Contents

CLOs

End-of-year boost for Euro CLO underlying

As European CLO market participants begin preparing for year-end, managers report an above average peak in new underlying loan activity for December. At the same time, a flurry of acquisitions has resulted in related loans prepaying.

"We've committed to the Vue Cinemas deal this week; in fact, it's our only active deal at the moment," one CLO manager says. Other than this, the market is in the process of winding down for year-end, he confirms.

The manager continues: "It's been relatively quiet, with hardly any secondary activity. However, although it is quietening down, the market has lasted longer into December than in the previous few years - so, all in all, it's not bad going."

Meanwhile, the manager says that after spending last week analysing the ConvaTec Healthcare refinancing, the business was eventually refused by his firm. "Although we were involved in the existing deal, it was a 6x leverage number, so it was not particularly special. Others are going back into it again and for that reason it's going reasonably well, although I can't understand why - it was a real surprise to us."

Elsewhere in the European loans market, acquisitions have been the topic of the week. First, PolymerLatex - a German latex maker - has been acquired by British chemicals maker Yule Catto. Second, PSN - an international energy services firm - has been acquired by the Wood Group.

"These prepayment trade sales won't be coming back into the leveraged loan market," the manager concludes. "Although the prepayments on these are expected soon, I don't think they will be immediate. This activity can only mean a return of the M&A market."

LB

CDS

CDS tail scenarios touted for 2011

Credit derivative strategists at Morgan Stanley suggest that the beginnings of a transformation in derivatives usage within credit markets is underway, dubbing it 'Credit Derivatives 2.0'. They point to a number of key areas for growth and opportunity in the coming year, the best of which serve some purpose in the market and attract organic demand.

"If we have one piece of advice to our clients in the credit derivatives world, it is to spend 2011 searching for and buying tail scenarios...[using] excessive risk premiums to help fund these tails," the Morgan Stanley strategists note. "This will be in conjunction, however, with the ongoing search for yield in an environment where spreads continue to tighten - even if volatility does not settle down right away."

The strategists outline six themes for 2011: protecting against or monetising market volatility via credit options; yield generation through callable credit strategies; gaining exposure to long-dated convex credit via tranches; structured CDS solutions to meet demand for credit risk without rates risk; first-loss risk transfer due to regulatory capital-based hedging; and the return of funded CSOs. For example, any significant return of issuance in funded synthetic CSOs is expected to follow the lead set by the broader securitisation markets, with a greater focus on shorter-dated and thicker tranches.

"We already see small long and short credit flows in bespokes, and the early flows in the CDX IG15 tranches have been encouraging as well," the strategists explain. "We expect high yield to be part of this world as well, perhaps more actively than in the last cycle, as securitisation technology is well suited for asset classes that have high degrees of default risk through the cycle."

In terms of capitalising on credit volatility, they believe that price volatility levels below 2% are attractive entry points for CDX IG long option strategies, while price volatility levels of 2.5% or higher are attractive entry points for short-option strategies. For iTraxx Main, 2.5% and 3% are suggested as the respective levels, given the potential for continued higher levels of volatility driven by sovereigns and financials.

In an environment where defaults are low but credit returns are likely to be dominated by carry and rolling down the curve, the strategists also have a general preference for at-the-money risk in IG15 seven-year 3%-7% and iTraxx seven-year 3%-6% tranches. Depending on market-implied volatility levels, they believe that the opportunity to sell strangles or straddles could be worth watching for throughout next year.

Additionally, with regard to hedging against downside scenarios, the tranche market offers a way to position for large tail scenarios due to their longer duration nature - notably 15%-100% in CDX IG and 9%-12% and 12%-22% in iTraxx. Credit options can be used as tactical hedges for shorter time horizons, according to the strategists.

CS

CMBS

Questions raised over Beacon Seattle mod

The US$2.7bn Beacon Seattle & DC Portfolio loan - one of the largest loans in the US CMBS universe, spread across six deals - has been modified. However, the disclosure of the modifications - via an S&P press release - leaves more questions than answers, according to MBS analysts at Bank of America Merrill Lynch.

"This is just another example of the poor dissemination of information that is occurring with respect to loan modifications," they note. "We continue to believe this is a fairly important issue for the CMBS community, as loan and bond value is so dependent on these large modification agreements."

The modifications include: a five-year maturity extension until May 2017; lowering the current payment rate by 2.8% to 3%; the ability to sell or refinance properties; some excess sale proceeds to be used to support other properties in the pool; and a pledge of additional collateral. But the BAML analysts suggest that it is unclear whether there is excess cashflow above the payment amount (and, if so, where it is going), what happens if the borrower sells or refinances for less than the allocated loan amount, how the excess sale/refinancing proceeds are going to be allocated, whether the loan allocation amounts will change and what the current appraisal is.

"The drop in the current payment amount (to almost half of what was being paid) on assets that represent such a large proportion of the trusts will have a sizable impact on interest shortfalls. Even though these shortfalls could potentially be partially repaid, as assets are sold and refinanced, that may or may not occur quickly," they add.

