 will not necessarily lead to further rating action, although Fitch will take rating actions based on the determination of work-out strategies by the servicer or actual proceedings in the property disposition activities.

CMBS

'Calm' Euro CMBS sector may be short-lived

The relative calm experienced in the European CMBS sector during June may be short-lived, according to S&P.

S&P credit analyst Judith O'Driscoll says: "Last month, loan breaches dropped for the first time since we began monthly reporting in November 2008 and servicers didn't transfer any loans to special servicing. However, this is more likely to be a reflection of the reporting cycle rather than the beginning of a new trend."

She adds: "This is borne out by data collected for July: servicers have already reported three loans as transferred into special servicing. Nineteen loans face maturity in July, as against one in June, and further discussion about extensions, standstills and restructurings can be expected."

According to S&P's European CMBS monthly bulletin report, both the loan and note levels in this sector continue to experience difficulties. At the loan level, in June servicers reported a number of property valuation declines that led to appraisal reductions in three transactions. At the note level, the prominent restructuring of Fleet Street Finance Two was swiftly followed by noteholder acceptance in June of the proposal to restructure the single loan that secures Tahiti Finance (SCI passim).

Indices

Consumer credit default rates decline

Data through to June 2010 for the S&P/Experian Consumer Credit Default Indices indicate that monthly default rates declined for all five credit lines covered by the indices.

Defaulting balances of bank card loans were 8.8% in June, down from 8.9% in May. First and second mortgage default rates were 3.3% and 2.4% respectively, with first mortgage default rates declining by 5% from last month and by 45.2% from a year ago. Auto loan defaults were 1.7% in June, down from 1.8% in May.

David Blitzer, S&P md and chairman of the index committee, says: "The consumer credit picture shows encouraging progress as default rates continue to fall across major categories and in the highlighted cities. The data is consistent with reports that people continue to eschew debt and as the slow recovery from recession and financial turmoil continues."

He adds: "For the economy, this is mixed news - better credit quality, as seen in this report is clearly positive. However, as reported earlier by the Federal Reserve, consumers' credit use is declining, dampening the outlook for spending."

Consumer credit defaults vary across major cities and regions of the US. Among the five major metropolitan statistical areas reported each month in this release, New York had the largest decline in defaults in the last month at 12.11%, while Dallas showed the smallest decrease of 29.59% in the past year. The sharpest decline was in Miami, where defaults have declined 53.55% in the last 12 months.

Investors

Property derivatives valuations service launched

Northern Trust has introduced a daily independent valuations service for complex OTC property derivatives. The product has been developed in response to an increasing trend for property funds to use OTC derivative instruments.

The product enables a transparent, daily independent valuation for complex IPD (Investment Property Databank) swaps. IPD is one of the most common benchmarks used for writing property derivative contracts in the UK and covers approximately
10,986 directly held UK property investments valued at around £117bn.

Northern Trust is offering clients outsourced OTC activities, such as daily independent valuations for OTC derivative instruments including, IPD swaps, interest rate swaps and interest rate caps and floors. It can also offer active collateral management, trade capture, trade confirmation, reconciliation, trade event confirmation and risk analysis.

In addition, Northern Trust offers a transparency report that highlights the market data attributes, as well as the mathematical model and techniques that were used to calculate the price.

Peter Cherecwich, global coo for Northern Trust's asset servicing business, says: "We are seeing activity in the market from two opposite ends of the investment industry. Investment managers holding commercial property portfolios are looking to hedge the financing of these portfolios through real estate derivatives and are now being joined by an increasing number of hedge funds."

He adds: "This latest product development enables us to cut through the complex data associated with administrating property OTC derivatives and deliver the information fund managers require on a daily basis, helping them make timely investment decisions."

