Contents

RMBS

Tapping demand

Re-emergence of UK non-conforming RMBS gains momentum

The re-emergence of UK non-conforming RMBS is gaining momentum, with Kensington's RMS 25 expected to print next week and Paragon anticipating a return to the market in early 2011. Uncertainty about house prices still appears to be weighing on the sector, however.

One portfolio manager confirms that the slight drop in house prices over the last quarter is somewhat dampening demand for buy-to-let RMBS in particular. "My opinion is that the bulk of opportunistic investors, who bought Paragon and Aire Valley bonds during the summer of 2009, have taken their profit and exited since the beginning of 2010," he says.

He adds: "Without opportunistic investors, volumes have dropped significantly and secondary market prices are still close to the lowest 2010 levels of April/May, when the sovereign crisis hit. As a result, the asset class - seasoned mezz Paragon paper, in particular - appears to be undervalued as spreads have widened without the liquidity and demand."

Nevertheless, depending on how long it takes to warehouse the underlying loans, Paragon remains hopeful about tapping the market early in the New Year. Peter Shorthouse, director of treasury and structured finance at the firm, says the collateral could be newly originated loans or a mix of existing and new loans.

Feedback from Paragon's non-deal roadshow in February (see SCI issue 169) indicated investor support for the company and that they're pleased with the performance of existing deals, given arrears are below the industry average. "We took a positive message from the roadshow in that if we returned to the RMBS market, there would be demand," Shorthouse explains. "But the most important step for us was to begin lending again, which the new warehouse facility with Macquarie will enable us to do [see SCI issue 202]. Certainly investors seemed happy to see us back in the market."

He adds that the firm has tightened its LTV criteria (up to 75%) and ICRs remain conservative, reflecting that the outlook for the property market remains mixed. "Most analysts expect house prices to remain flat to negative over the next six months and so we're originating to more conservative guidelines to reflect the increased risk inherent in the buy-to-let sector."

Shorthouse notes that the spread tightening seen since the beginning of the year has certainly helped deal economics, as well as to build confidence among investors. "BTL RMBS typically price outside prime RMBS because of the perception of extension risk, but the yield pick-up is what makes the sector attractive," he continues. "It's an exciting time for us: we're back lending, the markets are freeing up and new investors are coming in."

The portfolio manager confirms that the market welcomed Paragon's warehouse announcement. But he says it is still waiting for clarification on some points, such as the fact that the warehouse is expensive and that significant uncertainty remains around the pending calls on legacy issues.

In the near term, meanwhile, Kensington's £186m non-conforming RMS 25 deal is garnering a positive market reception. "Kensington is definitely doing the right thing going forward. People like the transaction, and you get a better credit enhancement and a higher running coupon for triple-As in the secondary market," one ABS investor says.

With the deal likely to price next week, the investor predicts that it will print at the tight end of the low-200s. "If that happens," he adds, "it would be a great result for Investec."

RMS 25 is expected to only trade patchily in the secondary market, however. "It won't be the biggest triple-A tranche ever. With £100m being split across 10-15 accounts, it is unlikely to be hugely liquid. Having said that, I'm sure people will make markets in it," the investor concludes.

CS & LB

Whole business securitisations

Glass half full

M&B leads the way for pub sector WBS, as others struggle

Results recently released by Mitchells and Butlers show the company has performed strongly and above expectations. M&B continues to lead the field for pub sector WBS, although rating agencies remain cautious about the company's intentions.

James Martin, MBS analyst at Barclays Capital, explains: "Moody's concern is to do with the sale of 333 pubs to TDR Capital in August. They still need shareholder approval - which they will probably get - but Moody's are concerned that these pubs are coming out of the securitisation and so gearing would increase."

Moody's has labelled five classes of M&B notes as under review 'ratings direction uncertain' (see SCI issue 202). Paul Crawford, ABS strategist in the global banking and markets division at RBS, notes that this is an unusual move by the rating agency.

He says: "Calling it 'direction uncertain' is an unusual thing to do. It is something of an unwritten rule amongst the rating agencies that if a deal can issue further debt, they do not upgrade it because that could potentially hinder debt issuance. Moody's clearly did not want to label this a potential downgrade."

He suggests that, rather than being an indication that Moody's is sceptical about M&B's plans, the action is intended to flag to investors that it is aware of the changing circumstances. He says: "The rating agencies have been criticised for not being reactive - or quick enough when they do react - so they are showing investors they can be proactive and are not behind the curve on this one."

Despite Moody's rating action, the nine weeks until 18 September proved to be a good period for M&B. Like-for-like food sales were up by 7%, while like-for-like drink sales were also up.

Operating margins are up on the previous year by 1.2% to 16.5%, marking a strong result. Management's outlook for the rest of the year is far more positive than it previously was.

"They have delivered good results after a fairly flat quarter, where the World Cup had a negative impact," says Martin. "They are getting people to shift up the menu and order more courses."

He adds: "They look like they have been pretty successful and I think they are quite in tune with what their customers want. It is a good offering and I think it will continue doing well, provided investment levels hold up. It is looking to make acquisitions, which are expanding on the food-led theme."

One recent acquisition is the Ha Ha Bar chain, which M&B will look to convert into its own franchises, such as All Bar One and Browns. The strategy shift to become a more food-led business has also been seen as a positive development, despite Fitch's concerns earlier this year when the strategy was announced (see SCI issue 178).

Crawford says: "The outlook for M&B is pretty positive in both the short and medium term. Their focus on the food business means their core estate is outperforming both their own wider estate, including the non-core pubs, and also the broader market. They have rebounded very quickly from the negative EBITDA trend that they experienced during the recession and bounced back very well."

Not all pub WBS are in such rude health, however. Crawford explains that M&B's position is an enviable one for its competitors.

He says: "The pub sector is pretty much split. At one level you have Marston's, Greene King and M&B, which are all moving in a broadly positive direction. M&B probably has the best outlook in the near term out of those three, but they are all showing decent results. Then you have Enterprise Inns and Punch Taverns, which have far more difficult outlooks."