The Beacon Seattle loan was moved to special servicing in April, but has not been delinquent. At the time of transfer, the borrower was reportedly facing declining cashflows and expenses were expected to climb with a number of large leases set to roll. The latest financials reported are for 2009 and they show a net cashflow DSCR of 1.08x and an occupancy of 86%.

The loan is backed by 20 office buildings in Seattle and Bellevue, WA, as well as properties located in Washington, DC and Northern Virginia. The collateral is atypical in that it includes the pledge of ownership interests on one property and covenants to deposit cashflows from three properties, which - at the time of securitisation - already had US$339m of existing debt. The sponsor is Beacon Capital Partners.

CS

CMBS

Special servicer strategies analysed

About half of all loans transferred to the six largest special servicers in the US CMBS conduit universe - LNR, CWCapital, C-III, Berkadia, Midland and JER - remain unresolved, according to MBS analysts at Barclays Capital. Totalling around US$60bn, the actions of the special servicers and their preferred resolution strategies in relation to these assets are a concern heading into 2011.

Out of all loans in special servicing for the top six specials, about 19% were resolved via modification and 17% via liquidation. While CWCapital, Midland and JER show high modification rates, Berkadia tends to favour resolutions through liquidations.

"Although some of this variance could be explained by divergence in the serviced pools, the differences in the preference of resolution strategies are very visible," the BarCap analysts note. "For 2005-2007 vintage loans, LNR has one of the highest percentages of resolutions via liquidation, aided by active participation in the note sales. CIII, on the other hand, has a much lower share of note sales in overall resolutions."

The special servicer's view on a number of variables influences the resolution strategy it employs, but it could be replaced during any remittance period and thus the strategy may change. The analysts suggest that a number of special servicer replacements could occur in 2011, either triggered by shifts in control or as a result of losses.

"Replacements could happen even without the shift in control and might affect not only individual loans but even entire deals. This would very likely also result in an increase in 'multi-serviced' deals - transactions in which most of the loans are serviced by the general special, while some larger loans are serviced by a different servicer appointed by a B-note holder for a particular large loan or a controlling certificateholder," they note.

Nevertheless, modifications - in particular, extensions - are expected to be a preferred resolution strategy for larger and better performing properties because they often yield a higher NPV. Looking ahead, rate reductions could also emerge as an alternative for 'alphabetic splits', especially for loans with substantial mezz and/or B-notes held outside of the trust. And for floating rate deals, hyper-amortising modifications may appear more often.

Loans with smaller balances - typically less than US$15m - are likely to be resolved via liquidation or a note sale because the high fixed costs associated with modification usually cannot be justified. The analysts estimate that about US$19bn of smaller balance loans are still in special servicing, implying that liquidation volumes will remain elevated in the near term. Most loans sized between US$15m and US$100m, however, might end up with longer-than-average resolution periods.

CS

Insurance-linked securities

Atlas VI closes upsized

The latest catastrophe bond from SCOR's Atlas programme (SCI 24 November) has closed at a higher than expected €75m. Originally targeting €60m, the European windstorm and Japanese quake deal priced within guidance at 1050bp over three-month Euribor minus 24bp.

The second series from SCOR's Atlas VI catastrophe bond programme, the series 2010-1 class A notes were rated single-B minus by S&P. Investors will be exposed to Japanese earthquake and European windstorm risk (in selected countries and regions in north and west Europe), between 10 December 2010 to 31 March 2014. This transaction succeeds Atlas IV Reinsurance Limited, which is due to mature on 31 December 2010 and provides similar geographical cover of €160m.

The deal is the first catastrophe bond to use Risk Management Solutions' (RMS) parametric-based Paradex index to determine the losses following a Japanese earthquake. "Paradex Japan Earthquake uses near real time ground shaking data available from US Geological Survey ShakeMaps to calculate insured loss estimates," explains Jinal Shah, Paradex manager at RMS. "There was no definitive authority providing industry loss estimates for catastrophe events in Japan, so Paradex was designed to bridge this gap."

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

MP

Insurance-linked securities

Fresh Green Fields on offer

Swiss Re has begun marketing the latest in its "Green" catastrophe bond series. The €75m single-tranche Green Fields series 2011-1 will cover windstorms affecting France and Corsica.

The transaction has been assigned a preliminary double-B plus rating by S&P. As with previous "Green" cat bonds issued by Swiss Re, such as September's Green Valley II, the proceeds of the notes will serve to provide Swiss Re with a source of industry loss cover for reinsurance provided to Groupama - in this case covering windstorms in France over four European wind seasons.

Following a qualifying event under Green Fields, Swiss Re will send an event notice to Risk Management Solutions (RMS), as the event calculation agent. RMS will determine whether there has been a qualifying event and will calculate an index value based on the industry loss numbers published by reporting agency PERILS.

The risk modelling is based on RMS's Europe Windstorm Model Version 6.0 using the 2010 PERILS industry exposure database. The class A notes will cover events above an index value of 620 million on an occurrence basis, with an exhaustion point of 718 million.

