Contents

CLOs

US CLO prices ramping up

Bid-lists continue to dominate activity in the US CLO market. At the same time, aggressive investor appetite and soaring price levels bode well for new issuance.

"The spurt of activity in bid-list land continues aplenty; we're seeing five to six large lists per day," one CLO trader confirms. "With pricing levels improving further and further and market conditions remaining firm, there is a real expectation from clients to put their allocated money to work."

He continues: "With the prices as firm as they are and with no setbacks in sight, these assets are continuing to ramp up and be pretty buoyant. The horizon looks very much the same."

One contributing factor to the current flow of activity is a sudden appeal for triple-A paper, the trader says. "Triple-As have been on fire - to the point that some of the price points have reached the mid-90s. Supply has increased, but it tends to come from one-off auctions."

Meanwhile, on a broader scale, visible CLO supply continues across the capital structure - particularly in mezzanine and equity paper, which is currently generating more yield. This firm tone is expected to continue, with the upcoming ASF 2011 conference expected to pause the CLO market only temporarily at most.

"To be honest, I can't see anything stopping this ball of money that's being allocated," the trader declares. "Or, consequently, the freight train effect on upward moving CLO prices."

All of this bodes well for potential CLO new issues. "If secondary first-pays are firmer, then coupons on new issue CLOs tend to be lower - making the likelihood of the deal printing much higher," he concludes.

LB

RMBS

Euro RMBS returns to life

The European RMBS market experienced a slow start to the week before a spike in bid-list activity today, which has generated investor interest. Meanwhile, Aire Valley paper has rallied strongly on the back of a statement from the issuer.

"Monday started slowly, with not much client or Street activity happening. We've seen a ramp up today, however, so it has got busier," one RMBS trader says. This ramp up involved the arrival of five bid-lists, which although not large in size - three to four lines each - helped generate activity.

The trader continues: "The bid-lists included some UK non-conforming, as well as off-the-run deals. With off-the-run deals, we have to sit back and wait to see who's interested; it's not clear-cut. A lot of non-conforming lists came out at the beginning of the month, so this week the market seems to have taken down a lot of that risk."

Elsewhere in the sector, Granite triple-A paper is down by 15 cents today from yesterday. "Triple-As opened at 94.05, while triple-Bs currently stand at 59-60 as the bid-offer," the trader confirms. He adds that although the recent rally in Granite paper has provided rich levels, investor interest remains relatively low.

Meanwhile, the Aire Valley programme generated publicity this week as a notice from the issuer revealed that some of the notes in the series were overpaid. "This caused a stir in the market, with people putting bids out for paper on the back of the news. Consequently, it has rallied quite heavily and driven prices up," the trader says.

LB

CMBS

Beacon Seattle mod creates waves

The modification of the second largest US CMBS loan ever securitised - the Beacon Seattle & DC Portfolio loan - has significant implications for a broad base of investors, according to MBS analysts at Barclays Capital. It was modified in December, with its maturity date extended by five years (see SCI 15 December).

Under the modification, several components of the loan structure were altered and - as such - the Barclays Capital analysts note that the outcome is dependent on which modification scenario is realised. There is also a high chance of other loans using components of the portfolio's modification as a template.

Beacon Seattle shares sponsorship with another recently modified loan, Columbia Center. It is therefore likely that the sponsor will look to carry out further CMBS modifications in the future, the analysts suggest.

They also comment that most of the additional collateral was non-cash in nature and indicate that the use of excess sales proceeds to de-lever the loan will only be meaningful if the sales price is high enough to generate such excess. This isn't expected to be the case with many properties, since the portfolio is barbelled.

Nevertheless, the Market Square property could be sold before the modification template deadline at cap rates potentially as low as 5.5%, which the analysts say would result in more than US$450m in proceeds. If realised, that would be sufficient to reimburse interest shortfalls accumulated through the Market Square sale, although such shortfalls would probably resume after the sale.

At least two additional properties are expected to be sold from the pool this year, which should substantially decrease the outstanding loan balance. BarCap currently values the portfolio at around US$3bn, but notes that 50bp of additional compression would be enough to add around US$400m to the valuation.

The loss severity of the loan is estimated to be 15%-20%, with the analysts' base case being US$218.8m of losses stemming directly from the interest rate modification. This will be lower if properties are released early.

JL

RMBS

Housing finance 'blueprint' published

The Center for American Progress (CAP) has published a report entitled 'A Responsible Market for Housing Finance', which MBS analysts at Bank of America Merrill Lynch believe is likely to serve as the blueprint for housing finance reform. By recommending important but minor tweaks to the existing system, CAP's proposal strengthens existing functional elements of the US housing finance system, the analysts note.

The CAP report urges moving away from a nationalised mortgage finance system towards one that relies on private-sector capital, through both depository institutions and the secondary mortgage market. This new mortgage finance system is characterised by five overarching principles: liquidity, stability, transparency/standardisation, affordability and consumer protection.

It also has three specific goals, the first of which is to preserve the availability of 30-year fixed rate mortgages. The second is to rebalance US housing policy so that private markets are the primary source of decent affordable rental housing, with public support where deep subsidy is needed. Finally, the proposal aims to ensure that a broad array of large and small mortgage lenders have access to secondary market finance.

CAP recognises that, under its proposal, the government would still be required to support the market to a limited degree but that any government guarantee must be explicit and paid for. Equally, the system preserves the traditional roles of mortgage originators but separates some of the functions previously provided by Fannie Mae and Freddie Mac among MBS issuers, Chartered Mortgage Institutions (CMIs) and a Catastrophic Risk Insurance Fund.

Where the MBS themselves and the loans backing them meet certain standards, issuers may purchase credit insurance on the MBS from the new CMIs. CMIs, in turn, are fully private institutions, regulated by a federal agency and backed by the Catastrophic Risk Insurance Fund. The Catastrophic Risk Insurance Fund would be a government-run fund fully accounted for in the federal budget and funded by premiums on CMI-guaranteed MBS.

The government would price and issue the catastrophic guarantee, collect the premium for the guarantee and administer the Fund. The new Fund would set the product structure and underwriting standards for mortgages that can be put into securities guaranteed by the CMIs and securitisation standards for MBS guaranteed by the CMIs.

Under this proposal, CAP estimates that the cost of a 30-year fixed rate mortgage would probably increase by about 50bp, bringing prices back to the level of July 2009. Assuming a US$5trn CMI MBS market and 5% capital requirement, the BAML analysts suggest that the capital need for the CMI system is in the order of US$250bn.

"Given the similarity between the CMIs and FN/FH, we think the most likely outcome of an evolution to the CAP system is that FN/FH survive and dominate, but adapt to the new requirements," they add. "As CAP notes, there are numerous operational requirements of any housing finance system; the reality is that FN/FH have many of the capabilities to meet these requirements. In our view, this puts them at the head of the pack in terms of adaptability to the new system."

Finally, the creation of a Market Access Fund financed by a small fee on all MBS has been proposed. This Fund would, on a competitive and shared-risk basis, provide credit enhancement and research and development funds to promising but untested mortgage finance products that could better serve underserved markets.

CAP notes three considerations that must be taken into account during the transition into a new system: the continued functioning of the single- and multifamily origination and TBA markets; maintaining the value of outstanding MBS; and preserving the human/technological capital that enables the MBS market to work without failures in execution, delivery or payment. These considerations have a few direct implications, according to the analysts.

