Contents

ABS

Support issues

Starkly different outlooks for Australian ABS and RMBS

The outlooks for Australian ABS and RMBS are starkly different. While the record ABS volumes seen in 2010 are expected to continue next year, growth in the RMBS sector appears to be being distorted by a lack of cheap funding and the government's deposit guarantee scheme.

2010 has been the busiest year on record for Australian ABS, according to Ilya Serov, vp and senior analyst at Moody's. He says: "ABS has historically accounted for 5%-10% of the Australian securitisation market, but now it accounts for 15%-20%. We're expecting around 12 deals to launch by the end of the year."

Prior to 2010, the ABS market had mostly consisted of vanilla auto deals. But this year issuance has been more diverse, including trade receivables and leasing transactions. Looking to next year, Serov expects vanilla ABS to account for the majority of issuance, with occasional deals featuring other asset types.

"I don't expect an explosion in issuance next year - it'll be more of a stabilisation in issuance trends," he explains.

In contrast, Moray Vincent, partner at Structured Credit Research & Advisory, suggests that it is difficult to see a long-term future for Australian RMBS unless cheap funding for securitised product becomes available. The Australian Office of Financial Management (AOFM)'s RMBS investment programme supports smaller regional lenders (SCI passim), but otherwise the market is concentrated around the four major banks - ANZ, Westpac, NAB and Commonwealth Bank of Australia.

"The four majors largely came through the financial crisis unscathed - they had minimal subprime or CDO holdings - and have emerged stronger," he explains. "As the market for ABS and RMBS dried up, they were able to put their balance sheets to work. But an unwelcome side effect of a strong banking sector was a reduction in competition in the mortgage market, as the mortgage securitisation vehicles didn't fare so well."

An additional A$4bn for the AOFM RMBS programme was announced on 12 December (see SCI 13 December), but without any changes to the criteria for participating in it. According to Alex Sell, coo of the Australian Securitisation Forum, there is some scope to change this - which is important because non-banks may feel that they didn't get much out of the government's competition package. For example, there is a ban on mortgage exit fees, which non-banks rely on.

Another issue that needs to be addressed is the requirement that RMBS collateral is insurable with mortgage insurance because lo-doc and non-conforming mortgages aren't. It has been suggested that this should be considered where any RMBS has enough credit enhancement to achieve a triple-A rating, otherwise credit to small businesses and the self-employed is cut off, which the government says it is serious about supporting.

Further, according to Vincent, the government's deposit guarantee for up to A$1m is distorting the market because it removes any differential for credit. "There is strong competition for funding, which has elevated rates, and there is no desire among many middle market investors to buy AAA/AA rated RMBS because term deposits can earn them 150bp over for five years with a full government guarantee, if they spread their investments across institutions."

Sell agrees that the deposit guarantee is causing distortion at the top end because investors are taking out term deposits rather than investing in RMBS. "The limit is rather excessive, but it is being reviewed. Ultimately, the market needs mutually reinforcing measures."

Meanwhile, the 12 December announcement also stated that the Treasury would "accelerate the development" of a bullet structure for RMBS. Recent BankWest and Adelaide & Bendigo Bank transactions included some bullet tranches, as well as amortising notes that trap principal and interest to be used if needed to meet a bullet payment.

Sell suggests that historically APRA's issue with bullet structures has been the lack of a true sale, with the issuer potentially remaining on the hook to meet the repayment. However, many superannuation funds prefer bullets because of the predictability of payment and the qualification of the structures into benchmark indices.

In addition, a portion of the AOFM's additional A$4bn could be used as a backstop to meet bullet payments if the issuer can't. "The Treasury will gain more leverage if bullets gain popularity: if it's only providing a contingent facility, that's better than the way it is now where it's investing every dollar. However, this is only at the triple-A level - we've urged the Treasury to come down the credit curve to the AA/A level, but it is worried about the political perception of doing so," Sell observes.

The ASF has also convinced the government to permit covered bonds. "Covered bonds are pro-prudential because they diversify the investor base and lengthen the maturity profile. The issue is that covered bonds have a perceived superior claim, but this isn't an insurmountable provision," says Sell.

Covered bonds are likely to be made eligible for liquidity requirements under Basel 3, following the Reserve Bank of Australia's recent announcement that RMBS is eligible, subject to a secured financing facility fee. There is a net shortfall of government debt to meet these liquidity requirements in Australia and so it would be helpful if both instruments were eligible.

Away from new issuance, another indication that the Australian securitisation market isn't functioning as well as perhaps it could is that secondary product typically trades wider than primary. Because funding costs are high and the paper is illiquid, valuations and bids are often very wide apart.

Vincent confirms that a significant amount of legacy bonds still have to wash through the system. About A$3bn-A$4bn in face volume of synthetic CDOs and capital protected notes remain outstanding, for example.

He notes that synthetic CDO valuations are increasingly becoming bifurcated. "Rather than pricing at 30c-70c, depending on whether they're likely to default or mature, many CDOs are either in the 90c-plus or 10c and below areas because it's obvious which ones will make it and which ones won't. If a deal has one year to run and can withstand six defaults, it will make it; if it has no credit support, contains some horrible names and has four years to maturity, it won't - or there will be a partial loss, depending on tranche thickness."

Vincent adds: "Every default now generally causes some losses as credit support on many CDOs are now eroded, but the losses are generally well provisioned for. Most CDO noteholders who have retained advisors mark to market and can see any losses coming, so there haven't been that many major blow-ups."

He suggests that middle market investors have been most affected by the fall-out from synthetic CDOs in Australia. "Although CDO losses and those from other 'capital guaranteed' products weren't that big in the end, investors have experienced significant ratings volatility and many will never buy these types of products again. Legislation has been introduced to prevent local governments investing in CDOs and other structured products. ASIC remains hostile to the listing of CDOs, even though the listed ones have generally performed well."

CS

CLOs

Different paths

US CLO improvement powers on as Europe lags behind

A good year is being predicted for US CLOs in 2011, driven by improving new issuance volumes and collateral trends. In contrast, the European CLO market remains mired in regulatory and sovereign debt issues.

Annaly Capital Management strategists note that the four CLOs that priced in November (SCI passim) mark a huge step forward for the market from just over a year ago, when triple-A spreads were coming in at over 600bp, and that post-recession collateral performance trends have now truly reversed course. They observe: "The loan default rate has dropped to 2.3% from a peak of 9.6% and surviving triple-Cs are edging up into single-B-land. As a result of these underlying collateral trends, the secondary CLO market has turned the corner both in price performance and rating agency trends."

Default rates are at a 23-month low and, given that the US economic outlook is positive, they are expected to remain low - within 1%-3%. Lower default rates benefit OC cushions and enable CLO managers to bring deals back into compliance. Equally, managers can build par by purchasing loans in the secondary market as they are trading at a discount to par.

Justin Pauley, vp at RBS, confirms that the US CLO market is generally on an improving trend, boosted in recent months by a handful of new issues. "About US$5bn worth of CLOs have been announced in 2010, most of which have priced reasonably well," he says.

Steve Baker, director at Standard Chartered, also says that CDO market conditions have improved significantly over the last year. He cites the fact that his firm's recent START VI CLO received a lot of investor interest - so much so that the deal was upsized - as an example.

