Contents

CLOs

Euro CLO market silenced

The European CLO market has had a very quiet couple of weeks as macro headlines continue to cause concern. Demand remains high for top-quality paper, but is quite thin below that.

"There is very little happening," explains one trader. "I have not seen any BWICs this week, although others might have seen some. From what we were seeing last week, about 50% of the BWICs traded. Of course, this also means that 50% didn't trade."

One notable bid-list from 26 July comprised mezzanine/junior tranches of Avoca V (accounting for €7.5m), CELF 2005-2 (€9.5m), EUROC VII (€1.6m), JUBIL II (€11.25m) and PETRU 1 (€5m).

The trader is not surprised by the lack of activity. Many market participants are on holiday this month, while the news headlines in both Europe and the US for the last couple of weeks have spooked a lot of people. The trader hints that banks may not be helping the CLO market at the moment, either.

He says: "From what I hear, dealers are keeping the prices up and have not seriously dropped them in order to trade. There are huge bid-offer spreads in the lower tranches; from triple-Bs to double-Bs, we are seeing bid-offers of as much as seven points."

First-pay triple-A paper continues to attract plenty of demand, with some good quality triple-As trading below 250DM, which the trader admits came as a surprise. Beyond triple-A, however, the market remains very quiet.

The trader notes that several buyers who were very keen on paper as recently as two weeks ago have since changed their minds. "I had a guy who had a reverse-enquiry for me just a couple of weeks ago. He was extremely keen to have it. It was a double-A and I located it. Then the guy came back and said because of the US everyone is scared. The bad news meant he really did not want to bid for it. I asked him to give me a bid and he was about 10 points behind."

Meanwhile, alternatives have recently widened. The trader points to high yield bonds, which in Europe have moved up to 10% yield. "People are scared. There is more liquid stuff out there where you can get a yield pick-up," he says.

"It will be worse than normal. Even forgetting the holidays, there is so much else going on. People who would normally be buying right now are just on the sidelines, so I really think it is going to be even quieter than normal this month; it will be dead," the trader concludes.

JL

ABS

Structured credit may provide 'safe-haven'

Assets that were once deemed responsible for the spread of the global financial crisis in 2007-2009 may find themselves offering refuge for investors in the wake of the recent market slide.

According to structured credit strategists at Citi, top-rated structured credit assets are behaving more like a safe-haven than a risky asset in the current economic climate. The triple-A structured credit assets - which are well diversified and well subordinated - may offer greater stability than many well-rated risky assets and some sovereigns, the strategists suggest.

However, the one exception to this safe haven characteristic is structures backed by subprime mortgages. "Even Pen AAA assets have been in decline since the start of the year as the recovery in US house prices that started in 2010 has faltered," Citi notes. "Investors have reassessed prospects for a recovery and are increasingly concerned about a protracted housing double dip. This is reflected in the most senior tranches of the later vintage subprime ABS, which have continued to decline from already depressed levels".

Tranches below triple-A with only a minimal chance of recovery have been trading below 10 cents in the dollar.

The story is similar for more junior tranches of the CMBX index where pessimism about real-estate prices has caused a similar price slump through 2011. This sell-off has started to accelerate more recently with fears of the potentially potent combination of a real-estate price slump, economic slowdown and corporate stress.

"However, it is interesting to note that CMBX triple-A assets are behaving more like a safe haven asset with only limited price declines in 2011 relative to other assets," adds Citi.

Equally, CLOs have been showing their mettle. Price-wise, triple-A CLOs have barely budged and even junior tranches seem well supported, even as US high yield spreads move wider. "Given that these assets are illiquid and many investors are hold-to-maturity, negative price reaction may come later," suggest the strategists. "However, we expect top rated tranches should continue to be resilient."

Synthetic CDOs have a different relationship with underlying spreads than CLOs in that they are priced with models based on the spread of the underlying index, while CLO prices are more based on supply and demand. Therefore, as iTraxx spreads have widened in recent weeks, synthetic tranches have widened too. Citi notes that this has led to a relatively busy period of investor interest in FTDs, index tranches and legacy bespoke CDOs as investors look to take advantage of wider spreads.

Citi predicts, however, that the initial enthusiasm for such transactions is likely to wear off if the the sell-off becomes more protracted in nature.

"In absolute terms, the most senior tranches such as 12-22% and 22-100% have moved the least in terms of basis points. However, systemic risk concerns have caused their spreads to more than double in the last few weeks from their very low base. A radical sell-off would see this relative underperformance extended as fears about systemic risk increase," Citi concludes.

AC

ABS

Unemployment impacting student loan ABS

The record high unemployment rate for young college graduates of 9% in the first half of 2011 is impacting student loan securitisations, with recent vintages performing worse than earlier transactions. Moody's notes in its latest Weekly Credit Outlook publication that the 2005-2007 vintages are impacted the most.

Default rates rose over the past year for the 2005-2007 and 2008-2010 securitisation vintages, which have a high number of young graduates. The 2005-2007 transactions saw defaults rise from 6% in the first six months of 2010 to 6.4% in the same period this year.

In contrast, defaults for 1999-2004 securitisations declined from 3.6% to 3.2% between 1H10 and 1H11. Moody's notes that this vintage has less exposure to the weak job market because it has a greater number of older college graduates, the unemployment rate for whom is less than half of that for young college graduates.

Securitisations from 1999-2004 have also already experienced their peak default years, so remaining loans should be of strong credit quality. This helps make them resistant to defaults in times of high unemployment.

Although securitisations from 2008-2010 are exposed to the highest number of young college graduates, they do not have the highest number of defaults. Moody's attributes this to low seasoning and stronger underwriting than their predecessors, as issuers became more cautious and either scaled back originations of poor quality loans or excluded them from securitisations. Defaults increased from 0.2% in 1H10 to 2.3% in 1H11.

The 2005-2007 securitisations are exposed to far more young graduates, helping explain why they have 6.4% defaults as opposed to only 3.2% for those from 1999-2004. However, Moody's notes that the discrepancy is also because of underwriting, with loans securitised between 2005 and 2007 of weaker credit quality because of looser underwriting policies.

Next year should see defaults stabilise and then decline for 2005-2007 student loan ABS, as the loan pools backing them reach and pass their peak default points. Record levels of default during the recession should also mean that remaining loans are of stronger quality than those which exited the pool, Moody's concludes.

Separately, S&P is expected to release details of the impact on FFELP student loan ABS of its downgrade of the US to double-A plus (negative outlook) later today.

JL

CDS

Tranche investors buying on sovereign concerns

As nervousness about sovereign debt concerns pushes CDS spreads on European peripheries steadily wider, tranche investors have been taking advantage of the deterioration.

CDS on Spain, for example, has risen to 423bp - 122bp wider week-on-week and significantly higher than the 270bp level at the beginning of last month. Higher spreads such as this have driven increased interest in leveraged investment grade trades, especially in equity and junior mezz, according to structured credit strategists at Citi. They note that much of this activity is being driven by a reach for yield.

"Many investors [are] seeing wider spreads without feeling that there is a corresponding shift in default expectations, which remains low," the Citi strategists note.

There has also been renewed interest in index tranches, as well as FTD and bespoke baskets, especially from hedge funds and even real money. CDX HY and IG tranche markets have seen activity in equity and junior tranches after they gapped wider when spreads were under pressure.

"Option skew has steepened considerably as investors have rushed to buy OTM payers," add the strategists. "This has been rewarded in Europe with significant moves in IG and XO indices."

The story is different in the US, however, where realised volatility has fallen with IG credit relatively resistant to the broader sell-off in risky assets. The market has been dominated by hedgers, including CVA desks, loan books and correlation accounts.

The strategists comment that from a positions perspective, markets are reducing their longs but remain vulnerable to a correction. "Net credit longs have dropped to their lowest levels since March 2009 and cash inflows continue to drop," they say. "HY and sub financials are looking extended, euro cashflows are declining and economic data is continuing to surprise to the downside."