Ratings

Wind farm securitisation downgraded

Fitch has downgraded CRC Breeze Finance's (Breeze Two) €258.4m class A notes to double-B minus from double-B and assigned a negative outlook. Fitch has also downgraded the €36m class B notes to single-B minus from single-B and assigned a stable outlook. The downgrades result from a combination of lower-than-expected energy yield, higher-than- anticipated operating costs, technical difficulties with some turbines and weaknesses in the transaction's financial structure, Fitch says.

The agency explains: "A significant overestimation in the pre-closing forecasts of the achievable energy yield and a period of weak wind conditions is the primary reason why at the November 2009 payment date Breeze 2 drew approximately €2m (out of €12.2m) from the class A debt service reserve account (DSRA) to meet the scheduled senior principal repayment, used the entire €1.1m class B DSRA to pay the class B interest and deferred the scheduled €2.4m class B principal repayment. At the May 2010 payment date operating revenues were sufficient to fully meet the debt service payments on class A and B bonds with a buffer of some €2m. This excess cash was reserved by Breeze 2 to meet foreseeable O&M costs, leaving the deferred class B principal outstanding and the two DSRAs un-replenished."

Additional negative effects on Breeze 2's financial performance derive from the original underestimation of O&M costs. Fitch says that Breeze's management has advised that an extra €1m should be added to the budget each year to reflect unbudgeted expenses. Fitch's projections reflect such higher costs since last year's review and incorporate a further €0.5m buffer going forward.

Fitch considers likely further class B debt service deferrals at November 2010 as well as in other future November payment dates. This is caused by the thin class B coverage (average debt service coverage ratio (DSCR) under the Fitch base case of 1.06x) coupled with a flat debt repayment profile which does not take into consideration the lower energy production achievable during the summer months.

The rating on the class B notes reflects the bond's terms and conditions, in that any missed payment of interest and principal is deferred to the following payment date (or after the full repayment of class A bonds) - i.e. a monetary default does not translate into a contractual default. In Fitch's opinion it is unlikely that Breeze 2 will meet all the scheduled debt service payments on the class B notes in a timely manner and fully redeem such bonds on their expected final repayment date of May 2016.

The following 10 years up to the class A maturity date, however, provide comfort about the borrower's ability to ultimately repay class B. Fitch says its stable outlook on the class B notes reflects the significant flexibility afforded to these notes by their deferability.

Class A DSCR is expected to average approximately 1.35x under Fitch's base case operating conditions, reaching the minimum of around 1.05x under P90 energy production scenarios. The downgrade on the class A notes reflects Fitch's view that the senior (as well as the class B's) DSRA will remain below its required amount in the medium term and the transaction would need a few consecutive years of average performance to refill reserves and repay Class B deferred interest and principal.

Real Estate

US CRE prices rise for second month

Moody's/REAL Commercial Property Price Indices indicate that US commercial real estate prices increased by 3.6% in May. This was the second monthly price increase in a row, after the 1.7% rise in April.

"We expect commercial real estate prices to remain choppy in the coming months," says Moody's md Nick Levidy. "The positive news of increasing prices over the past two months is tempered by low transaction volumes, forecasts for slowing macroeconomic growth and the rising risk of a double-dip recession."

In May there were 107 repeat sales, down slightly from the 114 repeat sales in April. By dollar volume, the amount of repeat sales almost doubled, rising to over US$1.5bn in May from less than US$800m in April.

Nationwide, prices are currently 38.9% below their peak in October 2007 and have come back 8.6% from their October 2009 low. Prices are down 6.3% over the past year and down 33% over the past two years.

Regulation

Basel reforms progress

The Basel Committee on Banking Supervision says it has developed concrete recommendations for completing its package of regulatory reforms, after reviewing the calibration of the capital and liquidity frameworks, comments on its December 2009 consultation package, the results of its comprehensive quantitative impact study (QIS) and its economic impact assessment analyses at its 14-15 July meeting. It has also issued for consultation a proposal on countercyclical capital buffers.

The Basel Committee's oversight body - the Group of Central Bank Governors and Heads of Supervision - will review the Committee's progress and recommendations at its upcoming meeting later this month. The Committee will present concrete recommendations for the definition of capital, the treatment of counterparty credit risk, the leverage ratio, the conservation buffer and the liquidity ratios.