The first is that the wind-down of the GSE portfolios will need to continue in a deliberate and orderly fashion. The second is that at the time issuance of CMI MBS commences, legacy FN/FH MBS will still be in existence.

Having a two-tier MBS market where the FN/FH MBS do not have the explicit guarantee that the CMI MBS enjoy would violate the principle that the value of outstanding MBS be maintained. The explicit guarantee would therefore have to be extended to legacy FN/FH MBS and probably by extension to the agency debt market.

CS

Technology

The industry standard

Sapient Global Markets risk analytics director Jor Molchan and senior associate Richard Ellis discuss the advantages – and challenges – of implementing an efficient credit valuation adjustment programme

The market volatility and numerous counterparty defaults experienced since September 2008 have shown the limitations of traditional credit risk monitoring techniques.

Credit lines welcome exposure until the cap is reached; thereafter exposure is simply refused. In an industry where risk is routinely 'dollarised', exposure caps fall far short of the mark.

Collateral management has proven itself to be too reactive to market movements and plagued with operational and legal failures. Both techniques also suffer from being backward-looking and reactive in their application.

Mixing credit limits, collateral management and third-party guarantees - as some institutions do - creates a complex and inconsistent mix that risks blurring the true picture of counterparty exposure. It also fails to incentivise trading decisions in the best interest of the organisation.

These statements are, however, not revolutionary; firms have recognised this and alternatives have been sought and found. Credit value adjustment (CVA) is the industry standard here.

The benefits of CVA are clear; CVA creates dynamic risk exposure monitoring that puts a dollar value on the cost of the risk incurred, or more accurately, the cost to hedge the risk. The risk offsetting hedge does not have to be purchased: an institution is free to carry the risk. What CVA does is allow for a decision to be made as to how much of that risk should be taken on - with eyes wide open.

Laser focused
We can say that decisions made using CVA are made with eyes wide open because CVA permits trade-by-trade risk management, making it as tightly focused as possible. CVA does this all in the context of the bigger picture by including aggregate exposure and marginal impacts to that exposure on a trade-by-trade basis.

CVA provides a true credit exposure position and real-time trading impacts. The nature of CVA allows for - in fact, highlights - the risk and enables an informed decision on what level, or dollar amount, of risk should be maintained and which risks should be hedged.

By highlighting the trade-by-trade impact and cost, CVA incentivises good decisions. The terms available for riskier trades make them harder to execute profitably. When they are executed an opportunity is created for trades that offset risk to be priced even more competitively.

Risk-taking behaviour thus subsidises risk-reducing behaviour. CVA consequently acts as a tool for monitoring, measuring and managing risk-taking decisions in the best interest of the company.

The cost
As the benefits of effectively using CVA are so great, they of course come at no small cost. Implementing and using CVA represents a significant cost for firms.

CVA is wrought with challenges, including:

• Data-heavy calculations
• Long processing times
• Costly implementation.

These costs can be paid continuously over the life of the CVA system in slow processing and heavy maintenance burdens or upfront in the development and implementation challenges faced when creating an industry-leading programme that manages key issues for both the current environment and the long-term direction of the firm. An effective CVA system will do this by appropriately managing the data burden with resources that match the volumes, while relying on real-time information - not end-of-day data - and by using calculation methods and engines that will result in the fastest calculations.

Real-time CVA is more than just a gold standard; it is the only way to capture its full benefits. A robust risk management capability, including the ability to determine which risks to hedge and which to carry, doesn't work if its function is a day behind the trades.

Neither will a CVA programme that covers most of the asset classes or instrument types. This CVA programme leaves gaping holes in the risk management programme.

CVA must cover all traded asset classes and instrument types across all desks, departments and divisions. Without this, the aggregate picture is inaccurate at the level of the individual counterparty and when aggregated across business lines.

CVA has several exceptional issues that add a level of complexity for any risk manager; however, for all involved, it is still an investment worth making.

Wrong-way risk: Wrong-way risk is incurred when the counterparty's financial strength weakens under the same market conditions that turn their positions against them. Taking the long side of an airline's short oil position would qualify as wrong-way risk because an increase in the cost of oil would hurt both their position and financial strength. Ideal CVA programmes will address right-way and wrong-way risk considerations.

Close-out netting: If close-out netting provisions are not considered, a CVA programme will default to the assumption that close-out netting is applicable to the full portfolio of any counterparty. This is a by-product of an analysis that considers the marginal, not the gross risk of each additional position. Of course, if there is an alternate structure - something other than full close-out netting across all of a counterparty's deals - the CVA programme needs to recognise this.

As CVA expands its application throughout the industry, questions will turn to how robust and how soon, rather than if and when. The value of CVA is clear: CVA can be used to improve risk management and measurement; it can incentivise good trading decisions by discouraging trades that negatively affect the risk profile; and it ensures accurate matching to counterparty marks.

The challenges of using CVA effectively are also quite clear cut. However, most important of these are the deficiencies that lead to a CVA analysis which is incomplete in its reach or too slow in its functioning. A near ideal CVA implementation is anything but.

ABS

New valuation perspectives

Duff & Phelps' alternative asset advisory practice head Warren Hirschhorn and US complex asset solutions group head Jim Finkel answer SCI's questions

Q: How and when did Duff & Phelps become involved in structured finance?
WH: Duff & Phelps established a group to handle valuations of complex securitisations in 2005. But we had been outsourcing some projects to Dynamic Credit Partners for a number of years, so the acquisition of Dynamic's US consulting business (see SCI 16 December) was strategic. Jim - who co-founded the business - is currently integrating it with our international platform, which includes groups in London, Washington, DC, and California that specialise in the valuation of complex securities.

JF: Dynamic joined Duff & Phelps because of our successful working relationship. We found we weren't being hired for large projects because our platform wasn't perceived to be deep or broad enough. Duff & Phelps has provided us with a brand and the capacity to handle large mandates - within a month of being acquired, we've been invited to pitches that I could only dream about before.

Q: Which market constituent is your main client base?
JF: The primary demand for Warren Hirschhorn                                    our services has been from hedge funds and financial institutions, which are concerned that they're not getting reliable mark-to-market valuations. We're also advising on portfolio optimisation and best practices, as well as providing regulatory capital assessments as Basel 3 comes online.

Q: What are your key areas of focus today?
JF: We're doing more than just straight valuations now. For instance, we have plenty of work in dispute resolution, arbitration and litigation, where lawyers need expert testimony and quantitative work. Many cases that were generated in 2007 and 2008 are now maturing, causing a more immediate need for experts.

We're also working on ratings migration and surveillance projects. Ratings exhibit cliff risk: they tend to be downgraded by six notches at a time. From a risk management perspective, we help investors holding 'cuspy' tranches to identify and prepare for subtle changes, which could mean that the tranche suddenly moves from current pay to zero pay.

Further, CMBS suffers from thin levels of subordination and larger collateral concentrations, so a default of one loan could wipe out an entire AJ or AM tranche. We test for the tipping point by looking at the collateral on a loan-level basis and running a number of discrete scenarios.

Another area of expertise is helping clients package up assets for risk transfer, in terms of sizing the optimal amount and then pricing the transaction. We'll collate hard-to-manage data and information about the portfolio to help the negotiation process.

One of the newest opportunities has been advising on structured repo transactions, which are becoming alternative financing arrangements to shadow banking. These deals involve a bank borrowing from, for example, a pension fund under a secured lending agreement - where the fund needs an independent valuation.

