Contents

RMBS

Timing issues

RMBS cases to swell as timing limits expire

The number of RMBS-related law suits in the US is unlikely to abate for some time to come. However, those considering claims will take note of the recent court case ruling involving Allstate and Countrywide, in which the judge threw out a number of RMBS fraud claims on the grounds that the statute of limitations had expired.

In a case originally filed in December 2010, insurer Allstate accused Countrywide of fraudulently misrepresenting certain RMBS with a value of US$700m, noting that falling underwriting standards of the mortgage securities stemmed from Countrywide's decision to adopt a mortgage 'matching' strategy in 2003. This strategy, claimed Allstate, could only be implemented through "material abandonment of Countrywide's claimed credit risk-reducing underwriting procedures."

However, in late October, a judge in California - the case having been transferred from New York to Los Angeles - threw out federal securities law claims on the grounds that the statute of limitations had run out.

"Statutes of limitations are running, so activity has to happen or the rights will be lost," comments Zachary Rosenbaum, chair, capital markets litigation at Lowenstein Sandler in New York. "In the next year there will be a crescendo. But once claims are brought, they have a long tail - cases may go on until 2017 or longer."

He adds: "Many institutional investors from life insurance companies to Fannie and Freddie Mac, through their federal conservator, are now bringing cases for alleged fraud and misrepresentations in the sale of RMBS securities. We're getting to the point where courts will decide whether those claims will survive initial motions or be dismissed," he says.

According to Rosenbaum, the US RMBS litigation landscape can currently be broken down into two broad categories: put-back claims and direct claims for misrepresentation and fraud.

Rosenbaum explains that put-back claims rest on many of the same factual underpinnings as fraud claims, for example, the failure to adhere to underwriting guidelines. However, they are contractually based on reps and warranties within the RMBS documentation. These claims are held by the trust that owns the underlying mortgage loans, not by the individual investors.

"Those cases have been more difficult for investors to bring as the investors do not have the direct claim - it's a derivative claim through the trust or directly by the trust, he says. "But the Bank of America-Countrywide case [SCI passim] is a good example because that settlement is premised largely upon put backs. The dynamic is such that the petition seeking to approve the settlement was filed by the trustee - Bank of New York Mellon - on behalf of over 500 trusts in an attempt to settle claims with BoA stemming from Countrywide RMBS deals.

He adds: "What I think this demonstrates is the banks' desire to resolve the put-back claims. It's not yet clear the bank's willingness to resolve fraud claims."

Rosenbaum says that certain trustees have been more resistant than others in various claims, noting that some have used protective language in their documents - particularly the pooling and servicing agreements - to contend that they do not have any obligation to pursue these claims.

"However, investors feel differently and are of the view that, if the trustee is presented with information validating the claim and fails to act, it will expose itself to liability," he says.

William O' Connor, partner at Crowell & Moring is also confident that the amount of RMBS litigation is unlikely to shrink any time soon. "We'll continue to see class action and bond certificate holder litigation based on reps and warranties. All of the problems such as robosigning that have purportedly caused losses to investors in MBS are manifesting themselves as claims now, so we'll see in the next couple of years how they pan out," he says.

Indeed, the ongoing probe into illegal foreclosure practices and robosigning involving 50 Attorneys General is yet to come to a conclusion, made all the more difficult by the departure of three states - New York, California and Massachusetts - from talks in recent weeks.

"My question would be: what is the end game for the Attorneys General that object to the settlement?" says O'Connor. "Do these states really want to go forward on their own? The robosigning issue is such an immense subject that it would be a major undertaking for each state to do of its own accord. While each state is large and has the tax base as a source of income, in today's economy I'm not sure this is the type of case that would net justifiable rewards, such as the tobacco litigation case back in early 2000."

He explains that many of the defendants - other than the large banks - are not in business any more, or they are on the brink and are therefore not in a position to withstand major suits.

"There's always the possibility that the three Attorneys General that have left the discussions will come back on board. In the case of New York, they are purportedly looking for more disclosure and transparency," says O'Connor.

He concludes: "There's a general frustration with the residential market that given the current situation there hasn't been large-scale engagement in forbearance or a resolution with many of the underlying borrowers that are in default but are still paying something. I think that's a legitimate concern of the AGs."

AC

ABS

SCI Start the Week - 14 November

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

Pipeline
A range of new transactions remained in the pipeline at the end of last week, including a couple of esoteric ABS - the US$400m Miramax Series 2011-1 Film Library Asset-Backed Notes and the US$787.57m TSA Minnesota tobacco settlement revenue bonds series 2011. Rounding out the ABS deals were the US$300m KAL ABS 8 and US$750m Volkswagen Auto Lease Trust 2011-A.
These were joined by two CMBS - the US$1.11bn FREMF 2011-K704 and US$784m JPMC Commercial Mortgage Securities Trust 2011-FL1 - a CLO (US$262m Ivy Hill Middle Market Credit Fund III) and an RMBS (A$712.5m IDOL Trust Series 2011-2).