The Committee also reviewed proposals for the role of 'gone concern' contingent capital in the regulatory capital framework and will issue shortly a proposal for consultation. It is continuing to assess these proposals, however.

The countercyclical buffer would be imposed when, in the view of national authorities, excess aggregate credit growth is judged to be associated with a build-up of system-wide risk. This will help ensure the banking system has an adequate buffer of capital to protect it against future potential losses, the Committee says.

The proposal discusses how the capital buffers would be calculated, communicated and policed, and how credit-to-GDP ratios will be used to extend the buffers when there is evidence of excessive credit growth in a given country. The buffer is an add-on to the normal Basel capital requirements in force and will not be hard rules-based, but will be a more flexible principles-based buffer to work out the build-up and release periods of the buffer.

Calculation of the buffer will reflect the geographic composition of credit exposures, meaning it will change over the years. Supervisors will pre-announce increases in the buffer 12 months before they come into effect to give banks time to adjust their capital planning.

The Committee also continues to review specific proposals to address the risks of systemic banking institutions. These include a 'guided discretion' approach for a systemic capital surcharge, in combination with other mitigating regulatory and supervisory measures.

RMBS

CWHEL trade touted

Odeon Capital Group has released a primer on the Countrywide Revolving Home Equity Loan Shelf (CWHEL) offering. The report highlights the strengths and weaknesses of this particular shelf registration and how they affect the price, yield and weighted average life of the emerging asset class.

A subject of significant attention from traditional and non-traditional ABS/MBS investors in recent years, the CWHEL shelf offers diverse performance metrics across the second lien sector, according to Odeon senior research analyst Ankur Makhija.

"Non-traditional ABS/MBS investors can utilise second lien wrapped bonds such as the CWHEL shelf to invest in the housing market," says Makhija. "Prudent investing in CWHEL bonds may provide investment opportunities that are simply not available in other ABS/MBS asset classes."

To the traditional ABS/MBS investor, this shelf and the second-lien RMBS asset class more generally have increasingly drawn interest due to disappointing collateral performance and credit complications with the backstop function traditionally provided by most monolines. Makhija adds: "We believe that CWHEL bonds' double-digit risk-adjusted yields provide an attractive risk/reward for investors."

RMBS

Agency MBS best practice guidelines mooted

The New York Fed's Treasury Market Practices Group (TMPG) has made available for review a new set of best practice recommendations related to trading and settlement in the Treasury, agency debt and agency MBS markets. The recommendations are designed to promote market integrity, market liquidity, robust control environments, responsible management of large positions and efficient market clearing.

The development of these guidelines follows the expansion in the scope of the TMPG beyond the Treasury market, to include the promotion of best practices in the agency debt and agency MBS markets. These guidelines adapt and build upon the TMPG's previously-published recommendations for best practices in the Treasury market.

"The TMPG strongly believes that widespread implementation of best practice recommendations will support the integrity and efficiency of these important markets," says Thomas Wipf, chair of the TMPG. "We encourage all market participants in the Treasury, agency debt and agency MBS markets to review the recommendations carefully and to provide feedback to the TMPG."

The TMPG is soliciting industry and public feedback on its publication, entitled 'Best Practices for Treasury, Agency Debt, and Agency MBS Markets', until 29 July 2010. A revised set of recommendations will be published in the weeks following the conclusion of this feedback period.

As with earlier TMPG market practice guidance, this publication is expected to be a 'living document' that will be updated as needed over time.

RMBS

UK master trust review completed

Following a performance review, Fitch has affirmed 10 UK RMBS master trust programmes, but has also downgraded some Aire Valley, Granite and Whinstone Capital Management notes.

Fitch's analysis covered the expected loss of each pool in different rating categories and an in-depth cashflow analysis with further stressing. It says negative rating action has been very restricted.

