Contents

CMBS

Multi-borrower issues

Euro CMBS servicers adapting to new challenges

The role of CMBS servicers in Europe has changed significantly post-crisis. Challenges remain, however, as the market prepares to begin restructuring a raft of multi-borrower transactions.

Nassar Hussain, managing partner at Brookland Partners, confirms that the role of primary servicers has changed dramatically since the crisis - from reactive to proactive and solutions-orientated. He notes that many have adopted a policing role in CMBS restructurings that goes beyond the legal requirements in the servicing standard.

"The typical standard is to act with due care and attention, check compliance with financial covenants, and ensure timely payments and maximisation of recoveries all at the loan level. But now servicers are promoting disclosure and managing conflicts of interest between the bond level and mezz level as part of broader restructuring roles," Hussain says.

He adds: "Servicers will have an important dialogue with lenders and noteholders when the market restarts, so the identity and role of servicers will continue to be important. Those that don't adapt will be left behind."

Further, it appears that if primary servicers take a pro-active approach, they can get paid appropriately to reflect the additional work they are asked to do and the additional risk they are asked to bear. "Borrowers are learning that if they don't incentivise transaction counterparties such as servicers to do far more work than they were originally contracted to do, they may not achieve the same results," Hussain continues.

Stewart Hotston, director Hatfield Philips International, suggests that before the financial crisis hit primary servicers were perceived almost as shepherds, but this has now changed. "Having to exercise discretion represents a change in the role of the primary servicer," he explains. "Frequently, there are gaps in the documentation where no-one's assigned the ability to make a decision; therefore, in such cases, the servicing standard can be used to take action."

He adds: "We can see the whole picture, which no-one else has the luxury of seeing, and so we attempt to hold it all together to create a consensual action plan. There is definitely pressure to do more as a primary servicer in a potential restructuring situation."

But this brings its own problems. For example, there are some cases where the consents and waivers mean that a restructuring to preserve a loan can only be done in special servicing. However, counter-intuitively, a loan can only go into special servicing when there's been a default.

Another issue is liability. Given that primary servicers often have to step into roles to which no specific party has been assigned, they are exposed to making decisions when they don't necessarily have the rights to.

Hotston says such situations beg the question about whether a distinction between primary and special servicers is necessary at all. "Why should there be, when both parties are trying to preserve the loan?" he asks.

At present, there isn't as much blurring of roles as there could be between primary and special servicers. The distinction is based on how the US market operates, with Hotston noting that the model has some positives, but they're outweighed by the drawbacks.

He says: "We'd prefer a blurring of the two roles to enable us to preserve value better as a primary servicer when there's no reason to put a loan into special servicing. We may approach noteholders about existing arrangements, but - given difficulties around consent and fees - it seems much more likely to be something for future transactions."

Hotston anticipates that such documentation will likely be revisited in the future. "Lawyers are reflecting on the fact that they may not have given leadership in the drafting of this documentation. There is openness towards revisiting legals and how to improve them."

Nevertheless, primary servicers have also strengthened their efforts in relation to junior lenders. They don't have a public profile and so HPI, for one, has established a dedicated team in this area. Junior lenders will be needed to make the market work in the future, so they need to be supported, according to Hotston.

"Their risk appetite has changed and they generally prefer lower LTVs. But they still have money and are looking to reinvest, albeit with a different approach," he adds.

However, Hussain suggests that servicers could improve their offering even further by considering the economic impact on investor returns in terms of loan extensions and the impact on note waterfalls when they exercise discretion. "Servicers typically focus on the loan level and don't interact with investors as much as they should," he remarks.

At present, one particular area of tension is between senior noteholders and both junior creditors and X note holders. Because interest to junior creditors and X note holders typically does not switch off until a loss is crystallised, it enables such holders - including originating banks - to continue taking cash out of a deal even if it is performing poorly. Recently, Citi agreed not to increase the margin on its X note as part of the Tahiti restructuring, while Goldman Sachs agreed to give up a portion of the revenue from its X note in the Fleet Street 2 restructuring.

Indeed, among the restructuring challenges that servicers face is marshalling support from the majority of all classes of noteholders for a given action, according to Hotston. He says that some ask for consent fees just for turning up, while others are strategically passive and so don't get involved.

Liquidity facilities are another problematic area in that most providers have exited the market and so it is difficult to extend the facilities if a loan is to be extended beyond current note maturities. Without such a facility, the sponsor could be left with a significant cashflow mismatch.

Rating agencies are suggesting that this could be detrimental and that they could therefore downgrade impacted transactions. Liquidity reserves are an alternative, but bring regulatory capital issues - to the extent that it may be more economic for sponsors not to securitise.

A further two challenges exist for CMBS restructurings. First is in the case where a loan appears in more than one deal and so it is necessary to restructure several affected transactions at the same time.

Second is in multi-borrower deals. "The loans all have different profiles and business cases, as well as differing B lender interests," Hotston explains. "However, focusing on multiple borrowers at one time is easier for servicers than for investors as the servicer already knows terms of each loan they manage."

He points out that many multi-borrower deals will have to be restructured over the next few years. "From mid-2011, there is a wall of refinancing for about 60% of all loans in CMBS deals (equivalent of around £80bn-£90bn) over the next 2.5 years, with most loans maturing within a year of each other."

According to Hussain, it makes sense to take a holistic approach on multi-borrower CMBS deals and restructure multiple loans and the bonds at the same time. "Multi-borrower restructurings are a question of negotiating with each borrower on a loan-by-loan basis and adjusting the note structure to reflect the chosen strategy. One issue is to ensure that if there is an increase in loan margins, this goes to the noteholders and not the X note holder, for instance," he explains.

Brookland Partners is currently involved in the first restructuring of a German multifamily transaction, which involves two servicers on the GSW loan (securitised in Windermere IX and Fleet Street 3) working together. The GSW loan is one of two in Windermere IX, but one of many in Fleet Street 3.

Meanwhile, Hussain indicates that a true European CMBS market is unlikely to re-emerge in the near term because the investor base isn't ready. "There are a number of legacy issues that need to be resolved; for example, the wall of refinancing that is due. At the moment, banks are simply extending every year. Hopefully, this will be resolved if/when markets start to recover, but if an unforeseen event occurs or banks are forced to sell, we could see a double-dip."

Nevertheless, a number of mezzanine funds - such as Pramerica, Duet, BlackRock, La Salle and M&G - have begun to exploit the funding gap in the commercial real estate sector and raise capital, albeit only around US$1bn so far. These funds are primarily focused on originating new mezzanine loans.

CS

Correlation

New beginning?

Redrawn index tranches set to bring liquidity

Tranche trading on the new Markit CDX.IG.15 index began yesterday, 28 September, following a redrawing of the capital structure from six tranches into four. Liquidity has been absent for past on-the-run index tranches, but a more concerted effort is now expected from dealers to ensure liquidity in the new tranches.

On the back of investor feedback, the 7%-10% and 10%-15% CDX.IG.15 tranches have been combined to form a thicker mezzanine tranche, while the 15%-30% and 30%-100% tranches have been combined into one super-senior tranche. The changes are said to reflect updated ratings methodologies and bespoke issuance expectations. All tranches still trade with an upfront plus fixed coupon format.

Structured credit strategists at Morgan Stanley suggest that CDX.IG.15 is, in a sense, a throwback to the pre-crisis CDX indices because it has "a good balance between a clean portfolio but with enough tail credits to make tranches interesting".

However, they add, in subsequent years the tranching became somewhat disconnected from bespoke structures, as the bull market for credit pushed investors to lower attachments and thinner tranches. "Today, we have yet to see how a large scale new bespoke market would look, but early indications are that thick senior tranches for longer-term investments and thinner junior tranches for short-term trading opportunities would work."

The credit crisis and the significant slowdown in bespoke issuance have kept the liquid index tranche market stuck on the CDX.IG.9 legacy series, which began trading in autumn 2007. According to the Morgan Stanley strategists, a successful IG 15 tranche launch is critically important to the future of liquid tranches and they believe there are several reasons why the odds are better this time around.

The first reason is slowing legacy flows, thereby giving market makers real motivation to move forward. Second, the very aspect that makes IG 9 appealing for legacy risk management is also what makes it less appealing for new investments and new hedges - there is considerable demand for a fresh series.

The third reason is the many advantages of using new indices, including fungibility with the standard liquidity points in the index market, as well as the index options space. Fourth is that the low rates environment combined with high corporate bond dollar prices motivates taking credit risk without interest rate risk, and Morgan Stanley expects a growing appetite for synthetic portfolio solutions to meet this demand. Finally, the new series will be a better hedge for new bespokes, which are slowly returning to the market.

Credit analysts at Barclays Capital add that IG 15 is a significantly safer portfolio than IG 9. There are 32 non-overlapping names (including the four in IG.9 that have already defaulted) in the indices; the duration-weighted five-year spread differential between the two non-overlapping sets of credits is 162bp, with the IG 9 and IG 15 subsets having duration-weighted five-year spreads of 286bp and 124bp respectively.

Among the ten widest names in IG 9, only Alcoa remains. Further, nine non-overlapping names are trading wider than Alcoa in IG 9, whereas in IG 15 there is only one (Sallie Mae). Moreover, while neither Sallie Mae nor Alcoa is in danger of default in the near future, BarCap fundamental analysts believe at least two credits (MBIA and iStar Financial) in IG 9 face significant risks in 2011.

The BarCap credit analysts estimate that the remaining IG 9 portfolio also has about 35% greater dispersion than the IG 15 portfolio. "This means, assuming the same correlation structure, that IG 9 equity tranche spreads should represent a higher portion of the overall portfolio spread when compared with IG 15."

Consequently, they recommend two trades based on their estimates for where IG 15 tranches will trade: buy seven-year 7%-15% IG.15 protection and sell 10-year 7%-15% IG.9 protection at a 1:0.5:0.5 notional ratio; and sell three-year 0%-3% IG.15 protection and buy five-year 0%-3% IG.9 protection.

