Contents

Regulation

Slow progress

Market recovery hampered by regulatory uncertainty

Regulatory concerns continue to weigh heavily on the securitisation market. Although activity is picking up month by month, a full recovery is unlikely until more detail on a number of regulations is fleshed out.

Regulation is the main stumbling block for the securitisation market, confirms RBS Group Treasury secured funding head Stephen Hynes, although he acknowledges that regulators could not afford to sit back and do nothing. "The main challenges facing the market are regulation, regulation and regulation," he says. "It is a bit like playing Twister. There are so many different regulations making it very hard to put together a securitisation transaction."

Hynes continues: "However, that is the price we must pay for what went wrong in the past. We are all trying to improve things, but we must be patient. It will take time. Unfortunately, the global recovery is not happening as fast as we hoped."

One issue currently weighing on the market is the 'stigma premium' - the negative connotations that securitisation still has for some investors. "Securitisation is a more difficult sell than it used to be," explains Jerry Marlatt, senior of counsel at Morrison & Foerster. "There were a lot of people funding ABS with commercial paper, but it will be a long time before people try that arbitrage again."

He adds: "On the other hand, typically the yield on securitisation is better than covered bonds. Those investors that are not wed to the security of covered bonds and are not put off by securitisation's 'stigma premium' will reach for the yield."

US subprime - however unfairly or irrationally - continues to cast a shadow over RMBS markets in Europe. Alexander Batchvarov, global head of structured finance research at Merrill Lynch International, notes: "The regulators have to stop lumping prime UK and Dutch RMBS with US subprime (and even US prime), when calibrating regulatory capital for securitisation - one size does not fit all. The uncertainties of regulation are delaying market recovery. We have a very small window of three to six months to persuade regulators to provide favourable changes."

Indeed, although the market is returning and securitisation activity is picking up, a full recovery is unlikely until more detail on a number of regulatory developments is fleshed out. The biggest question marks hang over Basel 3 and Solvency 2.

Peter Green, partner at Morrison & Foerster, observes: "There is still a lot of doubt about Solvency 2 and the market is waiting for that to be resolved. The impact of Solvency 2 on insurance companies holding ABS will have an important impact."

But even when regulation is clearer in different jurisdictions, there will still be differences between them to resolve. Marlatt says: "[It] will take time [to co-ordinate] regimes between the US and EU. The follow-on issue from the regulatory changes will be getting the two to mesh properly."

Once the uncertainties surrounding regulation become clearer later this year, it will be interesting to see who is confident enough to step back into the market. "The leveraged investor base has disappeared from the market and largely they have been replaced by the ECB, which is being relied on to repo a lot of securitisation. That is fine up to a point, but it cannot go on forever," says Marlatt.

"The question will be which investors will step up when the ECB pulls back? At the moment, that is not clear and that could be an issue," he adds.

While bank appetite for securitisation is returning, Batchvarov argues that the investor base also needs to expand to include private accounts. "We need retail investors and pension funds coming into a market, which has proven its worth in a difficult time, and so we need the insurers. Regulatory change could help with that."

JL

CDS

Lessons learnt

A closer look at the CDS industry's response to Dodd-Frank

Since the Dodd-Frank Act was signed into law last year, the CDS industry has been asked to undergo a significant transformation in a short timeframe, the likes of which have taken many years in other sectors. But, while operational challenges and regulatory uncertainties remain, the CDS market's response to enforced reform may serve as a blueprint for other markets in the future. (The full SCI Special Report on CDS can be downloaded here.)

The Dodd-Frank Act, signed into law on 21 July 2010, mandates the clearing of eligible CDS contracts through central counterparties (CCPs), the trading of CDS on swap execution facilities (SEFs) and compulsory reporting requirements. In each of these cases, the market has responded positively: numerous firms have spent the past year developing SEF propositions, increasing volumes of contracts are being cleared by CCPs and technology is being implemented to satisfy reporting obligations.

But a common thread in the post-Dodd-Frank era is lack of clarity. Disparities still exist surrounding the definition of SEFs; it is unclear which CDS contracts should ultimately be clearable and with what margins; and questions remain over the timeliness and form in which raw data should be reported.

"One of the challenges facing the market is trying to get clarity from the various regulators on both side of the Atlantic," says Jeff Kushner, ceo of BlueMountain Europe. "This is an extremely complicated matter. It's not what we thought it was when we first went down this road."

