Contents

ABS

Discretion development

Sea-change seen for European trustees

The trustee's role in the European securitisation market has undergone a sea-change since the onset of the financial crisis. At the same time, increased volume of deal restructurings and workouts has also brought more clarity around the tricky issue of trustee discretion.

Chris Knowles, deputy head of corporate trust & loan agency (CTLA) Europe at HSBC, says that pre-financial crisis the trustee role was somewhat misunderstood, but there has been a sea-change over the last four years with trustees stepping up to the plate on complex issues. "While discretion and indemnification are issues that won't disappear, at least there is better appreciation of the trustees' abilities now. Equally, trust deeds held up well during the crisis, so we haven't seen any wholesale rewriting here but more tweaks, for example, around downgrade language."

Rafe Morton, business development manager at Deutsche Bank, agrees that the role of the trustee is clearer now that the industry has more real life experience of workouts. "One obvious effect of the crisis was increased volume of restructurings and workouts rather than new business flow," he says. "Expectations about what trustees would do when transactions became distressed were unrealistic, given the fees paid. But there is better understanding post-crisis about the different courses of action trustees can take when transactions default."

Pre-crisis the role of a trustee was fairly passive and only became proactive after an event of default, with trustees being remunerated accordingly. But with the onset of more defaults, the trustee operating model shifted and more resources were allocated to default and amendment groups.

Equally, many origination teams disappeared during the crisis, leaving skeleton staff to service ongoing deals, according to HSBC co-global head of CTLA Europe Mark Crathern. This meant that trustees and agents were relied on as experts not only in terms of reporting, but also in terms of attempting to cure structural defects embedded in transactions and interpreting how inefficiencies with liquidity facilities should be resolved.

"The onus placed on trustees was to effectively become the originator/arrangers of transactions, but this isn't the typical skill-set of trustees," he explains. "Arrangers are still rebuilding their teams, so the substantial reliance on trustees and agents remains, especially for CDOs."

Similarly, exercising trustee discretion over changes in bond terms was fairly peripheral prior to the crisis. But this became sensitised, according to BNY Mellon md and co-head of EMEA corporate trust Dean Fletcher, mainly because investors were more focused on proposed changes, given the volatility of the environment.

"Discretion is now a core differentiator between trustees," he explains. "Prior to the crisis, pricing was the main differentiator. But now there is often an emphasis on how willing a trustee is to use its discretion." BNY Mellon has consequently added resources to its separate ring-fenced entity, which deals with such trustee issues.

"As a trustee, we would try to exercise discretion as much as possible," adds Anne Danhaive, co-head of CTLA transaction management and head of CTLA trustee services HSBC. "But there are issues where investors have to make decisions and cannot rely on trustee to make commercial decision on their behalf."

A related issue is changes in rating agency confirmation criteria. "Investors are being pragmatic about the changes, but there are certain issues that are beyond the realm of trustees exercising discretion. In these cases, we'd expect noteholders to provide direction," Morton notes.

The introduction of a range of rating agency engagement levels, depending on the materiality of the change in documentation, has been suggested as one way to approach rating agency confirmations (see SCI 2 June). However, Morton says that the concept of materiality is subjective and suggests that it would be difficult to gain consensus on what this range should be, especially as the situations where trustees have to use their discretion are deal-specific.

Nevertheless, Fletcher suggests that the clarity around the use of discretion has improved post-crisis. "The concept of something being materially prejudicial to investors is complex, so often the process and due diligence involved in reaching a decision is as important as the decision itself," he notes. "The volume and nature of amendments is constantly changing, so the policy set around how a trustee reaches decisions is key. However, the issue of discretion highlights a potential conflict: trustees act on behalf of noteholders, but are often appointed by other parties to the transaction."

Clarity around discretion is being facilitated by improved documentation for new issues. "There is a greater focus on downside risk, albeit some documentation is better than others in terms of specifying what a trustee should do in the event of a default," says Morton.

BNP Paribas Securities Services global head of sales and relationship management Gary Webb concurs: "There is a misapprehension that trustees will drive and have the resources to be able to remodel deals that become stressed, but that's not the role of the trustee. While the attention paid to the parameters for the exercise of trustee discretion and various other provisions in the documentation pre-crisis was sometimes not as high as it should have been, new deals are building in more information and clearer language that provides clearer direction if the transaction gets into difficulty."

He adds that there are specific instances in the remodelling of a deal where trustees turn to entities that can offer informed advice. "If a change is potentially materially prejudicial to noteholders, we might seek advice from legal or financial advisors. Typically most transactions have waterfall priorities [and] the trustee can be reimbursed for its costs before distributions are made. But problems occur when there is no money in the deal, in which case trustees have to be indemnified by the investors before they can act."

The trustee and agency business model is also changing as a result of the crisis, with an emphasis on relationship banking. "The aim is to get closer to clients and understand more about their general balance sheet funding requirements going forward. We're restructuring so that we're facing the market on a relationship rather than asset class basis and staffing up accordingly because the contact points are much broader," Fletcher confirms.

Indeed, the crisis has thrown out the need for trustees to be more accessible and transparent in terms of facing the market. Deal documentation typically has a generic set of contact details, so it takes time for noteholders to find the right people to talk to. This has lead, in some quarters, to noteholders becoming frustrated by their inability to speak to trustees quickly.

"When a deal is in crisis, the ability to identify a trustee quickly and actually speak to them is key," confirms Mark Jones, vp and EMEA product head, agency & trust, global transaction services at Citi. "Building relationships are important from a franchise perspective. Trustees are meant to be protecting the interests of noteholders and so we're looking to develop a more personalised approach towards communicating with them."

However, he says that the current system of communicating with noteholders remains a problem. "The messaging process is protracted and takes a long time and the industry is trying to find a better way of streamlining it to make it more efficient. Often trustees don't know who the relevant noteholders are, so it's difficult to ensure that the message gets through to the right people."

Webb agrees that reaching out to investors in a timely manner can be challenging - particularly where the trustee wishes to canvas investor opinion or get instructions. "Noteholder communications take time," he explains. "There are some industry initiatives underway to improve this, but the biggest problem remains how custodians handle notices. Investors historically had the ability to set criteria regarding which notices they want to be advised on; however, the selection process means that if a notice is classified incorrectly, it may never get to the investor."

Morton concurs that there is appetite to improve investor communications, citing the work being undertaken on this by ICMSA. "We need to redesign the whole process as an industry, but it is difficult to get investors to take part in a dialogue on how best to do this," he says.

In an ideal world, Jones suggests that a register of investors should be kept to faithfully record who moves in and out of positions. "But this is unlikely to happen as long as the market remains in bearer form with many noteholders keen to retain their anonymity," he notes.

In terms of producing reports for investors, some sensitivities remain around accuracy and timeliness. Technology is key in providing investors with access to these reports.

Jones notes that trustee reporting is improving, driven by pressure from issuers, regulators and rating agencies to facilitate transparency at the underlying asset level in the securitisation market. Citi, for example, has assigned a specific agent to this function and posts monthly collection and waterfall analyses, as well as originator and servicer information on a dedicated website.

BNP Paribas also has a dedicated website for investor reporting, but it is currently upgrading its systems to allow investors access to the underlying raw data. This comes ahead of the introduction by the European Securitisation Forum of minimum standards for data presentation.

With respect to technology, Fletcher points out that large-scale market changes are underway to harmonise pre- and post-trade processes. He expects the impact of technology on trustees to increase because the industry needs to be in step with developments in the overall market.

"Technological improvements will likely result in greater volume of deals but compressed fees for agents and it will be a case of the survival of the fittest. For the agency business, scalability of systems and a robust mid/back office are key," he notes.

With this in mind, the industry is trying to improve straight-through-processing around new issues and corporate actions, as well as improving documentation under the auspices of the International Securities Market Advisory Group (ISMAG). But Knowles notes that one impediment - from a new issues perspective - is the requirement to receive executed final terms.

"No matter how automated STP becomes, there will inevitably be breaks in the process because written instructions are necessary from the issuer. Only so much can be automated because it has to be balanced with legal requirements," he says.

Meanwhile, rating agency counterparty criteria changes are a significant issue for trustees at present. "With one stroke of a pen, S&P and Moody's have introduced more stringent criteria for agency roles, which are either driving them off transactions or forcing them to post collateral. The resulting increase in amendments to deal documentation is forcing trustees to spend greater amounts of time on what is perceived as 'post closing' issues than they have historically had to do," notes Jones.

He says that his firm is adopting a piecemeal approach in terms of dealing with counterparty issues as and when a trigger occurs. "We're looking at it in a reactive manner - although we've been able to formulate a view in terms of the approach we take regarding certain deals, which has allowed us to [be] more proactive, especially with regard to swap counterparties."

The collateralisation of derivatives components within deals also brings a new dimension to the role of the corporate trust service provider in terms of handling margin calls and preventing assets from being rehypothecated, according to Webb. "It's also challenging for structurers because they will have to build in a mechanism to facilitate this, which will likely drive up the cost of transactions going forward."

Looking ahead, Crathern says it's difficult to predict how the trustee role will develop until there is more clarity on the capital structures of new transactions. But he stresses that more thought is needed about the competing noteholder priorities prevalent in many structured transactions and how EODs and PEODs are managed in the future.