Pricings
Auto-related ABS dominated last week's pricings, with four prime auto (the US$1.1bn Ally Auto Trust 2011-5, US$1.25bn Nissan Auto Receivables Owner Trust 2011-B, €800m FCC Auto ABS Compartiment 2011-2 and €953m Private Driver 2011-3), three lease (US$500m SMART Trust 2011-4US, US$1.1bn Mercedes-Benz Auto Lease Trust 2011-B and US$661.46m Porsche Innovative Lease Owner Trust 2011-1) and one fleet (US$696.6m Enterprise Fleet Financing 2011-3) deals printing.
Adding to the ABS volume were: the US$812m SLM Student Loan Trust 2011-3; US$1.15bn American Express Credit Account Master Trust 2011-2; and US$69.75m New York City Tax Lien 2011-A. Finally, one RMBS - the US$3.52bn-equivalent Gracechurch Mortgage Financing 2011-1 - completed the issuance.

Markets
Amid Euro-driven volatility and a short trading week in the US, securitisation markets were generally quiet in terms of trading volume last week.
The exception remains the consumer ABS primary market, which "continued to churn out transactions in what seems to be a sprint before the end of the year", according to ABS analysts at Barclays Capital. At the same time, the analysts say that secondary market trading volume remained generally robust, with interest remaining relatively strong in higher spread/yield product such as containers and aircraft ABS.
This resulted in senior fixed and floating rate credit card spreads moving 2-3bp tighter week on week, while other sectors' spreads were unchanged. However, mezzanine and subordinate classes of credit card ABS widened by 5-10bp following pricing of the AMXCA 2011-2 transaction.
Equally in US CMBS, Citi securitised products analysts note that although trading was moderately slow, volatility persisted. "Early in the week CMBS spreads were tightening. That trend reversed with the Wednesday sell-off triggered by the Italian debt contagion. The GG10 duper spread dropped below 300bp before reaching 315bp on Wednesday's close. With the spread back to 305bp in trading on Thursday, the sector actually held up relatively well in the face of another external macro shock," they say.
In addition, the Citi analysts report: "Strong demand continues for the new super senior classes. Spreads tightened on the week by 5bp to 130bp, as the publicly issued, 30% credit-enhanced bonds continue to garner broad appeal."
In the synthetic CMBS space, Deutsche Bank CRE debt analysts note: "TRX II volume increased as investors begin to get more comfortable with the product and see it as a good way to gain levered exposure to a limited supply new issue product." They continue: "TRX I widened by 11bp, a bit less than CMBX, while TRX II continued to grind tighter. The term structure of TRX II was fairly flat week over week, but has steepened 35bp since launch as spread risk has shifted from the front to the back end."
Meanwhile, Barclays Capital non-agency RMBS analysts say: "As the broader markets continue to take their cues from the European saga, non-agency markets followed suit. While the 'risk-on one day, risk-off the next' pattern is not as easy to observe in non-agency markets, we did see more enthusiasm towards the beginning of the week, only for it to wane on Wednesday to some extent."
Non-agency cash prices closed Wednesday marginally higher but mostly flat over the week. The ABX and PrimeX indices, on the other hand, were down by a quarter- to half-point on average.

Deal news
• The likelihood of a break-up of the eurozone has increased over the past few weeks, forcing ABS investors to consider the implications of currency redenomination. Should a country leave the eurozone, analysts expect significant consequences for related securitisations, with large losses on mezzanine tranches and downgrades of senior bonds.
• Investors in CMBS bonds backed by Stuyvesant Town and Peter Cooper Village collateral are likely to face negative consequences following a recent court ruling. Tenants in the properties were granted permission to continue with their US$215m class-action lawsuit against MetLife and Tishman Speyer Properties by the New York Appellate Court, the original case having been dismissed in 2007.
• Fitch has cut its ratings on the Punch A and Punch B pub securitisations by between two to four notches, with the most meaningful impact being the removal of the Punch B class A notes from the iBoxx investment grade index. While not unexpected given the agency's revised criteria for UK whole business transactions (SCI passim), some technical selling pressure on the notes is anticipated as a result of the move.
• Daniel Zimmermann has replaced Manfred Gabriel as the key person on the PULS CDO 2006-1 and 2007-1 deals. This follows the latter's resignation from the board of the portfolio manager, Capital Securities Group, which triggered a key personnel event (SCI 28 September).
• CWCapital Investments has been named as the successor collateral manager for Sorin RE CDO 1, following Sorin Capital Management's resignation.

Regulatory update
• The Australian Personal Property Securities Act 2009 (PPSA), due to take effect in February 2012, could be credit negative for transaction parties. The PPSA will replace 70 state and federal acts, as well as eliminate more than 30 individual securities registers and apply to a host of securitised assets and structures.

Top stories to come in SCI:
European CMBS refinancing trends
Spotlight on Northern Rock's Granite programme
Profile on Solve Advisors

ABS

Euro ABS trader hired

Paolo Binarelli has joined Banca IMI's securitised products and loan trading desk in Milan, headed by Roberto Lucchini. In his new role, he will trade ABS and MBS.