Aside from lack of clarity, many of the demands stated in the Dodd-Frank Act are also deemed too rigid. For example, requiring that all trades on SEFs (bar block trades) should be electronic is said to be unrealistic, while reporting requirements - as they stand - could leave institutions vulnerable from a hedging standpoint.

However, according to Scott Fitzpatrick, global head of sales at GFI group, the CDS market's response to Dodd-Frank reforms may give some indication as to how other markets will respond to enforced change. "The CDS market could be seen as the poster child for how things will go in other markets, in that the liquid end of the market will be centrally cleared and there will be a strong relationship between electronic platforms for the liquid side of the market and voice/hybrid platforms for the less liquid side," he says. "It also shows that it does take time to set up a complete 'straight through' infrastructure, from an electronic trade to immediate clearing."

More importantly, Fitzpatrick highlights that only a few new entrants have emerged since the CDS market was forced to go cleared two years ago. "There's been no rise of the 'new' e-platform: it's been the incumbent providers of intermediation services that have upped their game, built the infrastructure and offered stronger services. My personal opinion is that this is not a coincidence: I'd expect to see the same in the FX markets and in the interest rate markets. I think it's a very good example of how things will go in other areas."

AC

ABS

Asset finance reorg completed

Credit Suisse has reorganised its asset finance management team in New York and London. The move follows the recruitment of Jay Kim in February as the firm's new head of asset finance within the securitised products division.

Mike Dryden and Pete Sack have been named co-heads of the securitised products portfolio solutions, residential mortgage finance and securitisation team. Their responsibilities include government advisory, strategic asset advisory and valuation, securitisation capital markets coverage, structuring and valuation for principal and financing transactions for Credit Suisse.

John Slonieski and Jon Claude Zucconi have become the co-heads of consumer asset-backed finance and securitisation team. They will continue to lead the coverage, strategy and transaction execution of structured asset finance transactions within the consumer securitisation sectors.

Meanwhile, Russ Burns continues as the head of the esoteric asset-backed finance and securitisation team and Scott Corman continues as the head of the transportation asset-backed finance and securitisation team. Bruce Kaiserman is the head of the asset finance lending team, while David Lister is head of the ABCP conduit lending team, reporting to Kaiserman.

In addition, Vaibhav Piplapure becomes head of the London asset finance team. Over the past eighteen months, in addition to his role in the credit solutions group, he maintained oversight of the London asset finance team, but will now be devoted full-time to the activities of this team.

Finally, Craig Leonard has been re-appointed head of the securitised products syndicate desk. He was most recently a trader on the consumer ABS trading desk.

Dryden and Zucconi were previously at Barclays Capital, respectively responsible for the mortgage/real estate/government advisory and auto/equipment businesses within its securitised products origination group. Lister was also a member of the securitised products origination group at Barclays Capital, where he focused on ABCP conduit and warehouse financing activities.

ABS

ABS salesman added

Jason O'Brien is set to join Credit Suisse in mid-July as a UK ABS salesman. He will report to Kevin Whyman, head of European ABS sales, and was previously at Jefferies.

ABS

Key SF appointments made

BNP Paribas has announced key appointments within its structured finance business line.

Andrew Shapiro, currently head of corporate acquisition finance and value preservation group for the Americas, is appointed head of loan syndications and trading. In addition, he has been named head of structured finance UK. He will be based in London and report to Dominique Remy, head of structured finance at the firm.

Prema Balakrishnan, currently head of energy & commodities, asset and project finance Australia, has been named head of project finance. She will be based in Paris.

Charlotte Conlan, currently head of leveraged finance and media & telecom finance origination for EMEA loan syndications & trading, is appointed head of origination and sales for EMEA loan syndications & trading. She is based in London.

Emmanuel Rogy, currently head of project finance, is appointed head of energy & commodity finance for EMEA. He is based in Paris.

ABS

SF partner recruited

DLA Piper has appointed Michael Macaluso as a partner in its finance practice. Macaluso joins from Morgan, Lewis & Bockius, where he was a partner in the international business and finance practice and a leader of its European capital markets team.

Macaluso focuses his practice on managing complex and international corporate finance transactions, including structured financings such as domestic and cross-border ABS, conduits, synthetic securities, repos and credit derivatives. He also regularly serves as treasury counsel and outside general counsel for clients.

ABS

Distressed fund formed

Northlight Financial has formed a limited partnership, under the Northlight brand, that will provide asset-backed loans to middle market companies, acquire whole loans in the secondary market and purchase distressed assets in the commercial, industrial and real estate sectors. The new fund will initially deploy US$100m in committed capital and target investments ranging from US$5m to US$15m in executing its investment strategy.

