Contents

Structured Finance

SCI Start the Week - 19 December

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

Pipeline
Three new deals remained in the pipeline at the end of last week, all of them from Europe. They comprise an RMBS (€90m AyT Celeris Hipotecario I) and two SME CLOs (€1.2bn BBVA Empresas 6 and Geldilux TS 2011).

Pricings
A variety of deals printed during the week. The US$100m Atlas VI Capital 2011-1 and €75m Atlas VI Capital 2011-2 catastrophe bonds both priced, as well as a US$811m equipment securitisation (CNH Equipment Trust 2011-C) and two auto deals - an Australian A$90m transaction (Liberty Series 2011-1 Auto) and a €427m German one (E-CARAT 2011-1).
Additionally, the US$191.3m COMM 2011-STRT CMBS and two RMBS - €960m FTA Santander Hipotecario 8 and €399.4m Giovecca Mortgages 2011-2 - were issued.

Markets
The overriding trend in the structured finance secondary markets over the past week was drop in volumes and a stagnation in spreads as participants completed the last full trading week of the year.
ABS secondary activity picked up significantly last week, while the primary market has unofficially closed for the winter holidays, according to ABS analysts at JPMorgan. "Trading remained focused in high quality and liquid sectors that serve as cash surrogates. While the flows were strong, spreads were unchanged for the most part," they add.
The JPM analysts continue: "Outside the benchmark triple-A bonds, subordinate auto ABS paper saw better bids, driving spreads tighter in that segment. For example, triple-B non-prime auto ABS spreads have tightened roughly 50bp in secondary from this year's wides observed in new issue pricing in October."
In the US CMBS market trading volume started to subside last week as many accounts prepared for the year-end holiday season, according to US CMBS research analysts from Barclays Capital. TRACE data showed that overall trading volume was down US$2.4bn for the week, from US$6.9bn to US$4.5bn.
"Overall, spreads were relatively stable week over week, with 2007 LCFs remaining at last week's level of 285bp over swaps. AM tranches compressed marginally and were 10bp tighter over the week for the 2006 and 2007 vintages. Lower in the capital structure, prices were broadly unchanged," the Barcap analysts add.
Similarly the non-agency RMBS sector is settling into year-end mode, with relatively low engagement levels before the holidays begin, according to MBS analysts at Bank of America Merrill Lynch. "Many investors appear to be taking a conservative view toward aggressive capital allocations at this time of year," they note.
The market continues to see lighter liquidity off BWIC lists, with a greater portion of trades getting done away from lists via offering sheets, for instance. Pricing remains broadly unchanged across both non-agency and subprime markets on lower volumes, the BAML analysts say.
Secondary CLO activity was also fairly subdued this week. BAML CLO analysts comment: "Conviction either way remains feeble, as the standard expectations of spreads tightening into the January effect are offset by the lack of confidence in the macro outlook. Indeed, while US data continues to surprise to the upside, the sovereign story is not going away and weighs on overall sentiment and risk appetite."

Deal news
• Apollo Global Management will merge Stone Tower Capital and its related management companies into Apollo's capital markets business.
• The trustee on Cedarwoods CRE CDO II intends to file an interpleader complaint against the issuer, the collateral manager, the class A-1 noteholder and the class A-2 noteholder regarding the declaration of an EOD and related issues.
• C-III Asset Management is proposing to assign the collateral management agreements for Centerline 2007-SRR5, Centerline 2007-1 Resecuritization Trust and Arcap 2005-1 Resecuritization Trust to C-III Investment Management. This follows the internal transfer of five other CRE CDOs last month (SCI 30 November).
• Final prices for the AMR Corporation, PMI Group and Seat Pagine Gialle CDS auctions - held last week - were determined to be 23.5, 16.5 and 10 respectively. This follows 13 dealers submitting inside markets, physical settlement requests and limit orders to settle trades across the market referencing the names.

Regulatory update
• The DTCC's Fixed Income Clearing Corporation (FICC) mortgage-backed securities division has filed an application with the SEC to provide central counterparty (CCP) and pool netting services for trades in US agency MBS.
• The US SEC has filed papers seeking review of the US Court of Appeals for the Second Circuit's rejection last month of the agency's US$285m settlement with Citigroup (SCI 20 October). The court declined to approve the consent judgment.
• The FDIC has agreed a settlement with the former directors and officers of Washington Mutual Bank. Under the agreement, US$64.7m will be handed over to the FDIC.
• Morrison & Foerster has been appointed as legal counsel for the European DataWarehouse (ED). Elana Hahn, capital markets group partner, will lead the counsel to ED.

Deals added to the SCI database last week:
CFCRE 2011-C2
CNH Equipment Trust 2011-C
CPS Auto Receivables Trust 2011-C
Dolomiti Mortgage
Dryden XXII Senior Loan Fund
E-CARAT 2011
Fanes series 2011-1
Flatiron CLO 2011-1
FTA Santander Consumer Spain Auto 2011-1
JPMCC 2011-PLSD
Royal Street - Compartment 3
Scandinavian Consumer Loan 2011-2
Start CLO VII

Top stories to come in SCI:
2012 outlooks: Asian ABS and structured credit; European ABS; US ABS; CLOs; CMBS; and credit derivatives.

CMBS

Innkeepers portfolio modified

The modification and assumption of the Innkeepers portfolio securitised in LBUBS 2007-C6 and LBUBS 2007-C7 has been completed (SCI passim), according to the December remittance reports. As a result of the modification, the US$825.4m loan was written down to US$675m (US$337.5m in each deal), with each of the deals taking a US$75m loss.