"START transactions have a good track record, which obviously helped," Baker explains. "Nevertheless, some reticence remains towards CDOs. There is no denying what happened during the credit crisis, but many investors recognise that not all CDOs are the same - there is a difference between CLOs and ABS CDOs, for example - and that CLOs have generally performed well."

He expects CLO issuance in 2011 to be up on this year's issuance, but volumes will remain a long way from where they were before the crisis. "Structures will continue to be simple, with low leverage and fewer tranches. Over time, if the overall economic environment continues to improve, we'll see leverage increase," he says.

RBS analysts echo this sentiment: they forecast US$10bn-US$20bn of new issuance next year. "We believe that new deals in 2011 will be driven by investors looking to add leverage to their unlevered loan portfolios combined with demand from CLO investors that want newly minted deals, lower leverage, higher rated CLOs with their choice of manager and size that they cannot get easily in the secondary market."

Chandrajit Chakraborty, cio and managing partner at Pearl Diver Capital, is also expecting something between US$10bn and US$15bn in new issuance. He predicts that the market will see some balance sheet transactions and may also see some selling from the large portfolios in the bad banks.

He says: "There is a lot of uncertainty with regulation and sovereign concerns. Because of these, there is still a lot of uncertainty about the new issuance landscape. But, even given those, I think there will be a combination of manager deals, warehouse repacks and maybe a handful of arbitrage deals."

Pauley suggests that increasing new issuance is being driven by three factors. First is the around US$1bn of loans in post-reinvestment CLOs due to mature, which need to find a home. Second, high yield hedge funds and loan funds are seeking to add leverage via CLOs.

Third is that many new accounts are moving into the sector looking for yield and safe cashflowing triple-A paper. "It's viewed as a safe investment, especially given QE2," Pauley notes.

However, most of the new issues this year have been one-offs and this is expected to continue into 2011. "Liabilities are still trading cheap to assets, which means new issue CLO economics don't yet work," Pauley explains. "Managers of the one-off deals either have close relationships with equity investors or take down the equity themselves. The larger managers will play more when they can when the market returns properly."

Nevertheless, he expects growth to be slow but steady. "The CLO rally began in April 2009 and - except for a dip in May through June 2010, with the European sovereign crisis - spreads have been tightening ever since."

In terms of structural tweaks in new CLOs, non-call periods have typically been reduced to one to two years - and this trend is likely to continue, albeit slightly longer and possibly with a call premium. Shorter reinvestment periods have also featured in recent deals.

"This is a function of trying to keep both triple-A and equity holders happy: it's a bit of a balancing act. Structures will continue to evolve as different investors push for different priorities," Pauley observes.

Most CLO activity is, however, still expected to be concentrated in the US next year. START VI is an exception because it was a synthetic structure and the exposure was to primarily Asian corporates, but it will be a while before new issuance picks up in Europe because - among other factors - triple-A pricing is wider than US triple-As due to the spread tightening caused by programmes such as TALF.

For regular cashflow CLOs in both Europe and the US, funding the triple-As at an economic level remains the biggest stumbling block. "Spreads on the triple-As and mezz will continue to tighten, but more money is coming into loan funds and separate accounts, so loan prices are also rising. Loan prices need to be low enough for the transaction to make sense," Baker comments.

Chakraborty believes how far European spreads tighten will be one of the main things to watch for next year, with performance possibly struggling to match that of 2010. He says the US will see the bulk of issuance as it has a deeper market and it is easier for investors to measure and model risk, while the investor base is also wider. The most important factor holding Europe back is that many macro issues, such as sovereigns, are European-focused.

"The sovereign issue has by no means gone away or been resolved and this will lead to macro volatility in 2011. We already saw a bit of that around Greece, although there was far less of a reaction when it happened to Ireland. However, in the Irish case there were other technical factors at play," explains Chakraborty.

He continues: "The big concern going into the New Year is that there is a high probability of issues surrounding Portugal and Spain. If that spreads across Europe, then clearly risk appetite among investors is going to shrink. This would result in volatility, with spreads widening."

Over the shorter term, the structured credit space may well be characterised by uncertainty and volatility. But Chakraborty says a positive development will be the widening out of the investor base.

"We will definitely see more variety of investors. There will be a period of risk aversion. A lot of old investors, such as SIVs and CDOs, have gone away - and I think gone away for good or the foreseeable future at least - but in the CLO space we have seen CLO managers themselves looking to participate in some of their tranches or the tranches of other similar deals. That is an area which was there before but has become more pronounced lately," says Chakraborty.

He continues: "Hedge funds will also be investing, but for them it depends on being able to get in and out quickly. However, we are looking at a longer time frame for any real money participation to come back because many of them have been burnt quite badly and want to stay away from structured products for some time. That said, they still realise that though they have been burnt, there will be opportunity in the medium term."

Finally, the ever-present issue of regulatory uncertainty will persist in 2011 - although this is less applicable to synthetic balance sheet deals, as the issuers retain the majority of the capital structure. However, as Chakraborty concludes: "Any investor coming in will be in for a very rough ride as we go through this patch of regulatory changes, sovereign issues and de-leveraging of the system - which still has a way to go."

JL & CS

Insurance-linked securities

ILS trio closes

Three more insurance-linked securities deals have closed in the past day - the first longevity trend risk securitisation, the first medical benefit claims ILS and two new tranches from the Montana Re multi-peril multi-country catastrophe bond.

Swiss Re has placed US$50m of its new longevity trend securitisation - Kortis Capital (SCI 2 December 2010). The single tranche Series 2010-I class E notes priced at 472bp over six-month Libor and are rated double-B plus by S&P.

The transaction provides cover to Swiss Re against a divergence in mortality improvements experienced between two selected populations. The bond is based on population data and would trigger in the event that there is a large divergence in the mortality improvements experienced between male lives aged 75-85 in England and Wales and male lives aged 55-65 in the US.

Swiss Re Capital Markets acted as sole manager and bookrunner on the note issuance. Risk modelling and analysis was performed by Risk Management Solutions (RMS). Collateral for the Kortis notes consists of securities issued by the International Bank for Reconstruction and Development.

Meanwhile, groundbreaking medical benefit claims ILS Vitality Re (see SCI 25 November 2010) has closed. The deal's US$150m class A notes priced at 425bp over three-month Libor, upsized from an initial US$125m, but its proposed US$75m class B notes were not placed.

The notes, rated triple-B minus by S&P, 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$1.5bn. The initial MBR attachment point for the notes is US$1.56bn.

At the same time, Flagstone Re's Montana Re catastrophe bond has issued two more series of notes. The US$70m class C notes cover losses from US hurricanes and quakes, while the US$60m class E notes cover losses from second and subsequent US hurricane and earthquake, European windstorm and Japan earthquake and typhoon.

The class C notes priced at 1190bp over three-month Libor and the class Es at 950bp over. S&P has rated the two tranches single-B and single-B minus respectively. The transaction's collateral is held in a tri-party repo structure with BNP Paribas and Euroclear.