CS

CDS

Perfect settlement pushed

Cleared trade workflows scrutinised

The US SEC and CFTC are being lobbied to adopt and enhance their current proposals for CDS and interest rate swap trade workflows that are based on the doctrine of 'perfect settlement'. At the same time, new master execution documentation is being developed for SEF-clearable trades.

"There is at present an artificial construct in the market that requires a dealer to self-clear," explains Mike Hisler, head of CDS at Javelin Capital Markets. "This arrangement prohibits the existence of independent execution-only dealers and clearing-only firms, who would increase liquidity and reduce systemic risk. Dodd-Frank and its subsequent rules and regulations will provide for the proper separation of trading and clearing to ensure new independent competition enters the market, much like every other market."

He adds: "We'll end up with two worlds: the non-SEF bilateral world, based on ISDA documentation, and the SEF cleared world based on Dodd-Frank compliant documentation. Bilateral arrangements will start to disappear, except for bespoke-type products."

Further, the designation of eligible contract participant (ECP) under Dodd-Frank is expected to significantly open up the CDS and IRS market in terms of new execution-only entrants and thus increase liquidity. ECPs will be required to have a minimum threshold for trading CDS and IRS, which is anticipated to be US$5m in worth.

The new workflow for the SEF cleared market is likely to be similar to the CME's ClearPort energy futures market. Clearing-eligible CDS and IRS will have to be executed via a SEF and the workflow will feature dual-sided straight-through-processing, affirmation and confirmation in seconds, as well as pre-approved position limits at the clearinghouse.

Specifically, the Swaps & Derivatives Market Association (SDMA) on 3 June sent a letter to the CFTC and SEC urging the two agencies to mandate the doctrine of 'perfect settlement' under Title VII of the Dodd‐Frank Act. Perfect settlement allows clearinghouses/CCPs to mitigate trade latency by requiring that their constituent clearing members guarantee all their customer trades at time of execution, much like it is done in the listed derivatives market currently.

In other words, the trade is both executed and simultaneously accepted into clearing, unless the clearing member has given prior notice to the execution venue or SEF to prevent such a trade from occurring. Trade integrity is assured and settlement risk mitigated because the trade counterparty can look to the customer's FCM or clearing member to be made whole if the defaulting customer cannot pay.

According to the SDMA, settlement uncertainty - caused by time delays between the point of trade execution and the point of trade acceptance into clearing - directly constrains liquidity, financial certainty and increases risk. The association strongly believes that the Commissions in their entirety adopt proposed CFTC Rule 39.12 (B)(7) that requires clearinghouses to accept for clearing all eligible swaps trades transacted on SEFs immediately upon execution and all eligible swaps trades transacted off SEFs immediately upon trade submission.

The SDMA points out that the rule needs to be further clarified, however, consistent with the agencies' original intent of ensuring market adoption of perfect settlement. Its letter also outlines why the two suggested alternatives to perfect settlement - 'low latency' and 'high latency' solutions - are likely to be problematic.

ClearPort's energy futures market is the model that the CDS and IRS markets should look to, according to Hisler, as it's already successful in all areas highlighted in the SDMA's letter. "We believe the ultimate clearinghouse winner will be decided by whomever can protect market integrity the most," he notes.

At present, the CME CDS model, the CME and International Derivatives Clearing Group IRS model and the ICE energy swaps model all conform to regulatory requirements, providing real-time trade acceptance and anonymity. Consequently, these clearinghouses stand to gain market share under Dodd-Frank. ICE and LCH.Clearnet, meanwhile, are understood to currently be developing such trade flows for CDS and IRS.

CS

CLOs

Down-time for Euro CLOs

The European CLO market appears to be entering a quiet phase as macro events begin to dent investor confidence. However, market participants hope that next week's Global ABS conference will provide a much-needed boost to the sector.

"We've had a good few weeks up until the end of last week and the beginning of this week, when activity started to slow down. The market's just treading water while the rest of the world figures out what's going on," one CLO trader says.

He explains that, due to changing macro events, the CLO space is becoming increasingly nervy. "We're hitting a weaker patch and if there's a cold to be caught, then we're worried we're going to catch it."

The trader predicts a quiet period ahead, where bid/offers will widen and performance will weaken overall as a result. "There's no fundamental reason for the market to have any wobbles or weaken too much, but it's fairly commonplace that when large macro events happen it pauses and no-one wants to put themselves out on a limb to take risk on. It certainly does feel like we're heading down rather than up."

However, the market is not at the mercy of any "significant selling pressure", the trader says. He also adds that next week's Global ABS conference held in Brussels may bring some light relief to this week's slow-down.

"We're hoping that the conference will provide a boost or give the market some direction either way," he notes. "It will certainly be interesting to attend to see what the tone is."

Meanwhile, due to the low volume of activity, the trader points to a rise in did-not-trades as bids fail to hit reserves. He also notes that triple-B pricing levels have not resumed the highs of the beginning of the year.

"From triple-B down, we haven't come back to the peak levels achieved at the beginning of the year. You can read an awful lot into the fact that we're not reaching the highs of before. Let's just say that we're in for a bit of a quiet patch," the trader concludes.

LB

RMBS

ML2 results prompt strategy switch

The results from Monday's Maiden Lane II BWIC have been released, indicating that 36 of the 73 assets out for bid traded - for the second consecutive time. Of the approximately US$2.55bn in non-agency RMBS on the list, 57% (US$1.47bn) traded, while only 34% of the US$1.25bn subprime RMBS on the list traded.

Overall, the majority of bonds that cleared were in the context of three to five points behind price talk, according to MBS analysts at Deutsche Bank. They suggest that the lack of participation in the subprime sector can be linked to Dexia Bank's announcement of its intent to sell US$6.4bn of subprime bonds in the near term.

"The skewed supply technical in the Dexia portfolio is mirrored in the Maiden Lane portfolio, which still owns US$6.7bn of non-agency and close to US$14bn of subprime," the analysts explain. "Concerns over additional deleveraging from European banks continue to weigh on the market as well, as banks position for Basel 3 and government asset guarantees begin to roll off. Given these factors, coupled with the overall negative macro landscape and weak bid for risk across asset classes, price action in subprime will likely stay under pressure in the near term."

Downward pressure on prices due to the Maiden Lane II supply appears to have prompted the Fed to change its strategy and begin releasing bid-lists sporadically after 4 July. It is hoped that by releasing a large list every few weeks, investors will have enough time to evaluate the offerings.

CS

Ratings

Rating the ratings

Blaise Ganguin, chief credit officer at S&P, looks at how ratings have performed over the downturn

Amid all the discussion about the role of credit ratings in financial markets, their actual performance has often been misunderstood. Ratings are forward-looking opinions of relative creditworthiness, so their performance can be measured by how well correlated they are over time with defaults and by the rate at which they change.

The key test is whether ratings have, generally speaking, effectively rank-ordered credit risks. In other words, have highly rated credits generally displayed lower default rates - and greater credit stability - than credits with lower ratings?

We have acknowledged that the recent performance of certain ratings in two specific areas - US RMBS and related CDOs - has been disappointing and we have taken major steps to address that. Elsewhere, however, ratings of companies, sovereigns and most classes of structured securities have generally continued to perform well.

The latest studies of corporate defaults spell this out clearly. Between 2008 and 2010 - spanning the worst economic downturn for decades - the global average default rate for companies rated investment grade was 0.9%, compared with 13.9% for those with speculative grade ratings. None of the 81 rated companies that defaulted in 2010 began the year at investment grade. At the same time, ratings stability increased, with the proportion of unchanged corporate ratings reaching 73% - a six-year high.

Overall, the performance of global corporate ratings during 2010 was broadly in line with their strong historic track record. It follows the record 289 defaults among rated companies and financial institutions in 2009, 86% of which had a first (original) rating at least three notches below investment grade.

In short, there continues to be a strong correlation between corporate ratings and defaults (the higher the issuer rating, the lower the frequency of default, and vice versa) and higher ratings have consistently demonstrated more stability than lower ratings. This is true for all corporate rating categories and geographic regions - an important point for investors who look to ratings to provide a common and comparable benchmark of credit risk across different sectors, regions and time.

A similar picture applies to ratings of sovereign debt. Since 1975, an average of 1% of investment grade sovereigns have defaulted on their foreign currency debt within 15 years, compared with around 30% of those at speculative grade. A study of sovereign ratings published last October by the IMF found that ratings provide a robust ranking of sovereign default risk - meaning that defaults tend to cluster in the lowest ratings grades - and noted that all sovereigns that have defaulted over the last 35 years had speculative grade ratings at least 12 months before default.

The recent performance of certain ratings of structured securities has been more mixed. The extreme credit cycle and high unemployment, which has impacted loan repayment, have hurt the performance of many structured finance securities - especially those linked to US mortgages. The ratings of these securities therefore have experienced much greater volatility over the last three years than in the past.

Elsewhere, though, the performance of structured finance ratings has been more in line with expectations. That includes, for instance, US securities backed by credit cards, student loans and other consumer debt, as well as most types of European structured instruments.

Despite the severity of the recession in Europe, default rates for European structured securities have been relatively modest, even among securities with low original ratings. And those securities with high investment grade ratings have been relatively stable in credit terms.

Over the three-year period since June 2007, European structured finance securities rated by S&P have experienced a cumulative default rate of below 1% (by value of original issuance) and a cumulative downgrade rate of under 20%. For consumer-related securitisations (residential mortgage securities, structured coverage bonds and consumer ABS), the cumulative default rate over this period is below 0.1% and the downgrade rate around 5%.