The new loan balance was consistent with the proposal put forth by the Cerberus/Chatham consortium in October, Barclays Capital US CMBS research analysts note. "We believe that the loan was also made freely pre-payable as a result of the modification, although the maturity date and coupon remain unchanged," they say.

The analysts report that the large write-down pushed losses all the way up to tranche L in both deals. AJ subordination levels are now down to 8.8% on LBUBS 2007-C7, from 11.5% at origination, while the 07-C6 AJ tranche saw enhancement levels drop to 12.2% from 14.75% at origination.

"According to the servicer commentary, the sale/assumption closed on 27 October 2011 and Five Mile was appointed the special servicer the following day. It is interesting to note that P&I servicer advances of close to US$50m and ASERs accounting for US$16m were still outstanding for both the deals, as of the December remittance," the Barcap analysts add.

MP

RMBS

Updated HARP 2.0 guidelines released

Fannie Mae has released updated guidelines for HARP. Most of the changes were previously announced, but the removal of the 'borrower ability to pay' clause was not expected and could have a significant impact.

Loans delivered to Fannie Mae must meet certain underwriting criteria. The borrower ability to pay clause was one such requirement, stipulating that lenders must determine whether a borrower has a "reasonable ability" to repay the mortgage based on information given by the borrower as well as their payment history.

"As part of relaxing and streamlining rep and warranty requirements for the HARP programme, the GSEs have reduced or waived most of the underwriting requirements of traditional loans. However, the ability to pay guideline has continued to burden lenders with a subjective underwriting evaluation process that contains rep and warranty risk," say MBS analysts at Barclays Capital.

The analysts note that the guideline was a significant hurdle to HARP refinancing, especially as 'reasonable ability' is so loosely defined. Lenders argue they could be exposed to indemnification liability in the event that a loan defaults.

The analysts comment: "Removal of this clause alleviates many of the remaining concerns about rep and warranty indemnification with respect to HARP refis. Lenders can now underwrite HARP loans assessing borrower credit based on a straightforward metric - number of payments made. This reduces a significant layer of complexity with respect to rep and warranties liabilities for these loans."

Other changes were less unexpected. The 125 LTV expansion, fee reduction and synchronisation of guidelines between Fannie and Freddie are not expected to have much impact. Although some hurdles remain, the Barcap analysts believe the removal of the ability to pay clause could help to increase prepays more than was expected before its announcement.

JL

ABS

ED counsel appointed

Morrison & Foerster has been appointed as legal counsel for the European DataWarehouse (ED). Elana Hahn, capital markets group partner, will lead the counsel to ED, with Andrew Crotty serving as principal associate on the project.

Hahn comments: "We are delighted to be working for ED in the creation of this data system which is fundamental to the development of a transparent European structured finance market. ED is an independent, market-led solution."

The appointment of counsel marks the start of a new phase in ED's development, with the placement of its shares to participants in the ABS market expected to be completed by the end of 1Q12 and the launch of its operations expected towards the end of summer.

Sapient Global Markets was appointed in early November to construct the technology platform for ED (see SCI 1 November), and Perella Weinberg Partners was appointed in mid-November to arrange the placement of ED's shares (SCI 16 November).

ABS

Fixed income role created

BlackRock has hired Jeffrey Rosenberg as md and chief investment strategist for fixed income. It is a new position and he will report to Robert Stanley, head of retail fixed income within the portfolio management group.

Rosenberg joins from Bank of America Merrill Lynch, where he was head of global credit strategy research, overseeing strategy for ABS, CMBS and RMBS, amongst other markets. Before joining BAML he was director of US investment-grade strategy at Credit Suisse.

Structured Finance

Advisory duo hired

Duff & Phelps has made two hires at its Chicago office. Brian Weber and Aaron Roberts both join from Houlihan Capital. Weber joins as portfolio valuation vp. He was vp at Houlihan and previously served as an analyst at The Fedeli Group.

Roberts also joins as portfolio valuation vp. At Houlihan he performed valuation engagements related to structured finance portfolios, commercial and residential real estate loans and other asset-backed loan portfolios. Before Houlihan he was an equity analyst and trading supervisor at High Pointe Capital Management and also held posts at Miller Advisors and T Wireless Services.

Structured Finance

Broker-dealer increases CDS, ABS coverage

ICE's inter-dealer broker Creditex has increased its coverage of corporate CDS and expanded its hybrid trading capabilities in emerging markets and ABS. The new hires are Gwilym Jennett, Conor Murphy and Eduardo Godinho.

Jennet joins as head of ABS. His background in trading and broking ABS includes senior roles at Rabobank and Barclays and he will work with Ian Vogt, an ABS broker also recently recruited by Creditex.

Murphy joins as head of investment grade corporate CDS. He has over 10 years of experience brokering CDS and fixed income products. Godinho, a senior broker with over 14 years of experience in emerging markets, joins as head of emerging market credit.

"The new employees as well as expansion into emerging markets and complementary products will continue to leverage Creditex's leading electronic execution platform. The credit market is changing and we are serving the increased demand for efficient execution, supported by knowledgeable brokers, across more market segments," says Creditex president Grant Biggar.

CDO

SEC seeks review of Citi judgment

The US SEC has filed papers seeking review of the US Court of Appeals for the Second Circuit's rejection last month of the agency's US$285m settlement with Citigroup (SCI 20 October). The court declined to approve the consent judgment because, in its view, the underlying allegations were "unsupported by any proven or acknowledged facts".

"We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits," comments Robert Khuzami, director of the SEC's Division of Enforcement.

The SEC believes the court was incorrect in requiring an admission of facts - or a trial - as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. It cites the fact that in the case against Citigroup, it filed suit after a thorough investigation, the findings of which were described in extensive detail in a 21-page complaint.