These two new tranches of Montana Re utilise RMS's parametric-based index, Paradex, which creates index values (reported on, or converted to, US dollars for this transaction) based on event parameters, such as the wind speeds during a hurricane, windstorm and typhoon that are measured by a network of reporting stations and spectral acceleration for earthquake (using data supplied from the US Geological Survey monitors seismic activity and published in post-event hazard maps). These index values are used to estimate industry losses by line of business.

As the event calculation agent, RMS will calculate an index value following a qualifying event. The index value is the sum of the products of Paradex index values and payout factors for a) US hurricane and earthquake, each county in the covered area, b) European windstorm, each CRESTA zone, and c) Japan typhoon and earthquake, each prefecture.

The class C notes will cover losses from US hurricanes and earthquakes, on a per-occurrence basis, in excess of US$342m (the initial attachment level) and US$469.1m (the initial exhaustion level).

The class E notes cover losses from second and subsequent events on an annual aggregate basis. The covered perils are US hurricane and earthquake, Japan typhoon and earthquake, and European windstorm. The initial attachment level is US$100m and the initial exhaustion level is US$200m.

The class E initial deductible amount for each event is: for US Hurricane, US$125m; for US earthquake, US$125m; for Japan earthquake, US$100m; for Japan typhoon, US$100m; and for Europe windstorm, US$100m. The initial maximum loss amount related to any one event is US$100m. Therefore, it would take a minimum of two events to result in a loss on principal on the class E notes.

MP

ABS

SLC acquisition completed

Discover Financial Services has completed its acquisition of the Student Loan Corporation (SLC). The acquisition includes SLC's ongoing private student loan business and private student loans and other assets, totalling US$4.2bn, along with US$3.4bn of SLC's existing ABS funding and other liabilities.

The acquisition was preceded by a series of transactions in which Sallie Mae purchased US$27bn of SLC's federal student loans and related assets, while Citibank purchased US$8.7bn of federal and private student loans and other assets.

ABS

Senior trio depart

Three senior executives are leaving Citadel Securities, the firm has confirmed. John Kilgallon, currently part of the leveraged finance group at Citadel, will replace head of leveraged finance Carl Mayer. Mayer had joined in 2009 from Merrill Lynch, where he was head of leveraged finance capital markets (see SCI issue 135).

Along with Mayer, the head of credit markets for Citadel Securities, Chris Boas, is also leaving. His successor has not yet been chosen and may be brought in from outside the firm. Boas joined Citadel's hedge fund in 2006 before moving to the firm's investment banking division.

Brad Kurtzman, who managed equity derivatives sales and trading, is also leaving.

ABS

Securitisation trust units acquired

US Bancorp's lead bank, US Bank National Association, has completed the acquisition of the domestic and European-based securitisation trust administration businesses of Bank of America. After conversion - expected to complete by the end of the third quarter of 2011 - the acquired US and European trust businesses will operate under the US Bank trade name and will open offices in Ireland and England.

Under the terms of the agreement, US Bank Corporate Trust Services acquired approximately 2,153 active securitisations and related transactions, more than 2.4m residential mortgage files, 84,000 commercial files and US$1.1trn in assets under administration. Additionally, the transaction provides US Bank with approximately US$8bn of related deposits at close.

CDO

CDO manager replacements minted

One new CDO manager transfer has been proposed and two others agreed ahead of year-end.

First, CWCapital Investments is proposing to replace Ventras Capital Advisors as the collateral manager for the Crest G-Star 2001-1 and 2001-2, and G-Star 2002-1, 2002-2 and 2003-3 CRE CDOs. Second, Pramerica Investment Management is to replace Aladdin Capital Management UK as the collateral manager for the Hudson CLO 1 deal.

Finally, Resource Europe Management confirmed that an affiliate of Intermediate Capital Group has acquired the management contract of the €300m Resource Europe CLO I (see SCI 6 December). In connection with the sale of the management contract, the firm also transferred its equity and other interests in that CLO to ICG.

Christopher Allen, senior md and co-founder of Apidos Capital Management - the firm's leveraged loan manager - comments: "Selling the management contract for our European CLO will allow Apidos to focus on expanding our US leveraged loan business. The interest in this management contract was great and this reflects on the outstanding performance of our CLO management team and our joint credit approach. ICG is an experienced asset manager, with a very good track record of managing corporate credit in Europe."

StormHarbour Securities advised on the transaction.

CDO

CRE CDO manager replaced

Cutwater Asset Management Corp has replaced Dillon Read Capital Management as collateral manager on Dillon Read CMBS CDO 2006-1. The collateral management agreement was amended as such due to the removal of Dillon Read Capital Management as the collateral manager, following the execution of a notice of removal of collateral manager for cause.

Moody's has determined that the move will not cause the current rating on any class of the notes to be reduced or withdrawn. It does not express an opinion as to whether the agreement could have non-credit related effects, however.

CLOs

CLO manager merger announced

Deerfield Capital (DFR) and Commercial Industrial Finance (CIFC) have merged. The firm will be headquartered in New York and maintain operations in Chicago. Subject to closing conditions, the merger is expected to close in the first part of 2011.

DFR, through its subsidiaries, Deerfield Capital Management and Columbus Nova Credit Investments Management, is a Chicago-based investment manager with approximately US$9.4bn of AUM, including approximately US$5.5bn in CLOs. Bounty Investments currently owns approximately 40% of the outstanding common stock of DFR.

CIFC is a New York-based investment manager specialising in leveraged loan credit products, with approximately US$6.2bn of AUM, including CLO assets. CIFC is currently owned by CIFC Parent Holdings, which is majority-owned by funds managed by Charlesbank Capital Partners. As part of the merger, CIFC Parent Holdings will receive 9,090,909 shares of newly issued DFR common stock and US$7.5m in cash in three equal instalments.

Following the merger, Peter Gleysteen, ceo of CIFC, will become ceo of the merged entity, while Jonathan Trutter, ceo of DFR, will become vice chairman. On closing the merger, CIFC Parent Holdings will own 36.9%, Columbus Nova will own 35.2% and public stockholders and management will own 27.9% of DFR's common stock. This will be based on the number of shares expected to be outstanding after the merger.

DFR's board of directors will be expanded to eleven members and will include three designated by CIFC Parent Holdings, three designated by Columbus Nova, three independent directors, as well as Gleysteen and Trutter.

Gleysteen says: "The combined company will be well-positioned for growth at a point of newly expanding opportunities for credit-based asset management products, particularly loans. It will have a highly differentiated investment model, ample resources and a top track record."

Distressed assets

Distressed fund manager named

Harbert Management has appointed Greg Jordan as portfolio manager of a distressed credit fund due to launch in February. Jordan will report to Mike Luce, the firm's president and coo.

Legislation and litigation

Lehman repo fraud case filed

US Attorney General Andrew Cuomo has filed a Martin Act lawsuit against Ernst & Young (E&Y), in which it is charged with helping Lehman Brothers Holding engage in an accounting fraud involving the surreptitious removal of tens of billions of dollars of fixed income securities from Lehman's balance sheet. The lawsuit - filed in the New York Supreme Court - claims that this was in order to deceive the public about Lehman's true liquidity condition.

The lawsuit further claims that for more than seven years leading up to Lehman's bankruptcy filing in September 2008, Lehman had engaged in 'Repo 105' transactions, explicitly approved by E&Y. The transactions' purpose was to temporarily park highly liquid, fixed income securities with European banks for the sole purpose of reducing Lehman's financial statement leverage, according to the lawsuit.