Despite the difficult economic situation in Europe and higher delinquencies and defaults in both corporate and consumer loans backing many structured securities, the cushioning against credit losses in these securities has meant their ratings have generally stood up well. Importantly too, ratings in recent years have generally been much less volatile than market prices.

Ratings are based on fundamental analysis of credit quality, while bond and credit default swap prices are driven by the ebb and flow of market sentiment, the liquidity of a security (which can be limited) and other short-term technical factors. That means credit markets are prone to regularly overshoot or undershoot, while ratings take a longer-term view of credit risk and tend to follow a more stable path.

A high rating, of course, is not a guarantee an issuer or debt issue will not default over time. Creditworthiness can and does change, sometimes as a result of unexpected and unpredictable events. Even a small fraction of credits originally rated triple-A have defaulted over the years.

However, it remains the case - as the latest ratings performance data suggest - that higher ratings are generally less prone to default and tend to be more stable than lower ratings.

The analytical and other changes we have made over the last three years underline our commitment to continue doing so in the future. They are aimed at strengthening our ratings so they continue to be broadly comparable across all categories, clear and understandable, and perform as we expect.

ABS

Acquisition strengthens MBS desk

CRT Capital Group has acquired Braver Stern Securities' institutional sales and trading platform. Braver Stern's team, led by Joseph Valentine and Rus Margolin, will join CRT's existing securitised products platform. The group will focus on agency and non-agency RMBS and CMBS, ABS CDOs and mortgage-backed pass-through securities.

Joseph Valentine, who served as head of institutional fixed income trading at Braver Stern, will join CRT as co-head of the securitised products group along with Jeffry Mullins. Prior to this, Valentine was md at UBS and Bear Stearns in various mortgage-related roles.

Rus Margolin will serve as head of non-agency trading at CRT and will report to Mullins. Prior to joining Braver Stern, Margolin worked on UBS' non-agency CMO trading desk.

ABS

SF advisory team hired

Lazard has recruited a structured credit advisory team to broaden its capital structure advisory business.

Led in Europe by md Alan Patterson, the team brings a broad range of complementary skills in structured credit products and credit derivatives, including capital and balance sheet analytics, structuring, syndication, placement, valuation and portfolio management. It is based in London and will advise a broad range of institutions across Europe, including banks, pension funds, insurance companies, asset managers and hedge funds, as well as central banks and governments.

Lazard ceo William Rucker says: "We are uniquely positioned to advise clients in this area. The team will work alongside our sector professionals in FIG and real estate, where we see this business adding tremendous benefit to our clients and will complement our restructuring and debt advisory business."

Patterson adds: "Many of the holders in the structured credit market are not the natural owners of such assets and are seeking independent advice. The European ABS market alone has over €2trn of placed and retained assets, of which €100bn are European CMBS deals maturing before 2014. There are also over €500bn of European commercial real estate loans maturing in the same time period."

Patterson was previously at Amias Berman, which he joined in 2009. Before that, he established and led Citigroup's capital management strategy group, providing balance sheet advice to financial institutions, as well as analytic and transaction support.

The other members of the team are Andrew Feachem, Juan Carlos Martorell, Aman Panaech - who are all directors and were previously also at Amias Berman - and Abror Ismailov, vp. Before Amias Berman, Feachem spent eight years at ABN AMRO, where latterly he ran the European credit derivatives origination and syndication team.

Martorell spent four years at ABN AMRO, where he was responsible for structuring and marketing structured credit investments and solutions. Panaech was a portfolio manager at Countrywide Alternative Investments, managing six ABS CDOs, a hedge fund and performed portfolio consulting on over US$14bn of ABS to clients.

Ismailov joins Lazard from Union Investment, where he was a senior portfolio manager. Previously, he was a portfolio manager at Cambridge Place Investment Management, overseeing two pan-European ABS CDOs, co-managing US$3.6bn of ABS funds and investments, and performing advisory work on structured finance portfolios.

ABS

Advisory strengthens Nordic coverage

StormHarbour has strengthened its client coverage in the Nordic region with the appointment of two new senior investment banking professionals in its recently launched Copenhagen branch. Torben Lykke Hansen and Ole Witmeur, former partners of Nordic securities firm AGL in Copenhagen, will join StormHarbour as directors. The pair will report to Jacoob Nielsen, md and head of the Copenhagen branch, which received regulatory approval in March this year.

Nielsen and Thomas Lester, director, client solutions, joined StormHarbour last year to establish the Copenhagen branch and drive its client coverage in the Nordic region across fixed income sales and trading, structuring and advisory, and capital markets. Nielsen was previously head of institutional sales at HSH Nordbank in Copenhagen, responsible for a team covering the Nordic region and the Baltics across products including structured credit and ABS. Lester was also previously at HSH Nordbank in Copenhagen, working as a senior fixed income salesman covering the Nordic region across credit, vanilla and complex debt capital markets products, CDOs and ABS.

Before AGL, Lykke Hansen was head of capital market structuring at HSH Nordbank in Copenhagen. Witmeur previously worked for Depfa Bank, where he was responsible for its activities in the Nordic and Baltic countries for over 10 years, and the investment banking arm of a US reinsurer, where he ran structured derivatives marketing for the Nordic region.

CDS

Trading portal preps for US expansion

Traccr has appointed Thomas Jasper as a senior advisor to its board. In his new role, Jasper will primarily advise the firm on the launch of its business and planned US expansion.

Traccr is currently beta testing its trading portal with select institutional asset managers. Jasper says: "With its focus on credit derivative products, I believe the Traccr portal will play an increasingly important role in providing best execution and increased liquidity across this market. I look forward to assisting the company and believe it is well positioned to be a major participant in the credit derivative market's move to electronic trading."

Jasper is currently the managing partner of Manursing Partners and a founding partner of PremieRe Insurance. Most recently, he served as ceo and a director of Primus Guaranty.

CDS

ISDA IIGC co-chairs named

Athanassios Diplas of Deutsche Bank and Charles Mulhern of Wellington Management Company have been appointed co-chairs of the ISDA Industry Governance Committee (IIGC). They succeed Stephen O'Connor, who stepped down as IIGC chair to become chairman of ISDA's board of directors.

The IIGC oversees strategic market practice and post-trade issues in the OTC derivatives markets. It is the main interface for global supervisory contact and serves as a forum to mobilise industry resources and track the progress of key initiatives. It is composed of senior business managers from both the buy-side and sell-side.

Diplas is md and global head of the systemic risk management group at Deutsche Bank. He recently co-chaired the ISDA credit derivatives steering committee. He also served on the market resiliency working group of the counterparty risk management policy group III.

Mulhern is the director of investment data and derivative services within investment administration at Wellington Management Company. He participates in several industry forums including the asset management group at SIFMA and the operations steering committee of ISDA.

CDS

Valuation partnership extended

SIX Telekurs has extended its partnership with FINCAD, allowing FINCAD's customers to access SIX Telekurs' database of global securities prices through its online derivatives valuation service, Fair Value Insight and Market Data. At the same time, SIX Telekurs has formalised and extended its use of FINCAD analytics in its evaluated pricing service.

CLOs

CLO assignment proposed

DiMaio Ahmad Capital (DAC) is proposing to assign its rights as collateral manager on the Duane Street CLO 1, II, III, IV deals to Citigroup Alternative Investments. DAC is currently seeking the consent of the majority of the controlling class to the proposal, in line with the collateral management agreement. Their consent is requested by 11 July.

CMBS

Morningstar expanding remit

Morningstar has rebranded Realpoint - which it acquired in May 2010 - under the Morningstar name. In March 2011, Morningstar expanded its ratings services to include an operational risk assessment practice, focused on evaluating commercial and residential mortgage servicing firms, loan originators, and service providers to these businesses. The firm is now expanding its services to include a comprehensive ratings and analytics offering for investors in RMBS and expects to launch it in the fourth quarter of 2011.

CMBS

New CREFC president takes reins

Jack Cohen began his one-year presidency of CRE Finance Council yesterday (14 June). The Cohen Financial ceo succeeds Jefferies md Lisa Pendergast in the role.

"On behalf of CRE Finance Council and its membership, I want to thank Lisa for her guidance and dedication to us and the industry," says CREFC ceo Steve Renna. He adds: "Lisa's lengthy relationship and contributions to the association preceded her role as president, and she took the reins during an unquestionably challenging period."

As well as Cohen becoming CREFC president for 2011-2012, Citigroup Capital Markets md Paul Vanderslice also becomes president-elect of the association.

Monolines

Ambac head steps down

Diana Adams will replace David Wallis as head of Ambac Assurance Corporation. Wallis has resigned as president and ceo and as a director of Ambac Assurance, effective 6 July. He will remain a director of Ambac Financial.

Wallis joined Ambac in 1996 first in its London office, where he was involved with developing and leading the European businesses, before moving to Ambac's New York headquarters in 2003 where he was a member of the risk management team. He was appointed president and ceo of Ambac in October 2008.

Adams, currently senior md, will become president and ceo on 7 July. She has also been appointed as a director of both Ambac Financial and Ambac Assurance, effective as of 7 July.