"The court's new standard is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide," Khuzami adds.

He also points to the fact that, in cases such as this, a settlement puts money back in the pockets of harmed investors without years of courtroom delay and without the twin risks of losing at trial or winning but recovering less than the settlement amount. In contrast, the new standard adopted by the court could in practical terms press the SEC to trial in many more instances, likely resulting in fewer cases overall and less money being returned to investors.

CLOs

Capital markets merger agreed

Apollo Global Management will merge Stone Tower Capital and its related management companies into Apollo's capital markets business. Stone Tower chairman and ceo Michael Levitt will join Apollo as vc of Apollo Credit Management.

The move will roughly double Apollo's capital markets AUM to US$39bn, making capital markets the largest part of Apollo's business. It will grant Apollo both greater scale and new credit product capabilities. Stone Tower's investment expertise spans senior loans, high yield bonds, long/short credit, private debt, CLO liabilities, CLO equity, RMBS, CMBS and other ABS.

Subject to conditions, the transaction is expected to close by the end of the first quarter of 2012.

CLOs

Manager seeks broader opportunities

Greenwich Loan Income Fund (GLIF) has shelved its plans to sell its exposure to T2 CLO I (SCI 27 April). The company says that although it received a number of proposals, none reflected the far lower risk profile of the CLO than the CLO market as a whole. Thus to have sold and reinvested would have increased its risk profile without a commensurate increase in return, it notes.

GLIF adds that the assets within the CLO continue to perform well. Given the decision to maintain the CLO holding, the two equity positions within the CLO - CBA Group and Provo Craft - will be valued by an independent valuation firm and shown in the consolidated accounts. Previously no value had been attributed to these holdings.

Additionally, the company continues to explore other opportunities in the loan market, outside of CLO structures. Following the AMIC acquisition, it will also consider further accretive acquisitions of other managers, if they are complementary to the existing business and long-term investment strategy.

RMBS

SEC charges ex-GSE directors

The US SEC has charged six former Fannie Mae and Freddie Mac executives with securities fraud. The SEC alleges the defendants knew and approved of misleading statements which claimed the companies had minimal holdings of subprime loans.

A complaint has been filed against former Fannie Mae ceo Daniel Mudd, former chief risk officers Enrico Dallavecchia and former executive vp Thomas Lund. A second complaint has been filed against former Freddie Mac chairman and ceo Richard Syron, former executive vp and chief business officer Patricia Cook and former excutive vp Donald Bisenius.

Fannie Mae and Freddie Mac each entered into a non-prosecution agreement with the SEC, in which each company agreed to accept responsibility for its conduct and not dispute or contradict the contents of an agreed-upon statement of facts. They have also agreed to cooperate with the SEC's litigation against the former executives.

Fannie and Freddie have neither admitted nor denied liability. The SEC is seeking financial penalties, disgorgement of ill-gotten gains with interest, permanent injunctive relief and officer and director bars against Mudd, Dallavecchia, Lund, Syron, Cook, and Bisenius.

The lawsuits allege that the former executives caused the federal mortgage firms to materially misstate their holdings of subprime mortgage loans in periodic and other filings with the SEC, public statements, investor calls, and media interviews.

The SEC alleges the former Fannie Mae executives reported less than one-tenth of its subprime exposure in 2007. The Fannie executives are also accused of underreporting Fannie's Alt-A loan exposure.

The Freddie Mac executives Syron and Cook are alleged to have misled investors by declaring the single family business had "basically no subprime exposure" when it was actually exposed to US$141bn of loans - or 10% of the portfolio - internally referred to as "subprime" or "subprime like".

RMBS

CMO trader moves again

Peter Ma has joined Guggenheim Partners as md and head of agency collateralised mortgage obligations trading. He joins from MF Global, which he joined three months ago.

Ma's previous roles include senior vp at Keefe, Bruyette & Woods, executive director at UBS Investment Bank and first vp at PaineWebber.

RMBS

KBCM expands MBS team

KeyBanc Capital Markets has made two additions to its fixed income team to expand its MBS capabilities. Christopher Moroz becomes vp while Michael Giasi joins as a director.

Moroz will be based in Cleveland and tasked with selling MBS products to banks. He most recently worked for JPMorgan Chase as financial services vp, performing credit and portfolio analysis.

Giasi will sell MBS products from New York. He joins from Keefe, Bruyette & Woods where he was senior vp in fixed income selling RMBS and non-performing loan packages.

RMBS

Trustees open investigations

Clients of Gibbs & Bruns have issued instructions to BNY Mellon, US Bank, Wells Fargo, Citibank and HSBC, as trustees, to open investigations of ineligible mortgages in pools securing over US$95bn of RMBS issued by JPMorgan affiliates.

Collectively, the clients hold over 25% of the voting rights in 243 trusts that issued these RMBS. The holders anticipate that they may provide addition instructions to trustees in the future to further the investigations.

"Our clients continue to seek a comprehensive solution to the problems of ineligible mortgages in RMBS pools and deficient servicing of those loans. Today's action is another step toward achieving that goal," says lead counsel Kathy Patrick.

RMBS

FDIC, former WaMu officials settle

The FDIC has agreed a settlement with the former directors and officers of Washington Mutual Bank (WaMu). Under the agreement, US$64.7m will be handed over to the FDIC.

The money is comprised of almost US$40m from insurance proceeds, $425,000 in cash from the defendants and the US$24.7m face value of the defendants' bankruptcy claims that are pending in the Chapter 11 of WaMu's former holding company, Washington Mutual Inc (WMI).

