Contents

CDS

Timing sensitivities

Schedule of CDS introduction in China, India questioned

The introduction of credit derivatives in China and India has been welcomed by market participants. Some are nevertheless questioning the timing.

The Chinese authorities last month licensed 17 financial institutions to trade CDS-like contracts, dubbed 'credit risk mitigation instruments'. Rohan Douglas, ceo of Quantifi, confirms that the contracts are similar to standard CDS, but have different terms and a legal framework that is specific to China based on NAFMII documentation.

"The choice of name is designed to separate the Chinese market from the perceived problems in other credit markets. But, if the market does take off, there will inevitably be pressure to adopt the characteristics of the global CDS market over time," he observes.

With CNY8trn bonds and CNY40trn loans outstanding, Douglas suggests that the Chinese fixed income market is developed to the point where the introduction of CDS-like instruments makes sense for hedging purposes. "Credit derivatives go hand-in-hand with having healthy and efficient bond and loan markets. I think the market has a positive long-term future."

However, risk consultant Satyajit Das questions why China needs a CDS market in the first place. "The market is dominated by state-owned banks that lend to state-owned companies, so does it really matter if they're not paid back?" he asks. "It may be because the government feels like it should have a CDS market. The bond market is growing, but is driven by government moves to rein in bank lending - meaning that bonds are often repackaged into wealth management products."

Das suggests the stipulation that the entity trading a credit risk mitigation instrument holds no more than five times the exposure to the underlying contract is unclear. For example, before the credit crisis ensued, the size of the CDS market was around four to five times the size of the bond market.

He notes that the prospect of an Indian CDS market is even more interesting, however. "The government is allowing CDS to trade, but it seems like it doesn't really want them to. Participants can trade anything, as long as it's physically settled and the exposure is limited to one-times the underlying. One party has to be an RBI-regulated entity and hold the underlying exposure."

The Reserve Bank of India released for comment its final CDS operational framework in August (see SCI issue 197). Das adds that CDS trades are supposed to be cleared by the Clearing Corporation of India, but the infrastructure to support this hasn't been developed yet. For instance, contracts still have to be margined bilaterally.

He points out that there are three main drivers behind why a country may develop a CDS market: to mitigate risk; to enable capital relief to be achieved; and to facilitate leveraged exposure to credit. Das suggests that risk mitigation would make more sense in India, as the financial market is more 'normal' than China's. Conversely, China's loan book has grown by 100%-150% over the last year and the country's banks may be short of capital, so capital relief trades could help in this case.

However, he indicates that transparency in terms of the CDS market remains an issue for both countries. Counterparties in China are all state-owned, for example, while India lacks a robust rating culture and accounting rules.

"Both China and India need to develop the necessary infrastructure, as well as facilitate a greater variety of bonds, but this takes time," Das says. "It's difficult to work out the logic behind launching CDS in these conditions - it's odd to launch now, when volumes are plummeting globally. Nevertheless, I think it's a good way to start: a little-by-little approach can't cause too much damage; at least I hope not."

In terms of the evolution of the Chinese and Indian CDS markets, Calypso product manager Shailendra Methi notes that both buyers and sellers are necessary, whereas at the moment they only have buyers. "Both countries have active corporate bond markets, so the ability to hedge is a positive step because it facilitates growth. However, the ability to only hedge positions is restrictive: some participants want to take credit risk but can't under the current framework. It should eventually be adapted to facilitate this though," he says.

Methi suggests that the introduction of CLNs will likely drive evolution in the Chinese and Indian CDS markets, as well as connect buyers and sellers. "Most investors are looking for principal protection and upside, so there will be demand for CLNs eventually," he explains. "Once the market has progressed from single names to CLNs, the next step is the introduction of indices - in order to gain exposure to specific sectors - and then first-to-default baskets."

He continues: "Conceptually, indices could be developed for each jurisdiction, once there are enough names - 300-400 - to trade. Whether the indices are administered by Markit is less important than market participants being involved in their creation."

The advantage both China and India have is that they can learn from the mistakes that were made in other markets, according to Methi. For example, trading can begin with standard contracts and clearing mechanisms can be introduced - although this brings its own set of challenges, such as calculating margin. Dispute resolution is another challenge: the biggest test for each market will be when a credit event occurs.

CS

ABS

Self-sufficiency drive

Portfolio risk managers taking matters into their own hands

The changing investor perception of rating agencies is driving a more independent attitude towards risk management. At the same time, while the need for due diligence is a given in the post-crisis securitisation market, increased transparency is creating its own challenges for risk managers.

The perception of the rating agencies' role has fundamentally changed post-crisis, with the overcompensation in safeguarding ratings driving some investors to lose confidence in the agencies' risk analysis assumptions. This stems from the large-scale rating downgrades over the last three years, according to IKB Fund Management md David Matson.

"Whilst it is tempting to think that as CLO managers we have worked miracles in the past year, the reality is that rating agencies had overdone the CLO downgrades last year and they are now correcting the position with appropriate upgrades this year," he says. "We direct investors towards reviewing risk themselves through loan-level analysis and this means that they place less reliance on the rating agencies."

Oliver Fochler, partner and head of origination and client management at Prytania Investor Advisors, agrees: "We, as an investment manager, can't and don't rely on ratings. Investors need to create their own assumptions, model deals bottom-up and then decide themselves whether it's worth buying based on a comparison between fair and market values."

Fochler notes that the securitisation industry is once again gaining momentum, with increased liquidity in Europe and the US across all asset classes and seniorities. This, he says, can continue with the help of risk managers setting strict parameters.

He refers to Prytania's investment guidelines as an example: "On asset class level, we set strict limits for RMBS and ABS. On regional level, we set e.g. a limit for emerging markets CDOs. Concentration limits are set for servicers and asset managers. We take a cautious approach, not looking further down the capital structure."

He continues: "Due diligence has changed a lot over the years. We look very carefully to find value in assets where we're comfortable. A lot of risks have been taken with other managers in terms of restructuring and refinancing, but for us it's a no-go-area."

The market's need for transparency and independent analysis is also driving improvements in risk management software. Douglas Long, evp of business strategy at Principia Partners, confirms the importance of transparency tools that can access and leverage loan-level data in a way that makes it more meaningful for investors. "Since the crisis, we've seen investors finding value in conducting their own due diligence."

