Contents

ABS

New issuance takes precedence in Euro ABS

The European ABS sector has had a busy week, with a growing volume of new issuance in the primary market taking centre stage. A focus among investors on diversification is helping to boost activity.

"The market is relatively busy; new issuance is just piling up," one ABS trader confirms. One new issue that is generating interest is the £325m BAA deal, which is currently marketing and is due to price today, 3 November.

"This transaction is on the high yield end - the debt analysis on this went very well," the trader says.

Another new issue attracting attention is Santander's Holmes 2010-1 prime RMBS. The deal - which is set to print any day now - is being eagerly awaited, the trader says.

He adds: "A very short-dated class A1 dollar tranche was pre-placed yesterday. We're expecting the rest of the capital structure to be priced tomorrow, so there is much interest."

Further new issuance, the trader says, includes the German Peugeot auto loan ABS that is marketing. "Genuine new issuance is becoming the latest market trend, particularly with more tranches being issued down the capital structure. Tranches are being offered now rather than being pre-placed or retained - it's an interesting development," he notes.

This recent boost of activity in the primary sector is slowly building momentum and demonstrates a growing confidence towards risk taking in the market, the trader says, which will hopefully follow into the secondary market. He continues: "You have real risk taking from the issuers right now and the more this happens, the more it provides precedence. In the UK prime space in particular, we're seeing a growing database of transactions being offered in the last two to three months, which provides good guidance, more stability for the issuers and greater comfort for investors."

Meanwhile, Barclays' restructuring of its RMBS master trust - Gracechurch Mortgage Financing (see SCI issue 207) - also garnered interest. "I wouldn't be surprised if Barclays are following the same motions with Gracechurch as Santander did with Holmes. It will be interesting to see how it develops," the trader observes.

Elsewhere in the secondary market, the trader says a trend is developing where originators are consciously targeting different pockets of investor demand. "We're seeing treasurers trying to diversify their funding base - particularly with the recent yen and dollar tranches. They're going for it, which proves that market interest is back."

He concludes that with this new investor attitude, as well as the high volume of new issuance, confidence is finally returning to the market. "The ABS sector has improved vastly from a year ago."

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ABS

New issuance takes its toll on US secondary ABS

It has been business as usual in the US secondary ABS market over the past week, with levels holding up to some extent. However, as new issuance increasingly dominates the market, a lack of investor interest in secondary activity is beginning to take its toll.

"The market's busy with new deals, but secondary levels have remained fairly strong in some areas," one ABS trader confirms. "However, the main focus at present is QE2 - that's the main driving force of the market."

Structured finance analysts at JPMorgan concur in a new report reviewing last week's US ABS market activity. "In secondary, bid-lists traded well and dealers continued to provide liquidity. However, buying interest remained focused on the primary market, where the oversubscription on various new issues contrasts sharply with the lack of interest in dealer inventory."

Nevertheless, they add: "With QE2 rolling forward, investors will need to put cash to work again sooner or later. In the meantime, the supply of ABS paper will only shrink."

The analysts confirm that while the primary sector continues to flourish with new issuance, it will eventually become a hindrance to the capital structure as a whole. "The secondary market has not been able to gain any traction, resulting in ABS spreads slipping yet again this week," they explain.

For example, in the prime auto loan ABS segment, triple-A three-year spreads widened by 3bp last week to 28bp over swaps. This contrasts with the year's tights of 17bp reached in August, with the 30bp level last seen at the start of June. A back bid is expected to keep spreads within the recent range, given the consistently lopsided supply/demand balance in the primary market.

Certainly strong demand for ABS with more spread is a theme that is likely to continue in the coming months. This trend was made explicit with the pricing last week of Holmes Master Issuer 2010-1's triple-A rated 2.8-year US dollar-denominated tranche at 140bp over three-month Libor. The bonds were widely distributed to roughly 30 investors, including some that were relatively new to the sector.

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RMBS

Euro RMBS market nerves hold

Primary issuance continues to be at the forefront of European ABS market activity, with another week of newsworthy deals. At the same time, traders report a spike in interest in mezzanine paper in the secondary market.

"It's been a steady week, with plenty of new issuance. Most of the activity is coming in from the UK right now," one ABS trader confirms.

One new issue that is generating investor interest is DMPL VIII, the €1.2bn Dutch RMBS originated by Achmea Hypotheekbank. "DMPL is receiving a good reception - despite upsizing the deal, there has been a real appetite for it," the trader adds.

Another widely anticipated transaction is Siena Mortgages 7. The Italian prime RMBS - originated by Banca Monte dei Paschi di Siena - is currently being marketed by JPMorgan and RBS. "Siena is generating a lot of interest," the trader says. "It's big news for us and should be pricing soon."

As Siena 7 is the first Italian RMBS issued since the beginning of the financial crisis, it is being touted as an indication of a return in market confidence. However, according to the trader, it will take a while before a full recovery in the structured finance industry as a whole is seen.

He continues: "The market is not what it used to be; there is still a gap where previous structured vehicles have left the marketplace, like SIVs, for example. However, the fact that current new issues are being so well received - like Siena 7 - is a positive reflection."

Indeed, the trader suggests that the market's current stability proves its survival of what he describes as "summer nerves", which resulted in deals pricing wider due to new issuance. This nervousness, he says, centred on Irish and Portuguese deals, which are still being viewed cautiously.

He adds: "The overall ABS market is still following the volatility in these segments, but despite government nervousness - which will probably not fade away at short notice - we expect the market to stay stable and remain at current levels."

Meanwhile, the secondary market has seen a surge in appetite for mezzanine paper, indicating a steady improvement over the previous three months, the trader says. "We've seen that banks are willing to make bigger offers on tranches below the most senior class; it's definitely a good development."

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CDS

LBO basket trade touted

Buying CDS protection on potential LBO candidates has been a popular trade over the past few months. To gain from a short position on a basket of LBO candidates, Goldman Sachs credit strategists estimate that investors need more than 17% of names to complete a deal, assuming the targets are downgraded to single-B. Conversely, names that have deteriorated on LBO fears represent an opportunity for protection sellers.

Many investment grade names have widened due to such protection selling - some on actual LBO-related news and others in sympathy with their peers. The Goldman strategists expect a pick-up in LBO transaction next year, though not to the record levels reached in 2006-2007.

LBOs pose a threat to bondholders, who use CDS to hedge against potential widening due to an increase in leverage. "But this time around, investors have been rushing into the trade without any substantial pick-up in volumes. This has pushed several investment grade names in the consumer, technology and healthcare sectors to widen around 47bp since June, while the CDX index tightened 25bp over the same period," the strategists note.

They recommend selling protection at approximately 167bp on an equal weighted basket of: ABC, ARW, AVT, CAG, CAH, DELL, EXPE, FO, GAP, HAS, JCP, JNY, MCK, SLE and STX. The basket is expected to generate 167bp of carry and 125bp of positive roll-down in one year, for total potential gains of 292bp. This would allow protection sellers to withstand more than two LBOs in the basket.

CS

CLOs

CLO liquidation risk examined

Moody's has comprehensively reviewed the indentures and related documents for all US cashflow CLOs it rates and concludes that, notwithstanding the presence of overcollateralisation-based event of default (EOD) triggers and OC haircuts in the documentation, EODs should remain rare among these transactions.

The rating agency explains in its latest CLO Interest publication that it examined: the extent to which CLO documents contain mechanisms whereby an EOD may result from failure to maintain a required level of OC; the various haircuts in OC when certain asset types are included in the CLO collateral pool; the current state of Moody's-rated CLOs in terms of likelihood of experiencing an OC-based EOD; and the likelihood of CLO liquidation if an EOD were to take place. The review - which focused on 558 deals - suggests that CLOs present an EOD risk profile that is unlike structured finance CDOs, a significant number of which have experienced OC-related EODs since early 2008.

Roughly 88% of the 558 CLOs have EODs that can be triggered by a sharp decline in senior OC levels. About three-quarters of the transactions studied apply OC trigger levels of 100%, while about 24% of the CLOs have a trigger level between 100% and 103%. Less than 4% of the deals set the trigger level either below 100% or above 103%.