CS

RMBS

Foreclosure scrutiny

GMAC servicing issues weigh on shadow inventory

The furore over servicing issues at GMAC Mortgage (see last issue) continued this week, as Ally Financial released further details about the firm's foreclosure processes. The episode could prolong the housing recoveries for the affected US states by keeping shadow inventory outstanding for longer.

Ally Financial says that a procedural error was found to have occurred in certain affidavits required in certain states. The error is not related to the accuracy of the underlying transaction or the ultimate decision to have exercised the foreclosure proceedings, the firm adds.

"We believe that the substantive contents of the affidavits in question were factually accurate and our internal review to date has revealed no evidence of any factual misstatements concerning the details typically contained in these affidavits, such as the loan balance, its delinquency and the validity of the note and mortgage," Ally explains.

The issue involves two specific areas: signing the affidavit in the physical presence of a notary public; and signing the affidavit with direct personal knowledge of all the information stated in the affidavit rather than knowledge and reliance upon the direct personal knowledge of other personnel, agents and local foreclosure counsel. Ally believes the defects occurred in some, but not all foreclosures in the 23 impacted states.

The problem was identified and then addressed a few months ago, and the execution process has been corrected. According to Ally, the changes that were made to the internal process include: all employees with responsibility for signing documents undergoing additional education and training; issuing a more robust policy on the requirements for this process; and the number of employees performing this process being substantially increased.

"While we are exercising an abundance of caution in the review process, we are confident that the processing errors did not result in any inappropriate foreclosures. If upon further review, we discover any harm resulting from these procedural errors, we will address and rectify it promptly," Ally adds.

However, MBS analysts at Barclays Capital note that the added scrutiny is likely to further slow down the foreclosure process in these states. Severities are expected to increase as well, as a result of both longer timelines and higher legal costs of processing judicial foreclosures.

"There remains some possibility that this added scrutiny could reveal some unanticipated issues," the BarCap analysts add. "Such concerns have risen because of some recently publicised lawsuits; however, most of these can be chalked up to mistakes and do not seem to indicate a deeper issue for now."

This could be a mild positive for housing if distressed supply is curtailed in the winter months in some of these states, according to the analysts. "That said, we still expect housing to decline in the coming months and the overall lengthening of timelines to further prolong the housing recoveries for these states by keeping a lot of shadow inventory outstanding for longer."

A recent S&P report suggests that the volume of distressed US residential mortgage properties indicates that a fledgling recovery has yet to have a meaningful impact on the housing market. The agency warns that although its estimates for the time it will take to clear the supply of distressed homes on the market have declined after reaching a peak in mid-2008, the number has been rising again since autumn 2009. Indeed, it estimates that the principal balance of these distressed homes amounts to approximately US$460bn, representing nearly one-third of the non-agency RMBS market currently outstanding.

Growth of the shadow inventory is having three primary effects on the housing market, the agency states. First, low liquidation rates artificially skew the visible supply of distressed homes available for sale; second, the growing inventory exerts negative pressures on existing home prices; and finally, when the backlog clears, market home prices will adjust.

S&P estimates that the months to clear the shadow inventory for the US as a whole increased by approximately 18% between the end of 4Q09 and the end of 2Q10. For the same period, estimated months to clear also rose in each of the 20 metropolitan statistical areas included in S&P's ongoing analysis.

The agency suggests that, as at the end of 2Q10, a 40-month timeframe is necessary to clear the shadow inventory. Overall, the value of the Federal Housing Finance Agency home price index indicates that home prices fell to values 20% below their heights in early 2007. S&P concludes that prices are likely to fall further as distressed properties are sold to clear the backlog.

Meanwhile, Moody's has placed the ratings of 319 tranches from 114 deals of GMAC-serviced RMBS on review for possible downgrade, impacting US$7.6bn of securities. In addition, 462 tranches of 80 other GMAC-serviced deals remain under review for possible downgrade.

The rating action is triggered by the irregularities in GMAC Mortgage's foreclosure process. Improper affidavit preparation procedure could cause the GMAC-serviced RMBS securitisation trusts to experience higher losses, according to Moody's.

In March 2010, other GMAC transactions were placed on review in response to servicing practices that created credit concerns. The ratings of the 462 tranches totalling US$4.5bn remain on review because of the foreclosure process issues disclosed by Ally. Of these, some deals are also on watch for poor performance of the underlying collateral.

During the review period, the agency will assess the extent of the increase to foreclosure and REO timelines, effectiveness of new procedures and any financial impact to the RMBS trusts. For the FHA transaction, in addition to this information, Moody's says it will seek to identify the affected mortgages in the pool and understand HUD's position on these mortgages.

Moody's has also placed on review for possible downgrade the servicer quality ratings of GMAC Mortgage.

CS & LB

ABS

'Peripheral' Euro ABS attracts more interest

There has been a positive continuation of activity in the European ABS market over the past week, with Spanish, Portuguese and Greek deals seeing a rise in interest.

"It has been pretty good this week: there have been a couple of new issues, which may weaken the secondary prime deals slightly - but overall the ABS market is holding up pretty well," one ABS trader confirms. "We still have buying interest for the higher coupon transactions and the new deals have traded up slightly in the secondary market. In general, it has been fairly positive."

However, he suggests that the deal pipeline could have a negative impact on the secondary market. "With the relatively big UK new issue pipeline, clients have been a little less focused on secondary deals."

He warns that although this is currently calming down, a large pipeline in the future could weaken the sector. "But, for now, it is all holding up," he says.

The trader adds that the European ABS market is starting to generate more interest and - with Spanish, Portuguese and Greek deals in particular rising in trade - a change of attitude has taken place. "People are starting to look at this area of the market more and actually engage in conversation."

He goes on to say that traditionally there has been little involvement from clients in this particular part of the market, yet now there is a noticeable appeal. "Clients are now starting to consider Spanish, Portuguese and Greek deals, whereas before they stayed away, feeling it was too risky and complicated. Now that the deals have started to tighten in, people are starting to look at them more seriously."

Generally across the market, the trader says it has been a solid and industrious week for ABS. "Although the student loans market is still illiquid, it has been trading better - the senior notes especially - and along with CMBS it is also looking positive. With more clients coming in, it has been dealer-driven over the last few weeks."

LB

CLOs

Liquidation and supply to drive CLOs forward

The secondary US CLO market has been extremely active over the past week, with mezzanine paper attracting the most attention.

"The CLO market this week has been a listathon, with size, scale and numbers of people - there has been up to eight lists per day," says one CLO trader. A few liquidations that contained a lot of CLO paper have also occurred, with one including a 50-item list.

The trader continues: "Having said that, the reception has been pretty good and prices are climbing all across the board. Although triple-As have lagged, there has been activity in every part of the capital structure - the market is rallying further and further and going tighter and tighter."

He adds that the bulk of the selling has been in the mezzanine part of the capital structure, with triple-Bs and single-As attracting the most attention and rising higher. "The participation rate definitely has a heavy feel of a balance sheet focus in buying interest. Higher up the capital structure, interest has been generated from insurance companies and money managers just looking to pick up paper. The mezzanine part has seen interest from funds and the bulge bracket guys."

The trader predicts that prices will remain firm and, as the market enters the 'heavy season' of autumn, the pace of liquidation and additional buying will accelerate. "There's cash on the sidelines and, with liquidity and yields being high, liquidation and supply are definitely going to drive the CLO market forward. Deals are definitely tightening in, so going forward the metrics and catalyst for CLOs will be more and more liquidation supply."

He also points to primary activity and that real CLO issuance is now taking place. "It seems", he concludes, "like there is ample demand for triple-As - simpler, lower leverage, cleaner deals with current complied attraction to investors."

LB

ABS

Uproar over final safe harbour rule

The FDIC has approved a final rule to extend through to 31 December its securitisation safe harbour, under which all transactions or participations in process before the end of the year are permanently grandfathered under the existing terms of 12 C.F.R. Part 360.6. However, industry responses suggest that it will be difficult for bank-sponsored securitisations to occur under the rule.

American Securitization Forum executive director Tom Deutsch says: "With its action, the FDIC is seriously harming the federal government's ability to exit the US housing market and re-establish a private mortgage market. Securitisation is key to virtually every plan for reducing the role of the GSEs, including Fannie Mae and Freddie Mac, and restoring a private housing market. But the FDIC's rule placing new conditions on Safe Harbor will make it extremely difficult for new bank-sponsored securitisations to occur."

He adds: "Although some of ASF's investor members may be supportive of some of the conditions in the new rules, they are not supportive of the FDIC creating an ineffective safe harbor that will disrupt contractually scheduled repayments of their investments in the case of a bank failure."

The FDIC had previously extended the protections twice, with the last set to expire on 30 September. The final rule is substantially similar to the 11 March extension and essentially requires banks to retain 5% of any securitisations they originate in exchange for protection under the safe harbour.

Sheila Bair, FDIC chairman, comments: "This rule has been in process for nearly a year, and the industry should have no problem adjusting to it by the time the safe harbor expires at the end of the year. We want the securitisation market to come back, but in a way that is characterised by strong disclosure requirements for investors, good loan quality, accurate documentation, better oversight of servicers and incentives to assure that assets are managed in a way that maximises value for investors as a whole."

The safe harbour regulation fully conforms to the provisions of the Dodd-Frank Act, the FDIC states. Specifically, the rule provides that, upon adoption of those interagency regulations, they shall exclusively govern the risk retention requirement in the safe harbor regulation.

The CRE Finance Council has also commented on the finalised rule. On 1 July, the association filed a comment letter urging the FDIC and other financial regulators to work within the new and coordinated framework directed in the Dodd-Frank Act. This requires regulators to promulgate rules 'jointly' and 'by asset class' to ensure that securitisation reforms are coordinated and customised.

For similar reasons, the final rule was opposed by Acting Comptroller of the Currency John Walsh. The OCC, along with the Federal Reserve, SEC and FDIC, are responsible for promulgating rules related to the CMBS market.