Although net longs have been trimmed, they remain at historically high levels. This leaves the market vulnerable to the risk that investors lower their long-term outlook and reduce their positions, thereby further extending the current correction, the strategists conclude.

AC

CMBS

'Harsh' action for Euro CMBS property

The Quartier 206 shopping centre - securing the defaulted loan of the same name - has been placed into public administration as of Tuesday (2 August), according to a Titan Europe 2006-5 transaction notice. CMBS analysts at Barclays Capital believe this is a harsh, if unsurprising, course of action, which could interrupt cash flow.

The Quartier 206 Shopping Centre loan has a current whole loan balance of €144.8m and has been in payment default since April 2010. Unpaid interest reached €8.9m in April this year. The notice says the special servicer rejected the borrower's offer to acquire or repay the loan in full for €90m, and applied to the court for the commencement of public administration for the mortgaged property.

The analysts believe the term 'public administration' in the investor notice refers to compulsory administration, which is one of the legal enforcement routes a mortgage beneficiary can take in Germany. It is similar to the appointment of a receiver in England and Wales, but with the appointment administered by the court. Creditors would receive ongoing payments of the income generated by the property.

"Compared with other defaulted German CMBS loans, the commencement of legal enforcement is a relatively harsh action taken by the special servicer," say the analysts. However, due to the un-cooperative behaviour of the sponsor and borrower, they add that it is not a surprising decision.

Recent quarters saw the servicer reporting repeatedly imply that there was serious borrower misbehaviour regarding property management and loan governance. The borrower is now expected to file for insolvency and the analysts note a subsequent moratorium could see loan enforcement and the collection of cash flows delayed or disturbed. There is uncertainty as to whether an application for a special moratorium would succeed, however.

Although the Quartier 206 loan would have been a candidate for a comprehensive restructuring if the sponsor was co-operative, the analysts say the recent events mean a loan restructuring - which could have been structured more favourably for senior noteholders - is now highly unlikely.

It is expected that the special servicer will now try to gain more control over the property management and stabilise rental income to use cash flows to begin paying interest due on the loan. A property sale after two or three years would then be an option, the analysts say, although it is unlikely to happen earlier.

On an arm's length rental agreement, a stabilised net operating income of €6.5m is achievable in the medium term, and using a cap rate of 5.5% for prime German retail properties, the medium-term property value could match the senior loan balance of €114.8m, the CMBS analysts say.

Compared to the borrower's discounted pay-off proposal, the public administration route is more positive for mezzanine and junior noteholders than for senior noteholders. The analysts note the €90m offer would have seen proceeds used first to pay costs and accrued interest, leaving approximately €65m as principal recoveries to be paid to class A1. Classes E and F would have been fully written off, with class D almost fully written off too.

These classes gain most from the compulsory administration of the shopping centre as allocation of losses will be delayed and optionality in terms of principal recovery maintained. For class D noteholders especially, but also for class C noteholders, the advantages of not selling the property or the loan at a loss also include the potential for ongoing note interest payments and potentially even the repayment of previous interest deferrals.

The Quartier loan is secured by a shopping mall in the prime retail area of Friedrichsstrasse, Berlin. Based on a valuation as of March 2010, the property value declined from €181m in 2006 to €96.3m a year later. Much of this value decline was driven by a fall in rental cash flow. Shortly before defaulting on its interest, in January 2010, the borrower approached the servicer for a 2-year interest and payment holiday, but failed to provide further information. Ultimately, the servicer declined the request.

JL

Whole business securitisations

Surprise downgrade for pubco deal

All of the notes in the Unique Pub Finance securitisation have been downgraded one notch by Fitch because of concerns over the stability of Enterprise Inns' business model. The class A notes have become sub-investment grade, dropping from triple-B minus to double-B plus.

Fitch says that despite an improvement in the trailing 12-month (TTM) June 2011 free cashflow (FCF) per pub of around 1%, it is concerned that aggregate FCF has continued to decline annually by over 6%. While the increased FCF per pub is mainly because of pub disposals, proceeds from those disposals have not led to an effective deleveraging, as the agency notes the EDITDA-to-debt multiple has increased since March 2010 from 8x to 8.3x.

In the long term, Fitch says that without further financial support from Enterprise, FCF DSCR for the class A, M and N notes could hit lows of 1.2x, 1x and 0.9x respectively. The transaction will resume amortisation in September 2012 if no more class A2N notes are prepaid, so the agency is concerned about the long-term pressure on FCF that a prolonged plateau in debt service would provoke, leaving the FCF DSCR close to its minimum level.

Fitch expects TTM June 2012 FCF to further decline by over 2.5% to below £155m. Despite favourable credit enhancements, the agency believes that there are fundamental financing problems, which may be exacerbated by long-term uncertainty over the tenanted pub business model.

In particular, the agency is concerned by the nature of Unique's business model. It says that the lack of a managed division - which Spirit, Marston's and Greene King each have - prevents Unique from stepping into the actual operation of the pubs, which remain mainly wet-led, with food sales representing less than 25% of total turnover.

A combination of the economic downturn and 2007 smoking ban have made Unique's exposure to tenanted wet-led pubs a problem, argues Fitch, especially as beer duty has increased by 35% over the past three years. Macro concerns, such as the uncertain job market and rising operating costs, are also negative factors.

Securitisation analysts at Barclays Capital describe the rating action as "a little harsh" for several reasons. They expect EBITDA-to-debt levels at the class A level to fall from 6.1x in FY11 to 5.3x by FY14 and note that the current ratio of 6.1x is consistent with investment grade. For example, Greene King junior notes - which are rated triple-B minus - are currently at 7.6x.

The BarCap analysts also suggest that the sub-investment grade rating for the Unique class As appears inconsistent with Fitch's investment grade rating for the class Ms in Punch A and class As in Punch B, so future action on those tranches can be expected.

Further, the analysts say that Enterprise is likely to reverse the £30m surplus it receives from procuring beer at the group level at a lower cost than it sells to Unique. "This would improve Fitch's expected minimum FCF DSCR for the class As to 1.5x from 1.2x. We think it very likely that Enterprise would choose to do this since a default in Unique would likely result in a renegotiation of the beer supply agreement, resulting in Enterprise losing this surplus anyway," they explain.

Unique is a securitisation of 2,945 leased and tenanted UK pubs owned by Enterprise Inns. The class A2N floating-rate bonds, A3 fixed-rate bonds and A4 fixed-rate bonds have each been downgraded from triple-B minus to double-B plus. The class M fixed-rate bonds have been downgraded from double-B to double-B minus, while the class N fixed-rate bonds have been downgraded from double-B minus to single-B plus.

The downgrades mean that the class A notes will be removed from the iBoxx index at the end of the month.

JL

ABS

Alignment of interest

Deer Park Road Corp founder Michael Craig-Scheckman and md Will Bashan answer SCI's questions

Q: How and when did Deer Park Road become involved in structured finance?
M: I founded Deer Park Road in 2003 when I moved to Colorado, with the aim of continuing the relationships I had built in previous roles at hedge funds. Initially I was managing money for a very large New York-based hedge fund. By May 2008, we were running a portfolio for this other hedge fund and had launched our own fund - the STS Partners Fund.

Q: What are your key areas of focus today?
M: I've been trading distressed securities since 1993 and before 2007 had been focusing on MBS and other ABS, such as manufactured housing, home equity loan and aircraft lease. At that time, we were finding opportunities in situations where structures were getting more aggressive or complicated, or where underwriting standards had slipped. Those sorts of situations appear to be on the rise once again.

In 2008 and 2009, it was much easier to make money on the basis of minimal analysis, but now you have to do the homework and pick your spots. In 2008 you could look at a subprime RMBS tranche with 30% delinquencies and assume that it would be liquidated in one year - although intellectually you knew the assumptions couldn't be correct, you could buy it there anyway. Now, it's clear that delinquent loans can't be liquidated at this pace and you have to be more selective.

