Contents

Regulation

Uncertainty knocks

Issuers adopting a 'wait and see' approach to regulation

The implementation of regulatory reform in the US is making it tougher to bring new securitisations. Indeed, some estimate that uncertainty around new rule-making will continue for another 18 months, as many issuers wait to see how the market is reshaped.

Hansol Kim, md with FTI Consulting's structured finance group, notes that overall the new regulations represent many roadblocks in the way of the market's speedy recovery. "While everyone is trying to avoid making the same mistakes again, the reality of the situation is that the net outcome of the recent and expected proposals makes it tougher to bring new deals."

He says it's difficult to anticipate what the ultimate impact of the regulatory changes will be because only a limited number of deals are getting done and, as such, there is not yet a big enough sample size to provide insight into market participants' future behaviour. Further, despite several recently published proposals and guidelines, many points of clarification remain and - even if one has a good understanding of Dodd-Frank - the final rules will depend on further interpretation and actual implementation by the regulators in real life situations.

Another source of uncertainty is how different regulatory bodies and jurisdictions will "triangulate and modify their current proposals against each other" to arrive at a consistent set of rules. "Generally, many issuers are taking a 'wait and see' approach, which obviously isn't good for the market," Kim explains.

Jonathan Wishnia, member of Lowenstein Sandler, agrees that the additional costs and burdens associated with regulatory reform will either be problematic or very problematic for the ABS market. "One principal question for each issuer is whether the market can support enough public issuance to make it worthwhile to go through the processes of registering and issuing publicly."

He indicates that there is growing support for issuing via the unregistered 144a market and through public offerings off-shore because they are subject to rules that are less cumbersome and more flexible for ABS products. "It's impossible to know how regulatory changes will unfold over the next year or so - there are a significant number of rules that still need to be promulgated - and the uncertainty makes it very difficult for issuers to come to the market. We're still not seeing significant issuance volumes: the market is coming back, but very slowly."

Kim has a different view about the 144a market, however. He says that unless the SEC backs off the current disclosure requirement proposal for 144a transactions as it has recently hinted, a migration away from private issuance to public issuance is a logical next step because the 144a market will require the same level of disclosure as public transactions.

When the disclosure rules go into effect, issuers will need to make a public versus private decision based on a trade-off between cost (of registration) and liquidity. However, Kim notes that "certain sectors which have traditionally utilised the 144a market for structural issues will continue to do so, until we come up with a better mousetrap".

Nonetheless, he is surprised at the proposed amendment of the SEC's due diligence rules (see SCI 21 January). "I was surprised to see that the SEC was fairly lenient," he says. "I think that giving issuers the option to conduct their own due diligence does not seem to go far enough in terms of protecting investors' interests. The lack of a well-defined scope of required information at this point is also problematic."

Kim adds: "While I can make a case on behalf of the SEC that, through this amendment, it is trying to remove one of the obstacles standing in the way of revitalising the securitisation market, arguably due diligence along with disclosure is the most important aspects of the reform effort. Your model is only as good as your input. A significant portion of the ills of the recent crisis could have been eliminated with accurate and insightful loan-level information."

Indeed, investors are hungry for product, but remain uncomfortable with large parts of the market. "I am concerned that without vastly improved review processes and independent entities that possess the ability to conduct nuanced and thorough due diligence, and not just check-the-box reviews, the market may revert to the old way of doing things - not dissimilar to what we observed in the high yield market in 2010 - which would be an undesirable outcome for our sector," Kim continues.

Wishnia says that in the case of the recent due diligence rules, the SEC made a good faith attempt to allow the market to direct how regulation should be developed. "This is the right approach," he observes. "The regulator has put forward a minimum review standard, without specifying how it should be adopted by each issuer, because it's up to the market to implement it."

He points out that regulation is usually promulgated on a 'one size fits all' basis, yet this doesn't allow for innovation and could cause long-term damage to the capital markets if overly burdensome regulation is promulgated without an understanding of the specific need of the various ABS investors classes. "It is clear that increased disclosure is in the interests of the investor community, at least for RMBS, given the damage done by reps and warranty breaches and the lack of an enforcement requirement. But there is some movement to find common ground."

Uncertainty also remains about the Orderly Liquidation Authority (OLA) provisions of Dodd-Frank, despite the FDIC's recent attempts to clarify matters in connection with securitisation. OLA pertains to entities that are deemed to be systemically important and could influence whether investors choose to buy bonds issued by such entities.

Kim suggests that some investors may choose only to buy from issuers that aren't 'systemically important', although he warns that there is always the risk of their being acquired by a systemically important entity in the future. He continues: "The process of determining which entities (outside of the usual suspects) are systemically important needs to be clarified further. The market needs a better sense of who will be on the list, who is on the fence etc in order to work out where certain issuers fit into the picture."

In terms of the next steps for regulatory reform, Kim indicates that SEC retention requirements for non-bank issuers still have to be defined better. "Questions still remain about how to implement the 5% requirement and which asset classes will be exempt from it," he says.

Clearly, how quickly the market returns is a function of how efficiently the final version of the regulatory reform is implemented and absorbed by the market, according to Kim. "Given the number of questions that still need to be addressed, market participants are not all that sanguine about 2011," he concludes.

CS

Investors

Exceeding expectations

Pre- and post-crisis credit hedge fund returns diverge

Credit hedge funds performed well above expectations last year, with returns from one portfolio monitored by Schwartzkopff Partners almost doubling the returns of the Dow Jones Credit Suisse HF Index. However, a stark difference in performance between pre- and post-crisis launches is also apparent.

Schwartzkopff's portfolio of 12 credit hedge funds generated a net return of 19.73% for 2010, with positive returns every month, against a 10.95% return for the Dow Jones funds, which had three negative months. "Last year in May, when things turned sour in many markets, I thought it would be a good idea to look at investable funds in the universe of credit funds we are aware of to see how they were performing. Credit funds had performed very well before that, but we wanted to see how they had performed in the first really negative month since 2008," says George Tintor, Schwartzkopff md.

He continues: "May 2010 was the first real test for credit funds, so we looked at the portfolio, added them all up and found they had managed a positive return. These guys held their own when the stormy weather came, so we continued to track them."

Tintor explains that the selection process for the 12 funds the firm follows was fairly simple, with the key criteria being that they must be investable. Six of the funds existed before 2007 and so are labelled as 'pre-crisis' funds, while the other six are defined as 'post-crisis' funds.

"Clearly the pre-crisis funds have proven risk management systems because they managed to survive in 2007 and 2008. They returned something like 15% last year, while the post-crisis group returned around 26%," says Tintor.

From his analysis of the funds, Tintor has found that the pre-crisis funds are far more diversified, taking in not only ABS but CDS as well. Even those funds that are purely ABS tend to invest across the ABS spectrum, taking in both major sectors and smaller niches where they see opportunities, from RMBS to aircraft lease ABS.

In stark contrast, the post-crisis funds are very concentrated. Some invest almost exclusively in US RMBS and within that one is exposed exclusively to subprime. Another of the post-crisis funds invests purely in Trups CDOs. For all their concentration, Tintor reiterates that the post-crisis funds have achieved higher returns than those set up before 2007.

He says: "The disparity in returns can be attributed to the fact that the pre-crisis funds are more diversified across sectors and strategies, as opposed to the post-crisis funds, which tend to have more concentrated portfolios. Also, the pre-crisis funds tend to focus more on portfolio hedging than the post-crisis funds."

Some new credit hedge funds have managed to launch recently. Tintor cites as an example Boaz Weinstein, formerly of Deutsche Bank, who has set up Saba Capital Management. Other planned credit hedge fund launches are rumoured to include new offerings from Highbridge Capital and TPG Credit Management.

Tintor believes the strong performance of credit hedge funds from last year will continue this year too, although whether returns will remain quite so high remains to be seen. He says: "I do not know if it will be as high as 19.73%, as in 2010, but then again I would never have predicted that kind of return a year ago either. Returns of around 12%-15% seemed more realistic then and again I would say that is realistic for this year. Clearly strong performance can continue."

