Contents

CMBS

Catching the wave

CMBS loan mod, refi likelihood explored

December saw the second highest volume of US CMBS loan modifications ever, after the GGP-related spike in 2010. The most visible increase in liquidations during the month, meanwhile, came from the 2007 vintage - ahead of the wave of five-year loans due to mature in 2012.

Among the CMBS loans resolved and modified last month were a number of high-profile names, including Innkeepers (SCI 19 December 2011), Empirian portfolio, 666 Fifth Avenue and PDG Roll-up. Malay Bansal, md at CapitalFusion partners, points out that each loan modification is different and the outcome generally depends on who the sponsor is and whether they have capital or can bring in another party with equity. He cites as an example the 666 Fifth Avenue modification, in which Kushner Companies formed a joint venture with Vornado Realty Trust to recapitalise the property, committing US$30m and US$50m of new capital respectively.

CMBS analysts at Citi agree that the role of the borrower in a workout is a key parameter that servicers will take into account when deciding whether to modify or liquidate a loan. "Specifically, if the servicer views the borrower as part of the solution to the property's troubles - whether it's their ability to access capital or otherwise - a modification will be more likely. On the other hand, the servicer might be more inclined to foreclose if the borrower is viewed as part of the 'problem'."

Judging by major split A/B modifications executed over the past year, special servicers appear to be requiring borrower concessions as a condition for the modification, the analysts note. Borrowers are, for example, being required to replenish reserve accounts for capital expenditures, tenant improvements and leasing commissions (SCI 25 August 2011).

Bansal points out that the market tends to focus on loans that have been extended or are stressed, whereas loans that pay off don't generate as much interest, even though they can also create cashflow uncertainty. He points to the US$340m Villas Parkmerced loan as an example.

The Villas Parkmerced loan, with original maturity in October 2010, was extended in November 2010 to February 2011. In March 2011, it was extended again by five years to February 2016, only for Fortress to refinance it just a few months later in December via the Fannie Mae DUS programme.

"The Villas Parkmerced case is one example illustrating how modifications make it tougher for investors to forecast when loans will pay off. It also shows that multifamily loans have a higher pay-off rate due to the availability of financing from GSEs," Bansal explains.

Meanwhile, the first major wave of maturities from the 2007 vintage hit this year, causing concern for investors. S&P puts the volume of these loans at US$19bn, approximately 85% of which mature in the first half of 2012.

The CMBS market is deep enough to handle the 2007 maturities coming due, according to Four Point Alliance president and ceo Dan Smith, but the question is whether the loans refinance at par. For a loan to be refinanced, it needs to have a debt yield of 10% or over with good coverage ratios, or the sponsor is able to inject equity.

Generally the amount of five-year loans maturing in any year is a small percentage of the overall volume maturing, but this year it is expected to total about 44%. Historically seven- and 10-year loans have performed better than five-year loans because there is more time for the real estate to appreciate in value.

In each of 2010 and 2011, about 78% of seven- and 10-year loans maturing that year have paid off, according to Bansal. In contrast, about 58% of five-year loans maturing in 2010 have paid off and only 50% of those maturing in 2011 have so far paid off.

The figures for 2012 will be worse. The five-year loans maturing in 2012 have had a net cashflow decline of almost 21% from original underwriting and have an average debt yield of only 8.4%.

Only about 45% of these loans are expected to be able to refinance, with less than 25% of them likely to refinance without substantial equity injections. The more trophy-like the asset, the more likely the sponsor will be able to raise sufficient proceeds to obtain a loan to fully refinance, the Citi analysts suggest.

They estimate that over half of the maturing five-year loans are located in major or primary markets, with the majority collateralised by office and multifamily properties. The loans are about evenly split between smaller ones (less than US$50m) and larger ones (US$50m-US$250m), with a small number of very large loans greater than US$250m.

"The larger loans are more apt to be considered trophy properties, but the portfolio lenders typically cannot finance very large ones without resorting to a club-deal execution in which a few team up. So these loans would have to attract sufficient capital to be right-sized to meet the currently more stringent CMBS criteria for refinancing proceeds," the analysts explain.

Capital is generally available for loans sized at US$25m and above, notes Smith. "But the downside for larger refinancings is that they're done on aggressive lending terms," he says. "Smaller loans will have to find new borrowers or sell some property, given that they're unlikely to be refinanced. Delinquency rates are likely to rise for smaller loans in particular, as a result."