LB

CMBS

Showdown for Innkeepers' future

Sponsors of competing reorganisation plans in the pending Innkeepers USA Trust bankruptcy case will meet on Thursday (30 September). Innkeepers, which filed for bankruptcy protection in July (see SCI issue 197), is an Apollo Investment Corp REIT that owns 73 upscale and extended-stay hotels in 19 states.

The first plan comes from Five Mile Capital and Midland Loan Services, which is the lead special servicer of Innkeepers' securitised mortgage loans. Competing with the Five Mile plan is the Apollo plan, which comes from Apollo and the bankruptcy estate of Lehman Brothers.

Moody's reports in its latest Weekly Credit Outlook that each plan will lead to losses for investors in five CMBS (LBUBS 2007-C6/C7, CSMC 2007-C1, CSMC 2007-C5, ML-CFC 2006-4 and CSFB 2005-C5) with over US$1bn of exposure to Innkeepers loans. Based on the proposed plans and portfolio values, the agency suggests that the Five Mile plan would retain more of the value of the underlying loans for the CMBS trusts than the Apollo plan would.

Innkeepers USA Trust was acquired by Apollo in June 2007 in a US$1.5bn leveraged buyout which included US$1.05bn in securitised loans, with US$825.4m funded by Lehman. The competing plans now value the hotel portfolio between US$900m and US$1bn.

According to Moody's, the Apollo plan did not include price discovery for individual hotel properties and offered limited input and feedback on the part of key creditors, such as Midland. Five Mile's alternative plan uses a stalking horse bid process, in which its proposals create a floor for a series of competitive bids from third parties. It is thought this process will help the market better gauge individual asset values and provide greater potential upside to the CMBS.

Potential drawbacks could come if a competing bid includes investors unfamiliar with the hospitality industry and a higher level of indebtedness under the Five Mile plan going forward, which will impinge on Innkeepers' ability to make timely debt payments.

JL

Real Estate

PPIP 2.0 proposed

MBS analysts at Bank of America Merrill Lynch suggest that a 'PPIP 2.0' should be included as part of the upcoming GSE reform proposal, to accompany the second round of quantitative easing (QE2). They believe a new PPIP could allow for the smooth absorption of the millions of homes expected to come onto the market in the next several years as a result of mortgage stress.

The BAML analysts say a public-private partnership funding the purchase of distressed real estate directly is needed and add that such a programme could help move 3-4 million homeowners "back to a more appropriate status as renters".

High homeownership rates reflect the fact that "many buyers never should have bought in the first place", note the analysts. They suggest a more natural level would be 62%-64%, with adjustment to that mark already underway. It is thought that US$600-US$800bn would be required to purchase the homes currently occupied by these homeowners.

The 5.5 million delinquent borrowers are put forward as candidates for the conversion to renting as modification programmes have not been able to do enough to help homeowners keep their properties. The analysts expect renting will be welcomed by many once they lose their homes and likely be "a relief".

By using the same model as the legacy securities PPIP, the analysts suggest a PPIP 2.0 framework could fund up to US$400bn worth of homes, with private capital competing for the remaining stock of distressed homes, potentially rendering that full amount unnecessary.

A select group of property management companies would fill the role that PPIP asset managers play, required to meet certain US Treasury criteria. The analysts believe this might mean the properties could not be sold within a 5-10 year period, to keep inventory off the market, while there would probably also be conditions related to public housing policy.

The analysts envision the Treasury providing up to US$100bn in equity capital, matching that raised by the property management companies. Treasury could then provide up to US$200bn in debt capital to the property managers, with equity representing 25% instead of 50%.

Considering the government's exposure to the delinquent loans through the GSEs, there is a vested interest in maximising the recovery on the ultimate sales of those homes. The analysts believe government should also participate in any profit associated with managing the financed properties, with profits used to help offset GSE losses.

As home prices are stabilised by this process, the analysts anticipate that there would be enormous benefits for the economy and employment, with the building out of the property management companies one example of where additional resources will be required.

Nuances around factors such as depreciation and deductibility would need to be considered, while funding would also be an issue, note the analysts. PPIP was funded by TARP, which expires on Sunday (3 October). They say that re-authorising similar spending "would be next to impossible" until after the election due to TARP's unpopularity.

JL

ABS

Investor caution remains in recovering market

Morrison & Foerster partners Peter Green and Jeremy Jennings-Mares discussed at a seminar the firm hosted on 23 September the outlook for, and investor confidence in, the European securitisation market.

Green began the discussion by outlining recent activity and signs of recovery in the market. "There are signs that the market is slowly recovering in some areas and, for the UK and Europe in particular, activity is picking up in the RMBS sphere."

He went on to say that last week the market saw RBS issue a large RMBS deal (SCI passim), while Lloyds and Santander had also undertaken RMBS earlier in the year. In addition to the banks highlighted by Green, Barclays is rumoured to be prepping a large transaction in the coming weeks.

However, Green noted, the RMBS market is still struggling to reach its pre-crisis high, only achieving 40% of its previous volume and with the overall ABS market significantly below that level.

Jennings-Mares also commented on RMBS marking its presence in the market, particularly with UK and Dutch deals. But he noted that supply and demand in the auto ABS sector still appears to be imbalanced. This is due, he suggested, to banks remaining cautious in lending large volumes.

"Before we start to see more adventurous deals on the table, the market has to regain investor confidence. Until then, current securitised deals will remain both small and simple," he remarked.

This theory applies to all asset classes across the market, Jennings-Mares added. "We should expect to see the structured finance market recover. Again, however, it will be the smaller and less complex deals in the pipeline until there is a competent change."

Out of all the asset classes, however, CDOs - synthetic deals in particular - will see the biggest challenge in making a meaningful recovery. This is due, Jennings-Mares continued, to the changes in derivatives markets with the coming central clearing legislation, as well as the lack of volume on the supply side.

With significant amounts of legislation coming into place over the next two years, Green discussed the effects that these legal upheavals may have on the market. "Although new legal frameworks may give uncertainty to the securitised markets at first, it will also provide a clearer landscape going forward, helping investors to structure and package transactions in a more proficient and effective way."

Jennings-Mares concluded the discussion with a highlight of the RMBS market and its focus over the coming years. "There has been a lot of funding in recent years from government schemes, which will soon be phased out. When this happens, there will be a void to fill and - with its wide distribution and increasing need - it is likely that RMBS activity will fill this gap in time to come." 

LB

Emerging Markets

Trading on trust

BTIG's London ceo Gary Hayes and Russell Scott, md and head of CEEMEA trading at the firm, answer SCI's questions

Q: How and when did your firm become involved in the structured finance markets?
GH: BTIG was growing - mostly in equities, outsourced trading and prime brokerage - and at the end of 2008 we realised there would be an opportunity to do with international equities what we were already doing in the US. It was our customers who asked us to move into that.

It was also our customers who asked us to move into what we are doing now with our agency platform in fixed income. We hired John Bass from UBS to start the fixed income business in February 2009, and we hired the best part of 70-80 people in the US. The next extension from that was to look at specific areas depending on when we could get the right people in Europe.

Q: What are your key areas of focus today?
RS: In the States on the fixed income side, the focus is on US high yield, investment grade, convertibles and emerging market fixed income products, mainly G7 based. That fits in with the natural customer base and overlap.

When the market becomes a little bit dislocated and we see these huge yield spikes and the market blows apart - as we did post-Lehman - you get equity investors looking to shop in fixed income markets that are broken. Banks do not want to add risk onto their balance sheets and, if anything, they are looking to reduce risk.

In that scenario, we get a huge cross-over of investor bases. That is why there is the desire to be in the fixed income world.

Q: Do you focus on a broad range of asset classes or only one?
RS: In the UK we see the market is broken down into pieces. The first piece is emerging market fixed income. The second would be emerging market local market products, which is not an area at the moment BTIG is looking to be involved in, but for a certain group of our core customer base that is 50% of their world.

There is also another core group of customers that overlap in and out of fixed income like marginal buyers and sellers. This would be the customer base that looks traditionally at investment grade credits, less risky assets and - in the recent past - are very much focused on bottom-up credit stories in the high yield market.

All of these are currently covered out of the US, except of course for the local products. In London, because it is the best fit for our customer base in the States, the natural fit is to do emerging markets first in London, before moving out in the future.

GH: I would say it is very important to get the right people. We look at what our customers are asking us for and then we look at who might be out there, instead of just hiring anyone.

The first thing we look at is our business model; then we look at what our customers want and at what is actually out there. When we set up in London I had an idea of what we wanted to do at certain times, but sometimes a great opportunity comes along - such as hiring a team that you know won't be available in a couple of months.

You might not want to start high yield until next year, but if a great team is available now, you might have to go for them. We react to where the market is. We have to be flexible and we think the banks cannot be as flexible as us.

Q: How do you differentiate yourself from your competitors?
GH: We have a partnership model and regional leadership. Our model gives us great flexibility.

It means that if I want to hire two people, I make one call to the partners and we can get those people hired in 24 hours. It is far more long-winded in the banks.

We are high-touch. So much of the market has gone electronic and people do not know where things are and where things are trading.

Actually having contact with human beings, people you know and trust, especially in the last two years when the market has been in turmoil, makes a huge difference. Do you want to put an order in to a machine or do you want to go to a professional?

RS: From a drilled-in fixed income trading perspective, the relative sizes in the market of the sell-side and the buy-side have completely flipped. We are a middle-man, with straight retail to our customers. We should know what our customers are doing.

One thing with the emerging market franchise is because we are only doing emerging markets fixed income credit at the moment we can be far more specific. The sales team is not trying to sell EM FX options and EM local markets to the same customers at the same time.

We are very much specialised in the asset classes that we are trading. The person who a customer deals with is a professional and a specialist in what they are doing.

All the little touches make the difference. The little things we do help speed orders through.

GH: Potentially banks are going to have their positioning limits on their market-making desks squeezed by the Volcker ruling, so there is no proprietary activity there. That helps us to provide a better service to customers, relative to the competition.