However, he notes that while loan level disclosure was a vital building block, in the long run investors would not have the capacity or resources to analyse every deal at this granularity. "People want to understand and track the key performance attributes of underlying pools and get an aggregated view across their portfolio. An investor with a large number of securities doesn't want to go through excessive analysis of loan information for every deal. They want to be able to set flags and monitor indicators of performance and then, when collateral is seen to be underperforming, be able to drill down further. It's imperative that investors have the tools to access and consistently analyse this data to make timely decisions."

Fochler concurs that although more disclosure is useful, it could overwhelm some traditional investors. "Loan-level initiatives are positive for the market and I do agree that more information is better. However, it can be daunting and the investor base is not necessarily equipped with the right tools and analytics to digest the information."

Therefore, to achieve a well balanced and competent risk management system that relies less on the rating agency function, the industry needs to adopt a more self-sufficient approach with the correct models in place. Looking ahead to the next 18 months, the industry remains hopeful that systems will improve in strength - particularly in Europe, which lags the US. Together with expected improvements in investor confidence, this is expected to eventually lead to a restoration of a more stable structured credit market.

SCIO Capital's managing partner Saul Greenberg recognises that significant positive credit-related changes have been made to many newly financed structured credit assets in response to the recent crisis. However, he believes that secondary traded assets will continue to trade at discounts, as they do not permit such credit-related improvements without refinancing or restructuring.

Greenberg notes that SCIO Capital undertakes significant and deep due diligence and produces its own fundamental valuation (not market value) in European secondary structured credit, helping investors to benefit from trading these discounts. He believes that the market for discounted European secondary structured credit is likely to remain for several years.

Greenberg explains: "Investors believe that certain structured credit and rating models are broken and, as a result, are not ever likely to pay par prices - except when refinance is certain. SCIO Capital looks to provide investors with understanding of what valuation and price levels are sustainable. Considering that the opportunity in Europe for secondary assets could be worth hundreds of billions over several years, it is strong motivation for specialist structured credit asset managers."

Fochler agrees that although former origination models are dysfunctional, he is confident that - with European structured credit performing better - certain market segments can return to their previous highs. "I believe that classic cash CDO and ABS structures will have to return in a very organised way for balance sheet management purposes and, with investors relying less on ratings and more in-house analysis, I believe that the market can make a comeback," he concludes.

LB

Distressed assets

Going down?

Distressed investors forecast ABS leg-down

Distressed investors are predicting a leg-down for the market in the near future. They suggest that while opportunities can be found in CLOs - particularly in the US - problems persist across the ABS asset classes.

Paul Rivlin, joint ceo of Palatium Investment Management, believes it will still be a few years before the European commercial real estate markets fully stabilise, for example. He says: "The underlying European commercial real estate markets are generally still distressed. Looking at European CMBS prices, prices today are higher than the risk and volatility implied by the underlying market."

One of the biggest problems with the underlying market has been its lack of improvement, which Alexei Garan, a secured credit analyst at PVE Capital, believes could cause a leg-down in the near future. He says: "We might be on the way to a leg-down in prices. There has been no improvement in fundamentals either in the US or Europe, especially in real estate. We see likely deflation of wages and collateral prices. There could be a leg-down in asset prices in the next six to 12 months."

Rivlin concurs that a leg-down could come soon: "There could be many triggers for a leg-down in real estate values. A move up in interest rates would hurt everyone, but it would be particularly bad for residential mortgages and residential values. I do not expect a crash, but there might well be a softening of values."

These views are echoed by one ABS trader, who says that the macro picture has not become distressed just yet, but it is not far from being so. Where opportunities do exist, they do so largely for CLOs.

He notes: "We see opportunities in the CLO space and in European CMBS. Fundamental risk assessment must be very deep and expertise is necessary to capture these opportunities. There was a brief window to short CLOs, but I would not recommend that now. We tell our investors to hold on; if you know your fundamentals, you will be fine."

Indeed, while real estate in particular continues to struggle, the outlook is far brighter for CLOs. "CLOs are still distressed, but liquidity has improved a lot. There have been lots of BWICs and bids are becoming more competitive," notes one asset manager.

He feels that current volatility is helping new issuance as managers look to CLOs. "Things are looking very positive for US CLOs. In the first quarter next year several CLOs should price, so there are certainly signs of life."

He adds: "We are cautious, but we are encouraged because corporates are doing very well and recoveries have been good, at least in the US. On the positive side, leveraged loans have been taken out by amend-and-extends. For US CLOs, technical support at the collateral level is very strong."

While the US CLO market may improve, with fundamentals in the ABS markets still struggling, some market participants are beginning to wonder whether this period can be described as just a dip or whether it is instead the start of a whole new phase for the market. "When reviewing the financing of European commercial real estate, I think people should look at the last ten years as an exception rather than the benchmark. Substantial changes are already happening. European CMBS will not come back in anything like the form we had before the crash," says Rivlin.

He concludes: "The future sources of capital are uncertain and whilst I am confident that there will be adequate capital, there may well be shifts - for example from banks to institutional providers. However, we do not know how the market will look in a few years and it is entirely possible that the commercial real estate funding market will be a lot less complex."

JL

ABS

Euro ABS still a waiting game

The current imbalance in the European secondary ABS market is beginning to take its toll. While pricing levels remain strong, investors wait-it-out for yet another day as the reluctance to engage in market activity prevails.

"Last week there was less activity than normal due to the weak Irish MBS market. However, other areas of the market held up fairly well," one ABS trader says. Although a portion of prime deals saw a drop of up to 10bp, the trader confirms that both high yield and CMBS deals have maintained steady pricing levels.

However, the weak and unpredictable sovereign market has resulted in a harsh decline in activity this week. "It felt like the market held up last week and, although it still is technically, the sudden halt in activity yesterday and today has put the market in a much weaker position. For example, there is far less negative pricing action, yet overall activity is really slow on both the dealer and client side," the trader says.

The trader explains that although activity has halted for the time being, prices overall are holding up at strong levels. "The deals are trading slightly wider, but the volume isn't there right now. The prime deals in particular haven't moved in price; they're still wider at the tighter end of the capital structure by 15bp from last week."

However, the lack of aggressive buying behaviour lies in contrast to the strong performance in bid-lists. "Bid-lists are still trading fairly high; in fact, there's more selling interest now than we've seen before," the trader adds.