Crawford adds: "Even then there is a split between Enterprise and Punch, with Enterprise Inns at least starting to show the market that there is a path through their refinancing needs over the coming years. I think the future is far less certain for Punch, particularly in the Punch A and Punch B transactions, and it is difficult to see a long-term strategy for those deals at present."

However, all of the pubs' securitisations may be buoyed by the recent WBS tap issued by Dignity, the UK's largest funeral services provider. It is the first issuance of a non-regulated corporate securitisation since the collapse of Lehman Brothers.

Crawford concludes: "The whole business market has largely been closed to non-regulated corporates for the last two years. Therefore the Dignity tap is a very positive sign, showing that for the right name and credit the investors are still there. There is still demand for long-dated fixed-rate sterling WBS. I think M&B will take heart from the fact that Dignity have managed to get the tap away."

JL

Ratings

Limiting liability

CDS framework suggested as solution to Rule 436(g) repeal

The end of the reprieve on the repeal of Rule 436(g) - 24 January - is nearing, without the industry seemingly having an answer to the issue of rating agency expert liability. One possible solution has been put forward, however, that would - under a CDS framework - see additional compensation given to rating agencies to rate securitisations.

Few people appear to be thinking about solutions to the repeal of Rule 436(g), yet most investors and bankers are sceptical about the worth of ratings, according to Wells Fargo Securities md Glenn Schultz. "Engagement letters typically put everything back on the bankers. Rating agencies need to come up with a new business model, where their ratings have meaning and are backed up by capital," he says.

Moody's, for example, is specific about what a rating means within a loss-given default framework. But a CDS behind that rating - where the agency would pay out based on dollar amounts exceeding the LGD of the implied rating - would force it to be much more conscientious about its ratings and encourage counter-cyclicality. Such a model would also allow price discovery for tail risk and could serve to standardise cashflow waterfalls.

"Alternatively, if a non-NRSRO were to adopt the model, it would take the ratings monopoly away from Moody's and S&P," Schultz continues. "It wouldn't be difficult for a non-rating agency to step in, providing they have the requisite expertise, viability and capital."

He points to Kroll Bond Ratings as an example of an entity that could compete with the rating agencies under the CDS model. "It will be interesting to see whether Kroll, having recently bought an NRSRO, acquires a reinsurer to help the capitalisation issue. Once one firm steps up and puts capital behind their ratings, the other rating agencies will have no choice but to do the same. It's better to be proactive; sticking your head in the sand will likely mean that you go out of business."

The CDS model, as envisaged by the Wells Fargo analysts, involves the securitisation trust paying a monthly fixed payment to the rating entity and the rating entity standing on the other side of the transaction as the floating-leg payer. Under this framework, the rating entity or assigned counterparty would support the assigned bond rating with 'capital'.

As such, the analysts believe it would be most economical to rate the triple-A and double-A rated bonds in the capital structure because the cost to the transaction would be minimal. Rating bonds further down the capital structure could adversely affect economics under the model, however, significantly reducing 'upfront' proceeds.

"Based on our analysis and conversations with investors, we believe a bond rating with capital backing would carry more weight than an NRSRO rating, either with or without consent. One of the more interesting findings is that, under our model, the unrated portion of the transaction would amount to almost a 5% horizontal slice," the analysts add.

The structure they envision would offer a number of benefits to issuers and investors: compliance with proposed regulatory reform (risk retention and consent); competitive advance rates; and capital-backed credit ratings. Schultz concludes: "There is no workable solution other than liability. Certainly, creating secret ratings behind password-protected websites isn't the way forward - particularly in terms of facilitating secondary market liquidity."

CS

RMBS

Japanese boost for Euro RMBS (updated)

The European primary RMBS market received a boost this week with the emergence of the first-ever Japanese yen-denominated tranche. Meanwhile, steady performance in benchmark names was observed in the secondary markets.

Lloyds TSB's £3.4bn Arkle Master Issuer Series 2010-2 is expected to include a Japanese yen tranche, as well as tranches in euros, sterling and US dollars. The reason for the inclusion of a yen tranche is believed to be due to a pre-negotiated deal by the originator.

"Lloyds must have had someone in mind for at least 70% of this deal," one ABS investor confirms. "The yen tranche is there because the bank has a big account in Japan that it can approach. Like an anchor investor, Lloyds will go to them to place most of it and, once secured, will build out the rest of the structure."

Elsewhere in the RMBS sector, Aire Valley, Brunel and Granite paper continue to perform well. "We've seen Granite bonds rising by approximately one point," one RMBS trader confirms. "Aside from this, however, there hasn't been much change in the regular triple-A three-year deals, such as Fosse 2010-4 and Arkle 2010-1. Generally, there's not that much paper being offered right now."

He adds: "There are a few deals going through, but no great change in levels on last week - albeit people are moving down the credit curve. Aire Valley, in particular, is showing a decent yield at around 300DM."

LB

CMBS

US CMBS review placements questioned

Moody's is reviewing the ratings of 277 tranches across 19 US CMBS, with a current balance of US$16.3bn, citing higher-than-expected losses as the major contributing factor in most cases. However, MBS analysts at Deutsche Bank suggest that the credit profile of many of the affected transactions has not deteriorated significantly over the last few months or at least enough to warrant such a large number of classes to be placed on review.

"The inclusion of 11 super-seniors, in our view, is a signal that Moody's has made another change to their CMBS rating methodology," the analysts note.

The affected transactions are primarily 2005-2008 vintage fusion transactions, with three floating-rate deals and one multifamily pool. The Deutsche Bank analysts indicate that CD 2006-CD2 has been hit the hardest hit in terms of number of affected classes. Included in the review were the Aaa ratings on the A4, A-1A and AM classes.

At closing, the CD2 transaction comprised 198 loans with a balance of US$3.06bn; currently there are 195 loans with a balance of US$2.85bn. The weighted average DSCR of the pool has declined from 1.52x to 1.36x.

Nearly 22% of the loans have a DSCR of less than 1x, but only 10 loans totalling 11.6% of the pooled balance are delinquent. Furthermore, the largest two loans comprise more than half of the delinquent loan balance, which narrows the range of possible loss outcomes on the overall pool, according to the analysts.