The composition of our portfolio is dictated by the market: we're an opportunistic, deep-value buyer. At the moment, it comprises about 80% MBS and the remainder ABS. The largest positions are mezzanine subprime deals, but there's aircraft, CMBS, franchise and manufactured housing in the portfolio too.

We typically avoid senior bonds and focus on the lower parts of the capital structure and on older transactions. About 70% of our subprime holdings, for example, is in the 2004 and pre-2004 vintages. These vintages aren't as volatile as the later ones.

Q: How do you differentiate yourself from your competitors?
M: We have an unusual fee structure: we charge 60% on the first 40% of ROI and 20% on the remainder. But we receive no fees if we don't make money for our investors.

We originally created this fee structure as an alternative structure, but the feedback was so positive that we made it our only fee structure. We believe this fee structure aligns us better with our investors.

W: The other differentiators are that we focus on high cashflow, generating 3%-5% a month, and keep the duration of the portfolio short (between 2-4 years). In addition, we don't use leverage because we're targeting high yielding ABS.

M: There is a simple reason for not using leverage: we're getting good enough returns without it. There is a certain amount of leverage inherent in securitisations anyway and it's easier to sleep at night without it.

W: Another edge that we have other funds is our dealer network. Michael's been in the business since 1993 and Scott since 2001, cultivating a network of 80 dealers from the major players down to the niche players. The ability to have the first look at an asset is a significant driver of our strategy.

M: Some of our competitors tend to only do business with the larger dealers. We don't use a prime broker either: we have a custody account with a large bank, which means we're not at risk of being on a bank's balance sheet.

Q: What is your strategy going forward?
M: We began raising outside investment in June 2010 and have been successful in attracting inflows every month since then. The firm has grown beyond our year-end target of US$100m AUM and so we are aiming for US$200m AUM by the spring. Another recent milestone was achieving a three-year track record.

On the staffing side, we hired Scott Burg as a portfolio manager last August (SCI 18 August 2010), Amy Charity in investor relations in June and Hao Li as a research analyst last month (SCI 22 July). We plan to hire another operations person in the autumn, bringing the number of employees at the firm to 10.

We continue to see a broad spectrum of opportunities in the ABS market.

Q: What major development do you need/expect from the market in the future?
M: The US RMBS and CMBS markets have been beaten up over the last couple of months. Loan modifications are having a significant impact on 2006-2007 subprime bonds, with cashflows seeing severe disruptions.

Losses flowing through the structure speed up repayments, but then modifications hit and the cashflows dry up. This is being reflected in bonds that were once trading at 80c now being worth 40c.

There could be months where the situation improves, but then it worsens again. The disruption is most obvious in older deals with fewer loans: when one loan is liquidated, it looks like a giant blip.

What trips you up are loans that aren't being processed traditionally; for example, where a deal is behaving like it has a 100% loss severity but is only being reported with a 50% loss. In these cases, it is necessary to reverse-engineer the position. While servicer reporting is improving, it's usually after the fact.

Nevertheless, there are greater opportunities in RMBS. It remains quite difficult to source attractively-priced CMBS: interest in the underlying properties is growing, which has held the lower part of the market in. We're not willing to be as speculative as others perhaps are.

What I'd really like to see is the private label RMBS market return. At present, the GSEs are the only game in town, but clearly they have to shrink. The unwinding of the GSEs will help drive the yields needed to justify new private label issuance.

CS

ABS

Law firm taps commercial finance pros

Peter Seiden and Bryan Petkanics have joined Loeb & Loeb's New York office as partners in the commercial finance practice. The pair were previously partners in LeClairRyan's New York office, prior to which they were partners at Seiden Wayne. They will be joined by Raymond Dusch, senior counsel, and John Oberdorf, associate, who also come from LeClairRyan.

Seiden's practice concentrates on representing banks and other financial institutions in loan and commercial transactions. His experience includes commercial real estate lending transactions, swaps and derivatives, and secured lending.

Petkanics also focuses his practice on the representation of banks and other financial institutions in private banking and commercial lending transactions. His experience includes financings structured around hedge fund interests, private equity interests and aircraft. He also has expertise in asset-based lending, derivatives, restructuring and loan workouts.

Dusch has represented domestic and international financial institutions in all aspects of asset-based financing and equipment leasing for more than 30 years. His practice focuses on equipment leasing and financing transactions and securitisations.

Finally, Oberdorf focuses his practice on the areas of commercial finance, corporate law, mergers and acquisitions, and intellectual property matters and transactions.

ABS

German pricing service expands

Interactive Data Corporation has expanded its evaluated pricing services capabilities in Germany. A new team of evaluators based in the firm's Frankfurt office will provide local market knowledge and expertise in the evaluation of German domestic fixed income securities.

Anthony Belcher, European fixed income director at Interactive Data, comments: "Our local evaluators are closer to the market and can obtain more in-depth local knowledge and market colour as input into our evaluations. As part of our global team of over 130 evaluators, this additional local expertise brings us wider knowledge and resilience. We aim to provide our clients with increased transparency into our evaluations process, and additional insight on the asset classes for which we produce evaluated prices."

In terms of outstanding nominal value, the German bond market is one of the largest in the world and has seen an increase in issuance with debt rising sharply over the past few months. In addition, the crisis in the financial markets that began in 2008 has led to changes in the way that thinly-traded securities are valued by German investment management firms.

In December 2009, BaFin amended the country's valuation rules in the Investment Fund Accounting and Valuation Directive to provide clear requirements for the investment industry. As a result, investment management firms either need to set up and maintain an in-house pricing team or use an independent third-party source and verify prices against other external sources.

ABS

Cadwalader adds Hong Kong partner

Jeffrey Chen has joined Cadwalader, Wickersham & Taft's Hong Kong office as partner. Formerly with Mayer Brown JSM in Hong Kong, he will be a part of the capital markets team.

Chen brings extensive experience of complex structured finance products and pioneered limited recourse receivables financing in mainland China under existing PRC law. He has advised on many of the headline structured finance transactions in Asia over the past decade, including Huarong AMC NPLs, Samsung Life RMBS, HKMC's cross-border Korean securitisations and more recently a slew of complex structured notes and derivatives litigation arising out of the global Lehman bankruptcy proceedings.

CDO

Key persons replaced

Faxtor ABS 2005-1 class C noteholders have voted to replace the key persons on the transaction by an extraordinary resolution (SCI passim). IMC Asset Management has nominated Egbert Bronsema and Misja Perquin as the new key persons, replacing Jeroen Bakker and Frans Wesseling.

Fitch says that the note ratings will not be impacted by the replacement. The agency believes the transaction will be at most lightly managed by the collateral manager because its reinvestment period ended in February 2011.

In addition to the annual senior management fee of 10bp on the average collateral balance, the collateral manager receives an additional collateral manager fee that stepped down to 10bp from 30bp after the reinvestment period. This additional collateral manager fee that ranks junior in the priority of payments is currently shut off because the coverage tests are being breached.

CDO

CRE CDO transferred

Wrightwood Capital has resigned as collateral manager and advancing agent on Wrightwood Capital Real Estate CDO 2005-1 and been replaced by Ares Commercial Real Estate. Moody's has determined that the move won't cause the ratings of the notes to be reduced or withdrawn. The agency does not express an opinion as to whether the replacement could have other, non credit-related effects.

CDO

China credit sales head named

Citi has appointed Steve Yang as head of Greater China credit sales. He will be based in Hong Kong and work alongside Esther Feng and Yang Ji, head of Taiwan investor sales and China investor sales respectively.

Yang joins from JPMorgan, where he was head of Taiwan credit and investor sales for seven years, before becoming co-head of structured credit syndication. He has previously worked in the institutional clients group at Deutsche Bank and in fixed income with Bear Stearns.

