Contents

CDS

Index ire

Markit's latest index proposal sits badly with investors

Investors are deeply sceptical about a planned synthetic CDS index referencing UK non-conforming RMBS. The index - presently dubbed NCRMBX - is being prepared by Markit for launch later this year, but there is serious concern that such an index would be detrimental to the market.

NCRMBX is not the only index that Markit is working on, however. The firm also approached a group of investors late last year about a benchmark index for the ABS marketplace. Investors have been working with Markit on this project and seem generally enthusiastic about it.

Indeed, it was while working with Markit on the ABS index that the group of investors first heard of NCRMBX. "Out of the blue, in mid-November last year, the group was contacted for a conference call. They were told that Markit had also been working with a group of dealers to create a synthetic tradable index referencing UK non-conforming RMBS, with a senior, mezzanine and sub index," explains one investor who was on that call.

He adds: "On the call, the investors were generally unanimous that this was not a product that they wanted to see in the marketplace. They felt it would not be beneficial to the market and could introduce a lot more volatility. It was also unattractive as a CDS-based index, whilst there is still a relatively undeveloped CDS marketplace in European ABS, especially considering it is in the non-conforming sector that is likely to be one of the more volatile areas."

The investor says nobody spoke out on that call in favour of the non-conforming index. However, Markit appears to be persevering with the project regardless.

A month after the conference call, Markit thanked the investors for their comments and asked them to give further feedback through a survey. One respondent reiterated that it would be a bad idea to launch such a product until the market has recovered more fully and declined to give any further feedback.

Rob Ford, portfolio manager at TwentyFour Asset Management, was one of the investors contacted. He says he did not reply to this survey, but that he agreed with the sentiment that the timing was not right for an index of this nature.

Chris Ames, senior fixed income portfolio manager at Schroders, is similarly unimpressed by Markit's proposals. He says: "I distrust indices that are built with illiquid instruments. If you were trading a derivative based on the Dow Jones Industrial Average and you felt that derivative was mispriced, then you could do something about it with the underlying assets. With the product Markit is proposing, there is no way you could construct the underlying portfolio in cash or even buy protection on all the underlying assets."

Ames continues: "It becomes a completely sentimental index. It is an opportunity for trading desks and hedge funds to maximise their trading profits at the expense of potentially remarking the cash sector, which I think most people treat as a buy-and-hold sector."

"Investors are not behind this; Markit seems to be being driven by the dealers," says the investor. "The strong suspicion is that this is being driven by the US investment banks. They were the driver in 2005/2006 for the development of the ABX mortgage index, which was subsequently tranched and ultimately became the product that helped to drive spreads significantly wider in US subprime. The volatility which was introduced by that product was huge."

Ames, meanwhile, is equally unequivocal in his explanation for why Markit seems to be disregarding investors' feedback. He says: "This is a completely dealer-driven exercise. Investors were given a say, but they were ignored. Investors have said they do not want this index and yet the issue has not gone away."

He adds: "This has played out as dealers and hedge funds against investors. People who have a longer-term stake in the market are not interested in this product, but people with a more short-sighted view are. Unfortunately, that has a knock-on effect on the longer term too."

This is not the first time such indices have been planned. A synthetic European CMBS index was approaching completion when the market breakdown in 2007 saw it shelved (see SCI issue 72).

Ford worked on that index. He says: "I was heavily involved at the time with trying to help Markit set up the CMBS index. We worked very hard for a long time to put it together and we were looking at something which would have been introduced to the market in late 2007. At that time, we had a big, liquid, tradable market with lots of contributions and it looked like an index which could have been very useful to the marketplace."

Another planned index, this time in 2008 for prime RMBS, also had to be scrapped (see SCI issue 93). Spreads had been very tight and stable the year before, but had since widened and reached around 60bp-70bp over Libor. However, the investor explains that the index became unviable very quickly.

He says: "In the run-up to the launch of that index the spreads in the market widened dramatically in both CDS format and in cash bonds. Rumour has it that this was initially driven by one particular US investment bank, which aggressively sold bonds or pushed up the bid for protection."

The investor continues: "This meant that spreads widened from 70bp over Libor to almost 200bp over Libor in the space of a few weeks in the early part of 2008, just as the proposed prime index was due to be launched."

That sort of volatility is why Ford is now more cautious. He explains: "As fund managers, we are heavily engaged in trying to win back our investors' confidence and to win back overall confidence in the marketplace. Most of us are not in a position in any of our funds to use CDS or synthetics or indices under our fund investment rules."

Markit says investors have been heard and the final version of NCRMBX is still to be decided on. The firm says it is "currently working with a number of market participants to launch a synthetic CDS index referencing UK non-conforming RMBS in 2011. The index is currently still in the planning phase and, as such, no finalised details can be provided at this time regarding the composition, licensed entities or launch date."

Nevertheless, the investor concludes: "I'm not particularly in favour of the dealers setting up what could be seen as a punting instrument for them to play in, which could be open to abuse in times of less liquidity. It doesn't really make sense to me. I'm not sure the European market is ready to support an index of this type."

JL

ABS

Euro ABS slows down

It has been a quiet week for the European ABS market, with bid-lists the only source of activity. A leg-down in Granite triple-B levels proved to be the highlight.

"It's been a fairly quiet week overall; much quieter than usual," one ABS trader says. The most significant movement this week was the price shift in Granite triple-B paper, he adds, which moved down from the 66-67 levels of last week to 65.

Aside from this, the main source of activity came from bid-lists, particularly in CMBS and mezzanine bonds. "The execution levels on the lists were all pretty good as everything was a few points higher than the last time. However, the volume just hasn't been there this week."

Another ABS trader concurs: "There hasn't been much activity away from the bid-lists, although we have seen more sellers than buyers this week." He adds that as activity slows, spread levels also remain stagnant.