The fund is Northlight's second to target the middle and distressed market segments. It will be managed by Northlight partners Michael Jahrmarkt, Robert Woods, Mark Hirschhorn and Chris Jahrmarkt.

ABS

Risk Institute looks to the US

Renowned ABS author Frank Fabozzi is set to join EDHEC-Risk Institute on 1 August, as part of its North American strategy. He will be working on the development of EDHEC-Risk Institute North America with Lionel Martellini, scientific director of EDHEC-Risk Institute, who will be in charge of North American development from the beginning of the 2011/2012 academic year. Fabozzi will also supervise dissertations of candidates to the EDHEC-Risk Institute PhD in finance, a programme opened to finance practitioners.

Fabozzi has been the editor of the Journal of Portfolio Management since 1986 and comes to EDHEC from his position as professor in the practice of finance and Becton Fellow at Yale University's School of Management. He also sits on the board of directors of the BlackRock family of closed-end funds.

ABS

Esoteric ABS team recruited

KGS-Alpha has recruited Fouad Onbargi, Richard Barry, Jason Muncy and Will Simonton from Aladdin Capital to focus on esoteric ABS. Onbargi - as head of the team - reports to Levent Kahraman and Dan Goldman, respectively ceo and president of the firm.

ABS

Credit trading head named

BNP Paribas has promoted Benjamin Jacquard to global head of credit trading. He will be based in London, reporting to Guillaume Amblard, global head of fixed income trading.

Jacquard will lead the implementation of BNP Paribas's credit development plan, which is to extend the product range and market share in all credit markets, including ABS trading and structured credit. He joined the firm in 2008 as head of structured credit & arbitrage and then became global co-head of credit trading with Christian Mundigo in May 2010. Mundigo has since been promoted to co-head of fixed income, Americas.

Prior to joining BNP Paribas, Jacquard built and managed exotic credit trading and structuring teams at Bank of America and Credit Agricole.

ABS

Capital injection for StormHarbour Japan

Asuka DBJ Partners, a private investment firm that is a joint venture between Development Bank of Japan and Asuka Asset Management, has acquired an 8% equity stake in StormHarbour Japan. Asuka DBJ Partners invests in companies and projects in growth sectors in Japan, China and other parts of Asia.

"We are delighted and honoured that Asuka DBJ Partners has made an equity investment in StormHarbour Japan, which we believe is a powerful endorsement of the firm's proposition and credibility of its long-term growth strategy," comments Michimasa Naka, a managing principal of StormHarbour Partners and ceo of StormHarbour Japan.

He adds: "The impressive international growth StormHarbour has already achieved combined with what we see as significant growth potential for StormHarbour Japan, has created a compelling investment case. With the support of Asuka DBJ Partners, StormHarbour Japan is in a stronger position to realise its potential as new financial leader in the country."

CDS

CDPC portfolio information revealed

Primus Financial Products has released details of its credit derivatives portfolio. As of 21 June, the firm's consolidated portfolio of single name credit swaps was US$5.43bn (in notional amount) and had a weighted average remaining maturity of 1.22 years. Approximately 62% of the single name CDS portfolio is denominated in euros, with the remainder denominated in US dollars.

The last single name credit swap is scheduled to mature in September 2013. Total future premiums on the single name credit swap portfolio are expected to be approximately US$33m, assuming the transactions run to full maturity and the euro/US dollar exchange rate remains unchanged.

Primus Financial's consolidated portfolio of credit swap tranches sold was US$3.79bn (in notional amount), as at 21 June, and had a weighted average remaining maturity of 3.07 years. The tranche portfolio is denominated in US dollars.

The last tranche transaction is scheduled to mature in December 2014. Total future premiums on the tranche portfolio are expected to be approximately US$43m, assuming the transactions run to full maturity.

Finally, the firm's portfolio of ABS CDS stood at US$13.65m (in notional amount) and had an expected weighted average remaining maturity of 2.73 years. The ABS CDS portfolio is denominated in US dollars.

CDS

Asset manager beefs up in credit

AXA Investment Managers has appointed James Gledhill as global head of high yield and deputy head of credit within its global fixed income department. He will report both to Theodora Zemek, global head of AXA fixed income, and to Graham Nicol, who heads up AXA's fixed income credit department.