Current low rates are one factor expected to help refinancing efforts, however. The average rate on these loans is just under 6%, so they don't face a much higher coupon on refinancing. A significant rise in coupons or cap rates will make refinancing difficult and require sponsors to contribute more equity.

Overall, of all the US$43bn conduit loans maturing this year, only about 55% - or around US$24bn - have DSCRs higher than 1.1x. That is roughly the total amount expected to be able to refinance in 2012 - less than in previous years. Of the loans that aren't refinanced, the larger ones will likely be extended and the smaller ones liquidated or sold via note sales.

"We'll certainly see more modifications, which are becoming increasingly complex - albeit at a choppy pace of activity. They typically involve 'hope notes', extensions, reduced coupons, decreasing or eliminating amortisation, and the elimination of prepayment restrictions - again, making it harder for investors to analyse and value bonds because of the uncertainty on timing of pay-off. Reduced coupons, in turn, drive interest shortfalls higher and push realised losses further out in time," says Bansal.

He puts the number of hope notes outstanding at 120, with a US$1.87bn balance. So far, only eight have been written down, at an estimated US$122m loss. But further losses are expected on these hope notes going forward.

Looking ahead, Smith identifies three main risks that will drive defaults this year: deterioration in cap rates; a decrease in value due to low NOI growth; and limited availability of leverage. Whereas in 2007 loans were being underwritten at 80%-90% LTVs, now they're at 65%-75%, meaning that more conservative structures are required.

CS

CDS

Competition questions

Trade execution, fragmentation in the spotlight

The issues of anonymity and real-time trade acceptance under Dodd-Frank appear to be splitting the OTC derivatives dealer community. At the same time, the competitive landscape is also proving tricky for CCPs.

"Real-time trading is at the heart of Title VII of the Dodd-Frank Act," explains James Cawley, ceo of Javelin Capital Markets. "If a participant knows in a millisecond that their trade has failed, they can put the same trade on with someone else simultaneously and the chances are that the market hasn't really moved - this promotes trade integrity in the swaps marketplace."

Anonymity is also important because it reduces potential front-running and the reliance on RFQs. Additional benefits include reduced transaction costs and the ability to trade in large sizes.

Recently proposed CFTC rules require swap trades to be accepted into central clearing as quickly as "technologically practicable". Javelin and CME's execution exercise last month was a good example of a broad coalition of market participants coming together to prove that real-time trade acceptance is possible with existing functionality, according to Cawley. Certain dealers had previously claimed that it couldn't be done without years of developing appropriate infrastructure.

The exercise involved executing and clearing over US$4.1bn of interest rate swap trades in an average time of under two seconds. Working with several dealers and the buy-side, Javelin executed 21 trades - at an average size of US$195m in notional - across multiple points of the swap curve using its anonymous execution platform. CME's clearing engine processed the swaps in real-time by utilising pre-set credit limits that were allocated to the customers by their clearing members.

Incumbent dealers had been pushing the use of tripartite agreements - between the FCM, dealer and buy-side participant - until the market infrastructure could guarantee real-time trade acceptance, before the CFTC ruled last summer that such agreements are anti-competitive. The agreements would have seen dealers guaranteeing trades on the proviso that they know who the customer is, effectively forcing customers to only trade with dealers that have the greatest chance of providing the best liquidity.

"Competition is good for the marketplace if it's on a level playing field - which is the fundamental goal of the new regulation. While some dealers may view it as a threat to their market share, others see real-time execution as a selling point. The market will ultimately vote with its feet," observes Cawley.

Liquidity in the most liquid parts of the swaps market is eventually expected to fragment, however. Recent TABB Group research indicates that dealers consequently intend to invest significant resources on creating, implementing and marketing swaps liquidity aggregation systems to their buy-side client base (see also SCI 22 December 2011). The research shows that these new aggregation solutions will be most widely adopted for vanilla IRS and index CDS.

"Whether there will be three or as many as 10 SEFs per asset class remains unclear, but finding the size you need at the right price will become less about who you know and more about the quality of your aggregation technology," says Kevin McPartland, a TABB principal and director of fixed income research. "Swap trading desks are asking their budget committees for tens of millions of dollars to build technology to aggregate liquidity in a market that isn't actually fragmented - yet."