Further, the complaint alleges that in 2007 and early 2008, when Lehman was facing demands to reduce its leverage, it rapidly accelerated its use of repo transactions - removing up to US$50bn from its balance sheet on a quarterly basis. The complaint also alleges that E&Y failed to object when Lehman misled analysts on its quarterly earnings calls regarding its leverage ratios, and that E&Y did not inform Lehman's audit committee about a highly-placed whistleblower's concerns about Lehman's use of repo transactions.

The Attorney General seeks the return of the entirety of fees E&Y collected for work performed for Lehman between 2001 and 2008 -­ exceeding US$150m - plus investor damages and equitable relief.

Legislation and litigation

SF partner appointed

Eversheds has appointed Kingsley Ong as partner in its Hong Kong banking and finance team. Kingsley will be responsible for spearheading the firm's structured finance and derivatives group.

Kingsley has over ten years of experience at both Mayer Brown and Clifford Chance as a structured finance and derivatives lawyer. In this time, he has helped set up securitisations and derivative products, as well as unwinding complex securitisation structures and close out of derivatives, repo and securities lending contracts.

ABS

Enhanced reporting requested for student loan ABS

S&P is requesting issuers and servicers of US student loan ABS to provide it with data reporting enhancements during its surveillance process. The agency says that the enhanced data will enhance its surveillance efforts and increase market transparency by including the additional information in its published articles.

The data reporting enhancements collectively constitute what the agency views to be a more comprehensive summary of a transaction's asset characteristics and liability profile. In addition to the items typically reported in student loan transactions, the list of requested data reporting enhancements includes additional items such as weighted average payments made, trigger calculations and weighted average time until loans enter repayment - based on current loan status.

"Based on what we have observed, current reporting for student loan ABS varies from issuer to issuer in terms of both data and format," says S&P analyst Frank Trick. "We believe there are several reasons for this diversity. For example, student loan ABS transactions often have several sub-servicers in addition to a master servicer and/or administrator, which may cause inconsistency in the data we receive."

"Additionally, certain issuers, particularly in the private loan space, typically analyse their own portfolio performance at a more granular level than other student loan issuers do, which allows for more detailed reporting," adds S&P analyst Erin McCutcheon.

McCutcheon also notes that recent events, particularly the impact that the economy has had on collateral performance in certain sectors, calls for an increased level of transparency through reporting. The data reporting enhancements sub-divide liability and asset performance information into five areas: class-level information, waterfall-related information, other asset and liability information, historical collateral performance information and current collateral/pool characteristics.

ABS

Positive momentum continues for US auto ABS

Positive momentum in the US used vehicle market continues to buck seasonal trends, according to Fitch. However, while the agency remains optimistic about the effect used vehicle values will have in the auto ABS sector in the near term, it remains cautious in its outlook for the medium term.

"Tight vehicle supply continues to push used vehicle values to record levels. Manufacturers will likely increase production levels at the same time that underwriting standards begin to loosen," says Fitch senior director Hylton Heard.
The agency's outlook for prime and subprime auto loan ABS ratings performance is currently stable to positive for the remainder of 2010 and 1Q11. However, as Fitch remains cautious, it will monitor the rise of gas prices and its effect on used vehicle values into 2011.
Seasonally adjusted used vehicle values have now posted gains in each of the previous three months, finishing up 1.1% month-over-month in November, according to the Manheim Used Vehicle Value Index. In addition, signs of increased stability in the US economy are being reflected in various metrics, including personal bankruptcies, claims for new jobless benefits and continuing unemployment claims.

Month-over-month prime auto loan ABS annualised net losses (ANL) were mostly stable in November, finishing at a rate of 0.83%. This is well below even pre-recessionary averages, as tight vehicle supply combined with conservative underwriting standards from manufacturers continue to contribute to improved loss levels. Fitch expects prime ANL levels to range from 0.80% to 1.0% for the remainder of the year and going into 1Q11.

Prime auto loan ABS delinquencies of 60+ days decreased to 0.54% in November, down 6.9% from October. For much of 2010, year-over-year numbers are down significantly over 2009 as market conditions continue to improve in the sector.
Subprime 60+ day delinquencies were also down in November to 3.12%, reflecting a 5.5% decrease since October and a 29.4% decrease over 2009. ANLs increased to 7.05%, a month-over-month increase of 12.1%.

Fitch has upgraded 61 classes of auto ABS notes through November, compared to 24 through the same time last year.

ABS

Greek RWN impacts SF

Fitch has placed all tranches of its rated Greek structured finance transactions on rating watch negative, following the placement of the triple-B Greek sovereign rating on RWN. The agency currently rates 18 SF transactions ­- 15 RMBS and 3 ABS - containing Greek collateral.

Fitch says that if the sovereign rating is downgraded, it will assess the rating cap impact on its SF ratings ­­- currently six notches above the Greek sovereign rating. It will also take into account any deterioration in the macroeconomic environment and its effect on transaction performance. Further, it will consider the composition of the collateral portfolios and credit enhancement available to the notes.

The agency expects the outcome to be resolved in January 2011, following the resolution of the sovereign RWN.

ABS

Stable outlook for Brazilian ABS

Moody's says its outlook for Brazilian securitisation performance remains stable. Favourable and stable economic conditions are set to continue to support performance, as well as promote new issuance, the agency notes.

"Favourable macroeconomic fundamentals and the overall economic stability of the government of Brazil continue to drive the demand for consumer credit, vehicle financing and real estate financing as the middle class consolidates," says Johann Grieneisen, Moody's vp.

Strong consumer confidence and the rapid formation of the middle class make consumer and vehicle loans the most attractive asset classes for securitisation, says Moody's. Additional areas of activity in 2011 will be in CRE and trade receivables.

Further, the agency says it does not expect banks to securitise residential mortgages in Brazil in 2011. While discussions on how to implement residential mortgage securitisations in the country continue and interest will be high, buy-side and sell-side hurdles remain - including the lack of long-term funding in the Brazilian securitisation market.

One concern for the credit quality of new issuance in 2011, however, is that lenders may be lowering underwriting standards as the demand for credit stays high and a prolonged benign credit environment continues. More loans are likely to be made to first-time borrowers with limited experience in managing debt, making them potential risks.

ABS

Fourth consecutive monthly decline for charge-offs

Charge-offs on US credit cards fell for a fourth consecutive month in November to 8.58% - down from 8.79% in October, according to Moody's Credit Card Indices. Delinquencies and early-stage delinquencies also continued to fall during the month, indicating that charge-offs could carry on declining in the coming months.

Jeffrey Hibbs, Moody's avp says: "The early stage delinquency rate in particular is now nearing its all-time low. The decline in the amount of receivables entering delinquent status supports our standing base-case expectation that charge-offs will ultimately break below the 7% mark later in 2011."

The charge-off rate is now almost 19% below its year-ago level of 10.56%. Among individual credit card trusts, however, performance was mixed, with three of the six largest trusts experiencing gains in charge-offs during the month.

During November, the delinquency rate fell for the thirteenth consecutive month to 4.38% - its lowest reading since December 2007 and almost 30% below its year-ago level of 6.21%. The early-stage delinquency rate also fell during November to 1.14% and is close to being an all-time low.