He concludes: "There is a lot of opportunity out there in a large and inefficient market that does not have many players. There are fewer bank proprietary trading desks and definitely fewer hedge funds in the space. The wheat has really been separated from the chaff and the guys who survived the 2007/2008 market stress have been able to take advantage of tremendous opportunities."

JL

ABS

Rally boosts Euro auto, credit card ABS

The volume of European ABS new issuance has boosted secondary market activity considerably this week. At the same time, last month's price rally has altered the appeal of many asset classes, fuelling activity in auto and credit card ABS in particular.

"It has been pretty busy over the last week, with new issuances taking up most of our focus," one ABS trader says. This focus has mainly been on auto loan ABS, whole business and RMBS new issues, which have all performed in line with expectations.

The trader continues: "The performance of the primary market is making secondary levels look fairly cheap, which is probably the reason why the primary market is continuing to perform so well and pricing fairly tight."

He believes that last month's rally in pricing levels was due to the perceived risk in senior financials and, in turn, has prompted investors to revisit the primary market. "Or perhaps they just have spare cash to throw around right now," he remarks.

Consequently, the tone of the market has changed fundamentally, with many previously dwindling asset classes now appearing to come back to life. The trader suggests that this reflects banks' desire to diversify their funding sources, with securitisation proving to be an interesting alternative for some.

He adds: "Auto ABS, which was previously dominated by captive issuers, is making a comeback for example. It's also reassuring that credit card ABS volumes are now drastically growing in size."

Looking ahead, the trader expects that while caution will prevail throughout the year, overall performance in 2011 will be stronger than in 2010. "Although regulatory reform will be a key risk in any asset class, mezzanine and subordinated pieces will likely continue to generate stellar returns," he says. However, he is cautious about expectations for non-conforming RMBS and CLOs.

Nevertheless, the trader believes that the European ABS market has started the year as it means to go on, with increasing issuance and strong performance. "It's comforting to know that in just one month there has been a lot of primary issuance - and hopefully there will be more to come," he concludes.

LB

CLOs

Euro CLO market takes stock

Several large CLO bid-lists set new highs across the capital structure last week. Now, the European market is entering into a consolidation phase as it readjusts and absorbs new pricing levels.

"It's been an interesting few days as we've had the run-off of several large bid-lists that were really standing in the way of the forward supply, with not much following on from those," one CLO trader says. As a result, the market is now in the process of absorbing the volume and outcome of the lists.

He continues: "It's been interesting in terms of how the market is absorbing the cover levels; it's a chance to gauge how real the market feels. It looks like it's in a consolidation phase, where the market is settling into a new pricing environment."

Consequently, there is now a lower volume of supply while investors familiarise themselves with pricing adjustments, the trader says. "Investors are trying to catch up to where dealers have pushed the market to, so there's some balancing going on as the market settles itself."

The supply and demand dynamic has undergone a significant change over the last month, the trader adds, as the beginning of the year saw little supply. "Investors were hungry for paper, while dealers were low on it - demand was outstripping supply massively."

However, last week's boost in supply shifted this imbalance, although investors remain cautious. "We've just got past absorbing last week's supply, but I think that some investors believe that some weakness could creep into the market so they're sidelining themselves a little."

But this should not be seen as an indication of a set-back in the European CLO market, the trader argues. "It's tough to see any significant reason for widening, other than a buyers' strike on behalf of their clients. The simple reality is that the market is still good value, so I class this as a consolidation phase, rather than seeing any real or significant push-back."

LB

CMBS

New US CMBS issues eyed

The US CMBS market has exhibited a positive tone this week, following the broad optimism generated at last week's CRE Finance Council conference and the launch of two new deals. Further, two more transactions are expected to be announced shortly.

"There have been a couple of new deals out this week and overall there's a good feel to the market," one CMBS trader says. Contributing to this, the trader notes, is a progressive tightening of spreads since the beginning of the year.

The trader confirms the details of the two condo securitisations that have launched this week. First, UBS and Deutsche Bank are marketing the US$2.18bn DBUBS 2011-SHC1 transaction. Second, the US$1.5bn MSC 2011-C1 transaction has also begun marketing this week via JPMorgan and Bank of America Merrill Lynch.

Additionally, the trader says there is market speculation that two other new CMBS issues are due to surface over the next month. "I've heard that Wells Fargo and RBS are coming out with a US$1.7bn deal. Also JPMorgan is expected to come out with a US$1.5bn within the quarter," he says.

Overall, the trader says: "There's a feeling that the CMBS sector has turned a corner and is improving. Technicals are very strong right now too, mainly due to lack of supply in the market."

Positive sentiment is also due to CMBS holding more of an appeal than other sectors, the trader says. "CMBS has more relative value compared to other products, with higher spreads and yield, as well as a safer duration. It's this that I think is helping the market right now; there's definitely been an improved tone over the last few months."

LB

RMBS

Euro MBS showing strength

It has been a strong week for the European MBS market, characterised by gradual spread tightening in Dutch RMBS - a trend that is set to continue into March. At the same time, investors remain eager to buy CMBS paper.

"The market has been pretty strong this week, with UK prime RMBS holding up particularly well," one MBS trader says. "Dutch RMBS has also performed well, with a noticeable tightening of spreads."

However, UK non-conforming activity has declined over the week. The trader continues: "It's been much quieter on the UK non-conforming front as we haven't seen the bid-list volumes that we saw at the beginning of the year. I think that it's fallen back a little from the high volume of sellers we saw in January."

Meanwhile, the CMBS market continues to grow in strength, the trader confirms. "In general, CMBS is still very strong, especially in the lower cash price senior region. There are a lot of Street bids: even though it's not the volumes that we saw at the beginning of the year, we're still seeing good involvement with clients."

These stable conditions across the MBS market look set to continue. "If I was to predict the month ahead," the trader speculates, "prime RMBS paper will continue to look steady, as will UK non-conforming - especially after the big rally in mezzanine paper. Senior non-conforming I would also expect to hold up too."

He concludes: "For CMBS, I would expect bonds to trade up. The senior paper has already seen a rise, so I believe we will see a change in the lower part of the capital structure this time around."

LB

ABS

Non-traditional ABS to take off

S&P believes that 2011 will see strong investor interest in non-traditional US asset securitisations. Spreads for non-traditional assets tightened last year, partly because of low yields and the limited issuance volume from more traditional assets classes - a combination the agency expects to continue this year.

Issuance of transportation, whole business, royalty, timeshare, catastrophe and longevity securitisations is expected to increase in 2011. Meanwhile, activity in tobacco settlement-backed, commodity-related and alternative energy securitisations could also pick up.

Last year saw varied recoveries for marine cargo container leasing, aircraft leasing and railcar leasing, with container leasing leading the way thanks to the rebound in global trade. Aircraft and container leasing both benefit from diversification through exposure to non-US risks, while railcar leasing improved slowly. Market consensus is that these trends will continue this year.

There was an uptick in inquiries about potential new WBS last year and S&P expects 2011 to see an increased need for financing in this sector. Some WBS issuers tapped the bank loan market for refinancing last year, but more are expected to look to securitisation in 2011 as there is strong investor interest and attractive spreads.

Royalty securitisation has been almost non-existent for a few years, but the market believes a comeback may be on the cards - even without monoline insurance - as investors' greater focus on credit fundamentals come into play.

Timeshare securitisations, meanwhile, are seeing less stress and so may experience a reasonable level of issuance. Now that the market is open to mid-size developers, it is predicted that issuance will continue at around the same rate as last year, albeit mostly dominated by larger players.

Catastrophe bonds are also attracting a lot of interest due to their strong performance and the fact that they are largely uncorrelated with the broader economy. The sector is expanding into new areas, with 2010 seeing the introduction of non-natural disaster-related perils, such as health care-related risks.

In addition, there is a growing appetite for longevity securitisation. Although such deals have traditionally been issued in the European market, demand from US pension fund investors looking to hedge their longevity risk could energise the sector. Issuance is expected to slowly develop in 2011, with future prospects thought to be strong.

S&P rated its first tobacco settlement-backed securitisation since 2008 last year. Many challenges face the sector - not least excise tax increases and tighter tobacco advertising restrictions - but the launch of the Railsplitter Tobacco Settlement Authority Series 2010 transaction suggests there is potential for future issuance in this sector too.