Q: How do you differentiate yourself from your competitors?
WH: Our global reach, deep technical knowledge and market-facing capabilities differentiate us from our competitors.

JF: We've learnt over the years that many valuations providers either have  Jim Finkel                                                  analytic strength or market experience - not both, like the combination of Dynamic and Duff & Phelps has. Many approaches are model-driven, while others don't have the technical and/or market data.

Dynamic's analytics platform was initially built to support our specialised investment activity. We amassed a huge amount of market data and built a strong team, converting the firm into an advisory business in mid-2007.

We've worked on large, high-profile projects - such as a US$39bn RMBS mandate for the Dutch government or a report on Lehman Repo 105 transactions for the independent examiner - which give clients a lot of confidence. There are few groups that have had such marquee mandates. These projects helped us build a talent pool with significant experience.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
WH: The market has changed dramatically in recent years: investors typically used to go to dealers for a price. While dealer marks remain a useful data point, the onus now is on investors to source independent, third-party valuations.

Some asset classes have come back post-crisis, but there is still some disjointedness in the market. In addition, the Dodd-Frank Act and other new regulations are driving increased transparency, which again necessitates third-party valuations.

JF: The demand for valuations services has changed since the height of the crisis: now it is more a case of the level of service given to the holders of risk. There are many cases where we become a trusted advisor for one part of a client's book and are subsequently asked to look at other parts.

Such demand has driven consolidation among valuations providers. Some large firms found they lacked certain specialised units and chose to acquire another team, rather than build their own. There is always competition for mandates and some clients are willing to pay more for differentiated skills or a certain suite of solutions.

But, as the market has moved, so have perceptions of risk. Models need to be modified as the paradigm changes.

For example, we retooled our RMBS approach to take into account US mortgage forbearance and modification programmes and the impact they would have on prepayments. We also tweaked our assumptions to reflect the deceptive characteristics that modifications create in pools: a modified loan gets presented as current, but most models don't pick up that it is a legacy problem credit and there is a high rate of it lapsing back into delinquency.

Q: What major development do you need/expect from the market in the future?
JF: There is more optimism in the industry now than there has been for a long time, but it still isn't matched by primary activity. Spreads are way off their post-crisis wides - they're not as tight as they were pre-crisis, but they're at a healthy level.

There is a lot of trading activity in secondary, but a lack of assets, meaning that technicals have outweighed fundamentals. Yet fundamental risks remain, especially as issues with legacy positions are finally beginning to bubble up or the refinancing wall in leveraged loans approaches.

A broader trend is the impact of consolidation in the banking and asset management industry. This has to be worked through before financial institutions begin operating fully again. Once the organisational side is rationalised, they can better shed risk, raise capital, extend credit and hopefully begin securitising again.

In particular, there is a need for refinancing options for non-conforming loans. At present, the GSEs are responsible for 80%-90% of mortgage refinancing, which is obviously unattractive for private-label securitisation.

CS

ABS

ABSNet revamped

Lewtan has updated its ABSNet website, with the aim of connecting investors in the structured finance industry to critical data, including end-of-day bond pricing from Thomson Reuters' pricing service. Additionally, the new site features a comprehensive search tool that will allow users to identify pricing and credit risk dislocations by comparing original versus current pool and bond performance data, bond ratings and prices. A customisable alert functionality also makes tracking trigger data for US RMBS transactions much easier.

ABS

Distressed credit md named

Nomura has appointed Sandor Hau as md and head of its high yield and distressed credit group for the Americas. Based in New York, he will report to Jeff Michaels and Charlie Spero, co-heads of fixed income for the Americas, and functionally to Georges Assi, head of global credit products. Sandor joins Nomura from Goldman Sachs, where he was md of its credit investing and capital arbitrage group.

"We continue to build our team and recently realigned our credit area by creating distinct high yield and high grade businesses in the Americas," note Michaels and Spero.

ABS

Orrick duo jump ship

Chapman and Cutler has appointed James Croke and Peter Manbeck - formerly of Orrick, Herrington & Sutcliffe - as partners in the New York office's asset securitisation group. The pair will focus on assisting clients to develop new ways to access and invest in structured finance transactions.

Before Orrick, the two lawyers worked at Cadwalader, Wickersham & Taft, where Croke headed the London capital markets department and was instrumental in the legal development of the European ABCP market.

Chapman and Cutler has extensive experience handling structured transactions involving financial assets, and asset-backed financings with unusual or unique revenue streams is a strength of its securitisation practice.

ABS

Boutique adds senior advisor

The Williams Capital Group has appointed Joseph Fichera as a senior advisor. He will advise the firm on various securities and capital markets-related initiatives involving its corporate and municipal client service efforts.

In 2000 Fichera founded Saber Partners, a financial advisory firm for corporate and public sector entities that specialises in auction rate securities and securitised debt. He will continue as Saber's ceo and senior md.

ABS

Dublin tax group formed

Walkers has made two appointments in its newly created tax group in Dublin. From March 2011, Anthony Smyth will assume the role of senior partner and head of the group. He was previously a partner for a Dublin law firm, leading its financial services and inward investment tax practices.

Petrina Smyth also joins Walkers' tax group as partner. She previously worked for a corporate law firm as the head of its tax practice in Dublin.

Walker's dedicated Irish tax practice has extensive experience advising a broad range of international clients on banking, structured finance, securitisation, asset finance, insurance, inward investment and investment fund matters. The team will provide integrated tax structuring solutions for the most complex transactions, in conjunction with the lawyers across the firm's other departments.

"The 12.5% corporation tax rate, allied with a continuing restoration in the competitiveness of Ireland, has seen a renewed market focus on investment both within the financial services and foreign direct investment sectors. During this time, we have also seen a strong desire from our clients for front-end tax structuring services in partnering clients to take advantage of arising opportunities, whether domestically or internationally," says Petrina Smyth.

ABS

Institutional coverage team expanded

BNP Paribas has named Tim Bitsberger md of its official institutions coverage team for the Americas. Based in New York, he will focus on the global needs of central banks, sovereign wealth funds, government agencies, GSEs and supranationals. He will report to Véronique Ormezzano, head of the firm's official institutions coverage in Paris, and to Joe Malley, head of the North American financial institutions group.

Bitsberger joins BNP Paribas from Freddie Mac, where he served as treasurer. Prior to this, he worked at the US Treasury from 2001 to 2005, first as deputy assistant secretary and then as the assistant secretary for financial markets.

Mike Albanese also joins the bank as an md in its financial institutions group, covering insurers and reinsurers. He will report to Malley and moves from Swiss Re, where he was head of business development for the Americas. He has 25 years of experience in the market as an advisor to insurers on corporate finance, capital management and structured finance matters.

Advisory

Hiring spree begins for advisory group

The Broadsmoore Group has appointed Brian Anderson as ceo in its effort to re-engineer the investment model with an in-depth due diligence process and risk analysis objective.

Anderson has over 29 years of experience working in fixed income sales and trading, mortgage finance and operational expertise. He was previously coo at Vanquish Capital Group and prior to this was at Washington Mutual's capital markets group as a director specialising in structured credit transactions.

The firm intends to add more executives in due course. Abraxas Discala, Broadsmoore ceo, says: "Over the last year, the Broadsmoore Group has built a vision of how it will create a more secure and efficient Wall Street and restore investor confidence. We are strategically selecting a team of seasoned executives with a vast array of expertise."