Yang will report to So-Yon Sohn, head of credit sales for Asia Pacific.

CDS

Indian credit trading team bolstered

Citi has bolstered its Indian credit markets trading and commodities team with four new hires.

Rohit Dusad joins Citi as director origination in credit markets trading. He previously originated structured products at JPMorgan.

Aditya Bagree has been named director credit structuring, having previously worked with Nomura as the head of India structuring. As vp credit trading, Chintan Shah brings cross-regional experience to the India trading unit, given his exposure to LatAm, US and emerging market products. Prior to joining Citi, he worked with the emerging market structured credit trading business at Merrill Lynch in New York and more recently on the India credit trading desk at Morgan Stanley.

Deepak Shaw joins Citi as a credit analyst, bringing over 11 years of experience in credit analysis on debt issuers, internal ratings and securitisations. He previously worked with BNP Paribas Mutual Fund, Bharati Axa and ICICI Bank in varying roles with significant exposure to fixed income products.

CLOs

Ares acquires Indicus

Ares Management is buying European leveraged finance and CLO manager Indicus Advisors. David Reilly and Ujjaval Desai, co-founders of Indicus, have been named co-heads of Ares Capital Markets Europe and will be responsible for all of Ares' European syndicated debt and global structured products.

"Our joint team will be much more significant in the marketplace at a time when we are seeing compelling opportunities for our investor base in existing and new mandates," say Reilly and Desai.

The acquisition of Indicus is the latest on a growing list of CLO manager acquisitions by Ares. Having acquired CLO manager Allied Capital in October 2009, it went on to take buy Navigare Partners' CLOs, a CLO managed by Octagon Credit Investors and, more recently, the Clydesdale CLOs from Nomura Corporate Research and Asset Management (SCI passim).

As a result of the latest acquisition, Ares will manage in excess of US5$bn in long-only, long/short, structured products and private debt investment strategies. Ares Management will have approximately US$43bn of committed capital under management and approximately 420 employees. A total of 17 Indicus professionals will join the Ares Capital Markets Group in the London and New York offices.

The terms of the transaction were not disclosed and it is subject to UK regulatory approval.

CLOs

Another GSC CLO hearing scheduled

A hearing in connection with the Gateway III Euro CLO and Gateway IV Euro CLO deals will be held on 17 August. The Chapter 11 trustee is seeking an order authorising the trustee to reject certain executory contracts, including the deed of novation and amendment effecting the appointment of a successor collateral manager. The motion also requests the Court to set a bar date for counterparties to file proofs of claim related to the contracts within 30 days of the entry of any order.

GSCP resigned as the collateral manager of the two transactions on 27 January 2010 and Pramerica Investment Management was appointed successor collateral manager under an agreement dated 28 April 2010.

Any objections to the motion must be filed and received by the Bankruptcy Court by 12 August. If no objections are received by this deadline, the Bankruptcy Court may grant the motion without a hearing. Any objecting parties are required to attend the hearing and failure to appear may result in relief being granted or denied upon default.

CLOs

CLO hit by occurrence of cause

Nomura Corporate Research and Asset Management has notified the trustee and preference shares paying agent on Clydesdale CLO 2003 of the occurrence of an event constituting cause under the management agreement. The management agreement may consequently be terminated and the collateral manager removed, providing that written notice thereof is given to noteholders and rating agencies within 30 days after two-thirds of the preference share holders or controlling class decide to proceed with such termination.

CMBS

Regulatory policy director added

Martin Schuh has joined the CRE Finance Council (CREFC) in the newly created position of director, legislative and regulatory policy. Schuh is based in CREFC's new Washington, DC office.

CREFC says Schuh is being brought in to promote the trade association as the leading expert and voice of the CRE finance industry with members of Congress and Capitol Hill professionals, the administration and the regulatory agencies. He will complement Mike Flood, vp of legislative and regulatory policy, to advocate on behalf of CREFC member organisations.

Previously, Schuh served as professional staff member on the Special Committee on Aging for ranking member US Senator Bob Corker. During his tenure in the Senate, Schuh advised the senator and the Committee on diverse issues, such as the economic effects of proposed legislation and regulation, securities provisions within banking reform as well as municipal finance, accounting and tax issues.

CMBS

Orrick partner finds new home

Cameron Cowan has joined King & Spalding as a partner in its capital transactions and real estate practice in Washington, DC. He moves from Orrick, Herrington & Sutcliffe, where he was a partner in its global finance group and oversaw the opening of its Washington, DC, and three China offices. Cowan counsels financial institutions, corporations and government agencies in complex financings in the US, Europe and Asia and serves as an advisor on financial markets regulation.

RMBS

Law firm taps servicing vet

SNR Denton has appointed Scott Samlin as a partner in its capital markets practice in New York. Samlin joins from Morgan Stanley, where he was executive director for the residential mortgage and lending compliance business.

At Morgan Stanley, Samlin helped oversee the operations of the firm's whole loan trading desk and its affiliated mortgage loan servicer, Saxon. Prior to this, he was evp, general counsel and chief compliance officer for EMC, Bear Stearns' primary mortgage loan servicer.

RMBS

US broker bolsters sales and trading

US broker-dealer Mizuho Securities has expanded its sales and trading department with a number of senior appointments across its fixed-income business, including high-yield, interest rate derivatives, mortgages and corporate credit.

Among the recent hires are Roger Yao in RMBS trading, Franklin Amoo, strategic credit trading and Tyler Patla in agency MBS trading. Fixed-income sales have been bolstered with the appointments of Robert Rotanz and Peter Brunell, both in MBS sales, Ryuta Ray Kawahara in global fixed-income sales, Coleen Mager and Jonathan Krause in high yield sales and Kevin Cullity as senior derivatives marketer.

RMBS

MBIA recoveries, commutations outlined

Expectations of future payments on MBIA's RMBS exposures increased by US$53m during the second quarter, according to the monoline's latest quarterly financial results. However, the increase in expected future claims payments was more than offset by additional expected recoveries of US$69m, primarily from contractual claims related to ineligible mortgages.

MBIA's estimates for expected recoveries related to put-backs of ineligible mortgages totaled US$2.7bn, as of 30 June. Based on the monoline's assessment of the strength of its contract claims, it believes it is entitled to collect the full amount of its cumulative incurred losses (US$4.6bn, as of 30 June) from securitisation sponsors against whom it is pursuing litigation.

Since the end of 1Q11, MBIA Corp has reached agreements with five counterparties for commutations of multi-sector CDOs and investment grade corporate CDOs. Commutation agreements with two of the parties were closed in the second quarter, an agreement with one counterparty was reached during the second quarter and subsequently closed in the third quarter, while agreements with the remaining two counterparties were reached and are expected to close in the third quarter. When fully consummated, the five commutation agreements will have eliminated US$8.7bn in gross insured exposure.

ABS

EMEA SF losses lower than expected

Realised losses for EMEA structured finance (SF) transactions are low and total credit losses will remain less than many commentators have suggested, Fitch says in a new report. Transaction performance varies significantly across asset classes, with the strongest performance visible in consumer assets.

In the four years since the onset of the credit crisis, many comments have been made about the performance of structured finance transactions, including discussions about the number of tranches that have had their ratings downgraded or even that have defaulted, as well as the level of mark-to-market investment losses. Fitch's study presents a different perspective by assessing the levels of credit losses that have actually been realised and those that are still expected to be realised across the sector. The findings are substantially different to those typically cited by commentators.

"The pure credit losses associated with the EMEA structured finance market are substantially less than many commentators have previously intimated," says Andrew Currie, md in Fitch's SF team. "The Fitch-rated EMEA SF tranches outstanding at the onset of the credit crisis have realised principal losses of €2.8bn, representing 0.3% of their original balance of circa €1trn, but these headline figures only tell a fraction of the story."