Also in November, the yield index ticked higher to 21.74% - an 8bp increase from 21.66% in October. Despite the modest increase this month, the agency expects yield to decline over the coming months with the end of aggressive re-pricing initiatives and as principal discounts continue to expire. The higher yields and lower charge-offs during November pushed up the excess spread to 10.32% - close to the all-time high set two months earlier, Moody's reports.

ABS

Portuguese ABS, RMBS on review

Moody's has placed the ratings of 25 Portuguese structured finance transactions on review for possible downgrade. The ratings under review include the triple-A ratings on two RMBS, most of the mezzanine and junior notes in 21 other RMBS transactions, and six notes in four ABS transactions.

The rating actions reflect the expectation of further asset performance deterioration, due to Portugal's longer-term economic vitality. On 21 December, the agency placed Portugal's A1 rating on review for possible downgrade, citing the country's sluggish growth, downward pressure on GDP growth, heightened funding costs and the financial impact of supporting the banking sector.

The vulnerability of the Portuguese financial sector to continued loss of funding and higher impairments is another important factor in the rating actions. On 21 December, Moody's also widened the review of Portuguese bank ratings to all rated Portuguese banks.

Despite the more stable performance of Portuguese RMBS recently, the agency expects increasing delinquencies and losses going forward. "The performance of the outstanding 29 Portuguese RMBS transactions has stabilised in recent months and average 60-plus delinquencies have remained at 1.4% since July 2010," says Maria Turbica, Moody's analyst.

Average outstanding defaults have also stabilised at around 1.7%. Turbica adds: "Moody's anticipates further deterioration of RMBS asset performance in the context of its forecast for very weak economic growth for Portugal in the next two years and as a consequence of fiscal tightening policy." In addition, house prices have resumed falling in the second half of 2010, dropping by 1.3% year-on-year in October 2010.

"We expect performance of ABS transactions to deteriorate in the context of weakening macro-economic conditions and implementation of austerity measures," explains Ariel Weil, Moody's vp.

Further, the agency has placed on review for possible downgrade the class C and D notes of Nova Finance No 4 and the most senior outstanding tranche in Chaves SME CLO 1. "We did not place on review ABS notes that have credit enhancement levels sufficient to protect against our anticipated deterioration in asset performance," Weil adds.

The review of the senior note ratings in Azor Mortgage Public Limited Company and Pelican Mortgage No 1 follows the review for downgrade of their respective servicers - BANIF- Banco Internacional do Funchal and Caixa Economica Montepio Geral. There are currently no mitigants in place to counter the operational risk in these transactions, such as a back-up servicer or a back-up servicer trigger, and therefore payment disruptions could occur.

For two ABS transactions, the rating review reflects the operational risk associated with the unrated servicers. The review of the Aa3 rated notes in the LTR Finance No 6 and the A1 rated notes in LTR 8 reflects weaknesses in the operational risk mitigating structural features, the agency concludes.

ABS

Counterparty risk update hits Euro SF

S&P estimates that approximately 29% of all its outstanding rated structured finance transactions could be affected and placed on credit watch negative on 17 January 2011, following the updates made to its methodology and assumptions for assessing counterparty risk (see SCI 3 December). S&P has derived this estimate by counting transactions that include counterparty roles covered by the new criteria and where at least one of the currently outstanding tranche ratings is higher than the lowest-rated counterparty's issuer credit rating (ICR) plus one notch.

Given the widespread use of counterparties in European SF transactions relative to some other jurisdictions, the agency expects the number of affected transactions in Europe to be higher, at an estimated 40%-50%. In European RMBS, for example, approximately 80%-90% of transactions are likely to be affected.

In European CMBS, fewer transactions - approximately 65%-75% - will be affected. However, those that are affected typically involve a larger number of counterparty entities - mainly due to hedging agreements, such as interest rate swaps and caps, which some European CMBS transactions employ.

However, the agency says that if it receives a written plan from issuers to adopt the new criteria containing a viable timeline, it may not place the affected ratings on watch negative. During the period from 17 January until the transition date of 15 July, by which S&P aims to resolve all credit watch placements, the agency intends to resolve the placements on a continuous basis by affirming or lowering the ratings within six months.

ABS

Improvement continues for credit card ABS

A continued improvement in US credit card ABS collateral performance has been recorded in Fitch's latest index results. Chargeoffs, delinquencies, and excess spread all improved to extend the positive trends that began last summer, the agency reports.

Riding a year-long string of improving delinquency trends, chargeoffs fell below 9% for the first time in 20 months helping excess spread levels top 10% for the first time ever. "Though still elevated, credit trends are pointing in the right direction for US card portfolios. Further gains on the labour front could drive more meaningful consumer credit quality improvement in first half 2011," says Fitch md Michael Dean.

ABS ratings on both prime and retail credit card trusts are expected to remain stable given available credit enhancement, loss coverage multiples and structural protections afforded investors, the agency says.

The Prime Credit Card Chargeoff Index for December dropped to 8.99% for the period, which covers the November collection period. The chargeoff index is now 238bp lower than the all time high of 11.37% set in February 2010 and is down 16% year over year. Chargeoff rates remain persistently high by historical standards, as the index averaged just over 6% for much of the last 20 years.

Late stage delinquencies trended improved by 6bp to 3.37% while 30 plus day delinquencies increased 3bp to 4.54%. "Late stage credit card delinquencies have improved by 26% since last year," says Fitch director Cynthia Ullrich.

Gross yield ticked up by 3bp to 21.83%, registering the 13th consecutive month of yield in excess of 20%. Gross yield has averaged 18.65% since inception and has been particularly strong since regulatory reforms changing the issuers' pricing strategies and trusts enacted the discount option to shelter the trusts from high chargeoffs.

The robust yield generation and improving chargeoff situation, combined with a low cost of funds resulted in a record high three month average excess spread of 10%, which is 47% higher during the same period in 2009. Monthly payment rate (MPR) fell 17bp to 19.06%, which is consistent with seasonal patterns, yet still back above the long-term average of 16%.

Retail credit card ABS showed a 91bp improvement in chargeoffs to 11.87% following last month's blip caused by a Citibank policy change. Both early and late stage delinquencies continue to show modest improvement.

Gross yield recovered after a slip last month - improving from 24.80% to 25.34%. On a year over year basis, gross yield is 90bp lower, reflecting regulatory changes which curtailed late and over-limit fees which were a significant revenue source for retail cards. MPR was 13.8%, tracking closely to the long-term average of 13.5%. Excess spread on a three-month average basis was 8.57% - approximately 6% higher compared to the same period last year, Fitch concludes.

ABS

Student loan servicing outsourced

CIT Group has completed a service agreement with the Pennsylvania Higher Education Assistance Agency (PHEAA) to service US$7.4bn of the firm's government-guaranteed loans portfolio.

Under the terms of the agreement, CIT will outsource all of its student loan servicing activities that are currently provided by its subsidiary Xpress Loan Servicing (XLS). PHEAA conducts its commercial student loan servicing activities as American Education Services (AES), which currently services approximately US$1bn of CIT's student loan portfolio. The servicing of the additional US$7.4bn portfolio is expected to be transferred to AES between January and March 2011. As a result, CIT will close its XLS offices in Cleveland and Cincinnati, Ohio.

