Contents

CDS

Credit solutions

CDS and CLN hedges for rate risk suggested

The current interest rate environment and changes anticipated in the short- to medium-term are creating challenges for credit investors. However, analysts suggest that there are a range of credit derivatives-based solutions that could help.

Three analysts have each discussed strategies which they believe will allow investors to cope best with the conditions and continue investing, while still limiting interest rate risk and maximising yield.

"Corporate bond yields are as low today as they have been since the 1960s, thanks mainly to the rally in rates," says Charles Himmelberg, lead credit strategist at Goldman Sachs in New York. "The last time corporate bond yields were this low, the Apollo programme had yet to put a Saturn V rocket booster into space."

He adds: "This milestone for corporate bonds - which have so far this year generated total returns for IG credit in excess of 10% - has many credit investors worried that the rates market, having given so generously, may now be inclined to take back."

A rates rally threatens the future of absolute returns of investment grade fixed income corporate bonds. One solution might be to buy floating rate notes, but Sivan Mahadevan, head of equity and credit derivatives strategy for Morgan Stanley, believes the yield sacrifice with this tactic is too substantial.

He explains: "Buying a floater is probably the most natural solution, but the problem there is that there are not a lot of floating rate opportunities around right now, particularly if you are looking for investment grade paper, which takes you into the CDS market and portfolio trades. So what you can do is create a credit-linked note and make it a floating rate note, much like you can create a floater."

But in a steep yield curve environment, there is a lot of yield give-up in a floating rate structure. "In a world where rates do not have to rise but could do, doing something with limited interest rate duration to it which would have a lot of near-term yield is something which I think is pretty interesting," Mahadevan adds.

He advocates collaring a CLN with both a Libor cap and a floor to ensure the interest rate component stays at yields similar to current ten-year Treasuries. Flooring Libor at 2% for five years, for example, would cost 89bp annually.

"One of the things many investors do not look at is that the forward rates for short-term rates will rise over time," Mahadevan continues. "In five years' time three-month Libor will be over 3%. A lot of investors do not believe that, but it is what the forward markets are saying. Using that information, you can try to floor a CLN. Introducing that floor structure means you have to pay a little bit more, but in the grand scheme of things that is very affordable for a credit investor."

Selling a cap on top of that at 2.5% would earn 34bp, bringing down the net cost to 55bp annually. Alternatively, an investor could not use a cap and so leave their upside unaffected if short-term rates rise faster than predicted by the forward markets.

A CLN with a collar is one way for investors to protect themselves against rate movements, but Himmelberg believes there is another way for investors to build in a rates hedge when purchasing bonds. He estimates bonds with a spread between 200bp and 400bp are part of a range where moves in ten-year Treasuries and corporate spreads will offset each other one-for-one, meaning yield sensitivity will be around zero.

Weak macro conditions have lowered Treasury yields, while credit spreads have been pushed wider, limiting the high yield bond rally. Himmelberg identifies investment grade financials and double-B rated bonds, some of which fall within the desirable spread range, as candidates for further tightening.

Praveen Korapaty, US credit strategist for Barclays Capital, recommends a hedge overlay involving buying a Libor payer spread and selling an OTM payer on CDX IG to go some way to financing it. Alternatively, he says investors may want to sell a strangle instead of the payer. These hedges would be conditionally long credit and short interest rate exposure.

"The biggest risk to total returns for the rest of this year comes from movements in underlying interest rates. Investors looking to preserve year-to-date total return performance should, therefore, consider hedging this risk," says Korapaty.

Mahadevan acknowledges that there are alternatives to going down the CLN route, which is not perfect, but he says the advantages of CLNs outweigh the disadvantages so greatly that he believes it is the best way for credit investors to keep their yield and reduce rate risk. "Liquidity is an issue," he explains. "Creating a CLN makes a package which is less liquid than any liquid corporate bonds. Sometimes these things are issued and multiple investors will buy them, so there is a real security in the market and there can be some trading of it. But it is an issue and we cannot walk away from the fact that it will be less liquid than a benchmark corporate bond. It is a price to pay, but it is worth it."

Many investors are now looking at CLNs, particularly in Europe where the basis is positive. Mahadevan says that while single-name structures have already been done in this way - sometimes but not always with Libor floors included - it is also beginning to happen on the structured credit side with bespoke portfolios.

He says: "This is an interesting proposition and I think we are going to see more people taking this up. So far credit investors have had it pretty good, but if interest rates go higher, those investors will look to protect themselves from interest rates while still being involved in credit. That would spark issuance."

JL

RMBS

Servicing slow-down

GMAC episode heightens concern over foreclosure glut

Ally Financial has denied that GMAC Mortgage instituted a moratorium on all residential foreclosures across 23 states in the US. [This story updates the one published 21 September on the same topic.] The episode nonetheless hit a raw nerve among MBS investors, who remain concerned about the impact of slowing foreclosure rates on bond valuations.

Ally issued a statement saying that reports of a foreclosure moratorium are not true and that all new residential foreclosures are continuing in the ordinary course of business, with no interruption in its usual practice. The firm suggests that such speculation likely emanates from a direction previously given by GMAC Mortgage to certain of its outsource vendors to "allow time to address a potential issue that was raised in a number of existing foreclosures", challenging the internal procedure used for executing one or more judicially required forms.

"This direction was to suspend evictions and REO closings where the related foreclosure could have been impacted by the same internal procedure," the statement explains. "We are also reviewing certain previously completed foreclosures where the same procedure may have been used."

Before the statement was issued, speculation had been rife about what could be behind the moratorium, with some suggesting legal issues with outsourcing vendors or a weakness in GMAC's own procedures. One MBS investor nevertheless indicates that the episode is symptomatic of larger problems in the industry.

"Judges are increasingly throwing out enforcement cases because of missing paperwork or incorrect title deeds," he explains. "It depends on the state, but judges will typically give the benefit of doubt to homeowners. Slower enforcements mean that losses flow through transactions more slowly and the risk is that eventually servicers will stop advancing, which will obviously hit RMBS valuations hard."

The investor points out that other lenders and servicers are likely to be experiencing similar issues to GMAC. "A number of firms have pulled out of the servicing business in recent months: this could be one of the reasons why; or they've simply realised that servicing is no longer a growth business. Fees aren't all that generous when it takes a lot of time and resources to enforce on a property."

Ally says a new process has already been developed and implemented so that - although some existing foreclosures may experience delays while corrective action is taken - there will be no interruption in new foreclosures. "These delays are expected to be resolved within the next few weeks and certainly before year-end, without serious consequence. GMAC Mortgage has been addressing the procedural challenge for more than three months. In all other respects, the mortgage business is operating as usual," it adds.

MBS analysts at Bank of America Merrill Lynch suggest that, as the restrictions appear to be confined to judicial states, the actions could be the result of court rulings or legal issues. "The specific issue causing the delays could be related to a set of Florida foreclosure cases, in which court affidavits were withdrawn after it was discovered that the assignment of loans from MERS prior to foreclosure did not take place with proper verification by GMAC employees," they note. "This particular verification affects an unknown number of GMAC loans undergoing foreclosure."

The BAML analysts expect legal issues to continue to remain a potential barrier for the timely execution of foreclosure proceedings, though they say they'd be surprised if any decisions caused insurmountable problems. Nevertheless, they agree that the issue raised in the GMAC case could have implications for other firms that use similar procedures for loan assignments.

"This could cause additional delays to the foreclosure process on top of those that already exist. Such delays may have implications for bonds whose cashflows are highly dependent on loss timing, but - given the quick resolution expected in the case of Ally - we suspect these implications are not far-reaching," the analysts conclude.

CS

CDS

The short of it

'Flawed' EC short-selling proposals discussed

The European Commission on 15 September adopted a proposal to introduce regulation on short selling and certain aspects of CDS. While market participants agree that the move could help remove uncertainty around short selling, the proposals are said to contain a number of flaws.

James Coiley, international finance partner at Ashurst, notes: "Although the text of the proposal is fairly balanced, ultimately it permits national regulators and ESMA to ban entry into CDS on as wide or as narrow a basis as they choose. So the test will be in the application of the new powers - one man's 'threat to market confidence' is another's rational response to over-leveraged sovereign balance sheets."

The new framework is aimed at providing regulators - both national and European - with clear powers to act when necessary, while also preventing market fragmentation and ensuring the smooth functioning of the internal market. The Commission says its main objectives are to create a harmonised framework for coordinated action at the European level, increase transparency and reduce risks.

EC Internal Market and Services Commissioner Michel Barnier comments: "In normal times, short selling enhances market liquidity and contributes to efficient pricing. But in distressed markets, short selling can amplify price falls, leading to disorderly markets and systemic risks. Today's proposal will increase transparency for regulators and markets, and make it easier for regulators to detect risk in sovereign debt markets. Regulators will also gain clear powers to restrict or ban short selling in exceptional situations, in coordination with the new European Securities and Markets Authority (ESMA)."

The proposal intends to enhance transparency by requiring that all share orders on trading venues be marked as 'short' if they involve a short sale, so that regulators know which transactions are short. In addition, investors will have to disclose significant net short positions in shares to regulators at one threshold (0.2% of issued share capital) and to the market at a higher threshold (0.5%).

Concerning sovereign bonds, regulators will be better able to detect possible risks to the stability of sovereign debt markets by receiving data on short positions, including those obtained through sovereign CDS.