Binarelli previously worked as a portfolio manager at P&G SGR Alternative Investments.

CDO

Replacement portfolio manager named

Daniel Zimmermann has replaced Manfred Gabriel as the key person on the PULS CDO 2006-1 and 2007-1 deals. This follows the latter's resignation from the board of the portfolio manager, Capital Securities Group, which triggered a key personnel event (SCI 28 September). Noteholders have consented to the appointment of Zimmermann as a replacement person of the skill and experience, from internally within the portfolio manager, at least equivalent to that of Gabriel in respect of managing the portfolios.

CDS

Hedge fund branches out

Saba Capital Management, the US$4.7bn hedge fund established by Boaz Weinstein, is set to open a UK office in 1Q12. The new branch - which has been launched as a research centre and sub-advisor to the US limited partnership - will be led by former Deutsche Bank leveraged finance trading head Prakash Narayanan and is currently awaiting FSA registration. Throgmorton will provide a full-range of back office services for the operations.

CDS

Broker adds CCDS team

Avatar Capital Group has hired ICAP's former credit hybrids team. The team will once again be led by Bill Mertens, who becomes head of credit hybrids at the New York-based firm.

Mertens' team will continue to intermediate trades in contingent CDS (CCDS) and quanto CDS. Avatar Capital Group is part of FXDirectDealer (FXDD) and Mertens will now report to Joseph Botkier, FXDD president and ceo.

CDS

Pickel returns as ISDA ceo

Robert Pickel has been appointed ceo of ISDA, effective on 1 January 2012. He returns to the post after serving as the association's executive vice chairman for the past two years.

Conrad Voldstad, ISDA ceo since November 2009, will continue to work with the association as a special advisor at the request of the board. He will assist on strategic initiatives.

Risk Management

Quantitative advisory board expands

Alexander Lipton, md and co-head of the global quantitative group at Bank of America Merrill Lynch, has joined the Numerix Quantitative Advisory Board. The board was established to further the standardisation and advancement of pricing and risk for the OTC derivatives market by promoting professional interaction between renowned academics, researchers and Numerix. Lipton becomes the fourth member of the board.

RMBS

RMBS pro recruited

Bill Twombly has joined Risk Management Group as md of its due diligence practice, replacing Dante Jackson. Twombly will be responsible for setting the strategic direction of the practice, as well as overseeing RMG's Phoenix operations centre. He has over 25 years of experience in the real estate and mortgage finance industry and was most recently head of due diligence at UBS, in addition to serving as chair of both the firm's credit compliance and seller-servicer committees.

RMBS

NCUA RMBS settlement reached

The NCUA and HSBC have reached a settlement regarding potential claims relating to the sale of RMBS to five failed wholesale credit unions. HSBC has agreed to pay NCUA US$5.25m.

NCUA will use the net proceeds from the settlement to further reduce assessments being charged to credit unions to pay for the losses. The association has received a total of US$170.75m in settlement proceeds to date.

NCUA has also taken other actions to mitigate losses to credit unions from the corporate failures. These include: re-securitising the problematic RMBS and reselling them with a government-backed guarantee; filing lawsuits against other securities firms for violations and misrepresentations; reaching settlements with Deutsche Bank and Citigroup; establishing a temporary share guarantee for deposits at corporate credit unions; and establishing bridge corporate credit unions in conservatorship to ensure the continuation of services to credit unions.

RMBS

NCUA settlements reached

The NCUA has reached settlements with Citi and Deutsche Bank regarding potential claims relating to the sale of RMBS to five failed wholesale credit unions. The two banks have agreed to pay NCUA US$20.5m and US$145m respectively to reduce the losses associated with the five credit union failures. Neither settlement admits fault on the part of Citi and Deutsche.

NCUA will use the net proceeds from this settlement to reduce assessments being charged to credit unions to pay for the losses. Since 2009, the agency has assessed credit unions US$3.3bn to pay for losses associated with the five failures. Given the current settlement proceeds, projections for remaining assessments range between US$1.8bn and US$6.1bn that must be paid by 2021.

ABS

SF deals to feel eurozone crisis effects

Whilst the expected default of Greece is "affordable", a final resolution of the Greek sovereign situation will not be enough to stabilise the rest of the region, which may have indirect inlays to structured finance transactions in the affected regions, says Fitch in a new report.

"We continue to believe that the crisis will be protracted, but we still don't expect any systemically important sovereign to be allowed to default,' said Tony Stringer, md in Fitch's Sovereigns group.

Nonetheless, pressure will increase on banks in the affected regions. As bank ratings have become less stable, the full recovery of the EMEA structured finance market is still on hold. The strength of the banks is crucial in ensuring that there is a viable number of counterparties eligible to provide support facilities.