Among the 490 deals with OC-based EOD triggers, roughly 64% apply one or more OC or collateral par haircuts for various types of assets when measuring OC for purposes of testing for EOD violations. Specifically, defaulted securities, Caa-rated assets in excess of a permitted concentration limit, deeply discounted obligations (DDOs) and long-dated securities are typically carried at less than their par value for purposes of meeting the OC tests that, if failing, will divert cashflows.

The most common OC haircuts used for EOD purposes are related to excess Caa concentrations and DDOs. Nearly half of the 490 CLOs reviewed that incorporate OC-based EOD triggers include OC haircuts for both excess Caa-rated assets and DDOs. By contrast, only about 17% of the deals include haircuts for long-dated assets.

As the global economy continues to recover, the number of defaulted assets and Caa-rated assets held in CLO collateral pools continues to decline. The average exposure to defaulted securities and Caa assets in Moody's-rated CLOs is 3% and 8% respectively, compared to 5% and 11% at the peak of the financial crisis a year ago.

Improved pricing for distressed assets and delevering has also bolstered OC ratios for most CLOs. As a result, the median senior (Aa) OC level is now 122%, a significant increase from 118% a year ago.

As part of its study, Moody's also examined the corporate governance rules that apply in CLOs for the implementation of remedies following an EOD for 266 CLOs that incorporate OC-based EOD triggers with Caa-related OC haircuts. In 79% of the deals examined, only Aaa noteholders have the authority to direct the post-EOD remedy of acceleration. In 19% of the transactions, acceleration requires the vote of both Aaa and Aa noteholders.

The voting power appears to reverse in liquidation, however. "In about 60% of the transactions, once an OC-based EOD Trigger occurs, a majority of each class of noteholders must vote in favour of liquidation before that remedy will be implemented," Moody's explains. "In 73% of the cases, approval from more than one class of noteholders is required in order to liquidate. The complexities and logistics of getting votes from the majority and in some cases super-majority of more than one class of noteholders raises significant obstacles to the likelihood of liquidation following an EOD and to date has acted to mitigate the liquidation risk faced by CLOs."

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CLOs

LCM VIII progresses

Further details have emerged on LCM Asset Management's highly-anticipated CLO, the US$300m LCM VIII. The deal is expected to close on 23 November via Bank of America Securities.

The CLO comprises US$197m triple-A rated class A notes (which are anticipated to price at 160bp over three-month Libor), US$23m double-A rated class Bs (225bp), US$26m class C deferrable notes (300bp) and US$14m class D deferrable notes (500bp). An additional US$40m unrated subordinated tranche takes the form of limited partnership certificates.

The transaction pools US dollar-denominated broadly syndicated senior secured loans, representing 107 obligors, with the largest obligor accounting for 2%. It has a portfolio weighted average maturity of 5.13 years and is 48.9% ramped, with the remaining collateral anticipated to be acquired by March 2011.

LCM VIII LP, the issuer, was formed as an exempted limited partnership organised under the laws of the Cayman Islands. LCM VIII Corp, the co-issuer, is a limited liability company incorporated under the laws of the state of Delaware.

CS

CMBS

Language inconsistency highlighted in Euro CMBS

European Prime Real Estate 1 recently avoided a sequential redemption event upon the occurrence of an NAI shortfall amount. The fact that a CMBS structure did not capture such an event and pay-out accordingly highlights the lack of language consistency - with respect to triggers and other protection features - between different CMBS programmes that is arguably not immediately visible until actually tested, according to European asset-backed analysts at RBS.

They suggest that the highly structured nature of legacy European CMBS mean that the finer detail embedded within the transactions are of particular importance in establishing value. "Much of this stemmed, in our view, from the greater balance of power of borrowers/originators rather than rating agencies or investors in the pre-crisis bull-market - in that seller's market, borrowers desire to repay debt on a pro rata basis for as long as possible, thereby maintaining a lower weighted average cost of debt (and thus maximise excess spread), was better reflected in CMBS structures. Also the greater perceived standardisation of what were increasingly complex deals arguably lessened the scrutiny of specific wordings of terms and clauses," the RBS analysts explain.

In connection with EPRE1, the Grays Shopping Centre was sold last month for gross proceeds of £20.9m, which - net of fees, costs, expenses and accrued interest - resulted in net sale proceeds of £20.1m. Consequently, an NAI shortfall amount of around £500,000 arose on the securitised loan.

Although the documentation provides for a sequential redemption event upon losses being incurred by any noteholder, this was not trigger by the NAI loss and the proceeds were repaid on a modified sequential basis. As a result, the class B and C notes, along with the class As, received partial repayment from the net sale proceeds.

The analysts point out that a sequential redemption event was not triggered because the documentation specifies that this only happens if the loss incurred is as a result of non-payment by the issuer on the due date. "Our reading of this is that such an event would only occur in the case of principal deficiency at the legal final (despite the fact that the NAI means that such deficiency will certainly occur) - as such, we would argue that there is little protection for senior noteholders."

Indeed, the class B and C noteholders benefited from principal redemption that was not generally anticipated, while the senior noteholders suffered value leakage. In this case, the size of the loan (accounting for less than 7% of the outstanding pool) meant that the impact was not material, however.

"We see further risks of such flaws in structures emerging as loans and/or assets are worked out in CMBS," the analysts conclude. "We suspect that [such] structural language may be replicated across some of the other Morgan Stanley originated transactions."

CS

CMBS

CMBS interest shortfalls likely containable

Interest shortfalls are on the rise in US CMBS, but are expected to generally be contained at the BB/BBB level. The probability of single-A exposure is potentially higher for the 2007 vintage, according to MBS analysts at Barclays Capital, although most of these shortfalls should be reimbursed in the near term.

The BarCap analysts note that more than half of interest shortfalls are caused by ASERs (appraisal subordination entitlement reductions), which are triggered by appraisal reductions on delinquent properties. ASER-related shortfalls are typically reimbursable at the time of liquidation, though that is not always the case.

Special servicing fees make up another 20% of overall shortfalls, the analysts add. Other contributors include workout fees, liquidation fees and reimbursement of servicer advances. Modifications that reduce scheduled interest on the loans can also add to interest shortfalls.

The analysts estimate projected interest shortfalls in the future using a simple roll-rate model. In their base case, interest shortfalls climb to 3.2% of total scheduled interest.

"Based on our findings, we see value in selected single-A tranches," they say. "We acknowledge that there is a limited liquidity argument, as some accounts cannot own bonds that low in the capital structure and because dealers might be required to hold additional capital against these positions. Therefore, we prefer super-low dollar priced single-As (for example, high singles to low teen dollar prices)."

Referencing a list that traded recently, the analysts highlight MLMT 2007-C1 F and CD 2006-CD3 H tranches as potential candidates fitting these criteria.

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RMBS

Door 'left open' for Fed MBS purchases

Under its widely-anticipated second round of quantitative easing, the US Fed is to purchase US$600bn Treasuries outright by June 2011, in addition to US$250bn-US$300bn reinvestment of MBS paydowns in US Treasuries. Contrary to the expectations of some MBS market participants, it did not commit to buying any MBS as part of this purchase programme.

However, MBS analysts at Bank of America Merrill Lynch suggest that the Fed "left the door open" for potential MBS purchases as it mentioned that it will review security purchases on a regular basis. "In case MBS spreads were to widen materially for any reason, we expect the Fed to review their allocations in the purchase programme," they note.

Overall, from a rate perspective the BAML analysts view the announcement as positive for agency MBS. But the Fed paydowns that will not be reinvested in MBS remain a key challenge for the market.

"The long-term risk to the basis is a gradual increase in lending capacity, as mortgage rates are likely to stay low for an extended period of time," the analysts conclude.

CS

RMBS

Likelihood of loan repurchases estimated

MBS analysts at Barclays Capital have formulated what they describe as a "first-cut" approach to estimating the likelihood of first-lien non-agency loan repurchases. This involved comparing the characteristics and distributions of repurchases with other delinquent loans.

The BarCap analysts found little evidence to suggest that loans that go delinquent later (for example, two to three years out) do not get repurchased. "This bucket in fact forms an ever increasing proportion of repurchases as these claims increase in volume," they note.