RS: However, we are not trying to compete with the banks; we are offering another service. We are trying to trade within the bid-offer spread, end-customer to end-customer, where you do not get these big lumpy moves within the market.

GH: If you give your customers options, then they tend to feel like you are working with them. That has been the ethos at BTIG; we try to do what the customers ask us.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
GH: What happened 18 months ago provided a real challenge. People have set up businesses in reaction to what happened in world markets, but world markets seem to have come back so quickly. There were spaces for us to operate in, but the banks have rebounded quicker than anybody thought and not that many of them went to the wall.

RS: One of the hard things is always getting good, quality talent. You can always put bodies in seats, but what you want is quality.

The other thing is individuals' views of the market. There is a double-dip scenario, which is bad for the man on the street but could be revenue-enhancing for banks. Volatility is dropping, which in my mind means it will have to pick up at some point in the future.

If there really is going to be a job cull, we hope it will not be because we have gone through a reasonably low volatility spell now and people think they can trim their workforce.

GH: There are lots of opportunities still to come, whether it is with the Asian economies or emerging European economies and the like. The market is in a slow spot right now, but things will pick up, and good people are still very much in demand.

Q: What major developments do you need/expect from the market in the future?
RS: From a personal perspective, I want markets to perform well. In emerging markets there is a large amount of in-flow of recycled dollars coming in from government agencies and central banks. That money is going to keep coming in to the better economies, such as the ones exporting to China.

That emerging market story is not going to go away, but there will be more credit differentiation. There will be relative changes between the different credits. People will tend to expand more and more and the knowledge base will become more specialised. In a rising tide, not all boats rise.

The markets are going to be much more credit intensive, which requires a lot more knowledge and skill. It may be what we had in 2006 and 2007, when the market had a huge bull run up.

GH: We think emerging markets is a place to be. It is something we have invested time and effort in within fixed income and equities, and we certainly think it is going to be a way to drive revenues.

But, once again, our customers want us to be in this space and that is why we are. They want to deal with people they know and they trust.

JL

ABS

Renewables SF group formed

SPG Solar has formed a structured finance group to offer its clients financial resources on public funding and tax credit opportunities for commercial solar projects.

The SF group will provide access to the private and public funding needed to make solar projects economically viable and a sound investment for the long-term. It will also offer its customers: access to power purchase agreements; debt and equity investment; operating and capital lease arrangements; and participation in renewable energy funds.

The group will be headed by Michael Johnson, former md of the renewable energy investment programme for the National Development Council. Johnson joined SPG Solar as vp of project finance in June 2010.

ABS

Investment manager adds partner

Titan Capital Group has appointed Keith Danko as partner. He will work closely with Titan founder Russell Abrams with a particular focus on business development and assist in the overall management of the firm. Danko is based in Titan's New York headquarters.

Danko joins Titan from London-based alternative investment firm CQS, where he served as chief executive of the firm's US operations for the past three years. Prior to CQS, he was for five years the chief executive and cio of ACAM Advisors, a firm specialising in funds of hedge funds, where he also managed the ACAM ACES hedge fund.

ABS

Trio joins new EM platform

Lazard Asset Management has added a new debt capability to its emerging market platform. Denise Simon, Arif Joshi and George Varino are to launch and manage the firm's emerging market fixed income strategies group.

Based in New York, Simon and Joshi will serve as co-lead portfolio managers and Varino as client portfolio manager. Additionally, three research analysts will join the group at Lazard shortly.

All three have joined Lazard from HSBC Asset Management. The team will focus on exploiting cyclical and structural trends, utilising the full spectrum of emerging market debt asset categories, including hard currency, local currency, corporate and securitised debt, and derivatives.

ABS

Bank strengthens fixed income sales

Ally Financial has appointed former JVB Financial vp, Robert Clark, to its institutional fixed income sales business. Clark will report to Jeff Gravelle, svp of the firm.

With an institutional sales background, Clark has previously worked for various bulge bracket and boutique firms in the industry.

ABS

ABL acquisition completed

The KBC group is selling its asset-based lending (ABL) division, KBC Business Capital, to a wholly owned subsidiary of The PNC Financial Services Group. The transaction is expected to be completed in 4Q10.

KBC Business Capital is a provider of ABL solutions to UK companies across a range of sectors, with 21 staff operating from London and four offices throughout the UK. PNC has assets of US$262bn and has been in the US ABL business for nearly 15 years, managing more than US$20bn in loan commitments. It operates 30 ABL offices across the US and Canada.

Asia

Bank adds Asian fixed income head

Nomura has appointed Rig Karkhanis as head of its fixed income group in Singapore. In this newly-created role, Karkhanis will enhance the firm's fixed income business, which provides its clients in Asia ex-Japan with solutions across foreign exchange, interest rates, credit and commodities, the firm says.

Karkhanis was previously a portfolio manager at Millennium Partners in Singapore. Prior to this, he was head of rates and currencies sales & trading for Asia Pacific Rim at Merrill Lynch.

CDS

Bank names global credit trading head

HSBC has appointed Niall Cameron as global head of credit trading, a role in which he will drive the group's global strategy for delivering technology solutions to its clients. Based in London, Cameron starts at the bank in December 2010 and will report to Samir Assaf, head of global markets.

Cameron joins HSBC from Markit Group, where he was global co-head of equities, indices, commodities, risk management and economics. Prior to this, he was global head of traded markets at ABN AMRO, responsible for the bank's trading, sales and research businesses in fixed income, equities and foreign exchange.

CDS

Lehman-backed structured product fines levied

The UK FSA has fined one firm and two individuals for failures in relation to the sale of Lehman Brothers-backed structured products between November 2007 and August 2008.

Dundee-based law firm Thorntons Law, which provides investment advice to customers under the brand name 'Thorntons Investment Services', has been fined £35,000, with a separate fine of £10,500 for one of its partners, Michael Royden. A third fine of £28,000 has been given to Robert Peter Yarr at McClelland Yarr Financial Services.

This enforcement action comes following an FSA review of the marketing and distribution of structured products, particularly those backed by Lehman Brothers, concluded in October 2009.

The FSA found that, in relation to its sales of Lehman-backed structured products, Thorntons did not give suitable advice to its customers in some cases. Further, Royden, the partner at Thorntons responsible for compliance oversight, had no financial services experience prior to taking responsibility for Thorntons Investment Services.

In particular, Royden failed to adequately inform himself about Lehman-backed structured products prior to Lehmans' insolvency, according to the FSA. He also delegated day-to-day compliance tasks to another person and failed to put in place adequate systems and controls to collate management information about Lehman-backed structured products.

The FSA has also found that not only did Yarr not fully understand and warn customers of the counterparty risk associated with structured products, he also failed to keep adequate records, conduct product research and ensure sufficient compliance oversight and management at the firm.

Thorntons, Royden and Yarr cooperated fully with the FSA investigations. They agreed to provide redress where appropriate and also settled at an early stage, qualifying for a 30% discount.

CDS

Dealer derivatives clearing group formed

Bank of America Merrill Lynch has formed a global futures and derivatives clearing services (GFDCS) group. This global initiative is in anticipation of the substantial growth in OTC derivatives clearing and the demand for education and related services from the firm's institutional investor and corporate clients.

GFDCS builds off the company's futures business to provide agent-clearing services for rates, currencies, credit, equities and commodities derivatives. It will operate as part of BAML's industry-leading global markets financing and futures (GMF&F) platform.

Bob Burke and Gonzalo Chocano have been named co-heads of the GFDCS group, reporting to Denis Manelski and Syl Chackman, co-heads of GMF&F.

CLOs

Primus divests CLO subsidiary

Primus Guaranty is to sell CypressTree Investment Management, its third-party asset management subsidiary that it acquired in July 2009 (see SCI issue 145), to Commercial Industrial Finance Corp (CIFC). Terms of the transaction were not disclosed.

CypressTree manages or sub-advises approximately US$2.8bn of high yield and leveraged loan assets in eight CLOs - Primus CLO I and II, and Hewett's Island CLO I-R, II, III, IV, V and VI. The collateral management contracts for the eight CLOs will be included in the sale. A total rate of return swap and a CSO managed by CypressTree also will be included in the sale.

CIFC manages US$3.6bn in assets across seven CLOs. The firm's team of 15 investment professionals averages 17 years of experience and is led by Peter Gleysteen, ceo.

"The divestiture of CypressTree is part of our previously announced plan to focus on managing and preserving the value of our credit protection business in amortisation," comments Thomas Jasper, Primus Guaranty's ceo. "While CLO management is no longer a core business for Primus, CIFC's talent, experience and track record helps to ensure that our CLOs and CLO investors remain in the hands of one of the premier credit investment firms."

Gleysteen stays: "We are pleased to add the CypressTree business to our existing platform. With this transaction, CIFC will have over US$6bn in assets under management and we believe that the additional scale and our leading track record will be beneficial to all debt and equity investors in the CypressTree, Primus and CIFC CLOs."

Berkshire Capital Securities acted as advisor to Primus on the sale of the CLO business (SCI passim).

CMBS

HPI enhances investor report transparency

Hatfield Philips International (HPI) has begun offering investors access to investor reports from its website, with the aim of providing both its clients and the market with a greater level of accessibility and transparency across all types of real estate transactions.

In addition to downloadable investor reports, HPI is publishing its primary and special servicing portfolio performance statistics. Mike Brown, director at the firm, says: "Allowing investors to access individual loan performance, as well as enabling them to compare that to the company's total 'benchmark performance', provides a powerful tool to judge portfolio and relative performance of assets in a market where information is king."

Distressed assets

Distressed trading head named

Jefferies has appointed Peter Santry as md and head of distressed trading in its leveraged finance sales and trading division. In this new role, Santry will manage the firm's distressed and special situations trading effort, which includes corporate bonds, leveraged loans, special situations and other distressed securities.

Santry joins Jefferies from Chapdelaine & Company, where he was head of leveraged products, building a high yield, bank loan and distressed debt trading business. Previously, he spent 14 years at Banc of America Securities, most recently as md and head of the global special situations group.