Moody's, Fitch and DBRS have all confirmed their ratings on the related portfolio of student loan asset backed securities.

Alternative assets

Cat bond duo closed

Swiss Re has closed two catastrophe bond issuances - the third series of Successor X and Green Fields Capital 2011-1.

Sized at US$170m, the Successor X transaction references major North Atlantic hurricane risk in selected states within the US and Puerto Rico and major earthquake risk in California and Australia between December 2010 and December 2013 (see also SCI 8 December).

The US$65m Series 2011-1 class III-R3, rated single-B minus by S&P, priced at six-month Libor minus 32bp, plus 12.75%.The US$50m III-S3 notes, also rated single-B minus, priced at six-month Libor minus 32bp, plus 14.5%. A third tranche of unrated notes was also issued. The notes were privately placed.

Swiss Re Capital Markets acted as sole manager and book-runner on the note issuance, while risk modelling and analysis were performed by EQECAT. This transaction is the third takedown of the Successor X programme, after a first bond for US$150m in December 2009 and a second for US$120m in May 2010 (SCI passim).

Swiss Re has also closed the latest issuance in its "Green" catastrophe bond series. Green Fields Series 2011 issued a double-B plus-rated tranche of €75m, which priced at 350bp above three-month Euribor, minus 32bp.

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 (see also SCI 15 December).

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. The risk modeling is based on RMS's Europe Windstorm Model Version 6.0 using the 2010 PERILS industry exposure database.

CDO

Trups CDO defaults, deferrals slowing

The rate of increase for both defaults and deferrals in US bank Trups CDOs continues to slow, according to Fitch's latest default and deferral indices. The combined default and deferral index increased to 32.08% in November, compared to 31.95% in the previous month.

New deferrals year-to-date (currently 161) remain lower than the 246 through to the end of last November. "There have been 12 cures through the end of November of this year, compared to just one through the same period in 2009," says Fitch senior director Alina Pak.

Through the end of November, 150 bank issuers have defaulted, affecting approximately US$5.48bn held across 82 Trups CDOs. "Jump-to-default rates have been low, with over 92% of the 150 banks currently in default previously deferring," adds Pak.

377 deferring bank issuers are affecting payments on US$6.59bn of collateral across 85 Trups CDOs.

CDS

ICE Trust CFTC reg withdrawn

The ICE Trust US has withdrawn its application for registration as a derivatives clearing organisation with the US Commodity Futures Trading Commission, according to a press release issued on 28 December, 2010. The ICE Trust US submitted its application on 12 November, 2010.

The application was withdrawn due to recently-proposed clearing regulations from the CFTC, according to reports.

CLOs

CLO investors call for decisive regulatory action

The new issue CLO market is expected to revive this year as regulations are finalised and arbitrage and liquidity return, according to CLO investors at a recent S&P roundtable. They also expect the investing community to be drawn to collateral managers with good track records and appropriate management styles, while they are divided on the seriousness of the pending maturity wall.

The panel highlighted pending regulation as a main concern, saying it must be finalised quickly for the CLO market to grow. However, they noted it is also important for regulators to consider the resilient performance of the asset class and existing structural features before setting requirements. One investor said the existing structures already align the interests of collateral managers with investors, while another noteed requiring managers to invest significant capital for new transactions may force smaller managers out of the market.

Indicus Advisors partner Keith Ashton said: "Despite my conviction that CLOs are both an attractive investment and an appropriate type of leverage, until the regulatory framework gets sorted out, and until there is a structural need for CLOs, the new-issue CLO market will look a lot more like 2010 than 2004-2005."

Matt Natcharian, md at Babson Capital Management, agreed that finalised regulations certainty will help. "Some senior CLO buyers will come back into the market if the regulations get settled, and CLOs continue to perform well," he noted. "Getting senior note buyers back really is the missing piece right now for CLOs to come back in size, and we're starting to see more interest from both equity and senior investors, who have been the toughest to find for new CLO issuance."

The investors said another factor for the market to consider will be which collateral managers to use. They noted that a collateral manager's experience with CLOs is one of the most important factors influencing future CLO performance, with trading practices and management capabilities particularly relevant. Transparency and ability to communicate with investors are also considered key.

As for the upcoming refinance cliff for CLOs (i.e. supply/demand imbalance in loans maturing in the near term), Ashton warned increased defaults for underlying loans and events of default for CLOs could be on the horizon. "I am absolutely concerned about it. It is a particularly interesting phenomenon in so far that it's very unusual that one can see the risk, and, for some people, the opportunity, years before it actually shows up at your doorstep. I believe there will be a big range of outcomes for CLO investors," he said.

"Some CLOs will sail through this period having been well-positioned for it, and having the capacity to take advantage of what will probably be at least a mild to moderate loan market dislocation," he continued. "But we also expect that other CLOs, managed by other managers, will literally hit the wall. The next two years are critical not only for the credit market as it looks to spread out those maturities, but also for CLO managers as they develop strategies to deal with this risk in their portfolios."

Citi Capital Advisors portfolio manager Serhan Secmen does not, however, attach so much importance to the situation and says it is a natural part of the market. He commented: "Maturity walls have always existed. From 2001 and even earlier, by the nature of the issuance and the market, there has always been a hump five to seven years out in the cycle, and it has moved as a wave as we were moving forward in the calendars."

Secmen says the refi wall is being eroded and does not loom so large as it did a year ago. He adds that around 30% of the CLOs in the market should still be within their reinvestment period when the wall is reached, creating a natural demand for the loans which should be enough to get over the hump.

CLOs

Watch positive for raft of Euro CLOs

Moody's has placed 53 tranches from 14 European CLOs under review for possible upgrade, impacting around €1.45bn of securities. The agency explains that there may be positive implications of improvement in deal collateral quality metrics since the deals were previously rated, including weighted average rating factor (WARF) and OC levels.

Improved credit performance of the underlying collateral and favourable market condition have had a positive impact on European CLOs, says Moody's. In many transactions the agency observed successful reinvestment of principal repayments and sale proceeds into substitute assets with below-par purchase price, higher ratings or both. It says the CLOs typically benefitted from haircuts due to decreased exposure to defaulted securities.

The review affects a majority of junior notes because they have one or more of the following: adequate OC coverage for the affected notes; a substantial improvement in OC and WARF levels since the last rating; the resumption of paying interest or a history of never deferring interest; sufficient OC test cushions for notes senior to those affected; or finally turbo amortisation, enabling the notes to de-lever ahead of more senior notes.

The affected deals are backed primarily by portfolios of senior secured notes. While in many cases not all tranches from the same deal are placed under watch for upgrade, Moody's says it will review the entire capital structure when it conducts full analysis of each deal and take rating action when warranted.

CMBS

Euro CMBS extensions, restructurings to continue

Loans across the European CMBS market suffered maturity breaches, term payment defaults or contributed to shortfalls on note payments last month, according to S&P. The assets backing these loans include retail, mixed-use, office and multi-family properties located in the UK, France and Germany.

The number of loans in the agency's delinquency index in November rose to 62, with euro- and sterling-denominated delinquency rates up slightly to 8.82% and 8.64% respectively. Negative performance resulted in S&P lowering nine of its ratings ­- four of which were downgraded to single-D.