Although primary activity has been absent this week, the market does anticipate an influx of new issuance next week. "Issuers and investors normally like to get things signed off before the quarter-end, so the market should be on a different ground soon," the second trader concludes.

LB

ABS

Charge-offs set for accelerated improvement in Q2

Moody's US credit card charge-off rate index is expected to drop below 7% in the second quarter, falling by approximately 17% from its 4Q10 level of 8.5%. The agency notes in its latest Credit Card Statement publication that although the index is likely to rise in February and March from January's projected 7.5%, improvement in losses should accelerate in the second quarter.

This forecast is based primarily on the observed relationship between credit card delinquency rates and lagging charge-off rates, Moody's says. At the trust level, charge-offs will fall for most of the six largest credit card securitisers by 15%-20% from 4Q10 levels in 2Q11.

For Citi's CCCIT programme, for example, charge-offs are likely to fall faster than the index in 1Q11 (by 15% versus 9% for the index), but remain fairly flat in 2Q11 due to stable early-stage delinquency rates in more recent months. The accelerated improvement for CCCIT resulted from a 4Q10 pull-forward of losses related to a change in charge-off recognition policy for deceased cardholders.

For Bank of America's BACCT programme, meanwhile, Moody's expects charge-offs to decline to 9.2% in 2Q11, which is higher than peer levels and still significantly higher than its pre-crisis rate of approximately 5% at the beginning of 2007. Since peaking in 1Q09, the charge-off rate for this trust has been falling steadily, but at a slower pace than the index. This trend will likely persist in the near term, as BACCT's charge-off rate will fall by approximately 13% in 2Q11, compared with a 17% decline for the index.

Meanwhile, the early-stage delinquency index has been improving since 2Q09 and is now at historically low levels. At the same time, roll rates to default have remained elevated since peaking in December 2009 and Moody's expects only mild improvement in the near term.

CS

CDS

Straps touted for widening market

Structured credit strategists at Citi outline in a recent client note their concern with the increasingly bullish consensus that European leaders are on the point of solving the region's sovereign and financial debt problems - despite apparent disagreements on key elements of any resolution. They suggest that by selling options investors can reduce exposure to any tightening while delivering superior results.

"More specifically, at this point, we like selling out-of-the-money receivers and 'straps'. We consider this on a standalone basis or a relative value trade against equity markets," the Citi strategists explain. A strap involves selling at-the-money receivers and at-the-money payers in a ratio of 2:1.

They note that the timing for such a strategy looks good across most of the main indices. iTraxx Main is near the 95bp resistance level that has been in place since May and a major break to pre-crisis levels seems improbable.

For the Crossover index, resistance levels seem even more well-established: the index has never traded tighter than 382bp since 2008. Resistance levels are less well-defined for the CDX, however. It recently broke 82bp, leaving 77bp as the next resistance point, according to the strategists.

"One way to profit from the view that credit indices are at tights and likely to move sideways or wider would be to look at the swaptions market," they observe. "For European indices, where there is potential for a large sell-off, buying out-of-the money payers seems more appealing. For US indices, where a sideways move is more probable, we think buying payers is less attractive than selling straps or out-of-the-money receivers."

CS

CMBS

Bond extension expected for Opera Uni-Invest

A bond maturity extension is expected to feature in a restructuring proposal for Opera Finance (Uni-Invest), if it defaults on its standstill agreement. This would be the fourth maturity extension in European CMBS and a closely watched one, according to CMBS analysts at Barclays Capital, given that it would be the first to be triggered by a pending bond maturity (in February 2012).

On its 15 February loan interest payment date, the Opera Finance (Uni-Invest) senior loan balance target of €580m was not met. The borrower was then given 10 business days to remedy the breach. In the event that the borrower fails to do so, a default under the standstill agreement would occur, entitling the special servicer or the mezzanine facility agent to terminate the standstill period.

The special servicer on the deal has received an undertaking by the borrower group to deliver a business plan by 11 March and a restructuring proposal by 18 March. To ensure borrower operational flexibility, the special servicer will also seek approval to enter into a new one-month standstill period subject to monthly rollovers.

"Taking into account the CMBS maturity in February 2012, we think that it is very likely that an extension of the CMBS bonds will be proposed," the BarCap analysts note. "This will be potentially accompanied by an increase in loan and CMBS notes margins, a change of the issuer level principal waterfall and/or conversion of mezzanine debt into equity."

Given the upcoming note maturity in 2012 and current NTV levels, they suggest that - compared to past bond extensions - it will be harder to incentivise the more senior noteholders to approve the amendment. The outcome will depend on the details of the restructuring proposal, as well as the updated valuation of the properties and a scenario analysis.

CS

CMBS

Euro CMBS pipeline building

A handful of new European CMBS are set to launch in the coming months, each sized at £300m-£500m and backed by trophy buildings, with good lease terms and well-known tenants. It remains unclear where primary paper can be expected to price, however.

"I expect to see some deals in April or May: borrowers are looking to close quickly, but the ratings and book-building processes are slowing efforts down somewhat," confirms one structurer. "I'm surprised to see CMBS return before the loan markets in Europe, but it speaks to the usefulness of the technology."

One transaction believed to be close to launching via Deutsche Bank securitises the Chiswick Park loan, with Blackstone said to have bought the equity piece. Nevertheless, the structurer indicates that the depth of the investor base for new issue CMBS remains unclear.

"It comes down to appetite from insurance companies and pension funds, but the capital treatment for CMBS is a mess for them. Yet they understand the need to invest in debt and property, so they may be pushed towards CMBS," he says.