Equally, there is little separation across FICO scores, although somewhat unexpectedly the 80-90 LTV bucket has a higher repurchase likelihood versus the average loan. However, this is likely due to the fact that these loans are from alt-A option ARM deals with monoline wraps.

Finally, large balance loans were found to be 30%-50% more likely to be repurchased than smaller loans, due to the fixed nature of some costs of pursuing repurchases. The analysts also note that no doc or limited doc loans are about 20% more likely to be repurchased than average.

CS

RMBS

Record agency fails prompt charge speculation

Failures to deliver in agency MBS reached a new high of US$1.1trn last week. MBS analysts at Barclays Capital suggest that this raises the probability of introducing a fail charge to the market.

Historically, fails remained somewhat low until 2H09 when the Fed's purchase programme significantly reduced float in the market. Yet, in the wake of the Fed's involvement in the sector, fails appeared to be slowly declining as available float caught up with TBA demand. But the latest data has reignited concern among market participants over fail rates.

While the headline number of US$1.1trn of fails is significant, the BarCap analysts indicate that it could be the result of accumulated 'round-robin' fails in the system. Additionally, the dollar value of fails is calculated as a cumulative sum of total fails outstanding each business day of the week. Consequently, the actual number of fails could be much smaller if continual fails are re-counted each day.

The Treasury Market Practices Group in September released a guide to best practices in the agency MBS market (see SCI issue 200), but increased concern around fails could lead to a fail charge being introduced. "While no such fail charge is currently planned, both rolls and the basis would likely trade well if one were eventually implemented or if concerns about a fails charge increased," the analysts note.

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RMBS

Master trusts' ability to pay examined

In the absence of sponsor support, CPR speeds have a significant bearing on the ability of RMBS master trusts to repay bonds on their scheduled maturities. European ABS analysts at Deutsche Bank suggest that certain UK trusts - such as Holmes, Lanark, Silverstone and Gracechurch - will likely generate ample principal receipts to ensure timely bond repayment. However, based on today's CPR, others - such as Aire Valley, Arkle, Permanent and Pendeford - would experience principal deferral, if support from sponsors is not forthcoming.

These findings are based on an analysis of expected principal receipts and scheduled bond redemption profiles over a two-year period for each UK master trust under the assumption that current CPR levels remain fixed. Sponsor support could be in the form of either further issuance or an injection of cash or mortgage assets.

The Deutsche Bank analysts point out that even trusts which generate sufficient principal under current CPR rates could, under lower CPRs, eventually need sponsor support. "We would emphasise that, given cashflows are often lumpy and principal trapping mechanisms imperfect, sufficiently high CPR is not a guarantee that adequate principal will be generated by the trust to ensure timely bond payment without recourse to seller support. In particular, principal could be released back to the seller under certain scenarios (high CPR followed by sharp drop, for example), reducing principal available to redeem bonds," they conclude.

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ABS

Roundtable discussion

The importance of loan-level data for ABS investors

Large amounts of aggregation and the absence of loan-level data have traditionally made determining the true value of assets in the ABS market difficult. S&P recently held an event at the London Stock Exchange ("Gearing up for European loan-level data") and chaired a round-table session with other market participants to discuss the impact that the provision of loan-level data may have for investors.

David Pagliaro: Good afternoon gentlemen and welcome to the London Stock Exchange for a roundtable discussion hosted by Standard & Poor's on the subject of the provision of loan-level data in the ABS market -focusing on the need for it, its availability and finally, the impact that it may have on investment decisions.

To start us off - who do you see as the key players driving the introduction of loan-level data into the market?

Gordon Kerr: There are three major groups driving this. First, investors are requesting loan-level data to better understand the true nature of the ABS instruments on offer and hence make better investment decisions. Then there are the regulators, which are pursuing increased transparency in the market. And finally, the banks are keen to find out what is held on trading records for risk management purposes.

DP: It seems that the provision of loan-level data to these parties may be aided by the European Central Bank and the Bank of England - both of which have already suggested that they are going to compel originators to make loan-level data widely available.

But, in terms of the European ABS market, why is loan-level data so important? Indeed, the widespread availability of loan-level data and analytical tools did not shelter the US from the effects of the financial crisis.

Craig Tipping: There is interest in European ABS products from foreign investors, especially in the US, who are keen to broaden their investment mandates. But they are also understandably nervous about dipping into European markets post-crisis.

In our experience, the ability to have loan-level data increases their comfort in dealing with Europe, however. For them it is almost a black box of investment information - as you have said, something that they are used to in the US and which they welcome in Europe.

Sriram Soundararajan: It is important to remember that loan-level data was very useful in the US during the financial crisis, providing great insight into what was transpiring. And even post-crisis - when modifications became so widespread that it was really difficult to buy bonds in the US - loan-level data was absolutely critical in figuring out where the modifications were likely to be directed and what was going to happen to bonds.

GK: Going forward, loan-level data also allows greater differentiation. A lot of investors are reticent to consider investment in Spain, for example, because of the economic issues facing the country as a whole. But if they were to look deeper into a lot of the deals on a loan-level basis, many investors could become more comfortable and willing to invest in certain sectors of the market.

DP: Standardisation can also help elevate this level of comfort. One of the key market concerns is about consistency of data and consistency of requirements. There may be one in four organisations that want information in a different format, but our aim is for everyone to base their work on the same template.

Now, looking at this from an investor or trader perspective, what capabilities do investors need to be able to extract the value out of loan-level data?

SS: Investors need to be able to handle a lot of information on a regular basis, from calculating benchmarks to building collateral models. Certainly, analysis is not predictive enough unless investors have a full collateral model available.

This is one of the key problems in Europe compared to the US - investors still tend to rely on personal judgement rather than strong analytics when making investment decisions. As such, European investors need to ramp-up their analytics capabilities to be able to realise the benefits provided by loan-level data.

I imagine that we will start to see companies offering analytical tools to investors and some companies, like S&P, offering integrated data and analytics that investors can buy and use. It's very common to see pre-payment and default models offered in the US. This is the next phase in Europe.

CT: Loan-level data is very specific to individual sectors. In European prime RMBS, for example, the availability of loan-level data will probably not have that big an impact.

But in a CMBS deal there is a far greater need for it. Here, there already is a detailed amount of information which most of the traders use and it is very useful in their niche market.

DP: Is there a flip-side to this from an investor perspective? Does the requirement for these capabilities create a barrier to entry or is it an opportunity for them?

GK: I see it as an opportunity. Going forward, organisations will build their own analytic models, buy from providers and borrow from larger research houses like ourselves.

So, not only is there a big opportunity for organisations with investing teams which are very good at doing detailed, high-level analysis. There is also a great opportunity for the organisations that can provide the tools and the framework for people to make their own sound judgements.

DP: Loan-level data is clearly advantageous for credit analysis, but what are the other benefits?

SS: Credit is one side, but there are definitely other angles. For instance, the way prices are in the secondary market, pre-payment risk is a very big deal now. Being able to forecast this risk more confidently by using a model could be critical.

GK: The ability to run real-time scenario analysis on loan-level data across different sectors will be a clear boon for investors. This will allow them to stress-test the effect of different events and look at the outcomes and potential benefit or loss on an investment.

CT: The provision of loan-level data will provide some key benefits, but it is not going to level the playing field for investors. In fact, it could make it more complicated - only the large investors will be able to afford the systems and personnel required to analyse the data. As such, the playing field will become biased in favour of the more sophisticated investor.

Question from the audience: Do you see the provision of loan-level data being widespread in the near future or will this take some time?

GK: This is where we can offer a real voice to move things forward. New issuers are not exactly putting it out there hand-over-fist, so it is up to investors to demand more detailed information when buying a deal.

DP: The initiatives of the ECB and BoE will support widespread availability of this type of data soon. Certainly, at S&P we are committed, through the use of ABSXchange, to bringing together the buy and sell sides in terms of transparency of information and analytics employed. Everything is moving towards greater transparency, more robust data sets and broader analytic capabilities and that is what we are working on.

Technology

Panoramic approach

Bob Park, ceo and co-founder of FINCAD, answers SCI's questions

Q: How and when did FINCAD become involved in the structured finance markets?
A: FINCAD is a 20-year-old company. Our core competence is building financial analytics for valuation and risk measurement.