The defendants are Kerry Killinger, Stephen Rotella and David Schneider. The FDIC filed suit against them in March. Combined with the US$125m the FDIC will receive under the settlement agreement with WMI to release its claims against 12 former WaMu directors and officers, total payments will amount to US$189.7m.

ABS

Bank credit quality weighs on ABCP

Deterioration in the credit quality of euro area banks will be the key credit exposure for ABCP holders in 2012, according to Moody's. The agency says that European bank ratings will be influenced by a reduction of government support, which had otherwise provided uplift to bank ratings, and the sovereign debt crisis putting additional downward pressure on bank ratings.

Moody's expects fully-supported, multi-seller conduits to continue to be the dominant ABCP product in 2012. Traditional asset classes will remain the focus of ABCP investments, particularly auto loans/leases originated in the UK and Germany, as well as trade receivables from a variety of industries and jurisdictions - though the economic crisis will put more pressure on some industries and countries than others.

European conduits are also expected to continue relying on the US market, with European investors remaining on the sidelines in 2012. Another important theme of 2012 will be the reconciliation of investor demand for shorter maturities with sponsor requirements to supply longer maturities, a tension created by conflicting regulations on money market funds and ABCP programmes.

ABS

Weak performance expected for private SLABS

Moody's expects the credit performance of private student loan ABS to remain weak in 2012 because of a variety of macroeconomic factors.

"Continued high unemployment, combined with high debt burdens and declining income means that recent college graduates and, to a lesser extent, their co-signers will continue having difficulty repaying their student loans," says Moody's avp Tracy Rice.

Delinquency and default rates will not decline significantly until unemployment returns close to pre-recession levels in 2015-2016. However, Moody's ratings of outstanding securitisations reflect this future negative performance.

The agency expects private student loan securitisation volume to remain flat in 2012 at the roughly US$3bn marketed in 2011 and perform better than those issued before the onset of the recession in 2009. Rice says: "The 2012 transactions will benefit more because the youngest borrowers will likely graduate into a stronger job market, which we forecast to occur in 2015-2016."

These securitisations will also benefit from better loan underwriting and stronger transactions structures - including more credit enhancement and less risk of loan servicing or payment disruptions - that has characterised new transactions in this sector since 2009.

ABS

Life securitisation marketing

Credit Agricole Securities (USA) is marketing an embedded value life securitisation for Aurigen Reinsurance, dubbed Vecta 1. The deal has been assigned a preliminary rating of triple-B plus by S&P.

The deal stems from a reinsurance agreement entered into in September 2008 by Aurigen Reinsurance Ltd (ARL) and Aurigen Reinsurance Co (ARC). Under the agreement, ARL provided permanent aggregate stop-loss protection with respect to 90% of the mortality risks assumed by ARC in excess of a specified attachment point, and coinsurance of a 90% quota share of lapse risks, in either case, for the period from 3 September 2008 to the close of business on 31 December 2010.

The new securitisation covers Vecta's obligations to ARL under a retrocession agreement between the two parties. ARC acquired the securitised business via 12 reinsurance transactions from six separate life-insurance companies. The subject business consists of 447,444 term, permanent and universal life policies on Canadian lives with aggregate face amount of approximately C$22bn, average face amount of C$49,779 and aggregate annual premium payments of approximately C$65m in 2010.

ABS

Auto fundamentals to remain healthy

Moody's expects US auto loan credit fundamentals to remain healthy in 2012: issuance volume is expected to increase and new loan credit quality to be fairly strong, although weaker than last year. In the event of a double-dip recession - a scenario with a one-in-three likelihood of emerging - underwriting is anticipated to tighten again.

"Our outlook for the sector is positive for the second year running, despite a few negatives," says Mack Caldwell, a Moody's svp. "The strong characteristics of the auto ABS market will outweigh any negative trends. Credit performance will remain strong and issuance volume will be slightly higher than in 2011."

The agency also believes that the used car market will remain strong in 2012, though not at the current high levels. The drivers for residual value performance are general economic and auto industry dynamics, which - following the recession - have shifted consumer demand for autos from new to used vehicles while constraining the supply of used vehicles.

"We don't expect these dynamics to change much in 2012. The manufacturers, servicers and dealers will maintain their financial stability, despite our low expectations for economic growth and vehicle sales for next year," adds Caldwell.

Issuers will likely issue slightly more auto ABS deals in 2012 than in 2011 due to the increased demand for high-quality, short-term auto ABS paper, as money market funds pull out of their European bank investments.

ABS

Credit card performance set to decelerate

The performance of US credit card securitisations will continue to improve in 2012, but at a decelerating pace throughout the year, Moody's believes. Some credit card companies are beginning to loosen underwriting guidelines, but they are not adding new originations of lesser credit quality to securitisations, which would weigh on their performance.

"So long as issuers don't add receivables from new accounts to the securitisations, the credit mix won't deteriorate from current levels," says Luisa De Gaetano, a Moody's vp and senior credit officer.

Bank sponsors are currently funding new credit card activity with alternative sources, such as deposits. Competition from these alternative sources will also continue to dampen the volume of credit card securitisations in 2012, which Moody's expects to be close to 2011 levels, at about US$10bn-US$15bn.

New credit card originations in 2011 were only about half the rate they were in 2007. At the same time, consumers are using less credit card debt to finance their spending than they did before the recession.

"Only after 2012, when the economic recovery begins in earnest, will cardholders start leveraging up again and issuers loosen underwriting standards to a level substantially higher than today's - which would lead to faster receivables growth and more securitisations," adds De Gaetano.