Looking ahead to the year-end, he believes that the unusual market behaviour is providing an unpredictable environment. "Month-end normally sees more dealers trying to sell, but at the minute it's the clients who are trying to sell. None of this behaviour is driven by month-end. I wouldn't expect prices to rise and, if anything, I think it will only get weaker in the coming week."

This pre-Christmas wind-down, he concludes, is partly due to the market attempting to alleviate high risk investments.

LB

CLOs

Hunt for absolute yield driving Euro CLOs

The recent flurry of activity in the European secondary CLO market has come to a brief standstill, with the sovereign crisis diverting investor attention. However, investors' quest for absolute yield continues to drive demand for mezzanine paper, causing the credit curve to flatten and - combined with positive CLO market technicals - limit potential pricing downside into the year-end.

"It's been a quiet couple of days, with not much in the way of bid-list activity," one CLO trader confirms. He adds that the correlation between the sovereign market and the CLO market remains low due to the lack of investor linkage and the positive outlook for high yield corporates in general.

He continues: "We're not seeing any forced selling; however, the likelihood is that we'll stay relatively quiet until Christmas. New Year is when we're anticipating the market to kick off again, but it all depends on the longevity of the current sovereign issues and the extent to which pricing contagion creeps across to low correlation asset classes."

Prior to the current lull, the market had a strong and encouraging few weeks, with bid-list activity in particular seeing strong interest. "We've seen fantastic bid-list execution in recent weeks and we're still seeing very strong prints on the limited number of bid-lists coming out," the trader adds.

Further, the trader says that regardless of the current pause pricing levels have been performing well. "We're still tracking higher price-wise; our technicals are unchanged, but volumes are logically lower. The US had a high profile equity print last week, printing above par at approximately 106 - US cash-flowing equity regularly trades in the 60s. On the European side, the highest equivalent print we've seen is in the 60s, with most cash-flowing equity trading in the 20-40 price range."

Meanwhile, the search for absolute yield by investors continues to be the prevalent force in the market. This, the trader explains, is causing the credit curve to flatten due to the ever increasing demand/supply skew in the higher yielding part of the capital structure - triple-Bs and double-Bs downwards.

"We're seeing the credit curve flatten and triple-As and double-As underperform relative to single-As, triple-Bs and double-Bs. At current prices, on a risk adjusted reward basis double-As look compelling value; however, double-A pricing is only just starting to squeeze higher," the trader notes. This, he concludes, is because "investors are looking for absolute, rather than relative yield".

LB

ABS

Auto ABS credit enhancement trending lower

The credit enhancement levels of 2010-vintage US auto ABS trusts have trended lower over recent months, according to ABS analysts at Deutsche Bank. They suggest that this is attributable to sharper-than-expected improvement in credit performance on both underlying originations and the related ABS securities, following more conservative underwriting guidelines.

Additionally, in the face of improving credit trends, rating agencies have reassessed the more conservative assumptions and loss expectations that were put in place during the credit crisis for these transactions.

The Deutsche Bank analysts note that one of the more notable changes to initial credit enhancement levels is for Honda Auto Receivables Trust 2010-3. At 2.75%, the credit enhancement level has decreased by 39% since 2009 and has fallen to a level not seen since 2003.

"A drop in credit enhancement to this degree could give pause; however, upon closer examination historical performance trends have been strong for this issuer," the analysts observe. "For example, for Honda, not only are the cumulative net loss rates for 2010 vintage loans trending well below cumulative net loss rates for 2007 and 2008 loans (i.e. the bad years), but 2010 loss levels are also outperforming 2003, 2004 and 2005 loans (i.e. the good years)."

Indeed, for some issuers - such as WorldOmni, CarMax and Nissan - the decline in triple-A credit enhancement levels has been substantive, while for others the change has been minimal. For some transactions, 2010 levels have come in higher than 2009 levels.

"As the recovery takes hold, we would expect more banks to ease [lending standards] further, but we don't believe this will happen until we see more meaningful improvements to unemployment. For ABS, the challenge will be to find a reasonable balance between the appropriate level of credit enhancement as lending switches into higher gear and the credit quality loans migrates," the analysts conclude.

CS

CLOs

CLO manager consolidation to continue in 2011

CLO manager consolidation shows no signs of slowing and is expected to continue at least through 2011. Both economic and market conditions will contribute to the continuation, as well as individual manager strategic objectives, according to Moody's in its latest CLO Interest publication.

"Beyond reducing the overall number of CLO managers, this consolidation has had a number of additional impacts," the agency notes. "The profile of the typical CLO manager has been revised as players enter and exit the field. Moreover, there may be consequences for CLO investors who experience management consolidation. The impact will vary depending on how the change occurs."

In 2006 the number of CLO managers of Moody's-rated US CLOs stood at 134, but it has since declined to 110. This compares with a figure of 59 in Europe, falling to 54. On average in the US about one in five Moody's-rated CLOs has experienced a collateral manager change during its life cycle, while in Europe manager change has affected one in 20 CLOs.

Consolidation means that not only has the number of 'small' managers declined since 2006, but there has also been a decrease in the number of managers who manage only a single CLO, according to Moody's. However, consolidation has not had a significant impact on the overall distribution of transactions among managers, a pattern that has been somewhat 'barbelled' since 2006. In both the US and Europe, the largest 10 CLO managers (in terms of number of CLOs managed) are in charge of more than 40% of the total number of transactions, while about 30% of the managers have only one deal under management.

Currently in the US 16 managers have 10 or more deals under management, compared to 14 prior to the credit crisis. Similarly, in Europe the number of managers with seven deals or more under management increased from four to seven over the same period.

Moody's believes that a complex interplay of economic, market-driven, strategic and regulatory reasons will continue to fuel CLO management consolidation next year. "Some existing managers will continue to pursue a strategy of ever-increasing CLO transactions under management, as they seek economies of scale to increase management fees and enhance profitability," it explains. "For these managers, the strategy is 'bigger is better'. They will look to acquire CLO platforms from management shops that have decided to reduce their presence in the CLO management space for one or more reasons."

Improved performance of CLOs over the last year and the resumed payouts of subordinated and incentive management fees make the economics of CLO management more attractive today than they were in 2009. But the fact that many existing CLOs will start entering their amortisation phase - hence generating lesser revenues - also calls for larger CLO platforms with economies of scale.