ESMA will be given the power to issue opinions to competent authorities when they intervene in exceptional situations. In line with the new supervision framework, ESMA will be able, when certain conditions are fulfilled, to adopt temporary measures itself, with direct effect, restricting or prohibiting short selling.

In addition, if the price of a financial instrument falls by a significant amount in a day, national regulators will have the power to restrict short selling in that instrument until the end of the next trading day. These measures will help regulators take the necessary action, in a coordinated way, to slow or halt price declines that can be amplified by short selling in distressed markets.

The proposal also requires that to enter a short sale, an investor must have borrowed the instruments concerned, entered into an agreement to borrow them or have an arrangement with a third party to locate and reserve them for lending so that they are delivered by the settlement date. Trading venues must ensure that there are adequate arrangements in place for buy-in of shares or sovereign debt, as well as fines and a ban on short selling, where there is a settlement failure.

ISDA, for one, believes that the EC's proposals are of great importance to the health of the economy and stability of the financial system. The Association says that strong and efficient derivative markets enable public authorities, companies and pension funds to manage and limit financial risks - which is key to supporting overall economic growth.

The Association is in full support of increased central clearing, which reduces counterparty risk in the financial system. It calls for robust and resilient standards for clearinghouses and a carefully judged approach to identification of derivative contracts appropriate for clearing.

ISDA also welcomes moves towards increased transparency of derivatives markets to supervisors through internationally consistent reporting to trade repositories.

However, the Alternative Investment Management Association (AIMA) says that although the proposals could help remove uncertainty in the market, they contain a number of flaws that it hoped would be addressed. AIMA ceo Andrew Baker says that in the interests of international regulatory consistency, it is desirable that the Commission harmonises the rules.

"One of the major problems that the industry has faced in respect of short-selling regulation was that some EU jurisdictions acted unilaterally and arbitrarily in imposing and then lifting bans," he explains.

Baker adds: "We are also glad that the Commission has acknowledged that short selling enhances market liquidity and aids price discovery. We do hope, however, that new powers to ban short selling are never used. And, while we support increased transparency in the field of short-selling, we think short position reporting by individual firms should be only to the regulator."

AIMA is concerned about the implications for EU hedge fund managers that use non-EU CCPs. "The regulation expects 'third country' CCPs to meet stringent conditions in order to be able to serve EU managers. This measure is potentially protectionist and we would urge European lawmakers to rethink it," continues Baker.

Richard Small, corporate senior associate at Ashurst, suggests that although hedge funds are likely to welcome the lower compliance costs resulting from the proposed regulation's pan-European disclosure regime, the ability of competent authorities to impose potentially indefinite restrictions on short selling and ESMA's ability to overrule competent authorities will be of concern. He notes: "This duality of jurisdiction has the potential to create a level of uncertainty which will not be well received by the hedge fund industry. This is the first good example of government of the industry from Europe."

The proposal now passes to the European Parliament and the Council for negotiation and adoption. Once adopted, the regulation would apply from 1 July 2012.

CS & LB

ABS

Investor caution for US student loan deals

The US ABS market has seen a surge in issuance over the past week. However, student loan deals are continuing to lag behind in terms of both supply and demand.

"The market was pretty much dead until the last week and has now come back to life," one ABS trader confirms. With US$4.3bn in total new ABS issuance from seven transactions, he adds, "we came back to work with a vengeance".

The trader continues: "Everything in the ABS market is pricing really, really well, which is due to all recent deals being over-subscribed. Consequently, secondary spreads are tightening across the board, even in what are perceived as second class names and assets."

The exception is student loan deals, where supply is dwindling away. "If this continues," the trader warns, "it will result in the total size of the outstanding market continuing to decline over the next couple of years."

He explains: "The student loan market is very dynamic, which keeps investors from wanting to dive in. They're not convinced of a lot of things - like how fast these loans will potentially pay off. There's a lot of misunderstanding about the product and the sector - which is unfortunate because, right now, student loan deals are horrifically underpriced. But, still, this hasn't contributed in improving investor interest."

The trader adds that although there have been three recent deals and another in the pipeline, the asset class isn't trading as it should be. "The new deals are not as over-subscribed as they could be. Therefore, the price stock doesn't tighten."

He notes that investors also remain cautious of the sector because of the negative graduate job market at present. "There is such a bad job market for graduates and coming graduates that the repayments will be really slow and the defaults will be really high. Yet, it doesn't matter whether it's a voluntary or involuntary repayment. If you buy a bond at a discount, it's still a repayment, it still benefits you from a yield or a spread perspective."

The trader continues: "If you look at Bloomberg for all old outstanding student loan shelves, you'll hardly find any outstanding older than 10-11 years. The investors are looking at this sector as a 20- to 30-year commitment like a mortgage, but that's not the reality. With the behaviour of people entering into their more financially productive years - 10 years after school - the repayment will inevitably go straight up. Yet no one has any faith in that right now."

He concludes: "There has been so much noise and confusion among all the private lenders because there are too many moving parts that they don't understand. We will have to wait another two years before investors start to believe in the student loan market again."

LB

CDO

Trups CDO investor options analysed

In light of the current market debate about whether investors should take up discounted redemption offers or wait for a greater cashflow, Algorithmics' latest white paper analyses the options for CDO investors in Trups. Approximately US$50bn of Trups issued by US banks and insurance companies have been pooled and repackaged into CDOs since 2000.

The passage of the Dodd-Frank Act in July 2010 eliminates Trups as an element of Tier 1 capital after an 18-month transition period (SCI passim). However, it exempts banks with less than US$15bn in assets, which encompasses much of the universe of banks that are issuers in Trups CDOs.

So, while many larger banks will need to recapitalise, smaller community banks are exempted from this provision. The net effect will be that Trups CDOs, and all of their complicated valuation and redemption issues, will remain for a while.

Richard Hrvatin, Algorithmics md of credit advisory, asks whether it would be better to have a discounted redemption offer or wait for an uncertain, yet potentially greater, cashflow in the future. He comments: "From our research, the short answer is 'it depends' - mostly on the probability that the Trups may default. If that is low, then riding out the storm could be the best alternative."

Algorithmics conducted a series of simulations and sensitivity tests on a hypothetical CDO structure. Using a mark-to-model approach, cashflows to the CDO were analysed under a variety of scenarios and discounted at the respective note's coupon rate to determine a present value for each class of CDO investor. Inputs that were varied included: credit quality and subsequent default probability of the Trups issuer; number of issuers currently in deferral or defaulted; leverage and structural features in the CDO; and correlation amongst the Trups issuers in the portfolio.

Algorithmics found that a fair discount offer for Trups is directly proportional to the bank's survival probability. Further, it notes that the valuation of the senior class holds up regardless of the stress scenario, but the average life is shortened. Taking out the senior class sooner allows future excess spread to flow to the mezzanine class, mostly impacting the mezzanine class of CDO investors, Algorithmics states.

The white paper concludes that, due to the potential for future excess spread to accrue, 'riding out the storm' is probably the better alternative for Trups CDOs.

LB

CLOs

'Less pessimism' reported among CLO investors

JPMorgan's latest CLO investor survey reveals that the majority of clients are less pessimistic about fundamentals and headline risks than earlier in the summer and are focusing on how to reach yield targets. For many respondents, the probability of a double-dip recession was viewed as low, with the most likely scenario being to 'muddle through'. Another positive development was said to the continued upgrade trend in US CLOs (see also Research Notes).

Investors also acknowledged the strengthening liquidity and terming out in the leveraged loan market, which is expected to soften the blow of any possible future resumption of credit stress. Improving OC cushions are also anticipated to buy time for managers to mitigate portfolio risks, should credit stress start to materialise.

According to structured credit analysts at JPMorgan, many investors pointed to a materially flatter yield curve over the summer as a major driver of the growing acceptance of lower returns hurdles for their CLO and related product investments.

A related theme to the search for yield has been clients' relative need for current yield or income versus yield to maturity, including the potentially back-ended price return. Preferences are largely delineated along investor types, the analysts note.

"For example, real money investors point out the previous few months' volatility as leading them to prioritise income over total returns, with interest in primary as a way to express this view (their expectation is primary will have higher current coupons)," they explain. "In comparison, hedge funds and other total return investors think the volatility will prove a temporary aberration and point out that positive YTD returns enables them to continue investment mandates."

Finally, some investors believe that non-MTM leverage will eventually return for secondary CLOs. This could be in the form of customised repo agreements, but likely only for senior positions and not in the near term.

CMBS

Future of Stuytown property in the balance

CWCapital is expected to proceed with the foreclosure of the Peter Cooper Village and Stuytown (PCV & ST) property on 4 October, following the New York Supreme Court's ruling in favour of the senior lenders. MBS analysts at Barclays Capital point to two possible outcomes of the foreclosure auction: it could be won by the trustees that have the right to credit bid up to the loan amount; or another potential buyer might indicate their interest during the auction and potentially win it.

If the trustees win the foreclosure auction, the property becomes REO, the title to the property is transferred to the trustees and the trustees become responsible for the property management, for property insurance and for the payment of the transfer taxes. In a distressed property sale, the transfer tax is usually estimated on the basis of the maximum of the fair value or the outstanding mortgage. Therefore, assuming that during a foreclosure auction the PCV & ST property is sold for no more than the outstanding mortgage amount, the associated transfer taxes are expected to be approximately US$90.75m.