Commodity-related securitisations could be helped by favourable spreads. One volumetric production payment (VPP) transaction was issued last year and S&P believes other commodity-related securitisations, such as timber securitisations, may be seen in 2011. It is traditionally an opportunistic issuance sector and current spread levels could see the opportunity for increased issuance seized.

Finally, renewed government focus on developing alternative energy sources has sparked investor interest in pure alternative energy securitisations. Most current alternative energy transactions are hybrids of project financing and securitisation, but in purer transactions securitisation's role could be as a provider of cost-effective long-term financing for this growing sector.

S&P concludes that market participants are generally optimistic about non-traditional securitisation for 2011. However, the encouraging environment for non-traditional asset issuers could be tempered somewhat by the uneven pace of the global recovery and regulatory changes. The agency highlights the US SEC's Reg AB rules - which are being amended - as one example of this, with originators expressing concern about enhanced disclosure requirements.

JL

ABS

Safe harbour-compliant ABS debuts

Ally Bank's US$1.3bn ALLYA 2011-1 - which priced last week via Barclays Capital, Citi and RBS - is notable for being the first FDIC safe harbour-compliant ABS. Given the uncertainty caused by the regulatory rulemaking process, the successful execution of a compliant deal under the new regime is a positive sign for the market, according to ABS analysts at JPMorgan.

The issuer successfully obtained the legal opinion, as well triple-A ratings from Moody's and Fitch to support the deal. The JPMorgan analysts note that the prospectus supplement filing indicates that Ally intends to satisfy the risk retention requirement under the FDIC rule by holding a separate, randomly selected pool of receivables equal to 5% of the securitised pool. In terms of the documentation requirements under the FDIC safe harbour, the indenture for the transaction will include a "FDIC Rule Covenant" section that details all the required provisions.

However, Moody's points out in its latest Weekly Credit Outlook publication that there is a risk that noteholders will not receive up to 10 business days of accrued interest under the FDIC's repudiation powers. Nonetheless, the agency believes that the small size of the risk, coupled with its low likelihood, is consistent with the deal's triple-A rating.

According to Moody's, this low likelihood reflects the low probability that all the following prerequisite events will occur:

• The FDIC becomes the conservator or receiver for Ally Bank before the bonds mature
• The FDIC repudiates the asset transfer and pays damages
• The FDIC pays damages after its notice of repudiation, causing accrual of interest between the repudiation date and the later payment of damages date
• The indenture trustee releases the deal's reserve fund to the FDIC or otherwise fails to use the reserve fund to pay the accrued interest payment shortfall.

CS

CDS

Credit versus equity explored

Credit derivative strategists at Morgan Stanley explore in a recent report credit versus equity relationships based on a macro approach. The report focuses on two themes: the strength of equity and rates market factors on credit market variables; and how these relationships can be used to identify credit-equity opportunities in today's markets.

In terms of trading themes, the Morgan Stanley strategists suggest that a credit options culture is developing in a manner that is similar to equities, where net flows in the market are biased towards long put and short call positions - thereby effectively reducing market risk and creating the steep skew relationship.

"But there are important disconnects in both markets as well," they note. "In particular, we think tails (upside and downside) are perhaps too extreme in credit options and we favour trading those tails for ones in equities where they are more valuable, given valuations, our fundamental views and the nature of equities in general."

Among the conclusions drawn from their historical study is that changes in equity prices and fixed strike volatility are among the strongest factors driving credit spreads. In terms of credit-implied volatility changes, spreads and fixed strike equity volatility are the strongest drivers in the US. In Europe, however, changes in spreads and equity skew are strong drivers, owing to more tail event risk within European credit markets.

For credit skew, changes in spreads as well as implied volatility from the VIX options markets are the biggest drivers in the US. In Europe, changes in spreads along with changes in equity skew are significant.

The strategists recommend trades around what they describe as 'European tails' and 'US upside' as a result. First, within options, the skew in iTraxx Main is steep relative to skew in SX5E and iTraxx Main volatility is modestly rich.

Consequently, they suggest selling OTM payers in iTraxx Main to fund the purchase of OTM puts in SX5E for roughly zero cost or, for less tail exposure, buying an iTraxx Main payer spread and selling a put spread in SX5E at zero cost.

Second, while upside skew has flattened in both credit and equity, it appears to be flatter in CDX HY versus the potential upside at this stage in the cycle. The strategists therefore advocate selling OTM calls in CDX HY and buying S&P 500 OTM calls (for a small net cost) or call spreads (for a small net credit).

CS

CLOs

Outlook for US CLOs mixed among managers

Responses to a recent S&P survey indicate that approximately 77% of larger collateral managers believe new US CLO issuance will range from US$10bn to US$20bn in 2011, while the range estimated by a similar number of smaller collateral managers is between US$5bn and US$15bn. Almost 60% of the larger collateral managers expect triple-A spreads to tighten during the year to 100bp-125bp, while a similar number of smaller collateral managers anticipate spreads to tighten to 125bp-150bp. Indeed, most respondents expect spreads to fall below 100bp in 1H12.

More than 40% of the respondents anticipate that there will be at least 20, but fewer than 30 CLOs issued during 2011. Over 70% of the smaller managers surveyed believe that smaller managers will become more active in the market between now and the first half of 2012, while an additional 14% of that group believes that smaller managers will never again actively participate. Respondents indicated that smaller managers are more likely to be active when the number of third-party equity tranche investors increases.

A majority of all collateral managers surveyed expect CLO buying power to decrease in the leveraged loan market, even with an expected increase in new issuance, as legacy CLOs end their reinvestment periods and some deals become constrained by weighted average life covenants. Despite this expected decrease in buying power, CLOs are likely to participate significantly in the future leveraged loan market, although at a lower rate than during the peak levels of 2006 and 2007.

Meanwhile, half of the respondents don't think that new CLO documentation requirements will allow for more flexibility in managing deals. This sentiment is primarily due to the belief that triple-A investors are now generally dictating terms of new transactions.

However, one out of three respondents disagrees. They believe that documentation will provide more flexibility in addressing obstacles that collateral managers faced in recent years; for example, managing around certain structural features such as triple-C basket limitations and discount purchase requirements.

Approximately 90% of respondents believe that performance of the underlying loans was a big contributor to strong CLO performance. Almost 73% of the larger managers and 52% of the smaller managers think that structural features, along with loan performance, had a big influence on CLO performance.

Finally, over 40% of all respondents believe that collateral manager consolidation will occur at the same pace as in recent years. Almost twice as many larger managers as smaller managers expect the pace to increase, with their comments indicating they believe that the ongoing desire for economies of scale will result in continued consolidation. A third of respondents believe that the pace of collateral manager consolidation will decrease, however.

CS

Criteria critiqued

John Uhlein, managing principal of Grenadier Capital, outlines his misgivings about S&P's proposed bond insurance rating criteria

In a 39-page report entitled 'Request for Comment: Bond Insurance Criteria', dated 24 January 2011, S&P endeavors to set forth "new" criteria for rating bond insurance companies (see SCI 28 January). This is a laudable effort to impose order to an industry that has not been well understood and imploded during the financial crisis.

Today only one company, Assured Guaranty, is still writing business, out of about ten several years ago (reinsurers included). At one point, the insurers guaranteed over 50% of the municipal market, covering over US$1trn in bonds outstanding, so it is understandable that there are constituents who still feel this industry has relevance in the new financial order.

Regrettably, S&P's report only highlights the complexity of monitoring the industry and the circularity of the ratings process. I will broadly review some of the misgivings of the report in the hope of eliciting constructive debate.

S&P attempts to outline various criteria and categories which provide the basis of its rating process. This is very confusing, but essentially it breaks the analysis into two parts: the financial risk profile and the business risk profile.

It states that there are nine "analytic categories" (see paragraph four of S&P's report) supporting its rating conclusion, but when I examine the flow chart (above paragraph five) included in the report I see a tenth that is not included: leverage. The criteria are: management and corporate strategy, competitive position, industry risk, liquidity, enterprise risk management, capital adequacy, investment risk, operating performance, financial flexibility and leverage.

