Contents

ABS

Improving tone

The European primary ABS sector has seen far more activity than in secondary, but positive developments in the broader markets are encouraging. Although confidence remains fragile, one trader reports that the news this week has given the ABS market a definite boost.

"There is still not a heck of a lot going on outside of the primary space. That said, the primary market has been quite a bit more active than we had anticipated, which is good news," the trader says.

He continues: "A few deals have come out and they all seem to have had pretty good execution. It is also positive that there has been relatively large US involvement, which has continued the pattern that had been developing in the earlier part of the year."

Volumes on the secondary side have remained relatively low, but the tone in the market has improved significantly. A new sense of optimism is developing, says the trader.

He notes: "Since the onset of the financial crisis, the ABS market has taken its lead from broader credit markets. That has happened to a much larger extent than it ever had historically and those broader markets have improved this week."

That positivity appears to be based on encouraging comments emanating from Brussels as well as Berlin and Paris, as the market believes politicians are starting to get to grips with the problems that have beset Europe. Even if it does not mean those problems will be solved immediately, the trader notes that acknowledging them is a good start.

He says: "That is the necessary first step: you need to acknowledge the problem before you start to fix it. There is also the ESFS vote going through on the enhanced bailout fund and even Slovakia looks like it might approve it either today or tomorrow. It is not so much that there has been a lot of good news, but there has been a run of not-negative news, which has given participants hope."

That hope remains fragile and the market is still very sensitive to what is going on in the wider world. A change in tone in the news flow could drastically change the market's outlook.

"It is tough to tell what the future will bring. Even though the tone is better, there may be other events that trigger the flight to quality and ratchet up the fear factor. Confidence is brittle and a vote of no confidence in the Italian government, for example, could really change the mood in the market," the trader says.

The improvements this week are a good start, but could be quickly undone. The market will only really push on once there is more clarity over the position of Europe's politicians, which the trader notes may take some time.

He concludes: "Although the right noises are starting to be made, I do not think a real, sustainable recovery will be possible until you start to see the details of what the plans are and get the chance to analyse what difference they might make."

JL

CLOs

Bids wanted

The European CLO market continues to see pockets of activity without quite building any momentum. BWICs are still struggling to trade as investors remain cautious, although senior paper is seeing increased activity.

Many bonds on BWICs are still failing to trade, says one trader. He believes that bids are low at the minute largely because investors are feeling very cautious. Despite several names being offered repeatedly, nobody is biting.

He says: "There have been some BWICs where bonds have not been trading. A BWIC circulated today with LFC and Euro Galaxy double-As that just did not trade. I sense the situation with BWICs is that people have reserves that are simply not being met."

The trader continues: "People are still scared to get involved and a lot of participants would rather hold off for now and not trade. Bids are quite speculative at the moment - there are a lot of bids that seem to be 'just in case we get it' and 'just in case the other guy really needs to sell'."

There has, however, been some encouraging activity for higher-rated paper, says the trader. He has noticed a marked increase in activity in the triple-A space, with senior paper being sold by US outfits.

The trader notes: "We have been busier on double-As. We have just done a junior triple-A trade on a Harbourmaster CLO, which was just under 700DM. That is pretty much mid-range for this kind of paper, where we have been seeing anything from 600DM to 750DM or 800DM."

Moving down into mezz territory, however, he points out that the market is a lot quieter. In equity, too, he says there is very little trading taking place.

"There are a couple of cases where someone specifically has to sell something, but otherwise there is little activity there. Also, all the guys looking to do switches are unable to do so," he adds.

The trader continues: "People think that things are getting worse and they are looking to move up from triple-Bs to single-As. But the fact that bid-offers are so big means switching is not very efficient, so there is not a lot happening."

The trader says that bid-offers for triple-As are around 350bp-450bp. Junior triple-A bid-offers are 550bp-800bp and double-As are 700bp-900bp. Double-Bs, meanwhile, are somewhere between 2000bp-3000bp.

"Equity now is anything over 50% IRR. I have seen trades that are ridiculous, including one at 100% IRR in equity," the trader notes.

Finally, there have been several reports of new buyers coming to the market, although the trader is somewhat dubious about this. "There has been some talk about US hedge funds coming in to start buying up distressed paper, but I have not yet experienced that myself," he concludes.

JL

ABS

SCI Start the Week - 17 October

A look at the major activity in structured finance over the past seven days

Pipeline
Further details of Credit Suisse Asset Management's latest CLO - the US$365.5m Atrium VII - emerged last week. Also entering the pipeline were the US$136.6m LEAF Receivables Funding 7 series 2011-2 equipment ABS and the US$75m Queen Street IV Capital catastrophe bond.

Pricings
Three jumbo European RMBS printed last week: the US$5.5bn Arran Residential Mortgages Funding 2011-2, the US$3.4bn-equivalent Silverstone Master Issuer 2011-1 and the €4bn Home Loan Invest 2011. A consumer ABS - €950m Golden Bar 2011-2 - rounded out issuance in Europe.
US pricings comprised of auto ABS: US$709.86m Ally Master Owner Trust 2011-5; US$100m American Credit Acceptance Receivables Trust 2011-1; US$90.33m First Investors Auto Owner Trust 2011-2; and US$1.48bn Honda Auto Receivables Owner Trust 2011-3.

Markets
The primary US ABS market continues to churn out transactions, although a short break in issuance is likely during the ABS East conference. However, the pipeline is expected to resume flowing steadily thereafter to Thanksgiving.
Top-tier benchmark spreads were mostly unchanged last week, with the exception of triple-A fixed rate prime auto bonds tightening by 1bp, according to ABS analysts at JPMorgan. At the same time, the bottom tier continues to weaken.
For example, off-the-run private credit student loan ABS spreads leaked wider in secondary trading. Lower tier FFELP names have also been soft amid negative rating action.
Despite strong rallies in the equity and credit indices, CMBS continued to underperform the broader market at the beginning of last week, according to US CMBS strategists at Barclays Capital. "After taking a day off on Monday, the CMBS market was expected to catch up with the broader markets on Tuesday; however, the trading volume that day was anaemic and spreads hardly moved. Wednesday certainly felt like a return to the good old days, with a strong two-way flow and the participation of a broader base of accounts. However, trading volume subsided again on Thursday," they note.
Overall, 2007 LCFs tightened by 5bp-10bp over the week and generic AMs from the same vintage remained nearly unchanged at around 780bp over swaps. Volumes remain well below the nearly US$2bn per week seen in the early part of the year, averaging less than US$800m per week over the past month, as most investors look to remain on the sidelines and wait out any short-term volatility.
Volumes are similarly light in the synthetic CMBS space, according to CRE debt analysts at Deutsche Bank. Looking at the new TRX.II index, they say: "Volume is low during this lull in issuance. After widening on its first day of trading, the index has retraced back to its launch levels. This has caused December settlement spreads to tighten as well, but the longer-term contracts have steepened relative to the shorter ones due to increased uncertainty over the next year."
Equally, the Deutsche analysts say that CMBX volume continues to remain depressed. This, they attribute to "a lack of conviction" among accounts that are not using the index as a macro hedge, noting that most of the index activity seems to be related to short covering.
The European primary ABS sector, meanwhile, saw far more activity than in secondary last week. Although confidence remains fragile, one trader reports that recent news has served to boost the ABS market.
Given encouraging comments emanating from Brussels as well as Berlin and Paris, the market believes that politicians are starting to get to grips with the problems that have beset Europe. Even if it does not mean those problems will be solved immediately, the trader notes that acknowledging them is a good start.
"It is not so much that there has been a lot of good news, but there has been a run of not-negative news, which has given participants hope," he says.
Meanwhile, the European CLO market continues to see pockets of activity without quite building any momentum. BWICs are still struggling to trade as investors remain cautious, although senior paper is seeing increased activity. However, last week saw little activity in mezz and equity tranches.