Adams is Ambac's chief administrative officer with executive responsibility for human resources, technology and administration. She is a member of the subsidiary Ambac Assurance UK Ltd, which she chaired between 2008 and 2010. Previously she oversaw Ambac's origination efforts in emerging markets and structured issuance, as well as international and structured finance.

Kevin Doyle will also step down as senior vp and general counsel on 29 July, to be replaced by Stephen Ksenak on 30 July.

ABS

Trade receivables programme closed

Finacity Corporation has closed a global trade receivables securitisation programme for Bunge Limited. The securitisation programme will contribute an additional source of funding for Bunge operations, while also providing it with cash proceeds of up to US$700m through the ongoing purchase of receivables.

Finacity helped Bunge to launch the securitisation by providing analytic and structuring support, and serves as ongoing administrator providing comprehensive reporting. The programme will be funded through a consortium of four bank-sponsored CP conduits, the firm says.

ABS

Further downgrades for Greek ABS

Moody's has downgraded 10 tranches of five ABS transactions, 14 tranches of eight RMBS transactions and confirmed the ratings of two ABS and seven tranches of five RMBS transactions that are backed by Greek assets and serviced by Greek entities.

Additionally, the agency downgraded the senior note ratings of two Greek ABS transactions - serviced by Cypriot entities - to Ba1 from Baa1. Meanwhile, the ratings of one ABS and one CLO transaction are maintained on review for downgrade.

The ratings are positioned such that an orderly restructuring of Greek government debt would likely have no further impact on the Greek structured finance ratings, Moody's says, with the exception of highly linked transactions. The highest rating achievable for a Greek structured finance transaction remains Ba1.

The rating actions follow downgrade of the Greek government debt rating on 1 June to Caa1 from B1 and, to a lesser extent, the ratings of Greek banks that act as key transaction parties to B3 from Ba3 on 3 June 2011.

ABS

Card delinquencies dip again

Despite mixed collateral performance for credit card ABS, improving US consumer credit quality continues to gain momentum, according to Fitch's latest credit card performance indices.

Credit card defaults and delinquencies fell again while yield and monthly payment rate (MPR) dipped during the April collection period. Three-month average excess spread improved at the same time, the agency says.

"Charge-offs are diverging from persistently high unemployment and underemployment rates due partly to tighter underwriting and US consumers chipping away at their debt levels. These positive trends point to further improvements in credit quality measures and credit card ABS performance as we enter the second half of the year," 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.

Fitch's prime credit card charge-off index showed a further decline in May and registered the second consecutive month-over-month improvement, decreasing by another 46bp to 7.42% during the month. Defaults are at similar levels last seen in February 2009 and are down 33% year over year. This decline also represents a 36% drop from its peak during September 2009.

According to Fitch's 60+ day delinquency index, late stage delinquencies fell once again and recorded an 18bp improvement to 2.75%. Marking a 16 consecutive monthly decline, this delinquency level for May is 34% lower year over year. Similarly, early stage delinquencies improved, with 30+ day delinquencies decreasing another 27bp to 3.54%.

On the other hand, gross yield retracted after a two consecutive month gain, decreasing by 1.81% to 20.09% in May. This is the first time in 18 months where yield has decreased close to the 20% mark.

However, it still remains approximately 7% above the historical average of 18.7%. Despite the continued improvement in defaults, the decline of yield during the month impacted and drove the level of excess spread lower.

Monthly excess spread dropped sharply 1.52% to 10.04%, but the three-month average remained relatively flat with a marginal increase of only 4bp to 10.72%. This average represents another new historical high and is 29% higher when compared to the same period last year.

"Yield and excess spread are likely to decrease 2% to 3% in the coming months as the effects of the discount options continue to abate. However, excess spread is currently at record highs and will easily absorb the decrease so no rating actions are anticipated," says Fitch director Cynthia Ullrich.

Fitch's retail credit card index exhibited mixed results in the month of May. There was across-the-board performance deterioration, with the exception of delinquencies and three-month excess spread. Charge-offs increased 17bp to 10.59%, while gross yield declined for the second straight month, posting another 52bp decline to 25.88%.

At the same time, MPR slowed in May and dropped 1.34% to 14.32%. The only improvement during the month was marked by both early - down 36bp - and late stage - 21bp lower - delinquencies.

ABS

Call for risk retention rethink

SIFMA has followed the American Securitization Forum in calling for a new round of proposed rules on risk retention (SCI 8 June). It says that the lack of clarity on certain basic concepts, such as the meaning of 'par value' and 'ABS interest', make it difficult for market participants to fully understand the impact of the proposed rules.

Because this regulation will fundamentally alter the securitisation market and the economy, SIFMA believes it is necessary that regulators allow for another opportunity to comment on revisions to the original proposal before finalising the risk retention rules. "Implementing credit risk retention - which helps to align the economic interests between the parties that securitise assets and investors - is a crucial step towards boosting investor confidence and reviving the securitisation market," says Tim Ryan, president and ceo of SIFMA.

He adds: "If the final regulations are going to realise the goals of Dodd-Frank to improve the securitisation process, align interests and promote sound lending decisions, they must promote sound securitisation and underwriting practices, effectively take into account the different features of various types of asset-backed securities and most importantly provide incentives for all participants in the securitisation process - from originators to sponsors to investors - to participate in that process. We are concerned that as proposed, all these criteria have not been met."

SIFMA also believes that regulators should perform and provide details on an inclusive economic analysis of the rules, which incorporates factors such as a reduction in the currently outsized role of the GSEs in residential mortgage markets, capital standards changes embodied in Basel 3, accounting standards, expectations of the timing and degree of recovery of private label mortgage securitisation markets, and the general economic condition. The association filed two comment letters on the risk retention standards, both of which recommend against instituting the proposed 'premium capture' provisions.

ABS

Call for stronger Euro ABS sector

An expanded and stronger securitisation market is critical to Europe's recovery from recession, according to AFME chief executive Simon Lewis. Opening IMN's annual Global ABS Conference in Brussels, he pointed to the fact that Europe's funding needs in the coming years will be considerable.

"The ECB estimates that €1,000bn of debt is due for refinancing over the next two years, so it is crucial that a stronger and reinforced securitisation market plays its part in this - alongside other funding tools, such as bank lending, covered bonds and retail deposits," he said. "We believe strongly that no single type of borrowing can provide a complete solution to Europe's funding needs; all have their part to play in a balanced funding strategy. Rebuilding the confidence of investors and regulators in the securitisation market is critical, not just for the recovery of our market but also for Europe's recovery from recession."

Lewis also highlighted the performance of European securitisations during and since the financial crisis. "Four years after the onset of the crisis, European securitisation has shown that it has withstood the crisis well in credit terms," he told delegates. "Asset performance for mainstream 'real economy' assets - such as residential mortgages, car and consumer loans and credit card securitisations - has been very strong and well within expectations. For example, the cumulative defaults incurred by European mortgage-backed securities in mid-2007 - at the height of the 'boom' -through to today amounts to only 0.07%."

This year, the conference will examine the European ABS market in 2011 and beyond. Key regulatory issues will include the impact of new prudential regulation on the securitisation market, as well as new European Central Bank loan level data and disclosure requirements and the Dodd Frank legislation in the US.

ABS

APAC ABS ratings less volatile

Fitch Ratings says in a new special report that Asia-Pacific structured finance (SF) ratings were considerably less volatile in 2010 than in the previous year. The total number of rating changes in 2010 was 76, down from 173 in 2009.

"The performance of SF in Asia-Pacific was less volatile in 2010 than in 2009, with stable economies in most regions except Japan, leading to a significant fall in the number of downgrades," says Alison Ho, senior director and head of Asia Pacific structured finance performance analytics. "As was the case last year, nearly half of all such bonds carry the agency's top rating and a stable outlook, resulting in very limited scope for future upgrades."

The overall stability and impairment rates for Fitch-rated Asia-Pacific SF transactions still compare favourably with those reported globally - 96% of investment grade tranches were either affirmed or upgraded and 99% of triple-A ratings were affirmed. Impaired bonds and defaults accounted for 2% of bonds, compared with 13% globally, reflecting the stable performance of the structured finance market in Asia-Pacific overall.

However, Fitch notes that commercial property and finance markets in Japan continued to deteriorate and it made further downwards revisions to cash flows and/or commercial property values as a result. Time to legal final maturity is a major factor in the agency's rating actions on transactions approaching maturity and the timing and size of any recoveries has been a key factor in its analysis. As in the previous two years, CMBS accounted for most Japanese downgrades in 2010; a total of 20 independent Japanese CMBS tranches from 10 transactions were downgraded but remained unimpaired during the course of 2010.

A small number of non-investment grade tranches from New Zealand non-conforming RMBS also experienced downgrades. All investment grade RMBS tranches were affirmed across Asia-Pacific; making it the most stable asset class during 2010.

Upgrades resulted from increased credit enhancement, as transactions repaid sequentially, coupled with strong asset performance in well-seasoned transactions.

In addition, 16 Japanese CMBS bonds became impaired during 2010 as recoveries were not sufficient to redeem the notes in question in full by the respective legal final maturity dates.

Fitch adds that important exclusions from the 2010 matrices include CDOs where assets are not predominantly located within Asia-Pacific and RMBS tranches whose ratings are dependent on the ratings of lenders' mortgage insurance providers.