In a somewhat convoluted way, S&P then argues that many of these categories fold into the other, using a matrix formula, until business risk and financial risk profiles (which are themselves blended) finally emerge, with several other factors falling outside this framework and impacting the ultimate rating. The word "analytic" is used often, but ultimately a majority of the criteria are subjective, without any real "weighting" given to any one category. Nonetheless, the process is detailed with the result that the rating is derived from the set of inputs, much like CDOs were rated based on complex models and assumptions.

Before I discuss the weakness of this approach, I should point out that the report does a good job in many of the categories themselves. For example, the discussion on liquidity does well to set forth parameters that will affect whether there is high risk or low risk.

On the other hand, the use of a 40-year-old report (The Hemple Study, see paragraph 41) that relies on the Great Depression as the basis of the municipal capital charges reminds me of the fallacy in all the pre-financial crisis mortgage models that used data from the 1980s Texas oil patch recession. It turned out the new option ARMs, Alt-A and other MBS products did not look anything like the mortgages from the 1980s, and certainly did not perform as predicted.

It is not clear to me what has really changed in S&P's approach to rating bond insurers, besides increasing the capital charges, providing an aggregate leverage test and using a matrix. There is no discussion as to how the new criteria would have helped avoid the implosion experienced in the sector and it makes me wonder whether S&P is really serious about its competency in this sector.

Moreover, the changes it does make with respect to the increased capital charges, and leverage ratios, simply enforce the notion that S&P does not have confidence in its own ability to rate the underlying transactions, as well as monitor the performance of such a complex financial enterprise. A stark example of this is the application of a 100% capital charge on ABS CDOs for purposes of determining capital adequacy (paragraph 52). There is no discussion as to how S&P plans to monitor and update its analysis on a regular basis.

When the noise around the new criteria is cleared out, what remain are increased capital charges and an aggregate leverage test. In fact, while the other criteria are important and should be monitored, capital adequacy and leverage really are the most crucial tests, and yet they are based on (potentially unmonitored) ratings given by S&P and others to the underlying guaranteed credits. These new capital charges - essentially a stress - are for me simply a recognition that S&P does not have faith in its own ratings.

This brings up another point: the circularity of the process. S&P is rating the bond insurer based on its own ratings of the underlying credits. By having so many criteria that are highly correlated with the crucial test - capital adequacy - S&P gives itself wiggle-room to blame the management of the bond insurers, as opposed to its own failings in the actual rating process.

The fact is that many of the now-defunct monolines met all the prevailing S&P criteria, until the MBS-related deals went bad. Once that happened, all the indicators were highly correlated and went south simultaneously.

Investors will likely never again gain comfort to the extent that the de facto regulator (i.e., the rating agency) is the same entity actually providing the underlying ratings to each transaction. The only way around this is to require a third-party credit firm to provide periodic independent corroboration of the underlying ratings, perhaps on a random basis.

Before providing a more detailed response to the proposed changes, I feel that it's imperative to raise threshold issues relating to the entire rating process:

• It seems clear that default risk (and potential loss severity) is the main driver of the rating and that all criteria move in tandem with a change in an insurer's risk profile. Accordingly, it should be clearly communicated that capital adequacy is the main driver of the rating and that it is (largely) based on ratings provided by the same rating agency on each guaranteed transaction.
• S&P needs to clearly articulate how it will monitor the insurer's ongoing performance, including the frequency. S&P ought to use a third party to independently corroborate, perhaps on a random sample, the underlying ratings and potential loss severities being applied by the rating agency. While this will add some cost, it will be more than offset by a potential reduction in capital required by the bond insurer, given that there will be more integrity in the process.
• S&P should keep all the criteria separate and indicate how much weight is given to each and the correlation it is assuming. Methodological transparency is a positive objective under Title IX of the Dodd-Frank Act and it provides investors with the tools necessary to perform adequate due diligence.
• S&P should update the assumptions it is using for default frequency and severity.

S&P has done a good job at detailing the main criteria for evaluating bond insurers and provides good safeguards to protect against a repeat of what transpired during the financial crisis. However, it needs to recognise the inherent conflicts of rating an institution that is essentially a CDO of credits, which have themselves been rated by S&P and others.

The criteria are all heavily correlated and the risk remains the credit performance of the portfolio, and the quality of ratings provided by S&P to the underlying credits. To suggest that one can simply fold one risk profile into the other serves to obfuscate this reality.

ABS

SF research head named

Credit Suisse has appointed Dale Westhoff as global head of structured products research in New York. Westhoff will focus on delivering the bank's research in MBS, ABS and other structured products to clients. He will also continue to develop the bank's suite of structured product analytics, with particular emphasis the MBS prepayment models.

Most recently, Westhoff was head of consumer modeling teams at JP Morgan. Prior to the merger between Bear Stearns and JP Morgan, he was senior md and head of quantitative research at Bear Stearns. Westhoff joined Bear Stearns in 1990, specialising in analysis and modelling of MBS prepayments.

ABS

FDIC names general counsel

The FDIC has appointed Michael Krimminger as its new general counsel. He has served as a key policy advisor to the FDIC board of directors since 2006, leading the development of major policy initiatives, including the agency's new Orderly Liquidation Authority under the Dodd-Frank Act. Krimminger was previously deputy to the chairman for policy.

ABS

Litigation counsel promoted

The US SEC has promoted Mark Cahn to general counsel. He will assume his new role when David Becker steps down from the position later this month. Cahn has served as deputy general counsel for litigation and adjudication.

CDS

Reference data head added

First Derivatives has appointed Bret Bange as head of global sales and marketing for its suite of reference data solutions. He will focus on leveraging the firm's reference data management capabilities, while addressing the data-centric requirements of clients' enterprise, trading, credit/market risk and back/mid office applications.

Based in New York, Brange will report to Dale Richards, head of data strategy and president of the Americas at First Derivatives. He joins the firm from GoldenSource, where he was senior sales director in the reference and enterprise data management space.

CDS

Chief data officer recruited

The DTCC has appointed Ronald Jordan as chief data officer. Jordan will be responsible for guiding the DTCC's strategy on matters related to its commercial and regulatory data business activities. He will also focus on the needs of the US Treasury's Office of Financial Research, reporting to Andrew Gray, DTCC md of core product strategy and management.

Jordan joins the firm after spending 26 years at NYSE Euronext, where he was most recently evp of global market data administration. Prior to this, he held positions with the American Stock Exchange and the Philadelphia Stock Exchange.

CDS

Structured products desk established

RJ O'Brien & Associates has appointed Hilton Sheng as svp of structured products. Based in New York, he will establish a structured products desk to meet the growing demand for exchange-cleared products, including OTC instruments.

With over 25 years of futures industry experience, Sheng most recently served as director and senior energy derivatives marketer for Hudson Capital Energy. He has also been an independent COMEX floor trader, partner of an energy hedge fund and a vp with ABN AMRO.

CDS

Asset manager expands credit coverage

Highbridge Capital Management has appointed Serge Adam as md in its Principal Strategies (HPS) division. He will share responsibility for managing the firm's public credit business with fellow md Purnima Puri.

Adam joins Highbridge after ten years at Sandell Asset Management, where he was most recently a senior md and portfolio manager in its credit business. Scott Kapnick, HPS ceo, comments: "Serge's experience managing complex hedged credit portfolios will be incredibly valuable as we take advantage of attractive opportunities in the credit markets, continue building out this side of our business and provide our clients with a broad range of investment solutions."

CDS

Bank names structured credit director

Hari Thirumalai has joined UBS as an executive director and trader in its structured credit team in London. He will report to Afif Baccouche, the banks's global head of structured credit.

Thirumalai is a former analyst on the credit proprietary trading desk at Bank of America Merrill Lynch, where he focused on relative value opportunities across the capital structure in investment grade, high yield and leveraged loans.

CLOs

CLO manager hires ahead of capital raise

Avoca Capital Holdings has appointed Robert Burns as director for sales and marketing based in the London office. This move forms part of the firm's growth strategy to expand its business by raising money for new funds globally.

Burns has over twenty years of sales experience working in major financial institutions. He joins Avoca from Citi, where he was director in structured product sales, and previously held positions at Lehman Brothers (where he was executive director of private investment management), RBS (as head of CDO distribution), RBC (as director of global credit) and Bear Stearns (where he was involved with fixed income sales).