The agency expects further losses to be incurred over the remaining lives of the transactions, despite the relatively low losses realised to date. Indeed, many SF transactions adopt structures whereby payment shortfalls will not actually be allocated to the notes until their maturity dates, even if some loss is already anticipated. Fitch expects total losses to reach €25.1bn, representing 2.6% of the original tranche balance.

"Performance has varied significantly between asset classes," says Gioia Dominedo, senior director in Fitch's SF team. "In particular, the performance of securitisations of European consumer assets, such as residential mortgages, has remained strong throughout the crisis. Fitch expects a total loss of 0.7% of the original balance of these assets, compared with a higher total loss of 4.7% on commercial assets."

The weaker performance of commercial assets - which include commercial ABS, CMBS and structured credit (SC) transactions - is already visible in realised losses. Over 90% of the losses realised over the past four years can be attributed to SC transactions and, in particular, SF CDOs, which account for 73% of the total losses realised to date.

SC transactions are expected to continue to contribute to future expected losses, with just over 50% of total losses accounted for by SC. CMBS is expected to make up the majority of the remainder, or around one-third of total losses.

"Fitch's expectations of future losses are highest for CMBS transactions," says Dominedo. "While only 0.1% losses have been realised to date, this is expected to increase to 6.3% of the original balance of CMBS tranches outstanding at the onset of the crisis. The severe market value declines that have occurred in European commercial property have been exacerbated by the lack of structural mechanisms in most transactions to provision for losses."

The study is the first in a series of research reports under the banner 'The Credit Crisis Four Years On', which will focus on the impact of the global credit crisis and the ensuing economic downturn on the world's major structured finance markets.

"The exact timing of the beginning of the crisis is subject to debate, but July 2007 marked an acceleration of the globalisation of the crisis as concerns over US subprime mortgage losses spread to European financial institutions," explains Ian Linnell, global head of structured finance at Fitch. "While the repercussions of the crisis continue to affect the global economy, the passage of four years is sufficient to begin to assess the true impact of the crisis on the securitisation market. This series of reports will assess the many changes that have occurred to the market, covering the extent of actual credit losses through to the future shape of the industry."

Securitisation in all its forms - including the performance of related credit ratings - has been severely criticised by many market commentators as a result of the crisis. Criticism was particularly fuelled by the large decline in the value of many securities as the market for these instruments became illiquid.

"At the height of the credit crisis, there was a significant dislocation between market prices and credit fundamentals," says Linnell. "This was exacerbated by accounting standards that forced financial institutions to mark their positions to market values and thus recognise the 'losses', even if the risk of actual credit losses was minimal over the life of the securities. In addition, a number of banks and non-bank investors became forced sellers, crystallising significant losses by selling into an illiquid market."

A key question is whether the fall in market prices also reflected a structural change in the underlying credit risk, according to Linnell. "In Fitch's view, to fully answer this question it is important to assess not only rating transitions but also default and loss rates for the securities. Clearly, the performance of US RMBS and large parts of the CDO market was poor. Not surprisingly, these areas have seen the most significant changes to criteria and credit enhancement levels for new transactions. However, outside these two areas, large parts of Fitch's rated structured finance portfolio have performed well, despite the severity of the crisis."

Other subjects to be covered in the series of reports will include the performance of other major securitisation markets, a comparison of the characteristics of transactions pre- and post-crisis, enhancements made to the rating process, Fitch's approach to unsolicited ratings and commentary, major criteria developments and the rise of covered bonds.

ABS

Global SF criteria updated

Fitch has updated its global criteria for rating structured finance (SF) transactions. The update incorporates additional information with respect to the treatment of credit events withint the surveillance process, rating sensitivity analysis and reasonable investigation. No rating changes are expected to result from the criteria update.

ABS

US-linked ABS ratings review underway

S&P says that its ratings on 744 structured finance transactions remain on credit watch negative (SCI 18 July) following the lowering of its long-term credit rating on the US to double-A plus with a negative outlook and the removal of its long- and short-term ratings from credit watch negative. The rating actions also included the affirmation of the A-1+ short-term rating on the US.

Following the sovereign downgrade, S&P will review the affected transactions, as well as any additional transactions that may be affected, and take rating actions as appropriate. The agency expects to lower the ratings on most of the affected transactions to a level no higher than the sovereign rating on the US, due to potential exposure to the US.

The ratings on principal protected notes backed by US government obligations and defeased securities (mainly tobacco securitisations and letter of credit-backed issues) are expected to be downgraded to a level equal to the sovereign rating. Equally, S&P anticipates lowering the ratings on transactions with ratings directly or in part linked to the sovereign rating of the US - such as securities guaranteed or collateralised by loans guaranteed by the US, a government-related entity or a government agency - to a level equal to the sovereign rating. However, there may be transactions that have other sources of credit support sufficient to maintain the current ratings, the agency notes.

Certain transactions, including CMBS that have defeased loan collateral, will be evaluated based on each rated security's degree of reliance on US government obligations and the availability of other sources of credit support.

S&P warns that if the sovereign rating action leads to subsequent rating actions on financial institutions, certain structured finance transactions with ratings linked to those financial institutions may be affected. But it notes that under its criteria, if warranted, it can continue to rate new structured finance transactions higher than the sovereign rating.

A review of a significant portion of the affected transactions will be completed within the next few days.

The broad impact on securitised markets from S&P's downgrade of the US falls into two camps, according to ABS analysts at Deutsche Bank. One generally negative set of effects is if financing markets reduce leverage or raise costs, or if investors back away or encounter higher funding costs. A second potentially positive set of effects is, however, if investors start gravitating towards the more than US$741bn in outstanding triple-A securitised debt.

ABS

APAC consumer ABS criteria updated

Fitch has published a new Asia-Pacific (APAC) consumer ABS criteria report, which details the agency's approach to analysing credit risk inherent in consumer ABS backed by portfolios of homogenous amortising loans or lease products advanced to a diversified pool of individuals.

The criteria outline the qualitative and quantitative factors considered in the agency's approach when assigning new ratings and monitoring existing ratings. This includes asset analysis, rating stresses, liability structure analysis, cashflow modelling, legal analysis, counterparty risk considerations and performance analytics.

The criteria report is expected to have a minimal impact on existing, seasoned APAC consumer ABS transaction ratings due to the structural build-up of credit enhancement over time, subject to individual deal performance. Should the criteria changes impact existing ratings, issuers will have the opportunity to indicate whether they intend to make any amendments to the transactions. Fitch will consider any proposed transaction amendments before resolving ratings.

ABS

Credit reports to include reps and warranty details

Fitch is to include expanded disclosure of representations, warranties and enforcement (RW&E) mechanisms in its global structured finance rating reports beginning on 26 September. This new practice follows the SEC's adoption of Rule 17g-7 pursuant to the Dodd-Frank Act, which requires NRSROs to include in credit reports for ABS offerings such a description and comparisons to the RW&E of 'similar securities'.

As an NRSRO, Fitch will apply this practice to all global structured finance transactions that are currently identified with the 'sf' modifier. The expanded disclosure will be included in all presale and new issue reports.

The RW&E disclosure will include: the characteristics of the underlying asset-pool; the parties to the transaction; the security interests of the underlying assets; and the remedies available to noteholders.

ABS

Euro SF downside risk remains

Fitch says in a new report that the performance of European structured finance (SF) transactions continued to stabilise over 1H11. However, downside risks remain as performance is heavily dependent on the macroeconomic environment. In Fitch's view, the key risks affecting SF transactions are interest rate risk, the potential for further housing market falls and the limited availability of credit.

The macroeconomic performance of the key European SF jurisdictions is increasingly diverging, according to the agency. While most northern European economies are recovering from the credit crisis, albeit at different speeds, peripheral Eurozone countries continue to suffer from its effects. Key macroeconomic drivers such as GDP growth and unemployment vary significantly across jurisdictions and their effects will be felt differently on the performance of SF transactions.

