Contents

CDS

Positive developments

Opportunities in Asia-Pacific outlined

The latest SCI Special Report explores how the launch of domestic CDS markets in China and India may spark new activity in the region. It also looks at the recovery taking place in the Australian RMBS market. (The full SCI Asia-Pacific Special Report can be downloaded here.)

Activity in the Asian CDS market remains subdued. Limited flow is driven by the G14 banks rather than domestic players, while regulatory restrictions and a poor appetite for the product appear likely to constrain growth for the foreseeable future.

"Most of the credit exposure in Asia is held by banks who actually like the risk," says risk consultant Satyajit Das. "They have a lot of capital, are awash with liquidity and are looking for ways to invest in interest-bearing assets. There is no reason for them to buy protection because they essentially want the risk and there's little reason for them to sell protection because they want physical assets, and a leveraged trade on credit is less attractive."

Nevertheless, India and China have shown enough interest in CDS to undertake the launch of the product domestically (SCI passim). The State Bank of India has initiated the launch of a Rupee-denominated on-shore CDS market referencing Rupee bonds, which is due to open on 24 October. Meanwhile, the CDS-equivalent (credit risk mitigation instruments or CRMs) launched in China last year is also expected to be re-launched this year following tweaks to the documentation.

Both jurisdictions face a tough road ahead, though. In India, one of the biggest problems is a lack of natural protection sellers.

"It will all come down to relying on the bank market makers to sell the protection, and their activity will be capped by their risk limits. The banks will hit these limits quickly as there are no natural hedges and no availability to issue CLNs," says Keith Noyes, regional director, Asia Pacific at ISDA.

The Chinese CRM market has also had to contend with a number of problems following its launch in 2010, including a lack of clarity over who could and could not trade the product. There was also confusion over the fact that domestic CRM does not recognise restructuring as a credit event, so the product has to be traded differently to CDS on Chinese off-shore names. A reconfiguration of the documentation is anticipated to resolve these issues.

Away from CDS, the come-back of Australian RMBS has been boosted by the return of cross-border investors in recent months. The recently-launched Torrens Trust, for example, was the first Australian RMBS to offer a Japanese yen-denominated tranche and could be the first of many as interest from Japanese investors increases.

"We've had a lot of enquiries recently from Japanese investors about Australian RMBS as the yield is more attractive than Japan," says Jennifer Wu, vp at Moody's.

However, concerns over market fundamentals in Australia persist. All three main rating agencies have embarked on reviews of their rating methodologies in the past few months, citing increasing household leverage and increasing prime mortgage delinquencies.

Moody's anticipates increases in mortgage default probabilities and house price stress rate assumptions. The agency also points out that Australia's economic growth is being increasingly driven by favourable terms of trade.

"Delinquency rates in the mortgage market are likely to be variable and, in our view, on average higher over the coming decade than in the past," it says.

AC

ABS

Patchy progress

Euro ABS market developing at varying speeds

Traditionally strong sectors within European ABS continue to perform, but beyond the usual suspects the outlook for the market is not so positive. Changes in sovereign volatility, financing and the approach of regulators may be needed before other sectors can begin to rival the likes of auto ABS or UK and Dutch prime RMBS.

The last few weeks have seen many ABS investors sitting on the sidelines as sovereign and financial spreads experienced strong volatility. Nervousness has knocked participants' willingness to make new investments, with Italian RMBS one sector that has been impacted.

Peter Nowell, head of ABS and ILS trading at BNP Paribas, says it now seems like the market will struggle to match the level of primary issuance it had last year - let alone surpass it. "Earlier in the year, we would have been delighted to see the Italian RMBS market moving up again because activity has been limited to UK and Dutch RMBS for years. There were some Italian deals successfully placed earlier in the year, but obviously with the current volatility on sovereign spreads and Italy trading over 300bp in CDS, it is no longer a good time for primary issuance," he explains.

While uncertainty and volatility persist, primary issuance is likely to be limited to the more familiar jurisdictions that investors are currently comfortable with. Primary issuance of UK and Dutch RMBS or certain auto ABS, for example, are seen as being unaffected by wider sovereign issues. But they are exceptions to the rule rather than reflective of the norm.

Beyond those jurisdictions, the sovereign situation remains the focus. "That is not because there is anything wrong with the underlying bonds, but because [investors] do not want to report any increase in their exposure to these countries, which is very sad," says Nowell.

Often, the underlying performance is actually quite strong. "The underlying performance of prime RMBS in Europe is still very good and there is very little in the way of realised losses. The black spot is CMBS, which has been the problem for the last four years," adds Nowell. He points to the many legacy deals that are unlikely to be refinanced before maturity and are still in the process of being restructured or renegotiated.

UK RMBS has been particularly popular not only with European investors, but with US investors too. This is a trend that could continue for some time yet.

Nowell explains: "Because UK master trusts can issue tranches in dollars, we have seen some massive deal tranches printing - such as US$2bn-plus - and being sold very easily into the US. I think this autumn we will the first US dollar-only UK RMBS deal."

He continues: "There is just no supply of new issues in the US at the moment and the spreads on UK prime are so attractive compared with US leases or autos. A 100bp pick-up for something with negligible underlying losses is a screaming buy for any US investor who is able to do so."

The market has been further boosted by the better-than-expected performance of UK buy-to-let (BTL) RMBS. Many investors were expecting poor performance, but the continuing low interest rates allowed landlords to switch to the standard variable rate, which has helped support the sector. This has prevented losses on BTL deals from becoming as bad as had been feared.

Beyond RMBS, the European auto ABS sector has also performed well, thanks to simple structures, short bond WALs and strong collateral performance - especially in German pools. Investor confidence has grown this year with investors now willing to consider non-German jurisdictions.

Last year auto ABS was almost exclusively backed by German collateral, but 2011 has also seen deals backed by UK, Dutch, French and Spanish collateral successfully placed with investors (SCI 23 June). The volume of publically placed auto ABS so far this year has also already overtaken 2010's total.

Once new products emerge and banks start lending again, not only will new transactions be safer with higher subordination, but refinancings will drive repayment rates on old deals to pick up. "This should help them amortise a little faster than people were expecting. New deals help both new investors and old investors," Nowell says.

He adds: "The only problem is that threshold on price. The triple-As need to come at a certain level to really get the market going again - they need to be in the low-200s to be sustainable. As soon as investors start demanding Libor-plus-300bp or more for the senior tranche, then new securitisation is just not going to work."

Nowell says that if pricing can come down to the low-200s, he can see "that level being sustainable for years on end" because then the cost is fully passed on to the consumer. This would point to a positive outlook for the market, although problems with central bank financing and regulators persist.