While they acknowledge that an 11.6% delinquency is above average for the conduit universe, they question whether it justifies the ratings review placements. They estimate that only 13.1% of the pool has an estimated debt yield of less than 5%. If these loans are liquidated at a 50% severity, the credit enhancement of the A4 tranche actually increases due to the recoveries and the credit enhancement available to the AM tranche declines by less than 60bp.

"In order to justify a rating watch or certainly a downgrade of the A4, the level of loss should be enough to bring the credit enhancement down to the mid- to high-teens," the analysts conclude. "This does not seem likely. Perhaps the rating methodology changes that have led to so many triple-A rating downgrades are behind the market."

CS

CMBS

Euro multi-borrower restructurings gain momentum

Announcements from Hatfield Philips regarding consultation processes with the noteholders of both Titan Europe 2006-3 and Talisman 7 in relation to multiple loans underlines that multi-borrower CMBS restructurings are not far away in Europe (see SCI issue 202).

"The experience of single-borrower consultations with noteholders has been extremely mixed depending upon sponsor, deemed necessity of the extension, the type of investor and the price at which investors bought into the deals," comment European asset-backed analysts at RBS. "The announcement of potential note restructurings may lead to increased interest in multi-borrower deals from more activist investors looking to profit from the situation."

To date a number of loans within multi-borrower transactions have been granted extensions by the servicer/special servicer without noteholders consultation, without an increase in the loan margin. Servicers have defended such actions by saying they are acting on behalf of all lenders in order to maximise recoveries on the whole loan, as well as the fact that multi-borrower transactions are not structured to facilitate the passing on of improved economics.

Such extensions are feasible providing the loan isn't extended to within the required minimum tail period, according to the RBS analysts. In the case of Titan 2006-3 and Talisman 7, the legal final of the notes is in 2016 and 2017 respectively, meaning that extending the legal final may be considered appropriate in order to extend the loan sufficiently while maintaining an appropriate tail period.

"As a basic terms modification, extending the legal final will require agreement of all noteholders, whom - once consulted - will no doubt demand increased margins in compensated for the extended term," the analysts add. "However, there are inevitably other structural considerations which need to be considered, including potential impact on the deferred consideration, ability for other loans to utilise the extended tail period as well as the impact on swaps and liquidity facilities."

CS

RMBS

Extended foreclosure impact analysed

To measure the impact of extended foreclosure periods on servicing costs, Moody's ran a hypothetical timeline scenario based on the ABX 2006-2 deals. This follows the widening of Bank of America's foreclosure moratorium to 50 states last week and the news that Litton Loan Servicing has suspended foreclosures.

Moody's analysis, which was published in its latest Weekly Credit Outlook, assumes for illustrative purposes that liquidation timelines would extend by 18 months. "On an individual subprime mortgage held up by foreclosure re-filing or moratorium, severity of loss could rise by 10% or more as a result of assumed increased legal processing costs, property preservation costs, taxes and insurance, and prolonged payment of servicing fees," the rating agency explains. "On average, our increased severity assumptions on impacted loans translated into an overall increase in losses on underlying mortgage pools of two percentage points."

The extended timelines not only increase overall losses on the asset pools, but also amplify senior tranche losses through a reallocation of funds from senior principal to subordinate interest, Moody's adds. The extension of timelines means slower write-down of subordinate notes and an increased amount of time that these notes receive interest while the supporting collateral is non-cash-flowing. This extended accrual of interest lowers the amount of excess interest that would otherwise be available to pay principal to the senior notes.

"The results of our analysis illustrate the different impact for senior and subordinate noteholders," Moody's continues. "Relative to our base case run, average principal recovery and discounted net present value (NPV) for the senior notes decline." Conversely, subordinate noteholders benefit from unusually slow write-downs and prolonged interest cashflow.

Amid all the news flow generated by the foreclosure issue, SIFMA released a statement in which its ceo Tim Ryan warns that "it would be catastrophic to impose a system-wide moratorium on all foreclosures". He stresses that such actions could damage the housing market and the economy.

"Increased uncertainty in the securitisation market would further constrain consumer credit and spending, dampening our already unhealthy economic situation," the statement continues. "If mistakes have been made in relation to foreclosure processing, SIFMA firmly believes such mistakes should be corrected. It is imperative, however, that care be taken in addressing these issues to ensure that no unnecessary damage is done to an already weak housing market and, in turn, that there is no further negative impact on the economy."

CS

CDS

Re-thinking valuation - part 3

In the third article of a series on structured credit valuations, R² Financial Technologies ceo Dan Rosen discusses the need for second-generation Monte Carlo pricing methodologies for structured credit instruments

Simple bond versus Monte Carlo
In the previous column (see SCI issue 197), I discussed the importance of understanding the meaning and use of a 'price' and developing a robust model risk framework for structured credit portfolios. Modelling of these products presents significant practical challenges, given the complexity of their structures and underlying risks (market, credit and liquidity).

Black-box approaches, which rely on external valuations or on simple models based on credit ratings, have resulted in a lack of price transparency and limited risk capabilities. In this column, we discuss the need for second-generation Monte Carlo pricing methodologies.

The predominant pricing framework, widely used by dealers and investors, is based on basic bond models and matrix pricing, where the yields of structured credit securities are expressed in a way similar to those of corporate bonds. These models have two key characteristics:

• They employ a single-scenario for valuation; i.e. they assume a deterministic stream of cashflows;
• They generally rely on credit ratings as determinants of yields (spreads) and risk.

A bond model is a simple 'price-yield' calculator. First, a single scenario defines the vectors of default, prepayment and recovery rates for each loan in the pool, as well as interest rates and other factors influencing cashflows.

This scenario is used to produce, first, the stream of cashflows from the collateral pool, and then the cashflows from the structure. The price of the security is given by the sum of its discounted cashflows, using an appropriate spread, which reflects the riskiness of the structure (see Figure 1).

Comparable spread matrices are constructed based on several instrument characteristics (ratings, asset class, geography, vintage, etc.). Practitioners have sometimes extended the method using several scenarios, where the final price is obtained by weighting the prices in each scenario, generally in an ad-hoc way.