In particular, the stabilisation of SF transactions has occurred against a backdrop of historically low interest rates. The performance of transactions as interest rates begin to rise will be heavily dependent upon the underlying macroeconomic environment.

"The majority of SF transactions - in particular, RMBS and consumer ABS transactions - are secured by floating-rate assets and have therefore benefited from current low interest rates," says Gioia Dominedo, senior director in Fitch's European structured finance team. "However, in many cases delinquencies have stabilised at levels significantly above those seen pre-crisis. Fitch expects both UK and Eurozone rates to increase in 2H11, albeit modestly, leaving transactions exposed to the potential for another round of performance deterioration."

In addition to the risk of interest rate increases, SF transactions and, in particular, RMBS transactions are also exposed to the potential for further housing market falls. "Most European housing markets remain below their peak levels and Fitch expects many to deteriorate further over coming quarters," says Andrew Currie, md in Fitch's European structured finance team. "Limited property sales volumes, especially in the troubled peripheral economies, create uncertainty about achievable sales prices. Countries that have suffered particularly steep declines in housing demand, such as Spain and Ireland, have seen the creation of a significant property supply overhang with the potential to further depress prices."

Many types of SF transactions are negatively affected by the limited availability of credit, though this is especially stark for commercial products such as commercial mortgage and small business loans. The availability of new debt remains constrained, with many banks focusing on their own recapitalisations and lending to only the best credits. While there continues to be political pressure to increase lending to households, such credit is typically only available under considerably more restrictive terms than those that were common pre-crisis.

ABS

Credit quality measures continue to improve

Caution still reigns supreme among US consumers as credit quality measures improve rapidly, according to the latest Credit Card Index results from Fitch.

Credit card defaults registered the second largest monthly decline since the passage of the Bankruptcy Reform Act in 2005 and are now back in line with historical averages. In addition, both prime card monthly payment rate (MPR) and late-stage delinquencies improved, while yield and three-month average excess spread dipped during the June collection period.

"US consumers are charging less and swiftly paying off existing balances in increasing numbers," says Fitch md Michael Dean. "Default rates are also pulling back more quickly than anticipated and appear poised for further improvements in the coming months."

Although economic conditions have been mixed, overall ABS performance in the meantime is pointing in the right direction. US consumer credit rose in June and marked the ninth straight month of growth. However, consumer spending dropped in June and marked the first decline in two years.

Continuing its course on an improving trend, Fitch's 60+ day delinquency index for the 18th consecutive month declined further by 11bp to 2.46% in July. After experiencing its peak during the beginning of 2010, current delinquency levels are approximately 46% lower. Early-stage delinquent balances, associated with borrowers who have missed at least one payment, remained steady at 3.34%.

As expected from the prolonged decline of delinquencies, credit card charge-offs registered its fourth straight monthly improvement in July. Particularly noteworthy this month was the fact that defaults dropped 96bp to below 7% for the first time in 2.5 years at 6.33%.

Every trust included in the index reported positive movements in defaults for the month. However, charge-offs remain roughly 6% higher than the historical average of 5.99% since 1991.

Monthly payment rate performance also made a splash in the news this month as it improved to an all-time high by increasing 36bp to 21.76% in July. However, yield and excess spread on a three-month average basis both dipped in July.

Gross yield decreased by 67bp to 20.17%. After registering a new record from the previous month, the three-month average excess spread bounced back below to 10.73%, but still remain 24% above last year's levels.

CDO

ZAIS clarifies stance on ZING VII

ZAIS Group has responded to Hildene Capital Management's recent letter regarding ZING VII's bankruptcy (SCI passim). As collateral manager on the transaction, ZAIS says it would like to express its concurrence with and support of Hildene's description of the facts in the ZING VII bankruptcy proceedings.

"We share Hildene's concern relating to this matter, both with respect to the investors in ZING VII and with respect to its ramifications for the market," the manager notes.

ZAIS also seeks to clarify Hildene's suggestion that it has ignored the interests of noteholders, stating that it understands the concerns of noteholders. It stresses that the action of noteholders in accelerating the notes ended ZAIS's right to manage the collateral pool.

Additionally, the manager refutes Hildene's implication that ZAIS had the legal right and ability to oppose the involuntary petition filed by Anchorage Capital. It points out that ZING VII is a legal entity that is separate from, and not controlled by, ZAIS. ZING VII has its own board of directors and its own counsel.

The manager says that, upon being made aware of the intentions of Anchorage Capital Group, ZAIS discussed the matter with the directors of ZING VII. But the directors of ZING VII, in consultation with their counsel, ultimately determined not to oppose the involuntary petition filing.

Furthermore, ZAIS says it values the interests of all of its investors in all parts of the ZING VII capital structure and was actively involved in causing the directors and trustee to circulate the proposed Anchorage reorganisation plan to all investors, rather than just the class A1 noteholders as Anchorage originally did. "ZAIS did not, and does not, support the filing of the involuntary petition and has been frustrated at its inability to intervene in the proceedings up to this point due to its lack of either contractual or judicial standing," the manager adds.

ZAIS has confirmed that it will file papers in support of Hildene's motion to dismiss the involuntary petition. It anticipates the filings to occur later this month.

CDS

Counterparty credit risk study published

ISDA has published a new analysis of counterparty credit risk management in the US over-the-counter (OTC) derivatives markets. The paper examines the extent of counterparty credit losses and notes the efficacy of credit mitigation techniques in the US banking system.

The paper states that according to reports published by the Office of the Comptroller of the Currency (OCC), US bank losses on OTC derivatives products due to counterparty defaults totalled less than US$2.7bn since 2007.

It also notes that risk management processes such as netting and collateralization significantly reduce US banks' net current credit exposure (NCCE). In fact, netting and collateralization decrease the NCCE of the US banking system to US$107bn, or 4 basis points (0.04%) of notionals outstanding. Less than one-third of this amount - or approximately US$30bn - is with entities covered by The Dodd-Frank Act's requirements on margining and clearing.

"The OCC Reports and ISDA's analysis demonstrate that the credit risk losses and exposure of US banks related to derivatives are quite manageable," says Conrad Voldstad, ISDA ceo. "It's also clear that a renewed focus on robust risk management practices - including netting, collateralization, clearing and portfolio compression - is helping to increase the safety and efficiency of OTC derivatives markets."

CMBS

Aggressive CMBS underwriting highlighted

The quality of the loans securitised in US CMBS conduits in the second quarter held steady in terms of leverage. But there were signs of more aggressive underwriting that could lead to weaker loan pools backing CMBS, says Moody's in its latest quarterly review of the sector.

"Leverage levels in the four conduit transactions we rated in the second quarter were consistent with those of loans in 2004 transactions, one of the last healthy CMBS vintages before the crisis," says Tad Philipp, Moody's director of CRE research. "However, we're already seeing signs of credit erosion as underwriting becomes more aggressive."

Specifically, Moody's says that for the first time in CMBS 2.0 the proportion of interest-only loans exceeded 20% and the proportion of loans with reserves in two key categories (capital expenditures and taxes) declined. In the second quarter, leverage - as measured by Moody's LTV rate - ranged between 90% and 98.2% for individual Q2 CMBS conduits, with an average of 93.9%, a slight uptick. At the same time, Moody's debt service coverage ratio rose to 1.48x during the quarter, a slight improvement over the 1.46x of the previous quarter.

In general, the agency views the credit quality of CMBS 2.0 deals as having moved through two phases. In the first phase - the second and third quarters of 2010 - Moody's-rated transactions had Moody's stressed LTV ratios in the low 80s, as these first post-crisis deals had underlying loans that were very conservatively sized. Since then, in the second phase, leverage has risen to the low-90s, with slightly more aggressive underwriting practices that are consistent with those of about 2004.