CS

CMBS

Operating advisor proposed for EloC 24

EloC 24 class G noteholders have been invited to vote on the appointment of Palatium Investment Management as operating advisor on the transaction. European ABS analysts at Barclays Capital suggest that the proposal is a pre-emptive move, given that to date none of the four securitised interest-only loans is in special servicing.

The class G is the controlling party and has the right to appoint an operating advisor. Palatium is the managing member of Tonnant and Spartiate, which have material holdings in the class G notes. The BarCap analysts suggest that these holdings amount to more than 10%, which is the threshold needed to request a noteholder meeting.

In EloC 24 the operating advisor has certain consultation rights for matters in relation to specially serviced loans. If the special servicer plans to appoint a receiver or to amend, waive or modify loan terms, it has to notify the operating advisor, which in turn has the right to object to the proposed action.

Further, the special servicer has to take into account the advice of the operating advisor regarding any further steps the operating advisor considers should be taken in the interests of the controlling party. Importantly, according to the analysts, if it objects to the special servicer's proposals, the operating advisor has to provide an alternative proposal. The controlling class also has the right to replace the special servicer, subject to rating agency confirmation.

The smallest loan in the portfolio (Hayes Park, accounting for 11% of the pool at £72m) matures in January 2011. Fitch estimates the securitised and whole loan LTV of this loan to be 89% and 114% respectively, as per June 2010.

However, the analysts expect a timely repayment to prove difficult, so the loan might enter special servicing early next year. "The most junior noteholders have an incentive to control the enforcement process, in our view. The transaction is overall characterised by long leases to good tenants, but the adverse performance of the UK office market has increased the risk of defaults at loan maturity."

CS

Insurance-linked securities

New assets for ILS

A new asset class is being brought to the insurance-linked securities (ILS) market - medical benefit claims. The deal, Vitality Re, is likely to prove popular with investors starved of diversification in the catastrophe bond sector.

The transaction's US$125m class A and US$75m class B notes have been assigned preliminary ratings of triple-B minus and double-B respectively by S&P. The agency says its preliminary ratings are partly based on a simulation-based stochastic model developed by Milliman specifically for this transaction.

The model is based in part on independently collected industry-wide data and assumptions. The deal's collateral will be put into a tri-party repo structure with Goldman Sachs, which is also sole bookrunner, as the repo counterparty and the Bank of New York Mellon as the tri-party agent.

The notes will cover claims payments of Health Re, a special purpose company capitalised and created for the transaction and, ultimately, ceding insurer Aetna Life Insurance Co (ALIC) related to the covered business to the extent the medical benefit ratio (MBR) exceeds the class-specific MBR attachment level. The MBR will be calculated on an annual aggregate basis.

The initial annual ceded premium is US$1.25bn. The initial MBR attachment point for the class A notes is expected to be US$1.3bn. The initial MBR attachment point for the class B notes is expected to be US$1.225bn.

There will be two annual resets, effective on 1 January 2012 and 2013. Forty-five days after the third payment date of the second and third annual risk period, ALIC (via Health Re) will supply to Milliman its updated exposure data, including the MBR for the previous annual risk period.

Milliman will use this information - plus the updated health industry exposure data - and run a new set of two million scenarios to determine new MBR attachment and exhaustion points for each class of notes. If the cumulative enrollment in the ceded block size changes by more than 300,000, Milliman will incorporate the change into the block size adjustment already built into the escrowed model; otherwise, this factor would remain unchanged.

Each annual reset will adjust the attachment point to maintain a probability of attachment and expected loss less than or equal to 0.20% and 0.05% respectively for the class A notes, and 1.71% and 0.69% for the class B notes. The initial probabilities of exhaustion are less than 0.01% and 0.20% for the class A and class B notes respectively. The reset will be subject to a floor such that the reset attachment point of each class of notes will never be less than its respective initial MBR attachment point.

The covered business to be ceded under this transaction is the commercial insured accident and health business directly written by ALIC and as reported in its annual statutory statements as 'Accident and Health-Group', except for the following excluded risks: all of ALIC's group insurance products (including, accidental death and dismemberment, life products, long-term disability, short-term disability, temporary disability, leave management and long-term care); all dental and limited dental products; all Medicare and Medicaid products; all stop loss products; all limited medical products; all individual products; all limited benefit plans (commonly referred to as mini-med plans) and all student health plans; all stand-alone vision products; all stand-alone employee assistance programme products; all AARP products; and all domestic expatriate products.

MP

Insurance-linked securities

New Lodestone marketing

The second catastrophe bond offering from the Lodestone Re programme has begun marketing as a US$250m two-tranche deal. The cedant, Chartis subsidiary National Union Fire Insurance Company of Pittsburgh, is again seeking cover from US hurricanes and earthquakes.

S&P has assigned preliminary double-B plus and double-B ratings to the transaction's series 2010-2 class A-1 and class A-2 notes. This is the second series issued in 2010 by Lodestone Re. Each series covers the same perils (US hurricanes and earthquakes), the only differences being the attachment and exhaustion points.

The rating agency explains: "At issuance, the series 2010-2 class A-1 notes have the same risk profile (attachment and exhaustion points) as the series 2010-1 class A notes and have the same rating. One difference between the two notes is that the 2010-2 class A-1 notes will have a probability of attachment of 1.13% and an expected loss of 0.95%, versus 1.14% and 0.96% respectively for the series 2010-1 class A notes. The 1bp difference is a result of simulation error in the modelling process, and we do not consider it to be significant."

As a result, at each annual reset, the series 2010-2 class A-1 notes may reset to a slightly lower attachment point than the 2010-1 class A notes because the series 2010-1 class A-1 notes have a lower probability of attachment.

The series 2010-2 class A-2 notes will cover an exposure layer not covered by the series 2010-1 issuance. These notes will have an attachment point of US$5.85bn and an exhaustion point of US$6.5bn.

In comparison, the series 2010-1 class B notes covered losses in excess of the attachment point of US$5bn up to US$6bn. The probability of attachment for the series 2010-2 class A-2 notes is 1.44%, with an expected loss of 1.28% and a probability of exhaustion of 1.13%.

The other difference between the series is that the series 2010-2 notes will have three resets, even though they will have a tenor of three years, as opposed to two resets for the series 2010-1 notes. Each series will have a reset that is effective 1 June 2011 and 1 June 2012 respectively.

The resets will use the same RMS model and industry exposure database for the two series. There is the potential for the state payout factors for series 2010-1 and 2010-2 to be different, though that is not the intent of the cedant.