Distressed assets

Lehman chapter 11 progress outlined

Alvarez & Marsal last week presented its State of the Estate report on the chapter 11 cases of Lehman Brothers Holdings Inc and its affiliated debtors. The timeline for plan confirmation, the claims reconciliation process and recovery analysis were all outlined.

In terms of the plan confirmation timeline, the debtors intend to file an amended disclosure statement in 4Q10 and are targeting 1Q11 for confirmation of a plan of reorganisation. Approximately US$1.2trn in general unsecured claims were initially filed against the debtors. To date, adjusted outstanding claims stand at US$464bn and the debtors are currently estimating allowed general unsecured claims of US$365bn.

In terms of recoveries, the debtors currently estimate that assets available for distribution will be US$57.5bn, an increase of US$2.2bn from earlier this year. According to Schulte Roth & Zabel, the increase is primarily due to derivatives recoveries, up by US$850m since A&M presented its last report.

Investors

Hires made as manager preps new strategies

TCP Global Investment Management has appointed David Vuchinich as cio and Greg Jacobs as md in its fixed income absolute return strategies group.

Brad Goldman, md, fixed income sales and marketing at TCP Global, says: "The addition of this highly experienced investment team also reaffirms our commitment to our client-first culture and complements our core fixed income team, comprised of Gerald Thunelius, Michael Allen and Martin Fetherston. David's appointment is very timely as we are also poised to launch a variety of additional fixed income strategies, including absolute return, high yield, distressed debt, special situations, global macro bond and/currency as well as emerging market products."

Vuchinich has over 20 years of broad fixed income investment experience in managing core, core plus and other fixed income strategies. Most recently, he was director of fixed income at Seminole Financial. Prior to this, he was a senior portfolio manager of fixed income strategies at ING Investment Management.

Jacobs, who will report to Vuchinich, has 15 years of fixed income management experience and was previously a member of the fixed income team at ING Investment Management.

Investors

Credit fund's early redemption period reduced

Third Avenue Management has announced that the holding period for shares of Third Avenue Focused Credit Fund subject to early redemption fees will be reduced from one year to 60 days, effective from 1 October.

David Barse, chief executive of Third Avenue Management, explains: "Given the success we have had in raising significant assets within one year of its launch, the fund is now large enough to reduce the holding period from one year to 60 days, to align it with all of the other Third Avenue funds."

He adds: "Jeff Gary and Tom Lapointe, co-managers of the Focused Credit Fund, have diligently managed the fund's composition, maturity and duration to ensure adequate liquidity and are comfortable with the fund's asset size and stability of the portfolio. We continue to focus on clients with longer-term investment horizons and have determined that the 60-day holding period is sufficient to discourage short-term trading, while enabling Jeff and Tom to manage the portfolio in accordance with the fund's investment objective."

An early redemption fee of 2% will continue to be imposed on fund shares redeemed within less than 60 days from date of purchase, in order to discourage short-term trading.

Operations

Acquisition set to boost risk services

Wolters Kluwer Financial Services is to acquire FRSGlobal from The Carlyle Group and growth equity investor Kennet Partners. The acquisition will enable Wolters Kluwer to offer financial organisations comprehensive compliance and risk solutions that cover operational, compliance and financial risk and reporting.

"The financial crisis, globalisation and increasing regulatory scrutiny have created a complex and challenging environment for financial organisations," says Brian Longe, ceo of Wolters Kluwer Financial & Compliance Services. "Financial organisations are requiring intelligent and comprehensive solutions and services to help them address the complexities of a rapidly evolving regulatory environment."

Steve Husk and Serge Minne will join Wolters Kluwer and continue to lead FRSGlobal.

Operations

Operational risk vet hired

The DTCC has appointed Andrew Leonard as md and head of its operational risk group. In this new position, Leonard will report directly to Donald Donahue, the firm's chairman and ceo.

Leonard has over 25 years of experience leading operational risk, regulatory compliance and auditing. Most recently, he served as svp and head of operational risk for Fannie Mae. Prior to this, he held senior roles with both Wachovia Bank and Goldman Sachs.

Donahue adds: "Andy will play a key role in helping us transform DTCC in how we think about risk, how we manage it and how we achieve 'best in class' risk capabilities to protect DTCC - and the industry."

Over the past several months, DTCC has been working with Ernst & Young to craft a detailed vision of the enhanced operational risk capabilities that it is looking to implement. The new programme will serve as a road map for the company and Leonard will have primary responsibility for guiding the execution of the plan.

Operations

Risk programme leader named

AMX International has appointed Steve Lindo to lead its banking and asset management enterprise risk management programme, which aims to facilitate the protection of directors by providing an understanding of major risk. It also helps directors to engage in the independent validation of senior executive claims that is required by business judgment rules, the firm says.

Lindo has over 25 years of experience in managing risks in portfolios comprising of fixed income, derivatives, high yield debt, sovereign debt, CMBS and RMBS. He recently completed a two-year engagement as ceo of The Professional Risk Managers' International Association.

Real Estate

German bad bank transfer due

€191.1bn of Hypo Real Estate's assets is scheduled to be transferred into the new German bad bank, FMS Wertmanagement, by 30 September. The figure is lower than the original estimate of up to €210bn.

The bad bank will have equity of up to €3.87bn, with new capital of €2.08bn set to be transferred imminently, according to credit analysts at RBS. Overall, the funds provided by SoFFin to HRE will amount to €9.95bn.

SoFFin has confirmed that "loans, securities and derivatives" will be transferred, but it remains unclear exactly which assets this refers to. The bad bank is nonetheless tasked with the "value preserving liquidation" of the portfolio.

European asset-backed analysts at RBS suggest the process demonstrates that any offer-side volumes from legacy risk holders remain sensitive to recoverable values, which in turn makes the asset overhang look less threatening. "Notwithstanding the pick-up in secondary BWIC activity over recent days, we have been surprised by the lack of selling into the recent market strength, which in turn leads us to re-think our previously held view that ABS prices may have a soft ceiling based on the reference levels of the 2008 IAS 39 banking book exercise - levels which have been decisively tested in recent weeks," they note.

RMBS

Global bond fund launched

ING Investment Management Americas has launched the ING Global Bond Collective Trust Fund, which aims to provide institutional investors with a proven and broadly diversified strategy to global fixed income investing. The strategy is based on an approach to global fixed income markets that the firm has overseen since 2006 that combines fundamental and quantitative analysis in seeking out opportunities in more than 20 countries.

"Institutional investors are increasingly recognizing global bonds as a way to diversify their portfolios and as a source of alpha," says Erica Evans, svp and head of the US institutional business at ING Investment Management. "Historically, global bonds have provided investors with non-correlated returns that help smooth out portfolio performance and improve returns. We believe that there will be considerable opportunity in global bonds over the next years and that this asset class will continue to provide favourable results over a market cycle."

The new fund seeks to outperform the Barclays Capital Global Aggregate Bond Index by investing in a wide range of debt securities, including MBS. The strategy employs three main tools to generate excess returns: duration and yield curve, active currency management and broad sector rotation.

RMBS

Ex-Fannie Mae trader joins advisory

The Collingwood Group has recruited Mary Lou Christy as svp. Prior to joining the firm, Christy served as svp of investor relations for Fannie Mae. During her 24-year career at the company, she also led the MBS trading desk and served as vp of sales and marketing in the southwestern region.

"We are delighted to have Mary Lou Christy join The Collingwood Group team," comments Brian O'Reilly, president and md of The Collingwood Group. "Her experience will be invaluable as we seek to increase the range and depth of services that we provide our clients. She will play an important role in the firm's growing practice in support of private equity firms and hedge funds that seek assistance from proven industry professionals with Washington experience."

RMBS

Asset management strengthened for GSE MBS

State Street Global Advisors (SSgA) has appointed investment manager Smith Graham & Co to help provide asset management services for the US Treasury's MBS purchase programme. Smith Graham will assist with portfolio analysis and reporting, while helping to develop cashflow projections, conduct stress-testing scenarios and assess risks to the portfolio.

As a financial agent of the Treasury, SSgA manages a portfolio of approximately US$180bn in GSE MBS issued by Fannie Mae and Freddie Mac. Under the Housing and Economic Recovery Act of 2008, the Treasury was granted authority to purchase GSE securities to provide stability to the financial and housing markets.

ABS

Basel 2 implementation analysed

A survey conducted by the Financial Stability Institute (FSI) on the Basel 2 implementation in 2004 and updates in 2006, 2008 and 2010 indicates that 112 countries - out of 133 jurisdictions surveyed - have implemented or are currently planning to implement the standard. This is compared to 106 countries in the 2008 survey.

The survey shows that the standardised approach is the most commonly used of the three credit risk methodologies. The foundation internal ratings based approach will be implemented by 65 jurisdictions - compared to 72 in the 2008 survey. 61 respondents - compared to 69 in 2008 - intend to offer the advanced internal ratings based approach.

The 2010 survey indicates that the basic indicator approach for operational risk is expected to be the most widely employed - by 90 respondents adopting Basel 2 - followed by the standardised approach and by advanced measurement approaches.

The results of the 2010 survey reinforce the conclusion that Basel 2 will be implemented widely around the world, the FSI notes.

ABS

Pre-emptive funding channels recommended

Debt finance for M&A activity is available to companies with pre-emptive funding strategies, according to Bishopsfield Capital Partners. The firm recommends that in the current environment corporates shift their focus away from cost of funding and develop other financing objectives, including strong liquidity management, diversification of funding instruments, internationalisation of funding relationships and frequent credit access.

"The recent acceleration in M&A activity indicates underlying business confidence, yet many corporates are held back by a perception that funding channels are closed. In our experience this is not the case for companies with proactive funding strategies," comments Mike Nawas, partner of Bishopsfield Capital Partners.