For example, Nowell notes that it was not unexpected that the push from the Bank of England and ECB to wean banks off central financing is yet to fully bear fruit. "Unfortunately, this is happening much slower than people expected and in the current environment this is not terribly surprising. I think it is going to take years to replace central bank financing, especially in the peripheral countries."

Finally, the growth of the ABS market will be held back for a while longer by regulators' clear preference for covered bonds. Nowell concludes: "If an insurance company buys a covered bond, it will have a tenth of the capital requirement against it that it would need for an RMBS. It is sending a very clear message that the regulators still do not trust securitisation. That is very unfortunate, because securitisation really is a very valuable funding tool for financial institutions."

JL

RMBS

Alternative approach

New tactics considered to revive non-agency RMBS

Non-agency US RMBS issuance is yet to return in a meaningful way, with just one deal from Redwood Trust sold to investors so far in 2011. However, a number of initiatives are underway that could increase the viability of the asset class by year-end, including a different approach to structuring and rating potential deals.

"There's a whole host of issues that need to get worked out before the market can return to its old self - or an operationally efficient market at least," says Randy Robertson, md and co-head of the securitised asset investment team within BlackRock fundamental fixed income. "A lot of it begins with the ratings agencies, their criteria and their processes. But that's not the be all and end all."

He adds: "There's also investor acceptance, transparency, issues of conflict of interest of servicers and originators being one and the same. There's also Dodd Frank reforms."

In addition, a continued fall in US house prices and the strong bank bid for mortgages are hindering issuance prospects. However, industry participants are keen to get the market back on track. BlackRock, for example, is looking at the possibility of issuing an RMBS that does not include a triple-A tranche at the top of the capital structure.

"Given the criteria that rating agencies currently propose, combined with what investors see as required enhancement, it seems to us that a double-A structure is a viable alternative to triple-A at present," says Robertson. "Triple-A enhancement levels are such that the transaction becomes uneconomical."

He adds: "We're hoping that the double-A enhancement levels, alongside where investor demand is for double-A type product will work such that a transaction will be economical and we can move forward."

Robertson says that the transaction would be backed by non-conforming loans - that is to say the balances currently exceed the agency guidelines for Freddie Mac and Fannie Mae. "Other than that, they are fully documented, prime, jumbo loans with relatively high FICO scores and relatively low LTV ratios," he notes.

BlackRock does not have a specific timeline to bring such a deal to market, however. "First of all, we have to amass enough product - which we're currently doing [SCI 15 November 2010] - and then there's a process to go through," says Robertson. "We're not going to force it, particularly with the current volatility in the market."

Redwood Trust is also expected to bring two more deals this year, following the launch of Sequoia Mortgage Trust 2011-1 in Q1. In its most recent Redwood Review publication, the firm confirms its issuance hopes, noting that this goal seems a bit more challenging than it did a few months ago.

"We see signs that things are slowly moving in the right direction for private market financing of residential mortgages," it says. "Still, we are not idly waiting for external factors to change. We are focused on buying loans from jumbo mortgage originators, realising that it will likely take until 2012 to start to gain real traction."

Suzanne Mistretta, senior director at Fitch, also confirms that Fitch has been approached by RMBS issuers with potential transactions. "[These] tend to be a lot more conservative than those issued at the peak. Collateral is far superior to what it was; for example, FICO scores are extremely high and LTVs low. There's also a greater emphasis on reps and warranties and in some deals there is an independent party charged with acting as an arbitrator reviewer to see if there are any breeches of reps or warranties," she explains.

She adds: "While collateral is pristine at the moment, we do expect that to revert to some extent. Average LTVs will likely come down to the 70% range and average FICO scores to around 740-750."

In addition, there are hopes that a new ratings approach from Kroll Bond Rating Agency (KBRA) may increase investor confidence in the asset class. The agency has issued a request for comment on its new methodology (SCI 2 August).

"We believe we are the only rating agency in the market with a current methodology that really reflects the lessons learnt in the crisis," says Glenn Costello, senior md at KBRA. "We have a lot of stresses in our methodology based on that."

"Integrated analysis at a granular level is one distinguishing feature of our analysis, as well as being focused on trends in the industry and the regulatory landscape at any point in time," adds Eric Williamson, senior md at the agency. "In terms of originator reviews, servicer reviews and loan file reviews - one of the key things for us is that those exercises don't become exercises in themselves. They will be highly integrated into the ratings process."

He continues: "The analysis and modelling of deals takes into account the current market environment: what the market trends are, what the current landscape is, what the regulatory issues are and how that will impact the operations of servicers and originators."

For example, KBRA will not provide an overall ranking for servicers and originators as it is deemed by the agency to be too general an approach. "Any adjustments we make in order to model or analyse a deal will be based on very specific issues for an originator or servicer's operations," says Williamson.

The timing of the first Kroll-rated RMBS will depend on the broader market, though. The agency confirms it is talking to a number of issuers, a small number of which are hoping to test the market in 4Q11 or 1Q12.

"Right now, banks have a lot of appetite to keep jumbo mortgages on the balance sheet. They are deposit rich and asset hungry; interest rates are very low so they have fewer asset/liability concerns today," says Williamson. "At the same time, the bank balance sheet is not the best home for a 30-year fixed rate mortgage, for example. I think a change in that asset/liability dynamic over the medium term will be a big factor for the RMBS market."

In the short term, the lowering of the conforming loan size limit for non-agency RMBS is expected to put a lot more jumbo non-agency collateral into the hands of the private market and may increase the desire of issuers to test the waters on the RMBS front. "In October of this year the maximum conforming loan size limit for non-agency RMBS is due to be lowered from around US$729,000 to US$625,000," says Mistretta. "We expect that that change may lead to an uptick in issuance of RMBS."

She concludes: "We understand banks and conduits are preparing to re-launch their operations in anticipation of this date."

AC

ABS

All quiet for Euro ABS, CLO markets

A combination of volatility in the broader credit markets and the traditional quietness of the August holiday season has served to silence the European ABS and CLO sectors. A limited amount of trading is taking place in each market, but activity is not expected to increase dramatically for a few more weeks.

A European ABS trader explains that despite prices below the top-tier of the capital structure decreasing sharply, activity is limited. He says: "There is not a lot happening in the European ABS market at the moment. At the top of the capital structure, bonds have held in relatively well. Prime UK RMBS has been off by about 10bp-15bp over the last couple of weeks."

He continues: "It is a similar story for Dutch RMBS and autos, which are not quite off by the same amount, but have definitely deteriorated. Down the capital structure the price movement has been more severe. But the impression is that outside of triple-A UK and Dutch RMBS and triple-A autos, there really is not much happening."

The trader adds that prices have fallen for Northern Rock's Granite transactions, but even there activity is limited. He explains: "The market is so quiet. You often see prices posted on Granite triple-Bs, but they have dropped pretty precipitously. Three or four weeks ago their price was about 60bp, and now it is more like 50bp. Even saying that, there is no activity; I think it is a case of dealers just marking things down."