CMBS

CRE bailout service prepped

ICP Financial has signed an agreement with an unnamed top-five European bank that will allow it to buy distressed property and mortgage portfolios directly from US banks for purchases between US$5m and US$180m at a time. The partnership also allows ICP to leverage the financial firepower of its new backer in bailing out small to mid-sized troubled US banks.

In some cases, the firm will also arrange private financing for banks in distress to raise more capital. ICP md Brad Wozny says: "Everyone knows the wave of distressed commercial real estate mortgages coming due will continue. And with foreclosures in the US expected to jump another 20% this year, American banks will be in a world of hurt."

He continues: "Their risk of being seized by the FDIC is huge. To avoid this from happening, they'll need to quickly sell part, or all of, their mortgage and foreclosed property portfolios, and we're here to help them do that. Then they can recapitalise and kick-start their lending operations once again. With this agreement in place, we can help out many of those banks who are in distress quickly and efficiently."

ICP's new service is needed, Wonzy explains, because it was only the banks involved in residential mortgage lending that received TARP money from the government. "CRE lenders didn't receive a penny of the benefits residential lenders are getting. And now with commercial real estate bank lenders, it's a double-edged sword. Because they don't have government bailout money and the market is in a recession, their foreclosures are piling up."

CMBS

CRE underwriting solution offered

Zenta and Rockport have formed a partnership to deliver a combined technology and services offering to the CMBS, commercial banking and CRE markets. The initiative will enable the firms to provide clients with a single turn-key underwriting solution, integrating cutting-edge technology and services.

"Rockport provides a true enterprise level platform for each facet of the loan origination lifecycle, as well as ongoing asset management capabilities. We are very excited to be able to offer our clients the benefits of the Rockport underwriting model, together with the analytical efficiencies of Zenta's capital markets team," says Colette Prior, evp of Zenta's global finance and real estate services division.

CMBS

Real estate division head hired

JPMorgan Asset Management has hired John Fraser as md and head of its new US opportunistic real estate investment division, Junius Real Estate Partners. Based in New York, Fraser will report to Joe Azelby, head of JPMorgan Asset Management − Global Real Assets.

The new business will manage assets separately from the bank's existing real estate asset management business. "We believe that the timing is right for this segment of the market, as owners, operators, banks and special servicers look to restructure or sell over-leveraged real estate assets. Institutional investors who have been focused on adding core real estate exposure will be increasingly interested in taking advantage of the investment opportunities currently unfolding," says Azelby.

Fraser was previously co-head of real estate at Investcorp, where he was responsible for all facets of its real estate investment business. Prior to his 15 years at Investcorp, he held various real estate investment roles at firms including The O'Connor Group, Eastdil Realty and Aston Development.

RMBS

Legacy asset servicing unit formed

Bank of America has formed a new unit, Legacy Asset Servicing, which will oversee the servicing all defaulted loans and discontinued residential mortgage products. Terry Laughlin will lead the unit and be responsible for the bank's mortgage modification and foreclosure programmes, as well as for resolving residential mortgage representation and warranties repurchase claims.

At the same time, Bank of America Home Loans president Barbara Desoer will continue building the bank's mortgage business. She is responsible for servicing loans for the more than 12 million mortgage customers who remain current on their accounts and for continuing the bank's strategy in this segment.

"This alignment allows two strong executives and their teams to continue to lead the strongest home loans business in the industry, while providing greater focus on resolving legacy mortgage issues," comments Bank of America president and ceo Brian Moynihan. "We believe this will best serve customers - both those seeking homeownership and those who face mortgage challenges - as well as our shareholders and the communities we serve."

Through to the end of 2010, the firm completed more than 775,000 permanent loan modifications, including more than 100,000 through HAMP - the most of any servicer.

It has also made a number of improvements to its servicing platform over the last four months, including: enhancing the foreclosure process prior to resuming foreclosure activities in December 2010; redeploying more than 2,000 specialised sales and fulfillment associates to support default servicing; expanding case managers for customers during the modification process; doubling Bank of America's outreach staff to assist more customers in their own local markets; and expanding management capabilities aligned to the Home Loans business. The most recent additions include former Saxon Mortgage president and ceo Anthony Meola as default servicing executive and Eric Telljohann, formerly cfo for Bank of America's consumer and small business bank, as credit loss mitigation executive.

RMBS

Agency MBS reviews released

1010data and the ASF have published agency MBS market review reports, offering aggregated statistics for each GSE. Included in the reports is the new FHLMC delinquency disclosure data, as well as the previously available GNMA delinquency data aggregated at the cohort level. With buy-outs being a potentially important component of prepays, this data should help investors refine their prepayment expectations, the two organisations say.

"As with the previously-released non-agency MBS report, the agency reports will provide a high-level overview of the current performance of these securities and will serve as a starting point for investors to begin their own deeper analysis," says Greg Munves, evp of 1010data.

ABS

Positive performance continues for US credit cards

US credit card ABS performance registered positive gains across the board for the second straight month, according to Fitch's latest credit card ABS index results. All variables - including charge-offs, delinquencies, yield, monthly payment rate (MPR) and excess spread - improved again during the December collection period. Credit card defaults dropped to a 23-month low, while delinquencies fell to a level not seen in 27 months - boding well for the coming months.

"Lower charge-offs are likely throughout the rest of the first quarter. Charge-offs are still above historical averages and will likely remain at elevated levels until we see more meaningful improvement on the labour front," 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 prime credit card charge-off index for January marked the fourth straight month-over-month improvement, decreasing by another 62bp to 8.37% during the month. The decline represents close to a two-year low, with charge-offs now down 18% year over year. The largest trusts that make up the majority of the index - including Bank of America, Capital One, Chase, Citibank and Discover - each reported sizeable monthly improvements in default rates.

Late-stage delinquencies trended lower for the 12-straight month period, Fitch confirms. "Late-stage delinquencies fell to an historic 27-month low, which likely sets the stage for continued loss improvement in the coming months," says Fitch director Herman Poon.

Meanwhile, the 60+ day delinquency index decreased by another 14bp to 3.23%. Early stage delinquencies also declined, with 30+ day delinquencies decreasing 36bp to 4.18% after a temporary uptick the prior month. For the month, all trusts that make up the agency's indices reported lower delinquency rates.

Gross yield improved for the second consecutive month after a momentary slip last year, while maintaining the sixth highest level ever. Gross yield increased to 21.98%, a 15bp gain, and remains 18% higher than the historical average at inception of 18.67%.

Accordingly, excess spread results followed suit. Monthly excess spread increased by another 71bp to 10.82%, while the three-month average improved by 26bp to 10.26%. This marks another all-time high and is 36% higher year over year. Consistent with seasonal patterns, MPR rebounded, surging ahead by 175bp to 20.81% and setting a 40-month high.

ABS

Stable outlook for EMEA ABCP

Moody's outlook for EMEA ABCP ratings in 2011 remains stable. Bank risk remains a key factor, however, as this stability is predicated on the structural support and high levels of enhancement provided to ABCP programmes by sponsor banks.

Any downgrade of the Prime-1 rating of a conduit sponsor or liquidity provider would have a direct impact on the Prime-1 rating of the related conduit's ABCP. "Despite the negative outlook for the banking systems in most EMEA ABCP markets, however, the majority of bank sponsors have ratings currently in the double-A range with stable outlooks for 2011," says Eli Laius, Moody's avp.

The agency also expects the trend to continue towards fully supported structures and seller additions in response to evolving investor expectations, as well as to the amendments to the Basel 2 framework and the Capital Requirements Directive. These implementations will affect capital requirements and create disclosure issues, particularly for multi-seller conduits. Regulatory changes will also likely undermine the economic incentives informing securities arbitrage conduits, Moody's says.

The EMEA ABCP market achieved some stability at the end of the year, in both the rate of contraction in issuance levels and the volatility of spread levels. "However, the trend for issuance in the USCP market by EMEA conduits persisted in 2010 as the USCP market continued to be more robust than its EMEA counterpart," Laius explains.

Moody's also believes that there will be a continued emphasis on traditional asset classes, such as trade receivables, and that sponsors will continue to proactively manage their conduit portfolios to address downturns in asset performance. "Such proactive management reflects the high level of sponsor commitment that continues to benefit those conduits that emerged from the contraction of the ABCP market during the credit crisis," Laius adds.