He adds: "It's a tough sell, but it shouldn't be. By providing these new liquidity-seeking tools to their buy-side clients, dealers can fight to maintain the screen real estate and relationships they've spent years obtaining."

Meanwhile, the issue of competition is also proving to be tricky for CCPs. Jonathan Philp, managing consultant at InteDelta, says that there is a fine line for CCPs between being competitive and serving as a utility.

"On the one hand, a concentration in one or a small number of CCPs enables the most efficient use of capital. However, if clearing is fragmented, CCPs may seek to charge less margin or require lower default fund contributions as competitive levers. Central banks may ultimately become CCP back-stops because of their systemic importance."

CCPs adhere to the CPSS-IOSCO framework, which requires them to collect default fund contributions that are sufficient to cover the default of their two largest members. But they maintain different approaches to membership: the debate about how open CCPs should be to smaller members is ongoing.

"CME's approach is to broaden membership and so it requires a US$50m net capital qualifying threshold, whereas LCH.SwapClear demands US$5bn, which rules out all but the largest broker-dealers. Concern remains about whether smaller members can fully support the risk mutualisation process in a stressed market scenario," Philp explains.

He adds that CCPs are more or less transparent about how they calculate initial margin. "There is a degree of standardisation evolving in respect of margin valuation methodologies, with most CCPs using a variant on the SPAN methodology. But calculations can be complex for single-name CDS because the credit event trigger acts like an option."

It will be interesting to see how the number of CCPs pans out, according to Philp. He suggests that it makes sense from a netting perspective to have products concentrated at one or two CCPs, unless interoperability is introduced.

In the meantime, market participants are grappling with collateral eligibility. Not all derivatives users are natural holders of the required CCP-eligible collateral, meaning that they would have to find cash or other securities - typically US Treasuries or equivalents - from another source or divert them from other areas of the business. At the same time, regulatory changes are serving to reduce the availability of collateral (see also SCI 26 September 2011).

"Collateral eligibility hasn't removed risk from the system, but moved it around," observes Philp. "The advent of CCPs has turned the counterparty risk problem into a liquidity risk problem in terms of the management of collateral throughout the life of the trade. The relationship between the OTC and security financing sectors is becoming ever more intertwined."

Against this backdrop, it is important for firms to form a holistic view of the assets available to them, as well as their counterparties' eligibility criteria. "The aim is to maximise balance sheet efficiency, so the process of selecting collateral needs to be as systematic as possible, particularly as CCPs issue incremental margin calls on an intraday basis. Typically, firms aim to deliver the weakest collateral first, saving the rest for counterparties that will only accept higher-quality collateral," Philp concludes.

CS

CMBS

Euro CMBS sparks into life

The European secondary CMBS market has seen a pick-up in activity over the last few days. However, activity is effectively limited to smaller players and broader market involvement still remains elusive.

"The market has not been extremely busy and clients' involvement is fairly limited, but they are definitely getting more involved in buying seniors. There is less interest in mezz, although the Street is pretty active and there are quite a few bids from broker-dealers," says one European trader.

He adds: "The Street is not very aggressive yet, even though dealers are starting to get lighter. However, it feels like the market is starting to pick up in the last couple of days."

In particular, the trader reports that the Mall Funding transaction has been trading up recently. From the mid- to high-84s a few days ago, it is now up to around the mid-85s. A few other liquid names are also up by half a point or a point from where they were at the end of last week.

The increased activity is certainly positive for the market, but the trader says a more significant pick-up will have to wait until the bigger asset managers get involved. Current activity is mainly being generated by the smaller hedge funds.

"Generally they would be looking for more yield, but right now senior CMBS is yieldy enough for them. Depending on the type of asset, you can get yields of 7% from most CMBS or 8% or 9% for the lower quality stuff," says the trader.

He continues: "To get the market really moving though, we need to see the asset managers moving in. I think they might start to come in slowly and it will be a little while before they are properly in play."

The trader believes that hedge funds, which currently have a lot of cash, will be enough to sustain the market until those larger asset managers do get involved. "We hear hedge funds have been running pretty big cash balances, both in Europe and the US," he says.

The trader continues: "Last year that was fine because as long as you had some sort of positive return, you were basically outperforming. But this year they will have to start putting their cash to work."

As for when those asset managers will return, the key will be how other markets perform. The trader says that the illiquidity of the CMBS market means investors will pick their moment based on broader performance.