Without a momentous announcement coming out of either the US or Europe, the trader says he cannot see anything in the near future that will give the market much direction. A CLO trader says the same situation is very much in effect for his market.

"We are pretty much on the sidelines. There have been some bonds turning over. We turned over a pretty significant clip of triple-A bonds in the past few weeks at reasonable pricing and in a reasonably narrow bid-offer range, but away from that it has all been very quiet," he explains.

He adds: "We are still supported by the positive fundamental back story, although to be fair the average pool NAV has decreased on the weakening in the loan market. But it is not a significant deterioration that will cause a long-term drag on the actual pool performance; it changes a few technicals within the transactions, but transactions are still markedly better than they were half a year or nine months ago."

The CLO trader believes that clients and dealing houses are currently generally happy to hold on to what they have and look for cheap bonds to add on weakness, but are struggling to find forced or distressed sellers. He says: "It is a bit tricky. If we had a situation where clients could hit the bid-side, then we would be able to turn over more paper. If we had clients that could lift the offer or would entertain trading within the bid-offer, then there would be a lot more going on than there is right now. That is not happening and I do not think it will happen soon."

The trader concludes: "It is just one of these situations where we are effectively pushed to a degree to the sidelines of investors' consciousness while they deal with more liquid and more urgent matters in other markets elsewhere."

JL

CMBS

Operating advisor skill-sets scrutinised

How much power CMBS operating advisors should have, as well as their source of revenue are among the issues being hotly debated ahead of the implementation of risk retention rules in the US. But the capabilities and quality of operating advisors also need to be scrutinised in a similar way to named servicers, according to Morningstar.

Standardised processes for determining when special servicer removal is warranted, how a removal should be executed - including the specific authority of the operating advisor - and how bondholder consent and voting mechanisms should work have yet to be adopted. Against this backdrop, Morningstar has released a report identifying the basic characteristics and skill-sets that it believes are essential for an operating advisor to execute its duties effectively.

First and foremost, the firm says it would expect a company serving as operating advisor to possess an asset management platform comprising staff experienced in commercial real estate analysis and working out distressed commercial loans, including a sufficient understanding of CMBS-related asset resolution issues, reporting requirements and related PSA requirements. "In our view, the operating advisor will have the requisite technology applications to review and track the flow of asset resolution proposals and other information received from special servicers, and to produce any required reports for the trustee," the report explains. "The company should possess documented policies and procedures exclusively for its role as operating advisor, as these functions and duties will likely differ in many respects from its other businesses and direct special servicing assignments it may concurrently manage."

To the extent that the operating advisor has its own special servicing function, Morningstar would expect the company to allocate sufficient staff for its operating advisor work and insulate it from other businesses and investment positions. The firm also believes that it is necessary for the operating advisor to carry errors and omissions insurance coverage, given that it has a fiduciary obligation and is required to report its activities to third parties. This requirement is already embedded in most PSAs involving operating advisors issued this year.

However, these PSAs also indicate varying degrees of operating advisor oversight. For example, one PSA required the operating advisor to approve what it labelled as 'major decisions', which included certain loans that may be performing and/or still with the primary servicer.

The definition of major decisions also included borrower requests for assumptions, partial releases, major tenant leasing issues and defeasance. In instances where the operating advisor is required to approve major decisions, it would earn a consulting fee to be charged to the borrower.

Morningstar believes that a company well-positioned to serve as an operating advisor is one that traditionally performs asset management or other advisory work for third parties predominantly on a fee basis. While operating advisors should be precluded from any ownership interest in a securitisation in which it may be the named special servicer, the firm suggests that a special servicer affiliated with a B-piece buyer or controlling bondholder on other transactions could still fill the role. But companies that mainly purchase distressed assets for their own balance sheet and work them out for yield returns may not be optimal candidates to serve as operating advisors.

The number of companies providing operating advisor services is expected to grow. Morningstar, for one, views the role as a potentially new specialisation opportunity for niche players that offers relatively lower barriers to entry compared to full servicing or even special servicing.

"We believe that there are firms which may lack the capital to directly invest in CMBS, but may have the asset management capabilities and infrastructure - in terms of technology tools, staffing expertise and third-party reporting - to perform the operating advisor function. While the income stream from this work may be cyclical and may not be particularly lucrative, it could provide another business opportunity for these niche players in a manner similar to those seen in stand-by or back-up servicing, which is more prevalent in Europe or is mostly limited to asset-backed transactions in the US," it says.

The firm intends to offer operational risk assessments of operating advisors once the regulatory proposals are finalised and established.

CS

Insurance-linked securities

Oil spill risk set for securitisation

CatVest Petroleum Services, a newly-formed company focused on providing insurance-linked securities (ILS) services to the oil industry, is seeking to help oil companies replicate the securitisation vehicles more commonly used to hedge hurricane or earthquake catastrophe risk. New risk types, such as oil spill liability, could now enter the market.

CatVest believes the oil industry has historically been underinsured, both because of a lack of capacity in the traditional insurance and reinsurance markets and because of the annual premium cost. As a result, companies rely on state or international civil liability convention sponsored liability trust funds and self-insurance mechanisms.

ILS could provide an alternative. The financial crisis has seen increased interest in the ILS market, which is seen to have low correlation with the wider financial markets. CatVest says that traditional catastrophe bonds are not providing sufficient capacity and extra demand is going unaddressed.

The company focuses on oil spill risk transfer and aims to provide a one-stop-shop - structuring, arranging and providing risk modelling in the course of bringing a deal to market. It says it is the only company in the risk markets to enable firms to achieve up-to-full oil spill risk transfer.

CatVest says: "During this volatile capital market environment, CatVest Petroleum Services' approach facilitates investors and issuers alike for transferring new types of risk, such as oil spill liability into the marketplace. Having explored this opportunity with institutional investors, it is clear that they would be willing to take on much larger amounts of oil spill risk than otherwise seen in previous ILS issuances."

The company has also created SPILLRISK, the world's first oil spill risk model, which it says removes many of the uncertainties surrounding the disaster type. SPILLRISK takes into account factors such as geographic location and proximity to sensitive areas of coastline, as well as spill type, volume and spread.

The modelling system can also generate exceedance curves and loss probabilities. SPILLRISK integrates decades of oil spill fate, effects and damage modelling to derive a robust parametric trigger that addresses moral hazard and adverse selection, as well as mitigating basis risk, according to CatVest.

JL

Whole business securitisations

More pub downgrades triggered

Fitch has updated its UK whole business securitisation rating criteria and downgraded care home deal EPIC Barchester's class A and B notes and pubco deal Mitchells & Butlers Finance's class A and AB notes. As a result of the criteria changes, all pub transactions not already on rating watch negative have also been placed on review.