"It doesn't matter whether you support the bank as a going concern: if someone is going to lose money, we are rating to that loss. This means that the rating is going to come down," says Bridget Gandy, co-head of EMEA financial institutions "We think that states will continue to support systemically important banks in Europe in the near term, though that likelihood may diminish over time."

ABS

Aussie act 'could be credit negative'

The Australian Personal Property Securities Act 2009 (PPSA), due to take effect around February 2012, could be credit negative for transactions parties, warns Moody's. The PPSA will replace 70 state and federal acts as well as eliminating more than 30 individual securities registers and apply to a host of securitised assets and structures.

"It is going to broaden the purview of a security interest and ignore its legal ownership. What is more important, it is going to materially change the priority and enforcement of the interest," says Richard Lorenzo, Moody's vp and senior credit officer.

The PPSA applies to the structure of all securitisations because of their security interests. Although it primarily applies to non-mortgage securitised assets, the PPSA will still impact RMBS and CMBS transactions because it also covers the creation of rights to payments on mortgage pools.

New transactions taking place after the act takes effect will have to incorporate measures to protect security interests immediately, but older deals be given two years. Moody's believes that should allow most transaction parties enough time to comply with the new law, particularly as they already appear to know what they need to do to preserve the priority of their security interests.

"Regardless, because transactions contain so many security interests, there is a risk that some of these interests may fall through the cracks, which would result in unperfected or unprotected security interests that could compromise the integrity of a transaction structure," notes Lorenzo.

Transactions of assets that do not require the registration of a security interest will have to incorporate a new set of procedures and documentation, to ensure the perfection or protection of the security interest.

ABS

Key macroeconomic SF influencers listed

S&P has identified the five top macroeconomic factors which it believes are most relevant to credit quality. The agency says unemployment, home price behaviour, GDP, equity returns and corporate credit risk premium are the factors most relevant to its global structured finance securities ratings actions.

"We selected our top five factors by examining correlations among economic variables and their sensitivities to changes in credit quality and ratings," says primary research analyst Erkan Erturk. "In particular, we conducted a sensitivity analysis that could cause ratings to change by one full rating category in relation to each economic factor's volatility."

Erturk continues: "We tested these factors on a Great Depression triple-A scenario to provide an analysis that describes the extreme volatility among these top five macroeconomic indicators and highlight potential changes in credit quality and rating transitions under the best, expected, and worst-case scenarios."

In that Great Depression triple-A stress scenario, S&P says it would lower its triple-A ratings on global structured securities by as much as 16 notches, down to triple-C. Global structured finance ratings would decline by about 12 notches. Less harsh macroeconomic scenarios, such as a 1% drop in GDP, would lower structured finance credit quality by less than two notches.

S&P's expected case scenario for 2012 is that a struggling US housing market is likely to pressure overall structured finance credit quality. Improvements in the other top factors indicate that there may be a small increase in credit quality.

ABS

Punch bonds pressured as downgrades hit

Fitch has cut its ratings on the Punch A and Punch B pub securitisations by between two to four notches, with the most meaningful impact being the removal of the Punch B class A notes from the iBoxx investment grade index. While not unexpected given the agency's revised criteria for UK whole business transactions (SCI passim), some technical selling pressure on the notes is anticipated as a result of the move.

Together with the application of the revised criteria, Fitch also cited continued performance deterioration and a weak outlook for the tenanted pub sector as reasons for the action. Strategists suggest that the agency is nearing completion of its pub downgrades, with anticipated actions on Greene King and Wellington bonds remaining.

ABS

Greek ratings ceiling reviewed again

Moody's has placed on review for downgrade Greek structured finance notes rated from Ba1 to B3, representing nine tranches of six ABS, 19 tranches of eight RMBS and one tranche in one CLO. The rating action reflects the increased risk of a disorderly default of Greece on its debt, the agency notes, which would increase the likelihood of high severity events that would have a material impact on both probability of default and loss-given default. As part of its review, Moody's is also reassessing the highest achievable rating for Greek structured finance transactions.

The agency had previously indicated that the highest achievable rating for Greek structured finance transactions of Ba1 would not be further affected if Greek government debt were restructured in an orderly way; for example, with the necessary steps taken to support the country's banking system, to ensure the continued functioning of the Greek state and to support implementation of the structural changes needed to achieve a resumption of growth. However, last week's events in Greece heightened uncertainty around the implementation of the country's economic and fiscal reform programme, which is a precondition of the EU rescue package approved on 27 October.

Moody's review will assess how far heightened political uncertainty and social unrest have increased the risk of disorderly default scenarios in which the functioning of the banking system and the state is materially impaired, and in which the economy experiences a further sharp contraction, and the implications for structured finance transactions. The rating agency will also assess the likelihood that its credit analysis should assume for a scenario in which Greece exits from the euro, which would carry severe implications for structured transactions, it says.

ABS

IRGs revamped

Fitch has revamped its issuer report grades (IRGs) to promote improvements in investor reporting standards for EMEA structured finance transactions. IRGs provide a measure of the quality, content, accuracy and timeliness of the reporting available for each transaction, the agency says.