Potentially, the transfer tax could be charged twice during the resolution of the defaulted assets: the first time when the title to the property is transferred to the trustees (if they win the foreclosure auction) and subsequently when the REO property is sold to the end buyer at the end of the workout period. Given that the transfer tax is typically included into the foreclosure expenses that are used for the realised loss calculation at the time when the loan is liquidated out of the trust, the BarCap analysts expect it to increase loss severity upon resolution rather than interest shortfalls to the underlying CMBS.

Similarly, if the PCV & ST property becomes REO, nothing is likely to immediately change from the standpoint of the bondholders. However, when the property is ultimately sold, it could result in liquidation out of the trust or modification.

If a third party wins the auction, the loan will be paid off at or very close to its par value with minimum losses to the trusts and most of its unscheduled principal passed through to the respective A1A classes. This better-than-expected resolution is likely to create substantial spread volatility for all credit levels of related transactions, according to the analysts.

But they note that the probability of a third party winning the auction is low. "The trustees, represented by the special servicer, are likely to start the foreclosure auction on 4 October by credit bidding the amount that is lower than the US$3bn mortgage. If another (cash) bidder surfaces, they are expected to continue bidding the property up until they exhaust their credit bid potential (US$3bn, or even higher, if expenses and advances are capitalised and allowed to be added to the credit bid ceiling)."

CS

CMBS

CMBS quality score mooted

Investors in US RMBS and consumer ABS typically cite a pool's average FICO score as a succinct measure of credit quality, but no similar metric exists for CMBS. Deutsche Bank has consequently introduced a quality score for the asset class, which attempts to address this disparity.

According to MBS analysts at the bank, the goal of the DB quality score is two-fold: to provide a quick and convenient way to assess and compare the collateral quality of various CMBS pools; and to measure how levered each transaction is to changes in the economic landscape. "Deals with above average collateral will likely respond more quickly to a changing economic environment," they explain. "So, in a sense, the credit score can also serve as a proxy for the future variability of loss projections."

The composite score is comprised of two separate measures: one assesses the quality of the collateral properties and the other measures the quality of the markets the properties are located in. There are three possible property quality scores, ranging from A to C.

The market score makes use of a number of variables, but the most important one is the CRE outlook - measured by the expected change in rental, vacancy and capitalisation rates - for each market within each property type.

The analysts calculated composite quality scores for all 2005-2008 vintage US conduit transactions and found that although there are some significant differences between deals in terms of the market quality component (due to the large and diverse nature of the 2005-2008 cohorts), there were only subtle differences between entire vintages. However, the results of the property quality score yielded more significant differences.

About 70% of properties from both the 2005 and 2006 vintages are average quality and only 16%-19% are above average quality, but above average properties from the 2007 vintage are found nearly twice as often. "The better average score for the 2007 vintage is a testament to how much more attractive CMBS financing was in 2007 compared to 2005 or earlier. Owners of trophy assets were able to take advantage of the better leverage the CMBS market offered relative to banks and insurance companies," the analysts note.

They point out that it is exactly the prolific use of CMBS financing on large loans that is the main contributor to the unprecedented rise in delinquency and specially serviced rates. It is for this reason that there is an inverse relationship between projected deal losses and the composite credit score.

CS

Clearing

Clearing foundation

Preparations in place for OTC transparency

ISDA's 2010 Regional Conference in London yesterday focused on, among other areas, global developments in OTC derivatives clearing. With the industry continuing to deliver on central clearing commitments, both traders and clients are preparing for the coming legislative impact on OTC trades.

In regards to both inter-dealer clearing and client clearing, LCH.Clearnet md Simon Grensted said during one conference session: "There is a common misconception that dealers will use methods to block clearing, which simply isn't true. Dealers have shown dedication and commitment to the CDS clearing service and so far have cleared 90% of eligible trades."

Central clearing legislation will come into force next summer in the US and during 2012 in Europe. Grensted went on to say: "For client clearing, both clients and dealers have to work together in order to get the best from the clearing function. In order to do this, it is critical that clients understand the risks of their trades and the impact on overall trading."

ICE Clear Europe president and coo Paul Swann commented on the functions of clearinghouses. "Clearinghouses are developed to build a pyramid to accommodate the asset classes and credit products and to provide the best services for user needs. They are also designed to ensure that there is a continuous innovation around the membership structure of each asset class," he said.

Swann went on to discuss the clearing eligibility of products, asking at what stage the OTC product becomes a risk. "Although transparency makes sense," he noted, "trying to force low liquidity into that structure doesn't always address the issue. We need a new sandbox for these to develop."

He further commented on the problematic aspects of clearinghouse risk committees, stating that products and trades will not be correctly cleared unless it is only professionals that judge the issues at hand. A lack of understanding on the central clearing process could have serious implications on how many OTC trades are cleared in the future, Swann warned.

ISDA reiterated that it fully supports increased central clearing where it reduces counterparty risk in the financial system. This calls for robust and resilient standards for clearinghouses, the association notes, and a carefully judged approach to identification of derivative contracts that are appropriate for clearing.

To date, over US$66trn in CDS have been torn up and another US$10trn of CDS trades have been cleared, according to ISDA ceo Conrad Voldstad. Considering that the current level of CDS outstanding is US$25trn, this means that the industry has worked collectively to reduce outstanding CDS volumes by nearly 75%, he added.

Based on DTCC data for CDS in the past six months, only five names - all sovereign entities - averaged 20 trades per day. Some single reference name may have multiples of 40 distinct contracts available for trading.

"These are interesting figures," Voldstad continued. "They illustrate the story of a market that has much less volume than one might imagine from the US$600trn figure we all talk about. They are much more consistent with a market where less than US$100trn is not cleared."

LB

ABS

SLC divestiture announced

Citi is to divest approximately US$32bn of its US$46bn of Student Loan Corporation (SLC) assets to Discover Financial Services and Sallie Mae. The transaction is expected to close by year-end.

Sallie Mae will purchase US$28bn of securitised federal student loans and related assets from SLC. Discover will acquire US$4.2bn of private student loans and related assets at an 8.5% discount, along with US$3.4bn of SLC's existing ABS debt funding.

As part of the transaction, Citi will also purchase approximately US$8.7bn of assets from SLC and will explore opportunities to reduce these assets over time. Additionally, SLC will sell US$4.7bn in FFELP loans to the US Department of Education.

Vikram Pandit, Citi ceo, says: "We expect that once this divestiture is completed in the fourth quarter, total assets in Citi Holdings will be less than 20% of our balance sheet as of year-end."

ABS analysts at Bank of America Merrill Lynch expect the sale of SLC to have a minimal impact on the student loan ABS sponsored by the company, as Sallie Mae has extensive experience servicing FFELP student loans and Citibank will continue to service SLC's existing private student loans. However, they point out that the private student loan ABS sponsored by SLC may become vulnerable over time to potential changes to Citibank's servicing platform due to reductions in the size of the serviced portfolio over time.

Nevertheless, the servicing agreement with Citibank will allow Discover to build its expertise in private student loans and consequently Discover may look to take over servicing in the future.

ABS

Structured settlements firm beefs up in legal

Woodbridge Structured Funding has appointed Jim Klohn as corporate general counsel. He was previously associate counsel for Imperial Finance and Trading's structured settlement division.

Scott Schwartz, evp of Woodbridge Structured Funding, states: "Jim has had years of experience in the structured settlement marketplace and brings to Woodbridge years of expertise in the settlement, lottery and buy annuity marketplace."

ABS

SF partner named for Greek market

Watson, Farley & Williams has appointed Nikos Kostikas as partner in its international project and structured finance group. Based in the firm's Athens office, Kostikas will help expand the firm's shipping and energy departments, covering both the finance and regulatory aspects of banking in the Greek market.

Kostikas was previously at UniCredit Bank in Greece as legal counsel. As a banking and finance lawyer, he has extensive experience in a broad range of domestic, cross-border, corporate and structured finance transactions.

ABS

AFME names chief executive

AFME has appointed Simon Lewis as chief executive. Lewis will help drive the agenda of AFME in its work with legislators, regulators and other stakeholder groups. Mark Austen, AFME's head of markets policy and acting chief executive, is appointed to coo.

Lewis was previously director of communications at 10 Downing Street and the Prime Minister's official spokesman from June 2009 until May 2010. Following the General Election, he joined UK Trade and Investment as strategic communications adviser.

CDO

CIBC comments on Lehman CDO suit

CIBC has published a comment on a lawsuit filed on behalf of Lehman Brothers with respect to a CDO transaction that occurred in 2008. The bank says it intends to defend itself vigorously in this matter.

"It is our belief that the trustee's actions in reducing the unfunded commitment on our VFN to zero should be upheld, although there can be no certainty regarding any eventual outcome. We continue to believe that the CDO indenture trustee's actions were fully supported by the terms of the governing contracts and the relevant legal standards," CIBC explains.

The bank notes that the timing of the lawsuits filed against a large number of financial institutions involving numerous CDO structures coincides with the expiration of a possible statute of limitations.

In Q408, CIBC recognised a gain of C$895m, resulting from the reduction to zero of its unfunded commitment on a variable funding note (VFN) issued by the CDO. This reduction followed certain actions of the indenture trustee for the CDO following the 15 September 2008 bankruptcy filing of Lehman Brothers Holdings Inc, the guarantor of a related CDS agreement with the CDO.