S&P this week underlined the increased importance of capital markets in debt funding, as banks continue to cut their term funding and syndicated lending investors remain scarce. However, Bishopsfield Capital Partners maintains that companies with funding relationships and facilities in place can pursue M&A opportunities - particularly with reduced competition from financial sponsors.

"Debt funding for financial sponsors - who drove M&A activity 2001-2007 - is no longer available and new Basel 3 capital requirement rules will not improve this situation. In such a market, there will be pockets of depressed valuations where companies may find attractive opportunities for their M&A agenda," continues Nawas.

The move by corporates away from a reliance on bank financing towards a diversification of capital sources is not wholly a result of the banking sector's own reduced exposure, however. "Cfos have been shocked by the volatility in the financial markets and many have experienced for the first time how dangerous their traditional over-reliance on bank or bank-backed funding can be for the continuity of their company," concludes Steve Curry, partner of Bishopsfield Capital Partners.

ABS

Positive trends for US auto ABS

Year-over-year (YOY) US prime auto delinquencies are down by 33%, boding well for auto loan ABS, according to Fitch. This comes even as prime losses and delinquencies tick up slightly in August from July - consistent with seasonal trends.

Prime auto delinquencies increased by 1bp to 0.57% from 0.56% in July. The rate is 33% lower than August 2009 and represents the tenth consecutive month of YOY declines. Additionally, annualised net losses (ANL) dropped by 54% in August from the prior year, despite marginal deterioration from July's statistics.

"With wholesale vehicle values likely to remain strong near-term, delinquencies have become the statistic to watch," says director Ben Tano. However, he adds: "The direction of both delinquencies and loss severities will be pivotal in the coming months as there is still significant strain on the US economy."

Subprime 60+ day delinquencies decreased in August to 3.11% - 5.8% lower than in July and 30.1% lower from one year prior. Subprime ANL rose by 6.8% in August month-over-month to 5.51% and were 32.1% below 2009 numbers. This represents the tenth consecutive month of annual declines.

Rating actions through August 2010 improved notably, with 38 upgrades and one downgrade - compared to 10 upgrades and 20 downgrades for the same period in 2009. Fitch's outlook for prime and subprime auto loan ABS ratings performance remains stable in 2010. This is primarily due to improvements in underwriting in the 2009 and 2010 vintages and support of structural features present in transactions.

ABS

Higher losses for rehabilitated FFELP loans

Moody's has commented on the performance of rehabilitated FFELP student loans, indicating that these student loan pools will display higher net loss rates compared with the non-rehabilitated loans. Based on this, the agency has changed its loss assumptions rating method, applying a higher cumulative default rate and a more front-loaded default timing curve.

The agency expects the performance of the rehabilitated FFELP loans to differ from other FFELP loans; namely, the cumulative default rate on rehabilitated loan pools to range from 30% to 40%. It also expects net rejection, voluntary prepayment, and deferment and forbearance rates to be similar to or lower than the non-rehabilitated loans.

"Higher defaults hurt transactions that rely on excess spread as a source of credit enhancement by shortening the life of the transaction, but benefit transactions that generate negative excess spread," says Moody's analyst Pedro Sancholuz Ruda.

ABS

SLABS ARS exposure reviewed

Fitch is to review US FFELP student loan ABS transactions with auction-rate securities. As part of its review, the agency will apply its updated surveillance criteria with a more refined approach to basis risk, also limiting the extent to which ARS can mitigate basis risk.

The potential rating implications on most triple-A senior bonds are likely to remain stable as they benefit from parity of 103% or more, with an increasing parity trend. Fitch may downgrade some triple-A senior bonds that contain no significant credit enhancement build up. The downgrades may be one or two rating categories, depending on the cost structure of the transaction and other factors.

Subordinate bonds with ratings between triple-A and single-A, containing no overcollateralisation from transactions that release excess spread will be the most negatively affected. The agency will likely downgrade these ratings to triple-B or below.

Ratings on bonds benefiting from overcollateralisation that cannot be released are expected to range from triple-A to triple-B, depending on the level of overcollateralisation as well as other factors. Bonds with parity of less than 100% are also at risk for downgrade - to as low as single-B. However, the extent of downgrades from current rating levels may be tempered, as many ratings were downgraded in prior reviews.

Implications for ARS begin when analysing FFELP student loan ABS transactions. Most ARS cap their interest rate at the net loan rate and will proportionately reduce the downside risk from basis risk volatility and will have a positive impact on performance.

Basis risk exposure is completely eliminated for transactions consisting of 100% ARS with a net loan rate cap. This benefit is especially relevant when the bond parity is above 100%, as the risk of parity declining below 100% is reduced.

ABS

Japanese consumer ABS criteria explained

S&P has published a report to help market participants better understand its approach to rating Japanese credit card receivables and consumer loans ABS transactions. The agency says the report aims to introduce a benchmark pool concept to Japanese credit card receivables and consumer loans ABS, which currently assumes a default rate of 9.5%-10.5% as a base case.

The criteria will also facilitate the global comparability of its ratings and explain the factors that lead to differences between US credit card ABS criteria, S&P explains. These factors include: the profile of benchmark pools, portfolio yield and payment rate assumptions, and the analysis of Japan-specific 'gray zone' interests.

CDO

CDO name-changes announced

A couple of CDO managers have announced changes to the names of some of their deals.

The Carlyle Group has renamed seven Stanfield CLOs to reflect its recent purchase of them (SCI passim). Stanfield Arnage CLO becomes Carlyle Arnage CLO, with the Vantage, Azure, McLaren, Daytona, Modena and Veyron transactions also adopting the new moniker.

Finally, Katonah VI has been renamed Essex Park CDO with immediate effect.

CDO

Updated criteria for hybrid CDOs

S&P has updated its assumptions for rating global CDOs backed by Trups, surplus notes and other hybrid securities issued by banks, insurance companies, REITs and homebuilders.

The changes are intended to effectively cap CDO liability ratings at single-A plus for transactions that depend heavily on hybrid assets rated double-B plus or lower. These criteria are effective immediately for all new and existing CDO transactions backed by hybrid securities, the agency notes.

S&P credit analyst Alfredo De Diego Arozamena says: "The ratings cap reflects our belief that under conditions of extreme stress commensurate with our triple-A rating scenarios and severe stress commensurate with our double-A rating scenarios. All such speculative-grade hybrid securities typically will be highly correlated and will defer making payments - irrespective of the industry of the issuing entity."

He adds: "Following the criteria update, we placed our ratings on 14 tranches from eight transactions on credit watch with negative implications pending our review."

CDPCs

CDPC debt ratings upgraded on commutation

Moody's has upgraded the senior subordinated debt ratings of Athilon Capital Corp from Caa2 to B3. The move affects US$350m of debt.

The key driver behind the rating actions was the commutation on 17 September of a CDS on an ABS CDO, against which Athilon had written protection. Athilon and the protection buyer of the ABS CDO have agreed on a termination payment that was paid at the time of execution of the commutation.

Based on Moody's analysis, the positive effect of the commutation outweighs the deterioration in credit quality of Athilon's remaining CDS portfolio. The termination payment is significantly less than the potential future credit protection obligation for the CDS on this ABS CDO. Additionally, the commutation reduces the uncertainty surrounding the amount of this future obligation.

CDS

Senior versus sub iTraxx trade touted

Approximately half of existing bank Tier 2 bonds could disappear over the next five years if the current Basel proposals are implemented, according to Goldman Sachs credit analysts. Existing Tier 2 subordinated bonds should continue to benefit from the likelihood that they will be either called, tendered or exchanged as banks reshape their capital structures.

New Tier 2 instruments are not expected to be deliverable into CDS contracts because of the write-down features required to qualify as regulatory capital under the new Basel proposals. This might leave senior bonds as the only remaining deliverables in some cases, which should narrow the spread differential between financial senior and subordinated CDS.

The Goldman analysts consequently suggest selling protection on the Markit iTraxx Sub Financials versus iTraxx Senior Financials at a 1:1 ratio, on the view that the gap between the indices will narrow from the current 71bp differential. They identify spread volatility, regulatory uncertainty and the substitution effect from new issuance and potential risks to the trade.

The strategy has positive beta to the market, which means a general rally in spreads will help sub outperform senior, but further volatility in sovereigns, for example, will generate volatility for the trade. Although the sub-senior spread differential has spiked above 100bp three times in two years, it is believed that the risk of a comparable spike is now smaller.

CDS

CEF derivatives use continues to evolve

Fitch reports that many US closed-end funds (CEFs) continue to utilise traditional forms of cash-funded leverage such as bank loans, debt or preferred stock in order to enhance yields and returns for their common shareholders. Additionally, CEFs may also utilise various types of derivatives to meet their investment objectives, either for purposes of hedging or as means to more efficiently achieve return and leverage targets, the agency notes.

As of 30 July 2010, 416 leveraged CEFs in the US had issued US$55.4bn of cash-funded leverage against US$180.4bn in assets under management. Additionally, 71 Fitch-rated CEFs had utilised US$4.7bn in notional of derivatives as an alternative to cash-funded leverage and, to a lesser extent, for hedging purposes.

While leverage strategies enhance equity returns in favourable markets, it may also amplify the downside risk to debt, preferred and common stock investors in less favourable markets, the agency notes. Current regulatory requirements for derivatives vary, however, and may not appropriately capture the potential for increased off-balance sheet leverage.

Fitch says it believes that derivatives can be an effective tool for CEFs to manage existing risks and/or take on new risk exposures - provided that the marginal risk contribution is appropriately identified and measured. Further, the agency expects that use of cash-funded leverage and derivatives by CEFs will continue to evolve and, as such, will remain an important consideration for investors in CEFs, affecting their return and risk profiles.

Regardless of the form that fund leverage takes, Fitch says that it seeks to account for the risk to fund investors. For derivatives, it seeks to recognise any additional economic leverage by 'grossing up' the CEF balance sheet, while also taking into account potential differences in the price volatility of the reference assets. Conversely, hedges are viewed as a reduction in the overall risk profile of CEFs, to the extent the hedge is well-matched, the agency concludes.