Green Fields will provide cover to Swiss Re against losses suffered between 1 January 2011 and 31 December 2014. The deal's collateral will be invested in European Bank for Reconstruction and Development floating-rate notes.

MP

Insurance-linked securities

Swiss Re closes Vega Capital II

Swiss Re has closed the second collateralised risk obligation from its Vega Capital catastrophe bond programme. The reinsurer obtained US$106.5m in coverage against North Atlantic hurricane, European windstorm, Californian earthquake, Japanese earthquake and Japanese typhoon.

Vega has a flexible structure that allows multiple issuances of securities at any time. Vega is the first cat bond programme with a reserve account to enhance protection to noteholder principal.

Martin Bisping, Swiss Re head of non-life risk transformation, says: "Vega allows Swiss Re to manage earnings volatility arising from peak natural catastrophe perils, over multiple events. It is an innovative cat bond that combines transparent indices for five different natural catastrophe scenarios with an efficient structure. Vega underscores our track record in product innovation, transforming high frequency cat events into capital markets."

The three-year deal was offered to investors in two tranches. The US$63.9m class C notes were rated Ba3 by Moody's and the US$42.6m class Ds were unrated.

Swiss Re says the private placement closed on 13 December 2010 and was purchased by a variety of institutional investors. The transaction was structured and underwritten by Swiss Re Capital Markets.

MP

RMBS

GSE short refi programme participation mooted

Fannie Mae and Freddie Mac are reportedly under pressure to participate in the FHA short refi programme. MBS analysts at Bank of America Merrill Lynch point out that the programme works differently for GSEs than for regular servicers.

"For the agency MBS market, it is very important to realise that even though [the short refi] programme is designed for borrowers who are current on their mortgages and even if GSEs were to agree to participate in the programme, it does not mean that current loans will be bought out of agency pools for modification," they note.

The BAML analysts explain that the GSEs are allowed to buy out 120+ days delinquent mortgages, modify these loans under HAMP and - if the loan becomes performing again - then they are eligible for FHA short refi. The agencies have the option to refinance the loan under the FHA short refi programme and offload the risk to FHA after taking some principal loss.

"We believe this workflow is convoluted and expect this programme to be even less successful than the original FHA Secure and H4H programmes. Also, GSEs can fund these re-performing loans at very attractive rates and have no incentive to take higher losses," the analysts state.

Additionally, the 10% dividend payment that the GSEs have to pay on preferred securities is an incentive for them to delay the realisation of losses. If participation in the FHA short refi programme accelerates realisation of losses by the GSEs, then the GSEs have an even lower incentive to participate in the programme.

The key risk for agency MBS investors is that the roll rates from current to delinquent may increase because of the moral hazard associated with principal forgiveness, according to the analysts. However, they don't expect the roll rates to pick up materially and cause a fundamental change in valuation of credit-impaired coupons.

CS

ABS

State Street unloads legacy assets

Goldman Sachs and Barclays Capital are understood to have acquired approximately US$11bn of legacy securitisation assets from State Street. The firm sold around US$4.1bn US non-agency RMBS and US$3.7bn US ABS, as well as US$2.5bn non-US mortgage-backed and US$600m asset-backed securities.

State Street says this transaction accomplishes several strategic objectives, including: increasing its balance sheet flexibility in deploying its capital; enhancing its capital ratios under evolving regulatory capital standards; and reducing its exposure to certain asset classes. The transaction will result in a pre-tax and after-tax loss of approximately US$350m, which will be recorded against earnings in the fourth quarter of 2010. The after-tax loss approximates the pre-tax loss due to the partial write-off of a deferred tax asset associated with certain of the investment securities sold.

CDS

Enhanced Alpha fund launched

AllianceBernstein has launched Enhanced Alpha Portfolio, a UCITS fund for institutional clients. The fund - a Luxembourg-domiciled UCITS, with a minimum investment of £1.5m - employs a relative value fixed income strategy with an absolute return goal of 8%-10% per annum net of fees.

The fund will use trading strategies to exploit structural anomalies and tactical investment opportunities in multiple global sectors, the firm says, aiming to boost returns with low correlation-to-market returns and various asset classes. Further, the fund will deploy hedging strategies, a stop-loss framework and dynamic tail-risk hedging to protect returns during periods of severe market stress.

Ivan Rudolph-Shabinsky, director of fixed income at AllianceBernstein, says: "We feel that this is the perfect time to be launching a product like this onto the market. The roller coaster ride over the last couple of years has switched the focus of investors to rebuilding returns while avoiding extreme negative outcomes."

He adds: "Enhanced Alpha uses a combination of bonds and derivatives to exploit opportunities, such as disparities in the shape of global yield curves and anomalous relationships between bonds and credit default swaps around the world, while ensuring that we hedge risks in the cheapest, most efficient manner."

CMBS

CRE borrower service launched

1st Service Solutions has launched 1st Equi-Debt Solutions, which aims to offer equity and debt to borrowers of non-performing CRE loans as part of their debt restructure. The new firm was formed by Ann Hambly, founder and ceo of 1st Service Solutions, and Mike Meisenbach, founder of Asset Advisory Alliance. Meisenbach will be based in Texas, where the firm is headquartered.