"Some issuers have made significant efforts to improve the information available to investors and deserve credit for the progress made, while the reporting for other transactions remains poor," says Andy Brewer, senior director in Fitch's structured finance team. "Fitch aims to further encourage and incentivise issuers to provide high quality reporting by revamping its issuer report grades programme."

The agency has reset the guidelines for assigning IRGs to ensure they reflect the extra challenges of monitoring structured finance transactions during a period of stress. The previous scores have been removed and the revised scores will be published in January 2012. In the interim, Fitch analysts will be available to discuss ways in which the reporting standards for individual transactions can be improved and so justify better IRG scores.

If no enhancements are made to current investor reports, Fitch expects the new scores to be significantly lower than previous grades, with RMBS transactions being the most adversely affected. The revised scores will be lower because the agency has introduced some new elements to the IRGs, including: detailed default, recovery and loss statistics; information surrounding transaction counterparties; and details of asset repurchases by originators.

"In a more stressful economic environment investors need better information about the factors that could affect deal performance, including delinquency status, recovery details and any asset repurchases," says Brewer. "Investors are now required to perform more detailed analysis, so greater transparency is now even more vital than when the IRG scores were first introduced in 2004."

ABS

Solar financing MOU signed

SolarTech and CalCEF have entered into a memorandum of understanding designed to bring finance, performance and reliability best practice leaders together. The aim is to accelerate industry efforts to increase investor confidence, decrease project risk and improve flow of capital in the solar financing sector.

"The securitisation of solar assets will unleash one of the most powerful forces in finance, establishing an enormous new pool of capital to support the industry's growth," comments Dan Adler, president of CalCEF. "With SolarTech, our goal is to identify and promote industry standards for establishing solar as an asset class, in order to increase the investor base and create ownership opportunities for broad new categories of investors."

"Increased acceptance of PV as an asset class by Wall Street, venture capital and equity markets in general is closely linked to proper evaluation of system production output and the risks associated with cashflow projections," adds Doug Payne, SolarTech co-founder and executive director. "The <1MW commercial market segment is undercapitalised. We want to change that."

Under the terms of the MOU, the organisations will form a Technical Working Group to identify market gaps with respect to quantification of project risk, capital formation and bankability. This will form the foundation of model guidelines for key stakeholders in project finance, capital markets, design/engineering and installation that drive standardisation of best-in-class solutions for increasing liquidity in aggregate for PV project portfolios. The team will expand on existing collaborative work with Sandia National Laboratories on ways to accelerate commercialisation of new technologies through validation of system performance and reliability.

The Working Group will also propose solutions aimed at reducing gaps between perceived and real project risk across the project delivery chain. Over the course of 2012, SolarTech and CalCEF say they will engage with regional banks and support financial institutions to catalyse creation of solar as an asset class.

ABS

EC eyes tougher CRA rules

The European Commission is proposing to toughen European legislation on credit rating agencies. The proposed draft Directive and draft regulation has four main goals: to ensure that financial institutions do not rely only on credit ratings for their investments; more transparent and more frequent sovereign debt ratings; more diversity and stricter independence of credit rating agencies to eliminate conflicts of interest; and make CRAs more accountable for the ratings they provide.

Internal market commissioner Michel Barnier explains: "My first objective is to reduce the over-reliance on ratings, while at the same time improving the quality of the rating process. Credit rating agencies should follow stricter rules, be more transparent about their ratings and be held accountable for their mistakes. I also want to see increased competition in this sector."

The Commission's Capital Requirements Directive IV proposals reduce the number of references to external ratings and require financial institutions to do their own due diligence. It is now seeking to make similar changes to rules relating to fund managers, in a complementary draft directive. This will be completed by changes to rules on insurance next year.

A general obligation for investors to do their own assessment is also included in the new proposal. In addition, more and better information underlying the ratings would need to be disclosed by CRAs and by the rated entities themselves, so that professional investors will be better informed in order to make their own judgments.

At the same time, credit rating agencies will have to consult issuers and investors on any intended changes to their rating methodologies. Such changes would have to be communicated to ESMA, which would check that applicable rules on form and due process have been respected.

Further, issuers would have to rotate every three years between the agencies that rate them. In addition, two ratings from two different rating agencies would be required for complex structured finance instruments and a big shareholder of a credit rating agency should not simultaneously be a big shareholder in another credit rating agency.

Finally, a CRA should be liable in case it infringes these regulations, thereby causing damage to an investor having relied on the rating that followed such infringement. Such investors should bring their civil liability claims before national courts, with the burden of proof resting on the credit rating agency.

"It is important to have more competition in the credit rating agency sector, but it is also critical to maintain the quality, stability and independence of credit ratings," comments AFME md Richard Hopkin. "While the slight relaxation of the draft rotation requirements is a step in the right direction, significant questions remain. Potential aspects of the new regulation are still to be discussed and we remain concerned that any ability for ESMA to suspend sovereign ratings may damage the independence of the credit rating agencies in the eyes of the financial markets."