We have been selling software for the last 19 years and over that time we have licensed our software to 4,000 different organisations in more than 80 different countries. Very early on we tried a more panoramic approach to analytics, whereas other companies were focusing on just one narrow asset class.

From the outset, we have built analytics to work across all the asset classes. We have tools to work with bonds and bond derivatives, commodities, equities and FX derivatives. In the late 1990s and early 2000s we started covering credit derivatives. A lot of our clients use our technology for interest rate products and a growing number are using our credit products.

We have three product families: our classic, function technology products under the FINCAD Analytics Suite; our structured products F3 brand; and an online offering where users can enter their portfolios and obtain independent valuations.

The analytics suite products have become an industry standard. We have a very diverse clientele, which includes all sorts of banks - from Wall Street firms to small savings banks - as well as hedge funds, non-financial corporations, quasi-governmental agencies and accounting firms.

Our F3 products are also pure analytics. In the mid-2000s we realised that the function-based technology would not meet the needs in the structured products area, so we put a team together and gave them the mandate to start afresh with a completely clean sheet. They started their design work in 2006 and we have just released two significant products under the F3 brand; one is F3 Excel Edition and the other is F3 SDK.

F3 is an entirely new approach for FINCAD to financial analytics and we were able to avoid a lot of the pitfalls that other companies go through because of legacy technology that has to be incorporated. It is highly flexible and you can define virtually any trait and it is configured to use Monte Carlo simulations in a computational grid. So it is grid-enabled from the outset and it is completely transparent, which is becoming an increasingly important factor in financial reporting, along with traceability tools through cashflow reports and audit logs.

Aside from those two pure analytics families, we also have an offering that allows users to enter their portfolios and obtain independent valuations. This is an online solution that embeds our analytics in our software-as-a-service offering and gives them the ability to enter their portfolios and receive values.

The system is integrated with daily market data from some of the world's leading sources and that gives them the ability to generate valuation reports either on an ad hoc basis or they can schedule them and have valuation reports sent to a distribution list - whether that is the compliance people, portfolio managers, etc.

Q: What are your key areas of focus today?
A: Our core competency is providing state-of-the-art tools for valuation and risk measurement. We look to do that across the entire asset spectrum, so we were ahead of the curve when a lot of analytics vendors specialised in one asset class or another. We continue to be unique to some degree in that we offer very comprehensive coverage across all the asset classes, while in each of those asset classes our coverage is very comprehensive.

We are beginning to get more traction in the structured markets as a result of F3. It is all about giving people accurate numbers both for valuation purposes and for risk assessment. Going forward, this unique risk technology embedded in F3 will get a lot of traction in the middle office for risk managers, but because of the granular detail it also gives traders the tools they need to hedge out exposures that they do not want in deals they are contemplating.

Q: Which market constituent is your main client base?
A: Historically we have been strongest in interest rate derivatives. I would guess between 50% and 55% of our users are working in interest rates and fixed income, including a growing number which are also using credit derivatives as a result of their activities in those two markets.

Once we get past the interest rates, fixed income and credit, then it is fairly evenly divided between equities and commodities. We have energy companies, agricultural producers and consumers, electricity companies, oil and gas, and a lot of metals companies.

This diversity has been a real asset at certain times in the market. The ability to move into different industry segments has been a real strength for us.

We were popular fairly early in the hedge fund industry as a number of traders moved out of banks to set up hedge funds or join hedge funds because those guys were already familiar with our tools. One of the great things about our business is that people move around in the financial industry and there are some clients we have sold our technology to multiple times over the years.

The other thing is that, because of our geographical diversification, if things go a little stale in one part of the world then the chances are there are going to be other opportunities elsewhere. If things go a bit flat in one industry segment, then we have others we can go to and do business with.

Q: How do you differentiate yourself from your competitors?
A: In the past we have done it on the basis of quality and value. We are able to add a very significant differentiator with F3; this F3 technology is quite different. It is the first 21st Century object-orientated analytical platform and, because it is legacy-free, we have been able to take advantage of some of the technologies that just were not available before.

Being grid-enabled from the beginning is important because one of the key lessons from the financial crisis is that value-at-risk is not a panacea as a risk management tool. Therefore, increasingly risk managers are turning to scenario analysis. In the context of large financial organisations with large portfolios, running multiple scenarios is very time consuming and resource intensive, so by having F3 enabled to run on massive computer grids, large financial institutions are able to run multiple scenarios.

F3, because it is so efficient and grid-enabled, will provide a significant edge in terms of running multiple scenarios. That, coupled with the very granular risk reporting that we provide, has the potential to change the way risk management is done because it provides information risk managers have simply not had before.

There are a number of innovations in this technology that will impact front, middle and back offices. The flexibility it provides gives the front office the ability to define any trade, so they do not miss an opportunity in the market, because some opportunities are there for a very short period of time. In the middle office this comprehensive risk information is going to give people much better information for risk management.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The dominant theme is the uncertainty caused by not knowing what the regulators are going to say. The good thing for us is there is a new focus on risk management and the inadequacies of how it was done up until the financial crisis.

I think we are going to see increasing budgets in the risk management area and we are already seeing the middle office having significantly increased influence in most financial institutions. In terms of the challenges, I think that there are a lot of people feeling very uncertain about the potential effects of the new regulations, especially with respect to the bespoke derivatives contracts and how that will affect use of capital.

Another challenge is that banks will struggle with margins going forward. Central clearinghouses can be used to deal with a significant part of the simpler derivatives markets. It may lead to customers being more willing to use simple products because of the greater comfort they will feel thanks to central clearing facilities.

In the structured markets there has been a real pull-back from exotics, which will not last. I think what is going to happen going forward is people will get yield hungry again and start looking for ways to pump up their yield, and a way to do that will be structured products.

Another area which holds potential for the future, provided the industry can improve its record of disclosure, is in retail structured products. These were taking off just prior to the crisis but then there were some real horror stories. Provided disclosure rules are improved, people will be able to make more informed decisions about the risks they are taking on in order to get a 7% yield instead of a 3% yield.

But there is huge pressure on the regulators, certainly in the US. These guys have been called on to do more work than they have done for the last 15 years! It just sounds impossible.

The time pressure involved means that mistakes will be made and there is a really good chance of unintended consequences. Hopefully, they will be easy enough to fix, but it only adds to the uncertainty.

JL

ABS

Structured solutions co-head named

RBS has appointed Chris Marks as co-head of structured solutions. He will report to Rory Cullinan, the firm's head of non-core division.

Marks was previously an md in Barclays Capital's London structured finance team.

ABS

Advisory services head recruited

Steven Campo has been appointed managing partner, advisory services at Paladin Advisors. He was previously principal at SeaView Advisors, an advisory firm focused on bringing specialised services to the structured finance marketplace.

ABS

Rating agency adds SF trio

DBRS has made a trio of appointments across its US and European structured finance groups.

Mike Babick joins the agency as svp and lead analyst, focusing on its ABS business. He reports to Claire Mezzanotte, head of the firm's US and European ABS, RMBS and covered bond group. Babick previously worked at Assured Guaranty Corporation as md in its consumer ABS group, here he originated and analysed consumer ABS in the auto finance and credit card sectors

Meanwhile, Alastair Bigley and David Harrison will join DBRS' newly established European structured finance group. Bigley was previously senior director at Fitch, while Harrison was a director in Barclays Capital's securitisation swaps team.

ABS

Promotions for investment management duo

Douglas Kelly is to succeed Edward Bedrosian as president of Annaly Capital Management's wholly-owned subsidiary Merganser Capital Management. Kelly, who was previously cio of Merganser, will continue to oversee its investment process along with Andrew Smock as co-cio. Founder of Merganser, Bedrosian will serve as chairman through 2011.

Kelly joined the firm in 1986, leading the portfolio team for ten years. Prior to this, his experience included portfolio management positions with American Can and Exxon Corporation. Prior to joining Merganser in 2003, Smock was a management consultant with Sibson Consulting Group.