Meisenbach has over 26 years of CRE experience and was most recently the former principal and president of investment and capital markets for Lee & Associates. Prior to this in 2007, Meisenbach founded Asset Advisory Alliance, a group of investment brokers who assist lenders, asset managers, owners and investors to resolve their asset challenges.

Insurance-linked securities

New member for LLMA

Aviva has joined the Life & Longevity Markets Association (LLMA) as a full member, bringing the LLMA's membership to eleven. The other members are AXA, Deutsche Bank, JPMorgan, Legal & General, Morgan Stanley, Pension Corporation, Prudential, RBS, Swiss Re and UBS.

The LLMA was formed to promote the development of a liquid traded market in longevity and mortality-related risk, of the type that exists for insurance-linked securities (ILS), and other large trend risks like interest rates and inflation. Since launch the association has been actively involved in the development of consistent standards, methodologies and benchmarks to help build a liquid trading market, including the publication of standard frameworks for longevity and a set of seven technical documents that provide the basis for indexed longevity transactions.

ABS

Positive momentum for US credit card ABS

Losses and delinquencies for US prime credit card ABS charge-offs continue to ride a wave of positive momentum as 2010 draws to a close, according to Fitch.

"Ongoing improvements in delinquency trends indicate card charge-offs may recede further in the coming months. We are starting to see positive divergence of loss rates from employment numbers, which indicates that credit card portfolio quality will improve further even as unemployment stays elevated," says Fitch md Michael Dean.

Fitch senior director Cynthia Ullrich adds: "Credit card performance improvements have prevailed over typical seasonal trends. Charge-offs and 30-day delinquencies have been in steady decline for the last several months at a time when they usually increase."

The prime credit card charge-off index remained relatively stable for the month, ticking down 2bp to 9.20%. This, Fitch says, represents the lowest point in 19 months.

The results, which cover the October collection period, show a 9% year-over-year improvement in charge-offs. However, charge-offs are lingering in stubbornly high territory at 55% above the long-term historic average of 5.93%.

This month, Citibank revised its loss recognition policy to write off uncollected balances of deceased noteholders within 60 days of notification. Before the implementation, accounts were charged off only upon the exhaustion of all collection efforts. This policy change resulted in a one-time acceleration of losses, creating a spike of over 125bp in the net credit loss rate for the October due period of the trust.

Late stage delinquencies trended lower for the tenth consecutive month and reached a 25-month low. The 60+ day delinquency index decreased another 7bp to 3.43% in October.

Early stage delinquencies also continued to decline, with 30+ day delinquencies falling 10bp to 4.51%. When compared to the same period last year, late stage delinquencies sit 98bp lower, representing a 22% decline.

Gross yield fell slightly for the second straight month during October, registering a 12bp decrease to 21.80%. Despite the decline, yield remained 11% higher year over year - a result of discount options and re-pricing initiatives from different issuers. However, the agency expects performance to decline by up to 10% in the coming months as a result of regulatory and legislative changes.

Despite the small improvement in charge-offs, the decline of gross yield during the month drove excess spread lower in October. Monthly excess spread decreased 7bp to 9.88%, yet remained 32% higher during the same period in 2009.

The three-month average excess spread also slipped by 3bp during the month to 9.78%, but still recorded the second highest level historically. Compared to last year, three month excess is 56% higher.

The monthly payment rate (MPR) fell again for the second straight month after registering a 31-month high back in September. MPR receded by 42bp in October to 19.23%. At the current level, MPR still represented a 4% increase compared to the same period last year and is more than 19% higher compared to the long-term historic average of 16.15%.

Retail credit card ABS, meanwhile, reflected a different view for the October collection period highlighted by negative across-the-board trends, with the exception of delinquencies. Contrary to the prior month, both early and late stage delinquencies decreased.

Delinquencies of 60 days or more for the month improved by 13bp to 4.56%, while delinquencies of 30 days or more fared better by 20bp to 6.61%. Meanwhile, defaults surged after an improvement in October, worsening by 124bp to 12.78%.

Gross yield fell for the second straight month, slipping by 117bp to 24.80%, while MPR performance also deteriorated 91bp to 13.47%. Accordingly, with a deflated gross yield and increased charge-offs for the month, excess spread declined after three consecutive months of improvement.

Excess spread on a three-month average basis dropped 35bp to 8.76%. However, this level is still approximately 11% higher compared to the same period last year.

ABS ratings on senior tranches of both prime and retail credit card trusts are expected to remain stable, given available credit enhancement, loss coverage multiples and structural protections afforded to investors. The outlook for subordinate tranches remains moderately negative, the agency concludes.

ABS

High inflation could weaken Argentine SF

Moody's says that GDP growth and low unemployment is expected to continue to support the performance of Argentine banks' and financial companies' loan portfolios and securitisations. Argentine transactions have benefitted from strong credit enhancement and excess spread, while securitisations backed by personal loans with automatic deduction mechanisms performed well compared to the loans without the feature.

