Contents

CDS

Switching to SEFs

New OTC trading platforms could boost the CDS market

The regulatory push taking place in the US has helped spawn the creation of a new electronic trading platform, which should be good news for CDS. A swap execution facility (SEF), called Javelin, is launching for OTC derivatives users who have to clear their swaps but do not want to do so on public exchanges.

The Dodd-Frank financial reform bill defines SEFs as facilities, trading systems or platforms that allow multiple participants to trade swaps by accepting bids and offers from other participants. The process must be open to multiple participants in the facility or system. This fairly vague Congressional definition will of course have to be tightened up by regulators when they come to writing the rules for SEFs.

However they are finally configured, these new platforms could provide a way for dealers and customers to buy and sell swaps electronically, conforming to regulatory requirements but also remaining flexible. Javelin has been half a year in the making and, even though it has not yet been formally launched, it has already cleared a swap with IDCG.

Transparency is the regulatory watchword of the moment and has played a large part in the drive to create these SEFs, but it is not just regulators who are pushing for them, as Jamie Cawley, ceo of inter-dealer broker IDX Capital, explains.

He says: "There is also a need from the customers, with their desire for greater transparency and lower transaction costs, and demand is also coming from dealers, who want greater transparency so that everyone gets best execution."

As well as increasing transparency for CDS, Cawley believes that SEFs could play an important role stimulating growth in volumes and lowering transaction costs. Yet despite these benefits, it is transparency that remains the central concern.

"There is a history in any opaque marketplace for there to be a propensity for abuse. Transparency is something which lessens that propensity, which can only be a good thing," Cawley says. "Certainly, greater transparency is also going to bring greater legitimacy to the asset class, as is consistent with other transparent capital markets."

All standardised OTC contracts could soon be required to be centrally cleared. Exactly how the new platforms will work alongside clearing is not yet clear, but there is a widespread conviction that many in the market will look to register as SEFs and establish relationships with clearinghouses, which will clear SEF trades.

Cawley says: "As it stands now, the law states that the clearinghouse must accept a trade from any SEFs out there. I would expect there to be a multitude of SEFs all connecting into numerous clearinghouses, be they ICE, CME, IDCG [as Javelin has already done] or Eurex."

As single name CDS can be quite illiquid, it is likely that index CDS will be the first to be traded on SEFs. After CDX and iTraxx, more liquid single names could be the next to follow.

"At first blush, the obvious products for SEFs and clearing are index CDS and beyond that single names. I would expect that over time we will see a quick migration of the initial constituent names of the index and then a slower migration of some of the more high-yielding credits," says Cawley.

Precisely what will be able to be traded on SEFs will not be known until final legislative drafts are written up by the regulators. However, dealers have made an early move and shown the strength of their faith in electronic trading by setting up Javelin. Other SEFs are sure to follow suit as the need to comply with regulators' demands for transparency are brought to bear upon the market.

JL

RMBS

Majeure concerns

Fear of mass refinancing spooks agency MBS market

Fear of mass government-sponsored refinancing in agency MBS spooked investors last week. With the market trading at a premium, bondholders could lose an estimated US$350bn if all agency borrowers refinanced into current mortgage rates.

"The Fannie Mae and Freddie Mac delinquent buyout programme [SCI passim] adversely affected a number of investors and dealers, and they're very sensitive about something similar happening again," explains one structured credit investor. "Talk of mass refinancings in connection with securities trading over par makes investors nervous because they could lose a lot of money. It dampens appetite for premium securities and puts a floor on spreads and yields."

MBS analysts at Bank of America Merrill Lynch suggest that if interest cashflows are viewed as somewhat fungible with principal payments, then wiping out premiums paid by investors for premium coupons is tantamount to a partial default on agency MBS. "Needless to say, we think this is exceptionally dangerous for financial markets," they note. "It might be countered that agency MBS investors are well aware when they purchase premium MBS that they face prepayment risk. But that risk has always been in the context of market forces...it never included the possibility that the government would override the market forces and wipe out the premiums paid just because it was economically convenient to do so."

The investor believes that current concerns about a possible agency refinancing programme are ultimately "a flash in the pan", however. "I expect it to have a marginal impact on the market because most borrowers are unlikely to be bothered to refinance. The cost of refinancing is prohibitive for borrowers with small mortgages when the costs of surveys and legal fees are included, while it is impossible for borrowers with large mortgages, given that Fannie's underwriting cap is US$650,000."

Credit conditions in agency MBS are arguably at the tightest levels seen over the past decade. Any refinancing programme would presumably target borrowers in existing agency pools with high rates.

ABS strategists at Barclays Capital suggest that one of the central elements of such a refinancing programme would involve the GSEs waiving the 'put-back option', which could open policymakers up to charges that big banks that made bad loans are being bailed out, again. In addition, the economics are much less compelling than they may seem at first glance.

"After compensating the GSEs for waiving put-back risk and rolling the cost of refinancing into a higher mortgage rate, the amount saved is unlikely to be more than US$5bn-US$6bn a year, using what we consider to be realistic assumptions," the BarCap strategists note.

Further, any new MBS are unlikely to be deliverable into TBA, given that they will not be newly underwritten. But if the new programme is non-deliverable, originators will be concerned about how far behind TBA these MBS will be executed.

"One solution would be for the Fed to commit to buying these MBS at a certain locked market," the strategists add. "The new MBS would never hit investor screens; they would go from the GSEs to the Fed. In turn, the Fed could sell a similar dollar amount of its existing MBS into the market. This would remove the execution risk for the originators."

It would also help the Fed's exit strategy: the new 4.5% MBS that it buys would extend less in a sell-off than its existing holdings, given higher involuntary prepayments.

But the BAML analysts stress that when there is limited origination and servicing capacity it is important for policymakers to use resources optimally. Helping a borrower who is more likely to default because they had a loss in income and stimulating housing demand are more important goals than trying to lower rates for all Americans, they note.

Market forces will likely resolve the low refinancing situation in due course, according to the analysts. "If rates stay low, then we think either existing lenders will build capacity or new finance companies will be formed to refinance borrowers... To incentivise lenders to originate loans with a below market rate, we think the government will have to assure a fair exit for lenders. For example, they could hold all the below market rate loans on their balance sheet or provide incentives to compensate investors for below market bond yields."

CS

ABS

Feedback provided on Reg AB proposals

The American Securitization Forum, CRE Finance Council and SIFMA have submitted letters to the US SEC, offering broad support for its proposals to increase transparency in the securitisation markets under Regulation AB (see seperate News Round-up story for AFME's response). But each association also highlights areas of concern for their members.

In its letter, for example, SIFMA specifically points to proposals that would improve disclosure and reporting, allow more time for investors to review a preliminary prospectus before making an investment decision and develop a better mechanism for enforcement of representations and warranties. However, the association also notes that the SEC's comprehensive proposal is too broad in some areas and imposes burdens that are heavier than justified in others.

Meanwhile, the CRE Finance Council notes in its letter that it has set up task forces that are working to create increased transparency and disclosure, including enhanced underwriting standards, PSA standardisation and industry standards for representations and warranties as well as Annex A disclosures. The organisation asks the SEC to consider its responses in light of the important role that CMBS and commercial real estate finance play within the US economy.

Dottie Cunningham, ceo of the CRE Finance Council, says: "We propose that the Commission take into account the unique aspects of CMBS and build on the protective measures already in place in the space rather than seeking to replace them."

Finally, the ASF's letter was submitted in conjunction with one responding to proposals affecting privately placed ABCP. While the association says it concurs with the commission's aim of providing investors with increased transparency, it also expresses concern over the SEC's proposed information delivery requirements.

In both letters, the ASF alternatively proposes market consensus views that represent the perspective of issuers, investors and dealers on large-scale improvements to information disclosure for various securitised asset types. For example, the association specifically refers to upgrades in disclosure for RMBS it developed as part of Project RESTART last year (SCI passim), as well as brand new consensus templates for credit card ABS and ABCP. It is also continuing to develop a broad-based consensus on model disclosure for auto ABS, which it expects to file in comments to the SEC by the end of the month, in addition to detailed comments on the complex SEC 'waterfall' proposals.