Using historical transaction performance, Fitch has revised the DSCR thresholds applied in its cashflow analysis of the WBS sector. Industry caps have also been introduced to limit the effect of debt tranching because, the agency says, "financial engineering cannot completely remove a debt instrument from the fundamentals of a transaction's business profile".

Securitisation analysts from RBS appear unimpressed by the move. They note that Fitch's actions are "in effect moving the goal posts for such transactions and in doing so further undermin[ing] the credibility of the ratings on the product".

The RBS analysts believe the key concern for investors will be whether the junior notes of Greene King, Marston's and Mitchells & Butlers remain investment grade and what the future holds for the rating on the Wellington Pub senior notes. They expect some notes to be cut to junk status.

MBS analysts at Barclays Capital also anticipate downgrades. The criteria changes have already seen Mitchells & Butlers class As and ABs cut to single-A plus because of the new ceiling. In the case of the class A notes, this was a downgrade all the way from triple-A.

The BarCap analysts believe that the class B tranches of Greene King will be cut from triple-B minus to sub-investment grade. The class A and AB tranches are each expected to be downgraded by one notch, taking them to triple-B and triple-B minus respectively.

They also predict Marston's class As and ABs to be downgraded one notch to triple-B and triple-B minus respectively. However, the class B tranches are expected to be affirmed at double-B plus.

Punch A class Ms and Punch B class As could well be downgraded to sub-investment grade, but the BarCap analysts note that had already been expected. At a relatively low leverage of 3.6x, Punch A class As could be downgraded to triple-B plus. Punch A and B tranches already at sub-investment grade are expected to be downgraded by a further notch or two.

For Wellington, more extreme rating action is expected. A FCF DSCR of 1.17x for the class Bs means a downgrade from triple-B minus to single-B looks likely. More significantly, the class As have an EBITDA DSCR of 1.5x, which could see them downgraded from single-A minus to double-B.

Ratings are expected to be affirmed for Spirit and Unique, however. The latter has already seen rating actions this month (SCI 10 August), while Spirit is only held back from an investment grade credit rating by its proportion of leaseholds, according to the BarCap analysts.

Finally, they note that indicative FCF DSCRs for managed pubs have become more lenient, while tenanted/leased ratios have become more stringent. For example, typical FCF DSCRs for managed pubs have changed at the single-A level from between 2x and 2.4x to anything greater than 1.95x, while for tenanted pubs the change is from between 2x and 2.3x to anything greater than 2.05x.

All deals on rating watch negative are expected to be resolved within six months. Fitch says the application of the new criteria will not necessarily result in further downgrades. The agency also says that the industry caps will result in notes with different seniority having identical ratings.

JL

ABS

Technological focus

Avarina Miller, svp at Demica, answers SCI's questions

Q: How and when did Demica become involved in structured finance?
A: We have been around since 1992 and we have been involved in structured finance since we started. What we do is provide automated solutions for accounts receivables-based trade financing, which involves setting up and running the technology.

Before joining Demica, I was on the banking side. I started out in the City working for Bankers Trust and then National Home Loans, as it was then, which was one of the first companies to securitise assets in the early days of the market. Then I worked at JPMorgan in the equities group, so I've followed a slightly unconventional route to get here.

Q: What are your key areas of focus today?
A: We are focusing on finance linked to trade receivables or trade payables. Our tagline is 'intelligently working capital' because the finance structures we enable and support are all related to optimising working capital.

There are other things we would like to do more of. Short term, high-turnover assets are where our sweet spot is, but for the most part we focus on supporting and enabling the financing of trade receivables.

Q: Which market constituent is your main client base?
A: On the corporate side, our customers could be in any sector or industry. That said, by the nature of trade receivables, it tends to be the business-to-business sectors rather than retail.

Our corporate clients tend to be multinational or mid-sized companies. The services we provide help companies which are either small and do not have the resources, or they are very large or multi-national companies with multiple operations systems who need to generate centralised, consolidated sales or purchase ledger information quickly and efficiently. And for supply chain finance, while the buyers tend to be largish, their suppliers can be of all sizes.

Geographically we are weighted a bit towards Europe, but we have clients around the globe. Our clients are both corporates and financial institutions, because the corporates are the ones whose assets are being financed, while it is the financial institutions that are providing the credit and liquidity in the programmes we support.

On the financial institutions side, they tend to be commercial banks or investment banks and there can also be an insurance element, and occasionally hedge funds. One way or another, the financial institutions we work with are involved in trade receivables-based lending.

Trade receivables have been spanned by a number of bank product silos, but the distinctions between the silos has started to blur. The underlying asset and risk is fundamentally the same, although there is a slightly different approach depending on how you fund a portfolio.

Q: How do you differentiate yourself from your competitors?
A: A lot of the time our competition is an in-house solution, either within a corporate or within a financial institution. In those cases, we offer greater specialisation; we have dedicated service and technology that is our sole focus.

Because we are not distracted by other priorities, we are more focused and so - we would argue - better. We can offer more consistent, specialised, customised, well planned and well executed service and support.

Elsewhere, we can also customise where other technology solution providers either will not - because it does not make sense for their business model, if, for example, they are trying to create an industry standard - or cannot because their technology is not as flexible. Our solution meets industry standards but is highly customisable to meet individual business requirements and models.

On top of that, we also tend to offer the most automation. That is to say, we try to find ways to reduce the amount of manual intervention to minimise operational risk and administration for our customers. We offer the best and the most automation, although that said there is of course a human element to all of this and we aim to have top quality and expertise on the personnel side too.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The main challenge is a case of who is doing it and what the funding structures look like. That may change. For us, that means we have to stay on top of where the financing is being originated and how it is being structured.

The current environment certainly provides opportunities for us, though. The thing about trade receivables funding is it has been around forever and I am confident it will be around for a long time in the future.

The high yield market was booming a few weeks ago and is now basically closed. But that creates opportunities for accounts receivables-based deals, especially if they are serving sub-investment grade corporates, which is an area we specialise in.

If liquidity dries up for one market group, say mid-sized companies, then supply chain finance is a perfect solution because it shifts liquidity from the buyer link of a supply chain that has better access to competitively priced liquidity into the supplier links in the supply chain whose position in the physical supply chain is key but whose access to funding is more limited. These are the sorts of circumstances in which trade receivables funding is the perfect solution.

It is a time of transformation and adjustment for the banking world and I think a lot of banks are having to spend an awful lot of time just getting to grips with the new regulatory environment. In that context, trade receivables are simple, straight-forward and 'self-liquidating', in the jargon, so attractive as a basis for financing for lenders and borrowers and will continue to be a key tool to finance and support trade.