ABS

Additional ratings on watch for counterparty risk

S&P has placed on credit watch negative its ratings on 149 classes of notes in 33 North American ABS transactions. This is in addition to the 950 North American structured finance ratings placed on watch negative on 18 January, following the update to the agency's criteria for assessing counterparty and supporting obligations (SCI passim).

The aggregate original issuance amount of the North American ABS securities with ratings affected by this latest watch negative placement is approximately US$27.9bn. In general, the affected ratings are those in the investment grade rating category.

ABS

Cashflow analysis application launched

Intex Solutions has launched INTEXcalc, a new end-user application offering transparency and speed in the analysis of structured finance securities. Available in web and local versions, INTEXcalc leverages Intex's cashflow model libraries, allowing users to analyse single securities, portfolios and bid lists with greater granularity and control, the firm says.

Kevin McCarthy, Intex md, comments: "Traders, investors, issuers and other participants in the global securitisation market demand increased transparency, as well as new and improved ways to analyse their exposure to structured securities. INTEXcalc meets those needs with new technologies integrated with the industry's leading library of cashflow models."

ABS

Seasonal trends driving timeshare delinquencies

Delinquencies for US timeshare ABS continue to tread gradually higher quarter-over-quarter, though overall figures are still lower than in the previous year, according to Fitch's latest indices for the sector.

"Seasonal performance deterioration, not surprisingly, has persisted through the winter months. However, year-over-year drops in timeshare delinquencies are bringing levels closer to historical averages," says Fitch director Brad Sohl. Given the expected stable collateral performance and ample credit enhancement levels, the agency's rating outlook for timeshare ABS remains stable.

Total delinquencies for 4Q10 were 3.77%, up from 3.68% at the end of 3Q10 but down by 23% from 4.89% in 4Q09. Monthly defaults increased to 0.77% in December 2010, up from 0.63% at the end of 3Q10.

On an annualised basis, defaults were 8.51% for the index in December, down from the 8.75% observed in 3Q10. The annual default rate has dropped steadily after hitting its all-time peak of 9.57% in January of last year, Fitch reports.

CDO

Auction proposed for CDO

BDO, as receivers for the US$1bn Tremonia CDO 2005-1, is proposing to sell the deal's English security assets in an auction to be held on or about 1 March. Henderson Global Investors will be assisting with the conduct of the auction.

The two firms say that if a noteholder or other party wishes to purchase any of the securities pursuant to the auction, they may deal directly with them or refer it to a financial institution that can submit bids on their behalf. Any proceeds received by the issuer pursuant to the auction will ultimately be applied in accordance with the enforcement priority of payments.

CDO

Call to replace Trups CDO trustee

Hildene Capital Management has sent a notice to the other investors in 67 Trups CDOs alleging that Bank of New York Mellon, as trustee on the deals, has not acted in the best interests of noteholders. Hildene says it is seeking the investors' support to replace BNYM with "an experienced CDO trustee".

The notice explains that prior to its 2006 acquisition of the corporate trust business of JPMorgan Chase, BNYM did not act as a trustee for a significant number of CDOs. "Recent developments have led us and other noteholders to understand why and conclude that BNYM is not well suited to act as the trustee for Trups CDOs," it states.

Numerous Trups held in CDOs either are deferring or are in default, affecting the calculation of certain overcollateralisation ratios that impact the payments made to various classes of notes pursuant to the CDO documents. According to the notice, although BNYM acknowledges that it is required by CDO indentures to follow the direction of the requisite percentage of the CDO notes, it does not recognise any obligation - nor is it willing to take any steps - to organise noteholders to obtain directions to protect their interests.

The CDOs involved are from the Alesco Preferred Funding, I-Preferred Terms Securities, MMCaps Funding, Preferred Terms Securities, Trapeza CDO, TPREF Funding and US Capital Funding series.

CDS

New SEF rules proposed

The US SEC has voted unanimously to propose rules defining security-based swap execution facilities (SEFs) and establishing their registration requirements, as well as their duties and core principles.

"Our objective here is to provide a framework that allows the security-based swap market to continue to develop in a more transparent, efficient and competitive manner. This is an important and complex undertaking that adds a significant new component to the regulatory framework for over-the-counter derivatives," says SEC chairman Mary Schapiro.

The Commission's proposed rules include an interpretation of the definition of 'security-based SEFs', as set forth in Dodd-Frank, while setting out the registration requirements for security-based SEFs. It also proposes to implement 14 core principles for security-based SEFs and to establish the process to file rule changes and new products with the SEC. Finally, it proposes to exempt security-based SEFs from the definition of 'exchange' and from most regulation as a broker.

The proposal is open for public comment until 4 April.

CDS

Anglo Irish CDS settled

The final price for Anglo Irish Bank 2.5-year CDS was settled at 71.25 at yesterday's restructuring CDS auction. 14 dealers submitted inside markets, physical settlement requests and limit orders to the auction, with deliverable obligations denominated in euro, sterling, Japanese yen and US dollars.

CDS

Single name CDS trading offered

Credit Suisse is now providing electronic trading of single name corporate and sovereign CDS on the Bloomberg Professional service. The offering gives clients the ability to execute fully electronic trades of single name CDS with the bank's credit derivatives desk on any desktop computer.

"The introduction of single name CDS electronic trading is another industry first for Credit Suisse, which continues to lead the way in today's evolving marketplace," says Eraj Shirvani, head of fixed income for EMEA and head of the European credit business at the bank.

He adds: "Clients want the efficient and immediate access to credit derivatives markets that is offered by electronic trading and Credit Suisse is committed to stepping forward as a key partner as the landscape takes shape."

The bank says it is initially offering select European industrial and sovereign names, with more European corporate sectors to be added in due course.

CLOs

US CLOs see improving maturity profile

The maturity profiles of most rated US cashflow CLO transactions have improved over the course of the past year, according to S&P. Questions about the impact of a significant amount of loan maturities in the coming quarters have been readily discussed, yet a recent review suggests that refinancing risk may be moderating, the agency says.

"In particular, many market participants have expressed concerns about a spike in loan defaults if CLOs cannot reinvest and lenders are unwilling to refinance obligors' loans. We believe, however, that data from a recent review of rated cashflow CLOs suggests that the potential issue may be receding," says S&P analyst Robert Chiriani.

To gain a sense of the reinvestment activity among recent-vintage transactions, the agency recently reviewed the collateral portfolio characteristics of over 600 rated US cashflow CLOs and found that overall the weighted average maturity profile of assets has slightly increased since the second quarter of 2010.

"At the start of February, 80% of the US cashflow CLOs we rate were still within their reinvestment periods," says Chiriani. "We also found that 64% of the CLOs that are past their reinvestment periods purchased assets in the third quarter of 2010."

Chiriani adds that this data likely reflects efforts by collateral managers to maintain the par balance of their CLOs' portfolios within the parameters of the transaction documents - even after the transaction's reinvestment period ends.

CLOs

CLO deferrable note impact examined

While recent financial dislocation caused many rated US cashflow CLOs to defer interest on some subordinate notes, most have resumed making current interest payments, with much of the deferred interest being repaid in full, S&P says.

The agency recently analysed interest payment information for 611 rated US cashflow CLOs between 2008 and 2010. "We chose this period because we believe it represents the greatest observed period of stress CLOs have experienced to date. We found that the percentage of these CLO transactions deferring interest payments during this period peaked at 27.7% in the second quarter of 2009. This portion, however, had fallen to 5.2% by the fourth quarter of 2010," says S&P analyst Robert Chiriani

The information indicated that the position of a deferrable note in a CLO's capital structure has a significant impact on whether it experienced a deferral. Specifically, interest was deferred for 18% of the mezzanine deferrable notes during the study period, compared with 41% of the subordinate deferrable notes.

CMBS

Accelerated collections likely for Japan hotel loans

Japanese hotel-backed CMBS loans are poised to enter an accelerated collection phase, according to Moody's. Five loans amounting to ¥59.5bn defaulted in January, two of which (amounting to ¥49.1bn) were backed by hotels, with the largest of the five being one of the ten largest loans maturing in 2011. As a result, the default rate of hotel-backed loans has increased significantly.