CDS

Credit fund investment confirmed

Asset Management Finance (AMF) has made a passive minority investment in Brigade Capital Management, a New York-based manager of credit strategies. The transaction is AMF's 21st investment and seventh since December 2009. Including its stake in Brigade, AMF has committed over US$750m of capital to asset managers that collectively manage over US$70bn of assets.

Brigade is an investment advisor focused on the long/short credit, distressed debt and traditional high yield sectors. Founded in 2007 by Don Morgan, managing partner, and Pat Kelly, president and coo, Brigade now has 51 employees managing US$7.9bn of assets across four credit strategies.

CDS

TriOptima undergoes management shuffle

TriOptima has restructured its European and Asia Pacific departments, allowing Mireille Dyrberg to assume the newly-created position of head of business strategy at the firm. She was previously ceo of TriOptima's EMEA department.

Former Asia Pacific ceo Peter Weibel will take over the role of EMEA ceo. He will be replaced by Yutaka Imanishi, who was previously director of TriOptima Japan.

CLOs

Transferred CLO renamed

Intermediate Capital Managers has renamed Resource Europe CLO I as St Paul's CLO I, as of 13 January 2011. This follows the assignment and delegation by the original investment manager (Resource Europe) of all of its rights and responsibilities under the management agreement to ICM (SCI passim).

CLOs

Permacap acquisition completed

Greenwich Loan Income Fund (GLIF) has completed the acquisition of Asset Management Investment Co (see SCI 26 October). In addition, it has confirmed the admission of the enlarged group to the official list of the CISX. 11,333,610 new GLIF shares were admitted to trading on AIM at the same time.

CMBS

Multifamily servicing acquisition agreed

Jones Lang LaSalle (JLL) has entered into a definitive agreement to acquire certain assets of the Atlanta-based commercial real estate lending and servicing group of Primary Capital Advisors, including its Orlando office. This acquisition adds multifamily mortgage lending and servicing capabilities to JLL's business offerings.

The take-over will allow JLL to operate as a Freddie Mac Programme Plus seller/servicer and will include a US$2bn loan servicing platform that the firm plans to expand across the US. The transaction is expected to close in the first quarter.

Primary Capital co-founder Faron Thompson will lead JLL's multifamily lending business and assume an executive leadership role in its real estate investment banking (REIB) team. He will be joined by Primary Capital md John Bray and they will partner with Americas capital markets president Jay Koster and the REIB leadership team of Tom Melody, Mike Melody and Tom Fish, along with Jubeen Vaghefi, md of the firm's national multifamily investment sales team, to help drive the expansion of the firm's overall Americas capital markets business.

Primary Capital Advisors' founder, president and ceo William Pendleton will serve as senior advisor to JLL, focusing on expanding client and lender relations.

Distressed assets

Portfolio solutions group poached

KPMG has appointed Graham Martin and Stuart King to head up its new portfolio solutions group service offering, within its transactions and restructuring practice. The pair will lead a broader team of eight, comprising four directors, three senior managers and one manager. The team joins from PwC.

Simon Collins, global head of transactions and restructuring at KPMG, comments: "One of the consequences of the credit crisis has been the reshaping of the financial industry's balance sheet; ranging from active management of portfolios to restructuring and divestments. To this end, we have ramped up our existing portfolio advisory capabilities, within the financial services team, by appointing two heavy-hitting industry players."

The portfolio solutions group offers loan and asset portfolio advisory services, covering all asset classes ranging from distressed to non-core. The team is based in the UK, Spain, Germany, Thailand and the US.

RMBS

RMBS litigation pro recruited

Sadis & Goldberg has appointed Sam Lieberman as of counsel in its litigation group. He has extensive experience handling all stages of high-profile securities class actions, complex commercial litigation and government investigations.

Prior to joining Sadis & Goldberg, Lieberman was senior counsel at Bernstein Litowitz Berger & Grossman, litigating securities actions on behalf of plaintiffs and defendants, including matters involving subprime RMBS.

ABS

Positive credit card charge-off trend continues

Moody's reports that charge-offs on US credit cards have fallen for a fourth consecutive month in December to 8.03%, down from 8.58% in November. With early stage delinquencies also declining, the agency expects the charge-off rate to continue to decline steadily in coming months - ultimately breaking below 7% by the middle of 2011.

"The positive trends that drove the marked improvement in charge-off rates during the second half of 2010 remain firmly in place at the beginning of 2011. The current low level of delinquencies, the improved credit profile of trust collateral pools resulting from weaker borrowers charging-off and the expectation for receivable balances to begin to climb as the year progresses will collectively place continued downward pressure on the charge-off rate well into 2011," says Jeffrey Hibbs, Moody's avp.

The charge-off rate index is now more than 22% below its year-ago level of 10.32%. Each of the six largest trusts posted monthly improvement, as the steady decline in delinquency rates from the summer continued to translate into lower losses.

During December, the delinquency rate index fell for the 14th consecutive month to 4.17%, reaching its lowest level in over three years. Further, the early-stage delinquency rate index fell to 1.05%, an all-time low.

December also saw the yield index ticking higher to 21.75%, a single point increase from the 21.74% of November. Yield has in fact declined during the fourth quarter overall as principal discounts expire, a trend Moody's expects to continue.

The higher yields and lower charge-offs during December pushed up the excess spread index to 10.82% - breaking the previous all-time high for excess spread set three months earlier.

ABS

EM criteria updated

Fitch has updated its criteria for analysing legal uncertainty in emerging market securitisations. In a new criteria report, it lays out the methodology it applies to cap securitisation ratings in 38 emerging markets worldwide.

The ratings capping criteria refer primarily to legal aspects in securitisations, but also provide a more general framework to capture some weaknesses evident in emerging market transactions. The report includes a list of country challenge factors (CF), which the agency applies to determine the likelihood that securitisation transactions may be challenged in the local courts of an emerging market jurisdiction.

The CF are indicators of the relative strength of a country's overall legal framework for securitisation and, in combination with Fitch's country ceilings, provide clear analytical limits to emerging market structured finance ratings on a country-by-country basis.

ABS

Ratings reinstated after system error

S&P has reinstated its triple-A and triple-B credit ratings on Trafigura Securitisation Finance's variable-rate CP-funded senior and junior notes. The agency withdrew these ratings on 31 December, due to an IT system error that has since been corrected.

Trafigura Securitisation Finance securitises trade receivables arising from Trafigura's energy and commodity trading business. The legal final maturity date for both notes is 15 December 2012.

ABS

Analytics platform enhanced

A series of enhancements have been made to ABSXchange - S&P's structured finance analytics platform - as part of an extensive programme to help investors deepen their analysis of structured finance transactions. The latest round of upgrades include automatically-calculated data fields where values are not otherwise supplied by deal servicers; a new screening capability that allows specific assumptions to be applied across chosen elements of a portfolio; and an upgraded user interface that enables investors to reorganise their portfolios more easily.

"In addition to these new functionality enhancements, we have been working with arrangers to add further deals to the pre-issuance modelling function, as well as additional counterparty data to the recently-implemented counterparty default analysis capabilities," says Derek Caussin, associate director, S&P Valuation & Risk Strategies.

Working with a number of deal arrangers, ABSXchange has modelled several pre-issuance deals already this year, giving investors the chance to perform their own cashflow analysis before they launch.