Deal news
• The issuer of Taurus CMBS (UK) 2006-2 has determined that the sequential payment trigger will not be breached if the sale of the St Katherine Dock property is completed successfully and the loan is prepaid prior to the October IPD.
• Henderson Global Investors held an auction for Avebury Finance CDO, comprising primarily of US assets, in Dublin on 12 October. The liquidation realised US$105.79m compared with an outstanding balance (including PIK interest) of US$121m. The trustee accepted bids for all of the collateral, but the assets of the issuer are expected to be sufficient for distributions to be made only to class A-1B noteholders and prior ranking creditors.
• The projected timetable regarding a restructuring of the GRAND CMBS is to be delayed slightly. DAIG says it intends to launch a scheme during this calendar year, with the expectation that it will be implemented during the first quarter of 2012.
• KBC has confirmed that it unwound the Fulham CDO at the end of last month and investors were paid back the full amount of capital invested and would receive a final coupon.

Regulatory update
• The advent of Basel 3 has significantly changed the way in which financial institutions address counterparty credit risk and credit value adjustment (CVA). While a small number of banks are geared up for the regulatory changes and are actively managing CVA, the complexity and cost of implementing the necessary infrastructure remains a daunting task for the majority.
• The SEC is to propose rules that lay out the process by which security-based swap dealers and security-based swap participants must register with the Commission.
• The Financial Stability Board (FSB) has published its second six-monthly progress report on the implementation of OTC derivatives market reforms. The report notes that, with just over one year until the end-2012 deadline for implementing the G20 commitments, few FSB members have the legislation or regulations in place to provide the framework for operationalising the commitments.

Deals added to the SCI database last week:
American Express Credit Account Secured Note Trust 2011-1
Arena 2011-2
AyT Novacaixagalicia Hipotecario I
Ford Credit Floorplan Master Owner Trust A series 2011-2
Gracechurch Card Programme Funding series 2011-5
Santander Drive Auto Receivables Trust 2011-4
Stichting Green Lion III
Turquoise Credit Card Backed Securities series 2011-1

Top stories to come in SCI:
Prospects for Trups CDOs
ABS recruitment trends
The role of CMBS LTV covenants
Australian/Asian CLN demand

CMBS

Refinancing risk re-examined

The readjustment of CMBS issuance expectations on the back of both economic and deal structure issues has led to concerns over refinancing risk. However, US CMBS strategists at RBS suggest that these concerns may be overplayed.

"The recent decline in CMBS 3.0 lending volume has led some market participants to question if the US$42.6bn in conduit loans maturing in 2012 without extension options will have greater refinancing risk," the strategists say. "We do not believe this is a significant risk and project a refinancing rate of approximately 50% based on expected CMBS 3.0 issuance of US$20bn to US$30bn in 2012."

They continue: "Our analysis shows that US$21bn (or 49%) of CMBS conduit loans scheduled to mature in 2012 without extension options are current and have a debt yield greater than 10%. We believe these loans are the most likely candidates to be refinanced by conduits, based upon the existing credit metrics of CMBS 2.0/3.0 deals."

The RBS strategists project that nearly all of the 1,974 loans totalling US$15.6bn with debt yields greater than 12% are likely to be refinanced in 2012. "The government agencies are likely to refinance the nearly US$2bn of these loans that are secured by multifamily properties and the life insurance companies may refinance the majority of US$2.2bn of loans secured by office properties located in primary markets. We believe the new issue CMBS 3.0 market can refinance the remaining US$11.4bn of loans with debt yields greater than 12%."

They add that retail properties secure nearly 50% of the loans they project will be refinanced through conduit lending. This indicates that CMBS 3.0 deals may continue to include a high percentage of these retail loans.

However, it is the 465 loans totalling US$5.3bn with debt yields ranging from 10% to 12% that are the most likely to be immediately influenced by 2012 CMBS 3.0 issuance volumes, the analysts suggest. "If CMBS 3.0 issuance volume is greater than US$20bn, we'd expect the majority of these loans to be refinanced through conduit lending. However, if CMBS 3.0 issuance declines to US$15bn, these loans are more likely to be extended by the trust."

The RBS strategists note that loans with less than a 10% debt yield will likely need to be recapitalised by the borrower in order to be refinanced through CMBS conduits. The larger loans with between 9% to 10% debt yields may be modified and extended by the CMBS trusts, with the remaining loans liquidated.

MP

CLOs

Capital structure plays

Charles Kobayashi, portfolio manager at BlueMountain Capital Management, answers SCI's questions

Q: How and when did BlueMountain Capital Management become involved in CLO management?
A: BlueMountain Capital Management was founded in 2003 with a focus on the credit derivatives and correlation markets. By 2005, the firm had expanded into cash loan assets, given their secured nature and low volatility. We also looked at launching a CLO to benefit from the associated leverage and secured recovery.

I was hired in April 2005 to establish the firm's loan/CLO effort, having previously managed about US$2bn of structured products - including CLOs and CDOs - at Credit Agricole Indosuez, before it merged with Credit Lyonnais. When I joined, BlueMountain had US$300m in loans under management; now, including CLOs, we have US$3bn.

Our first CLO issuance was in November 2005, sized at US$512m. We set out to opportunistically grow the business in a calculated way, particularly given our view that CLO equities were an attractive investment opportunity. We brought additional CLO transactions to the market in 2006 and 2007.

Despite the crisis, our three pre-crisis CLOs have performed extraordinarily well through the cycle. The lowest Moody's rated tranche is Ba3.

After the crisis hit, we launched a long-only loan fund to take advantage of the dislocation in the market: pricing at that time was attractive mostly because of technical, not fundamental, issues. Because of TRS unwinds and de-leveraging by market participants, loan prices dropped to the low-60s in 2008.

Our first loan fund was launched in April 2009 and the deal was called in January 2010, having returned 35% IRR in an eight-month period. We had targeted a high-teens to low-20s return over a two- to three-year timeframe, but the market recovered much quicker than anticipated.

We also manage some separate accounts investing in long secured/short unsecured.

Q: What are your key areas of focus today?
A: More recently, we discussed a long-only fund, but decided that the best way to invest in the sector at the present time is through a CLO. Investors these days are increasingly nervous about mark-to-market risk in volatile markets.