Structured Finance

Stable outlooks for Aussie, NZ SF

Going into 2012, 98% of Fitch-rated Australian and New Zealand structured finance tranches - by value - have stable outlooks. The agency expects this to continue as a result of stable economic conditions and low unemployment, with widespread deterioration in underlying asset performance unlikely to occur over the coming year.

The risk to the stable outlooks remains the potential for negative global shocks that may ultimately have an impact on Australia and New Zealand in 2012. Some factors that may impact this outlook include continued high Australian house prices and historically high levels of household debt that could negatively affect the ability of individuals to service debt if economic conditions were to deteriorate, particularly higher unemployment. Higher interest rates are another potential pressure point, given high household debt levels, although recent interest rate reductions by the Reserve Bank of Australia have lessened this risk.

Structured Finance

MBIA Insurance on review

Moody's has downgraded to Baa2, from Baa1, the insurance financial strength (IFS) rating of National Public Finance Guarantee Corporation and changed its outlook from developing to negative. The rating agency also downgraded the rating of National's parent company, MBIA Inc, to B2 from Ba3 and placed the ratings of MBIA Insurance Corporation and subsidiaries under review for possible downgrade.

The downgrade of National's rating reflects weakening of the overall MBIA group's market standing as losses grow at National's affiliated companies, principally MBIA Insurance, and the risk that resources at National could be drawn away to support losses elsewhere within the group.

MBIA Insurance commuted US$20bn of gross insured exposure in Q4 for approximately US$500m above related Q3 reserves. The company previously disclosed liquid assets of about US$800m at 3Q11, a level that would leave it challenged to meet large liquidity requirements of bulk settlements with its counterparties.

Moody's believes that growing losses at MBIA Insurance are negative for National, whose future business prospects are premised on its ability to avoid or minimise negative financial and business impacts from its affiliation with the broader MBIA group. National's negative outlook reflects its credit linkage to the other weaker entities of the group as a result of ongoing restructuring litigation.

The review for downgrade of MBIA Insurance reflects continued weakness in the firm's insured portfolio, as highlighted by losses in excess of reserves on recently commuted transactions, and the potential for claims settlements at less than the economic value of the contracts due to its weakened financial position. As part of the review, Moody's will assess the company's financial profile in light of insured portfolio trends, ongoing putback litigation and recent commutations.

The substantial recent settlements with Morgan Stanley and other counterparties, plaintiffs' exits from the restructuring litigation and the April 2012 scheduled trial date (SCI passim) may help build momentum for additional settlements over the near term, according to Moody's. Only five, including Bank of America, of the original 18 litigants remain in the critical Article 78 lawsuit that challenges the New York State Insurance Department's decision to approve MBIA's restructuring, for example.

MBIA Insurance has commuted about US$35bn of risk since the beginning of 2011, mainly related to insured CDO exposures. While these settlements have reduced potential volatility, they have been a substantial drain on the capital and liquidity resources of the insurer, Moody's says.

The downgrade of MBIA Inc's senior debt rating to B2 reflects the increasing stress in the firm's wind-down operation and a more negative view of National's and MBIA Insurance's credit profiles and related ability to support the holding company through dividends or otherwise. MBIA's wind-down operation reported a US$600m book value deficit at 3Q11. The negative outlook reflects the holding company's ongoing credit and liquidity issues.

Structured Finance

Stable outlook for Japanese SF

Fitch's rating outlook for Japanese structured finance (SF) transactions is broadly stable in 2012, given the recovering economy and stabilising real estate market.

"While Fitch does not expect underlying asset performance to see tangible improvement in the short term, overall stabilisation in 2012 is likely on the back of Japan's improving economic conditions," says Atsushi Kuroda, senior director in the agency's Japanese structured finance team. Fitch predicts that Japan's GDP will grow by 2.2% in 2012, after a forecast drop of 0.3% in 2011.

For 2012, Fitch expects higher-rated Japanese CMBS tranches to show stable rating performance. This is due to increasing credit enhancement caused by sequential payment, as the workout of defaulted loans progresses, and by significantly stressed recovery assumptions under the higher rating scenarios.

However, the agency warns that the progress of workouts may also lead to further negative rating migration of lower-rated CMBS tranches, since the remaining properties in the Fitch-rated portfolio include those backing defaulted loans whose sales values tend to fluctuate. Consequently, property sales with lower-than-expected prices may result in actual losses on tranches already at distressed rating levels.

In the RMBS space, expected stable pool performance and structural support mechanisms should keep ratings broadly stable, according to the agency.

The underlying portfolios of Fitch-rated MBS include some properties located in the region affected by the March earthquake. However, its impact on the ratings was and is expected to remain limited for various reasons, including limited exposure to the affected properties in the transactions and structural mitigants.

CDO

CRE CDO delinquencies fluctuate slightly

US CRE CDO delinquencies reversed two months of slight increases this past month, according to Fitch's latest index results for the sector. CRE CDO late-pays fell to 12.4% in November from 12.5% in the prior month.

In November, asset managers reported only four new delinquent assets, Fitch says. Among them were one term default, one matured balloon loan, one new credit impaired security and one repurchased asset. Offsetting these new delinquencies, 11 assets were removed from the index in the month, including seven CMBS bonds that previously had interest shortfalls.

CRE CDO asset managers reported only US$10.2m in realised losses from the disposal of eight assets during the month, according to Fitch. The weighted average loss on these assets was low at 16%. The largest single loss, which was less than US$5m, was related to the disposal of a REO office property.

CDO

CDO interpleader complaint filed

The trustee on Cedarwoods CRE CDO II intends to file an interpleader complaint against the issuer, the collateral manager, the class A-1 noteholder and the class A-2 noteholder regarding the declaration of an EOD and related issues.