While the Lehman estate expressed its disagreement with the actions of the indenture trustee, the estate has not instituted any legal proceeding with regard to the CDO or the VFN. The Lehman estate has, however, instituted legal proceedings involving a number of other CDOs and in Q110 - in Lehman Brothers Special Financing Inc v. BNY Corporate Trustee Services - the US bankruptcy court in New York ruled unenforceable a customary provision in a CDO transaction that reversed the priority of the payment waterfall upon the bankruptcy of Lehman, the credit support provider under a related swap agreement.

That ruling, which the defendant has sought leave to appeal, does not change CIBC's belief that if contested, the trustee's actions in reducing the unfunded commitment on the VFN to zero should be upheld.

CDS

Latest ICE Clear clearing member approved

UniCredit Bank has become ICE Clear Europe's 15th CDS clearing member and has begun clearing CDS transactions. The move comes as ICE's credit default swap clearinghouses reach US$12trn in gross notional value since inception, with aggregate open interest of US$1.1trn.

ICE Clear Europe has cleared €3.4trn of gross notional value of CDS transactions, including €530bn in single-name CDS, resulting in €443bn of open interest. ICE Trust has cleared US$7.4trn of gross notional value, including more than US$3bn in buy-side clearing and US$455bn in single name clearing, resulting in open interest of US$494bn.

CLOs

CLO key manager events remedied

Moody's has been notified that a key manager event occurred in respect of the First 2004-I and 2004-II CLO, as well as TCW Select Loan Fund transactions on 1 July 2009, leaving the issuers with only one of their three key managers. TCW Asset Management Company, the collateral manager, is now proposing Mark Attanasio and Matthew Miller as successor key managers for both deals.

The transactions' management agreements provide that the proposed key managers shall each be deemed an approved replacement if TCW does not receive written rejection of them from the holders of the outstanding preferred shares or subordinated interests, upon a vote of at least two-thirds, within 30 days after the date of the proposal.

Moody's has determined that the proposed modification of these management agreements to appoint replacement key managers will not cause the current ratings on the deals to be reduced, suspended or withdrawn.

CMBS

CRE advisory appoints cio

Andrew Reiken has joined Poinsett Capital Advisors as cio, overseeing all investment services offered by the firm. Reiken comes from Graycliff Capital Partners, where he was a partner and coordinated investments in CMBS debt securities and other debt instruments. He has a long-standing relationship with the principals of Poinsett through their other firm TIC Properties, where Reiken originated financing on many of the properties in TIC Properties' syndicated portfolio.

Reiken's prior experience includes acting as co-head of the capital markets desk within real estate structured finance at Macquarie Holdings (U.S.A.).

CMBS

REO acquisition boosts investment portfolio

Sand Capital has successfully acquired over US$100m in distressed debt and real estate-owned properties - adding 1.2m square feet to its portfolio. The types of assets acquired are commercial, residential, office and industrial real estate. The company has a goal of acquiring US$1bn of distressed assets before the commercial real estate markets stabilise.

Sand Capital president Jay Stein says: "In nearly all cases, these distressed properties and notes are a product of the current economic climate and to ownership under-management. By aggressively leasing and rehabilitating these assets, we expect these properties to rebound fully in the near future."

Real Estate

US real estate md named

Miller Buckfire & Co has expanded its investment banking and real estate capabilities with the appointment of Kevin Stahl as md. He will assist clients in managing financial issues while pursuing long-term value-creation strategies.

With over 16 years of real estate experience, Stahl was previously md and co-head of US real estate investment banking at RBC Capital Markets. Here, he was responsible for overseeing strategic advisory and a range of public and private financings.

RMBS

Ambac rehab case to be determined

The RMBS Policyholders Group has challenged the legality of the Ambac Assurance Corporation (AAC) segregated account. The Group says that the challenges made against AAC highlight the "inequitable treatment of policyholders and the lack of transparency" in the Wisconsin insurance regulator's rehabilitation of the firm. A case has been presented in the Circuit Court of Dane County, Wisconsin, by Deutsche Bank, US Bank, Depfa Bank, Wells Fargo, Bank of America and Lloyds TSB Bank, as trustees for securities insured by AAC.

The segregated account includes over US$57bn of policies insured by AAC that were involuntarily transferred into the account. The challenges and concerns presented in court, in conjunction with briefs filed by the parties, raise fundamental issues of fairness in the rehabilitation proceedings.

One of these issues, the Group states, is the unequal treatment afforded to policyholders whose policies have been allocated to the inadequately capitalised segregated account. The rehabilitation proceedings for this case require policyholders in the segregated account to continue paying premiums to Ambac - even though the company suspended benefit payments to policyholders. Equally, the court has issued a 'temporary restraining order' that prevents legal action against AAC and that prohibits exercising the right of set-off.

The judge made no decision at the hearing. The RMBS Policyholders Group filed a motion to enable litigation seeking to enjoin AAC's parent, Ambac Financial Group (AFG), from receiving dividend payments from AAC. AFG has publicly stated that it is likely to file its own bankruptcy proceedings in the near future (see SCI issue 198).

RMBS

Mortgage REIT names new cfo

MFA Financial has appointed Stephen Yarad as cfo, replacing William Gorin. Gorin, who has served as the REIT's cfo since 2001 and as president since June 2008, will continue to serve as president and will remain a director of the company.

Yarad comes to MFA with almost 19 years in public accounting serving financial services companies. He was previously a partner with KPMG, based in the firm's New York financial services audit practice.

RMBS

Agreement to bring enhanced RMBS analytics

CoreLogic has entered into agreement with Intex Solutions and Vichara Technologies to integrate CoreLogic LoanPerformance loan-level non-agency RMBS database with Intex's RMBS deal models. The aim is to enhance the accuracy of cashflow projections and price/yield analytics.

Joint subscribers to the LoanPerformance RMBS dataset and Intex's non-agency deal libraries will now be able to match each individual loan in the LoanPerformance dataset to the correct deal name, group name, Intex ground group name and Intex loan identifier in the dataset. This enhancement will also help investors to leverage the loan-level data within the Intex Subroutines and Intex Wrapper application programming interface, the firms say. The results are expected to produce significantly higher accuracy for trading decision support.

The matching of loan-level data elements between the CoreLogic and Intex datasets utilises Vichara's proprietary mapping algorithms, CoreLogic states.

George Livermore, CoreLogic's group executive for data and analytics, says: "With this solution, the market can now take full advantage of the very best in data and analytics to make better investment decisions. We intend to continue partnering with Intex and Vichara to bring unique solutions and greater transparency to a market in a time of need."

ABS

TARP's successes, failures weighed

The Congressional Oversight Panel (COP) has released its September report, which assesses TARP on the eve of its expiration - 3 October. The report notes that although TARP provided critical support to the financial markets when market confidence was in freefall, it suggests that the programme has been far less effective in meeting its other statutory goals.

First, the panel says that although TARP quelled the financial panic in the autumn of 2008, severe economic weaknesses still remains today. Since authorisation in October 2008, 7.1m homeowners have received foreclosure notices. Since their pre-crisis peaks, home values have dropped by 28% and stock indices have fallen 30%.

TARP's extension, the COP also notes, was served primarily to extend the implicit guarantee of the financial system. The Treasury Secretary stated that extending TARP would preserve his authority to intervene swiftly in the event of another financial crash. This proved significant, as the Treasury did not add additional funding to any programmes intended to address the specific economic weaknesses identified.

Further, the TARP's 'stigma' has grown and may prove an obstacle to future financial stability efforts, according to the COP. It is so widely unpopular that some banks refused to participate in the Capital Purchase Program for fear of losing customers. The unpopularity of the TARP may mean that the government will not authorise similar policy responses in the future.

Finally, the panel states that expert economists have raised severe concerns about moral hazard and unanimously felt that the programme created significant moral hazard. TARP offered its funding on relatively generous terms, without requiring participating institutions to enter liquidation or receivership, remove failed managers or wipe out existing shareholders. The fact that the government chose not to impose such stringent costs meant that TARP's moral hazard costs were much greater than necessary, the COP concludes.

ABS

Brazilian SME fund issued

IFC has issued a R$50m guarantee - its first - for investors in a fund that securitises loans originated by Banco Industrial Comercial to SMEs in Brazil. These firms provide more than two-thirds of the 35 million jobs in the country's formal economy.

"This transaction will help BicBanco access a new type of institutional investor to support the loan portfolio expansion for our Brazilian small and medium enterprises," comments Milto Bardini, BicBanco's evp. "We confirm once again that IFC is a long-term partner to BicBanco. Together, we were able to provide an instrument to the local capital market that is rarely offered and meets institutional investors' needs."

The fund issued R$192.5m of senior quotas and R$57.5m in subordinated quotas for a total of R$250m. The senior quotas were sold to qualified local investors, who have the right to sell up to 25% or as much as R$50m of their senior quotas to the IFC. BicBanco has subscribed to the subordinated quotas.

Paulo de Bolle, IFC's acting country manager in Brazil, says: "The successful placement of the BicBanco [fund] demonstrates IFC's capacity to mobilise local market resources for financial institutions that play a key role in economic development and job creation in Brazil. This capacity is particularly important in allowing mid-sized banks to diversify their funding sources."

ABS

Tariff deficit deal in approval process

A preliminary prospectus was lodged with the CNMV, the Spanish financial markets regulator, last week for a €25bn debt programme refinancing tariff rebates due to four Spanish utility companies (SCI passim). The approval process is likely to take several weeks, according to ABS analysts at UniCredit.