Although conceptually simple, there are important differences when applying the method to price structured credit instruments. The spread of a corporate bond essentially captures the default and recovery risk of the issuer (and perhaps liquidity). For structured credit instruments, the spread additionally embeds all the risks not modelled beyond the deterministic scenario:

• Credit risk of the underlying pool (default and recovery);
• Volatility and correlations of the cash-flows of the underlying loans (resulting from default and prepayment);
• Non-linearities and embedded optionality of the instrument's waterfall.

The sensitivities and risk measures obtained from these models are limited and sometimes misleading. Further, spreads based on ratings may not be ideal. While corporate bond ratings have proven reasonable indicators of credit risk, their application to structured finance has been flawed and has not held up to the test of time.

In the end, a robust stochastic model is required to model consistently these structures and capture explicitly their complexity, as well as the embedded market and credit risks. These techniques are conceptually simple and can be seen as a sophisticated extension of the single-scenario methodology, where:

• A sample of scenarios, typically large, is generated. Each of these contains detailed vectors (default, prepayment and recovery rates), interest rates and other factors. Scenarios are generated from a well-defined stochastic joint process for the factors.
• Under each scenario, cash-flows are generated for every security and a conditional net present value (NPV) is obtained by discounting them using the risk-free rate.

The final value is given by averaging the conditional NPVs over all the scenarios. Some important features of this approach are that:

• It is a structured, multi-scenario approach, which effectively uses advances in credit models, Monte Carlo methods and CDO analytics developed over the last decade;
• It explicitly models the key risks: credit (default, LGD, spread), prepayment and market risk, as well as their interactions;
• It is a portfolio risk-based approach, where correlations and concentration risks are captured;
• It can be implemented as an 'arbitrage-free' approach and can also be complemented with liquidity premiums, subjective views, etc.;
• It provides consistent valuation of all the deals based on the same collateral pool (by using consistent parameters), as well as of various asset classes (synthetics, cash; ABS, CLO, CDO, CDO-squareds) through the consistent use of scenarios;
• It naturally provides sensitivities to various risks, as well as hedge ratios (although this may be computationally intensive).

Option-theoretic approaches, based on stochastic models, are standard valuation techniques for derivatives. However, their practical application to valuing structured credit products is more recent.

These models are now best-practice for corporate synthetic CDOs, since they have simple, analytically tractable waterfalls. They are also applied broadly to compute OAS for agency MBS, which have only prepayment and interest rate risks.

Given the complexity of the collateral and their waterfall structures, the valuation of other structured credit instruments (ABS, CLO, cash CDOs, etc) is more involved and computationally intensive, requiring Monte Carlo methods. The underlying risk profiles are also more complex; there are interconnected default and recovery risks, prepayment and potentially other market risks. Finally, standardised calibration may also be more difficult, due to illiquidity and lack of reference instruments.

In the next column, I will discuss some of the challenges of applying stochastic models in practice and the development of more recent second-generation models.

ABS

Hire to boost EMEA retail coverage

Mark Valentine has joined Bank of America Merrill Lynch as md in its securitised products EMEA group. He will report to both Eric Personne and Marco Piccioni, EMEA co-heads of the bank's asset retail distribution unit.

Valentine is expected to focus on developing BAML's footprint in the European securitised market across retail and high net-worth channels, as well as creating e-commerce solutions for key distribution partners of the firm.

ABS

Polish partner recruited

Chadbourne & Parke has recruited Marek Krol as an international partner in its Warsaw office. Krol was most recently a partner at CMS Cameron McKenna, where he served as head of the banking and finance department. Previously, he led the structured finance department at White & Case.

Krol advises clients on banking and finance transactions, including project financing, real estate investments, syndicated loans, air transportation and maritime equipment purchase financing, loan repayments, bond issues, debt instruments and securitisation.

ABS

Citi retail card portfolios acquired

GE Capital has purchased US$1.6bn sales finance portfolios from Citi Retail Partner Cards. The sale is part of Citigroup's restructuring efforts and follows its recently announced sale of Student Loan Corporation (see SCI issue 201).

"We believe lenders will continue to look for opportunities to purchase loan portfolios, as organic growth has stalled due to low spending and tighter underwriting standards," note ABS analysts at Bank of America Merrill Lynch. "The lack of organic receivable growth has lowered the available supply of ABS."

The purchased portfolios include nearly three-dozen retail partner relationships that collectively represent more than 18,000 small to mid-sized merchant locations across the US. The purchased portfolios provide consumer financing programmes and related services retailers and dealers in: home furnishings; flooring; consumer electronics; and heating, ventilation and air conditioning.

Under terms of the agreement, Citi will provide interim servicing until GE Capital Sales Finance completes the conversion of merchants and cardholder accounts to its own system. But Citi Retail Partners will remain part of Citi Holdings, which houses the businesses and assets that Citigroup is looking to sell.

The BAML analysts point out that the portfolios are not part of Citibank Omni Master Trust (COMNI).

Advisory

Derivatives vets launch risk advisory shop

Joyce Frost, Frank Iacono and Chris Frost have founded Riverside Risk Advisors. The launch is in response to the soaring demand for independent risk assessment, structuring, pricing and execution advice for complex derivative and structured product transactions.

"The Dodd-Frank Act creates an effective mandate that some end-users seek independent advice for derivative transactions. We expect, however, that even where a statutory or regulatory requirement is not created, outside advice with respect to suitability and fairness, from professionals with relevant transaction experience, will become the new best-practices standard," Iacono states.

Prior to co-founding Riverside, Iacono was formerly an md at Morgan Stanley and ceo of Cournot Financial Products. Joyce Frost has over 25 years' experience in interest rate, currency and credit derivatives, most recently as an md with Morgan Stanley. Chris Frost served as md at Societe Generale in New York, where he ran the corporate interest rate derivatives and foreign exchange sales business for the Americas for fourteen years.

CDS

Asian markets vet moves into advisory

Iku Nishino has joined GreensLedge Asia as md and general manager to expand its business activities in the Asian markets. In this role Nishino will be responsible for providing capital markets advisory solutions and managing transaction executions from the firm's Tokyo office.