Appetite for secondary European CMBS paper among banks and hedge funds appears insatiable, however. "Post-crisis investors are savvier in terms of realising risk: there has been a shift in mentality from buy-and-hold towards being prepared for a number of different distressed or restructuring strategies. Not many bonds used to trade, but this has changed now. We've even seen bondholders building up positions in a deal, working through the problems and then selling the position at a profit - particularly where servicers have been replaced because they're seen to be relatively inactive," one portfolio manager notes.

While heavy volumes in secondary trading have also bolstered demand for new issues, it remains unclear where primary paper can be expected to price. A recent Barclays Capital research article suggests that the senior tranche of the Chiswick Park deal could price at 250bp over Libor, with the subordinated tranches coming at 300bp and 350bp. However, the portfolio manager points out that this estimate is based on secondary levels and thus reflects the risk of assets valued in 2007, whereas new issues should price tighter because the underlying properties are better quality.

CS

CMBS

REC 6 restructuring mulled

Three restructuring plans have been proposed for the REC 6 (Alburn) CMBS, following a failed tender for the notes (SCI passim). Strategists at Chalkhill Partners suggest that the first option is likely to be unattractive to senior noteholders, while more work is required to flesh out the strategy and eventual value recovery to enable a decision to be made between the second and third options.

Option one involves a senior loan of £90m being granted. The current CMBS structure would then be collapsed and the £90m distributed to noteholders, with the portfolio sold down and remaining distributions made by 2016.

The second option would see an orderly sale of assets to be completed by 2014. The Chalkhill strategists expect funds to flow sequentially after repaying swap breakage costs.

Finally, the third option is to work out the portfolio over a five-year period, which the strategists indicate is effectively an extension to legal final. The portfolio would be managed by the sponsor until an eventual sale in 2016, when it will receive an agreed fixed fee and potential equity once all debt is repaid.

CS

ABS

Analytics providers team up on ABS

Moody's Analytics is set to make its structured finance deal data and analytics available to DelphX subscribers. The agency will also establish a link to connect its users to the DelphX network from Structured Finance Workstation (SFW), Moody's cashflow and valuation platform for structured finance.

Additionally, Moody's SFW users will be able to enter, negotiate and execute orders on the DelphX network in real-time, which provides a transparent and global facility for public disclosure of asset-level data, documentation and waterfall cashflow projections for new SF securities. Further, DelphX subscribers will gain access to the potential value of assets, portfolios and securities while viewing their historical market values, informed by the interaction of DelphX members' trades.

ABS

Credit trading head hired

RBC Capital Markets has hired Ian Pearce as head of European credit trading. He joins the team in London from UBS, where he was most recently co-head of sterling credit and European ABS. Pearce will report to John Greenslade, head of fixed income and currencies for Europe.

Harry Samuel, global co-head of fixed income and currencies, comments: "Ian is a fantastic addition to our European platform, where we have a dedicated and experienced credit trading team. Ian and his team will be responsible for ensuring we maintain our position as the market leader in UK credit trading and on all major electronic credit trading platforms."

CDO

CDO manager replaced

FriedbergMilstein has been replaced as collateral manager on FriedbergMilstein Private Capital Fund I by GSO/Blackstone Debt Funds Management. GSO/Blackstone is understood to have provided collateral management services to the issuer as sub-adviser since July 2007 and the transfer of management responsibilities to the firm is not expected to result in a material change of personnel or resources.

Moody's confirms that, in connection with the proposed termination and appointment, all requisite consents and approvals have been received and conditions precedent to the termination and appointment of the collateral manager will be satisfied. It has determined that the replacement will not result in the withdrawal, reduction or other adverse action with respect to the current rating of any class of notes.

CDS

Key hires for credit hedge fund

Candlewood Investment Group - which focuses on distressed debt, special situations and structured credit - has hired Al De Leo as head of trading and Gurdev Dillon as cfo. De Leo joins from Marathon Asset Management, where he was a portfolio manager, while Dillon comes from Archer Capital Management, where he was also cfo.

Michael Lau, Candlewood ceo, says: "We are excited to expand our team with two professionals of such high calibre. Al and Gurdev join Candlewood in key areas of the business and further enhance our ability to serve the best interests of our clients."

CDS

Advisory firm adds structured credit pro

TradeRisks has appointed Jon Slater as joint chief executive. He joins from JPMorgan, where he was global head of structured credit trading.

Slater and Alex Pilato, the founder and existing chief executive of TradeRisks, previously worked together at JPMorgan from 1989 and also at Tokai Bank Europe from 1997. Slater subsequently re-joined JPMorgan in 2000, where he has spent the past 11 years developing and leading its structured credit trading business.

CDS

Broker beefs up distressed desk

BTIG has appointed Elie Radinsky and Mark Palmer to work on its high yield and distressed desk. The desk - led by Robert Langer - is part of the firm's wider fixed income group and covers various sectors, including structured products.

Radinsky joins BTIG as md and head of high yield and distressed analytics. With over 20 years of industry experience, he joins the firm from Chapdelaine Credit Partners, where he was head of high yield and distressed desk analysts. Prior to this, he was head of high yield and equity arbitrage research at Summit Securities Group.

Palmer assumes the role of md, high yield and distressed desk analyst. He was previously a portfolio manager with Prudence Holdings, as well as a high yield and distressed debt analyst with AIG Global Investment Group and BNY Capital Markets.

CDS

SEF beefs up leadership team

Javelin Capital Markets has appointed Mike Hisler and Chris Koppenheffer as its CDS and interest rate swaps heads respectively.

Hisler most recently launched the boutique investment bank, Hexagon. Prior to this, he was md of institutional credit sales at UBS, where he focused on management and sales of corporate credit and structured products.

Koppenheffer was most recently at Mizuho Capital Markets, where he was responsible for all US dollar interest rate derivatives sales and trading. Prior to this, he was senior md at Bear Stearns, where he traded IRS.