ABS

Card performance improvement continues

Performance trends observed in the US bankcard trusts in S&P's Credit Card Quality Index (CCQI) in April showed continued improvement, despite a 20bp increase in the the country's unemployment rate to 9%. However, the overall performance of the US private-label card trusts in the CCQI declined moderately, while performance trends for the trusts in the agency's Canadian CCQI were stable.

The charge-off rate for US bankcards decreased by 2.5% in April to 6.4%, representing a 36.9% decline on a year-over-year basis. However, charge-offs in the private-label credit card trusts increased by 3.4% to 8.7% in April - 27.7% lower than in April 2010.

Delinquencies continued to decline for both US bankcards and private-label cards. 30+ day delinquencies were 3.5% for bankcards, down by 6.8% from March. Meanwhile, private-label 30+ day delinquencies were 4.9%, down by 6.1% from March.

The April CCQI report also highlights ratings transitions for triple-A rated US credit card ABS since 1983 and the stability of Canadian credit card ABS on an original-to-current basis. US and Canadian credit card ABS ratings remained stable in April, but S&P downgraded two classes due to its revised counterparty criteria.

ABS

Risk management platform, alliance announced

Sapient Global Markets has launched Structured Finance Risk Manager (SFRM), a fully flexible combination of services and software to automatically value, monitor and manage the risks associated with structured assets. The firm has also announced a formal alliance with S&P Valuation and Risk Strategies (VRS), which aims to provide clients with in-depth valuation and analysis of structured finance securities.

SFRM enables firms to achieve greater visibility into asset valuations and cashflows, according to Sapient. Deployed and proven in environments with portfolio values in excess of US$200bn, the offering automates the risk monitoring and analysis of ABS and covered bonds. It also provides the transparency and robust audit trails needed to meet new and existing regulatory directives via loan level analytics.

Meanwhile, S&P VRS has become the first data and cashflow engine provider for SFRM. "Increased regulatory scrutiny on the most complex instruments is a key concern for capital markets participants trading structured finance products, such as ABS/MBS and covered bonds," says Kevin Samborn, vp, Sapient Global Markets. "The formalisation of our partnership with S&P VRS allows us to deliver transparent, consistent and auditable valuation processes to those who have been struggling to achieve visibility into large portfolios. S&P VRS's structured finance analytics products are a tremendous resource in the drive to increase transparency into value and risk."

Building on previous joint projects for major central banks and financial institutions, clients will benefit from Sapient Global Market's business and technology consulting expertise and experience designing, developing and implementing large-scale technology solutions. Meanwhile, S&P VRS adds comprehensive data coverage and advanced modelling technologies.

CDO

ABS CDO liquidation scheduled

Stone Tower Debt Advisors has been retained to act as liquidation agent for Coldwater CDO. The collateral will be sold to the best qualified bidders, subject to a reserve level, in five public sales in New York on 21 June.

CDS

BNY Mellon launches clearing operation

BNY Mellon is launching a new company to clear futures and derivatives trades on behalf of institutional clients in Europe, the Middle East and Africa. Headquartered in Dublin, BNY Mellon Clearing International - or BNYMCIL - is the first MiFID-authorised futures and derivatives clearing entity in Ireland and is regulated by the Central Bank of Ireland. It plans to become a clearing member on major exchanges and central clearinghouses globally to support the trading activities of BNY Mellon clients and intends to lead to the creation of 50 new jobs in Ireland over the next two years.

Tim Murphy will serve as head of BNY Mellon Clearing International for Europe, Middle East and Africa, reporting to Sanjay Kannambadi, ceo and global head of BNY Mellon Clearing (BNYMC), who is based in the company's New York headquarters.

The company plans to clear listed futures and option trades on behalf of institutional clients. Services are expected to include general operations including trade novation, margin management, risk management and reporting. As OTC swaps move into control clearing, BNY Mellon Clearing International and BNYMC will provide solutions to clear these products.

BNY Mellon Clearing LLC currently provides direct clearing services with major exchanges and central clearinghouses including the New York Mercantile Exchange, Chicago Board of Trade and International Derivatives Clearing Group. The company intends to continue to expand the roster of exchanges through which it clears.

CDS

AIB credit event determined

ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a restructuring credit event occurred in respect of Allied Irish Banks. It has determined that one or more auctions may be held in respect of outstanding CDS transactions of varying maturity buckets.

However, AIB has stated that it will not be paying the interest due in respect of certain of its notes, for which the due date has passed and in respect of which the grace period has not yet expired - meaning that the possibility of a failure to pay credit event cannot yet be considered by the DC or resolved. As such, the restructuring auction resolution was made by the Committee on the understanding that if another credit event occurs prior to the date of the auction, the auction may be held on the basis of that other credit event, rather than the restructuring credit event.

In such a case, there would not necessarily be an auction on the basis of the restructuring credit event. Accordingly, to the extent that a buyer triggers its CDS transactions referencing Allied Irish Banks with respect to the restructuring credit event, those CDS transactions will not be eligible to settle by reference to any other auction held based on a different credit event.

ISDA will publish further information on the potential auctions in due course.

CDS

SBS requirements to be clarified

The US SEC is set to clarify the requirements that will apply to security-based swap (SBS) transactions as of 16 July - the effective date of Title VII of the Dodd-Frank Act - and provide appropriate temporary relief. Specifically, the Commission will provide guidance on which provisions of Subtitle B of Title VII will become operable as of 16 July, as well as on the various pre-Dodd-Frank provisions of the Exchange Act that would otherwise apply to security-based swaps.

Under Dodd-Frank, SBS would be included in the definition of 'security' under the Exchange Act. While such swaps will be subject to provisions addressing fraud and manipulation, the Commission intends to provide temporary relief from certain other provisions of the Exchange Act so that the industry will have time to seek - and the Commission can consider - what, if any, further guidance or action is required.

In addition, the SEC will take other actions, such as extending existing temporary rules under the Securities Act, the Exchange Act and the Trust Indenture Act, and extending existing temporary relief from exchange registration under the Exchange Act. This will help to continue facilitating the clearing of certain CDS by clearing agencies functioning as central counterparties, it says.

The Dodd-Frank Act contains more than 90 provisions that require SEC rulemaking. The Commission already has proposed or adopted rules for about two-thirds of the mandatory rulemaking provisions.

After proposing all of the key rules under Title VII, the SEC says it will consider publishing a detailed implementation plan in order to enable it to move forward expeditiously with the roll-out of the new securities-based swap requirements in the most efficient manner, while minimising unnecessary disruption and costs to the markets.

The move comes after SIFMA, along with a number of other trade associations, submitted comment letters to the SEC and the CFTC requesting regulatory relief from and legal certainty for a number of derivatives-related provisions of the Dodd-Frank Act that would arguably otherwise become self-operative without rulemaking on 16 July. The letter identified five key areas that require resolution: SBS must be defined; definitional and registration rules for SBS dealers and major SBS participants must be adopted; rulemaking on capital, margin and business conduct standards must be completed; antifraud liability must be clarified; and extraterritorial guidance is needed.

Additionally, the letter notes that the most problematic of the self-operative provisions are those that would expand the definition of 'security' in the Securities and the Exchange Acts to include SBS. The definitional changes would result in substantial new compliance requirements and implementation challenges that the SBS market is just beginning to understand.

According to the letter, the inclusion of SBS in the definition of security beginning on 16 July raises three key problems: application of regulatory requirements under the securities laws may be virtually impossible to ascertain with any precision because they raise questions concerning, or are related to, issues that will be addressed in rules that are not yet final; application of some of these regulatory requirements will make little sense in the context of SBS and should be permanently exempted, while other provisions will involve significant interpretive issues for which SEC guidance is needed; and a number of requirements raise technical or operational hurdles that require more time to surmount. The letter also notes that the CFTC should provide relief from the self-operative provisions to avoid unprecedented confusion, potential market disruption and an environment that would not be conducive to the respect for the rule of law that underpins the strength and competitive position of US markets.

CDS

Call for clarification of Indian CDS guidelines

Fitch says that the CDS guidelines issued by the Reserve Bank of India (RBI) have introduced a much needed credit risk management tool for India's debt investors (SCI 24 May). Currently, the unavailability of a financial guarantee for debentures severely limits the options available to debt investors, the agency says.

However, further clarification may be expected from RBI, particularly with respect to capital adequacy requirements in CDS transactions. While restructuring is considered under RBI's CDS guidelines as a credit event, it should be clarified whether a CDS contract mandatorily needs to include restructuring to be eligible for maximum capital release, Fitch says.

As per Basel 2 guidelines, if restructuring of the underlying obligation is not covered by the credit derivative, only partial recognition (capped at 60% of the underlying value) may be provided for such an instrument for the purpose of capital adequacy calculation. However, the guidelines state that the protection buyer shall replace their original exposure to the reference entity with that of the protection seller

Further, the agency says that the extent to which a CDS contract provides credit risk mitigation would depend, among other things, on timely identification as well as unambiguous documentation of credit events so as to mitigate documentation risk. "To the extent such comprehensive CDS are made available by market makers of superior credit profile, the issuance of debentures by corporates with middle investment grade ratings is likely to increase," says Deep Mukherjee, director of Fitch's structured finance team in Mumbai.

CDS

Gap widening between sovereign CDS

The gap in average CDS liquidity between emerging and developed market sovereigns has been increasing in recent weeks and is now at its widest level since mid-April of this year, according to Fitch Solutions.