However, the agency says that persistent high inflation could weaken the credit performance of Argentine borrowers and result in higher delinquencies in 2011. "High inflation has not had much of an impact on the performance of the banks' loans portfolios so far; however, we anticipate higher delinquencies and losses for the banks' portfolios in general and the securitised pools in particular if salary increases are insufficient to cope with another year of high inflation," says Martin Fernandez Romero, Moody's vp.

During 2010, Argentine securitisation witnessed a year of strong growth in total issuance, which came to the equivalent of US$4.27bn in the first 11 months of the year - an 86.28% increase from the total at the same point last year. Looking ahead, the agency expects issuance volumes to continue to rise with increased government participation. Specifically, more new infrastructure deals are expected, driven by investments by ANSES, the Government's Social Security Agency.

However, Moody's concludes that the Comisión Nacional de Valores' proposed regulations to address market concerns about the risk of improper servicing is not sufficient to mitigate the risks that arise when borrowers make in-store payments to financially weak seller-servicers.

ABS

Positive outlook for auto ABS

Moody's outlook for the US auto ABS sector in 2011 is positive, benefiting from continued strong underwriting, a turnaround in the US auto industry and a strong used car market. The volume of issuance in the sector is likely to increase substantially in 2011, the agency says.

The quality of underwriting should ensure that loan and lease ABS performance continues to improve throughout 2011, even if the US economic recovery falters. "The credit quality of originations probably peaked in 2009, but we expect continued improvement in the performance of sponsors' portfolios over at least the next two years because of the lagging effect of the earlier tight originations," says Moody svp Mack Caldwell.

The agency predicts that auto loan ABS rating upgrades will continue in 2011. Further, as rated auto loan ABS transactions season, Moody's anticipates that a structural build-up of credit enhancement will generally offset any potential increases in remaining losses in the loan pools in the coming year.

Auto floorplan transactions, in turn, will benefit from improvements in the auto industry generally as the original equipment manufacturers fundamentally reshape their underlying the economics. "The original equipment manufacturers are no longer overproducing and resorting to expensive incentives to push sales. These practices strengthen their dealership base and improve inventory management, key performance drivers for these transactions," adds Caldwell.

Moody's expects issuance for 2011 to jump to US$65bn, spread among loan, lease and floorplan sectors. The prime sector had 25 public deals and US$28bn in issuance, while new 11 public and private subprime deals worth US$5bn came to market through to 10 November 2010. Leases and floorplan each had US$8bn in issuance in the same period.

A number of factors could affect 2011 volumes, however, including new and used vehicle sales, the cost of other funding alternatives and the costs of legal and regulatory compliance.

Subprime auto ABS sponsors who survived the downturn are now poised for growth and profitability, benefiting from a relatively benign competitive environment. The performance of subprime portfolios should continue to improve over the next several years as a result of the credit tightening over the past two years, Moody's concludes.

ABS

Receivables securitisation programme launched

Armstrong World Industries has established a US$100m receivables securitisation programme. Under the programme, Armstrong World Industries and its subsidiary Armstrong Hardwood Flooring Company will sell their US receivables to Armstrong Receivables Company (ARC), a Delaware special purpose entity. ARC will in turn initially finance those receivables through Credit Agricole.

In addition to the financing of receivables by Credit Agricole, under the documentation establishing the programme, the bank may also issue letters of credit at the request of ARC. The purchase and letter of credit commitments under the programme expire in December 2013, subject to possible extensions thereafter.

ABS

NCUA student loan deal closes

The US National Credit Union Administration (NCUA) has closed its debut student loan ABS resecuritisation - the US$1.16bn NCUA Guaranteed Notes Trust 2010-A1 - via Barclays Capital. The coupon pays 35bp over Libor - an indication of strong investor interest, the agency says.

The NCUA has now completed 60% of the securitisations designed to fund deposits assumed by the bridge corporate credit unions. Total proceeds from the 2010 securitisations now stand at over US$17.75bn, with the agency planning to resume NGN offerings in the first quarter of 2011.

"NCUA's ongoing efforts to resolve the corporate situation have yielded very positive results. The financial success of the securitisation is not only enabling NCUA to manage the disposition of troubled corporate credit unions, it is also allowing the credit union industry to pay for the losses without diminishing service to consumers," says NCUA chairman Debbie Matz.

CDO

CDO manager consolidation slowing

The replacement of US CDO asset managers continues to be a trend observed by Fitch, albeit at a declining rate, it says.

While CDO asset managers can be replaced for a number of reasons, the agency has observed that in most instances, the replacement has been effected due to the outgoing manager: exiting the business and/or ceasing operations altogether; failing specific performance covenants built into the indenture or collateral management agreement; or seeking an infusion of capital, in an effort to remain solvent and to pursue other business lines, which can be obtained through the sale of CDOs under management.

The decline of manager replacements is attributable to the significant amount of consolidation of CDO asset management responsibilities that has already taken place, as several large asset management institutions expanded their presence in the space to include CDOs backed by additional asset classes. Furthermore, the majority of underlying collateral deterioration stemming from the financial crisis has filtered through to CDO underperformance and related overcollateralisation and event of default triggers, a key driver of replacement activity. Given these factors, Fitch says it expects such replacement activity to further slow going forward.