As part of his role, Gledhill will replace Hannah Strasser as the leader of AXA IM's US credit team, based in Greenwich, Connecticut. Strasser has decided to pursue other opportunities outside of AXA IM, with Anne Yobage and Thomas Kelleher also resigning from their roles within the firm.

Gledhill was most recently at Henderson Global Investors in London, with responsibility for a range of bond funds following Henderson's acquisition of New Star Asset Management (NSAM) where he had been head of fixed income since 2007.

CMBS

Barclays Capital expands in CMBS

Barclays Capital has hired Larry Kravetz and Spencer Kagan to expand the firm's activities in CMBS origination.

Kravetz has joined the firm as an md and head of CMBS finance, reporting to Tom Hamilton, head of securitised products trading. Kagan has joined as an md and head of CMBS credit and underwriting, reporting to Kravetz. Both are based in New York.

Kravetz most recently was a partner in G2 Investment Group and a managing partner and founding member of G2 Real Estate. Prior to that, he spent over 15 years at Lehman Brothers in various roles across the firm's commercial loan origination, underwriting and securitisation businesses. While at Lehman Brothers, he established and led the firm's large loan group. He began his career in the real estate investment banking group at Chemical Bank.

Kagan also joins the firm from G2 Real Estate where he was a partner. Prior to that, he worked for more than ten years at Lehman Brothers, most recently as an md and head of large loan credit and underwriting. Before joining Lehman Brothers, he was had of the new CMBS ratings group at S&P.

RMBS

Subprime fraud charges settled

Morgan Keegan & Company and Morgan Asset Management have agreed to pay US$200m to settle fraud charges, brought by the SEC, state regulators and FINRA, related to subprime MBS. Two Morgan Keegan employees also agreed to pay penalties for their alleged misconduct, including one who is now barred from the securities industry.

The Memphis-based firms, former portfolio manager James Kelsoe and comptroller Joseph Thompson Weller were accused in an administrative proceeding last year (SCI 14 April 2010) of causing the false valuation of subprime MBS in five funds managed by Morgan Asset Management from January 2007 to July 2007. The SEC's latest order also finds that Morgan Keegan failed to employ reasonable pricing procedures and consequently did not calculate accurate NAVs for the funds. Morgan Keegan nevertheless published the inaccurate daily NAVs and sold shares to investors based on the inflated prices.

The order finds that Kelsoe instructed Morgan Keegan's fund accounting department to make arbitrary "price adjustments" to the fair values of certain portfolio securities. The price adjustments ignored lower values for those same securities provided by outside broker-dealers as part of the pricing process and often lacked a reasonable basis. As a result, Morgan Keegan did not price those bonds at their current fair value.

The SEC's order further finds that Kelsoe screened and influenced the price confirmations obtained from at least one broker-dealer. Among other things, the broker-dealer was induced to provide interim price confirmations that were lower than the values at which the funds were valuing certain bonds, but higher than the initial confirmations that the broker-dealer had intended to provide. The interim price confirmations enabled the funds to avoid marking down the value of securities to reflect current fair value.

According to the SEC's order, through his actions Kelsoe fraudulently prevented a reduction in the NAVs of the funds that should otherwise have occurred as a result of the deterioration in the subprime securities market in 2007. His misconduct occurred in the context of a nearly complete failure by Morgan Keegan to employ the fair valuation policies and procedures adopted by the funds' boards of directors to fair value the funds' portfolio securities.

Under the settlement, Morgan Keegan is required to pay US$25m in disgorgement and interest and a US$75m penalty to the SEC to be placed into a Fair Fund for the benefit of investors harmed by the violations. Morgan Keegan will pay US$100m into a state fund that also will be distributed to investors.

The firms are additionally required to abstain from involvement in valuing fair valued securities on behalf of investment companies for three years. Kelsoe agreed to pay US$500,000 in penalties and be barred from the securities industry by the SEC, while Weller agreed to pay a penalty of US$50,000.

RMBS

Policyholder group wins appeal

The New York State Court of Appeals in Albany has reinstated the bank policyholder group's US$5bn fraudulent conveyance and breach of contract lawsuit against MBIA Inc (SCI passim).

The Court's written ruling notes that the New York State Insurance Department (NYID) approved the restructuring of MBIA Insurance in 2009 without giving policyholders any notice or opportunity to be heard. The ruling also states that the New York state legislature did not intend for the New York Insurance Law to pre-empt the fraudulent conveyance and common law claims asserted by the policyholders.