ABS

Future flow criteria released

S&P has published its global methodology and assumptions for rating financial future flow securitisations. Specifically, the criteria apply to transactions whose repayment of principal and interest are secured by the generation of future diversified payment right (DPR) and merchant voucher (MV) receivables.

The criteria provide a framework for assigning ratings to financial future flow transactions based on a multifaceted approach consisting of: the indicative issuer credit rating (ICR) for the originating bank; a structural assessment; knock-out features; and a sovereign interference assessment. Once the indicative ICR has been established, a number of structural features - stressed DSCRs, transaction-adjusted bank liquidity and the stressed pay-down period - are then taken into account to determine any notches of elevation above the indicative ICR. The application of these factors will produce a structural assessment.

Additional structural features are reviewed on a pass/fail basis, with the rating on the future flow security being capped by the lesser of the structural assessment and the sovereign interference assessment. Finally, the rating on the security will be capped at three notches above the foreign currency ICR on the bank.

ABS

Euro ABCP responding to regulatory requirements

S&P reports that the European ABCP sector is responding to increased regulation from national and supranational bodies, in particular the Basel 3 requirements. Specifically, conduits are making structural modifications to their programmes to meet new liquidity requirements.

The inclusion of unrated trade receivables sellers continues to account for the majority of conduits' new seller activity. By contrast, their holdings of rated securities continue to decline, reflecting - in S&P's view - the falling investor appetite for CP backed solely by rated securities.

Funding volumes for European ABCP conduits appear to have found a sustainable level at around US$160bn, being roughly equal to the level observed in August 2010. However, the intensifying European sovereign debt crisis appears to have triggered some nervousness in the sector, according to the agency.

Nevertheless, credit performance over the past 12 months has been stable and issuance levels are also expected to remain stable in the near term.

CDO

CRE CDO delinquencies inch up

Delinquencies on US CRE CDOs rose slightly for the second month in a row, according to Fitch's latest index results for the sector, increasing to 12.5% in October from 12% the previous month. The agency expects volatility to persist for CRE CDO delinquencies as asset managers continue to work out troubled loans within the CDO or pursue resolution outside the CDO, including sale or refinance.

In October, asset managers reported ten new delinquent assets, according to Fitch. Among them were three term defaults, two matured balloon loans, three new credit-impaired securities and two repurchased assets. Only two assets were removed from the index in the month, including an REO multifamily property located in Phoenix, AZ. The property was sold at no loss to the CDO.

Four of the newly delinquent assets (approximately 70% by loan balance) consist of loans secured by interests in hotel properties. While too early to indicate a trend, Fitch notes that hotel-backed properties now comprise the largest property type by dollar balance in the delinquency index.

CRE CDO asset managers also reported approximately US$25.5m in realised losses from the disposal of five assets during October. The weighted average loss on these assets was 28%. The largest single loss, which totalled US$7.4m, was related to the discounted sale of a mezzanine loan secured by interests in a portfolio of luxury hotels.

CDS

Absolute return fund minted

PIMCO has launched a credit absolute return fund for investors seeking a global, diversified strategy that is not constrained by a benchmark. The PIMCO GIS Credit Absolute Return Fund, which is managed by md and global head of corporate bond portfolio management Mark Kiesel, aims to invest in the best long and short credit positions in every part of the fixed income market.

The fund is designed to capture long-term strategic investments, as well as shorter-term tactical opportunities to provide positive returns in any market environment. Kiesel explains: "This strategy can pivot in order to help achieve the absolute return objective. For example, the strategy can take on greater exposure to credit when spreads are attractive and, conversely, reduce overall exposure when necessary and instead focus on relative value between credit sectors."

The fund has been added to PIMCO's UCITS-compliant Global Investor Series (GIS) range.

CDS

Bank monoline losses updated

An ISDA study as part of its examination of losses incurred in the US banking system due to counterparty defaults on OTC derivatives has found the counterparty credit risk exposure of 12 US bank holding companies and international banking companies to monoline insurers has led to US$54bn in bank write-downs since 2007.

ISDA's study follows an earlier paper based on data from the US Office of the Comptroller of the Currency (OCC) (SCI 5 August) which showed losses for US banks amounting to only US$2.7bn.

From 2007 through 1Q11, ISDA now says the 12 firms analysed by the association took aggregate credit provisions in the form of counterparty valuation adjustment (CVA) charges of approximately US$54bn on their monoline exposures. The exposures and corresponding charges were primarily related to real estate and consisted of CDS on pools of MBS.

Four of those banks accounted for US$43bn of CVA charges, while their losses on cash mortgages was even greater. Counterparty credit losses on plain vanilla derivatives products were "insignificant compared to these charges".

"This and the earlier study on losses from counterparty defaults provide additional evidence that structured real estate risk taken in synthetic form resulted in a large majority of losses taken by banks on derivatives during the crisis," says ISDA ceo Conrad Voldstad.