Q: What major developments do you need/expect from the market in the future?
A: I think we are in for volatile times. Volatility is tough and I think people are a little bit easily spooked at the moment. That said, that is an environment in which there is increased demand to capture and monitor data and create transparency.

That is the direction we are going in. Clearly that is good for Demica.

JL

ABS

Valuations duo recruited

Opera Solutions has hired Joseph Henbest and Bill Hunt as vps in its global markets analytics group. Henbest will lead the sales and business development activities for Opera's analytics in the financial portfolio solutions arena, while Hunt will assist in the strategy, deployment and research related to the company's capital markets and structured finance products.

Henbest has worked for almost 20 years in the capital markets industry, assessing value, risk, regulatory capital and strategy. Hunt is a seasoned quantitative finance executive, with 15 years in capital markets in fixed income quantitative analysis and portfolio risk management. The pair were previously mds at Algorithmics/Fitch Solutions, where they were global co-heads of the advisory services and structured finance valuation practice.

CDO

Wisconsin fraud case launched

The US SEC has charged Stifel, Nicolaus & Co and a former senior executive with defrauding five Wisconsin school districts by selling them unsuitably risky and complex investments funded largely with borrowed money.

In a complaint filed in federal court in Milwaukee, the SEC alleges that Stifel and svp David Noack created a proprietary programme to help the school districts fund retiree benefits by investing in notes linked to the performance of synthetic CDOs. The school districts established trusts that invested US$200m in three transactions from June to December 2006, paid for largely with borrowed funds.

According to the SEC's complaint, Stifel and Noack misrepresented the risk of the investments and failed to disclose material facts to the school districts. In the end, the investments were a complete failure, but generated significant fees for Stifel and Noack.

The SEC alleges that Stifel and Noack made sweeping assurances to the school districts, misrepresenting that it would take "15 Enrons" - a catastrophic, overnight collapse - for the investments to fail. They also misrepresented that 30 of the 105 companies in the portfolio would have to default and that 100 of the top 800 companies in the world would have to fail before the school districts would suffer a loss of their principal.

Among the material facts that Stifel and Noack allegedly failed to disclose were the portfolio in the first transaction performing poorly from the outset, credit rating agencies placing 10% of the portfolio on negative watch within 36 days of closing and certain CDO providers expressing concerns about the risks of Stifel's proprietary programme and declining to participate in it.

According to the SEC's complaint, Stifel and Noack sold the school districts an unsuitable product that did not meet their investment needs. The school districts contributed US$37.3m towards the US$200m investment and borrowed the remaining US$162.7m.

The SEC alleges that the heavy use of leverage and the structure of the synthetic CDOs exposed the school districts to a heightened risk of catastrophic loss. The school districts suffered a complete loss of their investment and suffered credit rating downgrades for failing to provide additional funds to the trusts they established.

The SEC alleges that Stifel and Noack violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. It also alleges that Stifel violated and Noack aided and abetted violations of Section 15(c)(1)(A) of the Securities Exchange Act of 1934. The SEC seeks permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest and financial penalties.

CLOs

Duane Street CLO transfers confirmed

The acquisition by Citigroup Alternative Investments - acting through its business unit Citi Capital Advisors - of Duane Street CLO I, II, III and IV from DiMaio Ahmad Capital became effective yesterday, 15 August (SCI 8 June). Each issuer has entered into amended and restated collateral management agreements on substantially the same terms as the existing collateral management agreements with DAC.

Moody's notes that the execution of the amended agreements and the appointment of Citi as the replacement collateral manager will not have an adverse effect on the ratings of the securities. In assessing the credit impact of the move, the agency assessed the history of Citi's collateral management of transactions comparable to the issuers, among other considerations.

CLOs

Second NCRAM CLO transferred

 Ares Management is set to assume investment management duties for Clydesdale CLO 2004 from Nomura Corporate Research and Asset Management (NCRAM). The investment management agreement will be essentially unchanged, according to Moody's.

Transaction documents will be amended, however, to change the name of the issuer to Ares XVIII CLO. The change in name results from a purchase agreement pursuant to which NCRAM sold, transferred and assigned to Ares Management all of its duties and obligations.

Moody's has determined that the move will not result in the reduction or withdrawal of its ratings on any classes of notes.

CLOs

Foothill CLO sold

The Carlyle Group has purchased the management contract of the US$500m Foothill CLO I from The Foothill Group Inc. The firm now advises 31 collateral loan funds, including its recently closed US$507m Carlyle Global Market Strategies CLO 2011-1, in the US and Europe totalling US$12.7bn in AUM.

Linda Pace, Carlyle md and head of US structured credit, comments: "We see continued opportunity in both acquisitions and the new issue market. CLOs are proven performers over the long term."

The Foothill CLO purchase was approved by the current investors in the transaction, which can reinvest for approximately the next two and a half years. The CLO invests in corporate leveraged loans and high yield bonds.

In the past 12 months, Carlyle has added 17 CLOs to its platform, totalling US$5.9bn of AUM.

RMBS

Goldman named in NCUA probe

The NCUA has filed suit in California against Goldman Sachs, alleging violations of federal and state securities laws, as well as misrepresentations in the sale of securities to now-failed US Central and Western Corporate federal credit unions. The action seeks damages in excess of US$491m from Goldman Sachs, bringing the total sought in the four lawsuits filed to date to nearly US$2bn (SCI passim).

NCUA's latest suit claims the sellers and underwriters of the questionable securities made numerous material misrepresentations in the offering documents. These misrepresentations caused the corporate credit unions to believe the risk of loss associated with the investment was minimal, when in fact the risk was substantial.

The MBS experienced dramatic, unprecedented declines in value, effectively rendering five corporates insolvent. The combined suits are the culmination of lengthy investigations into the circumstances surrounding the purchases of these securities.

RMBS

Mortgage trading md added

Knight Capital Group has appointed Darren Stumberger as md, mortgage trader. He joins from Bank of America Merrill Lynch, where he was responsible for trading and risk management of reverse mortgages.

At Knight, Stumberger will trade mortgage and structured products as part of the ABS/MBS team with a specific focus on the firm's growing reverse mortgage and HMBS business. He will report to Bob Lyons and Al Lhota, co-heads of global fixed income.

ABS

US-linked rating actions hit

S&P has lowered its ratings on 154 tranches from 64 US structured credit transactions to double-A plus from triple-A, following the 5 August lowering of the long-term sovereign credit rating on the US to double-A plus from triple-A. At the same time, the agency removed the 151 ratings that were on credit watch negative prior to the downgrade actions and assigned negative outlooks to 57 defeased tobacco settlement securitisations following the downgrades. The affected tranches are linked to the rating of the US and principal protected notes, defeased tobacco securitisations, securities guaranteed or collateralised by loans guaranteed by the US and funded synthetic CDOs holding US government-related securities.