Robert Giuffra, lead counsel for the policyholders and a partner with Sullivan & Cromwell, comments: "The Court of Appeals has squarely rejected MBIA's efforts to shut the courthouse door, in violation of basic principles of due process, and to shield MBIA's unprecedented US$5bn fraudulent conveyance behind a secret administrative process. The Court of Appeals has reinstated all of policyholders' Debtor and Creditor Law claims and our claims for breach of contract and for abuse of the corporate form. Policyholders will now vigorously pursue our plenary DCL and common law claims alongside our Article 78 claims, and we're confident that MBIA's fraudulent restructuring will be reversed."

The policyholders are pursuing a separate Article 78 action against MBIA and the New York State Superintendent of Insurance at the time, Eric Dinallo.

ABS

Positive trend continues for cards

Moody's reports that both US credit card charge-off and delinquency rates improved yet again in May, continuing the positive trend of much of the past year. At the same time, the payment rate index - complementing the near record low levels of delinquent credit card receivables - rebounded sharply in May and is once again near its all-time high.

"These positive credit trends reflect the steady shift in trusts towards obligors with higher credit quality, a transition that has been unfolding over several quarters now," says Jeffrey Hibbs, a Moody's avp and analyst. "And we expect both charge-off and delinquency rates to continue to decline well into 2012. We also expect the payment rate, which is a good proxy for cardholders' willingness and ability to pay their balances, to continue to rise."

The charge-off rate for May was 6.95%, down from 7.16% in April. The delinquency rate index fell to 3.30% - just shy of its record low in the 22-year history of Moody's Credit Card Indices - while the payment rate surged to 21.57%, just below the all-time high it reached only two months ago during the tax refund season.

The yield index posted a seasonal rebound in May, although Moody's expects it to decline steadily for the remainder of the year largely because of the end of principal discounting. The rise in yield, together with the decline in charge-offs, resulted in the excess spread index returning to 11.07% - close to its historically highest level.

The early-stage delinquency rate index also fell, as Moody's expected, to 0.84%, for the third consecutive all-time monthly low. "The ongoing decline in the early-stage delinquency rate clearly supports our near-term view that the charge-off rate will continue to fall, at least through the end of summer, although we do expect to see a marginal uptick in early-stage delinquencies at some point in the next few months due to seasonal forces," adds Hibbs.

ABS

ABCP op risk RFC issued

Moody's has issued a request for comment regarding a proposed update to its operational risk guidelines as they relate to rating ABCP programmes. Specifically, the agency proposes explicit guidelines for the analysis of performance disruption risk posed to ABCP programmes by their administrators.

The ABCP operational risk guidelines address the risk of non-performance by transaction parties on Prime-1 rated ABCP. Based on a preliminary assessment of the impact of the proposed ABCP guidelines, Moody's believes that almost all of the ABCP programmes will be in line with the proposed standards for administrators, cash managers and other relevant roles. However, the ratings of a small number of ABCP programmes in North America, Europe and Asia may potentially be negatively affected, given their current structures.

The RFC provides a definition of operational risk for ABCP programmes, starting with the identification of parties involved in the critical path for the timely repayment of ABCP. It goes on to detail how Moody's evaluates the capability of service providers, such as administrators, through the operational review process.

The criteria address the creditworthiness of key transaction parties and the existence of support, back-up or delegation arrangements. They also recognise that certain operational arrangements require additional analysis, determined on a case-by-case basis, that could take into account the incentive structure created by the alignment of the parties involved in the programmes and their interests.

ABS

Law firm expands litigation group

Bingham has expanded its securities and financial institutions litigation group in London with the addition of Mark Dawkins, a former managing partner of Simmons & Simmons. While at Simmons & Simmons, he was instrumental in building and leading the firm's global financial markets department and its banking litigation department. Dawkins will work closely with Bingham financial institutions litigation partner Natasha Harrison.

ABS

ABS-focused fund launched

Angel Oak Capital Advisors has launched the Angel Oak Multi Strategy Income Fund, which seeks to achieve high current income while providing less interest rate sensitivity than traditional fixed income products. The fund is managed by an Angel Oak team headed by portfolio managers Brad Friedlander and Ashish Negandhi.

"Our strategy initially is to focus on the asset-backed securities market. This asset class has traditionally been available only to hedge fund-like structures, so we are excited to be opening a mutual fund that takes advantage of these types of opportunities in the fixed income marketplace," says Friedlander, Angel Oak's managing partner.