According to a 2 December notice, the transaction experienced and continues to experience an EOD under Section 5.1(f) of the indenture. Pursuant to the EOD, the controlling noteholders subsequently voted on 6 December to accelerate the maturity of the notes and liquidate the collateral.

The trustee then indicated on 13 December a written objection to the declaration of the EOD from both the collateral manager and the representative of the class A-2 noteholder. Until these matters have been resolved, it is understood that the trustee will suspend the sale and liquidation of the collateral and continue to escrow all amounts payable to the notes.

Consequently, S&P has placed its ratings on credit watch with negative implications on eight classes from the transaction, to be updated pending the resolution of the interpleader complaint.

CDS

AMR Corp results in

The final price of the AMR Corporation CDS auction, held yesterday (15 December), was determined to be 23.5. This follows 13 dealers submitting inside markets, physical settlement requests and limit orders to settle trades across the market referencing the name.

CDS

NRAM credit event called

ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a restructuring credit event has occurred in respect of North Rock Asset Management. An auction will be held in due course in respect of outstanding CDS transactions on the name.

CDS

Euro sovereign collateral policies revisited

AFME, ICMA and ISDA have released a paper on the impact of the collateral policies of European sovereigns. Entitled 'The Impact of Derivative Collateral Policies of European Sovereigns and Resulting Basel III Capital Issues', it suggests that such policies could significantly affect the liquidity and dynamics of the credit default swap (CDS) market and create substantial additional bank liquidity requirements.

The paper estimates that European sovereign collateral policies may drive a significant percentage - approximately half - of the volume in the sovereign CDS market. The associations recommend that adoption of two-way collateral agreements by European sovereigns be given careful consideration.

As outlined in the paper, many sovereigns transact OTC derivatives on a regular basis. Nearly all of these entities do not post collateral on derivatives transactions, but their counterparties do post collateral to them. The use of such one-way collateral arrangements creates credit exposure in the banking system, in the form of credit valuation adjustments (CVAs), and significant liquidity issues for the dealer community.

Dealers routinely hedge the exposure arising from transactions with European sovereigns using CDS. In fact, under the current Basel 3 proposals, the only way to reduce the CVA charge is to purchase single name CDS.

Preliminary estimates using data provided to AFME and ISDA by the G14 group of dealers indicate that the notional amount of CDS required to hedge these dealers' sovereign-related CVA would have been roughly US$70bn as of March 2011. By comparison, the net CDS outstanding on the entire European sovereign market as reported to the DTCC was roughly US$143bn. Such hedging may therefore account for as much as 50% of the open interest in CDS for the European sovereign community, the associations note.

The recently announced Short Selling regulation, which will be converted into technical standards by the European Securities Markets Authority (ESMA), permits European sovereign CDS to hedge financial contracts. The associations strongly recommend ESMA respect the clear intent of the regulation, particularly as regards its identification of financial contracts as exposures that firms might legitimately hedge through CDS. The need for European sovereign CDS for hedging purposes is large and the inability of dealer firms to use such instruments in this context may create unhealthy concentrations of credit risk and reduce European sovereign access to the OTC derivatives marketplace.

CDS

RFC issued on OTC UPI

ISDA has published its draft taxonomies for credit, interest rate, commodity, fx and equity derivatives. These taxonomies are open for a 30-day comment period.

As part of ISDA's ongoing efforts to improve the OTC derivatives infrastructure, it developed an implementation plan in June to define a standardised classification for OTC derivatives and develop unique product identifiers (UPI). The ISDA OTC Taxonomies and UPI will support regulatory mandates to increase transparency through public and regulatory reporting, the association says.

In addition to coordinating the market discussions that led to the proposed taxonomies for the different asset classes, ISDA put a governance model in place to oversee their development and ensure proper support going forward. The final taxonomies will be included in the FpML data standard to facilitate the reporting process. Coordination with other international standards, such as ISO, to align with the ISDA taxonomies is ongoing.

CLOs

CLO sale agreed

The receivers (Deloitte) of Clio European CLO have entered into a sale agreement, pursuant to which the portfolio will be sold to Hyacinth Funding No.1. The purchase price for the sale will be satisfied by the surrender by Hyacinth to the issuer of notes with a principal amount outstanding of €413.81m. The portfolio will be split into two separate sub-portfolios with different settlement dates in order to complete the sale, which is expected by the end of January 2012.

CLOs

US CLO review completed

Moody's has completed its review of all US CLOs previously placed on review for possible upgrade on 22 June, upgrading 2,867 tranches with an original rated balance of US$169bn. The review covered 2,912 tranches, representing over 80% of its US-rated CLO universe, from 561 transactions with an original rated balance totalling US$170bn.

Of the 2,867 CLO tranches that were upgraded, the average magnitude of upgrades was just under four notches. The most junior tranches of affected CLOs experienced larger upgrades of an average five notches, while senior tranches experienced smaller upgrades of about two notches.

Moody's upgraded its ratings on 592 tranches to triple-A; as a result, 86% of US CLO tranches - 903 tranches with an original balance totalling US$174bn - originally rated triple-A have retained their original ratings, versus 47% (491 tranches with an original balance totalling US$86bn) at the start of the review. In contrast, only a minority, or 35% of US CLO tranches originally assigned ratings at Aa and below, were restored to their initial ratings or were assigned ratings higher than their initial ratings after the review.

CLOs

Euro, US CLO outlooks diverge

US CLOs issued in 2012 will have a strong credit profile, Moody's suggests. The agency has a stable outlook for the performance of outstanding US CLOs and a negative outlook for the performance of European CLOs. New issue CLOs will continue to be originated primarily in the US next year because of challenging economic conditions in Europe.