CDS

OTC transparency discussed

ISDA has released two studies on transparency in the OTC derivatives industry, with respect to CDS and interest rate swaps. The studies highlight the spectrum of methods that can be used to increase transparency and the consequences and costs of doing so.

For CDS, the study found that increased transparency may affect large and small trades differently, suggesting it may be necessary to consider different transparency requirements for large trades. The move towards central clearing of standard CDS contracts, the study states, will increase the level of transparency - as will reporting of CDS trades to data repositories.

For the interest rate market, the study finds that the industry would benefit from improving transparency in key areas, including considering the end-of-day dissemination of anonymised, composite post-trade indicators.

Conrad Voldstad, ISDA ceo, says: "These studies, coupled with other research that ISDA has recently conducted among derivatives end-users and market participants, are part of our ongoing commitment to make the OTC derivatives markets safer and more efficient by ensuring appropriate levels of transparency."

He adds: "This work underscores the importance of understanding the current levels and types of transparency that exist in the various OTC derivatives markets, and of developing solutions that balance the desire for greater transparency with the need to maintain liquidity."

Both studies propose that a distinction should be made between regulatory transparency and market transparency. It also warns that increased public transparency - that does not take transaction size into account - may affect liquidity and have a destabilising effect in the CDS and IRS markets.

CDS

Need for fundamental credit analysis reinforced

According to S&P, market participants relying on price signals from the bond and CDS markets for credit analysis may receive a limited view of credit risk. While market price data contain a wealth of information that can shed light on credit quality, credit market dynamics are far more complicated than a simple price or bond spread might suggest, the agency says.

S&P analyst Peter Rigby says: "Unlike fundamental credit analysis, market prices provide neither diagnostic capabilities nor insights into the reasons that differentiate one company's credit standing from another's. As important, securities pricing data do not indicate why a company's creditworthiness is strong or weak."

Markets capture investors' emotions with great speed and efficiency and, consequently, can overreact to headlines, creating excessive volatility, the agency says. Additionally, a great deal of evidence indicates that securities pricing is vulnerable to market illiquidity, unreliable information, asymmetrical information, investor herding and differing investing and trading strategies.

The number of traded bonds and CDS contracts - less than 3,000 names daily - represents only a fraction of the universe of rated securities covered by credit analysts. Globally, there currently exist more than 300,000 corporate bonds, about 1.3m US municipal bonds and more than 117,000 structured finance bonds. Therefore, as experience has shown, investors who use market-based indicators and prices to the exclusion of fundamental credit analysis do so at the risk of mispricing their investment decisions, S&P warns.

CDS

Bankruptcy credit event mulled

ISDA's Americas Determinations Committee is mulling whether a bankruptcy credit event has occurred with respect to The Great Atlantic & Pacific Tea Company, after it filed for Chapter 11 reorganisation on 12 December.

CDS

Anglo Irish CDS settled

Anglo Irish Bank subordinated bucket 2 CDS trades were yesterday settled at a final price of 18.25. The remaining buckets - subordinated bucket 3, SNR/SUB bucket 1, senior bucket 2 and senior bucket 3 - were settled at 18, 74.5, 76 and 74.5 respectively. 14 dealers submitted inside markets, physical settlement requests and limit orders to the auction administered by Creditex and Markit.

In other credit event news, ISDA's Japan Determinations Committee has determined that a succession event occurred with respect to Nippon Oil Corporation on 1 July 2010 and that JX Holdings is the sole successor. In addition, the Americas DC has ruled that a succession event didn't occur with respect to Coca-Cola Enterprises Inc.

CDS

Ambac Financial CDS settled

Ambac Financial Group CDS have been settled at 9.5. 14 dealers submitted inside markets, physical settlement requests and limit orders to the 10 December auction.

CDS

CCR backtesting guidance issued

The Basel Committee on Banking Supervision has issued its guidance on sound practices for backtesting counterparty credit risk models, which sets out supervisory expectations as well as recommendations to strengthen the backtesting of internal assessments of counterparty credit risk exposures.

Banks that have received supervisory permission to use internal model methods to calculate regulatory capital are required to validate their models on an ongoing basis. Backtesting is an integral element of the model validation process and the financial crisis has revealed that additional guidance in this area is required, the Committee notes. It believes that implementation of these sound practices will improve the backtesting of banks' models and, as a result, enhance the resilience of individual banks and the financial system.

CMBS

US CMBS delinquencies continue rising

The delinquency rate on loans included in US CMBS conduit/fusion transactions increased by 24bp in November to 8.63%, according to Moody's Delinquency Tracker (DQT). The increase was larger than the 15bp increase in October and continues a trend of moderate increases that has prevailed over the second half of the year.

In November, 294 loans became newly delinquent, while 245 previously delinquent loans became current, worked out or disposed. "As has been the case in recent months, the resolution and liquidation of troubled loans has helped to largely offset the increase in delinquent balance," says Moody md Nick Levidy.