With over 25 years of investment banking experience, Nishino joins from JPMorgan Tokyo, where he was md and head of its fixed income sales. Prior to this, he worked in the firm's New York office as head of Japan structured credit distribution - responsible for overseeing a team that originated CLOs, CDOs and credit opportunity funds to Japanese investors.

CLOs

LCM takes on Hewett's Island

LCM Asset Management has been appointed replacement collateral manager on Hewett's Island CLO IV. The firm is assuming the collateral management responsibilities previously performed by CypressTree Investment Management, which was recently sold by Primus Guaranty to CIFC (see SCI issue 202).

CMBS

LNR names co-ceos, launches new fund

LNR Property has named two new senior executive officers to lead its diversified real estate services, investment company and CRE mortgage special servicer. The firm has also launched a new US$200m fund as part of its new investment management platform (IMP).

Justin Kennedy has been appointed as co-ceo and is responsible for the firm's strategic direction, current investment activities and its new IMP. He has spent over 20 years in the real estate development business and was previously md and global head of real estate capital markets at Deutsche Bank.

Tobin Cobb, who also joins the firm as co-ceo, is responsible for broad oversight and management of the existing LNR businesses. With 22 years of CRE capital, lending and loan servicing expertise, he was most recently at DB as md on special assignment to the office of the ceo of DB Americas, focusing on the Emergency Economic Stabilization Act of 2008.

LNR's former chairman and ceo Thomas Hughes has resigned, agreeing to serve as a non-employee advisor to the company's board.

CMBS

Distressed debt director hired

Steven Bandolik has joined Deloitte Financial Advisory Services as director in its distressed debt and asset practice group. Based in Chicago and New York, Bandolik is responsible for developing financial advisory and consulting services for clients nationally. He will also deliver services in real estate restructuring, asset recovery and capital markets, while providing valuation services and asset management advice to clients

Before joining the firm, Bandolik led Real Asset Recovery Group, a firm he founded in 2008. Prior to this, he was md with Nomura Securities focusing on CMBS.

Investors

Seix ceo finds new home

GoldenTree Asset Management has recruited Bob Sherman as a partner. He will work closely with partners Frank Jordan and Tom Humphrey in the continued expansion of the firm's institutional franchise.

Sherman joins GoldenTree following 14 years at Seix Investment Advisors, where he rose to the position of ceo. Previously, he was svp at Daiwa International Capital Management and a director at Pine Tree Capital.

Monolines

Rehab plan filed for Ambac segregated account

The Wisconsin Office of the Commissioner of Insurance (OCI) has filed its plan of rehabilitation for the Segregated Account of Ambac Assurance Corporation in Dane County Circuit Court in Wisconsin. The segregated account (SCI passim) was established on 24 March, at the direction of the OCI, to segregate certain liabilities - primarily policies related to credit derivatives, RMBS and other structured finance transactions. Policies totalling approximately US$57.6bn of net par outstanding at 30 June have been allocated to it.

Before the plan can become effective, it must be confirmed in Wisconsin courts. The OCI has stated that it anticipates the court to schedule a hearing shortly to consider confirmation of the plan.

Claims on segregated account policies remain subject to a payment moratorium until the plan becomes effective. The plan provides that, once it is effective, holders of permitted policy claims will receive 25% of their permitted claims in cash and 75% in surplus notes with a scheduled maturity of 7 June 2020 and bearing interest at 5.1%.

RMBS

RMBS director added

The Paragon Group has appointed Peter Shorthouse as director of treasury and structured finance. Reporting to the firm's director Nick Keen, Shorthouse will spearhead Paragon's RMBS strategy.

With over 20 years of experience in the securitisation market, Shorthouse joins the firm from UBS, where he was head of European securitisation.

RMBS

GMAC sued over 'fraudulent' affidavits

In a lawsuit filed against GMAC Mortgage and its parent Ally Financial, Ohio attorney general Richard Cordray accuses the loan servicer and its agents of filing fraudulent affidavits to mislead courts in hundreds of Ohio foreclosures.

"We know that as Ohioans were fighting to save their homes, this loan servicer benefited financially from the dire circumstances," says Cordray. "Instead of stepping up and assisting those at risk of losing their homes, it is clear that GMAC chose to compound the problem through fraudulent and unfair and deceptive practices."

According to the lawsuit filed in Lucas County Common Pleas Court, GMAC and its employees committed fraud on Ohio consumers and Ohio courts by signing and filing hundreds of false affidavits in foreclosure cases. The fraud came to light after a GMAC employee, Jefferey Stephan, testified in a foreclosure case admitting that from 2006 to 2010 he signed thousands of affidavits without verifying the content.

Through the lawsuit, Cordray is asking the court to grant a preliminary and permanent injunction preventing GMAC/Ally from proceeding to foreclose in any pending Ohio case or allowing the property to be sold. The attorney is also asking for civil penalties of up to US$25,000 for every violation of Ohio's Consumer Sales Practices Act and for consumer restitution.

As a result of similar reports regarding depositions taken by JPMorgan and Bank of America employees, Cordray has also requested that both of these banks suspend moving toward a judgment, sale, eviction or property transfer involving any foreclosure case with affidavits signed by those employees.

ABS

RFC issued on US ABS regulation

The US SEC is seeking public comment on proposed regulations under the Dodd-Frank Act that require both issuers of ABS and rating agencies to provide investors with new disclosures about representations, warranties and enforcement mechanisms. Section 943 of the Act requires the Commission to prescribe regulations on the use of representations and warranties in the ABS market by 14 January 2011.

Under the proposed regulations, issuers would be required to file with the SEC - in tabular format - an issuer's repurchase history for its outstanding ABS in order for investors to identify any originator underwriting deficiencies. Specifically, an issuer would be required to provide the last five years of repurchase history in an initial filing and, following this, would file updated information on a monthly basis.

The proposed rules would also require an issuer of a registered ABS offering to include in the body of a prospectus repurchase history for the last three years for ABS of the same asset class as the securities being registered. Similarly, they would be required to provide updated repurchase history for the asset pool on an ongoing basis.