Because the series 2010-2 notes will mature in December 2013, there will be one additional reset effective on 1 June 2013 that will cover the last (approximately) 6.5 months of the risk period. The series 2010-2 notes will reset to a probability of attachment of 1.13% (A-1) and 1.44% (A-2) for the final risk period as well.

MP

RMBS

Foreclosuregate impact seen in ABX remittances

Subprime serious delinquency and loss severity rates are both rising, according to RMBS remittance reports for the 80 deals that make up the ABX indices. Indeed, October is the first full month in which the impact of foreclosuregate on liquidation rates can be seen.

Following several months of decline, the percentage of loans 60-plus days delinquent increased for all series, by an average of 30bp. The 2006-1 series seriously delinquent loans increased by 60bp to 40%, whereas increases for 2006-2, 2007-1 and 2007-2 were 24bp up to 43.8%, 11bp to 48.4% and 23bp to 45.7% respectively. The 30-day rate remained stable, after previously rising.

CDRs largely decreased, with Carrington deals proving an exception at 19.8% CDR. The average CDR of RASC deals declined by 383bp to 7.9%, while for CWL deals it declined 93bp to 6.1% and for FFML deals it declined 938bp to 3.3%. Deutsche Bank ABS analysts indicate that this strong CDR decline for FFML is largely explained by the consolidation of the servicing platform.

Average CDR for all series declined by 0.9 CDR. The 2006-1 series decreased 0.1% to 9.3 CDR, although the 2006-2 series increased by 30bp to 11 CDR. 2007-1 and 2007-2 both decreased - by 1.3 CDR and 2.2 CDR - to end the month at 10.9 CDR and 11.8 CDR respectively.

Cumulative loss rates rose steadily, reaching 12.3%, 17.6%, 19.6% and 21.6% for the 2006-1, 2006-2, 2007-1 and 2007-2 indices respectively. Voluntary prepayments rose marginally, but are still very low, according to the Deutsche Bank analysts.

Finally, the November remittance reports show loss severity increasing by 3.8% to reach 78.5% for the aggregate, while REO rates were relatively stable for all series other than 2007-1, which dropped by 50bp.

JL

ABS

Law firm strengthens Irish presence

Walkers is further expanding its Dublin office by creating a significant number of jobs in Ireland. With approximately 25 new positions made by the end of 2010, this will rise to approximately 50 new jobs by the end of 2011. This, the firm says, demonstrates their confidence in the Irish economy.

"The International Financial Services Centre has been a beacon of strength for the economy and has benefited from a very broad network of global tax treaties and the maintenance of the 12.5% corporation tax rate which we are pleased to see is part of the Government's four year national recovery plan," says Vicki Hazelden, managing partner of the firm's Dublin office.

Initially opening in Dublin in October 2010 with capability in investment funds, asset finance, structured finance and corporate administration, Walkers has since added a taxation practice to its suite of services. This will be followed in early 2011 with a series of recruits in corporate, insurance, regulatory and listing services, the firm says.

ABS

Euro ABS head named

Jefferies has appointed James Fadel as md and head of European structured debt capital markets in London. He will be responsible for the origination, execution and syndication of structured products, including MBS and ABS.

With over 28 years of experience, Fadel spent over 12 years at Morgan Stanley in New York and London as md and head of European ABS and RMBS. Prior to this, he was md and head of ABS at Prudential Securities in New York and vp of MBS at Citigroup.

ABS

Debt advisory md named

Quayle Munro has appointed Stuart Roberts as md in its newly created advisory team. Based in Edinburgh, Roberts will be primarily responsible for the development of the firm's debt advisory business while assisting in building its corporate finance capability in Scotland.

Roberts joins the firm from RBS, where he was head of structured finance in Aberdeen. Prior to this, he was with the Bank of Scotland as a member of the integrated finance teams in London and Edinburgh.

ABS

Boutique adds asset advisor

The Prytania Group has appointed Matthias Mosler as senior advisor. In this role, he will advise the firm's clients on their legacy asset positions.

With over 25 years of industry experience, Mosler was previously at Deutsche Bank in its debt capital markets group. Prior to this, he was md in the corporate finance and capital markets group at Goldman Sachs in New York and London.

ABS

Law firm names global finance leader

Nixon Peabody has appointed Craig Mills as leader of its global finance practice. Mills will represent both banks and other financial institutions, as well as many different types of borrowers and other users of capital in a wide range of debt finance transactions.

Mills has experience representing clients in asset-based transactions, equipment finance transactions, mezzanine and subordinated debt facilities, workouts, restructurings and other related issues.

ABS

Japanese broker-dealer established

StormHarbour Partners continues its international expansion with the launch of a broker-dealer in Tokyo, StormHarbour Japan. The new firm has been established through the integration of NSH Securities and will be led by Michimasa Naka, ceo and managing principal. Naka has over 20 years of investment banking and global markets experience, and most recently was deputy president and head of global investor sales for Citigroup Global Markets Japan.

The Tokyo team aims to provide clients in Japan with specialist advice and services in sales and trading, structuring and advisory and capital markets across fixed income, equities and alternative investment products.

CDS

Dechert beefs up in Germany

Dechert has appointed Wolfgang Kissner as a national partner in its financial services and investment management group. Based in Munich, he will help further expand the firm's practice in Germany.

Kissner has a variety of experience in advising on the establishment of investment fund platforms, structured note programmes, mezzanine funds, hedge fund re-packaging and OTC transactions. Prior to joining Dechert, he worked as a structurer and platform specialist for an international investment bank in Paris. Before this, he worked in the legal department of an investment bank in London.

CDS

Credit manager adds in business development

BlueMountain Capital Management has appointed Louisa Strutt as director of business development. Based in London, Strutt will implement business development strategies to attract institutional investors and consultants in the UK, Europe, the Middle East and Scandinavia. She will also be responsible for client relationship management and will have input in product development.

Prior to joining BlueMountain, Strutt was responsible for marketing at Odey Asset Management.

Distressed assets

EM manager recruits research head

Gramercy has appointed Doug Krehbiel as md and European regional head in its newly opened office in London. Krehbiel will be responsible for leading the research and investment management process, relating to the allocation of capital to CEEMEA. He will also become a member of Gramercy's centralised investment committee.