We launched our latest transaction - the US$361m BlueMountain CLO 2011-1 - at the end of July. The deal is fully ramped and has outperformed the targets we set at closing.

We have been in discussions with underwriters about a new CLO and expect to launch one in Q4 or 1Q12. The timing depends on the economics because ultimately the transaction needs to be accretive to equity. We're ready to access the market, but are waiting for the right entry point.

Q: How do you differentiate yourself from your competitors?
A: The depth of our research bench differentiates BlueMountain from other CLO managers: we employ 18 fundamental analysts, which is more than other CLO managers. Investment decisions are based on a bottom-up approach that focuses on the entire capital structure, not just a specific tranche.

This approach is a major differentiator - especially through the downturn - because it provides us with relative value signals ahead of our competitors, which allows us a first-mover advantage if our view of default risk and recoveries change based on these signals. This is in contrast with other CLO managers that typically only look at the secured loan space.

Q: What is your strategy going forward?
A: We expect market volatility to continue for the next few months. To take advantage of the dislocated market, we are executing new trades.

Secured is a cheap asset at the present time, so we are purchasing both high and low beta single names. We have a bearish view on unsecured recoveries and are currently shorting unsecured versus secured to capture this opportunity.

Q: What major development do you need/expect from the market in the future?
A: New issue loan spreads have cheapened significantly and the underlying collateral quality has improved, which is benefiting most CLO structures. If a manager has an existing vehicle, this widening has helped fuel asset purchases in the secondary market. Certain loans in the market are trading at attractive valuations as technical reasons have sparked a sell-off.

In terms of liabilities, triple-A CLO spreads at 150bp still yield good IRRs for equity holders because the underlying assets are wider. But it's a question of being able to place the liabilities at particular levels. A number of managers are due to price deals in the next few weeks and it will be a good indication of where the market stands.

Nevertheless, the US primary CLO market is fairly healthy at the moment and the well-regarded managers have been able to price transactions. Although volumes won't be as sizeable as expected in May, a solid pipeline remains for 4Q11 and 1Q12.

The choppiness is a result of broader credit market volatility, which is causing everyone to take a breather. But the underlying loan market is still strong - we're not expecting a spike in default rates any time soon.

The secondary CLO market has widened in tandem with the broader credit market. Decent appetite for equity and triple-A tranches remains, but mezzanine tranches have widened significantly.

There is less demand for this part of the capital structure because of the volatility and low current income. While the DM on a double-B piece is attractive, at around 1300bp, the coupon is low.

High quality equity has performed very well recently, since it pays large upfront cashflows of 28-32 points and annual IRRs in the high-teens. Triple-A spreads have widened but remain a solid investment. In addition, recent Moody's upgrades have incentivised banks and insurance companies to invest in senior CLO tranches.

CS

ABS

SF partner recruited

SJ Berwin has appointed Andrew Bliss as a partner in its finance team in London. He joins from Sidley Austin, where he has been a partner since 2002.

Bliss' experience includes working on the securitisation of loans and rental deposits, repackagings, credit-linked notes and the establishment of secured and unsecured MTN programmes. He also has extensive expertise in real estate finance.

Bliss will be working alongside Vanessa Therrode in SJ Berwin's structured finance group.

ABS

Restructuring team recruited

Mark Fennessy has joined Dewey & LeBoeuf's London office as a business solutions & governance partner, heading the European restructuring group. He was previously head of Orrick's European restructuring practice and has extensive experience in all areas of turnaround and insolvency matters, including the Cheyne SIV restructuring (SCI 9 July 2008). His team at Orrick has also been hired by Dewey & LeBoeuf.

ABS

Structured lending head hired

Nomura has appointed Munish Varma as global head of structured lending and special situations, based in London. He will report to Georges Assi, global head of credit products & co-head of fixed income EMEA, and Kieran Higgins, co-head of fixed income EMEA.

Varma and his group will focus on providing tailored financial solutions at all levels of the capital structure to Nomura's clients in both the public and private sector. He joins the firm from Deutsche Bank, where he had worked since 1999. Most recently, he was head of its global markets business in India.

ABS

IDC, FINRA join forces on data

Interactive Data and FINRA have developed a set of reports designed to provide transparency into US structured securities market activity on a daily basis. The reports consist of the US Structured Trading Activity Report and the US Structured Trading Pricing Tables.

The reports incorporate FINRA's TRACE data, offering an aggregate summary of daily transactions in the US structured securities market by asset class. The US Structured Trading Activity Report will include the volume of transactions, number of trades and number of unique securities. The US Structured Trading Pricing Tables detail average prices, volume by trade size and buy or sells.

The reports are available on FINRA's website and to Interactive Data's clients via its Vantage application.

CDS

OTC clearing pro hired

CME Group has appointed William Knottenbelt to lead its EMEA regions, effective in mid-November. He most recently served as global head of central counterparty clearing at RBS, where he worked on developing the bank's OTC clearing solutions.

Robert Ray, who previously led the company's international offices, will transition to a new role managing key strategic initiatives for CME Group in Europe and South America. Both Knottenbelt and Ray will be based in London, reporting to Bryan Durkin, CME Group coo and md, products & services.

CDS

SSgA beefs up in credit

State Street Global Advisors (SSgA) has appointed Catherine Powers as md and head of fixed income alpha strategies for North America. Powers joins the firm from Standish Investment Management, where she most recently led the insurance client strategies group with a focus on customised fixed income solutions. In her 23 years at Standish, she held numerous roles, including head of the structured finance team.

Additionally, Sandeep Bhatia has been named head of fixed income alpha strategies for EMEA. Bhatia, who was most recently a senior portfolio manager specialising in credit markets, joined SSgA in 2010 from UBS Global Asset Management. He has deep experience in managing investment grade, high yield, structured credit and credit derivative strategies.

Powers and Bhatia both report to Bill Street, global head of fixed income alpha strategies at the firm.

CLOs

Crescent Capital beefs up in Europe

Crescent Capital Group has launched a new European credit strategy, which will focus on credit opportunities across Europe from the firm's newly formed office in London. Christine Vanden Beukel joins as md to lead Crescent Credit Europe and its investment strategy across the continent.

Prior to joining Crescent Capital, Vanden Beukel served as a senior md in the London office of Clayton, Dubilier & Rice. She also previously served as senior md in the London office of GSC Group, leading the firm's European mezzanine lending and collateralised corporate debt activities, which totalled €3bn of assets.

Vanden Beukel will coordinate closely with Louis Lavoie at Crescent Consulting, who will continue to lead its mezzanine offerings in Europe.

RMBS

Mortgage platform bolstered

Janney has expanded its fixed income capital markets team with the addition of seven high-profile professionals in the area of institutional taxable fixed income sales and trading. The new hires bring with them extensive experience in structured mortgage products.

Erik Graham and Matthew Byrne have been recruited as directors, institutional taxable fixed income sales in Fredrick, MD. Kevin Walsh has been named a director, institutional taxable fixed income sales in New York.