ABS

Stable outlook for Indian SF

The performance of Fitch-rated Indian ABS and RMBS transactions are expected to remain stable in 2011. The outlook is attributable to the Indian government's focus on the infrastructure and agriculture sectors, as well as credit enhancement build-up and excess interest spread.

"While marginal deterioration has been observed in commercial vehicle (CV) loan ABS, particularly transactions originated after 1H09, such transactions benefit from excess interest spread, due to which the credit enhancement available in such transactions has remained largely unused,'' says Deep Mukherjee, Fitch's Indian structured finance director.

ABS transactions backed by construction equipment loans and tractor loans continue to benefit from the government's spending in sectors such as infrastructure and agriculture respectively. These asset classes exhibited strong performance in 2010, with a significant level of amortisation leading to credit enhancement being 1.5 to 4 times that at transaction closing.

Additionally, Indian RMBS transactions are expected to perform well in 2011, given the high borrower equity and low instalment to income ratio. Fitch is monitoring two factors with caution, however.

First, the impact of rising interest rates on the payment ability of borrowers, particularly those who were availed of teaser rate loans. Second, real estate property prices in cities such as Mumbai, Pune and Chennai have surged significantly in the recent past, and have a higher likelihood of correction which could place recent originations in a negative LTV zone.

All Indian SF transactions were either affirmed or upgraded in 2010. The upgrades were related to second loss credit facilities of seasoned CV ABS transactions originated by Shriram Transport Finance, Fitch concludes.

ABS

SLABS back-up servicers recommended

Some US student loan ABS servicers may go the way of the now-defunct US FFELP programme, which in turn leaves some SLABS transactions susceptible to rating downgrades, according to Fitch.

With the Health Care and Education Reconciliation Act of 2010 (HCERA) effectively ending new FFELP originations, many not-for-profit and state-owned servicers are now left with a portfolio that will run-off over time and produce operational inefficiencies, Fitch director Cynthia Ullrich notes. This would weaken the financial conditions and affect the ratings on the student loan ABS they service.

The presence of a back-up servicer can act as an effective mitigant against downgrades and is becoming more widely used. However, the mere presence of a back-up servicer is not a solution itself, according to the agency.

"It needs to be determined whether the back-up servicer contract obligates the provider for the length of the student loan ABS transaction, what triggers a transfer to the back-up and who tracks the trigger targets and initiates a transfer upon a trigger breach," Ullrich concludes.

CDS

Succession event deliberated

ISDA's Americas Determinations Committee is deliberating over whether a succession event occurred with respect to Mariner Energy. On 10 November the firm merged with Apache Corporation and the separate existence of Mariner ceased.

CDS

ISDA comments on derivatives reporting

ISDA says it welcomes the efforts of the IASB and FASB to seek convergence on their current US GAAP and IFRS models regarding offsetting of assets and liabilities in the balance sheet (see SCI 31 January). However, the association notes that the Boards' proposal to report derivatives on a gross basis rather than on a net basis is counterintuitive and may lead to complexity in practice obscuring the real position of the entity. It is likely to be misleading when presenting the leverage, credit risk and liquidity risk position of an institution.

ISDA believes that reporting derivatives positions on a net basis where netting is enforceable gives the best information for users of financial statements. Net presentation is consistent both with the way derivatives are managed by the entity and with the regulatory treatment of them, thus providing the most relevant and risk sensitive information.

CDS

Anglo Irish auction scheduled

The auction to settle the senior and subordinated 2.5-year maturity credit derivative trades for Anglo Irish Bank will be held on 2 February. This follows ISDA's EMEA Determinations Committee's resolution on 23 December that a restructuring credit event occurred.

CDS

OTC players pledge progress

International supervisory authorities and market participants met at the New York Fed yesterday (27 January) to discuss how to further reduce risks in OTC derivatives markets. Market participants updated supervisors on recent work and pledged to continue working towards G20 objectives for risk reduction.

Participants pledged to communicate next steps and commitments in a collective letter to the OTC Derivatives Supervisors Group (ODSG) by 31 March, in accordance with FSB recommendations from last October. Commitments will continue to focus on increasing standardisation and transparency, while further development of central clearing facilities is also a priority.

"We must continue to advocate for solutions that will extend central clearing benefits to a broader set of participants in a safe and sound manner," says William Dudley, Fed president and ceo.

He adds: "As market participants begin operating in a more regulated environment, supervisors of major market participants must continue to work cooperatively and proactively to drive structural improvements, monitor emerging risks and support consistent supervisory approaches across jurisdictions. The ODSG will continue to play a key role in meeting these objectives."

CDS

Uncertainty driving EMU sovereign, FI spreads

Despite spreads on EMU sovereigns reaching parity with non-EMU EM sovereigns, the movements over the last year in CDS spreads for both EMU sovereigns and financial institutions is not driven by fears over the viability of the euro area, according to Fitch Solutions. Instead, the agency says that current lofty spread levels reflect the market's extreme uncertainty over future debt market conditions and support.

This is reflective through the CDS market dynamic breaking from historic norms, with non-financial EMU corporate names undergoing milder CDS spread and liquidity changes versus those seen for EMU sovereigns and financial institutions. This has resulted in a market anomaly where CDS spreads for sovereigns and financials are far exceeding average ranges for their respective corporate sectors, Fitch notes.

"The relative stability of EMU corporate spreads and liquidity suggests that, at the macro level, the CDS market continues to have faith in EMU countries. If this were not the case, corporate spreads and liquidity would be impacted to a much larger extent," says Fitch md Jonathan Di Giambattista.

"The CDS market sees the prospects of EMU sovereigns and banks as heavily intertwined but that the volatility in their spreads, when viewed in the broader context of price and liquidity movements in the corporate sector, is purely a function of uncertainty on future challenges, support and market conditions. This uncertainty is likely to persist until the European Monetary Union solidifies its position on financial bail-outs and regulatory reform for its weaker members," adds Fitch director Diana Allmendinger.

CLOs

Euro CLO performance stabilising

Fitch reports that the performance of European CLOs continues to stabilise. The triple-C exposure of the CLO portfolios has remained stable at 7.4% since October.

All senior overcollateralisation (OC) tests are being passed with an average level of 135%, according to the agency. 11 transactions have equity and subordinated management fees shut-off, compared with 13 transactions in October.

However, the average OC cushion for CLO tranches originally rated double-B remains close to 0%, highlighting that junior and mezzanine CLO tranches remain vulnerable to further portfolio deterioration and that there is still uncertainty about the refinancing of European leveraged loans.

CLOs

CLO rating process enhanced

Fitch has enhanced its rating process for US CLOs by working more closely with its leveraged finance team to render credit opinions and recovery ratings on portfolio assets that are shadow rated. By increasing its coverage on the portfolio, the agency's CLO analysis will be less reliant on external ratings.

"Augmenting our structural analysis with corporate credit opinions, which we aim to make available to CLO investors, will help to ensure greater transparency for new CLOs," says Fitch director Elizabeth Nugent.

The agency's rating methodology incorporates peak default rates observed over 30 years of global default statistics, as well as recovery rate assumptions that reflect exceptionally low recoveries observed in the leveraged loan markets in 2009.

CMBS

Q4 APAC downgrades driven by Japanese CMBS

Fitch reports that a total of 35 Asia-Pacific structured finance tranches were downgraded during Q410. At the same time, 15 were upgraded and over 250 tranches were affirmed.