Even though the initial focus will be on the ABS market, the fund allows the portfolio management team to continuously evaluate relative value opportunities across all areas of the fixed income market. "The fund invests across fixed rate and floating rate securities, in an effort to effectively manage the interest rate risk of the overall portfolio according to our current views on the market," adds Friedlander.

ABS

Counterparty criteria updated

S&P has updated its criteria for counterparty and supporting obligations by providing a framework for classifying currencies and determining the volatility buffers for derivative obligations. The updated criteria apply to all new and existing structured finance securities, certain US public finance securities and to financial counterparties in corporate and government issues possessing structured finance characteristics.

The criteria provide a framework to classify currencies eligible for derivative obligations into one of four risk groups: 1-4, with one being the least risky and four being the most risky. They also provide volatility buffers for groups one, two and three currencies, and limit the security rating to one notch above the issuer credit rating on the counterparty for group four currencies. Additionally, the list of currencies has been updated to include the Hong Kong dollar, Korean won, Mexican peso, New Taiwan dollar, New Zealand dollar, Russian ruble, Singapore dollar and South African rand.

The update may affect the ratings on 25 securities in the Asia-Pacific region and on two securities in EMEA. S&P says that it will maintain the ratings on the affected securities on credit watch for an additional six months in order to apply the criteria and account for any changes to transaction structures.

CDO

SF CDOs on upgrade review

Moody's has placed 98 tranches of US and European structured finance (SF) CDOs with material exposure to CLOs on review for possible upgrade. This follows the agency's announcement that nearly all CLO tranches it rates Aa1 and below have been placed on review for upgrade.

The latest rating actions affect 88 tranches in the US and 10 tranches in Europe. The tranches are from 22 transactions - including 19 transactions in the US and three transactions in Europe - and they total approximately US$4.28bn based on their current outstanding balance, including US$3.87bn in the US and US$405.3m in Europe.

The actions are the result of these deals' significant exposure (greater than 20%) to cashflow CLO tranches that Moody's has placed on review for possible upgrade. The agency says it will resolve these watch list actions over the coming months as underlying CLO rating reviews are being completed.

CDS

AIB auction scheduled

The auction to settle the credit derivative trades for Allied Irish Banks CDS is to be held on 30 June. A senior auction and a subordinated auction will be held.

CDS

Collateral optimisation service offered

Calypso Technology says it has developed an innovative collateral optimisation solution specifically designed to "address major functional gaps" in the industry. The new software product is aimed at responding to new challenges in collateral management driven by substantial shifts in the basis markets, regulatory requirements for OTC clearing and associated margins, improved counterparty risk management, more stringent liquidity control and demand for greater visibility at an enterprise level.

A key component of the solution is a proprietary algorithm that allows users to intuitively manage the collateral allocation process. Key benefits include reduced costs for collateral management through improved decision-making, as well as a global view of counterparty risk and operational efficiencies.

CDS

Collateral management service prepped

Lombard Risk Management has announced two key business appointments. The move comes as the firm prepares to release COLLINE, its automated collateral management solution.

Elaine MacAllan joins Lombard Risk to direct the further development of repo and securities lending functionality of COLLINE. She comes from Credit Suisse, where she held an svp role in the collateral department.

Martin Wingate joins Lombard Risk from Daiwa Capital Markets Europe, where he worked for six years as head of OTC, securities lending and repo collateral management.

COLLINE includes new functionality to meet the market's current and future demands for a consolidated solution, the firm says. Among its features are: master netting/convenience margining; settlement risk management; and 'what if' scenarios to forecast the liquidity impact of collateral agreements affected by credit rating changes.

CLOs

Moody's CLO criteria changes finalised

Moody's has finalised changes to its global methodology for rating cashflow CLOs (SCI passim). The changes will generally result in expected credit enhancement levels below those based on the current methodology but above those in effect prior to the financial crisis. In addition, the methodology changes will result in upgrades to the majority of outstanding CLO tranches the agency rates.

Moody's believes it is now appropriate to remove the temporary 30% default probability stress that it had used since February 2009 in its binomial expansion technique (BET) model, which is used to rate CLOs. With credit conditions relatively more stable and default rates low for corporate credits, the agency will both remove the temporary stress and institute methodology adjustments, reflecting a review of historical default rates that includes the experience from the recent credit crisis.