Sarah Finlayson becomes a director, institutional fixed income sales in Towson, MD, while Terrell Wilson joins the institutional fixed income sales team in Atlanta. Finally, Reed Newkirk and Brian Maloney have been appointed mds in Philadelphia. Their roles will be institutional mortgage trader (non-agency RMBS) and institutional CMBS trader respectively.

Finlayson was previously with Raymond James & Associates. Graham, Byrne, Newkirk and Walsh were all most recently with Stone & Youngberg. Wilson was at Wells Fargo Advisors, while Maloney has spent the majority of his career at FTN Financial.

RMBS

Non-agency RMBS group formed

Clayton Holdings has formed a new securitisation group that is says is dedicated to helping the private market prepare for the return of non-agency RMBS.

The securitisation group will have two primary roles. First, it will provide a wide range of high-level consultative services to help issuers, investors and aggregators align their programmes and procedures with new rules that govern the issuance and ratings of RMBS. Second, it will deliver operationally excellent loan review and diligence that will assure transparency, quality and compliance - not only for new issues, but also for resecuritisations and pre-securitisation readiness.

Ron Castro has been appointed md of securitisation, reporting directly to Paul Bossidy, president and ceo of Clayton. Castro previously headed up Clayton's expansion into the UK, where he was responsible for operational and IT integrations. An 18-year veteran of the firm, he has been responsible for the development and implementation of Clayton's core due diligence and reporting systems within the RMBS market.

Other members of Clayton's new securitisation group include Vicki Beal, Jeff DeMaso, Grant Beal, Brad Bradley and Derick Greene.

ABS

First floorplan summary shows strong performance

Moody's has launched a new quarterly auto floorplan ABS sector summary, consolidating key floorplan trust information and performance data used to monitor ratings on outstanding publicly rated securitisations. The first summary reports that performance has remained strong since the economic downturn.

The summary includes data on monthly payment rates, excess spread and charge-offs. It references approximately US$19bn of outstanding securities, most of which are currently rated triple-A with none on review for upgrade or downgrade.

Issuance is heavily weighted towards transactions sponsored by US auto captive finance companies. Ally and Ford Credit were the top floorplan ABS issuers, as of August, with around US$8bn and US$7bn outstanding securities respectively.

US original equipment manufacturers (OEMs) have spent the last three years restructuring and are no longer overproducing. Moody's says that OEMs are now managing production, pricing and incentives in a more sustainable way, which strengthens their dealership bases and improves inventory management. This is, in turn, positive for auto floorplan ABS transactions in the near future.

Although floorplan ABS typically see very little loss during the life of the transaction, they are exposed to significant event risk if there is a manufacturer or servicer failure. Key performance metrics tend to weaken in tandem with deterioration of the related manufacturer and servicer, so Moody's uses those metrics as early indicators of potential event risks.

ABS

Differing drivers for Eurozone performance

The deterioration in the creditworthiness of some peripheral Eurozone sovereigns has created uncertainty about the performance of securitisations from those countries, says Fitch. Drivers are different across the jurisdictions and performance deterioration is not always driven by sovereign downgrades.

"Sovereign risk has become of far more importance in the analysis of structured finance transactions in this latest phase of the credit crisis," says Andrew Currie, Fitch structured finance md. "While Greek, Irish and Portuguese transactions represent only a small proportion of Fitch's portfolio of EMEA structured finance ratings, they provide useful illustrations of the potential effects on structured finance transactions of a significantly weakening sovereign or an asset market collapse."

Fitch uses a country's issuer default rating (IDR) as an indicator of sovereign risk. A falling IDR indicates increased uncertainty and increased likelihood of extreme stress. In these situations Fitch does not assign the highest ratings.

Greek, Irish and Portuguese ratings are currently capped at triple-B minus, double-A and single-A plus respectively. In Ireland, senior tranches have often been downgraded below the double-A cap due to asset underperformance.

"While ratings caps are the most obvious repercussion on structured finance transactions of sovereign downgrades, they are not always the key driver of rating action," notes Gioia Dominedo, Fitch senior director. "In Ireland, for example, the collapse of the Irish property boom resulted in the underperformance of Irish structured finance transactions well before the banking crisis put the sovereign rating under pressure."

However, in Greece and Portugal sovereign downgrades were the key drivers of downgrades, especially at the highest rating levels. The extremely low Greek sovereign IDR has led to Greek SF bonds becoming 'de-linked' from the sovereign, although a ratings cap remains in place.

Fitch says Greek and Portuguese transactions performed well in the early days of the crisis, with low delinquencies and defaults. Highly seasoned collateral and increased credit enhancement for many tranches were positive factors.

"More recently, securitisations in both countries have seen deterioration in transaction performance, but the majority of negative ratings migration remains driven by the ratings caps imposed by the sovereign ratings," says Dominedo.

ABS

Spanish ABS ratings reviewed

Moody's says it is considering the implications for Spanish structured finance transactions of its two-notch downgrade of the rating of the government of the Republic of Spain to A1, with a negative outlook. The agency believes that a triple-A rating remains achievable for Spanish structured finance transactions that benefit from sufficient credit enhancement and have highly rated transaction parties or appropriate operational risk mitigants in place.

Moody's believes that for Spanish structured finance transactions to achieve a triple-A rating, credit enhancement levels are expected to be: 15%-20% for RMBS (depending on pool characteristics); 20%-25% for auto ABS; 25%-30% for consumer ABS; and 30%-40% for SME/lease ABS (depending on collateral and sectors). Equally, for transactions with adequate liquidity arrangements, servicers with current ratings at or above A3 or appropriate back-up servicing provisions in place, the senior notes will be able to retain or achieve a triple-A rating.

The factors driving the downgrade of the Spanish sovereign increase the risk that asset performance will deteriorate significantly and uniformly, Moody's says. While the probability of such deterioration remains very low, it has reached a point where current levels of credit enhancement for some senior notes may be insufficient to support the highest rating levels.

The agency will review all Spanish structured finance transactions and announce any rating actions within the next few weeks.

CDO

ABS CDO liquidation announced

Stone Tower Debt Advisors has been retained to act as liquidation agent for Kent Funding II. The collateral will be sold at five public sales - split into subprime RMBS, prime/Alt-A, CDO, CMBS/re-REMIC and small-balance loan auctions - in New York at 10am EST on 26 October.

CDO

Auction due for hybrid CDO

VCAP Securities has been retained to act as liquidation agent for Dalton CDO. Public sales of the collateral will be held in the morning and afternoon of 26 October.

CDO

Fulham CDO unwound

KBC has confirmed that it unwound the Fulham CDO at the end of last month and investors were paid back the full amount of capital invested and would receive a final coupon. This follows the redemption of the Lancaster CDO earlier in the year.

KBC announced in July (SCI 28 July) its intention to sell or unwind selected ABS and CDO assets as part of its strategic plan, which will allow the group to release capital at no or limited loss. It says it is looking at other CDOs, whose prospectuses also contain an early redemption option, to establish whether such an option can be exercised.

CDO

ABS CDO RFC issued

S&P is requesting comments on its proposed update to the criteria for rating cashflow and synthetic ABS CDO transactions. The proposed criteria would apply the same basic criteria currently used in rating CDOs of corporate debt, but with some differences driven by the characteristics of structured finance assets.