"The most significant rating actions in Q410 were once again the downgrades of Japanese CMBS classes as property values continued their downward path and losses were crystallised in one transaction. A number of tranches were upgraded during the quarter due to deleveraging and strong asset performance," says Alison Ho, head of performance analytics in Fitch's Asia-Pacific structured finance team.

The quarter saw 26 Japanese CMBS classes downgraded. Over half of these were on junior classes, which are now non-investment grade ratings, and one class that was previously rated triple-A is now rated single-A. One rating from a Japanese CMBS transaction was downgraded to single-D from single-C during the quarter, as losses were crystallised. Five senior classes of Japanese CMBS were also upgraded as cashflows are now applied on a sequential basis, following the default of all the underlying loans.

Upgrades during the quarter were spread between regions and asset classes, including CDOs, while de-leveraging has led to a build-up of credit enhancement in transactions backed by non-Japanese assets. Fitch says that the performance of most Asia-Pacific SF transactions remains in line with its expectations, as evidenced by the fact that the vast majority of rating actions in the quarter were once again affirmations.

Meanwhile, 21 Japanese CMBS tranches were placed on rating watch negative during December 2010, with a further nine being placed on RWN in January 2011. All three tranches from Cathay Dun Nan were also placed on RWN during 4Q10, following the departure of the key tenant.

Indeed, throughout 2010, over 60% of the downgrades were Japanese CMBS, while a large proportion of the total upgrades were accounted for by Australian RMBS. Fitch affirmed a total of nearly 1,000 publicly or privately rated tranches, downgraded 109 and upgraded 70, giving an overall upgrade-to-downgrade ratio of 0.64. This compares with 0.15 for public and private ratings in 2009, the agency confirms.

CMBS

Concerns outlined over special servicer replacements

The current trend of controlling class noteholders (CCN) replacing special servicers in European CMBS transactions is creating additional operational risk in the sector, according to Fitch. Should newly-appointed special servicers lack demonstrable expertise and experience in the functions associated with the office, the transfer may lead to negative rating action for affected CMBS, the agency warns. The likelihood of negative rating action - whether immediate or at some point in the future - will be greater for larger distressed loans and for CMBS with higher ratings.

Most transactions permit the operating advisor (acting as the CCN's agent) to request that the incumbent is replaced. In view of the sensitivity surrounding new appointments, these requests generally require trustee and/or issuer approval.

Rating confirmations have been occasionally misconstrued by some market participants as the agency's 'approval' of a specific event or a tacit acknowledgement of a specific party's ability to carry out its designated responsibilities effectively. However, Fitch says it prefers to incorporate the credit impact of decisions taken by approving agents in its rating opinions and transaction commentary thereafter. Where rating action is attributable to a transfer, it may follow very promptly or after some delay.

The agency has developed servicer rating criteria that outline the approach the agency adopts in assessing the quality of servicers. These criteria can provide investors, operating advisors, servicers, issuers and trustees with insight into the potential effects of a proposed transfer ahead of time.

In the absence of a Fitch CMBS special servicer rating covering the jurisdiction of the collateral, attributes of a special servicer that it judges favourably include: at least one year of relevant practical experience managing specially-serviced European CMBS loans; sufficient in-house knowledge and resources to manage the transferring loan, including special servicing staff with appropriate language skills and practical knowledge of the local commercial real estate market; and a drafted and credible business plan discussing the special servicer's strategy for working out the CMBS asset.

While judging the capability of a special servicer is a matter of opinion and is especially challenging for entities lacking much involvement in public transactions, Fitch believes that some form of benchmarking is useful. In addition, the agency says it will take into account its view of the motivation for the transfer. Where replacement cannot be obviously attributed to underperformance or inaction on the part of the original special servicer, it may signal a motivation to bias servicing towards the interests of the CCN at the expense of senior classes of notes in particular.

In conclusion, Fitch says that it will treat each replacement on a case-by-case basis by broadly applying the standards outlined when reviewing the capabilities and experience of the successor special servicer.

CMBS

Deco 8 CMBS special servicer replaced

Moody's has commented on the replacement of Hatfield Philips International as the special servicer for the Rowan UK Commercial Property, MPH (UK) and Braeside loans in the Deco 8 - UK Conduit 2 CMBS transaction.

Based on its assessment of the capability of Solutus Advisors to perform the role as a special servicer and the relatively small size of the loans, the agency confirms that the replacement will not result in a reduction or withdrawal of the current ratings of the notes. However, Moody's believes that the strategy and timing regarding the future workout process for loans being subject to an event of default - impacting the potential recovery proceeds - is of significant importance in relation to the credit risk posed to investors.

UK Conduit 2 closed in April 2006 and represents the securitisation of initially 22 mortgage loans originated by Deutsche Bank. It is secured by first-ranking legal mortgages over initially 75 commercial properties located across the UK. Since closing, seven loans have prepaid in full, reducing the pool balance to £567.6m from £630.1m.

The Rowan UK Commercial Property, MPH (UK) and Braeside loans represent 2.7%, 0.7% and 0.3% of the current outstanding pool respectively. In October 2010, the Rowan UK Commercial Property loan was transferred into special servicing due to an ICR covenant breach and failure to repay at loan maturity in October 2010.

The MPH (UK) loan is currently on the servicer's watchlist due to the breach of LTV and DSCR covenants. The servicer is in discussions with the borrower to restructure the loan.

Following its loan maturity in January 2011, it is likely that the Braeside loan will be transferred into special servicing at the next reporting date. Based on the transaction documentation, the operating advisor is entitled to replace the party acting as the special servicer for such a loan.

CMBS

Maturity delinquencies weigh on Euro CMBS

S&P says that the European CMBS downgrades of late last year have set the tone for 2011. Factors that caused the credit watch negative placements in December include special servicing fees and declining cashflow, and in turn value declines and country risk in the case of loans backed by assets in the Hellenic Republic and Portugal.

"Despite signs of recovery reported in the mainstream property media, December's downward rating actions give a clear picture in microcosm of European CMBS performance in 2010 and could point to what can likely be expected in 2011," says S&P analyst Judith O'Driscoll.

By the end of last year, the delinquency count had risen to 59 loans from 38 at the beginning of the year. Maturity delinquencies contributed significantly to this group, with 51 of the 80 loans scheduled to mature failing to repay. The number and volume of euro loans that became delinquent outstripped sterling loans for the first time, S&P reports.

Further, the number of loans in special servicing had risen to 77 from 58 at the beginning of the year, causing note interest shortfalls to accumulate in many cases where the costs of special servicing were not covered by excess spread or liquidity. By the end of 2010, interest shortfalls caused the agency to lower its ratings to single-D on 27 tranches across 14 transactions.

Looking ahead to 2011, the number of maturing loans steps up to 141 - including 60 loans secured by office properties that may have declined in value since original valuation. "In view of economic constraints across Europe and property fundamentals, we anticipate that borrowers will continue to have difficulty in refinancing maturity payments. Of the 29 loans scheduled to mature in January, five are already reported to have been extended into 2011 or 2012," says S&P analyst Robert Leach.

"If this trend of loan extensions continues, we believe that some maturity delinquencies may be avoided for now, but refinance needs will merely be compounded in later years," he concludes.

CMBS

Plantation Place sale to progress

The owners of Plantation Place, the property in the REC 5 CMBS portfolio, have confirmed that they will pursue a strategy to sell the property. This is despite the same single class B noteholder blocking their proposal to break the deadlock on the transaction (SCI passim).