"Following its performance review, Fitch has affirmed 99% of all the outstanding notes issued by value from the 12 Fitch-rated UK RMBS master trust programmes," says Francesca Zwolinsky, Fitch RMBS director.

Aire Valley master trust has had 12 junior tranches downgraded and Fitch has changed its outlook on the class B tranches to negative. The agency says credit performance of the underlying collateral has deteriorated significantly since the credit crisis started. Mortgages 90-plus days late peaked at 5.52% in May 2009 and reserve fund draws are expected.

"Whilst arrears have shown signs of stabilisation, falling to 4.14% as at May 2010, Fitch expects Aire Valley to suffer from volatile performance throughout 2010 and 2011. This is a result of the expected increase in interest rates, which exposes Aire Valley's 81% of variable borrowers to affordability constraints in addition to the ongoing effects of higher unemployment," notes Zwolinsky.

Meanwhile, Granite Finance Funding has had five class M tranches and nine class C tranches downgraded, though ratings have not fallen below those originally assigned. Meanwhile, two class B notes and two class M notes have been upgraded.

Fitch says credit performance for the underlying collateral has deteriorated faster than for Granite's master trust peers. The agency says it is the "worst performing master trust in terms of both mortgages between 30 and 90 days past their due date and mortgages 90 days past".

Prepayment rates are expected to continue declining as a long-term trend. The reserve fund has been drawn for every interest payment since June 2009 to pay interest on the notes and this too is expected to continue.

Finally, Whinstone Capital Management's class C and class D notes have also been downgraded. The downgrades on the synthetic transaction reflect Fitch's expectations of a slower increase in credit enhancement and continued deterioration in the underlying collateral. Whinstone references Granite's reserve fund, so it is impacted by the same funding problems as Granite.

The affirmed RMBS trusts are Arkle, Fosse, Gracechurch, Holmes, Lanark, Langton, Mound, Pendeford, Permanent and Silverstone. Whinstone 2, a synthetic securitisation referencing Granite Finance Funding 2, has also been affirmed. All outstanding tranches have been affirmed.

The agency says the more seasoned transactions have seen credit enhancement levels increase following the partial or full principal redemption of notes and the non-amortising nature of the reserve funds. Programmes where notes have been more recently issued have been structured with large first-loss buffers, thanks to inflated reserve funds or the use of deeply subordinated notes.

RMBS

Eurosail deals on review pending hearing

Fitch has placed the senior A1 to A2 notes of Eurosail-UK 2007-3 BL on rating watch negative (RWN), following yesterday's commencement of a High Court legal action by the trustee to obtain an interpretation of certain provisions of the transaction documentation. Moody's has already warned of the possibility of rating action on the development (see last issue).

Eurosail-UK 2007-4 NP and Eurosail-UK 2007-6 NC have similar profiles to Eurosail-UK 2007-3 BL and so the outcome of the legal proceedings could also negatively affect these transactions, according to Fitch. As a result, it has also placed the class A1 to A2 notes of these two transactions on RWN.

Certain class A3 noteholders of Eurosail-UK 2007-3 BL claim that the issuer is unable to pay its debts under the UK Insolvency Act 1986, as the value of the issuer's assets are less than its liabilities. Consequently, these noteholders believe that the trustee should serve a notice on the issuer that an event of default has occurred, which could affect all the outstanding notes. However, the issuer contends that the existence of a post enforcement call option means that the issuer cannot be deemed unable to pay its debts within the provisions of the Insolvency Act.

The hearing is expected to last for three days. If an event of default were declared, it would result in the application of the post-enforcement priority of payments and the class A1, A2 and A3 noteholders being repaid on a pro-rata basis, rather than sequentially in accordance with the currently applicable pre-enforcement priority of payments. A switch to the post-enforcement priority of payments could also result in enforcement of the security for the notes, which could involve a liquidation of the underlying collateral to repay the notes.