If adopted, the updated criteria would apply to all new and existing ABS CDOs and will likely cause downgrades to existing transactions by one or more rating categories. The level of change would be primarily driven by the ratings on the assets relative to the rating on the CDO liabilities, S&P says.

The lower the ratings on the assets, relative to the existing rating on the ABS CDO liabilities, the larger the downgrade would be expected. However, some transactions with liabilities already rated in the triple-C rating category will likely not be highly affected by these changes.

CDO

CRE CDO delinquencies up slightly

After four consecutive months of decline, US CRE CDO delinquencies rose slightly last month, according to Fitch's latest index results for the sector.

CRE CDO late-pays rose to 12% from 11.6% in August. "Given the instability in the broader economy, CREL CDO delinquencies are expected to continue to see-saw going forward," says Fitch director Stacey McGovern.

In September, asset managers reported 11 new delinquent assets, including three matured balloon loans, six new credit-impaired securities and two term defaults. Partially offsetting the new delinquencies were six removed assets - one REO asset, which was sold at 38% of par; one mezzanine loan that was foreclosed out at a total loss; and four formerly credit-impaired CMBS securities.

Since Fitch began rating CRE CDOs, one rated transaction has paid in full. Of the 33 remaining Fitch-rated CRE CDOs, close to 75% have received at least some pay-down to their most senior classes.

Three CDOs have seen their senior-most classes paid in full. The average pay-down has been approximately 33%.

As of the September reporting period, 19 CDOs remained in their reinvestment periods. However, three more are scheduled to go static during the next month. The senior-most tranches of 22 rated CRE CDOs have either a stable or positive outlook, Fitch says.

The agency adds that ratings on the most junior classes remain subject to volatility as losses continue to accumulate.

In September, CRE CDO asset managers reported approximately US$60m in realised losses. The highest losses, totalling approximately US$42m, were related to full losses on multiple classes of one CMBS transaction.

The bonds, which contributed to three different CRE CDOs, were written down to zero during the reporting period. The largest single loss on a commercial real estate loan was related to the sale of an REO condo conversion property.

In September, 31 of the 33 deals rated by Fitch reported delinquencies ranging from 0.8% to 52.9% and 15 were failing at least one overcollateralisation test, which is in line with the prior month's total.

CDS

Swap registration rules prepped

The SEC is set to propose rules that lay out the process by which security-based swap dealers and security-based swap participants must register with the Commission. The rules stem from Title VII of the Dodd-Frank Act.

"Registering the major market participants in the largely unregulated security-based swap markets is a critical step toward better protecting investors," comments SEC chairman Mary Schapiro. "Today's proposal draws from our experience with registration rules regarding broker-dealers - rules that are familiar to many market participants."

Public comments on the SEC's proposal should be submitted within 60 days after it is published in the Federal Register.

CDS

OTC reform progress reviewed

The Financial Stability Board (FSB) has published its second six-monthly progress report on the implementation of OTC derivatives market reforms. For each of the G20 commitments, the report provides an assessment of progress in the three key steps that need to be taken: the development of international standards and policy; the adoption of legislative and regulatory frameworks; and actual implementation through changes in market practices.

The report notes that, with just over one year until the end-2012 deadline for implementing the G20 commitments, few FSB members have the legislation or regulations in place to provide the framework for operationalising the commitments. While recognising the implementation challenges and the complexity of the necessary laws and regulations, the report concludes that jurisdictions should aggressively push forward to meet the G20 end-2012 deadline in as many reform areas as possible.

Consistency in implementation across jurisdictions is critical, according to the FSB, and it is understandable that smaller markets want to see what frameworks the US and EU put in place when developing their own frameworks. Nevertheless, it is important that all jurisdictions advance development of their legislative and regulatory frameworks as far as they are able even before finalisation of the US and EU regimes, to be in a position to act expeditiously once rules are finalised in these two largest OTC derivatives markets.

The FSB says it is aware that there is a risk that overlaps, gaps or conflicts in legislative and regulatory frameworks - if not addressed - could compromise achievement of the G20 objectives. One such potential gap concerns the applicability of the G20 commitments to standardised derivatives that are moved onto exchanges or electronic trading platforms. The report clarifies that in order to achieve the G20 objective of mitigating systemic risk, full implementation of the G20 commitments needs to cover these derivatives, irrespective of whether they continue to trade OTC or are moved onto organised platforms.

As a key element of its work going forward, the FSB's OTC Derivatives Working Group will continue to actively monitor the consistency of implementation across jurisdictions and bring to the attention of the FSB any overlaps, gaps or conflicts that may prove detrimental to G20 reform objectives. FSB members have also agreed more generally to strengthen their coordination to address these issues and to provide senior-level steering on OTC derivatives reforms.

CDS

Hong Kong OTC consultation begins

The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) have issued a joint consultation paper on the proposed regulatory regime for Hong Kong's OTC derivatives market. The bodies have been working together since G20 commitments were made in 2009.

The HKMA and SFC propose that they jointly oversee the new regime. The HKMA will oversee and regulate the OTC derivatives activities of authorised institutions (AIs), while the SFC will oversee and regulate activities of non-AI persons.

All transactions will also have to be reported to a trade repository, which the HKMA is currently setting up. Initially this would apply only to some IRS and non-deliverable forwards (NDFs), but would subsequently be extended to other product classes.

Standardised OTC derivatives transactions will have to be centrally cleared through a designated CCP. Again, this would initially only apply to certain IRS and NDFs, before applying to other product classes after market consultation.

Unlike proposals elsewhere, in Hong Kong OTC transactions would not initially be required to be traded on an exchange or electronic trading platform, as the authorities say they need more time to assess how such a requirement would be best implemented locally.

The final proposal is that large players not regulated by the HKMA or SFC may be subject to certain obligations and requirements. These could include needing to produce information on their OTC derivatives activities as well as reducing their OTC derivatives positions, if so requested by the SFC.

The HKMA and SFC are working towards meeting the G20 implementation deadline of year-end 2012, although this is subject to external factors, such as the progress of reform in other major markets. The consultation period will end on 30 November.

CDS

Quanto CDS service launched

ReMATCH has introduced a new service to help its customers reduce their exposure to quanto CDS risk. The service, which launched in September, has eliminated over US$15bn of quanto CDS risk for customers in its first three sessions.

Typically, Eurozone sovereign CDS contracts are denominated in US dollars to mitigate the strong correlation between the creditworthiness of the Eurozone countries and the embedded currency risk in the event of default. Quanto CDS presents a particular difficulty to trading portfolios because they are denominated in euro and carry this correlation risk.

ReMATCH's new service helps banks reduce their exposure to Quanto risk by using proprietary technology to build accurate mid-level curves and generate risk-reducing trades from the set of portfolio data supplied by participating banks, enabling them to reduce positions that they may otherwise have been unable to exit.

CDS

Naked CDS ban moves to Council vote

MEPs have voted to ban naked CDS trading, with the sole exception of an option for a national authority to lift the ban temporarily in cases where its sovereign debt market is no longer functioning properly. This possibility would be closely circumscribed, however, because the text specifies a limited number of indicators that could justify the regulator's action.