"The increase in emerging market sovereign CDS liquidity has been led by the United Mexican States, Ukraine and Brazil, who have climbed 13, 9 and 9 regional percentile rankings respectively over the past month," says Fitch director Diana Allmendinger.

As of last Friday's market close, average CDS liquidity for emerging market sovereigns was 8.37 versus 8.49 two weeks previously, while developed market sovereign liquidity was 8.84 compared to 8.76 over the same period.

Globally, the basic materials and financial institutions sectors saw the biggest surge in CDS liquidity in the past two weeks. For basic materials, it was led by companies such as ArcelorMittal Finance, Anglo American, Olin Corporation and Weyerhaeser. The financial sector was led by HSBC Finance Corporation, JPMorgan Chase & Co, Banca Nazionale de Lavoro and Banco Popolare Societa Cooperativa.

CLOs

Euro SME CLOs stabilising

European SME CLO transaction performance is continuing to stabilise or improve across all jurisdictions, according to Fitch.

Default rates for Spanish transactions have stabilised at 1.2% after a rise in impairments over the past two years. Elevated loan prepayment rates have also returned to their pre-2009 levels, which is attributed to originating banks restructuring non-performing loans, the agency says. Despite the improved performance, Fitch believes that Spanish SMEs will continue to be challenged by an uncertain macroeconomic environment and that delinquency rates will remain at relatively high levels.

German balance sheet transactions continue to show improved performance, while Schuldschein transactions continue to underperform the balance sheet segment. Principal deficiency ledgers (PDL) for two Schuldschein transactions have remained virtually unchanged since the last SME Tracker was published, as the transactions benefit from excess spread.

CLOs

Clydesdale CLO changing hands

Clydesdale CLO 2007 is being transferred to Ares CLO Management, which will serve as the new investment manager. Current investment manager Nomura Corporate Research and Asset Management has notified Clydesdale (the issuer) and Deutsche Bank Trust Co Americas (the trustee) of the proposed assignment of all the investment manager's rights, duties and obligations to Ares.

Ares CLO Management is a wholly-owned subsidiary of Ares Management LLC and will utilise the services and employees of its parent. It is also proposed that the name of the co-issuers be changed to Ares XXII CLO Ltd and Ares XXII CLO Inc. Consent has been sought from noteholders to approve the changes and responses are due on 22 June.

CMBS

Further MEPC prepayment slated

The borrower for the Opera Finance (MEPC) loan - securitised in the Opera (MEPC) CMBS - has announced that it is to pre-pay a further £125m of the outstanding balance. Two pre-payments were made earlier in the year (SCI passim) as part of a wider financing strategy to address the early repayment of the securitised loan before its maturity in July 2012.

The loan (current balance £293m) is secured by four of MEPC's business estates: Milton Park in Oxfordshire, Birchwood Park in Warrington, Chineham Park in Basingstoke and Hillington Park in Glasgow. Chineham Park will be released from the security package as a result of the prepayment, which will take place on 20 July, 2011.

Following the prepayment, the loan to value decreases from 75.1% to 61.5% (based on March 2011 values) and interest cover improves to 274%.

According to analysts at Chalkhill Strategy, MEPC will use a combination of cash from recent disposals and equity, alongside a new five-year facility of £62m from Deutsche Hypothekenbank and Santander, to make the prepayment.

CMBS

CMBS balloon payments fall again

The percentage of US CMBS loans paying off on their balloon date fell for the second straight month, according to Trepp's May pay-off report. While April's reading shows a sharp fall off, the percentage of loans paying off in April was well above the 12-month rolling average. While the rate fell once more in May, the latest reading was below the 12-month rolling average.

In May, 34.9% of the loans reaching their balloon date paid off - almost 13 points below the April reading. The May number fell short of the 12-month rolling average of 39.4%.

By loan count 48.1% of the loans paid off - down from April's 53.8% reading. In the basis of loan count, the 12-month rolling average was 47.5%.

Prior to 2008, the pay-off percentages were typically north of 70%. Since the beginning of 2009, however, there have only been two months where more than half of the balance of the loans reaching their balloon date actually paid off, Trepp concludes.

CMBS

CMBS delinquencies in 'holding pattern'

Delinquencies for US CMBS remained largely in a holding pattern for the third consecutive month, according to Fitch's latest delinquency index results. Late-pays increased by 6bp to end the month at 8.81%. The small net delinquency rate that increased in each of the last three months came in stark contrast to those logged over the previous two years, with the average monthly fluctuation being 0.39%.

Additionally, the recent driver has been the shrinking of overall CMBS volume outstanding. The US$36bn of May late-pays remains well short of the US$37.9bn high reached in September 2010. While delinquencies across the CMBS universe appear to be tapering off, pool concentrations and varied underwriting practices continue to expose individual transactions to the potential for future volatility.

"There seems to be a bifurcation between loans and transactions driving the reported delinquency rate. Adverse selection and maturity defaults are resulting in high delinquency rates to transactions issued between 1999-2001, while 2006-2008 deals suffer from performance issues," says Fitch md Mary MacNeill.

Meanwhile, loans originated between 2002 and 2004 continue to perform well, with current vintage-specific delinquency rates ranging from 2.78%-5.38%. Current delinquency rates by property type are: 16.37% for multifamily (from 16.81%); 13.89% for hotel (from 13.83%); 10.10% for industrial (from 9.60%); 7.03% from retail (from 6.94%); and 5.81% for office (from 5.65%).

CMBS

Pro forma warning

The pro forma underwriting of commercial real estate loans is not currently a widespread practice among originators of loans used in US CMBS, according to a new Moody's report. However, the rating agency expresses concerns as to how underwriting practices may evolve as the cycle advances.

"At present, Moody's sees only limited amounts of pro forma underwriting taking place," says Moody"s director of CMBS research Tad Philipp. "There have been several recent instances of underwriting future income that some may call pro forma but these have not had any negative credit consequences."

Moody's says it considers pro forma underwriting to be the practice of counting toward underwritten cash flow in a loan income that is based on an unwarranted projection of near-term property performance. "Almost always pro forma underwriting is a negative for credit quality."

The agency notes that the present lending environment is highly competitive and many loan originators that used pro forma underwriting in the past may use it again in the future. "Moody's will track and report on developments in pro forma underwriting, as well as highlight specific cases of it in its presale reports on new CMBS deals."

It goes on to say that the practice among appraisers of using expected, but unrealised rents and occupancies in their valuations is normal. "While Moody's does not hold appraisers accountable for considering upside adjustments to income we do hold debt underwriters accountable, and our views are expressed as higher cash flow haircuts and subordination levels," says Philipp.

Pro forma underwriting was indeed widespread during the last peak in the market, says Moody's, as borrowers looked to borrow fixed rate proceeds on assumed future performance instead of demonstrated past performance.

CMBS

Japan CMBS default period set to lengthen

Collection periods for defaulted loans in the Japanese CMBS sector are lengthening, according to Moody's. In the underlying loan portfolio backing Japanese CMBS transactions that the agency rates, the recovery period for one of the two loans collected in May was over 34 months - the longest ever in the tracking records for this series of reports.

One of the 59 loans was recovered over two years, while 11 of 75 defaulted loans show delayed payments over two years. This situation suggests that the loan default period is likely to lengthen, Moody's says.

Recovery rates of underlying loans remained high. This was mainly because in many CMBS transactions with sufficient time to final maturity the collateral properties of the loans were sold without strong time pressures in their tail periods, even under weak market conditions. Bulk fire sales were avoided.

After the sharp recovery in the real estate market in 2010 and first half of 2011, it is now more difficult to expect any increase in sales prices and improvement of recovery rates for loans, Moody's says. Many CMBS transactions are scheduled to mature in 2013, or later, although several will mature in 2012.

However, the agency believes that there is enough time to work out strategies to further stabilise cashflows from underlying properties, as well as to improve recovery rates during longer collection period.

Five loans amounting to ¥11.8bn matured, as of May 2011; one loan amounting to ¥1.7bn was paid down; four loans amounting ¥10.1bn defaulted; while no loans were extended or prepaid. Two defaulted loans amounting to ¥1.1bn completed recovery, while a total of ¥19.3bn defaulted loans made a partial recovery. A total of ¥557.5bn loans defaulted as of end-May - a 1.8% decrease over the previous month, the agency reports.

CMBS

Bishopsgate property sale secured

Hatfield Philips International has secured the sale of 6-8 Bishopsgate for £95m to Mitsubishi Estate Company - one of Japan's largest property development and investment companies. Located in London, the 20-storey landmark tower comprises 146,879 square-feet of office space, which is let in its entirety to Deutsche Bank on two leases expiring in 2015.

Despite suffering from a payment default, Hatfield Philips chose to keep the loan in primary servicing as its knowledge of the market and analysis of the assets indicated it could resolve the issues without recourse to the special servicer. Hatfield director of real estate John Muldoon says: "Whilst traditionally the loan would be transferred to special servicing, we felt that we would better serve the lenders - given the nature of this loan - to keep it in primary servicing and are confident that the LPA and sales team appointed have delivered the best possible results."

CMBS

Kroll details CMBS ratings process

Kroll Bond Rating Agency (KBRA) has released three CMBS criteria publications, which provide detailed insight into the process that the agency uses to rate single borrower CMBS transactions and evaluate CMBS servicers.