CDO

MS sued over CDO swap obligations

Morgan Stanley has disclosed in a 10Q filing that it could take a US$274m loss on a CDO, known as Tourmaline CDO I. The firm - along with Barclays Capital - is being sued by US Bank for breaching swap agreement obligations under the transaction, which involved posting collateral if Morgan Stanley was downgraded. A trial is due to begin on 17 November.

CDO

Goldman fined over Wells Notices

FINRA has fined Goldman Sachs US$650,000 for failing to disclose that two of its registered representatives, including Fabrice Tourre, were the subjects of investigations. Tourre's Wells Notice was issued in connection with the SEC's investigation of the Abacus 2007-ACI CDO (SCI passim).

Firms are required to file a Form U4, reporting the receipt of a Wells Notice within 30 days. In Tourre's case, his Form U4 was not amended until 3 May 2010 - more than seven months after Goldman received his Wells Notice and only after the SEC filed a complaint against Goldman and Tourre on 16 April 2010.

"Goldman's failures impacted the ability of FINRA and other securities regulators to discharge their registration, examination and oversight duties. This limited the ability of investors and other market participants to adequately assess the individuals through FINRA's public disclosure programme, BrokerCheck," says FINRA evp James Shorris.

In concluding this settlement, Goldman neither admitted nor denied the charges, but consented to the entry of FINRA's findings. The firm also agreed to review its supervisory procedures and systems in the reporting area and to implement and document any necessary remedial measures.

CDO

Broker adds CDO/ABS trading head

Braver Stern Securities has appointed Peter Howard as md and head trader of CDOs, CLOs and esoteric ABS. Howard joins Braver Stern from Cross Point Capital, where he was most recently head trader focusing on all securitised products. Prior to this, he spent three years with Peloton Partners, as partner and head of the firm's ABS master fund.

CDS

Asian structured credit fund minted

Hong Kong-based Oracle Capital has launched its second fund, Oracle Structured Credit Segregated Portfolio 2. The fund targets non-US investors and will focus on securities backed by a variety of corporate credit assets. It offers a five-year investment period, with a lock-up for the first year and monthly investor redemption thereafter.

Oracle may trade or hold assets until maturity in order to achieve its target of 20% annual returns.

CDS

CVA pro joins advisory firm

Jon Gregory has joined Solum Financial Partners as a partner. Previously, he had been working as an independent consultant in CVA and counterparty credit risk for the last two years. Prior to this, Gregory was involved in credit derivatives and credit trading at Barclays Capital and BNP Paribas.

CMBS

Boutique strengthens real estate team

Future Capital Partners (FCP) has appointed Elodie George, Tim Mycock and Aysha Banks to its real estate team. The team, led by Peter Young, is responsible for managing the investment partnerships for the firm's £150m luxury real estate development in Budva, Montenegro, as well as a number of landmark UK real estate developments.

As real estate manager, George is responsible for the development and execution of existing and new investment opportunities. Prior to FCP, she worked within the property investment group at Alpha Real Capital, as well as in the property debt management group at Hatfield Philips International.

Mycock will assume the position of structured finance manager and will be responsible for developing the firm's real estate investment opportunities. Before joining FCP, he gained four years of real estate experience at CLP Structured Finance and most recently Red Chilli Structured Finance.

As real estate associate, Banks will assist in developing FCP's real estate investment products. She previously worked within the corporate tax group at PricewaterhouseCoopers and Ernst & Young in Australia.

CMBS

Mortgage finance partner recruited

Berwin Leighton Paisner has appointed structured finance lawyer, Lucy Oddy, as partner in its banking and capital markets team in London. Joining the firm from Clifford Chance, she has experience in working on UK and pan-European SF transactions, with a focus on residential and commercial mortgage financing portfolio disposals.

CMBS

CRE firm on hiring spree

The Situs Companies has opened a new office in Atlanta, Georgia, headed by Tammy Ellerbe. As part of the firm's integrated platform, the new office offers due diligence, loan underwriting, primary and special servicing, and asset management.

Ellerbe will initially recruit 25 professionals with experience in CRE loan underwriting, collateral valuation, asset management, workouts and strategic disposition and REO advisory services. With over 20 years of industry experience, Ellerbe previously worked for CWCapital as md and head of underwriting in its capital markets lending business.

Monolines

Ambac files for voluntary bankruptcy

Ambac Financial Group has filed for a voluntary petition for relief under Chapter 11 of the US Bankruptcy Code for the Southern District of New York. The firm will continue to operate in the ordinary course of business as 'debtor-in-possession' under the jurisdiction of the Bankruptcy Court.

Ambac says it was unable to raise additional capital as an alternative to seeking bankruptcy protection and was also unable to agree to terms with an ad-hoc committee in order to restructure its outstanding debt (SCI passim). However, the firm has agreed to a non-binding term sheet that will serve as a basis for further negotiations and which may allow Ambac to emerge from bankruptcy more expeditiously. As of 30 June 2010, the firm had outstanding debt amounting to US$1.622bn.

Meanwhile, Ambac is seeking an interim order restricting certain transfers of equity interests and claims against it that are retroactive to the time of filing. The purpose of the interim order is to preserve the firm's net operating losses (NOLs), which totalled approximately US$7bn as of 30 June 2010.

Under section 382 of the Internal Revenue Code of 1986, transfers by persons or entities holding 5% or more of Ambac's outstanding equity interests could impair or permanently eliminate its NOLs. Additionally, transfers of claims against the firm by persons or entities who may receive 5% or more of the reorganised stock may impair or permanently eliminate its NOLs.

Finally, Ambac is seeking a declaration to confirm that it has no tax liability for 2003 through to 2008, in which it is entitled to retain the full amount of the tax refunds for this period.

Real Estate

Mortgage servicer sale completed

Walter Investment Management has acquired Marix Servicing, a high-touch specialty mortgage servicer. Marix, based in Phoenix, Arizona, focuses on default management, borrower outreach, loss mitigation, liquidation strategies and component and specialty servicing. The closing of the transaction will allow Walter to expand its portfolio acquisition and revenue growth opportunities, the firm says.

RMBS

Bank adds trading heads

BB&T Capital Markets has appointed Peter Faherty and Jim Maughan to its fixed income trading operation. With nearly 20 years of mortgage securities experience, Faherty joins the firm's New York office as head of mortgage securities trading. Maughan joins BB&T's Boca Raton's office as head of agency trading, bringing more than 20 years of experience to the firm's agency operations.

ABS

CSCF exposure sold on

The Business Development Bank of Canada (BDC) has announced the sale of C$250m ABS - original face value - to RBC Capital Markets. The sale represents a portion of the term auto loan ABS that BDC purchased under the provisions of the Canadian Secured Credit Facility (CSCF).

Paula Cruickshank, BDC vp of securitisation, says: "This transaction is very encouraging because it is another indication of growing liquidity in the secondary market for ABS."

BDC invested C$3.65bn in ABS across five different asset classes between November 2009 - when the firm's first investment under the CSCF programme was made - and 31 March 2010, when the CSCF programme ended. The CSCF programme was a federal government initiative, managed by BDC, to stimulate economic activity by helping businesses and consumers access credit to purchase and/or lease new vehicles and equipment (SCI passim).

ABS

Counterparty risk assessment highlighted

The financial disruptions of the past few years underscore the central role that counterparty risk assessment plays in the analysis of structured finance securities' creditworthiness, according to S&P.

"Under stressed conditions, there is a risk that a counterparty might not perform its duties, which - in some cases - could lead to a payment default on the securities," says S&P analyst Andrew South.

Recent history has brought aspects of counterparty risk in SF to the fore, as some financial institutions that served as counterparties in a number of structured finance transactions became insolvent. "These experiences, along with the evolving characteristics of the world's financial system, have led to a reassessment of counterparty risk by market participants, including regulators and credit rating agencies," South adds.

He concludes: "Even as the securitisation market recovers, and structures begin to evolve to reflect lessons learned, we believe that counterparty risk is likely to remain an important consideration in determining the creditworthiness of structured finance securities."