With 18 years of emerging markets and distressed debt experience, Krehbiel was previously at BlueCrest Capital Management, where he led global emerging markets credit research. Prior to this, he was leader of the institutional investor research team at JPMorgan.

RMBS

Broker adds sales svp

Amherst Securities Group has appointed Ryan Stroker as svp in its institutional sales division, based in New York. Before joining Amherst, Stroker was md and head of Price-Smart valuation advisory at Royal Bank of Scotland, where he developed and managed the global structured products valuation advisory and pricing service. Prior to this, he was vp at Merrill Lynch and a senior member of its subprime and non-agency RMBS trading division.

ABS

Seasonal strength bolsters US auto ABS

Fitch reports that the unprecedented seasonal strength in the US used vehicle market, combined with two months of lower new jobless claims has bolstered auto ABS performance for October.

"Historically high used vehicle values brought on by positive supply and demand dynamics by manufacturers are helping to contain loss levels," says Fitch director Hylton Heard. "Lower loss levels are expected for the remainder of 2010 and into 2011 and should lead to more positive rating actions."

Data from Manheim's Used Vehicle Value Index indicates that seasonally adjusted used vehicle values were up by 3.4% month-over-month in October. Additionally, the four-week rolling average of new claims for unemployment benefits was down by 5.8% in September and 0.5% in October. New jobless claims trended 16.1% lower in September, while the year-over year figure was 13.3% lower last month, the agency says.

Month-over-month prime auto loan ABS annualised net losses (ANL) were stable in October - an unusual trend for this period, according to Fitch. Additionally, although the Prime ANL index decreased by 1.1% month-over-month in October, a 43% increase occurred over the same period in 2009.

The ANL rate of 0.89% in October was within range of pre-recessionary levels of 0.85%-0.94% recorded during the same period in 2007. Prime ANL levels are expected to range from 1% to 1.3% in the fourth quarter and hold well below 2009 levels - consistent with the continued strong performance of the 2009 and early 2010 collateral vintages.

Prime auto loan ABS delinquencies of 60+ days decreased to 0.58% in October - down by 9.4% from September - although still notably down by 22.7% over October 2009. Current delinquencies are relatively in line with the ten-year total average for the index of 0.57%, the agency notes, despite persistently high unemployment figures and low consumer confidence.

Meanwhile, subprime 60+ day delinquencies also decreased in October to 3.47%. This represents a 10.8% decrease since September and is 27.1% lower than the same period last year. Subprime ANL decreased in October to 6.64%, down by 1.6% month-over-month, representing a decline of 27.8% from the 2009 number.

However, due to the limited subprime auto ABS issuance in recent periods, monthly subprime index results are more subject to individual transaction volatility, Fitch concludes.

ABS

Flip clause validity clarified

Ongoing uncertainty over the validity of provisions subordinating swap termination payments owed by structured finance vehicles to defaulting counterparties - known as 'flip clauses' - has no rating impact for most cashflow transactions, according to Moody's. The agency says that the validity of flip clauses is not a material consideration in relation to liquid interest rate and currency swaps that comply with its de-linkage criteria.

Parties involved in the Dante case (SCI passim) recently agreed to settle both US and English proceedings, subject to approval of the US bankruptcy court, ahead of an appeal to the English Supreme Court scheduled for March 2011. Nevertheless, uncertainty remains around the validity of flip clauses relating to structured finance swaps.

Moody's announced on 28 January an investigation of the potential impact of the US bankruptcy court decision on the ratings of structured finance transactions. The agency has now determined that the validity of flip clauses is not a material consideration in relation to liquid interest rate and currency swaps that comply with its framework for de-linking swap counterparty risk. Reasons for this include: framework swaps are likely to be transferred before swap counterparty default; the validity of flip clauses is not significant if the issuer receives a replacement fee with which to make its termination payment; and an issuer is very unlikely to terminate an out-of-the-money framework swap before finding a replacement.

ABS

Canadian ABS reform considerations put forward

A new report released by the C.D. Howe Institute offers suggestions, from a Canadian perspective, about how to restore a healthy ABS market. It calls for a policy approach that reflects Canadian market realities, indicating that while enhanced transparency and better accountability regimes are welcome steps, they may constrain the return of full liquidity to the ABS market.

The report notes that the intent of current reform proposals is to reduce the risk of systemic liquidity failures in the senior ABS market, resulting from an excessive reliance on rating agency assessments. However, if this objective is to be realised without discouraging broad investor participation in the senior market, participants should retain a subordinate tranche of ABS, the report suggests. It also recommends that a subordinated class of ABS be placed with a third party as a condition of accessing public markets for senior asset-backed MTNs.

Further, unique Canadian considerations are put forward. Specifically, the report claims that it would be prudent in the Canadian context to impose new disclosure requirements for all public market MTN issuance.

So-called monthly-pay pass-through notes need special attention, according to the report, and historically the capacity of the market to absorb these securities has been problematic. However, since autumn 2009, the Canadian market has appeared to be more accepting of these securities. Should this support falter in the future, a public-sector entity may be required to replace former funding, the report concludes.

CDS

CDS impact on Asian bond market analysed

The BIS has published a Working Paper entitled 'The impact of CDS trading on the bond market: evidence from Asia', which investigates the impact of CDS trading on the development of the bond market in region. The report's findings suggest that, in general, CDS trading has lowered the cost of issuing bonds and enhanced liquidity in the Asian bond market.

First, the authors of the report find strong evidence that CDS trading is associated with lower cost and higher liquidity for new bond issuance in Asia. This is consistent with the hypothesis that CDS trading helps create new hedging opportunities and improves information transparency for investors.

Second, they find that the positive impact of CDS trading on the bond market tends to be more remarkable for smaller firms and non-financial firms. In addition, those firms with higher liquidity in the CDS market benefit more in the primary bond market in terms of cost and liquidity.

Finally, the report finds that the impact of CDS trading on the bond market is different during the crisis period. The analysis shows that, at the peak of the global financial crisis, those firms included in CDS indices had to face higher spreads than those not included in CDS indices, above and beyond the general increase in credit spreads observed in the bond market during this period. According to the BIS, this suggests that CDS trading could be a double-edged sword: it also introduces new sources of shocks to the bond market.

CDS

Lawsuit filed over SIV restructuring

Abu Dhabi Commercial Bank (ADCB) has filed a lawsuit against - among others - Credit Suisse and S&P in New York. The suit alleges that Credit Suisse failed to disclose conflicts of interest and provided misleading information when structuring, marketing and selling an investment - Farmington. Further, the bank claims that S&P provided inaccurate investment-grade ratings to assets associated with the Farmington structure.