"The presentation of asset-level information has been a long time coming in some asset classes such as residential mortgages and, as such, the ASF is very supportive of some of the SEC's proposals," notes Tom Deutsch, executive director of the ASF. "At the same time, the proposal aimed at providing asset-level information is wholly unworkable for other asset classes, such as credit card ABS and ABCP, where asset-level disclosure requirements would radically shrink these critical financing markets for consumer and business credit."

The ASF also presented collective concerns regarding the commission's proposal to require 'public' disclosures, upon request, in all 'private' 144A transactions. It has therefore suggested a more balanced approach - the 'SQIB Proposal' - toward ensuring that only sophisticated investors participate in the private market for structured finance products by creating incentives for those investors to consider and understand the risks of their investments.

Detailed comments on the SEC's proposed risk retention requirements were also provided, indicating that for many assets, such as RMBS and CMBS, a 'vertical' slice approach in addition to a number of retention alternatives to the flat percentage-based approach would be the most appropriate set of rules, given recent accounting and regulatory capital changes. For other asset classes, such as auto and credit card ABS, a 'horizontal' or 'first loss' approach would be better, given their current market structures.

CS

ABS

Securitisation included in UK government consultation

The UK government has launched a consultation on financing a private sector recovery. Specifically, the government says it is interested in views on whether similar schemes to TALF could help support lending in the country, as well as if there are other roles it could play in helping industry develop stable securitisation markets.

The government says it wants to ensure that, within a more stable financial system, businesses have access to a more diverse range of sources of finance that suits their needs. It has consequently published a paper that explores a broad range of options, including trade finance, the role of non-bank institutions, corporate debt markets and securitisation.

The government "welcomes views from businesses, individuals and financial institutions on what they regard as the key challenges in facilitating business access to finance; the approaches they think would best address these; the roles for businesses, financial institutions and government in this; and the extent to which such interventions should be temporary or permanent". Where problems are identified, industry and market-led solutions are generally to be preferred and the government will support and promote these as appropriate.

However, the government is also ready to intervene to prevent downside risks to the economic recovery materialising. Any proposal for government intervention must satisfy a number of criteria, including that it should:

• reflect a realistic expectation that it will successfully address a clearly identified market failure;
• represent value for money for the taxpayer and be affordable within the Spending
Review envelope set at the June Budget;
• be timely and time-limited, with appropriate sunset clauses and a clear exit strategy;
• be compliant with state aids rules;
• not crowd out private provision or market solutions; and
• avoid introducing distortions elsewhere in the economy.

The paper highlights that although mid-sized firms have not been the target of explicit government support, this segment of the economy is significant in macroeconomic terms. "Mid-sized firms tend to have reasonably long track records and comparatively sophisticated treasury functions, both of which help them to manage more complex financing arrangements and relationships," the paper says. "They also, however, typically lack the knowledge, scale and experience necessary to access debt capital markets. Feedback from market participants suggests that a lack of awareness among mid-sized firms has limited growth in these markets."

HM Treasury and the Department for Business, Innovation and Skills (BIS) have been seeking to promote debt capital markets to diversify the sources of funding for mid-sized firms.

CS

CMBS

Citi and GS CMBS deal to price tight

A US$788.5m CMBS offering from Goldman Sachs and Citigroup is marketing at tight levels, leaving some investors to pass on the deal. However, enough demand exists in the overall CMBS-starved market that others are likely to gobble it up despite the aggressive pricing, say investors.

The deal, which is sponsored by Flagship Partners, was originally sized at US$750m. It consists of 48 mortgages that are mostly retail properties. An investor call on the offering took place on 29 July and it is expected to price this week.

"The pricing is not overly attractive, given it's a fusion deal and a lot of large loans," says one investor. "Individual loans are 12% of the pool."

The two class A tranches, which total about US$640m and include the super-senior five-year piece, are marketing at 130bp-140bp over swaps. The US$27m B class is expected to come at 200bp over.

The collateral itself is made up of loans that are not too leveraged, notes the investor, but he questions what could happen in a few years time. "It's not a blue-chip sponsor," he adds.

Credit support relative to the loan portfolio on the Goldman and Citi deal is also not overly conservative for some investors' liking.

But from a relative value standpoint, there is little else that compares to the CMBS asset class, notes another investor. The deal is still attractive versus corporates to insurance companies and money managers. "There's a hunger for relative attractive yield," he says.

A US$650m Vornado Realty Trust CMBS offering is also due in the market this week. The deal is to be lead-managed by JPMorgan.

Other REITs are expected to follow Vornado's offering. Despite the unsecured markets being attractive for several REITs, CMBS investors anticipate additional REIT offerings.

"They can borrow unsecured fairly cheaply, but I think the bigger REITs try to hit the CMBS market to diversify their funding sources," adds the second investor. Simon Property is among those cited as a potential issuer.

Developers Diversified Realty said in June (see SCI issue 189) that it has no interest in initiating another single securitisation. Market participants expect it could be part of a grouping of collateral for deals in the future.

KFH

CMBS

US CMBS loan modifications tracked

MBS analysts at Barclays Capital have introduced a US CMBS Loan Modification Index to track modified loans and their performance. The analysis is based on data that includes trustee remittance reports and various servicer files, with the aim of improving the index as more information becomes available.

The BarCap analysts believe that about 1,300 CMBS loans (including pari passu and A/B split loan structures) worth about US$31.4bn have so far been modified. The list of modified loans includes GGP-related modifications, as well as floaters, if the loan modification was performed outside of the standard three-year extension option.

The analysts report that in some cases defeasance and assumptions were mistakenly reported as modification although no modification was undertaken, but these cases were excluded from the data set. There are also examples where original loan assumption was executed simultaneously with changes in the structure of reserve accounts and these cases were included.

The index shows that employment of modification as a resolution strategy has accelerated sharply in the past two years. In 2009 alone, about US$10bn worth of conduit loans were modified and the year to date is already surpassing the 2009 mark. As a result, the analysts estimate that about 3% of the conduit universe is already modified, with this number being closer to 4.5% if fully defeased loans that cannot be modified are included.

The index also underlines the unique nature of CMBS modifications, which may be permanent or temporary and can include modification of maturity date, outstanding principal balance, original note structure (A/B notes) and the amortisation type (P&I versus IO) or changes in coupon or the structure of reserves and a waiver of prepayment provisions. The analysts also came across some interesting but less common modification types, including limitation of gross management fees, repayment of legal fees by the borrower, introduction of cash sweep towards faster principal reduction, changes in the grace days convention and changes in cashflow waterfall.

Nevertheless, they estimate that modification of loan maturity date remains the prevailing modification type, accounting for about 30% of loans in the index. The split note A/B structures and principal write-downs were among the less popular modification types, accounting for less than 10% each.

To highlight the fact that modification assumptions can impact valuations at both the top and bottom of the capital stack, the analysts run four possible scenarios using the benchmark GG10 deal. These are: 0 CPR, 0 CDR assumptions; extend all delinquents by 24 months; extend all delinquents by 24 months, along with a WAC reduction of 2%; and default all delinquents immediately with a loss severity of 50%.

The A2 and A3 notes gain in an extension scenario, but extensions combined with widespread rate reductions could cause some interest shortfalls on the A3. All three front pays - A1, A2 and A3 - perform very poorly in the extreme liquidation scenario, where a flood of involuntary prepays pay down the bonds at par. The A4 bond maintains a steady yield profile across even the most extreme mod scenarios.

CS

Technology

Data warehousing

Greg Munves, vp at 1010data, answers SCI's questions

Q: How and when did 1010data become involved in the financial markets?
A: 1010data provides an analytics platform delivered over the web as a service. The data comes from our clients and third-party vendors.

We began working with the New York Stock Exchange in 2001 and that relationship continues to this day. We host and provide the analytics tools for all of the data (bid, ask, trade) the NYSE creates on a daily basis and historically.

We initially helped NYSE to distribute its data to the market in electronic form through both bulk distribution and over the web. The relationship has expanded over the years to include internal analysis and investigation of their data.

As firms realised that they needed better systems to analyse agency MBS, due to the complexity of the analyses and size of the datasets, our technology became popular with the fixed income markets starting in 2002. Since then, as the non-agency market expanded, 1010data has grown to become an invaluable tool for the credit markets.

We have 23 different data partnerships with vendors ranging from CoreLogic and Equifax to Lewtan Technologies and Trepp. One of the key benefits of using the 1010data analytics platform is the flexibility that allows users to link disparate datasets together for in-depth analysis. Another key benefit is the speed of the analytically-driven 10base database technology.