"The November data reinforce our view - compounded by the volume of impending loan maturities - that the current pressures on most subsectors of European CMBS will persist in the near term. The negative performance will likely invite more thoughts of loan extensions and restructurings, in our view," says S&P analyst Judith O'Driscoll.

Indeed, today sees a borrower-led invitation to noteholders to vote on a restructuring of the REC Plantation Place transaction. The single loan backing the deal has been in breach of its loan-to-value covenant since August 2008. The restructuring proposed by the borrower, if voted through, would see noteholders agree to a temporary waiver of the LTV breach until October 2102.

CMBS

Fleet Street 2 affirmed post-restructuring

S&P says the restructuring of the Fleet Street Finance Two CMBS this month by Capital Asset Services (Ireland) does not affect the transaction's ratings. The restructuring, begun in February 2010 and completed in October, followed the insolvency of key tenant Karstadt (SCI passim).

The restructuring includes extending the notes' legal maturity to July 2017, on the condition that the application of all property income and sale proceeds service the bonds in interest and principal. S&P views this as a favourable credit factor, but believes the transaction remains exposed to inherent risks lying within single-tenanted portfolios.

The agency says its loan analysis has taken into account the likely level of recoveries to be made available to the issuer following Karstadt's insolvency. It believes the immediate disposal of the underlying properties would boost recoveries.

Important elements of the restructuring include:

• Additional hedging instruments at loan and note levels to protect the borrower and issuer against interest rate rises
• No liquidity facility in the extended period. The servicer is required to use excess cash to build up a liquidity reserve, available to fund interest on the class A notes only
• The balance of the liquidity reserve account now stands at €22.6m, which can reach a maximum of €82.6m or minimum of €7m, at the servicer's discretion, in conjunction with the rating agencies. S&P is not one of the agencies that will be consulted; therefore, it will not be involved in setting the size of the reserve.

CMBS

Plantation Place proposal stalled

The REC 5 (Plantation Place) CMBS restructuring proposal (SCI passim) has received a high level of support from noteholders, with four out of the five tranches voting in favour to break the deadlock. However, a single noteholder in the class B tranche rejected the proposal and a further meeting of the class B noteholders will be held early in the New Year to enable further consideration of the proposal.

Of those noteholders that were represented at the meetings, 81% of class A, 74% of class B, 97% of class C, 82% of class D and 100% of class E voted in favour of the proposal. Despite these levels of support, the proposal was not approved due to the required 75% threshold needed. 74% of the class B noteholders voted for the proposal.

Regardless of the outcome of the second meeting of the class B noteholders, the owners will continue to seek a consensual solution to maximise value for all stakeholders. Nassar Hussain, managing partner of Brookland Partners, says: "The result illustrates the difficulty with the very high thresholds that need to be achieved across the capital structure on CMBS structures generally. The owners will now seek to bring the opposing class B noteholder on board, with a view to implementing the proposal. However, irrespective of the outcome of the further class B meeting, they will continue to work pro-actively with noteholders and other transaction parties to seek a solution to maximise value for all stakeholders."

Distressed assets

RoundPoint closes second FDIC transaction

RoundPoint Financial Group has purchased a 40% stake of a US$603m mortgage loan portfolio from the FDIC in conjunction with RBS Financial Products. The FDIC retains a 60% equity interest in the structured transaction.

The newly created venture will acquire the mortgage pool and the loans in the portfolio will be managed and serviced by RoundPoint Capital Group and RoundPoint Mortgage Servicing Corporation.

"Our participation in this transaction is another step in the execution of our strategy of being a fully integrated mortgage investment firm and demonstrates our commitment to the residential mortgage market," says Kevin Brungardt, ceo of RoundPoint Financial.

The transaction closed on 30 November and is one in a series of structured sales of residential loan pools offered by the FDIC. It is the second time in 2010 that RoundPoint has acquired a loan pool from the FDIC, following April's US$491m purchase (see SCI issue 179).

"Our asset management and special servicing platforms were developed to address the needs of the current housing market and enable us to participate in FDIC structured loan sales," comments Shaun Ahmad, president of RoundPoint Capital Group.

Legislation and litigation

Further Anglo Irish auctions considered

ISDA's EMEA Credit Derivatives Determinations Committee may hold one or more auctions to settle 'relevant transactions' in respect of the Anglo Irish Bank Corporation following its resolution on 23 December, 2010, that a Restructuring Credit Event occurred. This is a subsequent and separate credit event to that which the Committee resolved on 23 November, 2010 and which was settled following auctions held on 9 December, 2010.

Monolines

MBIA downgraded on higher loss expectations

S&P has lowered its counterparty credit, financial strength and financial enhancement ratings on MBIA Insurance and National Public Finance Guarantee to single-B from double-B plus and to triple-B from single-A respectively. At the same time, it has lowered the counterparty credit rating on MBIA Inc to single-B minus from double-B minus. While the outlooks on MBIA Insurance and MBIA Inc remain negative, the outlook on National is developing.

The agency says the downgrades on MBIA are due to its stress-case loss projections for the company's ABS CDOs and its CRE-related exposures now showing as significantly higher than previously projected. However, these loss expectations do not require immediate cash outflows and the company has adequate liquidity for the next few years, S&P notes.

For the CRE exposure, S&P says it now views this asset class as being under moderate stress. It has modified its methodology to exclude any previously applied diversification benefits. This change in methodology results in a substantial increase in stress-case losses.

In addition, changes to the modelling methodology for assessing RMBS and updated criteria for assessing CDOs - both ABS and CRE backed - have resulted in higher stress environment loss projections for these asset classes.

The rating action on National is related to the rating action on its sister company MBIA Insurance. Although National and MBIA Insurance are separate legal entities, they both are subjects of litigation that seeks to void the restructuring undertaken in 2009 that split off the municipal business (SCI passim). As long as that litigation is unresolved, the agency believes there is a risk that the two companies could be required to be recombined or that National would be required to bolster MBIA Insurance's capital.

As such, the MBIA Insurance rating acts as an anchor on the National rating. Given the possibility that a downgrade could move the rating on National nearer to the rating on MBIA, S&P says it is constraining the National rating at two rating categories higher than MBIA.

The rating action on MBIA Inc, meanwhile, reflects the downgrades to its key operating subsidiaries MBIA Insurance and National. However, MBIA Inc's liquidity is currently strong - bolstered in 2010 by a small dividend from Cutwater and a tax refund. Cash on hand and cash inflows expected in the next few years adequately cover the holding company's debt-service and operating-expense obligations.

Currently, MBIA Inc's cash and short-term investments on hand plus expected cash inflows are sufficient to cover about 3.8 years of cash outflows, the agency says. The company faces debt maturities of US$91m in 2011, with the next maturity in 2022.

The negative outlook on MBIA Insurance reflects the possibility that adverse loss development on its structured finance book could continue, diminishing liquidity and weakening capital. Liquidity is currently adequate to meet projected claims payments over the next several years, but there could be increased losses and earnings volatility.