12 hotel loans amounting to ¥243.7bn accounted for approximately 10.1% of the total outstanding loans (¥2.4trn) backing Moody's-rated Japanese CMBS. Two loans amounting to ¥15.7bn were paid by their maturities in 2010, while six loans totalling ¥67.7bn had defaulted as of end-January 2011.

Since 2010, the number of recovered defaulted loans has increased for Japanese CMBS; however, no hotel loans have been recovered as yet. Additionally, Moody's notes that hotel deals have experienced difficulties due to a sluggish economy, as well as negative incidents such as the outbreak of influenza. While cashflow has deteriorated, the agency expects that stabilisation in the profitability of hotel operations may lead to accelerated collection of hotel loans.

CMBS

US CMBS delinquency rate at highest level

The US CMBS delinquency rate rose again in January, according to Trepp's latest Delinquency Report, with the percentage of loans 30 or more days delinquent, in foreclosure or REO climbing by 14bp to 9.34% - the highest level yet. The value of delinquent loans now exceeds US$61.4bn.

"While the rate continues to head higher, optimists can point to the fact that the rate of increase is significantly smaller than it was in the prior two months," comments Manus Clancy, md of Trepp. "Pessimists can counter that the jump comes despite the fact that new issues continue to make their way into the calculation and servicers continue to resolve troubled loans."

The new deals - which theoretically should have low delinquencies for a while - will continue to put downward pressure on the rate as issuance continues to grow in 2011, according to Trepp. Similarly, the resolution of troubled loans will help to reduce the rate.

The rate of increase has averaged 25.3bp per month over the previous twelve months, after backing out the Stuyvesant Town impact in March and the Extended Stay Hotels impact in October.

CMBS

EMEA CMBS assumptions updated

Moody's expects the loans backing EMEA CMBS to continue to perform poorly over the next five years. This forecast is based on the rating agency's 2011 updated key assumptions, which look ahead to the coming five years and represent the central scenarios it uses in its quantitative rating assessment for the asset class.

Moody's updated assumptions are in line with its broader global macroeconomic risk scenarios for 2010-2011 that a sluggish economic recovery remains the most likely scenario. In particular, lending is expected to remain subdued as availability of CRE financing is unlikely to increase meaningfully over the next two years. It will also remain subject to strict underwriting criteria and heavily dependent on the underlying property quality.

Tiering of refinancing prospects among CRE loans due to mature over the coming years is also expected to differ significantly, depending on the quality of the underlying properties. In addition, the expected increase in CRE investments will focus on prime properties, with only very limited volumes likely in secondary property markets.

While CRE capital values will stabilise for prime properties overall, they will remain low for non-prime properties. But Moody's believes that one factor counteracting the potential increase in capital values will be the considerable amount of CRE loans refinancing in 2012/2013.

The CRE occupational markets - i.e. the dynamics of tenant demand and space supply - will remain weak over the short term and will only recover slowly in the medium term in line with the sluggish economic recovery. Finally, work-out strategies are expected to continue to avoid a fire sale of properties, provided that cashflows are sufficient to service outstanding debt.

"Based on the updated key assumptions, the risk of a downgrade is greatest for CMBS transactions with loans that are secured by non-prime properties and need refinancing in 2012-2013, especially those transactions that have already undergone downgrades in the past two years. This is because the recovery of the lending market for non-prime properties will take longer than previously expected," says Oliver Moldenhauer, a Moody's vp.

CMBS

GSW refi positive for Euro CMBS

Fitch confirms that the ratings of Windermere IX CMBS and Fleet Street Finance 3 will not be affected by the proposed redemption of the GSW loan, due to the transactions' respective pay-down structures. The loan is expected to prepay within the next three weeks, following completion of the portfolio refinancing.

The €890m loan is securitised in two CMBS transactions: a 75% participation is securitised in Windermere IX, comprising 54% of the loan balance; while the remaining 25% participation is securitised in Fleet Street 3, comprising 23% of the loan balance. Fitch expects that redemption funds will be allocated on a fully pro rata basis, leaving credit enhancement unchanged.

Proceeds will be allocated to Fleet Street 3 on a 50% sequential, 50% pro rata basis - with pro rata amounts being allocated to the class A to C notes only. However, the lower average quality of the remaining loans in the pool would offset the resulting increase in credit enhancement.

"The redemption would be by far the largest successful refinancing of a European CMBS loan to have occurred in recent years and would provide a strong positive signal regarding the availability of debt funding for high-quality collateral. In particular, it would provide a reference point for other large German multifamily portfolios," says Gioia Dominedo, Fitch's European CMBS director.

The proposed redemption comes ahead of the scheduled loan maturity in August 2011. The documentation includes two one-year extension options, which the borrower could exercise if the loan was not in default or in breach of its debt service coverage ratio and loan-to-value ratio covenants, and the borrower obtains additional hedging.

CMBS

Canadian CMBS completed

Institutional Mortgage Capital Canada (IMC) has completed a C$206m CMBS private placement. The transaction, dubbed Institutional Mortgage Securities Canada series 2011, is the first CMBS issued in Canada since 2007 and is backed by 16 loans to two of Canada's largest REITs - RioCan REIT and Calloway REIT. TD Securities was the lead placement agent on the transaction.

"IMC is doing its part to help re-open the Canadian CMBS market. It's unfortunate that the Canadian market has lagged behind the US when Canadian bonds performed extraordinarily well, even after 2007. Where US CMBS is experiencing 10% defaults, Canadian CMBS has had virtually 0% losses on the US$24bn of CMBS issuance over the past 13 years," says IMC president John Ho.

He adds: "IMC plans to issue future CMBS deals in 2011 and expand our marketing to the US and international investors seeking the stability of Canadian credit. We think this will expedite the return of the Canadian CMBS market and make it more efficient this time around."

IMSC 2011-1 is comprised of six investment grade classes and one weighted average coupon interest-only certificate (WAC IO). The certificates were rated triple-A to triple-B by DBRS. The triple-A certificates have a 16.75% subordination level, with fixed pass-through rates of 3.69% for the five-year class and 4.697% for the 10-year class.

The double-A certificates have a pass through rate that is the lower of 5.259% and the net weighted average coupon (NWAC) of the underlying mortgage portfolio, while the single-A, triple-B plus and triple-B rated certificates have NWAC pass-through rates. All classes below the five-year triple-A have expected maturities of 12 February 2021, including the triple-A rated WAC IO.

IMSC 2011-1 is backed by anchored retail shopping centres owned by RioCan REIT and Calloway REIT. The loans have a 10-year term and a 30-year amortisation schedule with fixed rate coupons. They are full recourse to each borrower, guaranteed by their respective REIT sponsor and do not allow for borrower prepayments.

CMBS

Multifamily defaults driving CMBS delinquencies

Large multifamily defaults contributed to a 36bp climb for US CMBS delinquencies to 8.59%, according to Fitch's latest loan delinquency index. Late-pays within the multifamily sector jumped from 15.63% to 17.40% in January - the highest level yet for the index. Three large loans totalling US$915m comprised the bulk of the US$1.2bn of new multifamily defaults, the agency reports.

"While the multifamily sector is generally expected to stabilise in 2011, certain high-profile defaults continue to run up the sector's delinquency rate. More defaults are likely for collateral with cashflow that was not stabilised at issuance and cash-strapped borrowers that over-leveraged their properties at the height of the market," says Fitch md Mary MacNeill.

The US$10.1bn of multifamily-backed loans currently in default is heavily concentrated. 955 multifamily Fitch-rated loans are currently delinquent and 15 loans - ranging in size from US$54m to US$2.8bn - comprise half of the delinquent dollars (US$5bn).

Current delinquency rates by property type are: 17.4% for multifamily, from 15.63%; 14.43% for hotel, from 13.99%; 8.53% for industrial, from 6.24%; 6.88% for retail, from 7.2%; and 5.5% for office, from 5.69%.

CMBS

CMBS loan liquidation volume spikes

The dollar amount of US fixed rate conduit CMBS loans that were liquidated in January reached its highest level in the 13 months since Trepp has been compiling this number. In total, 189 loans with a total balance of US$1.51bn were liquidated during the month, according to the firm.