At a vote held yesterday (31 January), the owners' proposal - which seeks a waiver of the LTV event of default in return for a sale of the property or the equity interest in the property - was blocked by the class B noteholder for a second time. The investor's position represents 2.41% of the total notes outstanding, but 26.25% of the class Bs.

The outcome was despite the remaining 73.75% of the class B noteholders voting in favour of the proposal, having been previously approved by all other classes of notes on 23 December.

CMBS

Fannie Mae multifamily offerings expanded

Fannie Mae has introduced Fannie Mae Guaranteed Multifamily Structures (GeMS), an expanded multifamily MBS execution that will include DUS Megas, DUS REMICs and syndicated DUS Megas. This expansion builds on the agency's DUS REMIC issuances, providing additional GeMS products with similar features and liquidity. Other new structures are expected to join the roster of multifamily structured product offerings in 2011.

Syndicated DUS Megas and DUS REMIC structures are customised to meet investor demand, creating opportunities for participation in larger, regularly-issued deals while enjoying the benefits of block size and collateral diversity. Fannie Mae GeMS execution is designed to be more nimble than conduit-style deals and provide the flexibility to quickly address reverse inquiries.

Syndicated Mega deals will be managed by broker-dealers and offered in issuance sizes similar to DUS REMIC transactions. DUS REMICs issued in 2009 and 2010 have been managed by dealers from the following syndicate group: Amherst Securities, Bank of America Merrill Lynch, Citi, Credit Suisse, Deutsche Bank, Jefferies and JPMorgan.

CMBS

Euro CMBS loan repayment falls

European CMBS loan repayments decreased in January due to the large proportion of maturing loans that were not redeemed, according to Fitch. The agency's CMBS Maturity Repayment Index decreased to 36.1% from 38.8% during January, excluding loans that were repurchased by their originators. Including repurchases, the index decreased to 42% from 45.3%.

The 23 loans that matured in January increased the matured loan balance by 22.1%, to €9.31bn from €7.62bn. As only five of these are reported to have been redeemed, the outstanding matured balance increased by an even higher 27.6%, to €5.95bn from €4.66bn. Overall, 50 of the 121 loans that have matured since 2007 have been fully repaid - excluding repurchases.

The largest principal distributions relate to the Prime loan (securitised in Talisman-1 Finance), the Epic loan (Taurus CMBS (Pan-Europe) 2006-3) and the Columbus Court loan (Perseus (European Loan Conduit No. 22)). A final Sfr53.3m redemption occurred on the Sfr162.9m matured balance of the Epic loan, following piecemeal asset sales since the original maturity date in January 2010 and in time for the extended maturity date of January 2011. The £69.6m Columbus Court loan matured in October 2010 and was fully redeemed after a three-month standstill.

The collateral for the €130.6m Prime loan was sold nearly a year after the original maturity date in January 2010. Despite the sale price being well in excess of the whole loan balance, a loss was allocated at loan-level and at bond-level. This is the result of liquidation fees and other senior expenses relating to the sale of the properties being borne by the borrower in line with the Prime loan agreement.

Senior expenses have been allocated on a pro rata basis between the securitised A-note and the B-note. This has resulted in principal receipts being allocated to the B-note, despite the loss on the A-note. Both tranches realised a loss of 1.3% of their respective balances at the start of the calculation period.

CMBS

NAIC revisions have mixed impact on CMBS

NAIC's revised risk-based capital requirements for CMBS for US life insurers' year-end 2010 statutory financial statements will improve the capital reserve measures of some companies, but will likely lead to higher capital requirements for others, according to Moody's. The agency is confident that these changes to risk-based capital (RBC) levels will have no impact on ratings, however.

"In our analysis of a company's investment portfolio, we look through RBC ratios to focus on expected and stress losses and take past impairments into account. Therefore, notwithstanding the potential impact on regulatory capitals ratios, there should be no rating impact," says Moody's svp Scott Robinson.

Those insurers who own super-senior CMBS securities and have vigorously taken impairments may see a reduction in capital requirements, Moody's says. In turn, those who own mezzanine securities with less subordination and have not taken impairments on more vulnerable securities may see their risk-based capital ratios adversely affected.

For certain companies, the implementation of the new approach could reduce RBC ratios by 10 to 30 points, while others may see a modest boost in their RBC ratios. The agency expects life insurers to report strong RBC ratios when they file their 2010 year-end regulatory statements later this quarter.

The mixed impact of the new methodology as applied to CMBS stands in contrast to the material regulatory capital benefit that insurers recognised with the revised methodology for RMBS at year-end 2009, mainly because the life industry has recognised significantly less impairments on CMBS than on RMBS.

CMBS

Deco 11 special servicer replaced

Moody's has commented on the replacement by Solutus Advisors of Hatfield Philips International as the special servicer on the Wildmoor Northpoint and CPI Retail loans in the Deco 11 - UK Conduit 3 CMBS transaction.

Based on its assessment of the capability of Solutus Advisors to perform the role of special servicer and the relatively small size of the loans, the agency confirms that the replacement will not result in a reduction or withdrawal of the current ratings of the notes. However, Moody's believes that the strategy and timing regarding the future work-out process for loans being subject to an event of default is of significant importance in relation to the credit risk posed to investors.

UK Conduit 3 closed in December 2006 and represents the securitisation of initially 17 mortgage loans originated by Deutsche Bank. It is secured by first-ranking legal mortgages over initially 56 commercial properties located across the UK. Since closing, four of the loans have prepaid in full, reducing the pool balance to £403.8m from £444.4m.

The Wildmoor Northpoint Loan and CPI Retail loan represent 10% and 2% of the current outstanding pool respectively. In March 2010, the Wildmoor Northpoint loan was transferred to special servicing as a result of an LTV covenant breach.

Following its loan maturity in July 2010, the loan remained unhedged, resulting in a current ICR of 2.1x on a whole loan basis. On 18 January, joint administrators were appointed in respect of the Wildmoor Northpoint borrower.

Monolines

RFC issued on bond insurance criteria

S&P has requested comments on its proposed changes to its bond insurance criteria. The agency plans to introduce a business risk profile/financial risk profile ratings framework and sub-factors under the new criteria, which will govern the ratings process for bond insurers. The criteria will also be expanded to incorporate an industry risk component, a discussion of enterprise risk management for bond insurers and a section on rating start-up bond insurers.

In addition, the criteria elements of management and corporate strategy, industry risk, competitive position, operating performance, investments, capital adequacy, liquidity and financial flexibility will be updated to include metrics for evaluating the sub-factors within each of these categories.

The proposed criteria include processes that address any identified risk or set of risks that in aggregate in stress scenarios could significantly impair a company's financial profile. These risks would lead to lower ratings, according to S&P. Examples of such vulnerabilities include significant calls on liquidity because of liquidity triggers, significant risk concentrations, entering businesses with the potential for large losses and risky investment strategies.

The business risk profile would include the analytical categories of management and corporate strategy, industry risk and competitive position. The business risk profile is defined by the risk/return potential for markets in which the company participates, the competitive climate within those markets and the competitive advantages and disadvantages the company offers within those markets.

The financial risk profile would include the analytical categories of capital adequacy, operating performance, investments and financial flexibility. The financial risk profile is the outgrowth of decisions that management makes in the context of its business risk profile and its risk tolerances, including decisions about the extent and manner in which the company is funded, how its balance sheet is constructed and the amount and kind of liquidity it maintains relative to its risks.