Q: What are your key areas of focus today?
A: 1010data provides a general purpose database platform with analytics tools as a web service. The largest share of our customers currently are in the financial services space, where over 100 firms and thousands of people use our service to analyse residential, commercial and auto asset-backed securities, along with equities.

In addition to 1010data's success in the financial services space, we've leveraged the ability to manage the largest data problems to improve business performance for some of the largest retail and consumer packaged goods companies.

Q: How do you differentiate yourself from your competitors?
A: 1010data eliminates the gap between users and data, hosting the most in-demand datasets for our customers without relying on their internal IT resources. Our users create queries that make use of multiple datasets without the need to merge the information; they can access the system from any internet-connected computer.

1010data provides the ability to undertake time-series analysis right in the database, which is a unique feature and critical for analysing large amounts of financial data quickly. It also provides functionality to do inexact linking.

For example, with 1010data, a customer can do inexact linking or time-shifted linking like a link between quotes and trades tables together, where the link is between the trade that directly follows a quote. It's a quick and easy process.

Since we manage the entire solution, not only is it cheaper than doing it yourself because there are minimal upfront software and hardware costs, but users also don't have to waste time focusing on data updates, hardware maintenance and software upgrades.

We are constantly improving the product - another advantage of offering 1010data as a SaaS solution.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The slowdown in the global markets means companies need to be more competitive. Our technology allows them to do this at a fraction of the cost and time of traditional solutions, particularly for the extremely large data volumes used by the structured finance market. As data is expanding at a scorching pace, we are in an enviable position because this plays right into our strengths.

We plan to leverage the relationships we have in the structured products space to move into other areas of financial services. We are intrigued by any large data problem and look to continue to grow in the financial services, retail and pharmaceutical sectors.

Q: What major developments do you need/expect from the market in the future?
A: We expect to see a deeper focus on combining data from multiple sources, because the market needs to glean deeper insights and react more quickly to changes. Combining disparate data can be technically challenging, especially when there are many sources and the tables are very large. We've developed techniques to easily handle the linking of large datasets.

The need for strong data governance is another factor to consider when talking about linking of disparate data. All parties must be contractually obligated and prevented from linking datasets that reveal personal information in inappropriate ways. The best way to handle this when working with research datasets is to anonymise the data before it is presented to the end user.

ABS

Partner strengthens NY, LatAm capabilities

Ed De Sear has joined Allen & Overy as partner in its international capital markets group in New York. He moves over from Bingham McCutchen and will work alongside A&O partners Lawton Camp and Cathleen McLaughlin to strengthen the firm's securitisation capabilities, both in New York and Latin America.

Sear has over 30 years of experience in capital markets and structured finance. His expertise spans a broad range of asset classes, such as credit card receivables, dealer floor plan receivables and mutual fund fees, as well as cross-border securitisations and whole business securitisations.

ABS

London partner adds to fixed income expertise

David Eatough has joined DLA Piper as partner in its structured finance team in London. With experience in fixed income and structured securities, Eatough will strengthen the firm's finance offering to financial institutions, corporate issuers and end-users of the securities and derivatives markets. He will be focusing particularly on the capital markets and corporate teams in London and EMEA.

Prior to joining Piper, Eatough worked at Morgan Stanley in London, where he structured derivatives-based solutions for sophisticated end-users and intermediaries as part of the bank's corporate debt and derivatives team. Previous to this, he was partner for twelve years with Clifford Chance's global debt and equity capital markets group in London.

ABS

Funds and derivatives practice boosted

Holland West has joined Dechert as partner in its financial services practice group in the New York office.

West was previously at Shearman & Sterling, where he was head of its global hedge fund, private equity, derivatives and structured finance practices. Prior to this, he was partner at Cadwalader, Wickersham & Taft, where he was head of the firm's asset management and derivatives practices.

ABS

Corporate trust enhances SF team

BNY Mellon Corporate Trust has appointed Richard Stanley and Debra Baker to oversee its structured finance business lines, reporting to the firm's ceo Scott Posner.

Stanley, who has more than 25 years of experience within the company, will be responsible for the growth and administration of structured finance for ABS, MBS and collateral management, as well as the QSR and asset solutions business units. Prior to this appointment, he was head of global product management for BNY Mellon Alternative Investment Services.

Baker, who also has more than 25 years of experience in senior product management, strategy and risk management roles, will manage the CDO business, including related ancillary products. She was previously the chief administrative officer for BNY Mellon Corporate Trust.

CDO

Uptick in CDO management transfers

CDO manager transfer activity picked up over the last week, affecting 18 transactions.

First, Cohen & Co Financial Management is transferring collateral management responsibilities for eight Alesco bank and insurance Trups CDOs to ATP Management. ATP is wholly owned by investment funds managed by Fortress Investment Group.

ATP becomes the successor collateral manager for the Alesco X-XVII deals. The transactions are arbitrage cashflow CDOs invested in portfolios of Trups and subordinated debt, senior notes and surplus notes issued by banks, thrifts and insurance companies. Cohen & Co initially selected and monitored the portfolios, which are predominantly static.

Fitch placed 22 classes of Alesco notes on rating watch negative in February and maintained a single-C rating on 13 classes, because it says defaults for those classes appear inevitable. The agency says it will not change its ratings or rating watch status on the basis of ATP's appointment.

Second, GE Asset Management is proposing to transfer its asset management responsibilities for the Summer Street 2005-HG CDO to Vertical Capital. Established in 2002, Vertical is headquartered in New York and specialises in structured finance investment management. As of 31 March 2010, the firm had 13 employees and managed approximately US$1.43bn.

Summer Street entered an event of default on 4 January 2009, with a majority of the controlling class of noteholders voting to accelerate the maturity of the transaction as of 26 January 2010.

Fitch has determined the manager's capabilities to be consistent with the current ratings assigned to the notes of the transaction, as well as ensuring that Vertical meets its minimum guidelines to manage CDOs. The agency last took rating action on Summer Street on 15 January 2010, downgrading three classes of notes to single-C and affirming two classes as single-C, indicating that default appears inevitable.

Finally, Stanfield Capital Partners is to assign its asset management duties on nine CLOs to Carlyle Investment Management. The Stanfield CLO, Stanfield Carrera CLO, Stanfield Veyron CLO, Stanfield Modena CLO, Stanfield Daytona CLO, Stanfield Azure CLO, Stanfield Arnage CLO, Stanfield McLaren CLO and Stanfield Bristol CLO deals will be included in the transfer.

Moody's has been informed that all requisite consents and approvals for the proposed transfer have been received and conditions to closing have been satisfied. The rating agency has determined that the assignment will not cause its current ratings on any of the transactions to be reduced, withdrawn or qualified.

CDO

Global CDO trading co-head named

Jefferies has appointed Erez Biala as md and global co-head of CLO and CDO trading. He will partner with Sharif Anbar-Colas, global co-head, in managing the firm's CLO/CDO trading business within the broader MBS/ABS group.

Biala brings to Jefferies nearly 10 years of experience in the structured markets and joins the firm from Barclays Capital, where he was a member of the distressed special situations trading effort. Previously, he focused on CDO trading and origination for five years at Lehman Brothers. Prior to that, he worked in Morgan Stanley's CDO origination team.

CMBS

Investment manager buys into real estate venture

Tetragon Financial Group (TFG) has entered into an agreement with John Carrafiell, Sonny Kalsi and Fred Schmidt to invest in their newly created multi-jurisdictional real estate venture, GreenOak Real Estate.

The trio formerly worked together at Morgan Stanley for more than a decade. London-based Carrafiell was the former global co-head of real estate investment banking and investing business, while New York-based Kalsi and Tokyo-based Schmidt were both former heads of the firm's real estate investing business.

Under the terms of the transaction, TFG will receive a 10% equity interest in GreenOak and will provide the firm with a working capital loan of up to US$10m and US$100m co-investment commitment. This is expected to fund up to a limited fixed percentage amount of any GreenOak sponsored investment programme, with TFG retaining the option to invest further amounts.

TFG will also grant the GreenOak founders options to approximately 3% of TFG's listed shares at a strike price of US$5.50. TFG's co-investment (including amounts invested at its option) will benefit from preferential or discounted fees in the applicable investment programme.