ABS

Rule 17g-5 enhancements suggested

Rule 17g-5 could be enhanced to provide structured finance investors with increased transparency regarding the rating agency selection process, according to a comment letter that Fitch is planning to submit to the US SEC. Specifically, the agency suggests that Rule 17g-5 be enhanced so that CRAs are required to list publicly on their websites all structured finance transactions for which they have been engaged to provide feedback, regardless of whether the CRA is ultimately asked to rate the transaction.

In order to avoid disclosing confidential information, publication would occur at the time that the transaction's offering documents become public. In this manner, investors would be able to directly compare which CRAs reviewed the transaction versus those that were ultimately selected to rate it. Such a mechanism would significantly increase the transparency surrounding the CRA selection process, Fitch says.

The agency is preparing a comment letter in response to the SEC's Solicitation of Comment to Assist in Study on Assigned Credit Ratings, which was required by Section 939F of the Dodd-Frank Act. The study is intended to review the process and practices for the selection of credit rating agencies for structured finance products, evaluate the potential conflicts of interest associated with the issuer-pay and subscriber pay models, and analyse alternative rating agency compensation and selection methods.

Specifically, the study is supposed to address the feasibility of establishing a system in which a public or private utility, established by the government, selects which CRA determines the credit ratings for structured finance transactions. The closing date for responses is 13 September.

In its response, Fitch will note that market and regulatory forces have already combined to drive numerous positive changes in managing conflicts of interest and in the level of disclosure available to investors regarding the CRA selection process. For example, the major CRAs are periodically issuing unsolicited assessments of major structured finance transactions and issuers have begun to include language in offering documents describing which CRAs they selected and why.

"Enhancing the Rule 17g-5 programme represents the most effective option for managing potential conflicts within the credit rating agency selection process," says Ian Linnell, group md and head of global structured finance for Fitch. "This approach builds on existing initiatives, minimises competitive distortions and is cost-effective."

One notable shortcoming of the current programme is that each CRA's list of 17g-5 related transactions is only viewable by other CRAs. This restriction limits its usefulness to investors, Fitch says. Enhancing 17g-5 to make the list available to investors and will help overcome this weakness.

Further, this enhancement could be implemented with virtually no cost as the systems, processes and procedures already established by issuers and investment bankers to comply with Rule 17g-5 would remain in place. The only additional costs would be borne by the CRAs.

While Rule 17g-5 has yet to produce any unsolicited ratings, it has provided CRAs with timely information, including an up-to-date inventory of active transactions. This disclosure has helped significantly in the production of unsolicited transaction level commentary.

Fitch's response will also address the Dodd-Frank Act's requirement that the SEC consider, if it deems necessary, the establishment of alternative CRA assignment systems that prevents issuers and others from selecting the CRA. One of the suggested alternatives - the proposed 15E(w) system, sometimes referred to as the Franken Amendment - would create a government established board that would select which rating agency rates each structured finance transaction.

In Fitch's view, this proposal runs counter to the mandate of Dodd-Frank to reduce the role of ratings in regulations. However, the Dodd-Frank Act instructs the SEC to implement the 15E(w) system unless the SEC determines that an alternative system would better serve the public interest and the protection of investors.

In addition to the 15E(w)/Franken system and the current 17g-5 programme, the SEC study includes a review of four other CRA compensation or selection approaches: the investor-owned credit rating agency model, the stand-alone model (CRAs compensated through issuance and secondary market fees), the designation model (security holders pay the CRA of their choice) and the user-pay model (all users of ratings pay the CRA). It is Fitch's position that the 17g-5 programme, if properly enhanced as suggested, would make the proposed alternative models unnecessary.

The agency argues that no CRA selection or compensation model is free from potential conflict and that the introduction by regulators of new CRA compensation or selection schemes simply introduces a new set of conflicts that need to be managed. Fitch says it has established processes and procedures in place to manage the potential conflicts in its business and has further enhanced its controls substantially over the past few years in response to regulatory and market directives.

ABS

Retail credit cards maintain momentum

US retail credit card ABS maintained its positive momentum last month, according to the latest Credit Card Index results from Fitch. All major collateral metrics posted month-over-month improvements during the June collection period. Late payments more than 60 days fell for the fifth consecutive month, while charge-offs decreased again and reached levels not seen since the end of 2008.

"Consumers are curtailing spending and charging less, while at the same time cleaning up their household balance sheets," says Fitch md Michael Dean. "In an uncertain economic environment, this is a plus for retail card ABS performance, which has improved rapidly and shows no signs of reversing course."

Approaching a four-year low, late-stage delinquent balances improved by 14bp, down to 3.28%. This marks the fifth straight monthly improvement for 60+ day delinquencies.

Current delinquency levels are approximately 28% lower than the historical average since inception of the index of 4.2%. Early stage delinquencies also declined for the third consecutive month, dropping by another 14bp below the 5% mark to 4.92%.

Fitch's Retail Credit Card Charge-off Index in July trended lower for the second consecutive month below the 10% mark. Defaults maintained course and fell to 9.45%, with a 40bp improvement. Current charge-off performance is 27% lower year-over-year and is now back in line with the historical average of 9.34%.

MPR surged 1.31% to 15.58% in July, marking the third highest level in three years. Current payment rates have performed roughly 15% higher compared to the historical average of 13.59%. Finally, gross yield and excess spread levels remain relatively stable, each improving slightly from the previous month.

CDO

ABS CDO liquidation due

VCAP Securities has been retained to act as liquidation agent for Kleros Preferred Funding IX. It will sell the collateral to the highest qualified bidders in four public sales on 13 and 14 September.

CDS

Subprime CDS prices recover

June's sub-par Maiden Lane auction results and their adverse effect on US subprime CDS prices appear to have faded from view for the time being, according to the latest index results from Fitch Solutions. US subprime CDS prices recovered most of last month's losses, increasing by 1% overall. The 2006 (6.1%) and 2007 (10%) vintages were the biggest movers, posting their largest price increases in the past year.

"The increase for 2006 prices is particularly notable because this vintage has significantly underperformed its peers over the past year," says Fitch senior director Alexander Reyngold. "That being the case, the 2006 price increase still pales noticeably when put up against the movement of the index overall."

2006 prices have risen by 5.2% year-over-year, compared to the 39% bump for the overall index and the 48.6% move for the 2007 vintage. Last month's month-over-month price increases for the 2004 and 2005 vintages were modest at 0.7% and 1.2% respectively.

Loan performance in July was mixed, according to Fitch. While 90-day plus delinquency rates declined by 1.4% to reach a new low for the year of 10.8%, the one-month CDR increased substantially by 13.5%.