CDS

Derivatives trading volumes fall again

In its quarterly report on bank trading and derivatives activities, the Office of the Comptroller of the Currency (OCC) indicates that commercial banks reported trading revenues of US$6.6bn in 2Q10. This is 28% higher than in 2Q09, yet still 20% lower than in 1Q10.

"It is normal to see trading revenues drop in the second quarter of the year," says Dave Wilson, deputy comptroller for credit and market risk. "In addition to the normal seasonal decline in revenues we expected to see, client demand fell under the weight of uncertainty about global economic growth and sovereign credit risks."

The OCC reports that net current credit exposure (NCCE) increased by US$38bn, or 11%, to US$397bn this quarter. NCCE peaked at US$800bn at the end of 2008, at the height of the credit crisis, and had declined for five consecutive quarters until the increase this quarter.

Wilson adds: "The flight-to-quality resulting from European credit concerns earlier this summer caused a sharp decline in interest rates, which led to a very significant increase in receivables from interest rate contracts. If not for a material increase in netting benefit percentage, the NCCE increase would have been much larger."

The netting benefit percentage increased from 91% to 91.9%, a new record, the OCC confirms. The report shows that the notional amount of derivatives held by insured US commercial banks increased by US$6.9trn, or 3.2% in the second quarter to US$223.4trn.

The report also notes that derivatives contracts are concentrated in a small number of institutions. The largest five banks hold 96% of the total notional amount of derivatives, while the largest 25 banks hold nearly 100%.

CDS is the dominant product in the credit derivatives market, representing 97% of total credit derivatives. The number of commercial banks holding derivatives increased by 14 in the quarter to 1,064, the OCC notes.

CDS

Credit events to be determined

ISDA's Japan Determinations Committee is deliberating on whether a bankruptcy credit event occurred with respect to Takefuji Corporation. The move comes after the company filed for bankruptcy with Y433.6bn in debts.

Meanwhile, Barclays Capital has requested that ISDA's Americas Determinations Committee rule on whether a bankruptcy credit event occurred with respect to Blockbuster Inc. This follows Blockbuster's filing of a voluntary petition in the US Bankruptcy Court in the Southern District of New York on 23 September.

The Americas DC is also deliberating on whether a succession event occurred with respect to XL Capital, pursuant to a Scheme of Arrangement dated 1 March 2010.

CDS

CDS PD product launched

Moody's Analytics has launched its CDS-implied EDF (expected default frequency) product, available through its CreditEdge Plus platform. The new product assists risk managers and investors by leveraging CDS market information to accurately estimate probability of default, according to the firm.

With the release of CDS-implied EDF credit metrics, probability of default measures are now available on entities with CDS contracts, such as sovereigns, local governments, subsidiaries of public firms and large private companies. "For entities with CDS contracts, this new data provides a more reliable probability of default measure than CDS spreads alone, and for publicly listed companies it provides an additional measure of default risk," says David Hamilton, Moody's quantitative research senior director.

"CDS spreads are often used as a proxy for default risk, yet can markedly distort the probability of an entity defaulting on its debt repayments," Hamilton notes. Further, CDS-implied EDF measures filter out factors such as regional and sector risk premia, loss-given default assumptions and the market price of risk to provide a more accurate gauge of risk.

The new measures can also be incorporated into internal risk ratings systems and required economic capital calculations and loss provisioning levels, as well as aiding compliance with Basel 2 and other regulations, Moody's notes.

CLOs

Review shows limited use of CDO buckets

A new report published by S&P indicates that most US collateral managers have not fully utilised the CDO buckets in their CLO transactions. The finding is based on a review of the agency's CDO collateral database.

The report suggests that only 327 CLOs, representing 52% of the US CLOs rated by S&P, hold CDO notes in their collateral portfolios. Of the 327 CLOs that do currently invest in CDO notes, 66% had exposures totalling less than 3% of their total portfolio assets. Furthermore, only nine CLOs have CDO exposures representing more than 10% of their asset portfolios, the agency reports.

Other observations from the report show that, to date, managers have predominantly used the CDO buckets to invest in other CLO notes. In fact, non-CLO notes represent less than 5% of the aggregate CDO exposure within these CLOs.

S&P also examined the composition of CLO holdings to assess whether the portfolios currently include other CLOs managed by the transaction's current collateral manager, or arranged by the same investment bank that sponsored the transaction. Only 43 CLOs, representing 13.15% of the 327 CLOs holding CDO notes, invest in other CLOs managed by the transaction's current collateral manager.

The positions currently range from 0.07% of the portfolio to 9.34%. 136 CLOs, representing 41.59% of the 327 CLOs holding CLO notes, currently invest in CLOs arranged by the same investment bank that sponsored the transaction, the agency notes.

CLOs

CLOs expected to smooth loan maturity curve

CLO transactions could play a role in refinancing the wave of US leveraged loan maturities over the next four years, S&P believes. The agency expects regulatory reform to spark investor demand for new US CLO issuances, with performance and transparency providing fertile ground.

"In our view, existing CLOs may help smooth out the maturity curve by utilising their reinvestment capacity to purchase additional corporate loans and potentially by extending the maturities of the existing underlying loans in their portfolios," says S&P credit analyst Robert Chiriani.

He adds: "We also believe that CLOs' continued strong performance, combined with transparency initiatives driven by changes in the US regulatory landscape, may lead to resurgence in investor demand for new CLOs."

If new CLOs do come to market, S&P concludes, they have the potential to refinance a significant portion of maturing US leveraged loans - allowing issuers to acquire collateral with longer maturities.

CLOs

German balance sheet CLOs stabilising

The performance of 12 Fitch-rated German balance sheet CLOs appears to be stabilising. This trend, the agency notes, corresponds to the improving economic environment in Germany this year.

Although Fitch has observed new defaults in almost all 12 transactions since the beginning of 2010, the extent of such deterioration has been moderate. Average new defaults have amounted to 0.4% of the maximum pool balance, with new defaults in only two transactions reaching 1.1% of the maximum pool balance (SMART SME CLO 2006-1 and PROMISE-I Mobility 2005-2). One transaction - RUEGENS EINS - has not yet experienced defaults in the current year.

Additionally, in seven of the 12 transactions, the proportion of performing borrowers with very weak creditworthiness has remained stable or even decreased. In the remaining five transactions, the lowest-rated performing bucket has generally only moderately increased, with the exception of PROMISE XXS-2006-1. On average, the lowest-rated performing bucket is 2.3% of the maximum portfolio notional.

The PROMISE-I Mobility group of transactions strongly deviates from this average, however. Although the lowest-rated performing bucket in these transactions has decreased in 2010 from 2009, its level remains particularly high compared to other German balance sheet CLOs.

Based on the above observations, the agency believes that the performance of German balance sheet transactions is becoming stable, after deteriorating in 2009. However, the ratings of most of the notes in these transactions currently carry negative outlooks, reflecting the agency's concerns over near-term performance in Germany's current volatile recovery environment.

CMBS

Latest US CMBS signals conduit re-emergence

Some US$10bn of new US CMBS debt is expected to be sold to investors this year, with JPMorgan, Goldman Sachs, Wells Fargo, Bank of America and Morgan Stanley among the banks rebuilding their conduit operations. The US$1.1bn J.P. Morgan Chase Commercial Mortgage Securities Trust 2010-C2 (JPMCC 2010-C2) is the latest such deal to hit the market.

The transaction is backed by a pool of 30 commercial mortgages secured by 47 properties. The pool benefits from a greater percentage of low leveraged loans in primary markets relative to the JPMCC 2010-C1 transaction issued in June 2010, according to Fitch. However, this benefit is offset by a higher concentration of larger loans.

The Fitch stressed DSCR and LTV for the transaction are 1.32x and 83% respectively, representing a slightly higher leverage than the JPMCC 2010-C1 deal, which had a Fitch stressed DSCR and LTV of 1.37x and 78.2%. Nevertheless, it compares favourably to the respective average Fitch DSCR and LTV of 1.05x and 110.7% across Fitch-rated conduit transactions from 2007-2008.

ABS analysts at UniCredit note that the revival of the CMBS market in the US is clearly supportive for the underlying commercial real estate sector. "CMBS borrowers are an exclusive club consisting mostly of owners of properties with steady cashflows and low leverage," they explain. "Those borrowers are benefiting from great rates."

Ten-year US CMBS loans reportedly pay between 5% and 5.5% in rates, down from about 6.5% six months ago.

CMBS

Benchmark indices to see CMBS changes

Barclays Capital has announced that, as of 1 January 2011, US CMBS classified as an A1A tranche will be removed from its US CMBS and US Aggregate Bond Indices. These securities are held primarily by US agencies and do not frequently trade in the secondary market and are consequently being removed because of investors' difficulty in purchasing them.

In addition, high yield CMBS will on the same date be removed from the Barclays Capital Global High-Yield Index due to their small issue size, difficulty to price and overall market illiquidity. These securities had previously been removed from the US Universal Index for similar reasons and will no longer be published as a standalone benchmark.

The bank says these decisions were made after carefully evaluating the evolving fixed income landscape and the perspectives of a diverse set of global investors that use Barclays Capital indices as both portfolio benchmarks and measures of broad fixed income market returns.

CMBS

Update due for investor reporting package

CRE Finance Council Europe is set to release a market exposure draft of its European Investor Reporting Package Version 2.0 on 15 October. Among the updates to the package, the new version will introduce minimum population fields and standards for calculating key financial indicators, such as ICR, as well as a methodology for analysing/reporting borrowers' property income statements. The package is designed for all commercial real estate transactions, including CMBS.

LCDS

LCDX, CDX.HY see constituent changes

The Markit LCDX index will roll into its 15th series on 4 October, with the coupon and maturity expected to remain unchanged at 250bp and 20 December 2015 respectively. The name turnover is likely to be higher than for the CDX HY index, with Avaya Inc, CDW Corporation, Reynolds Consumer Products Inc and Smurfit-Stone Container Corporation anticipated to replace Boston Generating, Chrysler Financial Services Americas, Mirant North America and WM Wrigley Jr Company.