They point out that previous such deals involved the receivables being purchased by third parties from the utility companies and subsequently securitised and classified as ABS. This time around, however, no third parties will be involved.

"The new paper will definitely be 0% risk weighted," the UniCredit analysts note. "What has yet to be decided is whether it will be categorised as an ABS. It seems likely, but by no means confirmed, that the transaction will ultimately fall under a Category 2 or Category 3 ECB definition... ABS is in the Category 5 bucket."

The leads on the programme have been confirmed as BBVA, BNP Paribas, Credit Agricole, Deutsche Bank, Goldman Sachs and Santander. Books for the tariff deficit deal could open as soon as 8 October.

ABS

NAIC ratings request met

In response to a request from the National Association of Insurance Commissioners (NAIC)'s Valuation of Securities Task Force, S&P says it intends to provide a list of certain loan-backed and other structured securities - in accordance with Statement of Statutory Accounting Principles No. 43R guidance - that will include the CUSIP number, securities description, rating as of 31 December 2010 and the date of its last analytical update. For the purposes of this request, the "last analytical update" can include a review that took place in connection with a rating committee or a portfolio review of the credit.

S&P aims to provide this information in the first week of January 2011 and to make it available to the public by posting the information on its website.

ABS

Improvement continues for UK credit card ABS

Fitch reports that the performance of UK credit card trusts continued to improve in July 2010, with credit card charge-off rates falling significantly and excess spread continuing to rise across the board. The agency believes that the latest monthly performance data further increase the likelihood of a stabilisation in credit card performance in the coming months. There, however, remains a threat to this stabilisation if charge-off levels begin to rise again as a result of the write-off of delinquent and debt management accounts.

The Fitch Charge-off Index registered a substantial monthly decrease of 3.5% to reach 7.5%, the lowest rate in more than 12 months. The reduction was mainly driven by the June 2010 repurchase of delinquent and debt management receivables from the CARDS I and CARDS II trusts. The Fitch 60-to-180 day Delinquency Index fell 0.2% to 3.2%, marking the sixth consecutive monthly reduction.

The Fitch Yield Index as at the end of July 2010 was 22.3%, representing a slight monthly decrease of 40bp from the June 2010 value. The Fitch Monthly Payment Rate Index was 16%, representing a monthly drop of 60bp. The movements in both of these indices are in line with monthly fluctuations arising from differences in monthly day counts, the agency notes.

Finally, the Fitch Excess Spread Index continued to increase in July 2010, rising for the fifth successive month to an all-time high of 10.5%. This is 1.2% higher than the previous peak value reached in July 2003.

ABS

Rental fleet ABS criteria outlined

Fitch has released its global rating methodology for rental fleet ABS, addressing key risks present in rental fleet ABS transactions. The criteria assess counterparty risks, including the bankruptcy of the rental fleet company and of any major manufacturer supplying vehicles to a securitised vehicle fleet. It also looks at the vehicle liquidation process and related risks in a bankruptcy and subsequent liquidation scenario.

Fitch's analysis assumes that the rental fleet company enters into bankruptcy, which ultimately leads to the liquidation of the securitised rental fleet during a stressed macroeconomic environment, assuming a depressed wholesale vehicle market. This approach intends to delink the ABS rating from the financial health of the rental fleet company. The agency's expected loss stress for each rating level is calculated based on the liquidation proceeds of the rental fleet vehicles under stressed scenarios.

Fitch's expected loss profiles will differ based on certain diversity considerations of the securitised fleet. This is derived from its observation that in aggregate, wholesale vehicle values tend to exhibit less price volatility than that of single vehicle segments and/or manufacturers. Diverse collateral pools are expected to produce more consistent depreciation rates, the agency states, resulting in better loss performance during the process of liquidation.

ABS

Expanded coverage for liquidity metrics

Markit is to provide liquidity metrics and composite liquidity scores for leveraged loans and European ABS covered by its pricing services. The firm already measures liquidity for CDS and evaluated bonds. It says that adding leveraged loans and European ABS will provide clients with a more comprehensive view.

Leveraged loan liquidity scores indicate that liquidity has improved steadily this year. The number of loans with Markit's score for the lowest level of liquidity has dropped globally by 13.6% in 2010, with the number in the highest two levels increasing by 133%. Markit says its new metric will help both buy-side and sell-side.

Markit's global co-head of fixed income, Armins Rusis, says: "Liquidity metrics provide [a] new perspective for portfolio managers studying opportunities in the over-the-counter markets. Our ability to provide insight on the average size associated with dealers' bid-offer quotes, for example, is extremely valuable to clients who, until now, have not benefited from this level of transparency. With the addition of leveraged loans and European ABS, our liquidity metrics now cover a broad spectrum of sectors in fixed income."

The liquidity metrics will cover 6,400 syndicated loan facilities that are included in Markit's loan pricing service. Every priced asset will be accompanied by Markit's composite liquidity score, which combines information on market depth, bid-ask spread, average size and frequency of quotes into a single score from one to five (with one indicating highest liquidity).

There are 4,400 European ABS in Markit's pricing service and the new liquidity score is a composite measure of the observable liquidity of a security based on the depth of pricing contributions and number of quotes in the market. Scores will once more range from one to five.

CDO

CRE CDO delinquencies resume climb

Delinquencies for US CRE CDOs resumed their climb in August, rising slightly to 12.1%, from 11.9% in July, according to Fitch's latest US CREL CDO delinquency indices results.

17 new delinquent assets have been reported, including two term defaults, six matured balloons, two foreclosures and seven credit-impaired securities. The increase in delinquencies was tempered by the resolution of 12 other previously delinquent assets, including extensions of two former matured balloon loans.

Realised losses of approximately US$68m were reported in August from the disposal of distressed assets. 34 of the 35 Fitch-rated CREL CDOS reported delinquencies in August, ranging from 1.2% to 39.8%.

"There continues to be investor interest in junior mezzanine loans," says Fitch director Stacey McGovern. "Junior mezzanine loans can provide the purchaser with an opportunity to gain control over a collateral asset."

CDO

Updated cashflow CDO criteria explained

Fitch has updated its global rating criteria for cashflow analysis of new and existing CDOs. The methodology for cashflow analysis of CDOs remains fundamentally unchanged, however.

The agency's approach to addressing the key risk drivers of cashflow analysis in CDOs include: portfolio default and recovery analysis, transaction-specific structural features and hedging strategies. The objective of the report, Fitch says, is to supplement the sector-specific criteria with assumptions specifically relevant to CDOs structured as cashflow transactions.

CDO

New criteria hits US Trups CDOs

Following the implementation of updated surveillance criteria, Fitch has taken rating actions on 86 US bank Trups CDO transactions. The agency reviewed 498 classes, affirmed 314 classes and downgraded the ratings on 184 classes of notes. Negative outlooks were assigned to 155 of the 156 notes with a rating of single-B or higher.

The agency's new Trups CDO surveillance criteria employs more conservative assumptions for deferring obligors in investment grade rating stress scenarios. Nearly 50% of the 123 notes previously rated triple-B or higher were downgraded by one rating category, while 34% were downgraded by two rating categories. Since Fitch placed 179 notes issued by bank Trups CDO notes on rating watch in February 2010, an average of 5.6% of the portfolio assets defaulted or began deferring.

Notes whose ratings were affirmed were issued by CDOs that experienced limited default and deferral activity in 2010. Additionally, rating stress assumptions for notes with a double-B or lower rating had limited change from Fitch's previous criteria assumptions.

Nearly 80% of the 375 notes previously rated double-B or lower had their ratings affirmed. In addition, the agency included a deterministic analysis in its rating decisions for notes issued by CDOs with fewer than 20 performing obligors.

CDPCs

CDPC drafting error corrected

NewLands Financial is proposing to amend its class A loan agreement, class B deferrable loan agreement and class B1 deferrable loan agreement. The amendments primarily correct a drafting error that potentially could prohibit the CDPC from making scheduled (interest and principal) and unscheduled payments (principal) to the holders of these loans, so long as more senior obligations are outstanding.

The amendment would also ensure that NewLands would be able to operate in a manner consistent with the assumptions Moody's made when it assigned original ratings to the company, including an assumption with regard to NewLands' option to call some of its debt in March 2012. While NewLands' calling debt, which is subject to the CDPC satisfying its own capital adequacy tests, could weaken its capital adequacy and precipitate a negative rating action, the amendment itself will not cause a negative rating action because it only clarifies language consistent with the original intent.

Further, the amendments would help prevent an event of default under the loans as a result of a possible interpretation of current documents that prohibit scheduled payments, Moody's notes.

CDS

Roll-down driving tranche performance

Implied and realised volatility, as well as credit spreads, ground tighter over the summer following the market gyrations in Q2. This has made roll-down an important underlying factor when analysing CDS index tranche performance, according to structured credit strategists at Morgan Stanley.

They note their performance attribution model shows that time decay and carry have played a meaningful part in driving total returns of junior tranches. While correlation had a significant impact on junior tranches as well, the time decay moves serve to partially offset the negative impact of correlation moves over the summer. This effect is most pronounced at the original five-year point, which has less than three years to maturity in both CDX and iTraxx tranches, the Morgan Stanley strategists add.