Vintages where the price performance was stronger, however, did benefit from better loan performance. The 2006 vintage saw both rates decline, with the one-month CDR on the 2006 vintage declining by 4.8% and the 90-day plus delinquency rate declining by 1.5%. However, increases in the 30-day delinquency rate of 4.4% and in the 60-day delinquency rate of 3.3% suggest that CDRs may increase going forward.

"Balance modifications may be playing a role in keeping 90-day plus delinquency rates low," notes Fitch director David Austerweil. "The percentage of subprime loans with balance modifications has increased by 120% over the last year to reach a high of 5%." The 60-day plus delinquency rate for balance modified loans was 18% last month; it was 29.4% one year ago.

Additionally, the importance of voluntary prepayment rates on subprime CDS prices may increase going forward. While the one-month CPR rate has been elevated since May, the recent sharp rally in mortgage rates could lead to further increases.

Last month, the 2004 vintage saw a 36.7% increase in the one-month CPR, bringing the rate to 4%. In December of last year, the one-month CPR on the 2004 vintage reached 5.6%, leaving plenty of room for additional increases to CPRs.

CDS

Data management rethink required

The implementation of OTC derivatives market reform will cause data levels to surge by as much as 400% above current levels, according to TABB Group. Electronic trading, clearing, reporting, risk management and other reform-mandated processes will produce and consume huge amounts of data never seen before by the swaps market.

Readying technology platforms to meet these reforms will not be an exercise in compliance but one of survival, says TABB principal and director of the firm's new fixed income practice Kevin McPartland. "OTC derivatives market reform in the US and across Europe is at the centre of this data challenge and he who holds the data, and knows what to do with it, will hold the power," he says.

Drawing on interviews with top-tier swaps dealers, buy-side firms, exchanges, clearinghouses and swap execution facilities, TABB estimates that OTC derivatives market participants will spend US$3.4bn in 2011 on clearing and back office technology alone. OTC derivatives reform is forecast to account for over 50 new sources of data.

Moving from 2,000 trade sides a day to an estimated 40,000 will require a fundamental rethinking of OTC derivatives data management. "To that end, bringing the data mart concept to the front office is essential," McPartland says. "An infrastructure that can pull in and normalise the most relevant data in real time and then distribute it out to the proper endpoints will make real-time margin calculations and cross-product risk management possible. The challenge will be in creating a best-of-breed solution based on a combination of in-house and third-party technology to solve the vast array of data challenges."

CMBS

CMBS defeasance criteria updated

S&P has refined its methodology and assumptions for rating US CMBS transactions with defeasance collateral by removing the triple-A rating requirement.

"For US CMBS transactions where defeased collateral substitutes all of the commercial real estate mortgage collateral (i.e. full credit substitution), the ratings on the transaction will be no higher than the credit quality of the defeased collateral," S&P explains. "For US CMBS transactions with a mix of commercial real estate mortgages and defeased collateral, S&P's analysis will consider the specific credit characteristics of all of the collateral as well as the transaction's structural features."

Defeasance collateral to date has included direct obligations of the US government. With the recent lowering of the US sovereign long-term debt rating to double-A plus, US direct obligations no longer qualify as defeasance collateral under S&P's previous defeasance criteria, published in April 2003. The agency says there are no current rating implications from the new criteria, which are effective immediately for all new and outstanding US CMBS transactions.

CMBS

US multiborrower CMBS criteria updated

Fitch has released an updated criteria report for analysing new US multiborrower CMBS transactions, but the agency is keen to stress that the core of its criteria has not changed. As a result, there are no rating implications for existing or new transactions. However, the updated criteria provide increased sensitivity to highly leveraged loans.

In particular, Fitch cites those loans with Fitch DSCRs below 1x and Fitch LTV ratios above 100% as being especially sensitive. As such, the agency will raise subordination levels from present levels if future pools contain loans with higher leverage than those seen in current transactions.

Refinements to Fitch's US CMBS multiborrower criteria include: higher probability of default (PD) for loans with low Fitch DSCRs; higher probability of loss (PL) for loans with Fitch DSCRs below 1x and Fitch LTVs above 100%; reduced sensitivity of PD and loss amount (LA) by property type; reduced sensitivity of PD and LA by geographic location; greater macroeconomic stresses; and the removal of credit for springing lockboxes.

The updated report also aims to provide more clarity on: Fitch's analysis of property-level cashflows; adjustments to credit enhancement for fusion transactions and examples of the calculation; new concentration measures; deterministic tests; and Fitch's sensitivity analysis.

Generally, these enhancements have already been applied in Fitch's rating methodology and have been described in recent US CMBS presales and new issue reports, the agency says.

CMBS

Pay-off percentage drops in July

The percentage of US CMBS loans paying off on their balloon date fell in July, according to the latest Trepp pay-off report.

In July 39.6% of loans reaching their balloon date paid off. This was around three points below the June reading. The July number was just above the 12-month rolling average of 38.9%.

By loan count - as opposed to balance - only 49.4% of the loans paid off. This was also down from June's 56.1% reading. On the basis of loan count, the 12-month rolling average is now 49%.

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

RMBS

German, Portuguese RMBS criteria updated

Fitch has updated its criteria assumptions for assessing credit risk in German and Portuguese residential mortgage loan pools. The move isn't expected to result in rating actions on existing German RMBS, but could impact Portuguese deals mostly at the lower rating categories.

The significant worsening in Portugal's macroeconomic outlook since Fitch's RMBS criteria review in February 2010 has warranted a revision to the agency's assumptions across the rating scale. Fitch anticipates the increased sovereign risk and fiscal consolidation measures to weigh heavily on the economy and mortgage performance.

The main changes to the criteria include an increase to the base foreclosure frequency assumptions, compression of the foreclosure frequency rating scenario multipliers at higher rating categories, increased quick sale adjustment and market value decline assumptions as well as a reduction in low prepayment rate assumptions.

"The expected sharp acceleration in unemployment, rising interest rates and property price corrections in Portugal will feed into mortgage performance. Consequently, Fitch has increased its near-term foreclosure frequency and peak-to-trough house price decline expectations to 8.1% and 10% respectively," says Lara Patrignani, senior director in Fitch's European Structured Finance team.

The impact of the revisions will result in higher gross loss rates at the lower rating categories and to a lesser extent at the higher rating scenarios to indicate the extreme levels of stress that the economy is expected to face over the coming years.

The main changes to the German criteria, meanwhile, focus on lower rating categories and reflect where the country is in the economic cycle. Assumptions at higher categories generally remain unchanged.

The macroeconomic environment has improved since the last criteria update in 2010 and GDP has recovered faster than expected from its record 2009 decline. Similarly, the German labour market has been surprisingly resilient: the unemployment rate has been falling since the summer of 2009 and is expected to decline further. These positive trends are reflected in Fitch's analysis.