Upon an event of default being declared, Fitch would downgrade all the notes of the three transactions to D. It has consequently placed the senior tranches of the three transactions which are rated above triple-C on RWN. The resolution of the RWN status will depend upon the outcome of the court proceedings and the subsequent reactions of the transaction parties and noteholders.

A further Lehman Brothers originated transaction, EMF-UK 2008-1, also has unhedged foreign currency liabilities and 'time-subordinated' class A note sub-categories. However, in the case of this transaction, the highest-rated notes are at triple-C and so have not been placed on RWN.

RMBS

Negative outlook for Irish RMBS market

According to the latest sector indices published by Moody's, Irish RMBS delinquencies have constantly increased since the beginning of the recession, and so far do not show any signs of abating. The lengthy repossession procedure partly contributes to higher arrears trends, the agency notes.

The indices show that 3.8% of the outstanding Irish prime RMBS portfolios were more than 90 days delinquent in March 2010. Repossessions among Irish RMBS pools remain limited as Irish lenders are encouraged to assist cash-strapped borrowers in order to avoid repossession.

The average total redemption rate (TRR) in Irish prime RMBS transactions is 5.4%. Reduced payment arrangements agreed with lenders result in further decreasing prepayment rates as many borrowers pay only the interest portion of their mortgage.

Interestingly, due to the high number of interest-only payment arrangements made with the borrowers in the Kildare Securities portfolio, an increasing TRR has been recorded because the interest-only loans had to be repurchased from the portfolio according to the transaction documents.

The indices further show that the Irish economy has substantially weakened during the past two years, due to unemployment rising and Irish house prices being more than 33.1% below the peak value recorded in late 2006. Moody's concludes that sustainable growth in the economy will not return until late 2011.

RMBS

Stable outlook for German, Dutch deals

Moody's has recently changed its performance outlooks for German auto ABS, SME ABS, RMBS and Dutch RMBS from negative to stable. Performance in these markets has been robust for some months and is likely to remain stable, the agency says. However, all other structured finance asset classes in the region continue to have negative outlooks.

Moody's economist Nitesh Shah explains: "Even though most EMEA economies have technically exited recession, economic conditions remain weak and we therefore maintain our negative outlook on the performance of the underlying assets in most jurisdictions."

In Germany and the Netherlands, the immediate need for fiscal tightening appears to be lower and the immediate threat of an increase in benchmark funding costs also seems lower than in other countries. The agency therefore expects that German ABS, RMBS and Dutch RMBS markets will remain stable.

"Beyond the performance of the collateral underlying structured finance transactions, sovereign and operational risks could put pressure on ratings," adds Nitesh Shah.

The performance of transaction parties such as the servicer, cash manager and trustee are important to the functioning of a transaction; any deterioration in their ability to perform their roles could impact the ratings of the structured finance transaction.

The ratings on several sovereign governments are on review for possible downgrade, while others have been recently downgraded. The rating actions on EU sovereigns, such as Greece and Portugal, along with the associated downgrades of local financial institutions had implications for ratings in some structured finance transactions. For Spain, the impact has so far been limited on tranches guaranteed by the Kingdom of Spain or the Spanish regions.

RMBS

Greek mortgage loss assumptions updated

Fitch has updated its criteria for assessing credit risk in Greek prime residential mortgage loans that are used as collateral for RMBS. The agency says its new criteria address Greece's sovereign risk implications and it has kept the double-A rating cap for all new Greek RMBS.

The economic outlook, with austerity measures to be implemented and uncertainty over future asset performance persisting, has also been taken into account. Fitch has amended assumptions at high rating levels to ensure stresses are sufficiently remote.

One key update concerns taking into account the implementation of the €110bn IMF-EU financial support package. Fitch says it has accounted for the impact of this package on the real economy by increasing its base foreclosure frequency and house price decline assumptions. Gross loss rates of Greek mortgage portfolios have increased across all rating categories.