Meanwhile, the Markit CDX.NA.HY rolled into its fifteenth series on 27 September. One constituent (Mirant North America) has been replaced (by SUPERVALU INC) in the index.

Ratings

Ratings education resource unveiled

S&P has launched 'Understanding Ratings', a new information and education resource for investors. The website brings together articles, videos, podcasts and educational guides to provide insights into what credit ratings are, the processes by which S&P produces ratings and how those ratings have performed over time.

"Discussions with investors around the world over the past two years have consistently highlighted their desire for more transparency about how ratings are determined," says Bruce Schachne, S&P's vp of market development.

He adds: "Credit ratings continue to serve as benchmarks for creditworthiness and investors continue to utilise credit ratings and research as part of their investment decision-making processes. Investors seek a better understanding of how S&P arrives at its ratings - what the methodologies are, what role the analysts play in the process and how ratings perform."

Real Estate

Serviced mortgage credit quality remains steady

The credit quality of first-lien mortgages serviced by the largest US national banks and thrifts remained steady during the 2Q10, according to a report by Office of the Comptroller of the Currency and the Office of Thrift Supervision.

The report indicates no clear trend in mortgage performance during the quarter, with delinquency levels remaining steady but elevated after rising for several quarters. Mortgage modifications were also up and an increasing number of more recent modifications, which decreased borrowers' monthly principal and interest payments, performed better than earlier modifications, the report suggests.

During the second quarter, 87.3% of mortgages were current and performing - unchanged from the previous quarter, but a decline from 88.6% in the same quarter a year earlier. The number of mortgages that were seriously delinquent and newly initiated foreclosures fell during the quarter to the lowest levels of the last 12 months, but were up from a year earlier.

Mortgages that were 30-to-59 days delinquent increased during the quarter, consistent with seasonal trends. Early-stage delinquencies increased across all risk categories from the previous quarter, but were down from a year earlier for prime, Alt-A and subprime mortgages.

During the past five quarters, servicers implemented almost 2.9m home retention actions - modifications, trial period plans and shorter-term payment plans. More than 90% of the modifications implemented during the quarter reduced the borrowers' monthly principal and interest payments, and 56% of them reduced payments by more than 20%.

The report concludes that HAMP modifications made during the quarter reduced monthly payments by an average of US$608m, while other modifications reduced payments by an average of US$307m. The reduction in borrower monthly payments as a result of modifications increased by 62% from a year earlier.

Regulation

European financial supervision reform agreed

The European Parliament has approved a financial supervision reform package that will see a systemic risk board and three new European supervisory authorities (ESAs) for the financial services sector being created.

The ESAs comprise a European Banking Authority (EBA) based in London, a European Insurance and Occupational Pensions Authority (EIOPA) in Frankfurt and a European Securities and Markets Authority (ESMA) in Paris. The new authorities will be made up of the 27 national supervisors. The European Systemic Risk Board (ESRB) will oversee systemic risk and launch action to stop them from becoming real threats to the economy.

President of the European Commission, José Manuel Barroso, comments: "The banking crisis exposed the gaps in financial services supervision in Europe. Our market was interdependent but oversight was purely national. In response I asked Jaques De Larosière to come with a vision which the Commission then turned into concrete proposals with an ambitious timetable."

The final agreement - which comes less than year after the Commission's proposals - means the new system will be established by January 2011. Commissioner for Economic and Monetary Affairs Olli Rehn says: "Macro-prudential supervision was clearly the weakest link of the pre-crisis framework. The creation of the ESRB is a decisive and innovative step towards a stronger and more stable financial system."

RMBS

Credit union legacy assets addressed

The US National Credit Union Administration (NCUA) has announced a plan to isolate impaired assets - mainly underwater RMBS - in the corporate credit union system, which involves repackaging them into securities that can be issued on the open market. The move comes after it assumed control of three undercapitalised corporate credit unions and is a key element in its efforts to resolve the financial challenges currently facing corporate credit unions, the regulator says.

Members United Corporate Federal Credit Union of Warrenville, Illinois; Southwest Corporate Federal Credit Union of Plano, Texas; and Constitution Corporate Federal Credit Union of Wallingford, Connecticut have all been placed in conservatorship. This is in addition to the placement in 2009 of U.S. Central Corporate Federal Credit Union of Lenexa, Kansas, and Western Corporate Federal Credit Union of San Dimas, California, into conservatorship.

The plan to address the impaired assets and resolve these troubled institutions involves several interrelated steps:

• Isolating the impaired securities (legacy assets) held by these five corporate credit unions;
• Repackaging the legacy assets into new securities with an NCUA guarantee backed by the unconditional full faith and credit of the US government;
• Issuing the new securities to investors on the open market;
• Transferring the corporates' still-valuable assets to newly created 'bridge banks' that will allow for continued operations; and
• Transitioning operations now under NCUA conservatorship over a target of 24 months to other service providers.

NCUA has consulted with the Treasury, Federal Reserve and other federal financial regulators in developing these plans, and will continue to work closely with these agencies to ensure the orderly resolution of conserved corporates, the effective implementation of the steps outlined and the continued smooth operation of the credit union system.

NCUA has also adopted a new set of regulatory reforms aimed at strengthening the corporate credit union system. The new corporate regulation (NCUA Rules and Regulations, Part 704):

• Implements stronger capital requirements and establishes prompt corrective action measures for corporate credit unions;
• Establishes clear concentration limits on investments that will require corporate credit unions to better diversify their portfolios;
• Improves asset-liability management requirements to avoid liquidity and interest rate risks; and
• Raises governance standards to improve levels of experience and expertise on corporate boards.

RMBS

Paragon re-enters BTL market

Paragon has signed a new £200m mortgage warehouse funding facility with Macquarie for four years at a cost of 287.5bp over Libor. It confirms its intention is to "use the facility to warehouse loans prior to arranging term funding in the MBS markets". As such, the firm will begin lending in the buy-to-let market again effective immediately.

The lender disclosed in a trading update that three-month plus arrears in its buy-to-let book have fallen and it expects operating profits for the year-end (end-September) to be better than current consensus estimates.

RMBS

Slight ABX CDR pick-up seen

Following a downward trend over the last year and a half, the latest ABX remittance report indicates that default rates picked up slightly in September for every index bar 06-2. Defaults were respectively 10.9%, 11%, 12.7% and 12.6% CDR for the 06-1 through to 07-2 indices.

CDRs have been declining for a year as servicers work through the modification process and extend workouts to distressed borrowers. However, ABS analysts at Bank of America Merrill Lynch note that a bottom in liquidation rates is far from being called, given the propensity for monthly variance in ABX data. They indicate that last month's print was on the higher end of typical CDR declines.

Lower defaults are expected, alongside increased severities as servicers must recoup increasing amounts of advanced principal and interest. Delinquencies declined month-over-month, with most of the improvement coming from the 60-plus bucket, which reflects slowing current-to-30 day transition rates and continued efforts to work through modifications.

Loss severities increased for the 07-1 and 07-2 indices, but decreased for 06-1 and 06-2. Average severities were 65.3%, 77.3%, 82.4% and 86% - equating to changes of -6.3, -4.7, 2.1 and 3.4 points on the 06-1 through to 07-2 indices respectively.

The BAML analysts believe severities are biased to the upside based on the increased advancing costs which come with slowing liquidations. They caution that fluctuations in ABX severities will be more outsized with lower and lower CDR levels, while recognition of losses due to principal forbearance can also cause month-to-month swings.

Finally, modification rates were down month-over-month for all indices except 07-2, at 0.88%, 1.22%, 1.18% and 1.66% of loans for 06-1 through 07-2.

RMBS

Stress test due for Aussie RMBS

Fitch says that, due to significant market commentary surrounding the sustainability of continued rising residential property prices in Australia, it will conduct a stress test analysis involving different scenarios of varying property price declines.

The testing is intended to ascertain the potential implications for its portfolio of rated Australian RMBS, banks and mortgage insurers to assess possible rating outcomes, should mortgage defaults rise and prices fall substantially. The agency says it is also in the process of reviewing its criteria and assumptions for rating Australian RMBS, which is expected to be completed in the fourth quarter.

Weighted average established house prices for Australia's eight major cities rose by 18.4% in the year to June 2010 and are now 41% higher than they were in June 2006. This continued rise in Australia is in contrast with property prices in the US, which have fallen by 28% since June 2006, and the UK - which fell by approximately 18% from peak to trough between 3Q06 and 1Q09. While a sharp correction in housing prices is not the agency's base case, Australian house prices and household indebtedness remain significantly above the long-term trend.

Ben McCarthy, Fitch md for Australia and head of Asia Pacific structured finance, comments: "While over the short to medium term a downturn is not Fitch's central expectation, the agency is performing its stress test exercise on ratings impact under the hypothesis of an imminent housing market correction. Fitch sees such scenario analysis as an important way of testing the robustness of our ratings, should such a downside risk occur, and will help to inform the review of our ratings criteria."

RMBS

Korean RMBS approach explained

Moody's has updated its methodology for the analysis of Korean RMBS transactions.

"Moody's rating analysis for Korean RMBS is based on loan-by loan data. The quality and depth of these data, which are the main inputs for the MILAN model, are important elements in our analysis. To assist originators and ensure that procedures accurately assess risk [and] are consistent, we provide a template - the 'MILAN input file' - for all the individual data fields required on mortgages to run the model," says Moody's vp, Jerome Cheng.

Helen Lam, Moody's avp, adds: "Since the accuracy of the ratings assigned to RMBS transactions depends largely on the integrity and accuracy of individual loan information provided by the originator, pool audits play an important role in assessing the quality of such information. We thus expect regular audit reports for all Korean RMBS transactions, the results of which we factor into our assessment of a portfolio's credit risk."

Moody's states that if quality information is unavailable, or if the results of an audit are negative, it may not be able to assign a high rating or be able to rate the securities at all.