ABS

COMET on review following servicer downgrade

Moody's says its ratings on 47 classes of ABS issued out of the Capital One Multi-asset Execution Trust (COMET) remain under review for possible downgrade, following the 1 November downgrade of Capital One Bank's long-term senior unsecured rating to A3 from A2. The rating agency has also extended its review of the counterparty instrument rating to the swap agreement relating to credit card-backed notes issued by COMET Class C (2004-3).

The COMET securities are backed by a US$42bn revolving pool of consumer and small business credit card receivables originated by Capital One Bank (USA). These securities were initially placed under review for possible downgrade on 28 July 2010.

The one-notch downgrade to A3 of Capital One Bank, the seller/servicer for COMET, is a credit negative for the COMET securities, according to Moody's. Even so, COMET's collateral performance trends - like those of the credit card industry at large - have improved and appear to be on a positive credit trajectory.

The agency's continued review will focus on the strength of these positive credit trends combined with the impact of the downgrade to the seller/servicer. Although it does not necessarily translate to a downgrade of the ABS, a downgrade of a bank sponsor's credit rating increases the potential for ratings volatility for the related card ABS programme, Moody's notes.

Like others in the credit card sector, Capital One's trust performance materially deteriorated during the credit crisis. Unlike most others, however, Capital One chose not to increase the credit enhancement to its ABS notes.

As a result, Moody's downgraded the two most junior classes of notes in 2009. The ratings on the more senior Class A and Class B notes, though marginally weaker, remained unchanged.

Since then, concerns about collateral performance have abated somewhat. For COMET, charge-offs have fallen from a peak of 12.7% in March 2010 to 10.4% in September 2010.

Even so, looking back at the extreme and rapid deterioration in collateral performance during the height of the credit crisis, Moody's remains cautious about the relatively recent improvement. For these reasons, and in light of the downgrade of the sponsor bank, the COMET ratings remain under pressure. A downgrade, if any, would not likely be more than two notches.

ABS

EU CRA consultation launched

The European Commission has launched a broad consultation on credit rating agencies (CRAs), which aims to widen the debate and gain input from all stakeholders in order to calibrate the scope of any possible future legislative initiative in the area. From 7 December 2010, new EU regulations will require CRAs to comply with rules of conduct in order to minimise potential for conflicts of interest, ensure higher quality ratings and greater transparency of ratings and the rating process.

Internal market and services commissioner Michel Barnier says: "We need to learn all the lessons of the crisis. We have already introduced EU-wide rules for better supervision and increased transparency in the credit rating market. This was an important first step. But we need to think about step two: the role of ratings themselves and the impact they can have on markets."

The consultation raises numerous questions. First, the Commission asks which measures could reduce the possible overreliance on CRAs and increase disclosure by issuers of structured finance instruments in order to allow investors to carry out their own additional due diligence on a well-informed basis.

Second, regarding sovereign debt ratings, the EU regulatory framework already contains measures on disclosure and transparency. However, the EC says that further measures could be considered to improve transparency, monitoring, methodology and the process of sovereign debt ratings in the EU.

Third, only a handful of big firms make up the CRA sector, with the lack of competition potentially negatively impacting the quality of credit ratings. The Commission says it will explore the options to increase diversity in this sector.

Fourth, the rules on whether and under which conditions civil liability claims by investors against credit rating agencies are possible currently vary greatly between Member States. The Commission is seeking comment on whether there is a need to consider introducing a civil liability regime in the EU regulatory framework for CRAs.

Fifth, the 'issuer-pays' model raises questions of conflict of interest, according to the EC. The consultation is seeking evidence about such practices and whether alternative models would be possible.

The deadline for replies is 7 January 2011. The Commission says it will decide on the need for further measures next year.

ABS

Positive outlook for 2009 vintage prime auto ABS

Fitch reports that lower-than-expected losses for 2009 US prime auto loan ABS are positioning the vintage for continued positive rating performance, as the broader economy slowly improves.

Through the first three-quarters of this year, expected cumulative net losses (CNLs) on 2009 auto ABS were twice as low -1.3% to 1.5% - than those of 2008 and 2007 vintages (2.8%-3%). Fitch consequently maintains a positive rating outlook for 2009 auto ABS.

CNLs for 2009 are likely to resemble the pre-recessionary vintages of 2005-2006, with numerous factors driving the better-than-expected performance. However, the agency says it does not expect future prime auto loan ABS credit enhancement to drop materially from 2010 levels, which are down from those of 2009.

Fitch director Brad Sohl says: "The wholesale vehicle market has improved significantly and job losses are slowing. The stronger credit quality and tighter underwriting of 2009 loans were an about-face from the loan attributes that worsened 2007 and 2008 vintage auto ABS performance."

The agency says it expects performance to stay largely positive, even in the face of high unemployment. However, Sohl concludes: "Future auto ABS performance remains susceptible to a potential double-dip recession and new job losses."

CDS

Ambac credit event determined

ISDA's Americas Determinations Committee has determined that a bankruptcy credit event occurred with respect to Ambac Financial Group on 8 November - the date it announced it had filed under Chapter 11. An auction will held in due course to settle CDS on Ambac Financial.

CDS

Central clearing infrastructure analysed

The Committee on Payment and Settlement Systems (CPSS) has issued a report on developments in the clearing industry's market structure, their drivers and the implications for financial stability.

The report shows that different types of market structure have developed over the last decade, creating specific risks and amplifying interdependencies between systems and markets. However, the Committee says, there is no evidence that the industry is settling on one particular structure or that one market structure is superior to another - either in terms of CCP risk management or wider systemic risk.

Nevertheless, central banks, regulators and overseers may usefully pay attention to specific risks that are more likely to occur in some market structures than in others, CPSS says. These include incentives to weaken the robustness of CCP risk controls that may in turn reduce the CCP's ability to manage a member default. Although some of the risks considered in the report have yet to materialise, CCPs and their regulators or overseers face significant future challenges, in particular as market structures in many countries continue to evolve.

The clearing industry's structure also has a bearing on how far central clearing will be used in different market segments and hence on the resilience of the financial system as a whole, according to CPSS. The broader risk-mitigating benefits of central clearing may be diluted if changes in market structure affect access to CCPs, raise the cost of central clearing or hamper the process of creating new CCP services, the report concludes.

CDS

Collateral broadened for Euro clearinghouse

ICE Clear Europe is to accept gold bullion as collateral for CDS transactions for initial margin only. Starting from 22 November, gold bullion will be accepted by the clearinghouse via electronic transfer in increments of 1 troy ounce and will be priced daily using the London Gold Fixing Price in US dollars.

In addition, ICE Clear Europe recently introduced a tri-party collateral management arrangement with Euroclear Bank, through which European government bonds may be used as collateral to fulfil initial margin requirements. Both the addition of gold bullion collateral and the availability of collateral via Euroclear Bank are intended to enhance the stability and flexibility of the clearinghouse, ICE says.

Acceptable collateral for ICE Clear Europe currently includes cash and government securities. Yves Poullet, Euroclear Bank ceo, says: "As the market continues to move from unsecured to secured transactions, accessing and efficiently managing collateral is becoming increasingly important. Helping clients optimise use of their collateral held with Euroclear Bank is precisely our objective."

CDS

Broker CDS mixed as indicators of default

The overall performance of CDS spreads as indicators of default risk during the financial crisis was mixed for the US broker-dealer sector, according Fitch.

As of October 2007, CDS spreads for the financial institutions sector were 50bp - implying an annual default probability of less than 1%. However, during the 12 ensuing year, two of the 30 entities within Fitch's sample experienced a credit event, akin to a realised default rate of 6.7% for the sector as a whole.

Financial institution spreads ultimately peaked in September 2008, coinciding with the two credit events experienced in the sector during the observation period. The September 2008 peak spread of 425bp implied an annual default probability of roughly 7%, even though there were no subsequent credit events among the remaining entities in the sample, Fitch concludes.

CDS

Mortality CLN issued

Signum Finance Cayman Limited Series 2010-09 has issued US$200m of credit-linked notes that reference the mortality experience of a block of insurance policies. The issuer is a bankruptcy-remote SPV established to issue the notes, the proceeds of which are used to purchase collateral assets in the form of 15-year senior unsecured bonds issued by Goldman Sachs Group. The issuer also entered into a 15-year CDS with Goldman Sachs International (GSI) as the swap counterparty.