Paddy Dear, TFG director and a principal of Polygon Credit Management (the investment manager of TFG), says: "We think there are significant opportunities in the real estate market, including widespread distressed opportunities, and gaining further exposure to this asset class - especially at attractive fee levels - is very appealing."

In connection with the transaction, a Polygon affiliate will also provide GreenOak with a working capital loan and a limited co-investment commitment. Certain Polygon affiliates will also enter into an agreement with GreenOak to provide operating, infrastructure and administrative services to the business, as well as providing GreenOak founders with an equity interest in Polygon.

CMBS

CRE advisory adds svp

Wayne Potters has joined RBS as svp for the firm's GBM Americas real estate advisory group. He is based in Stamford and will report to Doug Tiesi, head of the group.

Potters joins the firm from Fortress Investment Group, where he worked in the debt capital markets group, responsible for arranging debt financings for portfolio companies. He previously spent six years at Merrill Lynch, most recently as a director in the commercial mortgage group, focusing on large loan structuring, syndication and rating agency management.

CMBS

CMSA-Japan follows suit

CMSA-Japan has formally changed its name to Commercial Real Estate Finance Council Japan, aligning itself with the North American and European associations, both of which changed their respective names in 2010.

Japan's CRE Finance Council is led by co-chairs Tokio Ueyama of Deutsche Bank and Atsuo Akai of Morgan Stanley MUFG. Akai says:"Working together with regulators and other market participants, CRE Finance Council-Japan is active in its work to ensure that the government understands Japanese CMBS as a useful tool to provide sustainable long-term financing to support economic growth."

Investors

REIT adds mortgage investments head

American Capital Agency Management has appointed Christopher Kuehl as head of mortgage investments. He will report to Gary Kain, president of the group and cio of American Capital Agency Corp.

Kuehl was most recently at Freddie Mac, where he served as vp and head of agency and non-agency mortgage investments. In this capacity, he was responsible for directing the firm's purchases, sales and structuring activities for all agency mortgage products, including CMOs.

Investors

Customised credit strategies group expands

GSO Capital Partners has recruited John Cashwell and Eric Storch as mds and co-heads of institutional marketing for its customised credit strategies group. They will lead an effort to expand GSO's presence in long-only credit products for institutional investors through both commingled funds and separately managed accounts. The pair joins from Seix Investment Advisers.

Monolines

Monoline holdings sold

PMI Mortgage Insurance Co has sold its equity ownership in FGIC Corporation. While the financial terms of the sale were not disclosed and the proceeds from the sale are said to be not significant, the firm could potentially realise certain tax benefits in future periods from the disposition of its FGIC assets.

PMI had impaired its investment in FGIC in Q108 and, consequently, did not recognise any losses from FGIC in 2009 or 2010.

Ratings

Moody's says it has enough insurance

Raymond McDaniel, chairman and ceo of Moody's Corporation, said on its 29 July conference call that the agency has enough insurance. "We think we carry very appropriate levels of insurance and will continue to do so," he commented.

In response to some of the regulatory revisions taking place, Moody's says it is enhancing its documentation processes and seeking additional third-party verification where appropriate. "We are also considering other actions that may help mitigate some of the potential risks," he McDaniel said.

As a result of the rescission of 436(g), Moody's said the action in no way limits its rating activity or public ratings through its website. "We believe that regulatory reform is helpful to the markets and are committed to implementing revisions that are specific to our industry as quickly and effectively as possible," added McDaniel.

In Europe, Moody's says it is in the process of implementing European Union Credit Rating Agency regulation. The agency is completing its application to register under the new EU regulatory regime and anticipates that additional regulatory review will be ongoing for the second half of the year.

Moody's Corporation reported Q210 revenue of US$477.8m, which was up 6% year over year.

RMBS

Misleading investors costs bank US$75m

The US SEC has charged Citi with misleading investors about its exposure to subprime mortgage-related assets. The authority has also charged one current and one former executive for their involvement in Citi's misleading statements in an SEC filing.

The SEC alleges that in response to intense investor interest on the topic, Citi repeatedly made misleading statements in earnings calls and public filings about the extent of its holdings of assets backed by subprime mortgages. Between July and mid-October 2007, the bank claimed that subprime exposure in its investment banking unit was US$13bn or less, when in fact it was more than US$50bn.

The US$13bn figure reported by Citi omitted two categories of subprime-backed assets: super senior tranches of CDOs and 'liquidity puts'. The bank had more than US$40bn of additional subprime exposure in these categories, which it didn't disclose until November 2007 after a decline in their value.

Citi and the two executives have agreed to settle the SEC's charges. Citi will pay US$75m, former cfo Gary Crittenden will paying US$100,000 and former head of investor relations Arthur Tildesley (currently the head of cross marketing at Citi) paying US$80,000.

"Even as late as fall 2007, as the mortgage market was rapidly deteriorating, Citi boasted of superior risk management skills in reducing its subprime exposure to approximately US$13bn. In fact, billions more in CDO and other subprime exposure sat on its books undisclosed to investors," says Robert Khuzami, director of the SEC's division of enforcement.

According to the SEC's order proceedings against Crittenden and Tildesley, they were repeatedly provided with information about the full extent of Citi's subprime exposure, and helped draft and then approve the disclosures that were filed with the SEC in October 2007. Without admitting or denying the SEC's allegations, Citi, Crittenden and Tildesley consented to the entry and issuance of an administrative order of a final judgment.

Technology

IDC acquisition completed

The acquisition of Interactive Data Corporation (IDC) by investment funds managed by Silver Lake and Warburg Pincus has been completed.

Pursuant to the terms of the agreement entered into on 3 May 2010, IDC's stockholders will receive US$33.86 in cash, without interest and minus any applicable withholding taxes for each share of IDC common stock they own. In conjunction with the transaction, IDC's common stock will no longer trade on the New York Stock Exchange and will be de-listed accordingly.

ABS

Euro repo haircuts raised

The ECB last week raised the haircuts for repo lending, including ABS assets, from 12% to 16%. The new haircuts for ABS lending will be valid as of January 2011.

Structured credit strategists at UniCredit suggest that the increase in haircuts is quite drastic at first glance, but isn't totally unexpected. "In our view, it is a further measure taken by the central bank in order to wind down repo activity by the ECB, particularly in the ABS market," they note.

The move follows a review of the risk control measures in the framework for assets eligible for use as collateral in Eurosystem market operations and the central bank's decision of 8 April 2010 to introduce graduated valuation haircuts for lower-rated assets. The new schedule graduates haircuts according to differences in maturities, liquidity categories and the credit quality of the assets concerned, based on an updated assessment of risk characteristics of eligible assets and the actual use of eligible assets by counterparties. The new haircuts will not imply an undue decrease in the collateral available to counterparties, the ECB notes.

The definition of liquidity categories for marketable assets and the application of additional valuation mark-downs for theoretically valued assets have also been fine-tuned. For example, the additional valuation mark-down of 5% currently applied to theoretically valued ABS will be extended to theoretically valued bank bonds.

The UniCredit strategists estimate that more than €70bn of new securitisations has been issued under a 'structure to repo' business model so far this year. They don't expect a flood of selling of lower rated and non-eligible ABS debt due to the change in haircuts, however.

ABS

AFME plea for a level ABS playing field

In its response to the US SEC's proposed rule for revisions to Regulation AB, AFME says that the rules on the offering, disclosure and reporting for ABS could introduce inequalities. These inequalities, AFME says, may deter the distribution of global securitisations into the US at a time when every economy is seeking funding.

AMFE supports the move for greater transparency and disclosure, helping to restore investor confidence in the global securitisation market. However, it warns that significant issues remain for European issuers since the proposals focus on US-originated transactions and, in general, do not acknowledge non-US transaction structures.

AFME's concerns for European issuers are:

• Without flexibility to reflect local non-US parties, regulations, transaction structures and product types, many European participants are likely to struggle to comply with the new rules.
• Inconsistencies between European and US regulations raise the cost of the compliance burden.
• Compliance with the SEC's proposed disclosure and reporting requirements could result in legal conflict in non-US jurisdictions. Compliance burdens for specific products, such as mortgage master trusts and ABCP, should be reviewed.
• The SEC's definition of 'structured finance product' does not differentiate between covered bonds and ABS.