CMBS

CRE firm adds svp

Broad Street has appointed Tim McCann as svp of its acquisitions and capital markets group. In this role, he will work closely with Broad Street principals Tom Yockey, Mike Jacoby and Jeff Kelly on sourcing new acquisitions and building the firm's debt and equity relationships. Prior to joining Broad Street, McCann held both credit and underwriting positions with several leading commercial real estate firms, including AEW Capital Management, JPMorgan, Ernst & Young and Transwestern.

Distressed assets

Distressed debt practice formed

Mintz, Levin, Cohn, Ferris, Glovsky and Popeo has formed a distressed debt and claims trading practice. The group - spearheaded by Frank Earley, Dominic Picca and Paul Ricotta - will be comprised of bankruptcy and litigation attorneys from across the firm's offices.

The group will assist clients in all aspects of the acquisition and sale of distressed investments. Clients will include both the sellers and buyers of these instruments, ranging from domestic and international private equity and hedge funds to private investment funds specialising in distressed investments - as well as trade creditors seeking to liquidate their bankruptcy claims.

"As the distressed debt market continues to evolve, client demand for experienced professionals who can navigate this complex industry is at an all-time high," says Richard Mikels, chairman of Mintz Levin's bankruptcy, restructuring and commercial law section.

RMBS

Real estate fund acquisition agreed

ING has reached an agreement to sell the majority of its ING Real Estate Investment Management (ING REIM) business in two separate transactions for a combined price of approximately US$1bn. In addition, as part of the transactions, ING has agreed to sell up to approximately US$100m of its equity interest in existing ING REIM funds.

CB Richard Ellis Group is set to purchase ING REIM Europe, ING REIM Asia and Clarion Real Estate Securities (CRES), as well as part of the equity interests in funds managed by these businesses. ING REIM Europe, Asia and CRES combined have €44.7bn in AUM as of 31 December 2010.

In a separate transaction, ING has agreed to sell the private market real estate investment manager of its US operations, Clarion Partners, to Clarion Partners management in partnership with Lightyear Capital for US$100m. Clarion Partners has €16.5bn in AUM as of 31 December 2010.

In the transaction with CB Richard Ellis, ING Insurance has agreed to continue its asset management mandate with CB Richard Ellis as the new manager of the funds. ING Bank will continue to have an equity interest in some REIM funds in Europe, Asia, the US and Australia. The equity stakes held by the bank will be monetised over time as it continues to steadily reduce its exposure to real estate.

Combined, the transactions are expected to result in an after-tax gain on disposal of approximately €500m at current exchange rates. Both transactions are expected to close in the second half of 2011 subject to approval.

"With these transactions, we continue to deliver on our strategic objectives of reducing exposure to real estate, simplifying our company and further strengthening our capital base," says ING ceo Jan Hommen.

The REIM business in Australia - with €4.8bn in AUM as of 31 December 2010 - is not included in these transactions. ING says it will undertake a phased withdrawal from its Australian real estate investment management activities.

ABS

Used vehicle market supports auto ABS

Strong recovery rates and residual realisations among both new and used vehicles should continue to benefit asset and ratings performance for US auto ABS into next year, according to Fitch.

Robust used vehicle values will likely continue to be supported by the notable reduction in supply of vehicles coming into the used vehicle market that began in 2009, the agency says. This reduction is a direct result of the markedly lower level of new vehicle production and sales beginning in late 2008, as well as the low lease origination volumes, relatively low incentive levels and increasing used vehicle age and scrappage rates.

On the supply side, new vehicle production and sales levels have remained compressed relative to historical standards for the last three years. According to WardsAuto.com, light vehicle sales averaged 17.2m units from 2000-2007, then dropped to 13.5m in 2008, 10.6m in 2009 and 11.6m in 2010. Fitch expects a sizeable increase in US light vehicle sales for 2011 - between 12.5m and 13m vehicles.

Meanwhile, retail lease origination volumes decreased considerably in 2008 and 2009 following periods of heavy residual losses. While lease penetration rebounded in 2009 and 2010, the origination levels serve to further limit used vehicle supply through 2013 due to fewer returned off-lease vehicles.

In terms of demand, "recent economic uncertainty has forced many potential buyers to the sidelines, creating pent-up demand for both new and used vehicles. The number of scrapped vehicles has exceeded new vehicle sales in recent years, which has also spurred demand," says Fitch director Brad Sohl. Average vehicle age increased during the same period, suggesting that the overall light vehicle fleet in the US is aging and demand for replacement vehicles will remain strong.

According to Manheim Consulting's Used Vehicle Value Index, used vehicle values rebounded and stabilised in 2010 and 2009 after dramatic declines, particularly for SUVs and trucks, in 2008. The index reached a record high of 124.9 in January 2011, rising 27.4% from its near historical low of 98% in December 2008.

Despite its positive outlook, Fitch warns of numerous factors that still present risks to the stability of the wholesale vehicle market. "Fuel price volatility and a lack of manufacturer discipline, in terms of both production and incentive levels, could still reverse the positive momentum. Residual value setting policies by lease originators and third parties can drive auto lease ABS residual loss levels higher, even in a stabilised wholesale vehicle market," adds Sohl.

Nonetheless, these potential risks are unlikely to dent strong wholesale market trends for the next few years, Fitch concludes.

CDO

CDO auction fails to attract enough bids

Investors in the Duke Funding High Grade I CDO have been informed that an auction call redemption will not occur on the 7 March quarterly distribution date. This is because the trustee was unable to sell the collateral via an auction as it didn't receive bids that, together with the balance of all eligible investments and cash in the accounts, would be at least equal to the auction call redemption amount.