Finally, Nationally Recognized Statistical Rating Organizations (NRSROs) would be required to provide a description of the representations, warranties and enforcement mechanisms available to investors for an ABS offering. Additionally, credit rating agencies would be required to disclose how the representations, warranties and enforcement mechanisms differ from those of similar ABS.

The public comment period ends on 15 November 2010.

ABS

ECB updates ABS guidelines

The ECB has announced changes to its guidelines on monetary policy instruments in the Eurosystem. While many of the revisions pertaining to ABS - such as ratings and tranche seniority - have already been signalled, there are some new rules designed to limit exposure to non-European collateral.

Essentially, from October 2011 any collateral backing a securitisation must be originated in the European Economic Area (EEA), their acquisition subject to European member state laws and provided to EEA borrowers. In addition, resecuritisations will be banned, while relevant documentation on clawback provisions - where an asset transfer to an SPV within a certain period prior to the occurrence of borrower insolvency can be invalidated - must be furnished in order that relevant risk assessment can occur.

ABS

Off-balance sheet treatment clarified

The IASB has issued amendments to IFRS 7 as part of its review of off-balance sheet activities. The board says the amendments will allow users of financial statements to improve their understanding of transfer transactions of financial assets, such as securitisations.

It is hoped the changes will help clarify the possible effects of any risks remaining with the entity that transferred the assets. Additional disclosures will also be needed if a disproportionate amount of transfer transactions are undertaken around the end of a reporting period.

"These are important disclosure requirements that will help investors to better understand off-balance sheet risks, and to alert them to the possibility of so-called 'window dressing' transactions occurring at the end of a reporting period," says IASB chairman David Tweedie.

The amendments broadly align the disclosure requirements of earlier IFRS releases and US GAAP. The ISAB and FASB say they will carry out further research and analysis, including a post-implementation review of FASB's recently amended requirements, before deciding on how to proceed.

The IASB has also announced that previous proposals to replace the existing derecognition model in IAS 39 and associated disclosure requirements in IFRS 7 will not be followed through. Instead, the existing requirements will be incorporated into IFRS 9 and improved disclosure requirements will be finalised.

ABS

SF qualitative risks examined

Moody's has released a report assessing how the misalignment of interests among transaction parties, as well as the effectiveness of transaction governance and safeguarding, poses an important qualitative risk in securitisations.

"The behaviour of transaction parties in ways not initially intended can affect the distribution of cash and performance of the assets in a structured finance transaction," says Moody vp Paul Kerlogue. "Such behaviour can give rise to unanticipated outcomes that belie model results and confound stakeholders' expectations."

The incentives for various parties may change over the life of a deal, the agency notes. If the deal comes under stress, it is likely that it will increase the opportunity and incentive for parties to seek protection at the expense of noteholders.

"Not only should the operative documents unambiguously govern the parties' activities, but effective oversight should be in place to limit the opportunities for behaviour adverse to the interests of the noteholders," adds Kerlogue.

CDPCs

CDPC ratings lowered and withdrawn

S&P has lowered its issuer credit rating (ICR) on Invicta to single-A plus from triple-A, and the ratings of its class A notes to single-A minus from triple-A and class Bs to triple-B minus from double-A. At the same time, the agency removed these ratings from credit watch with negative implications and subsequently withdrew them.

S&P also disclosed that it placed its ratings on Invicta on credit watch negative on 21 June, but due to an error the ICR on the CDPC was not updated in its rating dataset to reflect the placement.

The downgrades reflect S&P's increased loss projections on the corporate CDS tranches and the results of its sensitivity analysis around the potential termination payments. As of 6 October, Invicta had not incorporated the agency's updated criteria into its capital model. Therefore, in lieu of Invicta's own capital model run results, under S&P's principles-based approach to rating structured finance securitisations it estimated the potential loss on the CDPC's corporate tranche CDS using its updated corporate default, recovery and correlation assumptions for corporate CDOs and estimated the potential termination payment that Invicta may need to pay if its counterparties were to default.

S&P also compared its estimated loss on Invicta with its estimated loss on other CDPCs that focus on corporate tranche CDS. Based on its estimate, the agency believes that the current credit support levels for Invicta's ICRs and the ratings on its class A and B notes are no longer consistent with our previous ratings. Therefore, it lowered these ratings to levels that are commensurate with the current subordination levels.

S&P says it subsequently withdrew its ratings on Invicta because it does not have sufficient information to maintain ratings on the CDPC, given that it has not updated its capital model to reflect the agency's revised CDPC criteria.

CDS

Fitch warns on CDS 'false positives'

CDS spreads indicated an elevated risk of default during the recent financial crisis that, for some sectors, was ultimately not borne out by subsequent experience, according to Fitch.

In a recent study, the rating agency analysed the performance of CDS spreads as market-implied indicators of default risk for more than 100 companies across five US industry sectors that experienced pronounced market pressure during the credit crisis: monoline insurers, REITs, homebuilders, banks and insurance companies. All of the credits studied were rated investment grade as of 30 June 2007.

Fitch's analysis illustrates that overall performance of CDS spreads during the crisis period was mixed. For example, widening spreads proved to lead the severe distress that occurred among monolines, but appeared to generate "false positives" for homebuilders and REITs - sectors that as a whole experienced relatively mild erosion in credit fundamentals and a considerable tightening in CDS spreads after reaching their respective peaks in late 2008.

Similarly, although CDS spreads also widened markedly for financial services firms during the height of the crisis, only one credit event (Washington Mutual) occurred among the approximately 60 US bank and insurance companies sampled. This discrepancy suggests that CDS markets might not have fully anticipated the significant role of external support - such as government assistance or acquisition by other financial institutions - in mitigating risks to debtholders, Fitch concludes.

CLOs

Garrison CLO nears

Further details have emerged about Garrison Investment Group's long-awaited US CLO - Garrison Funding 2010-1. The US$219.55m transaction, arranged by Deutsche Bank, will pool primarily middle-market and broadly syndicated senior secured loans.

S&P has assigned preliminary ratings to four classes of notes: triple-A to the US$164.5m class A-1 and US$25m class A-2 notes (which are expected to print at 240bp over three-month Libor), double-A to the US$12m class B deferrable notes (375bp) and single-A to the US$18m class C deferrable notes (475bp). There are also US$80.5m unrated subordinated notes.