Features in new US CLOs will offer more protection for debt investors than pre-credit crisis transactions; hence, post-crisis CLO structures will better withstand another downturn. "This increased protection includes strong subordination, tight investment constraints and enhanced documentation provisions, which we expect will mirror the attributes of typical 2011 US CLOs," says Moody's svp Danielle Nazarian.

Moody's stable outlook for outstanding US CLOs reflects a low corporate default rate forecast and stable to positive rating outlooks for speculative grade issuers. US leveraged loan issuers have significantly improved their balance sheets and pushed back loan maturity schedules, supporting a stable outlook for the primary collateral backing CLOs.

Nonetheless, while the risk of recession in the US remains low, continued stress in the euro area and high volatility in the financial markets will tighten funding for leveraged loan issuers, presenting moderate downside risks to US CLO performance.

The outlook for outstanding European CLOs is negative primarily because of the rising risk of recession in the euro area. "The European sovereign debt crisis has tightened funding from the financial markets, increasing refinancing risk for speculative grade companies and particularly for companies with ratings at B3 or below. This will negatively affect European CLO collateral," says Moody's vp Guillaume Jolivet.

However, a number of positive factors help mitigate the risk to CLOs of the European sovereign debt crisis, according to the agency. CLOs continue to deleverage at a fast pace as more than half of the outstanding US CLOs and European CLOs will be in their amortisation periods by the end of 2012. Additionally, built-in cashflow diversion mechanisms will further offset potential performance deterioration by triggering deleveraging.

CLOs

Euro CLO refi risk underlined

There is more flexibility in Fitch-rated European CLO reinvestment periods than many commentators believe, the agency reports. But refinancing risk and collateral credit quality remain serious concerns.

The periods during which CLOs can purchase new loans start coming to an end next year and are all finished by 2014. In Fitch's view, many of these vehicles will continue reinvesting beyond that because most pre-crisis CLOs are allowed to reinvest unscheduled principal proceeds after the reinvestment period ends.

Regardless of whether CLOs reinvest unscheduled proceeds, the amount of CLO financing will shrink materially, however. This will make the weakest leveraged borrowers vulnerable to default, according to Fitch.

"The weakest companies cannot afford to invest in their business and finance their debt at current market rates," it notes. "If market financing conditions have not improved and the companies have limited liquidity, we may well rate them triple-C by the time CLO reinvestment periods end. This would exclude most CLOs from purchasing loans and close an important reinvestment channel."

CLO WAL tests also mean that the financing available is likely to be short term. Although this can keep a company on life support, borrowers need financial flexibility and resources to maintain or even increase their capital expenditure so as to be able to compete effectively in their industries. In addition to the triple-C covenant, some CLOs include overcollateralisation and rating triggers, which - if breached - would also prevent the vehicle from financing new loans.

Fitch says its experience of CLOs that have already ended their reinvestment periods is that managers keep them as fully invested as possible. The agency cites two transactions that passed their reinvestment date in 2007 and which have only recently started to deleverage. Jubilee II, the most extreme case, has only paid down 3% of its portfolio and 20% of the remaining loans now mature after the CLO needs to pay back its noteholders.

Most Fitch-rated CLOs need to repay their noteholders in or after 2020. The longer they invest after their reinvestment period ends, the more likely they are to be exposed to market value risk if any of their loans need to be restructured.

CLOs

Leveraged finance funding mix forecast

S&P has put forward three possible options for filling the funding gap in the European leveraged finance market: the corporate high yield bond market, loans from retail investors and new institutional investors.

The agency believes that the corporate high yield bond market will form the main part of the solution in the near term. In the future, retail schemes could account for a greater volume of leveraged loans, it says.

Funds have already been set up to capitalise on demand from retail investors to gain exposure to speculative-grade credit. Overall, S&P anticipates that there will be a broader mix of investors in leveraged loans, including new institutional investors lending via subordinate loans.

"In the long run, we believe that the leveraged loan market will revive and provide a portion of funding, but that it is likely to look much different than it does now," the agency notes. "Specifically, we foresee that investment through CLOs will consolidate significantly and that there will be a broader range of investors in the high yield asset class, including credit funds, insurance companies and pension funds."

CMBS

2012 'pivotal' for CMBS performance

With over US$55bn of US CMBS loans scheduled to mature next year, the most for any year to date, 2012 could be pivotal for CMBS credit performance, according to S&P.

Of the 2007 vintage maturities, US$19bn are five-year term loans, approximately 85% of which are scheduled to mature in the first half of 2012. S&P argues that the retrenchment in the capital markets and among other lenders in the third quarter of 2011, which has continued into the current quarter, dims the refinancing prospects for loans maturing next year.

Of the 2007 vintage five-year-term loans maturing next year, 50%-60% may fail to refinance, with retail loans being at the greatest risk. Maturity extensions are expected to continue at a healthy rate, but payoff rates may fall further.

S&P's delinquency rate forecast for 2012 for the sector remains unchanged at 9.5% to around 10%. The loss severity rate is unlikely to improve much in the first half of 2012 and negative rating activity should trend lower, albeit downgrades will likely remain high.

"Although we expect upcoming maturities in a tight lending environment to put upward pressure on delinquencies, other factors are at work that could limit the increase," says S&P credit analyst Larry Kay. "The modest improvement that we expect in property fundamentals and collateral performance should help to contain any significant increase in delinquencies."