He concludes: "CMBS is a bit of a weird market because most people had the view that medium-term there will be issues again, so I think with a more illiquid product like CMBS people are more cautious of going in. They need to see a sustained positive sentiment in other markets before coming in."

JL

Structured Finance

SCI Start the Week - 23 January

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

Pipeline
The increased rate of deals entering the pipeline continued last week with seven new names announced. Two CMBS deals (US$1bn Freddie Mac SPC series K-705 and US$1.154bn GS MST 2012-GC6) were joined by two Canadian ABS transactions (Master Credit Card Trust 2012-1 and Canadian Capital Auto Receivables Asset Trust II series 2012-1). There were also two ILS transactions (US$100m Ibis Re II 2012-1 and US$150m Kibou) and a solitary CLO (US$400m Ares XXIII CLO).

Pricings
The majority of last week's prints were in the ABS sector, but one CLO priced as well (US$388m Symphony CLO VIII). Included among the pricings were two auto ABS deals (US$1.16bn Ford Credit Auto Owner Trust 2012-A and US$1.25bn Volkswagen Auto Loan Enhanced Trust 2012-1), a single credit card issue (US$844m GE Capital Credit Card Master Note Trust Series 2012-1) and a single student loan transaction (US$276m South Texas Higher Education Authority 2012-1). In addition, a servicing advances ABS (US$548m American Home Mortgage Servicing 2012-1) and finally one RMBS deal (US$4bn-equivalent Holmes Master Issuer 2012-1) printed.

Markets
The 'January effect' was still much in evidence over the last week in most structured finance markets.
In ABS, JPMorgan analysts say: "The second tier names/asset classes - such as floorplan, non-prime auto and rental car - are seeing better bids, while cash surrogates have continued to do well. The primary market is also off to a blazing start in 2012 with US$12bn in year-to-date supply...Even with the heavy supply, auto paper in secondary continues to see great demand and trades rich to primary."
Over the last week triple-B credit card ABS tightened by 5bp to 20bp and subprime auto subordinate tightened by 10bp to 25bp across maturities. In addition, two- and three-year triple-A stranded asset spreads also narrowed by 2bp. Meanwhile, the JPM analysts say triple-A UK RMBS spreads widened by 5bp across the curve.
US RMBS moved the opposite way, albeit slightly, according to residential credit analysts at Barclays Capital. "Non-agency cash bonds participated in the [wider market] rally to a modest extent, with jumbo and alt-A prices up approximately half a point w/w. Meanwhile, the ABX and PrimeX indices were significantly higher w/w, with prices up 2-3 points across most indices."
However, the Barcap analysts add that with many accounts focused on Thursday's Maiden Lane II sale, trading volumes were lighter last week versus last week and in line with average daily volumes over the past three months.
There was a different pattern in US CMBS as the market exhibited what Citi securitised products analysts call a curve "twist", as investors sold the top of the capital stack and bought lower in credit. As a result, duper spreads - which had come in by 21bp-52bp from the end of 2011 - saw profit taking and widened back out by 5bp-17bp on the week. GG10s widened by 5bp to 255bp after rallying 20bp since year-end.
But, the Citi analysts add: "With improving sentiment in the market, investors put these proceeds back to work down the credit curve into the AM and AJ sectors." They report that AJ volume was noticeably higher in a holiday-shortened week, with BWICs totalling US$283m in AJs, the highest such level since mid-2011. At the same time, the AM sector is seeing much improved liquidity, as dealers have begun making two-way markets on these bonds.
European CMBS too is seeing an uptick in activity. CRE debt analysts at Deutsche Bank say: "Benchmark names such as TMAN 6 A and TMAN 7 A advanced a few points higher on the week and taking their price gains for the year to around five points or so. Other benchmark names such as MALLF also benefitted from the risk-on appetite, advancing around one and a half points. This strong activity was accompanied by a ramp up in BWIC activity, with lists totalling over €80m circulating today [20 January]."
At the same time, there were positive signs in the US CLO market. Bank of America Merrill Lynch CLO analysts say: "Buoyed by strong sentiment, CLOs continue to move tighter on good volumes, with double-Bs leading the charge. We are mindful not to expect a one-way move tighter in 2012, and some degree of caution remains warranted in our view."
Nevertheless, they continue: "Secondary spreads have continued to behave very well across the capital structure over the past couple of weeks, on good volumes (US$250m-US$300m of BWIC volumes each week). With risk very much on in fixed income assets, the longer duration assets have performed the best, with double-Bs moving around 200bp since the start of the year."