Rick Watson, AFME md, comments: "It is critical to create a level playing field for US and non-US issuers. Prior to the financial crisis, up to 25% of total issuance of European originated securitisations were eligible to be offered in the US and we urge the SEC to take account of the global nature of securitisation distribution."

ABS

Cabela's eyes more frequent securitisations

Specialty retailer Cabela's is planning more securitisations this year, instead of its more typical once-a-year schedule, according to Kevin Werts, cfo and treasurer at Cabela's wholly owned bank subsidiary World's Foremost Bank.

The retailer will have to bring anywhere from one to three securitisations a year, due to its upcoming maturities and the amount of growth it expects, says Werts. Depending on the market and timing of deals, future transactions will likely be between US$250m to US$500m. The company is still in the process of evaluating offerings currently, however, amid the regulatory uncertainty.

It last brought a US$300m securitisation via Cabela's Credit Card Master Note Trust earlier this year. That deal also included subordinate notes totalling US$45m.

ABS

Another Wyndham ABS planned

Wyndham Worldwide is planning another ABS transaction this autumn, which will likely be smaller than the US$350m ABS deal it completed earlier this month (see last issue), according to Tom Conforti, evp and cfo at Wyndham.

"The transaction was oversubscribed and we couldn't be happier with the execution," he said on the company's 28 July conference call. "We had to take advantage of exceptionally positive market characteristics."

Wyndham's US$350m Sierra Timeshare 2010-2 Receivables Funding offering was upsized from initial price talk to include US$286.09m class A notes and US$63.9m class B notes. The offering follows a US$300m Sierra Timeshare 2010-1 Receivables Funding offering last March (see SCI issue 176).

The company says its advance rates and cost characteristics on its latest offering were close to deals initiated prior to the economic downturn. Its advance rate was 83.25% and its all-in yield was 4.15%.

In June, Wyndham closed a US$185m premium yield securitisation, which was more expensive than normal term deals. The notes were ineligible for its conduit due to certain borrower or loan characteristics. However, Conforti said the premium yield securitisations significantly enhanced its liquidity and cashflow.

Stephen Holmes, chairman and ceo at Wyndham Worldwide, noted its free cashflow projections beyond 2010 have increased to US$600m to US$700m annually, which is up from original guidance of US$500m to US$600m.

During the next five years, the company says it will streamline its timeshare balance sheet.

ABS

Improving sukuk market still faces barriers

An S&P report on the sukuk market says that global issuance in the sector exceeded US$13.7bn in the first half of 2010, nearly doubling the US$7.1bn of issuance over the same period last year. The agency attributes some of the increase to improved international market conditions, but notes that obstacles in the market remain.

Sovereigns accounted for around 75% of total sukuk volumes as governments sought to stimulate the market. Private institutions from both the GCC and Asia have also begun to come back to the market, which is a trend that S&P expects to continue.

The agency highlights key challenges for the sukuk market to overcome. The main obstacles are learning to deal with sukuk defaults, standardising the interpretation of Shari'ah and improving the market's liquidity.

Although each default is unique, S&P says documenting them as they happen will help create a track record on default procedures, which would include information on the proportion and timing of potential recoveries. Kuwait-based International Investment Group, which defaulted on a US$200m sukuk issued in 2007, is the only default so far this year.

Growth in the sukuk market has been dampened by Shari'ah scholars, who in 2008 decreed that several transactions were not Shari'ah-compliant. However, the agency believes progress has been made in the last couple of years to standardise the interpretation of Shari'ah. Malaysia has led the way, granting the Sharia Board of the Central Bank the final say on what is or is not Shari'ah-compliant.

Despite the progress so far, S&P believes that further standardisation will be slow and difficult as there are so many parties to reconcile. More standardisation should reduce the costs associated with issuing sukuk, which are still higher than those for similar conventional bonds.

Finally, in terms of sukuk liquidity, the agency notes that the market is moving from OTC to listed instruments. Listing sukuk on organised markets is expected to facilitate liquidity for the instruments and make it easier for financial institutions looking to broaden the asset class.

ABS

DPR notes to be exchanged

S&P has assigned preliminary triple-B ratings to Yapi Kredi Diversified Payment Rights Finance Co.'s floating-rate notes series 2010-A, 2010-B, 2010-C, 2010-D and 2010-E. These new series are the result of an exchange offer, whereby monoline-wrapped notes are exchanged for unwrapped notes with the same tenor and amortisation schedules.

S&P has also affirmed its triple-B ratings on the notes to be exchanged - series 2006-A, 2006-B, 2006-C, 2006-D, 2007-A and 2007-B. The total outstanding debt under the diversified payment rights (DPR) programme remains unchanged.

The transactions are securitisations of all current and future DPRs in the form of US dollar, euro and sterling-denominated SWIFT MT100 category payment order messages, letters of credit (LOCs) and cash against documents transactions.

ABS

Some AmeriCredit ABS tranches on upgrade review

Moody's has placed on review for possible upgrade six tranches from two auto loan securitisations sponsored by AmeriCredit Financial Services in 2007. Despite the overall pool losses now projected to exceed original pool loss expectations, the credit enhancement supporting the affected securities in these transactions has increased substantially.

Specifically, the agency expects AmeriCredit Prime Automobile Receivables Trust 2007-1 to incur a lifetime cumulative net loss of between 7.5% and 8.5%, up from its loss expectation of 3.5% at issuance. Total credit enhancement for the affected C1, B, C and D structures is approximately 41%, 28% and 15% respectively as a percentage of the remaining collateral. The other transaction affected is AmeriCredit Prime Automobile Receivables Trust 2007-2-M.

Moody's currently views the used vehicle as stronger now than it was a year ago, when the uncertainty relating to the economy as well as the future of US auto manufacturers was significantly greater.

ABS

Stable performance for trade receivables ABS

According to S&P, the performance of European term trade receivables securitisations has remained relatively stable through the recent economic downturn.

"Of the five European trade receivables securitisations that we rate, none has experienced downgrades during the downturn," says S&P credit analyst Nikki Patel.

The agency says that several reasons lie behind this relatively good collateral performance. "We believe businesses are more likely to honour their trade receivable invoices because the commodities behind the invoices tend to be vital to the business," Patel adds. "This helps sustain cashflows and thus performance levels of the transactions backed by receivables from those invoices."

S&P notes that originators may be seeking to issue new term trade receivables securitisations, which is most likely a result of the current fragile economic climate.

ABS

Credit card ABS performance improving

Credit card charge-offs declined during the month of June, the third consecutive month, according to a credit card report from Moody's. Analysts at the agency note that 10.28% of securitised credit card loans were written off as uncollectible in June, which is down from 10.71% in May.

Fitch's Credit Card Index also shows a similar improvement. Analysts at the agency say overall economic and employment declines are slowing, which is buoying credit card ABS performance. They expect senior credit card ABS to remain stable, partly due to available credit enhancement.

However, consumers are still being stretched and employment will remain under pressure for an extended period, says Michael Dean, md at Fitch. "While the improvements are a welcome sign, we still have a ways to go before we are out of the woods," he says.

But Moody's notes that the negative consequences of a possible double-dip recession would not be significant for credit card charge-offs since credit card charge-offs are likely to peak at around 10%. The agency expects charge-offs to continue falling in the short term and then increase and peak at around 10% in a second recession.

ABS

Capital One's ABS on review for downgrade

Moody's has placed on review for possible downgrade 47 classes of ABS issued out of the Capital One Multi-asset Execution Trust. The review impacts approximately US$21.6bn of ABS.

The securities are backed by a US$42.4bn revolving pool of consumer and small business credit card receivables originated by Capital One Bank. The action follows Moody's announcement on 27 July that it is reviewing for possible downgrade, among other ratings, the short-term and long-term unsecured ratings of Capital One Bank (Prime-1 and A2 respectively).

The rating agency says the ratings under review benefited from its increased expectation of government support since 2009. Specifically, the A2 long-term unsecured rating benefits from one notch of systemic support.

ABS maturing within the next six months were excluded from this rating action due to the low probability of early amortisation in the very near future. None of the bank's unsupported ratings, such as its bank financial strength rating, are on review. Capital One Bank is the seller/servicer of the Trust.

Additionally, Moody's performance expectations for the Trust are unchanged.

CDO

Trups CDO credit risk transferred

Zions Bancorporation has entered into a total return swap and related interest rate swaps with Deutsche Bank on US$1.16bn worth of bank and insurance trust preferred CDOs. As part of the deal, Deutsche Bank will assume all of the credit risk of this CDO portfolio and pay all interest and principal due to the company.