The major change on the foreclosure frequency side is a reduction of the 'Bsf' base foreclosure frequency closer to its long-term average value. Prepayment assumptions at lower rating scenarios were also moderately adjusted: the base prepayment assumptions for the first years after loan origination are at a moderate 5% annually; the rates increase with ongoing seasoning of the loans to 10% in year seven and 15% thereafter.

RMBS

Belgian, French RMBS criteria updated

Fitch has updated its criteria assumptions for assessing credit risk in Belgian and French residential mortgage loan pools. The updated criteria assumptions are not expected to result in rating actions on existing RMBS transactions.

The main changes to the Belgian criteria assumptions focus on overall foreclosure frequency and base recovery assumptions, reflecting at the same time the country's general macroeconomic environment and the solid performance of Belgian residential loans throughout the crisis.

"Fitch believes that the impact of the recession on the performance of residential loans in Belgium has been less harsh than previously expected and, in particular, comparatively milder than the impact of the early 1990s recession," says Paul Peyre, director in Fitch's structured finance team in Paris. "Despite a stressful macroeconomic environment, Belgian residential loans have shown a certain resilience, as demonstrated by the overall delinquency and default levels observed. As a result, Fitch reduced its base-case foreclosure frequency assumption at all rating levels."

Similarly, Fitch decreased its expectations for peak-to-trough house-price decline, taking into account the effect of the current economic environment on house prices to date and its general expectations regarding the macroeconomic environment in Belgium in the next few years. In addition, as well as taking into account its expectations regarding the effect of a rising interest-rate environment on prepayments, the agency has reduced its low and high prepayment assumptions.

The main changes to the French criteria assumptions, meanwhile, focus on recovery assumptions in higher rating categories, reflecting the general macroeconomic environment and the continued overall increases in house prices in France. While base-case assumptions remain unchanged, the effect of stressed house price assumptions over the longer term is seen as more prevalent in higher rating scenarios.

"Fitch's expected 'B' house price decline assumption of 10% takes into account both the positive and negative short-term drivers of house prices, such as the lack of over-supply in the construction sector or, conversely, the potential for rising interest rates," adds William Rossiter, associate director at Fitch.

In addition, the agency has slightly reduced its low and high prepayment assumptions. More specifically, its reduction in low prepayment assumptions reflects the low historical prepayments observed during the crisis, as borrower refinancing capabilities became less available.

RMBS

UK north-south arrears gap widening

An updated study of regional differences in UK mortgage arrears and borrowers' equity positions indicates that arrears continue to diverge between the north and south of the country, according to S&P. Based on 1Q11 data from a sample of 1.5 million securitised loans backing UK prime RMBS that it rates, the agency found that mortgage borrowers in the north of the country are 35% more likely to be in arrears than those in the south.

"We believe the widening north-south gap in arrears is partly due to the significantly more robust employment trends evident in the south of the UK since the start of the recent downturn in 2007, compared with the trends in the north," says S&P credit analyst Mark Boyce.

He adds: "Our study also found that more mortgage borrowers in the north continue to be in negative equity, with northern regions accounting for about two-thirds of the overall rise in negative equity in the nine months to 1Q11. We believe that the sluggish housing market in northern regions over recent quarters may be partly responsible for this rise."

Looking ahead, the study anticipates the north-south arrears divide to further widen as the effects of the government's fiscal austerity measures start to bite. Boyce concludes: "Given the north's public sector jobs bias, we anticipate that unemployment in those regions - and consequently arrears - could escalate. And mortgage risk in the north could diverge even further if the UK's already fragile economic recovery falters."

RMBS

New US RMBS loss criteria finalised

Fitch has finalised its new criteria for estimating losses on US prime mortgage pools for RMBS transactions. The core principle of the framework is the interaction between borrower equity and market value declines in determining expected loss for each loan. In addition, the methodology accounts for both loan-level attributes and macroeconomic factors in deriving loss expectations.

Fitch's new framework also includes the application of a proprietary regional home price model to measure a property's sustainable value. Performance during the recent downturn has reinforced the strong correlation between borrower equity and borrower default behaviour. The new framework acknowledges this relationship by focusing on borrower equity as a key driver of both probability of default and loss severity.

Additionally, the new model demonstrates greater countercyclicality. By focusing on sustainable home prices, Fitch is able to take a countercyclical view on the potential for negative equity when projecting defaults and losses. As a result, credit enhancement levels will demonstrate improved sensitivity going forward.

In short, credit protection will increase materially during housing booms accompanied by unsustainable home prices. Conversely, credit protection will decrease as bubbles deflate and risk in the housing market neutralises.

Another key enhancement is the application of a two-step process to achieve a stressed market value decline scenario. In this scenario, home prices are first reduced to their sustainable value and then subjected to a further stressed market value decline assumption at each rating category. This approach provides greater transparency into the Fitch's view of sustainable prices, as well as the magnitude of home price stress that the loss protection levels can cover, the agency says.

Two independent default probability variables have been combined into one new variable. The sustainable market value decline and original combined LTV are now known as sustainable LTV, which is now the most predictive variable of borrower default.

Fitch will apply the new model to analyse both new and existing ratings for prime RMBS transactions. The implementation of the new model is expected to have a moderate impact on existing ratings, given the more conservative stress scenarios. The review of existing prime RMBS ratings potentially affected by this implementation will be completed within the next 90 days.

RMBS

Irish RMBS assumptions revised

Fitch has updated its criteria assumptions for assessing credit risk for Irish residential mortgage loan pools. The move is likely to result in negative rating actions on the junior tranches and, in some cases, the mezzanine tranches of existing RMBS transactions.

The main changes to the criteria include increased foreclosure frequency assumptions to reflect the deterioration of the Irish economy and the heightened sovereign risk and its impact on mortgage performance. In addition, the agency increased Market Value Decline (MVD) assumptions to reflect its more conservative house price expectation.

"The Irish economy has experienced unprecedented stress, which has knocked 12% off real GDP over a three-year period and increased the unemployment rate by 9% over the same time. Combined with a sharp house price correction, Fitch's revision to its Irish mortgage loss criteria reflects the stress in the Irish economy," says Michael Greaney, associate director in Fitch's European structured finance team.

"Irish house prices continued declining during 2010 and now are approximately 42% below the peak. In light of the oversupply of properties and continued restricted credit availability, the agency sees further downside risks to Irish house prices and, as result, Fitch now expects a peak-to-trough house price decline of approximately 50% as the most likely scenario," adds Ketan Thaker, senior director in Fitch's European structured finance team.

The low prepayment assumptions have been revised downwards and reflect future expectations of prepayment rates in the Irish market.