Under the CDS, the SPV will provide mortality protection on a defined block of US level-term life insurance policies. The SPV will make payments to GSI in the event actual mortality experience of the defined block exceeds specified trigger levels, while the fixed payments from GSI to the SPV will be paid to investors in the notes.

An agreement with a collateral assets settlement provider (CASP) provides for a return of par value to the issuer in exchange for a principal amount of the collateral assets equivalent to the payment due from the issuer to the noteholder in the event of an early redemption due to a cancellation event under the CDS, or from the issuer to the swap counterparty following a loss. GSI serves as the back-up CASP, providing for the full payment of par value should the CASP default in its obligations under the agreement.

Fitch has rated the notes single-A with a negative outlook. Its credit analysis of the notes is credit-linked to the ratings of Goldman Sachs Group, as guarantor to GSI, the swap counterparty and back-up CASP, as well as the mortality experience of the defined insurance block under the CDS.

CDS

Swaps fraud prevention rule proposed

The US SEC has proposed a new rule to help prevent fraud, manipulation and deception in connection with security-based swaps. The rule is proposed under Title VII of the Dodd-Frank Act and aims to ensure that market conduct in connection with security-based swaps is subject to the same general anti-fraud provisions that apply to all securities.

The proposed antifraud rule would apply to offers, purchases and sales of security-based swaps, as well as to cashflows, payments and deliveries. The rule would make explicit the liability of persons that engage in misconduct to trigger, avoid or affect the value of such ongoing payments or deliveries.

The SEC is seeking public comment on the proposed rule for a period of 45 days following its publication in the Federal Register.

CLOs

Positive credit watch for US CLOs

S&P has placed its ratings on 415 tranches from 146 US corporate CLO transactions on credit watch with positive implications. The affected tranches have a total issue amount of US$39.08bn.

The performance of the speculative grade corporate credit environment has improved in recent quarters, S&P notes, which has consequently improved the collateral quality of US CLOs. With no leveraged loan defaults in October, the lagging 12-month loan default rate continued to edge lower, falling to a 23-month low of 2.28% by principal amount and to a 27-month low of 3.22%.

94 corporate issuers were downgraded and 124 upgraded in 3Q10, bringing the global downgrade ratio to 43%, which ties with 2Q07 for the lowest downgrade ratio of the decade, S&P reports. Additionally, the number of global issuers poised for downgrade has declined to 532 - just over half the 1,028 issuers a year ago.

Consequently, cashflow CLOs have continued to benefit from a gradual improvement in collateral credit quality, the agency notes. Further, some transactions that are past their reinvestment periods have paid down portions of their senior note balances, resulting in improved coverage ratios.

The agency expects to resolve the credit watch placements within 90 days and will continue to monitor the CDO transactions rated.

CMBS

Milestone drop for CMBS delinquencies

Fitch reports that US CMBS loan delinquencies have declined for the first time in 33 months, according to its latest loan delinquency index results, with a large assist from the hotel sector.

CMBS delinquencies dropped by 88bp to 7.78% due largely, the agency says, to the resolution of seven loans greater than US$100m - including the US$4.1bn Extended Stay America loan (see also SCI 3 November). Additionally, hotel delinquencies declined to 14.14% from 21.31% - the largest drop ever recorded of any CMBS asset type by Fitch.

"Whereas hotel-backed loans saw the most rapid performance deterioration, now the opposite is true," says Fitch md Mary MacNeill. "Hotel loans are now the most well-positioned to recover quickly when business and consumer spending resume and the economic recovery gains traction."

Current delinquency rates by property type are: 14.57% for the multifamily sector; 14.14% for hotels; 6.25% for retail; 5.83% for industrial; and 5.38% for office.

CMBS

Japanese CMBS loan behaviour analysed

Moody's reports that a large proportion of Japanese CMBS loans maturing this month and next are originated in 2007, backed by retail properties or amount to more than Y20bn each.

16 loans totalling Y270.9bn will mature in November and December - the equivalent of 24% of the CMBS loan amounts maturing in 2010, the agency says. 40% of the loans maturing in this period were originated in 2007, 70% of which amounts to more than Y20bn each, while seven are backed by retail properties.

According to the report, nine loans amounting to Y67.1bn matured in October 2010, four loans of Y16bn were paid and four loans of Y50.6bn have defaulted. Additionally, one loan totalling Y0.5bn was extended, three loans of Y8.9bn were prepaid and four loans of Y13.7bn were recovered.

Defaulted loans amounted to Y287.8bn at end-October 2010, up by 12.6% from the previous month, Moody's notes.

CMBS

New NAIC CMBS model 'less punitive'

The National Association of Insurance Commissioners (NAIC) has released guidelines detailing its new method for determining capital requirements for CMBS. The new capital requirements are expected to be less punitive than under the existing model, leading to little or no forced selling from insurers.

Initial results from the Blackrock model indicate that it is more optimistic than most Street projections, according to MBS analysts at Barclays Capital. Consequently, they anticipate strong insurer demand for AJ/AA and, to some extent, single-A tranches. The basis between 2007 dupers and conduit 2010 issuance is also likely to tighten.

"We expect a price rally to play out over the medium term as the regulatory process continues," the BarCap analysts note. "Insurance companies will likely step up purchases toward Q1/Q2 2011. In the meantime, pre-emptive buying from hedge funds could drive cash prices somewhat higher."

CMBS

Careful implementation urged on Volcker Rule

The CRE Finance Council has submitted a comment letter to US Secretary Timothy Geithner, chair of the Financial Stability Oversight Council (FSOC), in response to an FSOC study on rulemaking to prohibit proprietary trading by certain financial institutions, known as the 'Volcker Rule'. The letter emphasises that regulators should strictly adhere to the Dodd-Frank Act, which directs that the Volcker Rule should not be construed to limit or restrict lawful securitisations.

"While Dodd-Frank explicitly exempts securitisation, CRE Finance Council urges regulators to carefully consider rules to ensure that a broad application does not negatively affect the CMBS market, which is critical to a CRE recovery," says John D'Amico, CREFC ceo. "We are starting to see a timely revival of the CMBS market, but policymakers must take extra care with rules that could unintentionally impact its fragile state."

The Council asserted in its letter that securitisation is also, as a business, conceptually different from the types of activities the Volcker Rule seeks to address. "Congress exempted securitisation from the Volcker rule both in recognition of securitisation's importance to the economy and in recognition that securitisation is conceptually different from the types of conflicts of interest and high-risk activities the Volcker Rule seeks to address," says D'Amico in the letter.

He adds: "Equally important, Congress understood that certain activities are less likely to raise these types of concerns, such as risk-mitigating hedging activities and market-making activities."

Investors

European private placement market wanted

A fully-functioning European private placement market could add in excess of €25bn of available funding for companies, according to a report by Bishopsfield Capital Partners.

Private placements and the issuance of unrated and privately negotiated medium- to long-term debt with institutional investors have historically been dominated by US capital markets, the firm says. Despite the creation of the Euro and development of high volume public bond markets, European borrowers seeking privately placed debt currently still have little option but to tap the US market.

US private placement issuance averaged US$42bn annually in the years prior to the credit crisis, with the US$22bn of bonds issued in the first half of this year almost exceeding total issuance in 2009. Non-US borrowers typically account for between 45%-55% of this issuance, Bishopsfield adds.

"European borrowers turning to the US private placement market provides clear evidence of the need for an equivalent market in Europe," says Steve Curry, Bishopsfield partner.

He adds: "With significant amounts of refinancing due and calls for corporates to diversify their funding away from banks, there is a real need for non-traditional sources of longer-term debt. A European private placement market that has real depth would provide much needed extra funding capacity, as well as an attractive new asset class for yield-hungry investors."

The European Commission has examined the failure of investors, borrowers and regulators to establish a regional private placement market following the creation of the single currency, Bishopsfield explains. The UK government also recently announced plans to raise awareness of this form of funding. However, no industry-wide momentum currently exists to support the development of the European private placement market, the firm concludes.

RMBS

GSE recapitalisation costs estimated

The ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach US$280bn, including the US$148bn already invested, according to S&P. However, the agency estimates that this figure could swell to US$685bn with the establishment of a new entity to replace the two GSEs, which the government would initially capitalise.