The transfer of credit risk to Deutsche Bank reduces the regulatory capital risk weighting for these investments to 20% compared to the weighted average risk-weighting of 455% on 30 June, according to Zions. As a result, the transaction is expected to reduce regulatory risk-weighted assets by approximately US$4bn, or approximately 8.4% of the estimated 30 June 2010 balance.

CDS

Novation overhaul prepped

ISDA is in the final stages of drafting the legal documentation for the Consent = Confirmation initiative. This initiative is being driven partly by the industry, which is seeking to streamline the CDS novation process, and partly by ISDA's efforts to update the way the Novation Protocol is supported by services providers.

Novation has historically involved a two-step process of consenting to the counterparty replacement and then legally confirming the trade terms. The aim of the new initiative is to combine consent and confirmation on an electronic platform. The platform is scheduled to launch on 30 September.

CMBS

Crown Castle deal adds to hybrid interest

Crown Castle International is due with US$1.55bn of Senior Secured Tower Revenue Notes, which marks its second securitisation this year. The deal, which is led by Morgan Stanley, consists of US$250m, US$300m and US$1bn tranches.

The notes are backed by equity interest in the special purpose entities that own or lease the cell towers. The notes are expected to close on 16 August.

The offering will assist the company in refinancing its 2006-1 notes, which are due in November of next year. The company is typically in the market 3-6 months before its notes are due, but this was an opportunistic offering given where pricing was, says one source.

The offering follows a cell tower deal from Unison last April (see SCI issue 182). But Unison's collateral for the securitisations were mainly from easements on the land where the tower resides and on the structures as opposed to the towers.

This offering, like other recent cell tower deals, is sold off of the corporate desks as opposed to the structured finance areas since many of the offerings are lower rated than other structured finance deals. The deals are typically viewed as secured corporate credit deals. Crown Castle hopes to obtain an investment grade rating, however.

"People like that. From their market, it's an interesting credit," says one ABS investor. "I think the deal was pretty well received."

Crown Castle last brought a US$1.9bn securitisation in January and also tapped the unsecured market last year.

CMBS

CMBS model RFP released

The National Association of Insurance Commissioners (NAIC) has released an RFP for a vendor to model expected losses on approximately 7,500 CMBS as of December 2010. This process will determine the NAIC designations utilised by insurance companies to calculate the solvency reserves required to cover their CMBS holdings.

NAIC chose PIMCO to establish designations for more than 21,000 RMBS owned by US-domiciled insurance companies last year (see SCI issue 162).

NAIC president Jane Cline says: "State regulators believe that adding this tool will improve our view of structured securities and our industry. As we decide to extend this type of treatment to CMBS, we will again look to partner with an established leader in the field."

Applicants must have the following qualifications to be considered for the role:

• Be a nationally recognised institution with at least five years of recent and contiguous experience in modelling CMBS;
• Have the capacity to assign qualified staff to this project until it is completed;
• Have sufficient data processing capability to generate these valuations by early December 2010; and
• Have safeguards in place to avoid conflicts of interest.

This recommendation is expected to be approved by the NAIC executive committee at the national meeting in August and a vendor is due to be selected by 3 September 2010.

CMBS

Bluebutton agreement positive for Broadgate Finance

Bluebutton Properties, the joint venture between British Land and Blackstone, has signed a binding agreement with UBS to develop a new 700,000sq ft building on the Broadgate estate at the site of 3, 4 and 6 Broadgate. As a result, the three buildings are being removed from the Broadgate Finance portfolio (and replaced by 201 Bishopsgate and Broadgate Tower), together with cash collateral of £226m. In order to bridge the gap between existing break options and the availability of the new office complex, extended terms have been agreed on UBS existing leases at 100 Liverpool Street, 8-12 Broadgate and 1-2 Finsbury Avenue for an average of 24 months.

European asset-backed analysts at RBS consider the news positive for the securitisation, with the substitutions increasing the weighted average lease length of the collateral, injecting more modern office buildings into the pool and removing the structural deficit cash collateral. It also illustrates the long-term commitment that the JV partners have to the transaction, they note, with the substitution representing a net equity injection of £229m. The final agreement with UBS (which remains subject to planning consent) and the redevelopment of 3, 4 and 6 ensure that the Broadgate estate remains a relevant city offices site and should thus be supportive of rents/redevelopment of the estate going forward.

CMBS

US CMBS loan defaults rising 'at record speeds'

Fitch says that defaults on fixed-rate conduit US CMBS loans are continuing at record speeds.

Cumulative defaults rose to 9.48% through June 2010. The 133bp climb from Q110 is consistent with the agency's expectation of an 11% cumulative default rate by year-end 2010 and is factored into Fitch's current ratings and negative rating outlooks.

Not surprisingly, recent vintages are driving the pace of defaults. "2007 deals already have cumulative defaults of 10.48% and are likely to reach 14% by year end," says Fitch md Mary MacNeill. "Large, highly leveraged loans are also adding to the rising rate of defaults, with 14 loans greater than US$100m defaulted in 2010."

CMBS

All-time high for US CMBS delinquency rate

The latest Trepp Delinquency Report highlights that although the overall US CMBS delinquency rate rose again in July to a new all-time high of 8.71%, the rate of increase in delinquencies showed more signs of moderating during the month.

In June, the increase in the delinquency rate was the smallest in about a year, according to Trepp. In July, the numbers were even more encouraging, with the rate up by just 12bp compared to 17bp the previous month.

Hotel delinquencies fell by 60bp during July. At 18.41%, the sector is still seeing the highest delinquencies among the major property types.

The multifamily delinquency rate was down by 9bp - the second highest delinquency rate among major property types at 14%. Office delinquencies moved up by 31bp (now at 6.35%), while the retail rate jumped by 22bp (now approaching 7%). Finally, the delinquency rate for the industrial sector increased by 56bp and is now above 6% but remains the best performer among major property types.

CMBS

Euro CMBS repayment index rises

Fitch reports that European CMBS loans have seen an increase in repayment, with the agency's Maturity Repayment Index rising to 37% by the end of July compared with 19% in the previous month. The rise in the index was largely driven by two transactions - White Tower 2006-3 and La Defense III.

White Tower 2006-3 saw a £734m partial repayment during the month, leaving an outstanding loan balance of £370m. This follows the sale of eight of the nine properties securing the loan. One of these property sales is not yet reflected in the reported data, as it did not complete in time for the July payment date, and will further improve the index in coming months.

The remaining £377m balance of the La Defense III loan was repaid during the month (the bonds have not yet repaid but will do so at the October IPD). The loan had previously matured in April 2009 and had seen its maturity extended.

While the outstanding loan balance was large, by current bank lending standards, the moderate Fitch LTV of 45% and high quality collateral will have facilitated the repayment. Only three of the 14 loans maturing in July repaid at their scheduled maturities. Fitch expects their small outstanding loan balances to have facilitated their respective refinancings.

CMBS

Excess cashflow criteria confirmed for Japanese CMBS

Fitch has clarified its methodology for calculating the credit that will be given to excess cashflow in the surveillance of existing Japanese CMBS transactions. The move follows the agency's recent publication of Japanese yen interest rate stress assumptions.

The criteria to calculate excess cashflow credit for the single-B rating scenario have been clarified as follows:

• Assume the base interest rate remains at 1% until July 2013 and, thereafter, assume the rate rises according to the single-B rating scenario in Fitch's recent publication of Japanese yen interest rate stress assumptions. Under this scenario, the rate reaches 2.25% in 48 months after July 2013.
• Calculate the excess cash amount as the difference between the interest amount derived above and the smaller of Fitch assumed net cashflow (NCF) or NCF based on the actual performance.
• Give credit for 36 months after the loan default (or shorter, taking into consideration the expected servicers recovery strategy and/or actual workout proceedings), with the maximum period ending up to one year before the legal final maturity.
• Apply a discount factor to the calculated credit amount of at least 20% and above.

The agency says it does not give credit to excess cashflow at the triple-A rating scenario. To calculate the credit to be given between triple-A and triple-B, linear interpolation is used. It thereby amends the application of the interest rate criteria for the Japanese yen to better reflect the short- to medium-term expectations of interest rates, and to simplify the calculation of excess cash in Japanese CMBS surveillance.