"As legacy series approach maturity and spread/default risk remains benign, roll-down should continue to be an important source of returns, particularly in the shorter maturities," they continue. "From an absolute-return standpoint, time decay alone should contribute over 6% to total returns of equity and 4.7% to junior mezz at the five-year point in the next six months. Junior mezz, in particular, should be a big beneficiary of time decay, given lower exposure to jump-to-default risk and lesser sensitivity to correlation moves in a range-bound spread environment than equity."

CSO valuations diverged over the summer, largely due to the fact that the stressed fallen angel names that drive mezzanine tranche risk had mixed to positive performance compared to a weaker broader credit market. "We also saw stronger relative performance in CSOs referencing US credits versus European credits, owing to healing tail risks in the US and an increase in some European tail risks," the strategists conclude.

CDS

Swap pricing considered

ISDA has released two new additions to its Research Notes series, 'The Value of a New Swap' and 'The Economic Role of Speculation'.

The first publication seeks to reconcile the theoretical and actual pricing of swaps at inception. Theoretically, swaps are priced at zero net present value at inception, yet in practice, originating and executing a transaction involves costs that must be covered by the dealer who arranges it. It is therefore necessary to adjust the mid-market price to cover various costs and risks of transacting, as well as providing a return to the dealer that makes a market.

"The result is that the actual price agreed for the transaction is not the mid-market price, but typically either a bid price if the dealer is paying the fixed rate or an offer price if the dealer is receiving the fixed rate," says David Mengle, ISDA head of research. "And because the actual price is the bid or offer price, the net present value to the dealer will be a positive amount and not zero."

The second publication covers the role speculation plays in the functioning of markets. It considers how speculation affects liquidity, efficiency and completeness in the market, as well as whether the existence of knowledgeable speculators makes the market more efficient by reflecting fundamental values more accurately and more completely.

CDS

Constituent change for CDX IG

The Markit CDX.NA.IG, CDX.EM and CDX.EM.DIV indices rolled into their fifteenth, fourteenth and twelfth series respectively on 20 September. One constituent (Universal Health Services) has been replaced (with CA Inc) in the CDX.NA.IG index. The composition and weights of the CDX.EM and CDX.EM.DIV indices remain unchanged.

CDS

Liquidity spike for technology sector CDS

Fitch Solutions reports that, in contrast to the broader stability of its CDS market liquidity indices, the global technology sector has experienced a sharp increase in CDS liquidity since early September.

"The liquidity spike could be due to recent M&A activity in the sector and the fact that the CDS market is still to make its mind up on who the potential winners and losers are from this round of industry consolidation," says Fitch md Jonathan Di Giambattista.

The total market CDS liquidity index for global technology companies closed at 10.1 on 17 September, from 10.3 on 30 August. "Average CDS spreads on European technology companies have tightened twice as much as in other regions since early September, which suggests the CDS market is most uncertain on the prospects for technology companies in the Americas and Asia Pacific," Di Giambattista adds.

CLOs

GSO CLO joins queue on strong market

Bank of America Merrill Lynch is marketing a US$400m CLO for GSO Capital Partners. The transaction joins the LCM, Garrison Investment Group and Guggenheim deals already in the pipeline (SCI passim).

The GSO CLO is likely to comprise four tranches, with the equity piece expected to be sold to a third party.

The news comes as the US CLO market sees strong technical pressure continuing to push prices higher. Bid-list activity last week saw the majority of 84 line items worth US$830m by par value from 13 lists being sold.

This week is also set to be busy, according to Babson Capital Management, with 10 lists scheduled, including a large mezzanine liquidation of a CDO-squared portfolio. "Away from bid lists, multiple dealers reported strong two-way flow, with one dealer indicating [last week] was his second busiest week of the year. This trend is expected to continue in the short-run," the firm notes.

The US$350m Garrison deal is expected to price tighter than expected later this week, as all four of the CLO's tranches are said to be oversubscribed.

CLOs

Microfinance CLO completed

IFMR Capital closed its eighth microloan securitisation transaction last week, an R370m multi-originator deal with Delhi-based MFI Satin Creditcare, Rajasthan-based Sahayata Microfinance and Tamil Nadu MFI Asirvad.

This transaction proves significant as it brings private wealth investors to microfinance for the first time, the firm notes. By bringing together these unconventional private wealth investors, IFMR Capital believes that the participating MFIs will be able to build a sound track record in debt capital markets and move beyond priority sector-led debt funding in a cost-effective way.

CLOs

Buyback to improve CRE CDO's par value ratios

Fortress Investment Group is set to buy back another €6m of the class A notes from Duncannon CRE CDO I at a discounted purchase price (SCI passim). The repurchased notes will subsequently be cancelled, thereby marginally increasing the available credit enhancement to all rated notes, according to Fitch.

The repurchase will be funded using cash available in the principal collection account, which - as of September 2010 - totalled approximately €4.5m. Due to the funding of the proposed repurchase of the class A notes, the amount of principal proceeds available for immediate distribution to the remaining noteholders will be substantially lower.

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

CMBS

Call for more focused TRX indices

The need for more focused Markit TRX indices for hedging CMBS bond spreads is becoming apparent, as increasing numbers of commercial real estate loan conduits begin gearing up for origination.

In many cases for larger loans, the risk of changes in bond spreads can be borne by the borrower, in which case the lender doesn't need to hedge widening risk. In addition, spreads have generally been tightening, which also reduces the need for hedging.

However, with less uncertainty on bond spreads and more competition from lenders, there may be more need for hedging than can be done efficiently with Markit CMBX, according to Malay Bansal, head of portfolio management and advisory for commercial real estate & CMBS at NewOak Capital. "Total return swaps, which were traditionally used by originators to hedge, will be efficient and ideal," he explains. "TRX can provide that ability in a standardised format. However, TRX has not seen a lot of activity and so does not receive a lot of attention."

Bansal suggests that the problem with TRX is that it comprises all of the bonds in the CMBX indices - making it less than ideal for taking any type of view. Consequently, it would be better for hedgers to use a new TRX index based on new deals being issued.

CMBS

CRE refinancing completed

Younan Properties has completed the refinancing of a 20-story, 405,693 square foot class A office tower in Phoenix. CMBS financing was provided by Deutsche Bank and Tounan represented itself with the assistance of RKM Capital.

Zaya Younan, chairman and ceo of the firm, says: "We have seen significant, positive steps and changes in the CRE debt market origination and we were able to take advantage of the opportunity to refinance this asset for a longer term at a more attractive rate."

CMBS

US CMBS delinquent unpaid balance rising

The delinquent unpaid balance for US CMBS increased in August by an additional US$551.8m, up to US$61.39bn, according to Realpoint's latest Monthly Delinquency Report. This follows only US$387.9m in growth from June to July 2010, remaining well below the average growth of US$3.136bn per month experienced from January through to June

Outside of a US$1.37bn decrease in the 90+ day category, the remaining four delinquency categories each increased, fuelled by further delinquency degradation and credit deterioration. Conversely, with ongoing loan liquidations, modifications and resolutions, the distressed 90+ day, foreclosure and REO categories as a whole fell for the first time in almost three years - down by US$496m (1%) from the previous month.

Having grown in aggregate for 31 straight months prior to such decline, these distressed categories remain up by US$30.4bn (167%) in the past year from only US$18.21bn in August 2009. Overall, the delinquent unpaid balance is up by 118% from one year ago and is now almost 28 times the low point of US$2.21bn in March 2007.

CMBS

EMEA special servicing activity to rise

Moody's reports that, as of end-August, there were 65 loans in special servicing across all EMEA CMBS large multi-borrower and single borrower transactions it monitors. During the month, two loans were newly transferred into special servicing, while one loan was removed due to repayment.

Currently, 37 transactions are subject to loans in special servicing. A total of nine different special servicers is working on the respective loans, with the workout of five loans currently in special servicing close to being finalised.

The weighted average Moody's Expected Principal Loss for loans in special servicing as of end-August is stable at 35%.

However, the rating agency expects the number of loans in special servicing to increase in the coming months, especially as a result of non-payment at maturity and of payment defaults. Given the relatively small number of EMEA CMBS transactions with IPD in August, new entries into special servicing have slowed during the month. But special servicing activity should heighten towards the end of the year, as there is a concentration of loan maturities in October when 20 out of approximately 30 loans with maturity before year-end need to be refinanced.

Insurance-linked securities

Green Valley II marketing

Swiss Re Capital Markets is marketing the second catastrophe bond from the Swiss Re Green Valley programme. The €100m single-tranche deal referencing French windstorm risk has been given a preliminary double-B plus rating by S&P.

The transaction, which is expected to close on 30 September and mature in January 2012, will serve to provide Swiss Re with a source of parametric cover for reinsurance provided to Groupama covering windstorms in France over 1.45 European wind seasons, which is a total risk period of 1.25 calendar years (15 months). Following a qualifying event, Swiss Re will send an event notice to Risk Management Solutions (RMS), as the event calculation agent. RMS will calculate an index value by collecting data reported by METNEXT SAS (the French meteorological agency) for French windstorm events to determine whether a covered event has occurred.

Green Valley II's collateral will be invested in European Bank of Reconstruction and Development floating-rate notes. Investors in Green Valley will receive a coupon of the directed investment yield plus an interest spread. The directed investment yield will be the interest accrued on the EBRD floating-rate note, which will total three-month Euribor minus 31bp.