In addition to removing the 30% stress, Moody's has made other changes to its model. After reviewing historical corporate default and recovery rate data, it recalibrated the default probability and recovery rate assumptions in its model in order to reduce the likelihood of future rating volatility resulting from assumption changes. It also adopted for European CLOs the same fixed recovery rate model as that used in the US.

In recalibrating the default probability stress factors used in the final methodology, Moody's relied on a historical data set ranging from 1970 to 2009 rather than the data set ranging from 1920 to 2009 used in the original proposal. The agency believes that the unusual industry distribution in the earlier data makes that data less predictive than the data on the more diversified corporate credit market of recent decades.

As a result of using the more recent data set, Moody's has revised its default probability stress factors. The revised default probability stress factor for Baa rated tranches fell to 1.65 from 1.75 in the original proposal, but remains higher than the 1.60 in the current methodology and significantly higher than the 1.23 in the pre-financial crisis period. The default probability stress factor for Aaa rated tranches remains 1.95 as proposed in the original proposal and remains significantly higher than its pre-crisis level of 1.50.

In conjunction with the publication of the revised methodology, Moody's has placed 4220 tranches currently rated Aa1 and below - totalling US$237bn in current outstanding balance - of 782 CLO transactions, or approximately 80% of all outstanding cashflow CLO tranches, on review for possible upgrade. Of the affected tranches, 3,153 are from 611 US deals (accounting for US$175bn) and 1,067 are from 171 European deals (US$62bn).

Moody's expects ratings upgrades on nearly all these tranches, with the magnitude of upgrades ranging from one to three notches for the most senior tranches and from one to five notches for mezzanine and junior tranches. The methodology changes will result in rating upgrades because the changes lower the level of credit enhancement that the agency deems necessary for a CLO tranche to achieve a specific rating.

It expects to complete its review within six months. The upgrades will be in addition to any rating actions taken recently as a result of improvement in the performance of the collateral pools backing CLOs.

CMBS

Fitch to update multiborrower criteria

Fitch ratings says that it will be releasing an update to its criteria report for analysing multiborrower US commercial mortgage transactions next month. The report will consolidate three existing criteria reports and aims to provide more transparency on Fitch's rating process for conduit and fusion transactions.

Specifically, the report will provide more clarity on the following: Fitch Ratings' analysis of property-level cash flows; the application of new concentrations measures; a discussion of Fitch Ratings' sensitivity analysis; and the application of new deterministic tests as a check on subordination levels. The report will also provide more detail on the enhancement of certain variables that affect the probability of default (PD), probability of loss (PL), and/or the loss severity (LS).

These enhancements include: the application of higher PDs for loans with low Fitch Debt Service Coverage Ratios; mean reversion of PD and LS by property type; mean reversion of PD and LS by geographic location; the application of higher PLs for loans with high Fitch Loan to Value Ratios; the application of higher macroeconomic stresses; and the removal of credit for springing lockboxes.

"Generally, these enhancements have been employed on all newly rated multiborrower US CMBS transactions since the first quarter of 2009 (as explained in our presale reports) and have no rating implications for existing transactions as Fitch Ratings uses its current surveillance methodology for reviewing the ratings on existing deals," the agency explains.

CMBS

German MFH balloon risk remains

Fitch says in a new report that balloon risk remains a key concern for the largest German multifamily housing (MFH) CMBS transactions, despite the refinancing activity that has occurred over the past year. This view is reflected in the agency's continuing negative outlooks for the three largest CMBS transactions entirely secured by MFH collateral: GRAND, German Residential Funding and Immeo Residential Finance No. 2.

In addition, Windermere IX (Multifamily) and DECO 14- Pan Europe 5 have both been placed on rating watch negative due to the high degree of uncertainty created by the ongoing legal action against the WOBA borrowers by the City of Dresden.

Considerable refinancing activity has occurred in the German MFH sector over the past year. The single largest refinancing was of the €890m GSW loan (securitised in Windermere IX and Fleet Street 3), achieved through six lending institutions in February 2011.

On a smaller scale, Immeo 2 saw a €260m partial prepayment in December 2010, while the €179m Hallam transaction was fully repaid in April 2011. Combined with prepayments and repayments of a number of smaller-ticket MFH loans, this has led to the outstanding German MFH loan balance securitised in CMBS falling to €12.5bn from €15bn over the past year.

Despite the pick-up in refinancing activity, Fitch argues that significant balloon risk remains for the four largest German MFH loans, which account for approximately three-quarters of the total outstanding securitised German MFH debt balance. These loans are all scheduled to mature in 2013, which could exacerbate the problem of making balloon payments for individual transactions. In fact, the agency says, the recent refinancings have also benefited the sector by beginning to spread loan repayments over a longer period.