The trustee, Bank of New York Mellon, says it will continue to conduct auctions prior to each subsequent quarterly distribution date unless the collateral manager notifies it that - due to market conditions - the auction is unlikely to be successful. It will sell the collateral only if the sale results in sale proceeds, together with the balance of all eligible investments and cash in the accounts, greater than or equal to the auction call redemption amount. Investors may, however, elect to receive less than 100% of these assets - in which case, the auction call redemption amount shall be reduced accordingly.

CDO

Trups CDO defaults, deferrals pick up

The New Year began with a slight pick-up in default and deferral activity for US bank Trups CDOs, according to Fitch's latest indices for the sector. Bank defaults increased by 0.36% to 15.17% at 31 January, while bank deferrals rose 0.12% to 18.19%.

The combined default and deferral rate for banks within Trups CDOs increased to 33.36% from 32.88%, while new deferrals remain significantly lower, with five in the first month of 2011 compared to 16 in January 2010. "While the rate of new deferrals continues to decline year-on-year, the pace remains elevated relative to 2008 levels," says Fitch director Johann Juan.

There was a modest level of M&A activity among banks over the last year. "Most acquisition activity has focused on consolidation among small community banks, which typically characterise Trups CDO portfolios," adds Juan. However, there were exceptions to the trend, with some acquisitions of regional banks by foreign institutions and investments by private equity firms during the second and third quarters of 2010.

At the end of January, 160 bank issuers were in default - affecting US$5.71bn held across 82 Trups CDOs - while 391 deferring bank issuers were impacting interest payments on US$6.85bn of collateral held by 84 deals.

Beginning this month, Fitch says it will count any issuer that files for Chapter 11 - regardless of FDIC closure status - as a default in its default and deferral index.

CDS

Subprime CDS rally continues

The latest Fitch Solutions index results indicate that US subprime CDS prices have increased for the third consecutive month. The current index level of 11.37 is the highest since October 2008 and the agency notes that market conditions remain supportive of further price increases.

The index increased by 5.2% last month, having increased 7.2% the month before. Both the 2004 and 2007 vintages saw returns of over 7%, although the 2006 vintage actually declined by 1%.

"Declining default rates, delinquency rates and prepayment rates with increasing market risk appetite are delivering a powerful boost to subprime asset prices," explains Fitch director David Austerweil. "The recent sharp rise in mortgage rates has been accompanied by a significant decline in constant prepayment rates."

Fitch says the decline in CPRs was skewed toward the most credit-sensitive borrowers, with the one-month CPR declining 7.6% for the 2006 vintage and 11.2% for the 2007 vintage. Delinquency rates are also declining, with drops in the 60-day delinquency rate across vintages.

"The decline in 60-day delinquencies was substantial for the 2007 vintage and it is now 30% lower on a year-on-year basis," notes senior director Alexander Reyngold. "If recent delinquency trends indicate that most troubled borrowers are already in foreclosure or have had successful loan modifications, delinquency rates should continue to decline."

Fitch believes the biggest risk now for subprime index prices comes from increased severities due to further potential residential home price declines and the large inventory of foreclosed homes.

CDS

CBOE to list credit event options

The Chicago Board Options Exchange (CBOE) will begin trading newly-designed credit event binary options (CEBOs) contracts on 8 March.

CEBOs contracts allow investors to express an opinion on whether a company will experience a credit event. Due to inverse correlations between credit and equity markets, CEBO contracts can also be used as a hedging tool for individual stocks, while also providing price transparency through a regulated exchange - currently unavailable in OTC CDS markets.

A CEBO contract has just two possible outcomes - a payout of a fixed amount if a credit event occurs or nothing if a credit event does not occur. Bankruptcy is specified as the only trigger for a payout, thereby simplifying the terms of a payout. If a bankruptcy occurs prior to expiration of the contract, the amount of the payout will be US$1000 per contract.

Initially, CBOE will offer 10 single-name CEBO contracts for trading; two of them will be introduced on 8 March, followed by eight on 9 March.

CDS

Succession event mulled

ISDA's EMEA Determinations Committee is deliberating whether a succession event occurred with respect to Brisa Finance. The Brisa Group confirmed at the beginning of January the substitution of Brisa Finance as issuer of €500m 4.797% Notes due 2013 in the context of the completion of the business reorganisation of the Brisa Group.

CDS

OTC electronic trading recommendations released

The IOSCO Technical Committee has published a report analysing the benefits, costs and challenges associated with increasing exchange and electronic trading of OTC derivative products. The report also contains recommendations to assist the transition of trading in standardised derivatives products, while preserving the efficacy of those transactions for counterparties.

The report was prepared by the Technical Committee's task force on OTC derivatives regulation in response to a request from the Financial Stability Board to examine increasing exchange and electronic trading of OTC derivative products. This was in response to the G20 Leaders' commitments on this issue and their stated objectives of improving transparency, mitigating systemic risk and protecting against market abuse in the derivatives markets.

The report concludes that it is appropriate to trade standardised derivatives contracts with a suitable degree of liquidity on organised platforms. Also, the report states that a flexible approach to defining what constitutes an organised platform for derivatives trading would maximise the number of standardised derivative products that can be traded on these venues.

Hans Hoogervorst, chairman of IOSCO's Technical Committee, says: "IOSCO believes that it is appropriate to trade standardised derivatives contracts with a suitable degree of liquidity on organised platforms, provided that a flexible approach encompassing a range of entities that would qualify as such platforms is taken by regulators."

He continues: "While there is debate amongst regulators regarding the characteristics that an entity should exhibit to qualify as an eligible organised platform, the overriding principle that regulators must observe is that they need to coordinate their efforts in facilitating the transition of OTC derivatives trading to organised platform trading to ensure that the objectives of the G20 are achieved and not undermined."