Ultimate recovery on the underlying defaulted loans will depend on the disposition price of the collateral properties and on-going cashflow generated by them. Excess cashflow can be expected to pay down the loan, after the payment of interest, as long as the current market circumstances continue and cashflows remain robust and interest rates remain low.

CMBS

Blue City CMBS downgraded

Fitch has downgraded the class B notes of Blue City Investments 1 to single-C from triple-C and affirmed the rest at either single-C or triple-C. The transaction is a securitisation of a US$925m financing package granted to Blue City Company 1 (BCC1) for the development of an upmarket residential, hotel and leisure resort on the coast of the Indian Ocean at Al Sawadi, located 90km to the west of Muscat, the capital of The Sultanate of Oman. Since Fitch's last rating action in June 2009, the transaction has continued to show poor and deteriorating performance.

As at the May 2010 interest payment date (IPD), cumulative net sales proceeds to date of off-plan villas and apartments stood at US$75.27m versus US$860m required by the 'sales test 5' trigger within the transaction and the US$1.319bn envisaged by the original business plan. Construction came to a standstill in January 2010 due to the borrower's inability to fund construction costs.

The borrower is also struggling to fund its own corporate overheads and has made the majority of its staff redundant, although no changes have occurred to senior management. At the same time, the long-running legal dispute between the project's shareholders is still ongoing.

As Fitch expected, the transaction breached the 'sales test 5' on the November 2009 IPD and all subsequent IPDs. While such a breach calls for an immediate acceleration and mandatory repayment of all of the transaction's debt and, in the event of non-payment, an event of default under the inter-company loan, the issuer note trustee has thus far not served the borrower with a notice demanding immediate debt repayment.

In the absence of a comprehensive restructuring of the transaction, Fitch continues to consider an eventual default of all note classes a distinct possibility as the escrowed reserves are being depleted. Current escrowed reserves available to the class A3/A4 notes are sufficient to cover approximately 18 quarters of interest at their capped interest rate of 7.723%, and for the class B1/B2 notes approximately three quarters of interest at their fixed interest rate of 13.75%.

This means that, within a relatively short time period, the class B1/B2 notes will likely stop receiving interest, precipitating Fitch's downgrade. No reserves are available to the class C and D notes, and no interest has been paid on these classes for several quarters; however, they are not currently in default as interest on them is deferrable, as per the transaction's documentation.

Essdar Investments, an Abu Dhabi based investment group, increased its holdings in the unrated class A1 and A3/A4 notes to 99% via a tender offer in June (see SCI issue 189) and is now seeking to purchase a controlling interest in the class B1/B2 and C notes. To date, Essdar is understood to have invested in excess of US$400m in the transaction's notes. The firm's apparent interest in acquiring materially all of the transaction's debt may be a precursor to a comprehensive restructuring or potential winding down of the securitisation, according to Fitch.

Distressed assets

Distressed exchanges lift recovery rates

A Moody's review of nearly 60 US non-financial companies that have emerged from default since the trough of the credit crisis shows that investors have recovered an average of 51 cents on the dollar on defaulted debt. This is near the historical average of 55 cents.

"Despite the high leverage and easy terms from lenders that characterised the credit bubble, recoveries have actually been better in this default cycle than the mid-40% range seen in the previous two downturns," says David Keisman, Moody's svp.

According to the report, the main reason recoveries have been stronger than expected is that the first wave of companies to emerge from default in the recession included a historically high percentage of distressed exchanges. These exchanges typically yield higher recoveries than regular or prepackaged bankruptcies. Without this lift to overall recoveries from the 25% of defaults that occurred via distressed exchanges among the 57 defaults Moody's reviewed, recoveries would have been at record lows compared to previous recessions.

The agency says that it continues to monitor about 180 defaulted companies, the majority of which have filed for bankruptcy. Recoveries are likely to be pressured because bond investors typically do not fare as well in bankruptcy proceedings.

However, the report notes that recoveries could be supported by a declining default rate. Recoveries are negatively correlated with the default rate, so as defaults decline, recoveries should rise. Moody's forecasts that under a baseline economic scenario the default rate will fall sharply to end 2010 at 2.7% and reach 1.9% a year from now.

RMBS

Good reception for FDIC RMBS

The FDIC has closed on a US$471.3m securitisation backed by performing single-family mortgages from 16 failed banks. The investors represented a wide variety of organisations and paid par for the senior certificates.

This pilot programme, which consists of three tranches of securities, marks the first time that the FDIC has sold assets in a securitisation in the current financial crisis. Approximately US$400m of senior certificates represent 85% of the capital structure and are guaranteed by the FDIC. The fixed-rate senior note, which sold at a coupon of 2.184%, is expected to have an average life of 3.66 years.

"I welcome the FDIC's attempts to recycle assets and clear up the mortgage overhang from the banks it has bailed out," says one RMBS investor. "It provides a much-needed supply of paper at a fair spread and represents an attractive pick-up over government bonds. We hope to see more FDIC issues in the future."

However, he adds, it is clear that no-one would buy the bonds without the FDIC guarantee. "The FDIC is essentially keeping the risk but sharing the financing," he continues.

The subordinated certificates comprise a mezzanine and an overcollateralisation class representing 15% of the capital structure. The subordinated certificates will be retained by the failed bank receiverships, which may sell all or a portion of the notes at some point in the future.

The deal incorporates transaction-governance procedures that align the compensation of the servicer with resolving problem loans and minimising losses to the trust. Delinquent mortgages will be considered for loan modification consistent with the HAMP or FDIC loan modification programmes. The transaction also allows for independent third-party oversight of overall performance.

The lead underwriter on the transaction was RBS Securities and the three co-underwriters were BoA, Deutsche Bank and Williams Capital, a minority-owned firm.

RMBS

Return of the agency MBS bank bid?

Large commercial banks' agency MBS holdings increased by US$51.4bn in the past two weeks, according to the Federal Reserve's latest survey data. Barclays Capital ABS analysts believe this might be the start of a strong return of the bank bid for agency MBS and suggest that banks could absorb more than another US$150bn of agency mortgages.

Capital concerns, a reduced appetite for credit risk and tighter underwriting are all leading to reduced loan origination, leading to banks adding agency MBS instead of loans, the BarCap analysts note. Fixed rate products, such as agency MBS, are made particularly appealing by a steep yield curve.

Until two weeks ago, banks were paring down loan holdings and increasing their securities portfolio without there being an increase in MBS demand, with agency MBS holdings actually decreasing from the start of the year to mid-July. The analysts believe this reluctance to take on agency MBS was because banks expected MBS spreads to widen as a result of the conclusion of the Fed's MBS purchase programme. Waiting for spreads to widen, they bought Treasuries and short-term cash substitutes.

As mortgage spreads have tightened, it has become increasingly expensive for banks to stay in cash substitutes. Continued strong growth in deposits and significant yield pickup in MBS against Treasuries has, the analysts say, encouraged banks to start adding MBS.

The US$51.4bn agency MBS addition in the last two weeks by the biggest 25 banks is the largest jump in the last 18 months. Whether this is the start of a renewed bank bid for MBS will be clearer when quarterly FDIC data are released. The banks have traditionally been one of the biggest sources of demand for MBS, so - should the FDIC data confirm the start of a trend - it should paint a very positive picture for the agency MBS basis.

RMBS

Court rules out EOD for Eurosail

The UK High Court has ruled that no event of default has occurred in Eurosail-UK 2007-3BL by reason of the issuer's assets being less than its liabilities (SCI passim). In addition, the High Court rejected an argument that the notes in this transaction were effectively limited recourse because of the incorporation into the structure of a post enforcement call option (PECO).

According to the judgment, the principal of the class A1, A2 and A3 notes should continue to be paid on a sequential basis according to the pre-enforcement waterfall (so long as nothing is recorded in the class A principal deficiency ledger). Permission to appeal to the Court of Appeal was granted to the issuer and to the A2 and A3 noteholders participating in the proceedings.

PECOs are often used in UK deals to avoid certain tax consequences of traditional limited recourse. This potentially opens the door to claims from disgruntled noteholders in other UK securitisations with such PECO structures, according to Berwin Leighton Paisner (BLP), which advised the issuer in the proceedings.