Reporting requirements have also been strengthened under the agreement. For example, supervisors are to be informed of large short positions already when this position accounts for 0.5% of the issued capital.

But the hard 'locate and reserve rule' - whereby a trader must not only disclose where it plans to borrow the shares from, but must also have a guarantee that it will be able to borrow them - was diluted. This will now require the trader to locate and have a 'reasonable expectation' of being able to borrow the shares from the located party.

The proposed ban will reduce liquidity in the CDS market, according to Andrew Shrimpton, member at Kinetic Partners - leading to increased volatility of CDS prices, undermined confidence in member state sovereign bonds and making it more expensive for member states to finance budgets. "This has been demonstrated by similarly ill-timed regulatory tightening, such as the banning by France, Italy, Belgium and Spain of the short selling of financial stocks earlier this year, which undermined confidence in bank stocks, reduced liquidity in the banking system and eventually led to a taxpayer-funded bailout of Dexia," he comments.

Both the European Council and the full Parliament must now ratify the agreement. A plenary vote in Parliament is expected to be taken in the third week of November. The regulation is expected to enter into force in November 2012.

CMBS

DQT rises 35bp

The delinquency rate on loans in US CMBS conduit/fusion transactions rose by 35bp in September to 9.36%, according to Moody's Delinquency Tracker (DQT). Delinquencies in the US have been above 9% for nine months now.

Moody's Specially Serviced Loan Tracker (SSLT) fell by 10bp to 12.13%, with the gap between the SSLT and the DQT narrowing by 45bp to 277 from 322. New delinquencies exceeded resolutions of delinquent loans: loans amounting to US$2.5bn were resolved, but this amount was counterbalanced by US$4.2bn in new delinquencies.

A single new CMBS deal in September added US$1bn to the CMBS conduit/fusion universe, although it was more than offset by the US$5.9bn of seasoned loans exiting the sector. This resulted in a US$4.9bn net decline in outstanding issuance to US$594.6bn.

The highest delinquency rates in the core asset classes were for multifamily and hotels, both of which are hovering around the 15% mark. Office experienced the greatest increase (of 0.8%), rising to 8.16% from 7.36%, followed by hotels, to 14.81% from 14.56%.

Geographically, Moody's says the greatest delinquency rate increase was in the East, up by 70bp to 8.20%; the West saw a rise of 41bp to 8.69%. Only the Midwest rate improved, declining by 14bp to 9.35%.

Hawaii experienced the greatest increase, due primarily to the Four Seasons Resort Maui loan. At US$394m, this is the second-largest new delinquent loan and currently the sixth-largest overall.

CMBS

CMBS pay-offs jump sharply

The percentage of CRE loans paying off on their balloon date posted their highest reading since December 2008, according to the latest Trepp pay-off report.

In September, 64.4% of loans reaching their balloon date paid off. This is only the third time since late 2008 that the percentage passed 50%: the previous high in the last 33 months was 55.5% in March 2011. The 64.4% payoff number was almost 25 points higher than the August reading.

The September number was well above the 12-month rolling average of 42.6%. By loan count (as opposed to balance), 55.6% of the loans paid off, up by over 12 points from August's reading of 43.1%. On the basis of loan count, the 12-month rolling average is now 49.4%.

Prior to 2008, the payoff 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.

CMBS

Uncertainty for special servicers

While special servicers have made tangible progress in stemming US CMBS losses, current economic uncertainty makes the outlook for next year more uncertain, according to Fitch in its latest annual US CMBS loss study.

At 1,427, nearly four times as many loans were resolved by special servicers in 2010 compared to 2009, Fitch says. Additionally, the average loss severity declined to 53.4% compared to 57% in 2009.

"Special servicers have been increasingly successful selling properties and working with borrowers for discounted loan payoffs," says Fitch senior director Britt Johnson.

However, current economic uncertainty makes it more difficult to predict 2012 numbers. "If the current economic volatility continues, special servicers may struggle to find borrowers capable of obtaining capital for distressed real estate," Johnson adds.

Drilling down into specific property types, loss severities fell for all major property types, except retail. However, Fitch expects the cumulative loss severity in 2011 to continue eclipsing historical averages, which increased to its highest level ever at 42.9% in 2010.

Losses on retail and multifamily loans will remain volatile. Elsewhere, office losses will trend north of historical averages, in spite of recent improvements in some regional markets.

"With leases set to expire in a weaker economy, office landlords will have to continue lowering rents and paying for tenant improvements and rent concessions," says Fitch md Mary MacNeill.

Though performance among hotel properties has improved notably in recent months, they still hold the second highest amount of defaults. "There are still many delinquent hotel loans to resolve, though dispositions will slow next year if the lending environment tightens," MacNeill suggests.

Risk Management

Through-the-Cycle EDFs launched

Moody's Analytics has introduced a 'Through-the-Cycle EDF' (expected default frequency) measure. A quantitatively derived credit risk estimate, the new measure is designed to dampen the short-term volatility arising from the aggregate credit cycle, providing more stable default probabilities than traditional point-in-time (PIT) credit risk estimates.

Through-the-Cycle EDF measures have been developed for applications in which a stable default probability input is desirable, such as banks and similar financial institutions managing regulatory capital requirements and long-term portfolio investment mandates. "Credit analysts have long struggled to manage the tension between default prediction accuracy and stability in their measurement of credit risk," says David Hamilton, md of quantitative credit research at Moody's Analytics.

He explains: "While point-in-time default measures are powerful predictors because they capture all available information, they are highly volatile and can obscure long-term credit quality signals. Through-the-Cycle EDFs preserve much of the accuracy of traditional point-in-time EDF measures, while eliminating noise from market-wide movements, yielding a superior balance of prediction accuracy and stability."

Covering more than 30,000 companies globally, Through-the-Cycle EDFs are derived from Moody's Analytics' public firm EDF model. Moody's Analytics research shows that Through-the-Cycle EDFs reduce cyclical volatility by 50% or more for the vast majority of companies.

Through-the-Cycle EDFs complement Moody's Analytics' traditional EDF, a point-in-time metric that estimates a firm's probability of default using information from equity markets, company financial statements and capital structure.

Risk Management

Collateral management system upgraded

4sight Financial Software has added new functionality to its Xpose Collateral Management system. The new features include: the ability to net and margin call exposures by multiple criteria across multiple asset classes; and optimised, schedule-driven booking of collateral trades in bulk, based on collateral concentration and cost.

The firm is working on further enhancements to help customers respond to the evolving regulatory landscape. Among these are: balance sheet utilisation, CCP margining and regulatory reporting.

Risk Management

Basel 3 implementation reviewed

The Basel Committee on Banking Supervision has issued its first progress report on the implementation of Basel 3, as of end-September 2011.

The report focuses on the status of domestic rule-making processes to ensure that the Committee's capital standards are transformed into national law or regulation according to the internationally agreed timeframes. The Committee believes that disclosure will provide additional incentive for members to fully comply with the international agreements.