LCDS

Boston Energy LCDS settled

The final results of the Boston Generating LCDS auction have been published. The final price was determined to be 96.75, with nine dealers submitting inside markets, physical settlement requests and limit orders.

Meanwhile, ISDA's Americas Determinations Committee has ruled that a succession event did not occur with respect to Energy Future Holdings Corp. The decision was delayed until 17 September (SCI passim).

Ratings

SF legal risk factors analysed

Moody's has commented on the unique risk factors of structured finance transactions, indicating that recent economic stress has tested some of the legal principles related to SF deals. It also discusses how legal risk is integrated into the ratings of SF transactions.

"Legal risk is a central factor considered when assigning a structured finance rating, but is often inextricably intertwined with the financial stability and incentives of the transaction parties," says Daniel Rubock, Moody svp. "Underlying our approach is the premise that a transaction's legal risk usually cannot be easily or properly quantified as a model input."

Instead, the impact that legal risks have on a SF transaction's rating is a qualitative assessment that, among other things, considers the circumstances that may trigger a legal challenge. The approach allows legal risks for a transaction to be compared to those of other transactions and across asset types, Moody's notes.

Real Estate

CRE investors focusing on core assets

PricewaterhouseCoopers' latest Korpacz Real Estate Investor Survey indicates that, with CRE fundamentals still ailing from the recession and lacking clear signs of near-term improvement, investors remain focused on core assets and proven markets. The survey further highlights an improved lending environment and strong appetite from both debt and equity capital for quality real estate assets, with some surveyed investors noting a surprise at the speed at which debt availability has rebounded over the past year.

With a limited number of quality offerings to absorb all the pent-up capital, the report reveals that competition is strong among buyers of top-rated assets, causing overall capitalisation rates to remain on a downward trend. Overall cap rates tend to move in step with interest rates, which remain very low on a historical basis.

Susan Smith, director, real estate advisory practice at PwC, says:"Many investors were waiting to pounce on the anticipated overflow of underwater and distressed quality assets, but that scenario never quite materialised as expected."

She adds: "With the skittish economic recovery, little rent growth and minimal leasing velocity, a flight to quality is evident among investors. Sellers offering quality CRE for sale are garnering a lot of attention."

Even as the US economic recovery signals uncertainty, lodging demand is continuing to grow at a brisk pace, creating cautious optimism for this sector (see also last issue). The survey also finds that the apartment sector is continuing to lead the recovery, with fundamentals having bottomed in most markets, where solid improvements in occupancy and demand are being seen.

With the fragile economy continuing to hamper consumer spending, the retail sector is showing mixed reviews, however. While leasing activity remains sluggish in the national mall market during Q210, surveyed investors note that the dynamics of the leasing market are indeed stabilising.

Real Estate

US CRE prices fall 3.1% in July

The latest data from Moody's/REAL Commercial Property Price Indices (CPPI) indicate that US CRE prices decreased by 3.1% in July - the second consecutive monthly decline of more than 3%. Nationwide, prices are currently 43.2% below their peak in October 2007 and only 0.9% above the recession low recorded in October 2009. The CPPI has declined by 7.3% in the past year and by 35.9% in the past two years.

"Commercial real estate markets were caught in a downdraft as the economy appeared to further weaken in the early part of 2010, resulting in relatively large declines in the index in the early summer," says Moody's md Nick Levidy. "The recent performance, while perhaps somewhat discouraging, should not come as a complete surprise. We have noted for several months that markets are likely to remain choppy for some time as property values slowly form a bottom in conjunction with a gradual recovery of the broader economy."

Additional annual indices published this month show prices on properties in the eastern states increasing in three of the four property categories - office, retail and apartments - over the past year. Prices in the fourth category, industrial properties, are down by 7.6%. Retail properties in the east have the greatest gain in the region, according to Moody's, increasing 12.9% during the year.

Retail prices in the South, in contrast, have declined by 31.5% during the year. Prices have increased in southern apartment markets by 1.4% over the last year, after dropping 44.2% in the previous year. The southern apartment index peaked three years ago and has declined by 48% since then.

Finally, the Florida apartment market also realised its first positive return since its peak four year years ago, increasing by 10.8% over the last year. Values are down by 44.4% from the peak.

RMBS

GSE liquidation remains on the cards

MBS analysts at Wells Fargo suggest that there is a 50%-75% probability that Fannie Mae and Freddie Mac will be liquidated as part of their rehabilitation. Their forecast comes after the 15 September hearing of the House Financial Services subcommittee on capital markets.

The Wells Fargo analysts provide what they believe is a viable framework for liquidation, whereby both outstanding GSE debentures and MBS will continue to enjoy a full-faith and credit guarantee. However, they note that liquidation may result in a two-tier conventional MBS market.

"To avoid a prolonged period of a two-tier conforming market, we believe that policymakers may repudiate terms of the GSE's trusts and debentures. We assign a less than 10% probability of repudiation versus a run-off strategy," they say.

Comments by Michael Barr, assistant secretary for Financial Reform, and Edward Demarco, acting director of the Federal Housing Finance Agency, indicate that each believe that a privatised conforming market can exist without a government guarantee. Absent the government pool policy, the analysts indicate that the most likely structure is a cooperative model, as put forward by economists at the Federal Reserve.

They conclude: "Structural questions aside, we continue to believe that a self-insuring conforming takeout will likely increase mortgage rates by at least 15bp-20bp and reduce 'up-front' proceeds...by as much as 3.5 points, inclusive of borrower paid points. With the only government MBS guarantee, GNMA MBS will benefit from wider primary secondary spreads and, in a sense, the market will 'pay' guarantee premium."

RMBS

Arran print sparks Euro optimism

The announcement that a significant portion of RBS' new UK prime RMBS - the £4.65bn-equivalent Arran Residential Mortgages Funding 2010-1 - would be marketed publically injected some optimism into the European market last week.

"On one hand, the attempt by RBS to place a new RMBS deal increased the likelihood that the existing Arran deals would be called at their respective call dates, which caused an immediate reaction in prices," explain ABS analysts at Barclays Capital. "On the other hand, the fact that a large government-owned bank like RBS is willing to resort to ABS for funding added some hope that there may be a future for this market after all."

However, they note that this enthusiasm was curbed somewhat by the consecutive announcements from a few other large banks (some with RMBS platforms in place) that they were issuing covered bonds, again reminding us of the pricing differential between the two asset classes."

The Arran transaction is expected to price today, but by press time levels for the M tranche (which is talked around 210bp over) were said to still be being discussed. However, the A2 and A3 tranches were fully covered at the 140bp and 150bp guidance.

JPMorgan affiliates are expected to account for a large proportion of investor participation. JPMorgan, Lloyds TSB and RBS arranged the deal.

Meanwhile, Aegon's Saecure 9 Dutch RMBS launched and priced last week, with the A1 class coming at 95bp and the A2s at 135bp over three-month Euribor. Books for the two senior classes were 4x and 1.1x covered respectively.

RMBS

NC RMBS prepped amid improving performance

Investec is believed to be prepping a £200m RMBS, backed by prime UK mortgages originated by Kensington Mortgages, as well as non-conforming loans bought by Kensington from other specialist originators. The move comes amid improving performance in the UK non-conforming RMBS sector, with a majority of transactions reporting lower arrears, lower losses and increases in excess spread.

European asset-backed analysts at RBS point out that this has enabled a number of deals to start replenishing their reserves. However, it also brings the possibility that certain transactions could improve sufficiently to switch to pro rata redemption, which further increases extension risks for class A noteholders and would moderate future increases in credit enhancement as the deal pays down. Conversely, junior noteholders would benefit from their holdings becoming current pay notes.

The current situation varies from the extremes of the Clavis transactions that are already paying pro rata to a large proportion of the UK Eurosail RMBS, which have breached the cumulative loss trigger so should never switch to pro rata redemption, and the Leek transactions where the structure is purely sequential. Most of the remaining UK non-conforming RMBS have the potential to switch to pro rata redemption, but currently do not meet their trigger requirements, according to the RBS analysts.

The performance triggers follow a similar pattern across most deals: class A credit enhancement reaching approximately double the level at launch; fully funded reserve; and 90+ day arrears below a certain level. "However, the rate of improvement suggests that most remaining deals will take a number of quarters to fully replenish their reserves," the analysts note. "LGATE 2007-1 and KMS 2007-1 also fail other triggers. ALBA 2006-1 and 2006-2 appear to be closest to a pro rata switch, although this is unlikely for another three quarters."

The last attempt to place a UK non-conforming RMBS was in June, when Merrill Lynch roadshowed Moorgate Funding 2010-1. The deal was eventually abandoned, at least temporarily, due to the volatility in the sovereign space at that time (SCI passim). But, as MBS analysts at Barclays Capital note, the tone is significantly more positive now and a non-prime RMBS transaction may be able to run more smoothly.

RMBS

Spanish RMBS reviewed on irregular performance

Moody's continues to review the ratings of Valencia Hipotecario 2, 3 and 4, while investigating the series' performance data. The agency notes that the Valencia Hipotecario 1 to 5 RMBS have shown irregular credit performance since its reporting period in Q409.

The deals experienced spikes in arrears in early 2010, followed by a rapid improvement in credit trends over the last two reporting periods. This variation in arrears, Moody's notes, proves significant in the deal's performance review. The delinquency trends in the five RMBS managed by Europea de Titulización are inconsistent with arrears trends observed for the Spanish RMBS market since late 2009.