The report identifies seven characteristics of organised platforms. First, the registration of a platform with a competent regulatory authority, including requirements relating to financial resources and operational capability should be implemented. Second, access for participants based on objective and fair criteria that are applied in an impartial, non-discriminatory manner.

Third, pre- and post-trade transparency arrangements are appropriate to the nature and liquidity of the product and the functionalities offered by the platform. Fourth, the report stresses the importance of operational efficiency and resilience, including appropriate linkages to post-trade infrastructure and measures to handle potential disruption to the platform.

Fifth, active market surveillance capabilities, including audit trail capability. Sixth, transparent rules governing the operation of the platform; and finally, rules that do not permit a platform operator to discriminate between comparable platform participants in relation to the interaction of buying and selling interests within the system, whether fully electronic or hybrid.

Many Task Force members believe that the opportunity to seek liquidity and trade with multiple liquidity providers must be offered within a centralised system. However, some believe that benefits can be realised where the opportunity to seek liquidity and trade with multiple liquidity providers is offered within a product market as a whole - irrespective of whether a particular platform offers access to multiple liquidity providers.

CDS

Swaps conduct standards 'go too far'

SIFMA is concerned about a proposed rule on conduct standards for swap dealers and major swap participants. In a comment letter to the CFTC, the association says it is worried about various aspects of the proposal - including unintended consequences for swap dealer customers - and suggests that there are instances of the CFTC going beyond the mandates of the underlying legislation.

The CFTC's business conduct standards rule relates to the relationship between swap dealers and major swap participants and their counterparties. This includes 'special entities', such as pension funds and state and local governments.

"We have serious concerns with the Commission's proposed rule and believe that, if implemented in its current form, it would inappropriately transform the nature of the relationship between swap dealers and major swap participants and their counterparties," says Ken Bentsen, SIFMA evp.

He adds: "We also believe that the overly broad proposal could effectively preclude participation in swap markets by pension plans, municipalities and other entities. As written the rule would seek, in effect, to impose a new fiduciary duty on institutional swap participants, a proposal that Congress rejected during consideration of the Dodd-Frank Act."

SIFMA says some of the CFTC's provisions go far beyond the requirements of the Dodd-Frank Act and that even those provisions that do not exceed Dodd-Frank are still concerning. The provisions include requirements-based best practices and rules that are rooted in retail customer protection, while the swap deals covered by the proposal are conducted in institutional markets. SIFMA says the proposals would limit the transactions that could take place in the institutional market by imposing a more restrictive regime than is currently in place in the retail market.

The association insists that communications between dealers and their customers providing information about potential transactions should not be deemed recommendations requiring dealers to perform special duties because that will discourage them from providing useful and important information to their customers. It is also worried that provisions to prevent front-running impose trading prohibitions that go beyond those in any other market and would handcuff legitimate dealer activity, even when a dealer is merely in early stage discussions with a counterparty.

Requiring dealers and major swap participants to obtain certain information or make disclosures prior to executing a transaction also concerns SIFMA, which says this is not feasible in many circumstances. Further, SIFMA says this will create delays that will adversely impact liquidity in the swaps market.

Finally, it is noted that the proposed rules and increased reliance on swap dealers and major swap participants do not fit with the fiduciary regulations of the Department of Labor (DoL). SIFMA says that if swap dealers are treated as fiduciaries under the DoL regulations, then any swap transaction with ERISA plans will immediately become a prohibited transaction under ERISA.

CMBS

CMBS restructured on REIT conversion

The Imser Securitisation 2, an Italian single-loan CMBS backed by 197 specialised telecom properties, has been restructured upon an application by the borrower and its majority shareholder for the special tax regime existing for REITs in Italy. This follows changes to corporate taxation in the country, under which an additional tax exposure has arisen for the borrower - Imser 60 - in the estimated amount of €226.7m over the remaining term of the transaction, causing a cash shortfall under the loan starting from 2009.

The estimated yearly shortfalls are covered by a payment undertaking of the shareholder of the borrower, Beni Stabili, which in turn is secured by a bank guarantee provided by Intesa Sanpaolo.

The main changes made to meet the legal requirements of the REIT regime include: a change of the legal form of the borrower from a Italian law limited liability company to a joint stock corporation; amendments to certain lender control rights and dividend distributions provisions under the loan agreement and the share pledge agreement; implementation of tax consolidation arrangements between the borrower and the majority shareholder; and amendments to the existing financial support undertakings of the majority shareholder.

Based on Moody's understanding, the applicability of the REIT regime leads ultimately to a significant reduction of the borrower's tax burden. However, it also imposes certain other financial obligations on the borrower, such as a one-off exit tax payment as a consequence of the change of its tax and legal status, and mandatory annual dividend distributions.

Nevertheless, in Moody's view, the restructuring does not negatively impact the rating on the notes. But the agency notes that the ratings remain dependant on the successful implementation of the business plan and an interpretation of the existing tax legislation by the tax authorities and/or courts similar to that of the tax and legal advisors involved in the restructuring.

CMBS

Decrease seen in delinquent unpaid balance

The US CMBS delinquent unpaid balance decreased slightly last month by US$229.8m - down to US$62.09bn - from the previous month, according to Realpoint's latest Monthly Delinquency Report. This 0.4% decrease follows increases of US$1.21bn and US$1.93bn respectively in December and November.

This is only the second time in the past 12 months that the delinquent unpaid balance decreased, following the previously recorded decline in October 2010 -mostly attributed to the resolution of the US$4.1bn Extended Stay Hotel loan from the WBC07ESH transaction. The decline in January is attributed to US$627.4m in loan workouts and liquidations reported across 81 loans, at an average loss severity of 46.5%, combined with the slower rate of new delinquency reporting.