Deal news
• The New York Fed has sold US$7bn in face amount of assets from its Maiden Lane II (ML II) portfolio to Credit Suisse through a competitive process. The regulator says the transaction was prompted by an unsolicited offer from Goldman Sachs to BlackRock Solutions, the investment manager for ML II, in January 2012 to buy a portion of ML II assets.
• S&P has published an unsolicited comment on the Sequoia Mortgage Trust 2012-1 RMBS, which is expected to close on 27 January. The agency has reviewed the preliminary term sheet filed with the SEC and the publicly available loan-level data on this transaction, and says that the collateral characteristics compare favourably to an S&P archetypical pool.
• The borrower behind the Titan Europe 2006-4FS CMBS has given notice in connection with the Four Seasons loan that it will not meet the minimum prepayment amount. As a result, investors will receive a step-up in coupon for both the class A1 and A2 notes.
• Freddie Mac has priced a 2.06% US$3bn mortgage-linked amortising note (MLAN) security due on 15 January 2022. MLANs are senior unsecured debt obligations whose cashflows mimic the principal payments of referenced agency mortgage-related securities held in Freddie Mac's mortgage-related investments portfolio.
• Banco BPI is set to purchase only €149.3m from its recent fixed tender offer for over €2bn of Douro RMBS. With a take-up rate of less than 7%, far fewer bonds were tendered then had been expected.

Regulatory update
• The FDIC has approved a notice of proposed rulemaking (NPR) that would require certain large insured depository institutions to conduct annual capital-adequacy stress tests. It has also approved a final rule requiring an insured depository institution with US$50bn or more in total assets to submit periodic contingency plans for resolution in the event of the institution's failure.
• The US SEC has charged UBS Global Asset Management with failing to properly price securities in three mutual funds it managed, resulting in a misstatement to investors of the NAVs of those funds.
• CPSS and IOSCO have published their final report on the OTC derivatives data that should be collected, stored and disseminated by trade repositories (TRs). The committees support the view that TRs, by collecting such data centrally, would provide authorities and the public with better and more timely information on OTC derivatives.
• Recent reforms of the INFONAVIT Law should result in better asset quality in new mortgage loans that are eligible for securitisation in the future, according to Moody's. One of the most significant items from a credit perspective is that INFONAVIT will be able to originate peso-denominated mortgage loans.

Deals added to the SCI database last week:
Ally Auto Trust 2012-1
Arran Cards Funding 2012-1
CenterPoint Energy Transition Bond Co IV
Golub Capital Partners CLO 12
MMCA Auto Owner Trust 2012-A
Santander Drive Auto Receivables Trust 2012-1
SLM Student Loan Trust 2012-1

Top stories to come in SCI:
CDS documentation
Asian CLOs
Recruitment trends
US CLOs

Structured Finance

Continued Euro ABS market contraction expected

The European securitisation market has begun 2012 on a positive footing: buoyed by a rally in European risk assets that was prompted by the ECB's LTRO programme, both ABS and RMBS have been better bid on the secondary market since the start of the year. At the same time, new deals from the Arran Cards programme and the Holmes Master Trust have kick-started primary issuance. However, European asset-backed analysts at RBS highlight that the European pipeline remains thin, with volumes expected to continue to shrink as redemptions outweigh new supply.

According to RBS figures, the European securitisation market has shrunk by over €400bn since 2008, with the current placed outstanding market sized at €838bn. There were net redemptions of €120bn in 2011 alone.

"Based only on our projections of calls and amortisation schedules and current CPR rates for the different asset markets, we project circa €157bn of bond redemptions this year - equivalent to net shrinkage of €70bn," the analysts report. "By 2015, the outstanding placed market could fall to as little as €667bn."

As the majority of Dutch and UK RMBS issued during the market peak between 2004 and 2007 have already been redeemed, RBS anticipates that the market run-down of approximately €474bn (equivalent to net redemptions of €175bn) over the next four years will be primarily concentrated in the off-the-run sectors, which still trade at significant discounts to other credit sectors. These sectors now include peripheral RMBS, CMBS and CLOs.