Whole business securitisations

Unique pricing 'looks attractive'

With operating performance expected to bottom out in 2011, pricing on the Enterprise debentures and Unique whole business securitisation looks attractive, according to European securitisation analysts at Barclays Capital. They note that current pricing on the bonds reflects the market's concern about their potential default and timely payment.

In order to avoid default on the Unique securitisation, Enterprise debentures and banking facility, Enterprise Inns will have to sell over 1500 pubs during the next three to four years. However, since Punch and Enterprise managed to sell over 1100 pubs in 2009 in a distressed market, the BarCap analysts believe that Enterprise can make these disposals.

Enterprise's Q3 trading statement indicates that so far this year 402 pubs have been sold for £124m, with a further 102 pubs having already exchanged contracts - which should raise a further £29m. Disposals continue to be focused on the tail end of the estate.

Additionally, the pub operator has executed sale and leasebacks on a further 69 central London pubs at an average yield of 6.4%, raising £110m.

The number of pubs on substantive leases is stable at 86%, covering 93% of income, with the company guiding for further increases towards year-end. The number of pubs on temporary management agreements is expected to reduce to close to zero by year-end.

"Overall [the bonds] are performing ahead of our expectations in terms of stabilising performance during 2010 rather than 2011, which we think is a positive for the bonds," the analysts remark. "We remain buyers of both the Unique securitisation and debentures, but with our preference for the debentures where credit quality is comparable with the class As but with around 135bp of uplift."

ABS

Retention requirements for ABS - part 2

In the second article of a two-part series, Paul Hastings partners Charles Roberts, Conor Downey, Ron Lanning and Diego Shin discuss the new regulatory landscape in the US

US initiatives
The Financial Reform Bill
Both the US House of Representatives and the US Senate have passed their own versions of a financial reform bill, which has emerged from conference consultations for the purpose of reconciling the two separate bills for a final vote by both houses of the US Congress (the Financial Reform Bill). If ultimately approved in its current form, the Financial Reform Bill will, among other things, amend the Securities Exchange Act 1934 and impose a risk retention requirement on issuers, sponsors and arrangers (each a securitiser) in connection with the issuance or disposal of ABS to a third party.

The Financial Reform Bill specifically empowers, within 270 days of its enactment, each of the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (collectively, the Federal banking agencies), in respect to any securitiser that is an insured depositary institution on the one hand, and the SEC, in respect of any other entities on the other, to "jointly prescribe regulations to require any securitiser to retain an economic interest in a portion of the credit risk for any asset that the securitiser, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party".

Legislative retention requirement
The proposed legislation generally requires the regulations to mandate that a securitiser retain at least 5% of the credit risk of its related ABS, except for certain RMBS backed by 'qualified residential mortgages' (a term to be defined by, among others, the Federal banking agencies and the SEC). In addition, the legislation requires rules for different types of asset classes such as residential mortgages, commercial mortgages, auto receivables, commercial loans and any other classes that the Federal banking agencies and the SEC deem appropriate.

The regulations are also required to specify, among other things:

• the minimum period during which such holdings are to be retained;
• the permissible forms under which the risk retention may be achieved (including, for example, an allocation of the risk between a securitiser and an originator, if the securitiser purchased the underlying assets from an originator); and
• the appropriate standards for risk retention for CDOs, securities collateralised by CDOs and other similar instruments backed by other ABS.

The regulations may also provide for total or partial exemptions from the risk retention requirement for any ABS transaction, as may be appropriate in the public interest and for the protection of investors. In addition, the regulations shall identify separate asset classes and establish separate underwriting standards for each such asset class which, if such standards are met by an ABS, will reduce the percentage of credit risk of the related ABS required to be retained to an amount to be determined but which would represent less than 5% of such ABS.

Furthermore, the regulations will prohibit the securitiser from directly or indirectly hedging or otherwise transferring the credit risk required to be retained pursuant to the Financial Reform Bill.