CMBS

Second-quarter CRE loan mods analysed

Modifications of the CRE loans that back US CMBS continued at a steady pace in 2Q11. At the same time, there was a small downtick in the share of loans in special servicing, according to the latest CMBS and CRE CDO surveillance review from Moody's.

The agency notes that along with a slight drop in the share of loans in special servicing in the second quarter, from 12.7% to 12.3%, the proportion of performing loans in special servicing also continues to decline. These account for 29.5% of the specially serviced loan balance in June 2011, down from 30.5% in March 2011 and 33.6% in June 2010.

Moody's observes that over the last few years, diligent servicing and a more positive refinancing environment have led to the resolution of a number of performing loans in special servicing. In many of these cases, proactive borrowers had requested modifications in an attempt to prevent default.

"As a result, the proportion of non-performing assets in special servicing has grown. But we still expect quicker resolutions of performing loans and for fewer performing loans to enter special servicing, on a rebound in commercial lending, a favourable interest rate environment and strengthening real estate fundamentals," says Moody's md Michael Gerdes.

Loan modifications have so far this year averaged 32 loans and US$1.6bn a month. Most modifications consisted of 'combination' strategies, such as extensions combined with principal write-offs.

"Basic maturity extensions are becoming just one component in an overall more complex loan modification process," says Gerdes. "We're seeing an increase in the use of A/B note splits or 'hope' notes and reductions to interest rates in conjunction with other strategies, especially for larger loans. But many of these strategies are resulting in interest shortfalls."

Modifications can mitigate or delay principal losses, as well as result in shortfalls due to interest deferrals and decreases in loan coupons.

CMBS

Barclays job cuts to hit seven CMBS

Job cuts at financial institutions will affect demand for office space and have a minor negative effect on CMBS credit, according to S&P credit analysts James Manzi and Howard Esaki. They note that the credit of financial tenants is much higher than the average for CMBS, so the increased risk is largely in terms of lease rollover rather than default.

Earlier in the week, Barclays announced a 38% drop in profits in 1H11 and plans to cut 3000 jobs in 2011. Seven loans (US$1.5bn) in seven CMBS deals have Barclays tenant exposure, with the most exposure in a European deal, TITN 2007-3X (18.4%). Five 2005-2007 Lehman deals have Barclays' exposures ranging from 1.7-4.0%, mostly from a loan on 200 Park Avenue, according to Trepp data.

CMBS

2011 conduit/fusion CMBS cleared

S&P has published an update to its review of the application of its US conduit/fusion CMBS criteria (SCI passim) and says that the approach used for DSCRs on new transactions rated since early 2011 has produced results that are consistent with its rating definitions. Effective immediately, the agency will resume assigning ratings to new conduit/fusion transactions by applying the averaging approach.

That approach is to calculate a loan's DSCR as the average of two ratios. The difference between these two ratios is their denominators.

One ratio uses the loan's actual debt service amount as the denominator. The other ratio uses a hypothetical debt service amount, based on the loan constants specified in the criteria, as the denominator. The averaging approach has been applied consistently to new CMBS conduit/fusion deals rated since early 2011.

S&P uses a different approach for surveillance. For surveillance on outstanding CMBS conduit/fusion deals, a loan's DSCR for purposes of applying the tests in the criteria is the worse (lower) of the ratio determined using the actual debt service amount as the denominator and the ratio determined using a hypothetical debt service amount, based on the loan constants specified in the criteria, as the denominator.

S&P identified a number of deals where the averaging approach was used in the surveillance process. After reviewing the affected deals, the agency has determined that no rating changes are appropriate.

The agency adds that it is currently reviewing its CMBS conduit/fusion criteria for potential updates, including the harmonisation of the two approaches to calculating DSCRs. "S&P intends to retain the overall calibration of the CMBS conduit/fusion criteria in its next update. That is, S&P intends the triple-A credit enhancement level for the archetypical pool to remain at 19%," it says.

At this stage of its review process, the agency does not expect any such criteria update to result in a large number of rating changes on outstanding CMBS conduit/fusion securities. "S&P expects that the magnitude of any such changes would be generally modest. To the extent that any such update results in rating changes on outstanding securities, S&P expects that the proportion of upgrades to downgrades would be roughly even."

CMBS

CMBS delinquencies hit new high

US CMBS delinquencies reached a new record high last month due to a slew of new late-pays combined with below-average loan resolutions, according to Fitch's latest index results. Nearly US$3bn of new delinquencies in July outpaced the US$1.4bn of resolutions from the index. This led to a 37bp increase to 9.01% - surpassing the previous high water mark of 8.81% recorded in May 2011.

"A change in the foreclosure status of several larger specially serviced loans coupled with slower resolution activity led to the spike in CMBS delinquencies," says Fitch md Mary MacNeill. "Despite the 37bp uptick, delinquencies are still trending within Fitch's projection of 10% by year's end."

Current delinquency rates by property type put multifamily at 15.92%, up from 15.69% in June; hotels at 14.22%, up from 13.85%; industrial at 10.45%, up from 9.89%; retail at 7.01%, up from 6.84%; and office at 6.64%, up from 6.14%.

July resolutions from the index totalling US$1.4bn fell well shy of the US$2.3bn per month rolling 12-month average. The volume of new delinquencies was also 24% higher than average.

Meanwhile, Fitch's rated portfolio continued to shrink, down over US$100bn (20%) from its June 2008 peak. This contraction accounts for roughly 180bp of the current delinquency rate.

CMBS

Three Japanese CMBS loans default in July

Three loans backing Moody's-rated Japanese CMBS defaulted in July, according to the agency's latest report on the sector. Two loans defaulted at their maturity date, including one large loan totaling more than ¥60bn (US$706m), and one loan defaulted before its maturity date because of a payment default. All loans were backed by office buildings in Tokyo and Osaka.

The report also says that four loans totaling ¥69bn matured in July. One of the loans was paid on its maturity date and the maturity of other loan was further extended. Additionally, one large loan - worth more than ¥10bn and due to mature after August 2011 - was prepaid in July.

Four defaulted loans were recovered, of which two were fully recovered through property dispositions, while two incurred losses on their remaining balances. The fully recovered loans were backed by an office building in Tokyo and a portfolio of residential properties in provincial cities.

The loans that incurred a loss were backed by a portfolio of mainly residential properties and a portfolio of only residential properties - both in provincial cities. Though the collection period for the loans that incurred a loss was prolonged, the recovery rate remained low, Moody's says.

In July, two Moody's rated single-borrower CMBS deals were newly issued and two loans were newly added to the underlying loans backing Japan CMBS. In total, loans in default as of July totaled ¥582.4bn, a 9.1% increase over the previous month.

Distressed assets

Small investor structured pilot closed

The FDIC has closed on the first sales in its small investor programme (SIP). The pilot SIP involved two competitive sales of equity interests in two limited liability companies, each formed by the FDIC in its receivership capacity to hold certain assets of FirsTier Bank that failed on 28 January 28.

The assets transferred by the FirsTier receivership to the LLCs consist of 213 loans pooled by loan type. A pool of performing and non-performing commercial real estate loans and commercial acquisition and development and construction loans and credit facilities (the CRE/CADC assets) were transferred to one LLC and a pool of performing and non-performing residential acquisition, development and construction loans and credit facilities (the RADC assets) were transferred to the other LLC.

The purchaser of the private owner interest in the LLC holding the CRE/CADC assets was Acorn Loan Portfolio Private Owner IV, which is owned by Calista Corporation, FACP Mortgage Investments and entities controlled by Oaktree Capital Group Holdings. The purchaser of the private owner interest in the LLC holding the RADC assets was HRC SVC Pool II Acquisition, an entity controlled by Hudson Realty Capital.

Acorn paid a total of approximately US$25.6m in cash for its initial 25% equity stake in the LLC holding the CRE/CADC assets; its bid valued the CRE/CADC assets at approximately 65% of the aggregate unpaid principal balance (UPB) of such assets. The CRE/CADC assets comprise 116 loans with an aggregate UPB of approximately US$158m, with the highest concentration in Colorado (96%).