CMBS

US CMBS volumes forecast down

Moody's expects new US CMBS issuance to hit US$40bn in 2012, down slightly from 2011. These transactions are anticipated to perform well, given that the underlying loans will be underwritten to values and rents that are well below peak levels. Property values in aggregate also should remain at current levels or slightly lower into 2014, followed by moderate growth in subsequent years, according to the agency.

"In 2012, new issue credit quality for CMBS will start the year consistent with that of normal pre-peak vintages, although there will be the risk of slipping as competition heats up among conduit lenders," says Tad Philipp, Moody's director of commercial real estate research.

Moody's expects US$15bn of the US$40bn of CMBS issuance in 2012 to come from the guaranteed portion of Freddie Mac-sponsored bonds collateralised solely by multi-family loans. Non-Freddie Mac issuance will be light in the first half because of crimped conduit loan origination pipelines resulting from euro area turmoil, but will ramp up as loan spreads tighten.

The agency also expects the ratings of existing deals to remain stable, with the majority of loans maturing in the next two years in good shape for refinancing. However, concerns remain that ongoing volatility in the credit markets may reduce liquidity.

The outlook for 2016 and 2017, when the ten-year loans originated during the peak of the market mature, is much more negative. "We don't expect the peak valuations from 2007 to return before these ten-year loans mature. As a result, we're going to see numerous maturity defaults five to six years out, many of which will result in extensions to maturities," says Philipp.

Additionally, Moody's expects the proportion of specially serviced and delinquent CMBS loans to remain within a few percentage points of their respective current levels of 12.1% and 9.3% during 2012. The current delinquency rate is near the high-water mark the agency expects for this cycle.

Loans entering and leaving special servicing will remain roughly balanced during 2012. The delinquency rate will then transition downward until the problematic 2016-2017 refinancing years cause it to reverse, although not back to current levels.

Risk Management

Enhanced supervisory measures proposed

The Federal Reserve Board has proposed steps to strengthen regulation and supervision of large bank holding companies and systemically important non-bank financial firms. The proposal - which includes a wide range of measures addressing issues such as capital, liquidity, credit exposure, stress testing and risk management - is mandated by the Dodd-Frank Act.

The proposal generally applies to all US bank holding companies with consolidated assets of US$50bn or more and any non-bank financial firms that may be designated by the Financial Stability Oversight Council as systemically important companies. The Fed will issue a proposal regarding foreign banking organisations shortly.

The risk-based capital and leverage requirements are to be implemented in two phases. In the first phase, the institutions would be subject to the Fed's capital plan rule, which was issued in November and requires firms to develop annual capital plans, conduct stress tests and maintain adequate capital under both expected and stressed conditions. In the second phase, the Fed would issue a proposal to implement a risk-based capital surcharge based on the framework and methodology developed by the Basel Committee on Banking Supervision.

Liquidity requirement measures would also be implemented in multiple phases. First, institutions would be subject to qualitative liquidity risk-management standards generally based on the interagency liquidity risk-management guidance issued in March 2010. In the second phase, the Fed would issue one or more proposals to implement quantitative liquidity requirements based on the Basel 3 liquidity rules.

The Fed is proposing that firms would need to comply with many of the enhanced standards a year after they are finalised. The requirements related to stress testing for bank holding companies, however, would take effect shortly after the rule is finalised. Comments on the proposal are requested by 31 March 2012.

Risk Management

Basel DVA proposal released

The Basel Committee has issued a consultative document on the application of own credit risk adjustments to derivatives. Under Basel 3, the rules seek to ensure that deterioration in a bank's own creditworthiness does not at the same time lead to an increase in its common equity as a result of a reduction in the value of the bank's liabilities.

Paragraph 75 of the Basel 3 rules requires a bank to "[d]erecognise in the calculation of Common Equity Tier 1, all unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank's own credit risk". The application of paragraph 75 to fair valued derivatives is not straightforward, the Committee says, since their valuation depends on a range of factors other than the bank's own creditworthiness.

The consultative paper therefore proposes that debit valuation adjustments (DVAs) for OTC derivatives and securities financing transactions should be fully deducted in the calculation of Common Equity Tier 1. It briefly reviews other options for applying the underlying concept of paragraph 75 to these products and the reasons these alternatives were not supported by the Basel Committee. Comments on the consultative document are invited by 17 February 2012.

RMBS

Spanish RMBS performance reviewed

Moody's has completed a performance review of the Spanish RMBS market and updated its portfolio loss assumptions in 67 transactions. At the same time, the agency has placed on review for downgrade the ratings of 47 tranches in 20 transactions due to worse-than-expected collateral performance. The rating action reflects the performance to date of the affected transactions, the level of credit enhancement supporting the notes and Moody's negative outlook for Spanish RMBS collateral.

The agency has revised its expected loss assumptions for the Spanish RMBS portfolio considering the current amount of realised losses and having completed a roll-rate and severity analysis for the non-defaulted portion of the portfolios. For the 67 transactions where Moody's revised its assumptions, the expected portfolio losses are now in the range of 1% to 3.7% of the current pool balance.

For the overall Spanish RMBS market, it is assuming an average of 1.5% future losses for seasoned transactions with relatively good assets performance. In the case of less seasoned transactions showing below average performance, it expects on average 4.8% of future losses.

The downgrades affect transactions whose ratings are at risk because credit enhancement is insufficient to offset the increase in the loss assumptions.

RMBS

BOE-compliant models offered

Lewtan is providing Bank of England-compliant cashflow models for the UK RMBS market via its ABSNet web portal, together with new functionality, including an asset projection engine and bond analytics. As of 30 November, the Bank requires issuers to provide investors with access to specific deal documentation, reports, loan level data and a liability cashflow model (SCI 31 October).