"It appears unlikely in our view that housing and mortgage markets will be able to operate normally without continuing and substantial government involvement," S&P notes. "That will likely mean further taxpayer support for Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs) that, along with the Federal Housing Administration, now buy more than 90% of all home loans compared to less than half before the crisis."

Although federal authorities have taken no concrete public steps toward sponsoring a GSE alternative, S&P says it believes that it's a useful exercise to consider how much such a recapitalisation might cost taxpayers. The agency's assumption is that it could cost an additional US$400bn to establish a new mortgage intermediary, capitalised at 7% of total assets - although a smaller entity could be formed and capitalised based on risk-weighted assets. The US$400bn would, in S&P's view, be enough to cover all losses and to support new business.

If the government retained ownership, however, the agency estimates that the surviving entity could be capitalised as low as 4% of total assets, or about US$225bn. S&P reckons that taxpayers could bear the recapitalisation for a purely government-owned entity, although private owners could also capitalise it cooperatively.

RMBS

US mortgage default rates improving

S&P reports that default rates among US residential mortgage loans continued to improve through 3Q10. However, the uncertain climate in the housing market highlights the possibility that conditions could deteriorate further, the agency says.

"Monthly default rates improved the most among subprime and Alt-A loans, while prime default rates remained largely unchanged," says Diane Westerback, S&P's head of global surveillance analytics. "Additionally, cumulative subprime and Alt-A defaults may be approaching plateaus as both the subprime and Alt-A default indices are flattening."

Despite the default patterns in the third quarter, Westerback notes that declining subprime, Alt-A and prime liquidation rates suggest that positive momentum in home prices might be temporary. The delayed liquidations create a backlog of unresolved distressed properties that have yet to be remarketed for sale, the agency adds.

"These properties that have yet to hit the market may be skewing the visible supply of homes for sale," says S&P analyst Brian Grow. "These not-yet-for-sale properties, which we refer to as the 'shadow inventory', are a key reason the housing market is recovering so slowly. They will also likely drive home prices down when the backlog clears and finally enters the market."

"The overall performance of securitised residential loans has progressively deteriorated from one vintage to the next," adds S&P analyst Nancy Reeis. "In short, newer vintages - particularly 2005 and later - have performed significantly worse than pre-2004 issuances. Specifically, cumulative default rates among recent vintages have reached levels that far surpass those of preceding vintages."

For example, S&P says, as of September 2010 - after only 33 months of seasoning - subprime loans from the 2007 vintage reported cumulative defaults of about 55%, which puts them on track to be the worst performers yet. This rate is over 100 times the rate of the prime 2005 loans, which are the best-performing residential loans the agency tracks. After 33 months of seasoning, these prime loans had a cumulative default rate of only 0.54%, the agency concludes.

RMBS

UK mortgage arrears hits North harder

S&P's study of regional differences in UK mortgage arrears and borrowers' equity positions indicates that the recent recession hit borrowers in the North of the country harder than those in the South. Using data from approximately 1.5m loans backing UK prime RMBS, the agency found that the level of arrears among mortgage borrowers in the North was almost 25% higher than in the South.

"Our study also found that the default rate over the 12 months to mid-2010 was more than 50% higher in the North than in the South," says S&P analyst Mark Boyce. "Additionally, an estimated 6% of mortgages in the North - and more than one in 10 in the North-West in particular - were in negative equity at the end of June, compared with only 1.5% in the South."

Looking forward, the recession may technically be over, but mortgage borrowers in the North of the UK could continue to feel the residual effects for several years. "Given the North's public sector jobs bias, looming cuts in government spending could widen this regional gap," Boyce concludes.

RMBS

Servicer ratings sector on negative outlook

Fitch has assigned a negative outlook for the entire US residential mortgage servicer ratings sector on increased concerns surrounding alleged procedural defects in the judicial foreclosure process. This industry-wide issue will cause all servicers to be under increased scrutiny from a wide range of state and federal regulators, attorneys and GSEs, the agency says.

Fitch's survey showed that approximately one-third of its rated servicers have completed their reviews of foreclosure processes and the accuracy of their foreclosure affidavits. However, some have found their procedures for reviewing, signing and notarising foreclosure documents may require corrective actions.

The agency further notes that it may place an individual servicer's ratings on RWN and/or downgrade the rating, if the servicer does not diligently and timely review its processes. Additionally, Fitch says it may also take similar actions on a servicer's ratings if the impact of further costs significantly affects its financial condition.

Meanwhile, an increase in loss severities on liquidated loans from expected trend lines or downgrades to servicer ratings may result in negative rating actions on related RMBS classes, the agency notes. As a direct result of the recent foreclosure issues, Fitch says it expects any negative rating actions to be limited largely to non-investment grade classes and tranches that currently have a negative rating outlook.

Finally, the agency confirms that it does not envision RMBS downgrades to exceed a single rating category in most cases.

RMBS

US subprime servicer advances declining

Further evidence of US mortgage servicers' more pessimistic view of recovery prospects is in the steadily declining rate of servicer advances on delinquent mortgage loans, according to Fitch's latest Performance Metrics results for the sector.

Where mortgage servicers were advancing payments on over 90% of delinquent loans across all asset types during the market peak of 2006, the number has dwindled significantly for subprime delinquent loans (at 63%) and is less pronounced for Alt-A delinquent loans (88%). Servicer advancing on prime delinquent loans has remained relatively unchanged at roughly 96%, the agency reports.

Falling home values and extended liquidation timelines are primarily responsible for a decline in servicer advancing. "The large home price declines have led to higher loan to value ratios and have caused servicers to deem advances non-recoverable sooner," says Fitch director Darren Liss. "Also, longer liquidation timelines have substantially increased liquidation expenses, making servicers less likely to advance."

While reduced servicer advances can lower loss severities on liquidated loans, they also reduce monthly cashflow available to the trust. "Changes in servicing practices add volatility to trust performance and can affect the timing of payments to bondholders," adds Liss. Bondholders may be affected differently depending on the class seniority and transaction structure.

When examining recent advancing percentages by delinquency status, servicers are advancing on approximately 90% of 30- and 60-day delinquent loans in each of the prime, Alt-A and subprime sectors. However, advancing for more serious delinquency stages shows a greater distinction between sectors.

For loans in foreclosure, the servicer advancing percentages for prime, Alt-A and subprime are currently 96%, 87% and 60% respectively. For assets in REO, servicer advancing percentages are 93%, 76% and 47% respectively for the three sectors, the agency concludes.

RMBS

Loss assumptions updated on 14 UK RMBS

Moody's has updated its loss assumptions for 14 UK non-conforming RMBS, but has taken no rating action in consideration of the sufficient levels of credit enhancement. The affected transactions are: Eurohome UK Mortgages 2007-2; Great Hall Mortgages No 1 Series 2006-01; Leek Finance 17, 18, 20 and 21; Mortgages No 7; RMAC 2005-NS1, 2005-NSP2, 2005-NS3 and 2005-NS4; ResLoC UK 2007-1; and Residential Mortgage Securities 21 and 22.

Due to the performance of the underlying mortgage portfolios being worse than previously assumed, Moody's has increased the lifetime loss assumption for 11 out of the 14 affected transactions. The remaining three transactions, however, are performing in line with expectations, the agency confirms.

It has also increased its Milan AaaCE assumptions for 13 of the deals, following the assessment of updated loan-by-loan information of the outstanding portfolios.

SIVs

SIVs affirmed following review

S&P has affirmed - following a review - its issuer credit ratings (ICRs) and senior liability ratings on the Centauri, Five Finance, Links Finance, Parkland, Harrier Finance Funding, Kestral Funding and Nightingale Finance SIVs. The rating affirmations follow an assessment of the support arrangements of each SIV. In each case, the SIV's ICR and senior liabilities ratings are linked to the rating on the relevant support provider, which has not changed.

At the same time, S&P has affirmed the double-C rating on the SIVs' capital notes to reflect its opinion of the likelihood of their repayment. The relevant support arrangements do not include the repayment of capital notes and the agency is of the view that the capital notes are highly vulnerable to non-payment.