In 2005 and 2006, ADCB invested in the Stanfield Victoria SIV, which faced liquidity issues in 2007 and ADCB alleges that it was induced to enter into an emergency restructuring transaction, Farmington, based on false and misleading information. ADCB says that the transaction was sold to it on the basis that it would help to preserve and protect the bank's original investment in Stanfield Victoria. Farmington, the restructured vehicle, appeared to have positive valuations and prospects and purportedly benefited from a high quality portfolio of assets rated by S&P. In addition, as a quid pro quo for the restructuring, ADCB was required to enter into an unfunded CDS to protect Credit Suisse's loan exposure to Farmington, which Credit Suisse and the other defendants led ADCB to believe was relatively safe and carried minimal risk.

ADCB's ceo Ala'a Eraiqat comments: "This latest action is brought with the aim of protecting the Bank from potential losses. Whilst we don't anticipate a material impact on our earnings as a result of the disputed exposure, we believe, for the benefit of all our key stakeholders, it is appropriate to take action against parties who we believe misled ADCB."

In accordance with ADCB's adherence with international best practice, the bank says it has fully provisioned its original funded exposure to Stanfield Victoria.

CDS

Restructuring credit event confirmed

ISDA's EMEA Determinations Committee has resolved that a restructuring credit event occurred in respect of Anglo Irish Bank Corporation (see SCI 24 November). The credit event will be settled under the terms of the CDS Definitions as supplemented via the 'Small Bang Protocol' in July 2009. The Committee determined that one or more auctions may be held in respect of outstanding CDS transactions of varying maturity buckets.

ISDA will release the initial list of deliverable obligations for each maturity bucket in due course. It says the DC will endeavour to work to an expedited auction timeline in order to address the timing constraints arising out of the exchange offer for the reference entity's subordinated bonds.

CLOs

Gresham CLO restructured

The class A1 note of Gresham Capital CLO 1, which carried a double-A plus rating, has been retranched and renamed Metropolis II series 2010-8. S&P has assigned the new €50.6m class A notes a triple-A rating, while the new €12.65m class B deferrable notes are unrated. The new rating reflects the expected level of credit support in the form of subordination and overcollateralisation, which Gresham Capital CLO 1's junior notes will provide.

CMBS

US CMBS showing signs of recovery?

US commercial real estate is exhibiting signs of recovery, according to S&P. While delinquency rates for CMBS remain elevated, the rate of growth has slowed considerably from recessionary levels.

Additionally, the agency reports that property fundamentals are improving, investment capital is slowly flowing back into the sector, commercial mortgage originations are increasing and demand for CMBS issuance is gaining traction.

"We also believe that loan modifications, particularly maturity extensions, are also relieving some of the stress in the property markets by reducing the number of liquidations at distressed prices," says S&P analyst Larry Kay. "While we believe the current momentum in the commercial property and credit markets will carry over into 2011, the rate of recovery will depend on the level of job growth and consumer spending."

Compared with the dramatic delinquency growth in 2008 and 2009, year-to-date 2010 through 30 September delinquency growth has slowed appreciably. S&P believes that a convergence of the following factors will limit delinquency growth: the slowing pace of new delinquencies as resolutions rise; increasing property sales; loan modifications staying at high levels; improving property fundamentals; and mortgage originations picking up.

"Although we believe delinquencies are moderating, the increase in the number and amount of loans maturing in 2011 and 2012 will continue to pressure delinquency rates," adds Kay. "The fixed-rate loans maturing in these two years will, to a large extent, include five-year term loans from the 2006 and 2007 vintage years, which were characterised by high leverage and aggressive underwriting. Compared with 2010, the amount of floating-rate loan maturities will spike 290.7% in 2011."

Although there are signs of improving market conditions, the agency believes that the advancements to a large degree are relative to the depths that the property markets and CMBS credit performance sank to during the recent recession. This is evident in two of the larger CMBS property types, office and retail, which represent 61% of outstanding CMBS. These sectors have experienced significant rent declines over the last few years and are not expected to have any rental growth until 2011 or 2012.

"Without rent recovery and property equity build-up, debt service coverage impairment and lower property valuations are expected to keep downgrades at high levels in 2011," concludes S&P analyst Eric Thompson.

CMBS

Euro CMBS loan repayments on the rise

The increase of European CMBS loan repayments was primarily driven by partial and full repayments of loans that had matured in earlier months, according to Fitch's latest Maturity Repayment Indiex. This, the agency says, is despite two of the three matured loans still outstanding.

The Fitch Maturity Repayment Index improved to 39.5% from 36.3% during November - decreasing the outstanding matured loan balance marginally by 1% to €4.86bn. Overall, 43 of the 102 loans that have since 2007 been fully repaid, the agency notes.

Two full redemptions and two partial repayments, each more than €10m, were the main drivers of the improvement in the index. The €34.5m Hanover loan - DECO Series 2005 - Pan Europe 1 - and the Sfr92.6m Trafalgar loan - Taurus CMBS Pan-Europe 2006-3 - were both fully repaid. The outstanding balance of White Tower 2006-3 was reduced by £64.2m to £305.7m, due to the application of the Leadenhall property's sales proceeds.

This was due, Fitch says, to the proceeds not being received in time for the July payment date, as well as excess cashflow generated by the remaining Aviva Tower asset. Opera Finance - Uni-Invest - had a similar €22.2m redemption, resulting from a combination of asset sales and excess cashflow, which reduced the loan balance to €661.8m.

Meanwhile, two of the three loans maturing in November remain outstanding. The Inovalis Eboue loan - Vulcan European Loan Conduit No.28 - was transferred to special servicing on 27 October and then failed to repay on 8 November. The Selaht loan, securitised in Europrop (EMC) Compartment 1, was also transferred to special servicing following a missed balloon payment on the maturity date. The Degi Expo loan securitised in the same transaction was repaid in full at its scheduled maturity date.

The sale of the last remaining asset securing the Mondeal loan - DECO Series 2005 - UK Conduit 1- and the Castlegate shopping centre - Ursus EPC - were announced during the month. While the sale prices are certain to result in losses on both loans, the precise amounts to be allocated to principal repayments remain uncertain, Fitch concludes.