Tamara Box, a partner at the firm, says: "While we are delighted at the outcome for our client and for this transaction, we do expect the Chancellor's judgement to give rise to further disputes. There are a lot of very large transactions out there with PECOs where similar arguments can be made. It is also unclear, given the importance that ratings agencies have placed on the limited recourse effect of the PECO and their close scrutiny of this case, how they will react to transactions with similar liabilities on their balance sheets."

Oliver Glynn-Jones, a commercial dispute resolution partner at BLP, adds: "It is clear that in granting permission for Eurosail, the class A2 noteholders and class A3 noteholders to appeal and in making the comments that he did, the Chancellor considers that the PECO structure and its application to transactions of this nature is of such importance that it is right that the Court of Appeal is given an opportunity to consider the issue further."

Moody's says it will review the written judgment and continue to monitor closely the Court proceedings and any appeals which may be made to the Court of Appeal by the participants in the proceedings.

RMBS

Chimera senior bond sales meeting robust demand

Chimera Investment Corp said the triple A-rated bonds the company is selling are meeting robust demand, according to Matthew Lambiase, ceo and president of Chimera, on its 3 August conference call. "We're getting good prices for them," he said.

"The subordinate bonds have cheapened up somewhat," he added, noting that some volatility is to be expected in the current state of the credit markets. Chimera's subordinate bond position went up to 30% for the quarter ending 30 June from 25% from 31 March 2010.

The company financed on a permanent non-recourse basis an additional US$627.9m of triple-A rated fixed rate bonds for US$629.7m in resecuritisations, which were accounted for as financings.

During Q210, Chimera reported no sales of RMBS. This compares with selling RMBS with a carrying value of US$75.3m for realised gains of US$9.3m during Q209 and selling RMBS with a carrying value of US$89.6m for net realised gains of US$342,000 for Q110.

Lambiase said the Dodd-Frank reform legislation and rating agency reaction is a "momentary disturbance". "The market will sort itself out," he noted, adding that the 144a market is large enough to absorb demand.

"We are not surprised by the weakness of the housing market," continued Lambiase. He expects the housing market to eventually find equilibrium.

RMBS

Agency MBS included in Fed repo transactions

From this week, the Federal Reserve Bank of New York intends to conduct a series of small-scale, real-value repo transactions with primary dealers using all eligible collateral types, which for the first time will include agency MBS from the System Open Market Account (SOMA) portfolio.

The Fed is fine-tuning operational aspects of triparty reverse repurchase agreements to be ready if the Federal Open Market Committee decides they should be used. It has also been working on a similar series of small-scale, real-value transactions with primary dealers using US Treasury and direct agency debt securities from the SOMA portfolio as collateral that did not include agency MBS.

The SOMA holdings of the US Treasury and direct agency debt securities are maintained in an account at the New York Fed, but the SOMA holdings of agency MBS securities are maintained at a custodian. This will affect certain operational and legal arrangements for agency MBS collateral.

The Fed says its actions are the result of advance planning and do not represent any change in the stance of monetary policy. The operations are being conducted to make sure the Fed, triparty repo clearing banks and primary dealers are operationally ready and have been designed to have no material impact on the availability of reserves or market rates. Transactions will be very small relative to the level of excess reserves and will be conducted at current market rates.

RMBS

UK RMBS ratings should remain robust

Most ratings on UK non-conforming and prime RMBS transactions should remain robust in the face of further economic deterioration, according to two new scenario analysis reports by S&P.

In the UK non-conforming RMBS sector, some tranches could see upgrades if foreclosure rates, house prices and prepayment rates remain at their current levels for the next 18 months. The rating agency based its analysis of the non-conforming sector on three hypothetical transactions that it considers to be typical of real transactions from the 2006, 2007 and 2008 vintages. The report explores the effect that different foreclosure rates, CPRs and house price inflation (HPI) might have on senior and junior note ratings over an 18-month period.

Assuming current CPRs and foreclosure rates prevail for the next 18 months, the analysis suggests that none of the hypothetical transactions' senior or junior tranches would suffer further downgrades over that time. Indeed, some tranches would likely see upgrades under this scenario, with the senior notes returning to their original ratings of triple-A.

Default of any junior notes, originally rated triple-B, remains a remote prospect over an 18-month timeframe, even for less seasoned transactions. For example, assuming a CPR of 10% per year, even if house prices renewed their decline at a rate of 15% per year, the annualised foreclosure rate would have to exceed 17% for the junior notes in the hypothetical 2007 vintage transaction to default within the next 18 months.

Meanwhile, in its report on UK prime RMBS, S&P found that - assuming current prepayment and foreclosure rates - house prices would need to fall at an annualised rate of more than 28% to cause a downgrade among any of the triple-A rated tranches over the next 18 months. Even if the foreclosure rate rose as high as 3% per year and annualised CPR fell to only 5%, the analysis suggests that triple-A downgrades over an 18-month timeframe would follow only if this were accompanied by double-digit annualised house price declines.

Whole business securitisations

Dignity 'ripe' for a tap

Credit analysts at RBS suggest that the Dignity whole business securitisation is "ripe for either a tap...or a restructuring". The company's half-year results indicate that rolling 52 week EBITDA has climbed a further 2% on last quarter to reach £65.5m, with growth in both funeral services and crematoria business. Overall leverage of the securitisation has fallen to 3.9x from 5.8x at the time of the last tap.

The analysts note that a tap of the transaction could lead to some spread widening, but that a restructuring - given the limitations of the existing deal - could lead to incentives being paid to noteholders. As a result, they are neutral on the deal.

Trading

Trading ideas: steely nerves

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright long on AK Steel Corp

AK Steel reported strong second-quarter revenues last week, as sales more than doubled since their nadir in 2009. With its CDS trading 3.75% upfront, selling protection is a solid play and will make for a fun ride.

AK Steel's fundamentals were hammered throughout the recession. Revenues, margins and cashflow all decreased substantially. However, recent data (the company released second-quarter earnings on 27 July) indicate that two of the three are recovering.

Exhibit 1 shows the time series of LTM interest coverage, which have had a superb reversal. Quarterly EBITDA has been positive for the past four quarters, resulting in LTM IC of 10.9x (Exhibit 1).

After hitting an absolute low back in 2009, revenue growth (year-on-year) is up 100% as second-quarter sales nearly hit US$1.6bn. Operating margins are also starting to turn upwards (by about 7%); however, to make up the short fall in cashflow they need to continue moving upwards.

Ongoing cash needs over the next 4-6 quarters will be of critical importance due to the negative cashflow. The company's total cash balance is down to US$129m (from over US$400m back in early 2009). This is largely due to a shortfall totalling more than US$300m (resulting from negative CFO (US$95m), dividend payments, pension obligations, capex and interest expense over the past six quarters) and debt reduction of around US$100m.

The company rolled its 2012 maturity out to 2020 in the second quarter, extending the bond's maturity while reducing its interest rate. Also, by making a US$110m pension contribution in the first two quarters, the company's 2010 pension obligations have been fulfilled (and thus freeing up more cash for the remainder of the year).

AK Steel still maintains an US$850m revolver due in February 2012, with more than US$700m available. Running into a liquidity crisis over the next year is not probable; however, eventual positive cashflow will be a necessity. The company forecasted required funding for 2011 and 2012 is now down to US$180m per year.

We expect AK Steel's CDS spread to tighten by at least 200bp. The expectation, from our quantitative credit model, is based on its overall leverage (total debt of US$502m against a US$1.5bn market cap), interest coverage and liquidity.

The long credit position benefits substantially from both roll down and carry, which will help offset potential adverse spread moves. By way of comparison, the company's 2020 bond (its only issue) trades with a z-spread of 500bp.

AK Steel's credit spread oscillated between 400bp and 800bp since the spring of 2009 (Exhibit 2). Based on the trading range, we set a stop loss on the position at 800bp.

Our biggest concern for the position is AK Steel's earnings quality. Though net income and EBITDA have been coming in at decent levels, CFO has also consistently been in the red. This results in positive earnings accruals, which are a harbinger for downward pressure on share prices.

That said, AK Steel's implied vol term structure has fallen dramatically since May (Exhibit 3). Given the decrease in equity-implied volatility and negative potential on its share price, the credit position can be hedged with downside or ATM puts.

Position
Sell US$10m notional AK Steel Corp 5Y CDS at 3.75% upfront.

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

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

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