The first publication, 'KBRA Property Evaluation Guidelines', details the approach KBRA uses to determine its estimate of sustainable net cash flow (KNCF) and value for the individual properties that secure CMBS mortgage loans. These guidelines will form the bedrock of KBRA's CMBS rating methodologies and are designed to account for the non-homogeneous nature of commercial real estate properties, which display unique characteristics that are a function of their specific market and overall quality and tenant mix, the agency says.

The second publication, 'KBRA Single Borrower Rating Methodology', describes KBRA's approach to rating CMBS single borrower transactions with examples that demonstrate the workings of the criteria. The approach leverages KNCF that is derived through the application of the KBRA Property Evaluation Guidelines and is the primary determinate that the agency uses to drive Kroll Loan to Value (KLTV) and Kroll Debt Service Coverage (KDSC). KLTV and KDSC are used to derive the amount of proceeds, by rating category, that can be assigned to a given loan and its related CMBS securities.

The third publication, 'KBRA Commercial Mortgage Servicer Review Process', describes the way KBRA reviews servicers on transactions they rate, or are likely to rate, in the future. KBRA performs a review to determine if the servicing organisation possesses the necessary attributes to satisfy the minimum requirements to meet its contractual obligations and the servicing standard in accordance with industry practices.

CMBS

CMBS recovery analytic updated

S&P has updated its tranche recovery analytic for US conduit/fusion CMBS transactions after incorporating market feedback it received following its January 2011 update and internal analysis.

The analytic utilises macroeconomic forecasts made by S&P's economists to reflect the impact such economic scenarios may have on the recovery prospects of CMBS bonds throughout the capital structure. S&P explains that its CMBS recovery analytic complements its credit ratings as it provides projected recovery results for rated US CMBS transactions.

The recent update includes incremental changes that enhance the previous methodology. These changes also provide greater convexity between each of the five macroeconomic scenarios the metric uses, especially with regard to the bullish cases.

The update generated aggregate- and security-level results for the CMBS deals included in each of the five series of Markit's CMBX indices. In S&P's baseline case, average losses ranged from 7.4% for CMBX 1 to 12.8% for CMBX 4. CMBX 4 and 5, which contain almost exclusively 2007-vintage transactions (series 5 has a few 2008 deals), are likely to sustain the highest losses of the five series.

Compared with the estimates in the December 2010 update, loss rates improved for the later series of CMBX as a result of a modestly more positive economic forecast and improving CRE fundamentals. Series 4 benefitted the most, as losses dropped 2.8% to 12.8% from 15.6%. The other series remain within a percentage point of our earlier estimates.

In S&P's current estimates, the super-senior triple-A tranches from each series (original 30% credit-enhanced classes) recover at least 95% of their principal in even the most bearish scenario. In the baseline case, S&P's model produced minimal (less than 11%) or zero recoveries for classes/contracts originally rated triple-B or lower.

In the weeks ahead, S&P will apply these changes to its rated universe of US conduit/fusion transactions and publish the most recent tranche- and deal-level recovery results.

RMBS

Call for transparency around Spanish foreclosures

Fitch believes that the relatively small number of repossessed properties and the low level of modified loans within its rated universe of 137 Spanish RMBS is due to originator support.

"Fitch notes that there is a significant difference in the total number of repossessed properties across transactions which share similarities in terms of seasoning and performance, depending on the fund management companies," says Juan David Garcia, Fitch senior director and head of the structured finance team.

He adds: "Fitch recognises that the bidding practices of originators for properties in judicial claim could be beneficial for the overall performance of the transaction, generating cash inflows and preventing lengthy sale processes. However, the agency is concerned that such practises could mask a transaction's real capacity to generate recoveries."

In the agency's view, reported loan modifications do not capture all refinance solutions made available to troubled borrowers. "The agency is concerned about the lack of information and the sustainability of such practices in the medium term," says Carlos Masip, Fitch RMBS team director.

He continues: "Fitch analyses each transaction to assess the materiality of the modifications granted. The main concern lies with maturity extensions. The agency perceives borrowers that request an extension of 80 months on average have a weak profile and will consequently make conservative assumptions about the future performance of such loans."

Both repossessions and loan modifications are expected to increase in the near future, as expected interest rate increases generate additional distressed borrowers in a mortgage market dominated by floating rate transactions, Fitch reports.

RMBS

RMBS master trust restructurings proposed

Lloyds Banking Group is proposing to restructure the Arkle, Mound, Pendeford and Permanent (both Funding 1 and Funding 2) RMBS master trusts, subject to noteholder approval. This is expected to occur during July.

Under the restructuring, the support provided by the reserve funds in all four trusts will be replaced with a subordinated class Z loan. For the Arkle and Permanent master trusts, the margins payable on the intercompany loans from the yield reserve will be reduced and the amounts payable from the trust increased. This would involve reducing the yield reserves, increasing the margins on the funding swaps and increasing the minimum trust yield during substitution.

Lloyds also intends to amend the documentation, including updating the swap criteria and incorporating changes that ensure that the collection amounts held with one particular account bank does not exceed a 5% threshold.

Finally, for the Pendeford and Mound trusts, criteria will be added to enable Lloyds to repurchase surplus loans from the trusts, as well as give all noteholders the option to sell notes to Lloyds on their expected maturity date (subject to certain conditions).

Moody's says that the proposal will not impact the current ratings assigned to any of the notes issued out of the four trusts. In each trust, the reserve fund will be reduced to 2% of the notes currently outstanding and the class Z loan should ensure that the overall credit enhancement provided to the rated notes in the trusts remains the same as pre-restructuring.

The interest on the newly issued class Z loan will be paid via the revenue waterfall below the replenishment of the reserve fund, as well as below all debits to the principal deficiency ledger (PDL). The addition of new loans will be permitted if there is an unpaid PDL on the class Z tranche.

For the Arkle and Permanent master trusts, yield reserves previously established to pay excess margin on certain class A notes will be reduced from 11.9% to 1.9% of the outstanding notes for Arkle and from 5.9% to 0.6% of the outstanding notes for Permanent. It is proposed that there will only be a general yield reserve for all notes rather than having separate yield reserves for each issuance.

Since the overall total margins payable on the notes will remain the same, to compensate for the decrease in the yield reserves, margins payable by the swap counterparty under the funding level swap will be increased. This will allow for the excess note margins to be reduced and for the rest of the margins payable on the notes to be paid directly from the revenue receipts, Moody's says.

As a result, the minimum margin specified in the substitution criteria will also be increased from 0.475% to 1.45% in Arkle and from 0.5% to 1.5% in Permanent. There will be no changes to the funding swaps or minimum trust yield during substitution in the Pendeford and Mound master trusts.

RMBS

Servicer op risk ratings hit

Fitch has downgraded the operational risk ratings of nine US residential mortgage servicers, following its November 2010 assignment of a negative outlook to the sector. Reasons for the rating actions include the growing burden of managing delinquent and defaulted mortgages in an environment of heightened regulatory scrutiny. Also factored into the downgrades were the increased areas of risk identified by various regulatory bodies, which ultimately resulted in consent decrees, as well as the slower than expected pace that institutions have demonstrated in responding to the foreclosure crisis and implementing process changes.

In Fitch's view, the largest bank-related mortgage servicers are most acutely impacted by these increasing operational risks. Therefore, the agency has downgraded the servicer ratings of Bank of America, Chase, CitiMortgage and Wells Fargo by one to two notches. In addition, the operational risk ratings of MetLife, PNC and Suntrust were negatively affected, albeit to a somewhat lesser degree.

Following the completion of its full annual review of all rated servicers later this year, Fitch may downgrade the affected ratings, as well as for servicers not subject to this initial ratings adjustment.

The agency's negative outlook for the US residential mortgage servicer ratings sector was initially based on increased concerns surrounding procedural defects in the judicial foreclosure process. Since then, other process and risk management concerns have continued to arise, which included bank regulator's consent orders issued to several of the largest servicing companies in Fitch's RMBS servicer rating universe.

In light of these concerns, Fitch adjusted the weightings for various scored factors within its RMBS servicer ratings programme to reflect the increased risks and deficiencies identified in the specific performance areas. Deterioration in risk management, staffing levels, quality control and in servicing defaulted loans scores were the major drivers of the downgrades.

RMBS

Subprime price increase doubles

US subprime CDS prices have more than doubled their increase from last month, extending the rally to an unprecedented seventh straight month, according to the latest index results from Fitch Solutions.

Subprime CDS prices rose by 1.7% overall, though price increases were not uniform across vintages. The headline index price increase was delivered by the 2007 vintage's 4.9% gain and the 2004 vintage's 84bp gain. With the 2007 vintage's 20.1% year-to-date price gain leading the 2011 rally, most vintages are in the black for the year.

The lone negative outlier is the 2006 vintage, which saw a large monthly price decline of 8.4% - the second largest of the year - following February's 11.3% fall.

"With prices down 16.9% overall this year, the 2006 vintage has been the worst performer in 2011. The 2006 vintage has the dubious distinction of having the highest one-month constant default rate and at the same time the lowest one-month voluntary prepayment rate," says Fitch director David Austerweil.

The one-month constant default rate for the 2006 vintage is at 10.8%, while the one-month voluntary prepayment rate is just 0.85%. The 2006 vintage also saw its 60-day delinquency rate increase by 1.6% last month, in line with increasing delinquency rates for every vintage.