This follows US$918.4m in loan workouts and liquidations for December across 143 loans, at an average loss severity of 56.7%, and US$636.3m in loan workouts and liquidations for November across 80 loans at an average loss severity of 45.7%. However, the delinquent unpaid balance in January is up 35% from one year ago and remains over 28 times the low point of US$2.21bn in March 2007.

Only two delinquency categories increased in January - 60-day and REO. With the ongoing rapid pace of loan liquidations, modifications and resolutions, the two most distressed categories of foreclosure and REO also fell by US$281m as a whole (1.2%) from the previous month, but remain up by US$14.15bn (147%) over the past year.

CMBS

Timely recovery for lodging loans

With almost US$10bn in lodging loan collateral scheduled to mature this year and another US$8.5bn due in 2012, a recovery in the sector is arriving at an opportune time, S&P says. While the early stages of recovery in the lodging sector first took hold in the higher-priced segments last year, the rebound is spilling over to the midscale and economy segments - something that will likely amplify the positive momentum already underway.

"Based on our analysis, the 2011 and 2012 maturing lodging loans are predominately within the upper upscale and independent segments; they are also concentrated in several major markets. We believe that borrowers for the maturing lodging loan collateral will find refinancing very selective over the next two years and the level of lender interest will vary by loan, market and chain segment," says S&P analyst Larry Kay.

In total, 34% of S&P's rated CMBS lodging loan collateral matures in 2011 (18.2%) and 2012 (15.8%). Of the lodging loans scheduled to mature in 2011 and 2012, 86% of the collateral balance comes from the 2006 and 2007 vintage years.

"It is our view that the RevPAR recovery to date, and considering our 2011 forecast, won't be enough to compensate for the operating declines that the sector has experienced. This will be particularly true for the maturing 2006 and 2007 vintage loans that were originated at or close to peak rental rates," Kay adds.

Further, the maturing lodging loans from these vintages may be more susceptible to default or modification as they were characterised by high leverage and underwriting that utilised pro forma operating statements, S&P says.

CMBS

US CMBS loss severities moderating?

The current historical weighted average loss severity for loans backing US CMBS that are liquidated at a loss increased in the last quarter of 2010, albeit at a slower rate than the prior quarter, says Moody's.

The average loss severity stood at 39.6% in December, up from 38.4% in September and 35.4% in June of 2010. Excluding loans with de minimus losses, the historical weighted average loss severity increased to 52.8% up from 51.5% a quarter ago and 49% in June.

An additional 425 liquidated loans were recorded in the fourth quarter at a weighted average loss severity of 45.9%, down from the 498 liquidated loans in the third quarter of 2010 with a weighted average loss severity of 52.6%. "We expect to see stabilising or increasing property values, higher transaction volumes, a slowing in the pace of loan delinquencies and greater liquidity for commercial real estate in 2011. In addition, the availability of debt capital continues to improve with terms returning toward market norms," says Moody's vp Keith Banhazl.

Total cumulative losses from the 1998 through 2008 vintages grew by 18bp to 0.96% from 0.79% a quarter ago. Moody's anticipates that the cumulative loss severity rate will continue to rise as more loans from the 2006 to 2008 vintages are liquidated at relatively higher loss severities.

Current loss severities vary widely by vintage, ranging from a low of 30% for loans from the 2000 vintage to a high of 58.8% for loans from 2006. "Our analysis considers timing relative to the cycle, origination vintage and year of default as factors that may be predictive of loss severity," adds Banhazl.

As expected, the majority of disposed loans continue to come from the 2006 to 2008 vintages. However, loss severities within these vintages remain volatile, with quarter-over-quarter loss severities falling for all three vintages from 61% to 58.8% for the 2006 vintage, from 60.9% to 57.8% for the 2007 vintage and from 53.2% to 51.1% for the 2008 vintage.

Loans backed by healthcare properties have the highest weighted average loss severity at 61%, while loans backed by mixed-use properties have the lowest average loss severity at 37%. The Dallas-Fort Worth-Arlington metropolitan statistical area maintained its status with the largest amount of liquidated loans by balance and loss amount, with a weighted average loss severity of 43% up from 42% last quarter.

CMBS

US CRE prices dip slightly

After three consecutive months of increases, US commercial real estate prices declined by 0.9% in December, according to Moody's/REAL National - All Property Price Index (CPPI). Although overall 2010 prices fell by 2.1%, the index has recovered by 5.5% since reaching its low in August 2010. Prices at the end of December stood at 42.1% below the October 2007 peak, the agency reports.

Moody's md Nick Levidy says: "A robust, broad-based recovery in commercial real estate prices has remained elusive, although some major markets - particularly capital-attracting gateway cities - continue to show signs of strength. However, we expect that an improving macro economy will mean fewer distressed sales as a percent of overall sales and higher transaction volumes, resulting in the emergence of positive market trends without the degree of choppiness seen in the index over the last year."

The total number and balance of repeat-sales transactions spiked in December, while November saw more than a 100% increase by count and nearly a 200% gain by balance over transaction activity. "A spike in transaction volume is typical for December as buyers and sellers attempt to close deals before the end of the year. However, the end-of-year spike in 2010 was particularly large," says Levidy.

All four property types showed an increase in prices in the past quarter, with apartment properties showing the smallest increase - gaining 3.6%. Over the full year, however, apartments have been the best performing property type, with prices rising by 11.8%.

Office prices increased by 5.1% in the past three months and have shown positive annual appreciation, rising 1.7%. Nevertheless, office property prices remain 30% off their 2Q07 peak.

Retail had the largest gain over the past three months, rising by 8.4%. However, over the last 12 months the retail sector has experienced the largest drop in prices, falling 2.7%.