The total number of delinquent loans increased in November to 4,091, with the total balance increasing by approximately US$1.1bn to US$53.8bn. Year-to-date, the DQT has risen 373 points. Though the largest basis point increase since May, November's 24bp rise was still significantly below the average monthly increase of over 50bp that occurred during the first five months of the year.

The office sector had the greatest increase in delinquency rate among the five core property types in November, gaining 44bp to 6.72%. During the month, US$1.2bn in office loans became newly delinquent and only US$455m became current, worked out or disposed.

Retail properties saw the next highest net increase, with an increase of 27bp to 7.14%. Industrial properties had a 13bp increase, with the delinquency rate standing at 6.36%. Industrial remains the best performing of the five property types.

Multifamily also experienced a modest increase in its delinquency rate, ending November at 13.90%, a 13bp increase since October. The hotel loan delinquency rate remained essentially flat in November, increasing by only 3bp. The hotel rate remains the highest among the major property types at 16.42%, however.

By region, the Midwest had the best performance of the four regions in November, with the delinquency rate falling by 6bp to 8.57%. The South saw the largest increase in November, rising 67bp during the month to end at 10.86% - the highest delinquency rate among the regions.

The West posted the second largest increase, rising by 34bp to 9.70% - more than double the rate a year ago. The East had essentially no change, however, rising only 1bp to 6.60%.

By State, Nevada continues to have the largest delinquency rate by a large margin, rising by another 31bp to stand at 27.5%. With a jump of over 700bp, Alabama has surpassed Michigan as the second worst performing state, with a delinquency rate now of 18.81%. Michigan's rate, meanwhile, dropped by 45bp in November to 14.43%.

Regulation

'Simpler' hedge accounting rules proposed

The IASB has published for comment an exposure draft on the accounting for hedging activities. The proposed model is principle-based and includes enhanced presentation and new disclosure requirements, with the aim of more closely aligning hedge accounting with risk management activities undertaken by companies when hedging their financial and non-financial risk exposures.

David Tweedie, chairman of the IASB, says: "These proposals sweep away the existing rule-based, complex and inflexible hedge accounting requirements and replace them with a simple, principle-based approach. The result, if adopted, will be a much simpler model that better reflects risk management practices whilst providing more useful information to investors."

The exposure draft builds on proposals contained in the IASB's discussion paper, 'Reducing Complexity when Reporting Financial Instruments', published in March 2008. The exposure draft forms part of the IASB's project to replace IAS 39 Financial Instruments: Recognition and Measurement and when its proposals are confirmed they will be incorporated into IFRS 9 Financial Instruments.

The exposure draft, 'Hedge Accounting', is open for comment until 9 March 2011, with a view to completing the new hedge accounting requirements in the first half of 2011. In addition to the general hedge accounting proposals in the exposure draft, the IASB is continuing to discuss portfolio macro hedge accounting.

RMBS

Foreclosure compliance documentation required

S&P has announced that it expects all residential servicers in its Select Servicer programme to provide documentation in support of their compliance with proper foreclosure affidavit and attestation procedures by 2Q11. The documentation should include written verification from an independent source that the servicer's foreclosure affidavit preparation and attestation processes are sound and are designed to be in compliance with individual state laws governing the relevant processes.

Where applicable, written documentation should also be provided of the servicer's identification of process, workflow and/or organisational deficiencies in its existing foreclosure affidavit preparation and attestation process, together with all relevant changes to internal policy documents that describe procedural changes that are specifically relevant to and designed to remediate/support ongoing statutory compliance with the preparation of foreclosure affidavits and attestation.

If S&P determines that a servicer's processes are inconsistent with these requirements, it will monitor its efforts to remedy the issues and revise its outlook and/or rankings on the servicer as deemed appropriate.

RMBS

Pressure to continue for US mortgage servicers

The intense spotlight placed on US mortgage servicers after the disclosure of irregularities in foreclosure documentation will continue into 2011, according to Moody's. However, although the scope of irregularities should become better defined over the next few months, the scrutiny may lead to fresh controversies about additional servicing practices.

Moody's expects that more clarity will come as servicers complete their extensive loan-level reviews of defaulted portfolios and internal procedures later in the year. The legal consequences of the irregularities will also emerge as courts respond to them.

"In 2011, it will become evident how seriously courts will view violations of court rules on foreclosure procedures. Since judicial foreclosure laws vary as greatly from state to state as judicial foreclosures do from judge to judge, we could see a wide range of judicial opinions on the legality of the foreclosure processes and actions taken to remedy each situation," says Gene Berman, Moody avp.

The agency believes that foreclosure flaws will lead to an extension of three months or more in the timeline it takes to foreclose on properties. Irregularities in foreclosure practices influenced Moody's decision to place the servicing quality ratings of 12 servicers - including the five largest US residential mortgage servicers - on review for downgrade earlier in the year.

Moody's says that both internal and external audit programmes will be broadened to ensure that servicing practices are sound - especially in the areas of default management - and proper controls are in place to identify areas of risk for investors. Meanwhile, external scrutiny is expected to continue from government entities and investors, while state attorneys general are also expected to continue their investigations into servicing practices.