"While the four main German multifamily transactions are secured by good quality portfolios with a track record of producing stable cashflows, the sheer size of the loan balances poses a significant impediment to an orderly refinancing unless there is a substantial improvement in bank or capital market conditions," says Gioia Dominedo, senior director in Fitch's EMEA CMBS team.

"The refinancing of the GSW loan earlier in the year sends a strong positive signal about the availability of debt for highest-quality portfolios. However, the number of banks involved in that transaction indicates that a full repayment of the largest facilities would be extremely difficult to arrange based on current lending limits of individual banks," Dominedo adds.

In the case of the WOBA loan, balloon risk is further exacerbated by the fact that refinancing discussions have been put on hold until there is more clarity regarding the ongoing legal action by the City of Dresden.

RMBS

Revised fails charge recommendations issued

The US Treasury Market Practices Group (TMPG) has published revised fails charge recommendations for the agency debt and agency MBS markets based on feedback it received on its 29 April proposal for fails charge recommendations (SCI passim). For the agency MBS market, the recommended trading practice has been modified slightly from the earlier proposal.

The revised recommendation consists of a fails charge equal to the greater of 0% and 2% minus the federal funds target rate. The charge accrues each calendar day a fail is outstanding, although an agency MBS fail is not subject to a charge if delivery occurs on either of the two business days following contractual settlement date.

Charges for fails settled in a given calendar month are aggregated between legal entities that are counterparties to one another in a transaction and a claim is made if aggregate charges for the month exceed US$500. Agency MBS issued or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are subject to this charge.

"The TMPG's goal is the practical elimination of fails," says Tom Wipf, TMPG chair. "The TMPG expects that the recommended trading practice for the agency MBS market will effectively reduce fails and support liquidity in the market. If fail levels do not decline satisfactorily within the first few months after the charge takes effect, the TMPG will consider raising the charge level and shortening or eliminating the resolution period."

The TMPG recommends that the fails charges apply to transactions in agency debentures and agency MBS entered into on or after 1 February 2012, as well as to transactions that were entered into prior to but remain unsettled as of 1 February 2012. It plans to publish a formal Agency Debt and Agency Mortgage-Backed Securities Fails Charge Trading Practice document, which will include a suggested form of notice to counterparties and standard confirmation language.

RMBS

Mortgage REIT index launched

Pine River Capital Management has launched the Pine River Mortgage REIT Index. The index aims to provide a way to track the sector performance of publicly traded REITs, whose principal business consists of originating, servicing or investing in residential mortgage interests, including RMBS.

The index uses a modified market capitalisation weighted methodology. Index components are reviewed quarterly for eligibility and index weights are rebalanced accordingly.

The index is calculated and maintained by S&P. For inclusion in the index, residential mortgage REIT constituents must have a market cap of at least US$250m, an average daily trading value for the last three months of greater than US$2.5m and be listed on a major US stock exchange.

At present, index constituents comprise: Annaly Capital Management, American Capital Agency Corp, Hattaras Financial Corp, Capstead Mortgage Corp, Anworth Mortgage Asset Corp, Cypress Sharpridge Investments, Armour Residential REIT, Chimera Investment Corp, MFA Financial Inc, Invesco Mortgage Capital Inc, Two Harbors Investment Corp, Dynex Capital Inc, Redwood Trust Inc, Walter Investment Management and Pennymac Mortgage Investment.

RMBS

Graphite tender offer launched

Northern Rock has launched a tender offer for eight tranches of Graphite Mortgages series 2006-1. The minimum purchase price ranges from 95% to 30% of par value for the class A+ to class E notes.

Northern Rock had previously announced that it has currently no intention to exercise its right to terminate the credit default swap with KfW relating to the notes, based on the assessment that an early redemption at par value would not be in its economic interests. But the firm warns that in the event that it decides it would be in its economic interests to terminate the swap after the expiry of the tender offer, all outstanding notes would be redeemable by at par on the August payment date.

The amount Northern Rock will pay for the notes validly tendered and accepted for purchase will be determined pursuant to the modified Dutch auction procedure. Under this procedure, the firm will determine the aggregate principal amount outstanding of notes of each class it will accept for purchase and a single purchase price.

Noteholders must validly tender their notes by 5 July. The offer results will be announced the following day, with settlement scheduled for 8 July.