As with regard to CMBS, the Financial Reform Bill provides that the regulations will specify the permissible types, forms and amounts of risk retention that would meet the risk retention requirements to be introduced by the Financial Reform Bill, such as:

• a securitiser retaining a specified amount or percentage of the total credit risk of the asset;
• the retention of a first-loss position in the CMBS by a third-party purchaser that specifically negotiates for the purchase of such first-loss position and provides due diligence on all individual assets in the pool before the issuance of the ABS;
• a determination by a Federal banking agency and the SEC that the underwriting standards and controls for the asset are adequate; and
• the provision of adequate representations and warranties relating to the underlying commercial mortgage loans at issuance of the securitisation and related enforcement mechanisms against the originator or issuer of the CMBS in the event of a breach of such representations and warranties.

The Financial Reform Bill also includes certain provisions requiring the Chairman of the Financial Services Oversight Council to both coordinate all joint rulemaking required to implement the risk retention provisions of the Financial Reform Bill and conclude a study within 180 days of the enactment of the Financial Reform Bill on the macroeconomic effects of the risk retention requirements. Such study shall include a retrospective analysis of the effect the risk retention requirement would have had if previously in place in averting the real estate price bubble of pre-credit crunch days.

In addition, the study will analyse whether future real estate bubbles may be minimised by proactively adjusting the percentage of risk retention in regional or national markets, whether such percentage adjustments should be made by an independent regulator or in a formulaic and transparent manner and whether such adjustments should be made independently or in concert with monetary policy. Therefore the Financial Reform Bill suggests that Congress is open for possible future legislation or rulemaking permitting an adjustment of the percentage of required risk retention in local or national markets.

The SEC's regulation AB2
While the Financial Reform Bill is at the forefront of the proposed new risk retention requirements, the SEC had prior to the finalisation of the terms of the Financial Reform Bill already proposed a set of amendments to Regulation AB, which would have a similar, though more limited, effect. On 7 April 2010, the SEC approved for public comment a new set of rules ('Reg AB2'), which would replace the requirement that any ABS intended to obtain shelf eligibility be of investment grade for new criteria with requirements that intend to better align the interests of sponsors with investors. In addition to including provisions relating to disclosure and ongoing reporting for ABS transactions, Reg AB2 contains provisions on retention requirements for ABS issuances.

Retention as a condition for shelf-eligibility
In contrast to the Financial Reform Bill, the SEC's proposed risk retention rules are set as a condition to an issuance's shelf-eligibility and require that the sponsor or an affiliate of the sponsor retain, on an ongoing basis, a net economic interest, to be measured at issuance (or on origination, in the case of 'originator's interest'), in one of two ways:

• by retaining a minimum of 5% of the nominal amount of each tranche sold or transferred to investors, net of related hedge positions taken by such sponsor or its affiliate; or
• in the case of revolving asset master trusts, retention of the 'originator's interest' of a minimum of 5% of the nominal amount of the securitised exposures, net of hedge-related positions taken by such sponsor or its affiliate, provided that the 'originator's interest' and securities held by investors are collectively backed by the same pool of receivables, and payments of the 'originator's interest' are not less than 5% of the payments of the securities held by investors collectively.

In addition, in order for the ABS to obtain shelf-eligibility, the prospectus of the related ABS will need to disclose that the related sponsor or an affiliate retains a net economic interest in the ABS by way of one of the two methods described above. Furthermore, the issuer and the securitisation depositor will, at the time of filing of the forms necessary to obtain shelf-eligibility for an ABS, need to state to the SEC that to the extent the related sponsor or affiliate of the ABS is required to comply with a risk retention requirement in connection with a previous shelf-eligible ABS offering involving the same asset class, that such sponsor or affiliate holds the required risk as at the date such forms were filed for the new shelf-eligible ABS.

Following the initial issuance, an issuer wishing to conduct a take-down off an effective shelf registration statement must provide quarterly reporting on the sponsor's or affiliate's compliance with the risk retention requirements (in relation to the ABS subject to the take-down and previous shelf-eligible ABS). The issuer will also be required to disclose to the SEC any material change in the amount of the sponsor's or affiliate's interest in the ABS under Form 8-K. All such information is publicly available through the SEC's EDGAR database and any non-compliance will not only result in loss of shelf-eligibility of the ABS, but may also result in the imposition of fines and liabilities under the US securities laws.