The other property type to have recorded a decline over the past year is industrial, with a 1.8% decrease in prices in 2010. In the fourth quarter, however, industrial prices showed a 4.9% gain.

CMBS

Euro CRE recovery limited to prime sector

Signs of recovery in the European commercial real estate market are being reported, but only in for prime properties, according to S&P. Given that the European CMBS universe is secured mainly by secondary assets, the agency therefore believes that loan maturity performance will remain under pressure in 2011.

Reports of asset sales over the past 12 months indicate that the secondary market is lagging behind the prime market in a number of jurisdictions. In the UK, for instance, asset sales have picked up since their trough in 2009, in part because trophy assets that promise income security are currently in demand from foreign and institutional investors.

However, the secondary market remains weak and constrained by the lack of finance for anything but the best quality stock. For Germany ¬- which suffered less severe peak-to-trough declines than the UK - a high demand for core properties with low risk is anticipated, S&P says.

However, the limited supply of such properties is likely to be a constraining factor on investment activity. In the French property market, investors appear to remain cautious and selective, with a strong concentration of asset acquisitions in the greater Paris region.

European CMBS loan performance in January was characterised by more loans failing to meet maturity obligations and either falling into default or being extended, S&P concludes.

RMBS

Moody's warns on Redwood earthquake risk

Investors in the new Redwood Trust RMBS should consider the risk posed by the underlying concentration of earthquake-vulnerable properties, warns Moody's.

"Based on preliminary information on the Sequoia Mortgage Trust 2011-1 transaction, we believe that the pool is more exposed to earthquake risk than most RMBS pools, given that 56% of the loans by principal balance are in California and much of that exposure is in the San Francisco Metropolitan Statistical Area (MSA)," says Moody's md Linda Stesney.

She adds: "If a major earthquake were to strike the San Francisco MSA, the decline in the values of damaged properties and the likelihood that borrowers could abandon properties whose value has plummeted will likely result in either losses to senior certificate holders or deterioration of the credit quality of the notes to junk status."

An April 2008 US Geological Survey study shows a 63% chance of a magnitude 6.7 or higher earthquake in the San Francisco bay region before 2038. The 1989 Loma Prieta earthquake, which was measured at 6.9, caused extensive damage in the San Francisco Bay area, rendering 9,202 homes uninhabitable.

"A high percentage of the loans in the new Sequoia transaction are in earthquake-prone areas and homeowners in earthquake-prone areas of California generally do not maintain earthquake insurance because of its high cost. In such a transaction a triple-A rated security must have enough protection to survive both credit losses under extreme economic stress and the damage from an earthquake," notes Stesney.

Moody's ran various scenarios to determine the potential loss to the triple-A rated portion of the transaction due to an earthquake of greater than seven magnitude at the end of any given year in the San Francisco area. For instance, if the earthquake occurs at the end of the fifth year - the pool prepays at the rate of 10% per year - 80% of the borrowers in the San Francisco MSA will default and the recovery on the damaged houses is 30% of the house price just prior to the earthquake.

"For example, if we determined triple-A credit enhancement to be 6.5% in the absence of an earthquake, we calculate that a pool that is highly concentrated in the San Francisco MSA could require an additional 50% enhancement to cover the incremental risk of damage from an earthquake to mortgage properties in earthquake-prone areas," says Stesney.

RMBS

Restructuring proposed for Sentry MBS fund

Sentry Select Capital is proposing to restructure the Sentry Select MBS Adjustable Rate Income Fund II to allow it to be administered as an open-end mutual fund - including daily liquidity at the net asset value per unit. If the fund is restructured, the structure of the management fees paid by the fund to the manager would also be changed; the existing Class X units and Class A units of the fund would be consolidated as Class X units; and the maturity of the fund would be extended beyond 30 April 2015.

The fund has continued to have difficulty in attracting a meaningful amount of new investments, Sentry says. In addition, net redemptions of units have continued consistently and the net asset value of the fund as at 16 February stood at approximately US$42.6m. In addition, Sentry has received a notice from BNY Mellon Alternative Investment Services - the custodian and administrator of MBS Limited Partnership - confirming a termination of the existing administration and accounting services agreement effective from 31 March.

A special meeting will be held on 17 March 2011 to consider the restructuring or, alternatively, the termination of the fund. Should the restructuring be approved by unitholders, it is expected to become effective on or about 25 March.

RMBS

Sequoia prices with stronger structure

Redwood Trust has priced Sequoia Mortgage Trust 2011-1 - the first US non-agency RMBS of the year - via Credit Suisse, Jefferies and JPMorgan. The US$270m triple-A rated (by Fitch) class A-1 notes priced at 4.125%. The offering is expected to close on 1 March.

The deal is backed by a US$296m pool of 303 prime mortgages consisting of 43% adjustable-rate loans, with an initial fixed and interest-only period of ten years, and 57% fully amortising fixed rate loans. First Republic Bank originated 65% of the aggregate pool and PHH Mortgage Corporation originated the remainder.

Analysts at S&P suggest that Sequoia 2011-1's structure is stronger than Redwood Trust's previous RMBS - Sequoia Mortgage Trust 2010-H1 - because it contains greater credit enhancement to the senior class (7.5% versus 6.5%), a greater subordination floor of 1.25% (versus 0.75%) and no two-times test to potentially accelerate the step-down date. The transaction's shifting interest structure, which uses subordination for credit enhancement, contains a five-year lock-out period for principal prepayments, subject to a subordination floor and delinquency and realised loss performance tests.

In addition to the triple-A rated tranche, the deal features triple-A rated A-IO notes, as well as double-A B-1, single-A B-2, triple-B B-3, double-B B-4 and unrated B-5 notes. The size of these tranches had not been disclosed at the time of writing.