He adds: "Losses on plain vanilla products occurred but were relatively modest as the earlier paper revealed. Serious risk management mistakes were made with real estate and insurance companies, but the industry's track record on plain vanilla product needs to be reconsidered."

CDS

Parliament ratifies naked CDS ban

The European Parliament has voted into law a regulation to curb short selling and trading in credit default swaps. The sole exception is an option for a national authority to lift the ban for a maximum of 12 months in cases where its sovereign debt market is no longer functioning properly and then possibly renew it for a further six months.

The regulation requires traders to locate and have a "reasonable expectation" of being able to borrow the shares from the located party. ESMA, however, will determine measures for judging what may be deemed a "reasonable expectation".

The resolution passed with 507 votes in favour, 25 against and 109 abstentions. It must now be formally approved by the European Council in the coming weeks and is expected to enter into force in November 2012.

CDS

Dynegy credit event determined

ISDA's Americas Credit Derivatives Determinations Committee has resolved that an auction will be held in due course in respect of Dynegy Holdings. This follows its resolution on 9 November that a bankruptcy credit event had occurred.

CDS

Dynegy auction set

The auction to settle the credit derivative trades for Dynegy Holdings CDS is scheduled to be held on 29 November. This follows the bankruptcy credit event that occurred on 9 November.

CDS

Sovereign CDS liquidity converges

As of last Friday's market close, average CDS liquidity for developed market sovereigns had outpaced that of emerging market sovereign debt for the first time since the beginning of this year, according to Fitch Solutions.

"This convergence in liquidity reflects the high levels of CDS market uncertainly on prospects for the Eurozone," says Diana Allmendinger, director at Fitch Solutions in New York.

Average developed market sovereign CDS liquidity closed last week at 8.10 versus 8.21 for emerging economies, which compared to scores for both in the 8.6 region when these indices last converged on 21 January this year.

"This uncertainty is also reflected in CDS spreads for developed market sovereigns, which resumed widening after a brief rally in the last week of October. However, spreads for developed market sovereigns still remain inside the record high levels seen in late September," adds Allmendinger.

Elsewhere, global CDS liquidity increased in the month to 11 November driven by Asia and Europe, while CDS on North American names remained largely unchanged.

CDS

First-half OTC outstandings published

After an increase of only 3% in 2H10, total notional amounts outstanding of OTC derivatives rose by 18% in 1H11, according to the latest BIS figures. Notional amounts outstanding reached US$708trn by the end of June 2011.

Notional amounts outstanding of credit default swaps grew by 8%, while outstanding equity-linked contracts went up by 21%.

Gross market value of all OTC contracts declined by 8%, however, driven mainly by the 10% reduction in the market value of interest rate contracts. CDS market values were almost unchanged.

Overall gross credit exposure dropped by a further 15% to US$3trn, compared with a 3% decrease in the second half of 2010.

CMBS

Drop in CMBS loan pay-offs

One month after posting the highest reading since December 2008, the percentage of CMBS loans paying off at their maturity plummeted in October, according to Trepp's October pay-off report.

In October, 41.8% of loans reaching their balloon date paid off. This was over 22 points lower than September's 64.4% reading, marking the single biggest monthly drop since April 2010.

Trepp notes that the payoff report data can be a lagging indicator, however. When commercial real estate sentiments are getting stronger, it can take a few months for that to manifest itself in stronger payoff numbers.

"The rising numbers that we had seen from late 2010 through last month were indicative of some of the bullishness that had crept into the market in the first half of the year," the firm says. "Now that all bullishness has left the building, we could be in store for a downward trend in these numbers over the next few months. Adding more pressure to this number is the fact that over the next 12 months, many five-year loans from late 2006 and 2007 will start reaching their maturity date. These loans will be among the hardest to get refinanced."

To underscore this last point, US$2.15bn in loans were slated to pay off in October and US$1.76bn was slated to mature in September. Those are the two highest amounts to come due since we began studying this trend in August 2008. Much of the increase in this volume is the jump in 2006 five-year loans coming due.

The October number was slightly below the 12 month rolling average of 44.2%. This number simply sums the averages of each month and divides by 12 - there was no balance weighting across the months.

By loan count (as opposed to balance), 44.2% percent of the loans paid off. This was down over 11 points from September's reading of 55.6%. On the basis of loan count, the 12 month rolling average is now 48.8%, says Trepp. Prior to 2008, the payoff percentages were typically well north of 70%. Since the beginning of 2009, however, there have only been three months where more than half of the balance of the loans reaching their balloon date actually paid off.

CMBS

2012 CMBS loan defaults set to increase

North American CMBS loan defaults slowed in the first half of 2011 after spiking in 2009 and 2010, according to a research paper published by S&P.

"With CRE lenders becoming more cautious in the current environment, refinancing prospects for maturing loans have lessened. As 2012 is a big year for CMBS loan maturities, annual loan defaults, in our view, could increase above current levels. Loss severity rates, however, may have already peaked, as the stress in the property markets that existed in 2009 and 2010 has subsided," S&P observes.