S&P says it could lower its ratings on existing investment grade bond insurers by one or more rating categories if the proposed criteria are adopted, unless those insurers raise additional capital or reduce risk. In particular, the amount of capital needed to achieve high investment grade ratings will increase significantly under the proposed criteria because of: higher capital charges used in scoring capital adequacy; and a new leverage test.

Regulation

Common offsetting practices proposed

A common approach to offsetting balance sheet financial assets and liabilities has been proposed by FASB and IASB. An exposure draft is open for public comment until 28 April.

Currently, whether assets and liabilities are presented in a statement of financial position as a single net amount or two gross amounts differs according to whether the reporting entity uses IFRS or US GAAP. The accounting differences result in the single largest difference in reported numbers on balance sheets prepared in accordance with IFRS or GAAP.

This makes it hard to compare financial statements and is particularly pronounced when it comes to derivative assets and liabilities, according to the two accounting boards. They note that finding a common solution is consistent with requests from the G20 and the Financial Stability Board (FSB).

David Tweedie, chairman of the IASB, says: "The fact that companies can, in some instances, report IFRS balance sheet figures that are double the size of their US GAAP numbers is not acceptable in global capital markets. Investors, and the FSB, G20 and others, have all called upon the IASB and the FASB to resolve this problem. The proposals would eliminate the differences in offsetting requirements."

The FASB and IASB propose that offsetting should apply when the right of set-off is enforceable at all times and the ability to exercise that right is unconditional. Amounts due must be intended to be settled with a single payment or at the same time. The proposals would amend IFRS and GAAP and remove many industry-specific netting practices.

Leslie Seidman, chairman of the FASB, comments: "This proposal would eliminate a major difference in reporting relating to financial instruments under US GAAP and IFRS. Investors expressed a desire for information about both the gross amounts of financial assets and liabilities and the net amounts, if credit risk has been mitigated. This proposal would change US GAAP to require netting in a narrower set of circumstances, but the effect of other forms of credit mitigation would be disclosed in the footnotes."

RMBS

Arrears overhang weighs on UK non-conforming

Record low interest rates have seen the cure rate for UK non-conforming borrowers in milder arrears rise as they get their mortgage payments back on track. However, there is a large core of borrowers who remain in severe arrears, despite lower scheduled payments. This suggests that some borrowers' mortgage payments may be at the limit of what they can afford and that any further stress due to rising unemployment or higher mortgage rates could lead to a substantial up-leg in repossessions, according to S&P.

The agency has published a new study of roll rates that reveals a divergence in behaviour between UK non-conforming mortgage borrowers in mild arrears and those in severe arrears. It suggests that the proportion of borrowers either falling behind or catching up on their mortgage payments tends to change with the economic climate.

S&P used loan-level data to track roll rates over the past four years for a sample of about 80,000 loans backing UK non-conforming RMBS. After deteriorating sharply during the recession, both the rate of new arrears and the cure rate are now once again comparable to their pre-downturn levels.

The study indicates that in the year to September 2010, the rate of new arrears dropped by more than 60% and the cure rate rose by about the same amount. Mild arrears cases in particular have shown improving performance, with over half curing in the 12 months to September 2010.

By contrast, however, nearly 60% of the loan balances that were in severe arrears in September 2009 remained in severe arrears 12 months later. As a result, the stock of severe arrears cases has steadily increased and, as of 3Q10, represented almost 20% of the mortgage balances of the UK non-conforming transactions that S&P rates - twice the reported level of two years prior.

This severe arrears overhang is, in the agency's view, a troubling sign and suggests that further economic stress could lead to a considerable increase in repossessions in the medium term.

RMBS

Two-thirds of NCUA legacy assets securitised

The latest National Credit Union Administration resecuritisation closed yesterday, bringing the total number of NCUA Guaranteed Note offerings to six with approximately US$19.3bn outstanding. The agency has now securitised 65% of the legacy assets originally targeted for securitisation in order to fund deposits assumed by the bridge corporate credit unions.

The US$1.5bn senior NCUA Guaranteed Notes Trust 2011-R1 notes priced at 45bp over Libor, with strong investor interest, according to the agency. Collateral for the transaction consisted of previously issued RMBS.

The remaining NGN offerings are scheduled to be completed over the next few months. Barclays Capital serves as the sole structuring agent and bookrunner on the transactions.

RMBS

PPIF IRRs decline

The US Treasury reported in its latest quarterly update that PPIP managers drew down an additional US$2.1bn, compared to US$3.3bn in Q3, bringing total draws to US$20.4bn. This represents 69.3% of the US$29.4bn in total purchasing power available to PPIFs.

Of the managers, only RLJ/WAMCO has fully invested all its funds. Oaktree, in comparison, has only deployed US$375m of its US$4.6bn in potential purchasing power. Excluding Oaktree, the remaining PPIP managers are approximately 80% invested, according to ABS analysts at Bank of America Merrill Lynch.

Of the total amount drawn, 81% is invested in non-agency RMBS, of which alt-A securities account for 46% of total market value of the portfolios. Prime is the next largest sector, with a 37% share.

Although PPIP manager performance continues to be strong, most managers have seen their net IRRs decline versus last quarter.

RMBS

New agency index series prepped

Markit is set to launch new MBX, IOS and PO indices that reference 2010 agency pools on 12 February. They will include a 3.5 series, as well as 4, 4.5 and 5 series, complementing the existing indices that reference 2009 pools.

MBS analysts at Barclays Capital indicate that prepayment speeds on 2010 agency pools could be significantly slower than 2009 agency pools, suggesting that the IOS off the new indices will trade better than their 2009 counterparts.

RMBS

Put-back loss estimates revised downwards

Losses resulting from loan repurchases and any related settlements are unlikely to materially affect the capital adequacy of the largest US banks, according to Fitch. While repurchase risk has limited the near-term upside momentum in the ratings of certain institutions, the agency does not see any immediate negative rating implications at this point.

However, growing litigation risk related to private label RMBS may have negative rating implications if court rulings are decidedly on the side of RMBS investors. Fitch expects that repurchase losses will continue to weigh on bank earnings over the near term.

Recent settlements with Fannie Mae and Freddie Mac have helped establish some certainty around a portion of bank exposure. However, potential future claims from investors in private label securities, financial guarantors (FGs) and mortgage insurers (MIs) represent a growing concern, the agency says.

In August 2010 Fitch estimated that the top four US banks would sustain losses in the range of US$17bn-US$42bn, based on the amount of delinquent mortgages in the GSE portfolios and estimates for put-back and recovery rates. While these estimates remain largely the same, it now seems that the lower end of the range is the most likely outcome, given recently announced settlements between some banks and the GSEs.

Repurchase claims on problematic mortgage loans continue to pose a risk to the largest banks, which were the most active originators and issuers of agency and private label RMBS. While agency RMBS represented over half of the 2005-2008 RMBS issuance, private label transactions have tended to exhibit weaker performance, increasing the potential risk for repurchase claims. However, Fitch maintains that investors in these transactions generally have weaker representations and warranties and face significant hurdles in gathering necessary information and pursuing claims.

The level of uncertainty regarding claims on private label securities is a focal concern regarding banks' residential mortgage repurchase risk. The agency will therefore consider any future settlements and/or litigation outcomes with the GSEs, private label investors, FGs or MIs in order to determine their respective impact on capital and financial performance.