"The 2006 vintage clearly indicates a high level of credit impairment among mortgage borrowers," adds Austerweil.

Improving subprime loan payment profiles also hit a speed bump this past month. The 30-day delinquency rate increased by 4.8%, partially reversing the sharp declines of recent months.

"30-day delinquencies are often a clear warning sign of future increases in default rates, so this month's rise should be watched closely. This past month's rise in 30-day delinquencies coincides with the recent weakening in labour market data," says Fitch director Alexander Reyngold.

Another area of potential concern is roll rates, which have improved for much of the year. However, May's remittance data illustrated new weakness in this trend, the agency notes.

Cure rates dropped from an elevated 7.5% last month to 5% this month for a -33.3% month-over-month decline. Borrowers who were 30-days delinquent were less likely to become current than in recent months, with 19.4% becoming current this month versus 34.3% last month.

Another area where the 2006 vintage has demonstrated worse performance than its peers is in loss severities from REO properties. The loss severity for REO loans for the 2006 vintage is now at 83.1% and increasing, versus the current 79.2% loss severity for the 2007 vintage. Additionally, the percent of REO loans is highest for the 2006 vintage at 4.8% of outstanding loans, versus 3.8% for the 2007 vintage.

RMBS

Price uplift seen in Celtic tender

Ulster Bank Ireland is to accept about €1.1bn of notes from its Celtic 9, 10, 11 and 12 Irish RMBS transactions, following the tender offer it announced last month (SCI 24 May). The final purchase prices for many of the bonds were significantly higher than the minimum purchase prices announced in the offer memo, by an average of 5.7 points across the 15 bonds involved, according to securitisation research analysts at S&P.

Junior tranches saw the biggest uplift from the minimum prices - and hence from secondary prices at the time of the offer. For example, classes Ca and Cc of Celtic 11 had purchase prices of 9-10 points above the minimums.

Technology

Seeing the wood and the trees

Douglas Long, evp business strategy at software provider Principia, discusses how addressing investor due diligence requirements today demands operational control across the entire credit investment business

Ask what is meant by 'investor due diligence' and you'll likely get a host of different answers. The term's openness for interpretation has meant that the simplest definition gradually became the benchmark in years past.

It was seen as a basic level of care, commensurate with the perceived demands of the powers that be. During the meteoric rise of structured finance, the true sentiment of the term got lost somewhere.

Perception is a funny thing. 'Due' was interpreted in the context of the cycle we were in. Only the minimum necessary checks were needed to satisfy investment guidelines or to verify independent credit performance and cashflow assumptions.

Third-party assessments, usually through ratings, were trusted and seen as adequate for appropriate care. Their opinions alone seemed sufficient.

Today, 'due' is placed in the new world concept. Investors would be unanimous in agreeing that due diligence now demands comprehensive and in-house credit analysis, risk management from the collateral performance level up and an array of activities related to the initial and ongoing understanding of structured finance assets and portfolios.

An investor has to perform an appropriate level of due diligence for every position entered. Third-party opinions cannot be used alone to make investment decisions and monitor their risks.

In January 2011, Article 122a of the revised EU Capital Requirements Directive went live, imposing a direct responsibility on investors and issuers to perform an adequate level of due diligence for any securitisation transaction. Hubris continues to overshadow important technical considerations that are fundamental to an organisation complying with new investor requirements.

Directions are given in the implementation guidelines of Article 122a by The Committee of European Banking Supervisors (CEBS), now the European Banking Authority (EBA). However, implementing those considerations across the credit investment operation amidst a complex network of systems, information and processes to comprehensively and assuredly satisfy the regional supervisors is no small task.

Much focus is placed on understanding ABS, MBS and CDO investments on a deal-by-deal basis, but for a credit institution investing in these securities, due diligence is not only a deal-by-deal job. It requires a portfolio- and business unit-wide operational approach to understanding investments in context, alongside detailed and thorough deal analysis. Without this, credit institutions won't be able to see the wood for the trees.

Before entering a position and in an ongoing manner, EU banks must demonstrate a thorough understanding of any given deal and that they have implemented 'formal policies and procedures...commensurate with the risk profile of their investments in securitised positions' to analyse and monitor any exposures arising from the performance or collateral underlying a deal. This demands a strong backbone to unify the necessary portfolio management and risk management activities, but also the operational sophistication and business-wide controls to establish due diligence processes and maintain compliance with internal investment guidelines.

Depending on the severity of a breach, an additional risk weighting of anywhere between 250% to 1250% can be applied to a securitisation exposure. A revision to risk-weighted penalties in the latest guidelines also states that the regulator "shall increase the risk weight with each subsequent infringement" over time. The penalties are now clearly outlined in national supervisor's implementation handbooks too; for example, the FSA's Handbook, BIPRU 9.15.16R.

What's an investor to do?
Monitor and track risk exposures
At the deal level, understanding the risk characteristics of individual tranches means monitoring issuance details, such as seniority level, cashflow profile, historical performance and credit enhancement.

Diligent investment analysis under today's CRD means implementing consistent ways to analyse and manage all of the data relating to a deal's structure and credit enhancement, the individual tranches of that deal and the performance of its underlying collateral pools. To avoid penalties, large credit institutions with growing exposures to different securitisations will need to find ways to consolidate the various data sets for all the deal information and performance data across its assets. This is the basis for sound investment analysis and risk management for individual deals, but also for effectively managing the entire portfolio and reporting to parent operations.

Know the structure
Investors must also understand or be able to analyse the structural features of deals, such as the waterfall, transaction triggers, embedded hedging counterparties or liquidity facilities.

A detailed understanding of the waterfall structure and strong cashflow models, alongside accurate, timely performance data is a pre-condition to informed and independent assumptions about the future behaviour of assets and proof of independence. Investors need to have the integrated cashflow models, performance data and analytical flexibility to forecast future performance for all the securities they hold, as well as for any potential investment. This demands the operational backbone to efficiently and consistently bring together all of these elements and incorporate internal credit research within a single view of credit and market risk factors surrounding the structured finance and fixed income business.

Underlying exposure statistics...and loan level if you have to
This requirement does not specify that investors track each loan underlying a deal. Rather, it defines collateral pool characteristics and stratifications, depending on the granularity of underlying pools and the asset class.

If the risk profile of the deal requires an investor to analyse individual loans, then that must form part of the due diligence process but it is not a direct requirement each time. The EBA guidance highlights Key Performance Indicators that should always be considered, such as delinquency, default, prepay and foreclosure rates and other metrics like pooled credit scores and geographical diversification. Investors need the clarity and tools to make assumptions based on the pool performance exposures most relevant to every transaction type.

Ensuring comprehensive asset coverage and the comparability of performance measurements across asset classes, geographic regions and sectors is a major operational challenge in ensuring comprehensive credit analysis. The difficulty of incorporating performance data for multiple deals and asset types from multiple internal and external sources and normalising it for consistent analysis can be operationally complex and resource-intensive to set up and maintain. Implementing a flexible infrastructure to consolidate this analysis sits at the heart of satisfying the requirement effectively and with confidence.

In-house due diligence
Where relying on third-party financial models, the credit institution must be running equally adequate models itself, with the ability to change inputs and stress levels as appropriate. While deal analytics providers provide tools like this for the assets they cover, a credit institution looking to analyse across the breadth of its structured finance and fixed income securities will require an integrated way to calculate future cashflow across the entire portfolio. Analysing different asset classes in isolation leaves gaps and analytical limitations when attempting to perform due diligence at the portfolio-wide level.

For each asset, being able to layer in model assumptions to independently verify and project future valuations is imperative. Institutions require the systems flexibility to be able to first see a complete view of the deal and its performance to make strong assumptions and then apply their assumptions to a cashflow model, both initially and then in an automated way over the longer term. Importantly though, this needs to be performed across all assets and data sources within a single environment to make fully informed investment decisions and proactively manage risk exposures.

On an ongoing basis...
All the information and calculations needed to make independent assessments over time must be accessible on-demand in a timely and comprehensive way and recorded for reporting purposes. Credit institutions need the operational rigor to see everything at once, bring in all the information required for analysis and then - with a fully informed view of the detail - have the confidence and tools to layer in assumptions regarding stressed scenarios.

Stress testing appropriate to each securitisation position is key to satisfying the requirements. Doing so also provides an ongoing framework for due diligence when combined with the establishment of operational guidelines, risk limits and controls.

Stress testing portfolio sensitivities and collateral performance exposures requires that there is first a view across the breadth of risk exposures and an ability to define and analyse any combination of exposure parameters. Alongside the consistent integration of cashflow models and data, stress testing by business line, portfolio exposure (e.g. asset type, geography, sector, ratings etc) or performance exposure (e.g. delinquency rates, default rates, prepayment rates, foreclosure rates) can be sustainable and complete.

Warning flags can be set for the most appropriate metrics of each asset class to automate early risk signals at the collateral, deal and portfolio level and highlight exposures demanding more in-depth analysis. Future valuations can more effectively be projected under many different scenarios to inform prudent choices across the entire structured finance business.

The original Basel 2 enhancements to the securitisation framework phrased due diligence as 'operational credit analysis criteria'. While credit institutions must prove they know every investment to satisfy the regulators, today they must also demonstrate they have the full operational sophistication required to do so, across all deals, portfolios and business lines.

Then, if a tree falls in the wood, you can be there to find out if it makes a noise or not.