HRC paid a total of approximately US$14.9m in cash for its initial 25% equity stake in the LLC holding the RADC assets; its winning bid valued the RADC assets at approximately 43% of the aggregate UPB of such assets. The RADC assets comprise 97 loans with an aggregate UPB of approximately US$139m with the highest concentration in Colorado (95%).

Acorn and HRC will provide for the management, servicing and ultimate disposition of the LLCs' assets.

The pilot SIP sales were conducted on a competitive basis, offering bidders the option to bid on either or both a leveraged structure (for a 50% equity interest) and an unleveraged structure (for an initial 25% equity interest). A total of 13 groups submitted bids to purchase an equity interest in one or both of the newly-formed LLCs.

The FirsTier receivership will hold the remaining 75% equity interest until all equity is returned. After the return of equity, the receivership's interest in each LLC will decrease to 50% and the private owner interest will correspondingly increase to 50%.

The FDIC says the pilot programme offers smaller sized asset pools and unique structural features to make it more accessible for smaller investors and increase participation in structured sales while maintaining a level playing field for all investors.

Documentation

Reps and warranties comparisons added to presales

As of September 26, all reports accompanying new ratings from Moody's on ABS will include comparisons to standard benchmarks for each transaction's representations and warranties and enforcement mechanisms. The new feature responds to Rule 17g-7, adopted by the US Securities and Exchange Commission last January.

The securities affected are both US and non-US securities, including RMBS, CMBS, ABS, commercial paper and CDOs. The securities also include some public finance securities, such as housing bonds and tender option bonds. Moody's will determine the benchmarks for comparable representations and warranties based on US standards, although it is also evaluating the use of local benchmarks.

Insurance-linked securities

ILS muted after turbulent start to year

Despite significant catastrophic events and a change to RMS' US hurricane model, the insurance-linked securities market coped well in early 2011, says S&P in its latest ILS report. The rating agency says cat bonds have performed largely as expected, while new issuance has continued, albeit at a slower pace than in the past.

S&P downgraded four bonds on the back of April's Tohoku earthquake and ensuing tsunami, while 11 bonds were downgraded due to RMS' model change. The agency notes that these events have dampened issuance as the year has progressed.

"New ILS issuance slowed considerably in second-quarter 2011 compared with previous years," says S&P credit analyst Maren Josefs. "We consider the release of the latest version of RMS' US hurricane model to be a key reason for this. As the insurance market and investors try to understand how this change affects their portfolios, it is perhaps unsurprising that issuance has slowed."

Josefs adds: "It is worth noting all three risk-modeling agencies update each of their models on a regular basis, albeit rarely with such an impact. Consequently, we believe the effect on issuance and ratings can be considered an exception."

Regulation

Warning over unintended risk retention consequences

Evolving US risk retention regulations require careful navigation by securitisation market participants, according to Fitch. The rating agency has issued a new report in which it assesses the potential effect that pending risk retention rules could have on securitisation market dynamics and how US requirements compare to rules already implemented by European Union regulators.

Fitch remains supportive of aligning issuer and investor interests by requiring issuers to retain some 'skin-in-the-game.' However it says conflicting US and EU approaches, contradicting or overlapping rules among different US regulators and varying treatment of different asset classes are creating confusion among market participants and increasing the potential for unintended consequences.

Some of the more controversial risk retention proposals are discussed in the report, including the concept of 'Qualifying Assets' (QA) and the introduction of a premium capture reserve account (PCRA) concept. The QA theory is aimed at recognising the limited need for risk retention for assets that are of exceptionally high credit quality but determining what represents 'high quality' has proven to be contentious. Others argue that the PCRA rule, which is aimed at minimising issuer's ability to offset risk retention by recognising upfront gains, has the potential to eliminate most if not all of the economic incentive to securitise for many originators.

The report further describes the key differences between the US and EU approaches to risk retention. Though the rules from the two jurisdictions have a number of similarities, they differ significantly in their application with the US rules aimed at issuers and the EU rules aimed at investors. As a result, there is a concern that there is not a level playing field between securitisation market participants in different jurisdictions.

RMBS

Need for viable TBA market underlined

Thomas Hamilton, md at Barclays Capital, testified yesterday (3 August) on behalf of SIFMA at a US Senate Committee hearing on the to-be-announced (TBA) market.

Hamilton underlined how the liquidity and forward-trading nature of the TBA market provides key benefits to consumers, such as the broad availability of 30-year fixed rate mortgages that may be prepaid without penalty. He also noted that the market provides a stable and attractive funding source for lenders that allows them to provide lower mortgage rates and longer-term rate locks for borrowers.

Without the TBA market, SIFMA believes that significant risk-averse investment capital would be directed elsewhere, reducing the amount of funding for and raising the cost of mortgage lending. Therefore, maintaining a liquid and viable TBA market should be considered as Congress addresses housing finance reform, it says.

However, SIFMA believes that while the TBA market should play a role in the future, it should not account for 90% of the market. "The reality is that this current outsized role of the government is not sustainable over the long term and should be reduced," it notes. "The TBA market's role, and the government's role, should shrink as the private markets regenerate over time."

RMBS

Subprime RMBS assets offloaded

Dexia Group reports that it has sold 94% or US$8.8bn of guaranteed assets from its financial products portfolio, of which 95% consist of US RMBS. The bulk of the firm's US RMBS holdings (about 93%) were backed by subprime collateral originated in 2006 and earlier. Since the disposition was a privately negotiated sale to a "targeted investor base", a significant impact on the market isn't anticipated.

RMBS

Aussie RMBS criteria updated

Fitch has published a new Asia-Pacific (APAC) residential mortgage criteria report, detailing its approach to analysing RMBS for new ratings as well as the surveillance of existing ratings. This new criteria is expected to have little impact on existing RMBS ratings in the region.

Separate country-specific criteria assumptions for each jurisdiction will be available in addendum reports, commencing with one for Australia. This follows the release of an exposure draft published in June (SCI 8 June), which outlined proposed changes to the Australian RMBS criteria.

The updated criteria for Australian RMBS includes: increased base default probability for both conforming and non-conforming loans; increased debt-to-income adjustments; reduced seasoning credits; one market value decline assumption for all states of Australia; increased probability of default for first home buyers; and the introduction of downward house price indexing if house prices show sustained downward price movements.

"The updated criteria reflect that the past decade has seen a significant change in the mortgage market, household leverage and a considerable increase in property prices. Those factors, combined with the increased borrower sensitivity to interest rate rises, may result in mortgage performance in any future downturn being significantly worse than the last recession," says David Carroll, director in Fitch's Australian structured finance team.

All Australian RMBS transactions will be reviewed by 10 February 2012. The impact of Fitch's global criteria for Lenders' Mortgage Insurance in RMBS will be considered at the same time.

Fitch's criteria will continue to give credit to LMI within RMBS transactions on the basis of the LMI's ability to pay claims measured by its insurer financial strength (IFS) rating and a quality adjustment (QA) that addresses the potential risk arising from the difference between the level of contractual coverage and the resulting actual coverage, which may be impacted by policy exclusions, denied and reduced claims and rescissions. The criteria will give credit to LMI through an adjustment to loss severity on a loan-by-loan basis.

The agency expects the LMI criteria to have a limited impact on existing, seasoned Australian RMBS transaction ratings due to the structural build-up of credit enhancement over time, subject to individual deal performance. The transactions most likely to be affected by the proposed criteria will be those issued more recently or which feature a pro-rata payment structure with low subordination or with ongoing revolving periods.

Issuers will have the opportunity to indicate whether they intend to make any amendments to the transactions if the criteria changes impact existing ratings. Fitch will consider any proposed transaction amendment before any rating actions are taken.