In the first six months of 2011, there were 801 defaults, versus 1,200 in the comparable 2010 period, the rating agency says. The loss severity rate also fell slightly in this period, dropping to 42.7% from 46.6%. Over the study period - which spanned from 1993 through June 2011 - 8,418 loans defaulted, yielding a cumulative loan default rate of 12.12%.

Of the major property types, lodging had the highest average loss severity rate at 42.96%.

Risk Management

OIS valuation capabilities included

Principia Partners has released the latest version of its Structured Finance Platform (SFP). Version 6.6 delivers enhanced valuation capabilities to support the shift in derivatives markets towards Overnight Index Swap (OIS) discounting (SCI 4 November), providing clients with the flexibility to adopt OIS discounting for collateral calculations and valuation of their derivative positions.

OIS-based valuations for most major currencies can be applied at any stage of the derivative portfolio management lifecycle, with seamless integration and downstream calculations applied through risk management, mark-to-market reporting and into accounting. As the OTC derivatives market moves towards central clearing, the OIS rate is increasingly seen as the benchmark 'risk free' rate when performing discounting valuations.

Douglas Long, evp, business strategy at Principia comments: "Derivatives players remain uncertain about how to operationally apply OIS discounting consistently from front to back office. With our online solution, users can rapidly assess the impact of OIS-based pricing across their portfolio with the flexibility to apply OIS discounting when trading, analysing cashflows, testing hedge effectiveness, doing mark-to-market valuations or for accounting."

RMBS

HARP 2.0 implementation details released

Fannie Mae and Freddie Mac have released key implementation details for the revised HARP programme (SCI 26 October), in line with market expectations. The biggest source of uncertainty about the initiative ahead of the announcement was the extent of rep-and-warranty relief, with this now seemingly clarified.

Overall the changes represent a moderate easing in reps and warranties for FHLMC, according to RMBS analysts at Barclays Capital, with waivers on reps and warranties on old loans being the most prominent. The theme seems to be a general harmonisation between FNMA and FHLMC HARP guidelines, they note.

Other changes common to both GSEs included: the elimination of the 125 LTV cap; the extension of the programme through 2013; and the reduction of LLPAs for borrowers above 80 LTV.

The BarCap analysts note that the revisions suggest only a moderate increase in overall prepayments. "We continue to expect the increase in prepayments from HARP 2.0 to be approximately 5-6 CPR."

RMBS

Resi cumulative defaults stabilising

Cumulative defaults for US residential mortgage loans continued to show signs of stabilising in 3Q11, according to S&P. While loans originated in 2006 and 2007 are still the worst performers, 2006-vintage mortgages have the highest cumulative default rates.

S&P's cumulative default metric aggregates two types of defaults: active and closed. While active defaults comprise seriously delinquent loans for which the collateral property has not yet been liquidated, closed defaults only include loans for liquidated properties. In looking at the 2006 and 2007 loans, cumulative defaults are leveling - furthering improvements that began at the start of the year - and active defaults actually decreased in the third quarter.

"Much of the improved performance has been due to reduced active defaults, particularly among 2006 and 2007 loans," comments Diane Westerback, head of structured finance global surveillance Analytics. "We believe moderating first default and redefault rates are propelling this reduction, and this reduction is likely the primary factor causing cumulative defaults to flatten."

Westerback notes that the retreating active default rate in the third quarter contrasts with its early trajectory, which initially suggested that the 2007 loans would perform worse than their counterparts from 2006. Early default rates for the 2007 loans were higher than those for the 2006 loans, but after 50 months of performance the 2006 loans maintain the highest active and cumulative default rates.

Despite the improving default trends, loss severities are rising. Specifically, the loss severity rate for closed defaults hit 64% at the end of the third quarter, which is the highest level observed in the last eight years.

"In looking at the growing number of properties waiting to be foreclosed, it's feasible that loss severities could continue rising, particularly because many distressed borrowers owe more on their homes than their homes are worth," continues Westerback. "This growing backlog of properties in the foreclosure pipeline is also having a significant impact on home prices because it increases the potential supply of homes into a soft-demand market."

RMBS

Sustainable home price model debuts

Fitch has launched a quarterly report detailing its US home price projections, based on the results of its sustainable home price (SHP) model. The inaugural study contains projections as of 2Q11.

Fitch expects home prices to fall by an additional 13% nationally in real terms. The agency notes that the housing market remains under stress from factors such as unemployment, existing inventory and more stringent underwriting standards.

A correction is likely to occur slowly, it adds, with much of the decline coming from inflation eroding nominal values. As of 2Q11, prices were down off their peak by 38% in real terms.

Each quarter Fitch will provide an update to its projections and market views with the release of the Case-Shiller indices. The agency will also provide a more detailed perspective on individual states or regions due to significant or unexpected price changes, evolving economies or general importance on the national housing scene.

This current study focuses on Michigan, a state that Fitch views as undervalued. It intends to provide projections at the metropolitan statistical area (MSA) level by 1Q12.