All notes in the Valencia Hipotecario 2, 3 and 4 transactions were placed under review for possible downgrade in November 2009, prior to any irregular performance trends being observed. The rating actions were prompted by the worse than expected performance of the collateral backing the notes.

The agency has been in contact with EdT and Banco de Valencia regarding the performance data for the period Q409 to Q210 to investigate the data and information provided by the gestora and the servicer. The agency says it will conclude the review of the three RMBS on completion of the irregular credit performance investigation.

SIVs

Restructured SIVs restructured further

HSBC has restructured the senior liabilities of its restructured SIVs, Barion Funding, Malachite Funding and Mazarin Funding. The restructuring involved the issuance of a further portion of junior deferrable notes and the consequent redemption of an equivalent amount of super-senior liabilities, as well as tranching the junior senior notes into a number of tiers ranking sequentially.

The move prompted S&P to take various rating actions on the programmes. This follows general credit deterioration observed within the portfolio for all three transactions and the application of the agency's revised assumptions for portfolios containing a mix of corporate and structured finance assets

Specifically, S&P withdrew its credit ratings on all three programmes and assigned ratings to the new liabilities. At the same time, the agency lowered its ratings on Barion's fast and slow pay income notes, Malachite's Tier 1 and Tier 2 income notes, and Mazarin's Tier 1 fast pay and slow pay income notes. It also affirmed its ratings on Mazarin's European and US CP programmes.

In addition, S&P has removed from credit watch negative the ratings on the downgraded notes in all three transactions.

As of the 30 July 2010 investor report, the Barion portfolio consists of approximately 68% structured finance securities, of which more than 20% of the portfolio is represented by US RMBS issued between Q405 and Q407, which have experienced stressed performance. The Malachite portfolio consists of approximately 90% structured finance securities, of which 25% of the portfolio is represented by US RMBS issued during the period.

Finally, the Mazarin portfolio consists of approximately 76% structured finance securities, of which 21% of the portfolio is represented by US RMBS. The remaining portion of structured finance securities across all three portfolios mainly comprises tranches rated triple-A on their respective issue date; however, only half of them are still rated this high.

Technology

Partnership expands risk solutions access

Numerix has partnered with Softek Computer Services to offer integrated pricing and risk solutions within the Softek Capital Adequacy Services (CAS) platform. Users of the Softek CAS platform will now be able to access the Numerix CrossAsset library of independent pricing models and methods. They will also be able to utilise Numerix's suite risk management capabilities, including Monte Carlo Value at Risk, Potential Future Exposure and Credit Value Adjustment, for effective enterprise wide risk management.

Steven O'Hanlon, president and coo of Numerix, says: "The integration of Numerix pricing, analytics and risk management capabilities within the Softek CAS platform offers their users a powerful and robust pricing and risk solution. The wide variety of available models means users can now value virtually any instrument using Numerix's different methodologies and custom model calibrations."

Whole business securitisations

M&B on review following property disposals

Moody's has placed five classes of notes issued by Mitchells & Butlers Finance on review with direction uncertain. The affected notes are insured by Ambac Assurance.

Ambac's current rating is Caa2 on review with direction uncertain. Consequently, the current ratings are now based solely on the underlying credit strength of the notes.

Mitchells & Butlers Finance is a whole business securitisation of a portfolio of 1,658 managed pubs - as of April 2010 - located throughout the UK. The transaction initially closed in November 2003, with one tap issue in September 2006.

The rating review action was prompted by the recent series of disposals and proposed disposals from the Mitchells and Butlers portfolio of a number of non-core assets (SCI passim). In total, the disposed assets represent almost 20% of the total pub portfolio of the Mitchells and Butlers group. This applied from April 2010, with a large majority of these divested assets being also part of the securitised portfolio.

Moody's will continue to closely monitor the transaction, focusing on the cashflow developments, capital expenditure activity and any potential new acquisitions over the next few quarters. The agency will also monitor the corporate situation of the parent company, as well as the implementation and results of the business strategy plan disclosed in March 2010.

CLOs

The CLO ratings upgrade story

Rishad Ahluwalia, executive director, and Maggie Wang, associate at JPMorgan, find that the pace of incremental CLO upgrades will be gradual going forward

As a result of credit performance, OC rebuilding, structural de-leveraging and other factors, the CLO market has been experiencing ratings upgrades and we turn our attention to this emerging story. First, we describe the ratings upgrade universe to understand what has been occurring. Second, we compare rating changes in CLOs with the broader leveraged loan universe to try to forecast upgrade trends.

Finally, we compare current CLO ratings with tranche par subordinations and market value overcollateralisation (MVOC), in a further experiment to differentiate bonds. It's challenging to predict future ratings actions, but we believe the CLO rating upgrade trend continues, albeit at a gradual pace.

Upgrades accelerated through the summer of 2010
By deal count, we estimate circa 15% of the outstanding global CLO deals have experienced upgrades since mid-2009 in at least one of its tranches by at least one rating agency, with a higher rate of 21% among US CLO deals and a lower rate of 7% among European CLOs. By tranche count, we estimate around 10% of the outstanding US CLO tranches have been upgraded since mid-2009 versus 3% in Europe.

There have been positive rating actions since mid-2009, but the trend gained steam in May to August 2010. A majority of ratings upgrades have been taken by Moody's and mostly involve US CLOs.

Since mid-2009, an estimated 545 tranches of 201 CLOs have been upgraded at least once and by at least one rating agency (or 595 tranche upgrades, including repeated rating actions), averaging about 40 tranche upgrades per month (Exhibit 1). Well over half (353 tranches out of 133 CLOs, or 373 tranches, including repeated actions) occurred on or after May 2010. The upgrade rate climbs to 89 tranches per month for May to August 2010.

US mezzanine CLO tranches have accounted for most of the recent upgrades
Original single-A and triple-B are the two largest broad rating constituents of the upgrade universe (Exhibit 2), with the remainder distributed among seniors (AAA/AA) and subordinates (double-B). This clustering makes sense as mezzanine has typically been the balancing point in loss expectations and is probably also due to the fact a triple-A rating in post-crisis methodologies is more difficult to obtain.

The average upgrade has been about two notches, though there is a range
The number of notches depends on transaction and point in the structure. In most cases, mezzanine and subordinates that have been upgraded are still below their original rating.

For example, a typical original single-A in our upgrade universe had been downgraded to the double-B to triple-B range, so assuming a two-notch upgrade, the tranche is now triple-B to triple-B plus. Notably, a few Moody's triple-As that had been downgraded to the double-A area have been upgraded back to trile-A, but these are few and far between.

Upgrades clustered in the 2006 to 2007 vintages
In part, this is a reflection of outstanding issuance (Exhibit 3). In Exhibit 4 we summarise with the monthly CLO upgrade/downgrade ratio since early 2007.

Moving onto a broader level, CLO rating actions appear to have lagged leveraged loans
In Exhibit 5 we plot the rolling three-month average upgrade to downgrade ratios of US CLOs (right axis) and the S&P/LSTA leveraged loan index (left axis). On an indicative level, it appears the CLO upgrade trend has lagged the first upgrades in leveraged loans by a few months.

Obviously, there are caveats to such a comparison. First, the methodologies for corporates and CLOs may be different. Second, the universe of loans underlying CLOs is different from the loan index.

Third, our CLO upgrade/downgrade ratio takes into account all rating agencies, but since the majority of CLO upgrades so far have been done by Moody's (74% since May), we are not comparing apples to apples, as the loan upgrade series comes from S&P. Nevertheless, CLO rating actions have tended to amplify the rating trends in leveraged loans, with bigger swings in both directions.

The current roadmap of tranche risk points to continued dispersion in future rating actions
It is not possible to predict rating actions, but in an analogous analysis we take a look at how ratings fit with other risk assessments. In a case study we map par subordination and MVOC of 539 US single-A bonds to the current rating (by Moody's).

In Exhibits 6 and 7, we assign a numerical score for the deviation in current from original rating (for example, 0 means currently still single-A and -3 means currently triple-B) and then plot the par subordination (Exhibit 6) and MVOC (Exhibit 7) on the y axis for each bond. There appears a slight upward-sloping relationship, which makes sense given that bonds with higher levels of credit enhancement (whether measured by par subordinations or MVOC ratios) have higher ratings, within this single-A sample. What these charts tell us is that future upgrades, as and when they occur, will certainly involve dispersion.

Conclusion: The upgrade pace will probably be gradual and may ease some pressure on risk-based capital, but this will be situational
It is challenging to forecast CLO ratings actions, but as structural de-leveraging, declining defaults and losses, and increasing OC are incorporated into surveillance, the trend should continue. However, we think the upgrade trend will probably be gradual, given the likely conservatism of the rating agencies following the crisis, potential weakness if economic growth decelerates and other factors.

A key risk to our view of further upgrades is a reversal in performance, as in a double-dip recession, and there is the private nature of the surveillance and ratings process. Since many investors include corporate ratings into risk-based capital, upward momentum in CLO ratings is positive.

The impact of rating changes will depend on investor type and capital treatment. On a simple level, since the Basel capital regime incorporates the lower of two ratings in determining risk weights, any alleviation of capital pressures for holders such as banks will depend on whether more than one rating for a bond has been upgraded, among other factors.

© 2010 JPMorgan Securities. This Research Note is an excerpt from JPMorgan's US Fixed Income Markets Weekly, published on 10 September.