An area of exposure may be the denial or curtailment of mortgage insurance and trust claims that result from servicing errors and how these may create losses for investors. Moody's says it will continue investigating servicers' cash management and investor reporting practices in 2011, following some commingling cash practices coming to light in the middle of 2010.

Other issues the servicers will be contending with in 2011 include enhanced government programmes to help borrowers and delinquency rates, which continue to be much higher than they have been historically. Additionally, the agency anticipates that the government will enhance its mortgage modification programmes and will likely seek a broader use of principal forgiveness.

RMBS

Mortgage servicing council formed

The US Mortgage Bankers Association (MBA) has assembled a task force of MBA members to examine and issue recommendations for the future of residential mortgage servicing. Dubbed the Council on Residential Mortgage Servicing for the 21st Century, the task force will be led by Debra Still, MBA vice chairman and president and ceo of Pulte Mortgage.

Berman says: "The residential mortgage servicing sector has been operating in a time of unprecedented challenges, presenting us with a unique opportunity to explore potential improvements to business practices, regulations and laws affecting the servicing sector and consumers. As the national trade association representing the real estate finance industry, we will bring together industry experts to take a comprehensive look at the current state and ongoing evolution of residential mortgage servicing and make recommendations for the future."

The Council will convene a one-day summit on 19 January 2011 in Washington, DC to take a detailed look at the issues that have challenged the industry and identify the essential building blocks for the future of servicing. Following the summit, the Council will meet on a regular basis to discuss how the industry must change moving forward.

RMBS

Aussie RMBS support welcomed

The Australian Securitisation Forum (ASF) has welcomed the introduction of a further A$4bn AOFM investment to support the country's RMBS market and the Treasury's announcement that it is to accelerate the development of a 'bullet bond' structure for RMBS.

The RMBS investment through the Australian Office of Financial Management has been critical to keeping competition - the second-tier banks, mutuals and non-banks - alive since the financial crisis (SCI passim). Through securitisation, the ASF says that non-banks have conspicuously led the charge on reducing home loan costs since the 1990s.

Meanwhile, the government's facilitation and market development of bullet-style RMBS has the potential to significantly increase the existing investor base for such securities, according to the ASF. This, it says, will permit securitisation to play a more meaningful role in the funding of home loans, as well as supporting a competitive and innovative market for residential mortgages.

Stuart Fuller, ASF chairman, says: "The intense and discrete work that the ASF has been conducting with the Treasury over the past 18 months is testament to our industry providing sensible and balanced solutions to complex, global problems. There has never been a 'silver bullet' to the funding challenges our financial institutions face, but we believe that the breadth and quality of the package outlined today will help all players in the market confront these challenges and, with securitisation playing its part, ultimately reduce the cost of living for Australian families."

The ASF says it will continue its productive relationship with the government on its Competitive and Sustainable Banking System package.

RMBS

Mortgage-related litigation on the rise

The Mortgage Litigation Index, a collaboration between Patton Boggs and Mortgage Daily, indicates that legal actions tied to mortgage-lending rose by over 40% in the third quarter of the year. The index tracked activity on more than 100 civil and criminal mortgage-related cases between 1 July and 30 September 2010.

Activity in this period leapt from the second quarter's 75 cases and was up similarly from the same period last year. Cases involving investor actions taken as a result of alleged violations to the Securities Exchange Act of 1934 outnumbered all other types - although activity was still lower than in the second quarter. Coming in next were actions related to foreclosures, the firms report.

"In recent months, the focus of mortgage litigation has begun to transition from primarily consumer foreclosure disputes towards loan documentation and servicing issues. Therefore, an increase in residential note repurchase litigation from investors in securitisation trusts and banks that face indemnity claims from government-sponsored enterprises should be expected," says Patrick McManemin, Patton Boggs partner.

Whole business securitisations

Euro WBS performance examined

S&P reports that challenging trading conditions have persisted in most sectors of European corporate securitisations in the second half of 2010. The agency says it has accounted for these short-term conditions in its stresses, which are largely driven by macroeconomic views, as well as the resultant impact on cashflow generation.

Deterioration in performance has been within the scope of S&P's accounted stresses. However, a notable exception is the tenanted pub sector - in which the agency has taken five adverse rating actions.

Looking forward, the agency believes that the present set of economic conditions will continue to affect the demand for most goods and services. Additionally, 2011 is expected to continue to see difficult trading conditions, although - with no regulatory price determinations to be made in the coming year - S&P expects regulated sectors to perform robustly.

From a new issuance perspective, volumes continue to be affected by the disrupted credit market conditions. As such, over the past couple of years the majority of corporate securitisation issuance derives from sectors that are arguably more insulated from macroeconomic trends - namely regulated entities and ILS.

This has meant that fewer 'traditional' corporate securitisations of operating companies that are reliant on discretionary consumer spend have emerged. However, notably the Dignity tap in September 2010 was the first market issuance of a non-regulated corporate securitisation transaction in the past two years.

Finally, the infrastructure sector has made up the majority of issuance volumes and is expected to continue over the medium term, the agency concludes.