The issuer has purchased approximately 81.2% of the portfolio's collateral, although 100% of the pool has been identified and is expected to be purchased or committed for purchase by the closing date.

Garrison has US$1.3bn in assets under management.

CMBS

Greater scrutiny of PSAs advised

MBS analysts at RBS suggest that investors should pay more attention to pooling & servicing agreements (PSAs) when analysing CMBS for relative value purposes. They note that PSAs can significantly impact principal and interest distributions, as well as losses allocated to a bond.

"The provisions are often not well defined, are not consistent across deals and have not been thoroughly tested. This results in errors in the application of these provisions and requires more investor due diligence and scrutiny," the RBS analysts comment.

In particular, investors should give specific consideration to three provisions - the application of liquidation proceeds, non-recoverable advance reimbursements and workout delayed reimbursement amounts (WODRA). Under the first provision, when a loan is liquidated any proceeds are applied to interest before principal. If there are insufficient proceeds to cover the full amount of principal owed under the loan, the shortfall will be allocated to principal, the analysts note.

A non-recoverable advance reimbursement, meanwhile, occurs when the servicer deems that the projected proceeds from the loan will be insufficient to repay existing or future advances, or upon liquidation when actual proceeds are insufficient to pay advanced amounts. Finally, a WODRA is an advance by the servicer prior to a loan modification that was not reimbursed as part of the loan modification. Instead, the advances are deferred under the terms of the modified loan documents.

"As interest shortfalls and losses increase in CMBS, we believe each of these provisions may have a material impact on the performance of bonds," the analysts conclude.

CMBS

Economically-challenged states driving CRE defaults

Loans secured by properties in economically challenged states are defaulting at an elevated rate and driving delinquencies higher, according to the latest US CMBS delinquency index results from Fitch. CMBS late-pays rose by 18bp to 8.66% last month.

"Though certain macroeconomic indicators have been more encouraging of late, CMBS delinquencies will not subside anytime soon," comments Fitch md Mary MacNeill. "National employment underpins demand for every property type and a jobless recovery for the US economy foretells continued challenges ahead for commercial real estate."

Currently, 10 states with CMBS loans rated by Fitch have delinquency rates in excess of 10%. States with the highest delinquency rates are: Nevada (at 25.85%); Hawaii (18.03%); Michigan (15.66%); Arizona (14.75%); Mississippi (12.26%); Georgia (12.05%); Indiana (11.65%); South Carolina (10.61%); Florida (10.42%); and Tennessee (10.22%).

Current delinquency rates by property type are: hotel at 21.31% (from 20.80%); multifamily at 14.45% (from 14.18%); retail at 6.10% (from 6.11%); industrial at 5.79% (from 5.55%); and office at 5.48% (from 5.06%).

Insurance-linked securities

Two new Vita tranches marketing

Swiss Re is marketing the latest in its Vita mortality catastrophe bond programme. The as-yet unsized dollar-denominated series III class E and series IV class E notes due 15 January 2015 issued by Vita Capital IV have been assigned a preliminary double-B plus rating by S&P.

The notes will provide the reinsurer with protection against extreme mortality events occurring to specified age and gender distributions in the US, Canada, Germany and Japan. The series III noteholders will be at risk from an increase in age and gender-weighted mortality rates that exceeds a specified percentage of a predefined index (the mortality index value; MIV) in the US and Japan. The series IV noteholders will be at risk from an increase in age and gender-weighted mortality rates that exceeds a specified percentage of the MIV in Germany and Canada.

The MIV self-adjusts for changes in general mortality trends over the risk period. The risk periods are: from 1 January 2010 to 31 December 2014, in respect of mortality in the US, Canada and Germany; and from 1 October 2010 to 30 September 2014for Japan.

The MIV will be defined on a rolling two-year period, with the probability of a loss attaching and the magnitude of the loss in principal depending on the extent to which the MIV for any country and measurement period (that is, two consecutive years) exceeds the attachment point for the notes. Index values corresponding to future measurement periods will be measured against the index value for 2009 for the US, Germany and Canada. For Japan, index values will be based on mortality between 1 October 2009 and 30 September 2010. Adjustments will be applied for changes in mortality over the risk period.

The attachment points for series III are 105% for the US and 107.5% for Japan. The exhaustion points are 110% for the US and 115% for Japan.

The attachment points for series IV are 110% for Germany and 111.5% for Canada. The exhaustion points are 115% for Germany and 120% for Canada.

At closing, Swiss Re will enter into a contract with the issuer using standard ISDA wording. Under this contract, Swiss Re will make payments to the issuer in exchange for extreme mortality protection. The issuance proceeds are to be invested in collateral in the form of triple-A rated notes issued by the International Bank for Reconstruction and Development.

Insurance-linked securities

New Euro wind cat bond on offer

GC Securities and Swiss Re Capital Markets are marketing a new European windstorm catastrophe bond on behalf of AXA. The three-year €150m Calypso Capital deal has been assigned a preliminary double-B rating by S&P.

The series 2010-1 class A notes are the first to be issued under the €1.5bn Calypso Capital principal-at-risk variable-rate note programme sponsored by AXA Global P&C. This transaction covers European windstorms that pass through Belgium, Denmark, France (excluding overseas territories), Germany, Ireland, Luxemburg, the Netherlands, Switzerland and the UK.

The deal will cover events above an industry loss value, weighted by CRESTA zone and line of business, of €1.9bn on an occurrence basis, up to a limit of €2.5bn, subject to an optional annual reset. Calypso Capital will provide cover to AXA against losses suffered between 1 January 2011 and 1 January 2014. The risk modelling will be based on EQECAT's Europe windstorm model, as released in WORLDCATenterprise Version 3.13.

The deal's collateral will be put into a tri-party repo structure with BNP Paribas, London branch, as the counterparty and Euroclear Bank as the tri-party agent.

RMBS

FNMA prepays 'close to peaking'

Fannie Mae 30-year prepayment speeds picked up by 6% month-over-month to 24.9 CPR, according to MBS analysts at Barclays Capital. Speeds came in at the lower end of the analysts' estimates, with the 2009 FNCL 4.5s and 5s printing 22 and 28.5 CPR respectively.