The FDIC's safe harbour
In addition to the Financial Reform Bill and the SEC's proposed Reg AB2, the FDIC on 11 May 2010 issued its own notice of proposed rulemaking (NPR) to the rules regarding the treatment by the FDIC, in its capacity as receiver or conservator of insured depository institutions (IDI), of financial assets transferred by an IDI in connection with a securitisation or participation (the rule) after 30 September 2010. The NPR addresses and intends to provide a final rule replacing transitional measures (the transition rule) implemented by the FDIC in a series of measures between late 2009 and early 2010 in order to address the FASB modifications to US GAAP.

FAS 166 and FAS 167 require IDIs to consolidate special purpose entities to their own balance sheets in certain circumstances, which has the effect of the related financial assets not being treated as having been sold. The FDIC's rule provided a safe harbour to the FDIC's general powers to repudiate contracts entered into by the IDI or reclaim property financial assets transferred by the IDI if certain conditions had been met, primarily if such financial assets were given accounting off-balance sheet treatment.

The rule also effectively avoided the application of an automatic stay against any third party which would otherwise prevent third parties from recovering property or monies due to them for a 45-90 day period following the appointment of a conservator or receiver over an IDI. In order to address the impact of the 2009 GAAP modifications, the FDIC implemented the transition rule, which provides a safe harbour for participations and securitisations until 30 September 2010.

Retention as a condition for continued safe harbour eligibility
The final rule sets out conditions which an issue of ABS would have to satisfy in order to qualify for the safe harbour after 30 September 2010, which among other things will require sponsors to retain an economic interest of not less than 5% of the credit risk of the related financial assets. Specifically, paragraph (b)(5) of the final rule would, if adopted in its current form, provide that the 5% retention requirement may be met by either holding: (a) a 5%vertical slice in each of the credit tranches sold or transferred to investors; or (b) a representative sample of the securitised financial assets equal to at least 5% of the principal amount of the financial assets at transfer.

As in the case of the Financial Reform Bill, and to all practical effects with regard to Reg AB2, the retained risk may not be transferred or hedged, in this case during the term of the securitisation. The FDIC states in the NPR that it does not regard this prohibition as precluding hedging the interest rate or currency risks associated with the retained portion of the securitisation tranches, but rather that the prohibition is directed at the credit risk of the transaction to ensure that the originator properly underwrites the financial assets in question.

With regard to RMBS, in addition to the retention requirements described above, the final rule proposes that in order for an RMBS issuance to qualify for the safe harbour, a reserve fund shall be established - presumably by or on behalf of the issuer - in an amount equal to at least 5% of the cash proceeds of the RMBS payable to the sponsor to cover the repurchase of any financial assets which may be required as a result of a breach of the sale representations and warranties, which balance (if any) shall be released to the sponsor on the first anniversary of the date of issuance.

The final rule also requires, among other things, that any ABS qualifying under the safe harbour cannot be sold to any affiliate or insider of the sponsoring IDI.

Conclusion
Despite certain discrepancies amongst the US initiatives, at this stage it is clear that US regulators will be directly implementing the retention of risk requirement 'across the board' to all ABS offered (and not otherwise exempted from such requirements by the relevant Federal banking agency or the SEC) in the US, be it by way of the actual ownership of the required percentage of ABS or by the ABS meeting certain 'quality' standards.

European regulation, on the other hand, applies a 'carrot and stick' approach by requiring a strict 5% holding requirement by limiting a non-conforming ABS' investor base either by, in the case of alternative investment funds, a straight prohibition on its acquisition or, in the case of European regulated credit institutions investors, imposing a higher cost of capital on such investors.

© 2010 Paul Hastings. This Research Note was first published by Paul Hastings on 2 July 2010.