The losses on those loans were almost US$583m - representing an average loss severity of 38.5%, compared to an average loss severity of 44.3% seen over the last 13 months. Special servicers have been liquidating at a rate of about US$960m per month over that time, so the US$1.51m in liquidation this month represents a 58% increase over the average.

Trepp notes that these loss percentage values are being significantly reduced by loans that are being 'liquidated' with losses below 2% of the outstanding balance. "Each month, there are a number of such loans appearing in our database where the loan has been removed from its CMBS trust and a small loss has been endured by the deal. We suspect that, in many cases, these are actually refinancings that have taken place where the losses reflect small, unpaid special servicer fees or other costs," the firm says.

On this basis, the January liquidations still represent a high watermark over the last 13 months. After taking out the 'small-loss' loans, the average loss severity jumps up to 46% for January - twelve points below the average for the last 13 months

NPLs

NPL criteria explained

Fitch has published its global rating criteria for non-performing loan securitisations. The agency's analysis of non-performing loan transactions is predicated on the level and timing of recoveries, from the disposition of residential and CRE-secured loans that are in default and/or properties that have been repossessed.

Recoveries, which are stressed incrementally higher for each rating scenario, are the basis for the agency's cashflow assumptions. Rating determinations are primarily based on the ability of these cashflows to cover debt service on the issuer's proposed liabilities and in the context of the structural features of the transaction. As servicing risk is considered an important element of the analysis, the criteria also focuses on servicer expertise and the likelihood and consequences of a disruption in servicing.

RMBS

Prime RMBS loss model prepped

Fitch has published an exposure draft introducing its new rating model for determining losses on pools of newly originated US residential mortgage loans. The model framework includes the application of a proprietary sustainable home price model to measure a property's effective or sustainable value. The agency will then be able to take a forward view on the potential for negative equity that has shown to strongly influence borrower default.

"Fitch's criteria has always recognised the importance of equity as a driver of borrower default behaviour. Fitch's new approach now measures how much of that equity is real versus how much was created merely as a result of a price bubble," says Rui Pereira, Fitch md and head of US RMBS.

The updated framework also incorporates data from the recent recession and unprecedented national home price decline. In developing its default regression model, Fitch says it considered cumulative default expectations on older prime vintages as well as incorporated a cumulative default view on 'peak' vintages originated ahead of the recent crisis.

The agency's new model is also countercyclical and based on home price movements where credit enhancement increases as risk enters the system and decreases when risk is neutralising. In addition, rating levels can be more easily associated with various economic stresses and home price decline scenarios under the new approach, which will provide an increased level of transparency.

Fitch intends to apply the new criteria to pools of newly originated prime mortgage collateral and expects that credit enhancement levels will be materially higher compared to pre-crisis levels, particularly for pools with layered risk attributes. As such, it anticipates that in the event that crisis-level home price declines are experienced going forward, rating stability would be substantially greater.

"New prime mortgage production has thus far been characterised by lower combined loan-to-value ratios, more complete documentation and higher credit quality borrowers. Fitch's new modelling framework is able to more effectively differentiate risk across the prime segment and recognises the strength of this higher quality collateral relative to the loans advertised as prime during the 2005-2007 period," adds Pereira.

Fitch is seeking comments on the model framework over the next 45 days.

RMBS

Greek RMBS 'showing signs of deterioration'

Fitch reports that the performance of Greek RMBS transactions has begun to show signs of deterioration, having previously been unaffected by the weakened economic conditions in the country. The agency highlights that although reported losses remain very limited, the proportion of loans in arrears for more than three months has increased rapidly to 2.6% in December 2010 from less than 1.0% a year earlier.

Along with increases in arrears levels, the agency has observed increases in period defaults in the majority of Greek RMBS transactions. Fitch notes that asset performance deterioration could accelerate with the proposed budget cuts, tax increases and reforms, especially in transactions with a high percentage of loans with government subsidies or loans to civil servants.

It downgraded 26 tranches from 14 Greek RMBS last month (see SCI 20 January), due to the downgrade of Greece's long-term foreign and local currency issuer default ratings to double-B plus from triple-B minus.

RMBS

Whole loan evaluations service prepped

Interactive Data is set to launch a US whole loan evaluations service in the second quarter of this year. The offering will provide evaluated prices for residential whole loans based on observable inputs from the securities markets. It will cover both performing and non-performing whole loans, complementing the firm's current offerings related to securitised debt, including US agency pass-through securities, agency and non-agency CMOs, ABS and CMBS.

Whole loans are becoming increasingly more common in banks' holdings, Interactive Data says. According to the Federal Reserve, commercial banks' residential whole loan assets totalled US$1.56trn as of 12 January 2011.

RMBS

Subpar loan mods driving foreclosure rates

With loan modifications steadily declining, the emphasis is becoming less on whether a distressed US mortgage borrower is able to stay in their home and more on when the servicer will ultimately have to foreclose on it, says Fitch.

Since the high watermark of 86,500 modifications in April 2009, loan modifications have steadily decreased, with 36,500 modifications completed in December 2010. "The combined efforts of HAMP and other mortgage loan modification programmes have made little more than a dent in the large volume of outstanding distressed loans," says Fitch md Diane Pendley.

Other loss mitigation efforts, including short sales and deed-in-lieu offers, have increased slightly. As of December 2010, 53% of prime, 34% of Alt-A and 32% of subprime liquidations were not by REO sale.

The alternative liquidation methods have resulted in slightly improved loss severities when compared to REO sales. Fitch expects the level of these alternative strategies to increase in 2011, although limited by borrower acceptance.

In addition, the agency continues to expect a majority of modified mortgage loans to default again within a year, though its projections are now slightly lower - 60%-70% for subprime and Alt-A loans and 50%-60% for prime loans. "While not meeting volume projections, HAMP did assist in standardising the reduction of payments and focused more attention on the use of modifications," adds Pendley.

Defects in servicers' foreclosure procedures have stalled the process throughout many US states, with the defects lengthening already-substantial timeframes for default processing and clearing out of the inventory backlog. "Based on current and expected inventory, it will take four years to remove the backlog of properties and return the market to balance," concludes Pendley.

RMBS

Valuation forecasting system launched

Altos Research has launched a forecasting tool dubbed AltosEvaluate Forward Valuation Modeling (FVM). The service tracks changes in a property's transaction price three, six or 12 months into the future based on the strength or weakness of any local real estate market, thus improving loan and pool level analytics for more precise asset pricing.

Further, the forecasting system applies algorithms to Altos' real-time local market conditions data platform of critical, current, market-specific leading indicators - DOM, inventory, demand and price changes - as well as HPI and transaction data to forecast the forward-looking value of assets. "Altos clients know that real-time housing data is vital to understanding distinct local markets and is rich with leading indicators of future home price changes. They've asked us to apply our analytical expertise to know more precisely how much to adjust housing asset valuations," says Michael Simonsen, Altos ceo.

RMBS

Loan modifications only a short-term fix

Loan modifications do not appear to be an effective way to permanently cure loan delinquencies, according to S&P. The agency's conclusion is based on a recent analysis of CoreLogic loan-level non-agency RMBS data comprising first-lien loans issued between 2000 and 2007 that were modified between 2007 and 2010.

The analysis indicates that over one million non-agency loans were modified between 2007 and 2010, while approximately 19% of non-agency loans currently outstanding have received at least one modification. In the first 12 months after a modification cured a loan that was seriously delinquent, borrowers made an average of 7.8 additional payments, S&P reports.

However, although loan modifications can provide additional loan payments for investors as well as a reprieve to borrowers from foreclosure proceedings, the agency found that these benefits are usually short-lived. "At 24 months following modification, the payment statuses of modified loans showed no significant improvement compared with the month before they were modified," says S&P md Diane Westerback. "Similarly, 80% of loans that a modification cured defaulted again within 24 months."

The types of loan modifications that are most commonly used as well as the quality of the loans that commonly receive them can partially explain the low success rate of modification programmes. Although principal reductions have been significantly more successful in preventing re-defaults compared with other modifications, this type accounts for approximately 3% of all modifications, S&P notes.