A subsequent element of the Committee's framework will be to review the consistency of members' national rules or regulations with the international minimum standard to identify differences that could raise prudential or level-playing field concerns. The framework will also review the measurement of risk-weighted assets in both the banking book and the trading book to ensure consistency in practice across banks and jurisdictions. These reviews are expected to commence by the beginning of 2012.

Risk Management

EMIR pros and cons examined

The increase in reporting requirements and the use of trade repositories under the European Market Infrastructure Regulation (EMIR) is expected to boost transparency and allow regulators to keep tabs on systemic risk, according to a new Celent report. Given that a high proportion (68%) of interest rate swaps is already cleared via a CCP, the regulation is anticipated to have the greatest impact on the CDS and FX markets in Europe.

EMIR will be voted upon by the European Parliament in 4Q11 and, subject to further consultations from the European Securities and Markets Authority (ESMA), is expected to be implemented by January 2013. Once implemented, it will be flexible in its orientation and further changes - especially with regard to the definition of eligible derivatives - and the threshold levels for nonfinancial users could be made, according to Celent.

EMIR will require financial users of eligible OTC derivatives to set aside collateral, likely at higher levels than before. The amount of collateral will depend on the CCP and the clearing brokers.

Besides the clearing requirements, both financial and non-financial participants would be subject to reporting obligations. The higher levels of standardisation and transparency are also expected to allow for the entry or growth of smaller brokers and help reduce the concentration of trading in the markets.

The estimated EMIR-related technology and connectivity expenditure in 2012 will be around US$950m. This would include the costs of improving risk and collateral management systems, as well as connecting to new trading platforms and CCPs. Clearing brokers and CCPs will incur a large proportion of the costs because they would be the main service providers, but the buy-side, trading platforms and custody providers will also incur a significant share of the initial expenditure.

RMBS

Agency prepayment tool minted

CoreLogic and Amherst Holdings have jointly launched 'Agency Prepayment Analyzer'. The two firms say that this online analysis tool is the first to enable fixed income investors to assess and forecast both voluntary and involuntary prepayment risk trends associated with agency MBS.

Agency Prepayment Analyzer tracks the speeds at which the collateral underlying commonly-traded agency securities will prepay due to refinances and property sales or defaults which, in turn, prompt buybacks by Fannie Mae and Freddie Mac. Investors can use a series of filters - coupon, vintage and aggregated credit scores, LTVs at origination and estimated current LTVs - to compare the characteristics of their bonds with the conditional prepayment rates (CPR) of similar collateral.

The subscription-based service provides a monthly forecast with a four-month horizon, as well as ongoing commentary from Laurie Goodman, senior md at Amherst Holdings. It combines the breadth and depth of CoreLogic data coverage with the forecasting and analytical acumen of Amherst, according to the two firms.

RMBS

Rising prepays unlikely to benefit RMBS

Fitch expects US mortgage prepayments to increase in the coming months on the back of expected HARP reforms, as well as low-risk borrowers taking advantage of low interest rates to refinance with cheaper loans. However, the FHFA's expected reforms to HARP only affect government-agency sponsored loans and therefore will not directly benefit rated RMBS.

Low-risk borrowers with equity in their properties are taking advantage of historically low interest rates. However, loans to higher risk borrowers with higher LTVs are unable to refinance and therefore staying in the portfolio.

Indeed, the percentage of non-agency prime borrowers with no equity in their homes has continued to grow over the past two years. It now makes up almost 40% of the remaining pool, while the number of borrowers with LTVs below 80% has declined to less than 40%.

Fitch expects home prices to drop by another 10% nationally before stabilising. A drop of this size would mean nearly half of prime borrowers in Fitch-rated pools would have negative equity. The increased concentration of weaker loans will weigh down the performance of outstanding non-agency pools.

In many transactions, the low-risk prepayments pay down the notes, which increases the percentage of credit enhancement but not the dollar value of the support. This means the transaction cannot withstand additional losses on a dollar-basis, but may appear safer.

In some cases, prime RMBS transactions are passing their performance triggers, in which case the prepayments pay down subordination. This is negative for the senior notes because they lose credit support despite a worsening pool.

RMBS

Servicer performance analysed

Moody's has published new detailed comparative performance metrics on the largest servicers of private RMBS. The agency's inaugural Servicer Dashboard covers the 12 months ending June 2011 and shows variations among mortgage servicers in their ability to prevent loans from becoming delinquent and their rate of curing delinquencies through modifications, foreclosures and other means.

The inaugural Dashboard finds that Chase and Bank of America exhibited poorer overall performance relative to other servicers analysed. CitiMortgage, GMAC and Ocwen generally exhibited stronger servicing performance.

"One reason driving Chase and Bank of America's poor servicing performance was that those banks underwent significant loan and servicing platform acquisitions, which resulted in the enormous task of combining servicing platforms, employees, processes and technologies," says William Fricke, a Moody's vp and senior credit officer. "As a result, these banks were less able to process their increasing number of problem loans."

Another cause of Chase and Bank of America's weak performance was the imposition by each of those servicers of foreclosure moratoria in the second half of 2010 as a result of the 'robo-signing' issue, which suspended foreclosure sales already in process and delayed the referral to foreclosure of distressed loans.

CitiMortgage and Ocwen did not impose foreclosure moratoria shortly before or during the period covered by the report. "GMAC and Ocwen also offered modifications to borrowers with verified financial information before the HAMP programme required full documentation and, as a result, had superior modification re-default rates," adds Fricke.

Moody's expects the servicing environment to remain challenging. While it believes servicers have made significant headway in addressing concerns over foreclosure documentation that arose from the robo-signing issue, the agency expects to continue to see the robo-signing issue delay foreclosure sale timelines over the rest of the year.

The Servicer Dashboard presents metrics including current-to-worse roll rates for collections, total cure and cashflowing/modification re-default rates for loss mitigation and various servicing timeline measures. It presents metrics for jumbo, Alt-A and subprime RMBS.

"We believe the metrics presented in the Dashboard allow users to easily make meaningful comparisons of performance among the major servicers," explains Fricke.

These metrics are important inputs into the servicer quality (SQ) assessments that Moody's publishes and uses in its rating of RMBS.

ABS

Tax efficiency matters

Petrina Smyth, partner in the tax group, and Noeleen Ruddy, senior counsel in the structured products and capital markets group in Walkers' Dublin office, explain how Irish vehicles are driving US life settlement deals

Ireland has become a leading jurisdiction for the establishment of vehicles to participate in US-originated life settlement transactions. As life settlements have become an increasingly attractive alternative asset class, sponsors have utilised two types of vehicles in Ireland to achieve their objectives - Irish SPVs or regulated qualifying investor funds (QIFs).

The US/Ireland Tax Treaty is of particular benefit for investment in life settlement policies. Where the various requirements of the Treaty are satisfied, no withholding tax will apply to payments of death benefits. In addition to benefiting from zero US withholding tax, it is possible to establish an Irish SPV or QIF such that there is no Irish tax leakage and investors receive an overall return on their investment in the most tax-efficient manner.