CMBS

CMBS delinquent unpaid balance decreases

The delinquent unpaid balance for US CMBS decreased last month for the first time in over a year, by US$3.02bn, according to Realpoint's latest Monthly Delinquency Report. The delinquent unpaid balance fell to US$59.18bn from US$62.19bn a month prior - a 4.8% decrease.

The previously reported monthly decline came in July 2009 after nearly US$4.8bn of GGP-sponsored loans tied to the SPE bankruptcy filing were returned to current payment status after a one-month 30-daydelinquency reporting anomaly. Outside of this, delinquency has been on a steady increase for over two years since the prior decline was reported back in August of 2008.

The recent decrease experienced in October was mostly attributed to the resolution of the US$4.1bn Extended Stay Hotel loan from the WBC07ESH transaction, which had been 90+ days delinquent through September 2010. The sale of Extended Stay Hotels to Centerbridge/Paulson closed in September, with corresponding distributions made to the certificate holders in October.

CMBS

Continued stress for Euro CMBS

S&P reports that despite glimmers of renewed activity in recent weeks, the stresses in the European CMBS market continue to be felt at both the loan and note levels.

Property value declines contributed to appraisal reductions in two transactions, Talisman 6 Finance and Windermere X. More significantly, the agency says, the declines contributed to principal losses on two loans - the Market Way loan in Bellatrix Eclipse 2005-2 and the Grays Shopping Centre loan in European Prime Real Estate No 1.

Downward values are also likely to have affected the refinancing prospects for borrowers in October: only three of the 24 loans scheduled to mature during the month were repaid in full. In the same month, four of the five reported loan delinquencies across European CMBS were caused by borrowers' failure to meet their maturity obligations, S&P notes.

Further, the agency says it has also noticed glimmers of renewed activity, with more fully or partially prepaid loans than usual in advance of their maturity date - the majority following property sales. Two of these sales resulted in loan defaults being cured.

The agency concludes that the recent significant spike in reported 12-month rolling default rates for the sector was a temporary phenomenon attributed to note restructurings.

CMBS

Marlin restructuring proposed

A noteholder meeting will convene on 10 December to vote on the proposed restructuring of the Marlin (EMC II) CMBS. Blackstone Real Estate Partners, the borrower, is seeking an extension of the loan to 17 June 2011. It has already sold down the majority of the original assets and expects to dispose of two more by June 2011 and fully repay the outstanding securitisation balance of €46.04m from these funds.

The extension proposal incorporates a full cash sweep and a 1% interest margin increase for all classes of the transaction, which has an LTV of 41.1% and a forecasted ICR of 3.06x. Given that the proposed extension facilitates a full repayment of the notes, strategists at Chalkhill Partners consider it to be in the best interests of both noteholders and the borrower.

RMBS

Loss assumptions raised for UK BTL

Moody's has increased its lifetime loss assumptions in 11 UK buy-to-let RMBS, due to worse performance of the underlying mortgage portfolios than previously assumed. The affected transactions are Auburn Securities 5; Ludgate Funding Series 2007-FF1; and Paragon Mortgages No 7 to 15. The agency has taken no rating action on these deals, however, in consideration of the sufficient levels of credit enhancement currently available in the structures.

It has also increased the Milan AaaCE assumption for one of the affected deals, following the assessment of updated loan-by-loan information of the outstanding portfolio.

At the same time, Moody's placed the classes M and B of First Flexible No 5 on review for possible upgrade. The review was prompted by better-than-expected collateral performance, as well as credit enhancement build-up since closing. The agency expects to conclude its rating review within six months.

RMBS

Improved performance for Aire Valley

S&P has affirmed its credit ratings on Aire Valley Funding 1's mortgage-backed notes and removed all long-term ratings from credit watch negative, where they were placed in July 2010 due to collateral performance and potential negative selection. A more detailed analysis indicated that negative selection relating to the prepayment of lower risk, low LTV loans is currently not prevalent, the agency notes. However, it will continue to monitor any potential negative selection, especially if prepayments increase.

House price declines in late 2008 and early 2009 had increased the weighted-average foreclosure frequency (WAFF) and weighted-average loss severity (WALS) forecasts since the last issuance from the trust in 2008-1. However, over the past 18 months, S&P believes that collateral performance has improved. In particular, delinquencies of 90+ days fell to 3.8% in October 2010 from a peak of 5.69% in June 2009.

Overall, S&P notes a net increase in its WAFF and WALS forecasts, although this is offset by an increase in credit enhancement. For example, the single-A notes now have 19% enhancement compared with 16.3% in September 2008.

In October 2008 a step-up trigger occurred following the partial redemption of the series 2007-2 class A1 notes. This action resulted in the sale of no new loans and consequently the trust size decreasing. At current prepayment rates, the agency believes the minimum trust size will be breached within 18 months, causing a non-asset trigger event.

If the non-asset trigger is breached, the trust allocates the principal receipts first to Funding 1 until all notes are fully repaid. Only after this is the seller entitled to principal receipts, which S&P views as a potentially positive development for the ratings.

It concludes that the improved collateral performance is mainly a result of the current low interest rate environment, as well as the arrears management process at the servicer level.

RMBS

Resi mortgage credit model to launch

Barclays Capital is launching a new residential mortgage credit model, tracking the progression of mortgages through the entire chain of borrower actions and servicer reactions. The loan-level transition model will be available on the Barclays Capital Live website from the close of business on Friday (3 December).

The model is implemented through Monte Carlo simulation at the loan level, so a borrower's entire payment history can be used when projecting future payments and defaults. Furthermore, BarCap says the model can evaluate pools containing almost any residential mortgage products, be they prime, Alt-A, subprime or second lien; fixed or adjustable rate; or amortising, interest-only or negatively amortising.

Delinquency classifications are based on the Office of Thrift Supervision (OTS) method and a distinction is made between borrowers not presently delinquent and borrowers who have never been delinquent. BarCap says this is particularly important for pools where large numbers of borrowers have been cured back through loan modification.

Further features include: distinction between loan modification cures and non-modification cures; LTVs marked-to-market using zip code home price indices; the incorporation of state-level differences in foreclosure laws and timelines for foreclosure to REO transitions; a loss severity model distinguishing between REO and non-REO liquidations; a prepayment model taking into account the dampening effect of tighter underwriting guidelines; and a range of scenarios on Barclays Capital Live to be used with the model.