The month before, prepayments had jumped by around 27% (see SCI issue 199). The BarCap analysts suggest that this is because the previous prints were "artificially inflated by spill-over refinancing activity from the previous month".

They add that "a 'classical' refinancing wave is not achievable at current levels of rates and underwriting". Speeds are thought to be close to peaking as the refinancing application index has come off its recent highs. Origination capacity bottlenecks are also expected to continue capping prepayments and the analysts believe these latest results should reduce both uncertainty and market expectations of speeds.

Lower coupons were still the most responsive to lower mortgage rates and the analysts explain this is due to their "excellent credit profile" and large loan size. The 2009 FNCL 4s rose by 31% to 9.5 CPR, while 2010 reached 3.3 CPR.

The 2008, 2009 and 2010 5s accelerated by 7%, 8% and 22% respectively, prepaying 41.8, 28.5 and 13.6 CPR. The next couple of months are expected to see FNCL lower coupon speeds picking up by a further 1-3 CPR because of lower driving rates.

Higher coupons, meanwhile, showed very little sensitivity to rates. The analysts believe the 2006, 2007 and 2008 6s and 6.5s are cut off from refinancing opportunities and would have their speeds almost completely unaffected by a further rates drop.

The 2006, 2007 and 2008 6.5s dropped by 2%, 6% and 6% respectively, printing 23, 24.7 and 25.9 CPR. The 6s increased 0%, 1% and 3% to reach 26.5, 28.2 and 30.8 CPR.

Across vintages, 2002 is still prepaying faster than 2003, which itself was faster than 2004/2005. The analysts indicate that call protection in seasoned pools comes mostly from a high SATO.

Bank of America Merrill Lynch MBS analysts add that servicer differentiation is also a key driver in prepayments for Fannie Mae 30-year prepayment speeds, as Wells and Chase pools continue to prepay much faster.

Meanwhile, aggregate Freddie Mac speeds went up by 9% from 26% CPR to 28% CPR. Across coupons and vintages, speeds were faster than expected for 2008 4.5s and seasoned collateral, according to the BAML analysts. Speeds for 2009 4s were also surprisingly fast.

Technology

Systemic risk tool launched

Macro Risk Advisors (MRA) has launched a 'Systemic Risk Dashboard', designed to monitor cross-asset risk premiums in order to help institutional investors manage portfolio uncertainty and optimise investment performance.

"A defining lesson of the financial crisis has been the high level of asset price correlation in times of macro uncertainty," says Dean Curnutt, ceo of MRA. "Our risk dashboard provides institutional investors with a powerful tool that identifies the linkages across asset classes, puts risk premiums in historical context and serves as a guide post for prudent portfolio risk management."

The application monitors the risk premiums and volatility in US and global equities, commodities, foreign exchange, credit default swaps, sovereign spreads and interest rates.

Technology

Pricing compliance portal offered

Interactive Data Corporation (IDC) is now offering a web-based client management and compliance oversight tool, designed to provide audit trails and compliance reports for a firm's pricing challenge process.

The portal can increase client workflow efficiency by centralising information and generating management reports, as well as improving the turnaround time of challenges, the firm says. It can also provide clients with additional transparency to the overall challenge process.

At any point in the day, clients have the ability to enter one or multiple evaluated pricing challenges directly through the portal, track existing challenges and monitor progress through the use of various report generation options. These challenges are then categorised accordingly, with those including market information being prioritised for review.

CDS

Trading ideas: euro euphoria

Tim Backshall, chief strategist at Credit Derivatives Research, looks at a sovereign-FX pairs trade

The enthusiasm for euros over US dollars has been incredible over the past few months. Started by a short squeeze and extended by government intervention, calling an end to this rally has been a fool's errand. However, we feel evidence is mounting that we are nearing a considerable turning point in the euro relative to the US dollar and we believe a pairs trade approach makes more sense to capitalise over the disconnect between short-term hope and medium-term malaise.

The last few months have seen unprecedented interventions from governments and supra-nationals in an attempt to avert a double-dip or worst to avoid sovereign collapse. The velocity with which the euro-zone managed to recover from its doom and gloom lows in the EUR/USD (inverted in green in Exhibit 1) is spectacular, but has been driven by technical factors rather than economic potential in our view. The disconnect from short-term FX trends and medium-term sovereign risk concerns are very visible. 

An initial jump from extreme CoT positions being squeezed, combined with carefully issued and executed interventions or aid in sovereign risk markets enabled a trend to continue. The lack of failure among peripheral European nations and Germany's strong FX-driven export results also pushed us further, but we feel this very much reflects the short-term perspective. This short-term view is even more evident when we consider the dramatic weakening in the US dollar (relative to everything) since the potential for QE2 began to be discounted.

The weakness in the US dollar - as measured by the Dollar Index - has been very significant, with the euro seeing the benefit of flows most, along with Gold and other precious metals. Exhibit 2 shows the last three times that DXY spot was at the current levels and the FX-forward-implied DXY forward curve. Critically, the forward curves are flattening currently and are considerably flatter than at the other times we have been at these levels - signalling to us that the current US dollar weakness may stall here as the competitive devaluations catch up with one another and 'equalise' as they will. (Note: we are not looking at Gold here, which is out of the zero-sum game CBs are playing with their currencies.)

We feel that the sovereign risk disconnect, the flatness of the forward DXY curve, ECB Weber's comments on phasing out bond support, IMF's attempt to extend Greece's facility and Germany's dislike of this, the rapid rise in short-term liquidity rates (as liquidity was soaked up prematurely in our view - see Exhibit 3) and the increasingly worrisome outlook for Ireland warrant significant retracement in the euro relative to sovereign risk. The weights below are derived from the DV01-adjusted empirical relationship (Exhibit 4).

Position
Sell US$10m notional SovX4 5Y protection at 144bp.

Buy US$1.83m vs Sell EUR at 1.3860 (Short EUR).

Stop-Loss at US$100,000 loss (4 standard deviation).

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

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

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