The outlook on National is developing. The stand-alone assessment incorporates S&P's view that National's capital adequacy currently meets its double-A standard and the expectations that National could be successful in its efforts to re-establish its presence in the municipal market. Success in this regard - as demonstrated by competitive market share, premium pricing power and enhanced financial flexibility -could ultimately lead to ratings in the double-A category.

Finally, the outlook on MBIA Inc is negative, reflecting the potential for liquidity to weaken over time due to access to cash subsidiaries being constrained as a result of adverse litigation outcomes. However, in the next few years liquidity will be adequate to meet debt-service and holding-company obligations, including operating expenses.

RMBS

Eurosail deals downgraded on FX risk

Moody's has downgraded the ratings of 19 classes of notes issued in four Eurosail transactions exposed to foreign exchange risk, following the review of its loss assumptions for the underlying mortgage portfolios. It has also updated its loss assumption in another UK non-conforming RMBS transaction exposed to foreign exchange risk, but has taken no action on the ratings of the corresponding notes.

The rating actions affect: Eurosail-UK 2007-3BL, Eurosail-UK 2007-4BL, Eurosail-UK 2007-5NP, Eurosail-UK 2007-6NC, Eurosail PRIME-UK 2007-A and EMF-UK 2008-1. In all six transactions Lehman Brothers Special Financing (LBSF) provided, among other hedging agreements, cross-currency swaps to hedge the notes denominated in US dollars and in euros.

The rating actions take into account the evolution of the collateral performance and foreign exchange rates since November 2008 in all six transactions. This review also reflects the assessment of the liquidity available in the structures, following the refusal by Danske Bank to renew its liquidity commitment or advance a stand-by drawing in Eurosail-UK 2007-4BL, Eurosail-UK 2007-5NP, Eurosail-UK 2007-6NC and Eurosail PRIME-UK 2007-A.

In five out of the above six transactions, the performance of the mortgage collateral has been worse than previously expected. This has been the main driver of the downgrade of the junior and mezzanine notes in Eurosail-UK 2007-3BL, Eurosail-UK 2007-4BL, Eurosail-UK 2007-5NP and Eurosail-UK 2007-6NC. The mortgage portfolio in EMF-UK 2008-1 has also shown worse than expected performance, but this has not had any rating impact as Moody's rates only the senior notes in this transaction.

The absence of an effective liquidity facility, following the refusal by the liquidity facility provider Danske Bank to renew its commitment or advance a stand-by drawing, in the context of worse-than-expected collateral performance and foreign exchange exposure, has also impacted the ratings of the class A2 and class A3 notes in Eurosail-UK 2007-4BL and of the Class A2 notes in Eurosail-UK 2007-6NC.

RMBS

RMBS default backlog continues to grow

The growing volume of residential defaults continues to have a notable effect on the US housing market, according to S&P. The time it will take for the market to absorb newly-distressed properties has continued to grow in 3Q10, with the growing volume of distressed properties remaining one of the primary factors hindering a full recovery, the agency says.

"At the end of the third quarter, we estimate that the principal balance of these distressed homes amounted to more than US$450bn - representing about one-third of the non-agency RMBS market currently outstanding," says S&P md Diane Westerback. "While this amount is down about US$10bn from the second quarter, we estimate that it will take 44 months to clear the supply of distressed homes on the market in the US as a whole, which is up from our second-quarter estimate of 40 months."

Given the pace of residential defaults during the housing downturn, the market's inability to quickly absorb the excess volume has created a large 'shadow inventory' of distressed properties, S&P says.

Miami is said to be the only metropolitan statistical area (MSA) of the top 20 for which the time estimate to clear the inventory of distressed properties has decreased since the second quarter. Comparatively, the agency estimates that it will take nearly 10 years to clear the inventory in the New York MSA at the current liquidation rate. That is at least twice as long as it will take in any of the other top 20 MSAs and nearly three times the average time to clear for the entire US, S&P concludes.

RMBS

Downgrades for Option ARM RMBS

Moody's has downgraded four tranches totalling US$6bn from four RMBS issued by Wachovia due to deteriorating collateral. The collateral backing these transactions consists primarily of first-lien, adjustable-rate, negative amortisation and Alt-A residential mortgage loans.

In these transactions Wells Fargo - as master servicer - is obliged to repurchase loans that are more than 90 days past their due date. Delinquent loans in the underlying pool have been bought back by Wells Fargo in the past year and, Moody's says, it has reviewed this repurchase rate to determine possible future default rates on the remaining pools.

The agency notes an increasing potential for a double-dip recession, which could cause a further 20% decline in home prices - versus the baseline assumption of roughly 5% further decline. Moody's concludes that a further 5% decline in home prices with stabilisation in late 2011 is due, accompanied by continued stress in national employment levels through that timeframe.

RMBS

BoA settles GSE buy-back claims

Bank of America has announced agreements with Freddie Mac and Fannie Mae to resolve repurchase claims involving certain residential mortgage loans sold to them by entities related to Countrywide Financial Corporation. The payouts are a result of the GSEs' drive to exercise their put-back options on certain loans (see SCI issue 198).

The agreement with Freddie Mac extinguishes all outstanding and potential mortgage repurchase and make-whole claims arising out of any alleged breaches of selling reps and warranties related to loans sold by legacy Countrywide. The agreement provides for a cash payment to Freddie Mac of US$1.28bn, which was made on 31 December 2010.

The agreement with Fannie Mae substantially resolves the existing pipeline of repurchase and make-whole claims outstanding as of 20 September 2010 related to loans sold by legacy Countrywide to Fannie Mae. The agreement provides for a net cash payment to Fannie Mae of US$1.34bn, which was also made on 31 December.

The Fannie Mae agreement extinguishes all outstanding and potential selling reps and warranties claims on 12,045 legacy Countrywide loans, with an approximate unpaid principal balance of US$2.7bn. The agreement also resolves specific outstanding repurchase or make-whole claims, or extends the cure period for missing documentation-related claims, on an additional 5,760 legacy Countrywide loans (approximately US$1.3bn of unpaid principal balance).

RMBS

GSE portfolio rules implemented

The Federal Housing Finance Agency (FHFA) has sent to the Federal Register a final rule pertaining to Fannie Mae and Freddie Mac portfolio holdings. The final rule implements section 1109 of the Housing and Economic Recovery Act of 2008 (HERA) and adopts without change FHFA's interim final rule on portfolio holdings, which was effective on 30 January 2009.

The final rule establishes, as the standard for the GSEs' portfolio holdings, the criteria set forth in the Senior Preferred Stock Purchase Agreements that each Enterprise may hold mortgage assets up to US$900bn as of 31 December 2009. For each subsequent year starting 31 December 2010, each Enterprise is required to reduce its maximum holdings of mortgage assets by 10% of the maximum limit in the preceding year until the limit reaches US$250bn. At that point, no further reduction in the maximum limit is currently required.

RMBS

Annaly eyes MBS purchases

Annaly Capital Management has priced an underwritten public offering of 75 million shares of its common stock. The shares are priced at US$17.20 for expected gross proceeds of approximately US$1.3bn. Annaly expects to use the proceeds of this offering to purchase MBS for its investment portfolio and for general corporate purposes.

Credit Suisse is acting as the lead book-running manager for the offering, while Barclays Capital, JP Morgan and RCap Securities are acting as book-running managers.