While matters concerning life expectancy, longevity and liquidity of the asset class quite rightly occupy the foremost positions when structuring a life settlements transaction, in our experience it is useful to consider at the outset the type of investment vehicle (whether a QIF or SPV) and the infrastructure required to establish and maintain such an investment vehicle, as well as the US and Irish taxation analysis. Both types of Irish vehicles, namely SPVs and QIFs, are entitled to avail of the US/Ireland Tax Treaty. The decision to establish an SPV or a QIF will depend on many factors, including whether the preference is for a regulated or unregulated vehicle and a debt or equity investment by the investors (the SPV is funded by way of debt instruments and the QIF is funded by way of equity).

Qualifying SPVs (Section 110 companies)
Overview
Section 110 of the Irish Taxes Acts provides for favourable tax treatment for SPVs. In order for an SPV to qualify for this treatment, the SPV must hold and/or manage "qualifying assets" or enter into legally enforceable arrangements in respect of these assets.

"Qualifying assets" includes an extensive range of financial assets (in addition to commodities and plant and machinery) and includes a direct acquisition by the SPV of life policies or the indirect holding by the SPV of life polices via a partnership or trust. The "qualifying assets" acquired by the SPV must have a minimum value of €10m (or a foreign currency equivalent) on the date they are first acquired or held. SPVs can be incorporated within five business days and there are no rulings or authorisations required for the SPV in Ireland, with the taxation treatment guaranteed by legislation.

Typically, the SPV will issue profit participating notes (known as hybrid debt), where the return on the notes varies with the profitability of the SPV. Depending on whether the investors are known at the outset or not, the SPV may establish a single-issuance note structure or a note programme. In a programme, the return on each series will be linked to a particular pool of policies and a default with respect to one series will not impact on any other series - in this way the same result can be achieved as in protected cell company arrangements.

Tax treatment
The SPV is entitled to receive a tax deduction for its recurring expenditure, including profit participating interest. It is subject to corporation tax at 25% but, with careful planning, it is possible to structure transactions so that the SPV is effectively tax neutral.

The "quoted Eurobond" exemption from withholding tax on interest payments is the exemption most often claimed by investors in Irish SPVs. A "quoted Eurobond" is a security that carries a right to interest, is quoted on a "recognised stock exchange" (such as the Irish Stock Exchange) and is either held in a recognised clearing system or payments in respect of the securities are made through a paying agent located outside Ireland.

In addition, interest may be paid gross without the necessity of the note being a "quoted Eurobond", where the recipient of the interest is a person resident in an EU Member State (other than Ireland), in a country with which Ireland has an in-force double taxation treaty or a country with which Ireland has signed a double taxation treaty that is waiting ratification.

Qualifying investor funds
Overview
Alternatively, the investment vehicle may be established as a QIF, which is a regulated fund targeted at sophisticated and institutional investors. There are a flexible range of eligible assets for the QIF to invest in, including direct acquisition by the QIF of life settlement policies.

Unlike SPVs, there is no minimum value in relation to the assets acquired. However, there is a minimum subscription of €100,000 per investor. QIFs can take a variety of forms, including being established as investment companies, unit trusts, common contractual funds¹ or limited partnerships.

They can also be established as a single portfolio of funds or as multiple portfolio "umbrella" funds with segregated pools of assets. QIFs offer a very flexible investment product with few investment restrictions and no borrowing restrictions.

Subject to promoter approval and a pre-submission process for QIF life settlement funds, they have next-day authorisation. In advance of filing the QIF application for next-day authorisation by the Central Bank of Ireland, the promoter proposing to establish the QIF must be approved. Promoter approval for a US SEC registered asset manager usually takes two to three weeks and for EU authorised asset manager approval usually takes one to two weeks.

Once promoter approval is obtained, a submission must be made in respect of the fund itself. Due to the complexity of the asset class, the Central Bank needs to be satisfied with the investment policy and with the valuation and custody arrangements.

It may be possible to run this submission process parallel to or combined with the promoter approval process, with the agreement of the Central Bank. While the length of time for the approval process will depend on the particular circumstance, it can usually be expected to take approximately four weeks.

Funding of the QIF is usually through direct investment in the shares or units of the QIF, with loan funding a supplemental option. Where investors have a preference for investing in a listed vehicle, the notes issued by the SPV or the units in the QIF may be listed through the Irish Stock Exchange.

No Irish tax
QIFs are exempt from Irish tax on their income and gains, irrespective of where their investors are located. In addition, no Irish withholding tax applies to income distributions or redemption payments made by a QIF to non-Irish resident investors.

Infrastructural requirements
Depending on the type of investment vehicle, it will be necessary for the SPV or QIF to appoint a number of service providers. These include a corporate services provider to provide corporate and administrative services, such as maintaining the registered office in Ireland, company secretarial services and the provision of non-executive directors.

Other services include the maintenance of books and records, preparation of annual accounts and providing general compliance services, such as the preparation and filing of tax returns². The investment vehicle will also need to appoint independent auditors to carry out the annual audit.

In a managed vehicle, it will be necessary to appoint an investment manager to perfect the acquisition or disposition of portfolios of policies by the vehicle in accordance with the terms of the transaction documents.

In the context of an SPV, a registrar will need to be appointed to maintain a record of all registered notes, and a paying agent and calculation agent to calculate the interest and principal due under the notes and to make payments to the noteholders (see diagram). Where the notes are listed securities, a trustee is required to represent the interests of the noteholders.

The QIF will generally appoint a custodian, who will have responsibility for holding and keeping safe custody of the assets and for monitoring compliance with investment policy, and an administrator will be appointed to calculate the net asset value of the QIF and prepare accounts (see diagram). In the case of a QIF established as a unit trust, a manager will be required and will make decisions in respect of the trust. A trustee will be required to constitute the trust and will fulfil a role similar to the custodian.

Tax treaty benefits
In order to obtain the benefits of zero US withholding tax under the US/Ireland Tax Treaty, the requirements that must be satisfied can be relatively onerous. It may involve an analysis of the tax residence and/or tax status of the various investors in the Irish vehicle, in addition to analysing the expenditure of the Irish vehicle.

US advisors should therefore be engaged at the earliest stage of the transaction in order to analyse these matters. Obtaining the benefits of the US/Ireland Tax Treaty is often vitally important to the economics of the transaction and - in addition to the infrastructure required from an Irish legal, regulatory and practical perspective - US advisors will examine the infrastructure required from a US perspective.

Conclusion
As an established jurisdiction for life settlement transactions with experienced advisors and a well-established infrastructure, Ireland's popularity is also attributed to its flexibility in terms of investment vehicle choice, the benefits of the Irish tax regime and access to the US/Ireland Tax Treaty. While life settlements are one of the more complicated asset classes, advance planning in terms of US tax analysis and the required infrastructure can help ensure the transaction closes in a cost-effective and expeditious manner.

Notes
¹ The tax treatment of a common contractual fund is different to that of a QIF established as a company, a unit trust or a limited partnership and is beyond the scope of this article.
² Not all providers offer tax compliance services. Alternatively, tax compliance services may be provided by the SPV's auditors or a third party.