"The pace of this rundown will be mitigated by loan extensions - particularly in CMBS (although lender extension terms have noticeably tightened with paydowns becoming increasingly frequent) - as well as forbearance measures in RMBS transactions, particularly from peripheral countries, that will potentially slow down CPRs and thus stem the tide and prolong the market," the analysts note.

On the other hand, however, ABS buy-back exercises driven primarily by bank liability management initiatives will continue to be popular and may thus drive contraction further. "With the ECB LTRO offering additional liquidity to European banks to potentially fund these initiatives, we may see these pick up further in the near future," they add.

In leveraged loan CLOs, RBS estimates that around 90% of existing vehicles will have exited their re-investment periods by 2015 whereby structures will only be able to re-invest prepayments, thus accelerating redemption rates in the market.

Given RBS' forecasted redemptions, new issue volumes in Europe will have to rise to about €120bn per annum for the outstanding market to remain flat by 2015. This appears highly unlikely, the analysts say, due to current originator distribution in Europe.

"Unlike the US, securitisation has become an asset financing tool that is almost exclusively utilised by banks as opposed to non-bank lending constituencies. In our opinion, although banks have started switching to secured funding as their 'de-facto' funding model, which should thus naturally favour ABS volumes, securitisation will remain a complement to covered bond financing in the wholesale markets," they note.

Central bank liquidity schemes, such as the ECB LTRO, have also provided significant inexpensive liquidity for banks that will diminish the need for ABS issuance - at least in the public markets. Finally, the pace of bank deleveraging is another constraint to securitisation volumes, with RBS' credit analysts currently predicting that banks will reduce their balance sheet size by around €5.1trn over the next three to five years.

AC

CDS

Bespoke CDS appetite persists

Bespoke structured credit activity continues in various guises in both the primary and secondary markets, despite the increasingly punitive regulatory environment. While most of the legacy structured credit market is no longer deemed to be distressed - and is also much smaller than it was in 2008, with around 1000 products today versus 3000 at the peak - significant risk-transfer opportunities remain, largely driven by European bank deleveraging.

According to structured credit strategists at Morgan Stanley, the secondary market for legacy instruments - mostly those issued from 2005 to 2007 in managed or broadly distributed form - persists, with movement from the original bank buyers to other end investors. The strategists have found that while many structures have healed in pricing terms and have either been unwound or have matured (with some experiencing write-downs), those that are outstanding tend to track the market movements of a common set of tail names, including distressed financials and LBOs.

At the same time, in the primary market the strategists point to three relatively strong trends with respect to demand for customised credit derivative solutions: first loss protection, first loss longs and portfolio replication. Several banks have been actively buying first loss protection on their lending portfolios, given the regulatory and economical hedging benefits (SCI 25 November 2011).

However, as Morgan Stanley points out, this sort of trade must be done in bespoke form almost by definition to address the specific exposures in a given bank lending book. Nevertheless, the strategists anticipate additional activity in this space as banks adjust their exposures and there is more clarity on Dodd-Frank capital rules and their inter-operability with the Basel framework.

"One consequence of this is that we may see more lending books use senior tranches (and in many cases, super-senior tranches) as an overlay to CDS hedges to effectively reduce idiosyncratic exposure and add back in market exposure," the strategists note.

Meanwhile, many investors are looking for convex opportunities in credit where corporate credit fundamentals remain robust - despite a market backdrop of elevated volatility, reduced credit liquidity and regulatory and European sovereign uncertainty. Morgan Stanley suggests that one way to implement this long credit view in a way that limits downside in spread widening scenarios is by taking first loss exposure on a bespoke portfolio.

"While we've seen activity in the index markets as well, for those investors who emphasise the importance of credit selection and maximising portfolio overlap, a bespoke portfolio may be a better fit," they say. "Additionally, some investors may have plenty of exposure to the narrower list of index constituents through various products, and a bespoke structure can help diversify away from this."

Portfolio replication is also in demand among investors looking to diversify away from the corporate bond market, but perhaps more so among those that have less appetite for direct interest rate risk. These trades tend to be thicker and have significant subordination, yet some pick-up over the average spread of the underlying portfolio. The strategists explain that these mezzanine structures have more similarities to early structured credit flows from a decade ago than to the 2005-2007 period, when structures were highly optimised, ratings-driven (as opposed to being investor-driven) and thinner.

"In the 2005-2007 period, tranches were very thin (1%), low attaching (3% to 7% range) and longer maturity (7- to 10-year risk), with spreads in the 150bp to 200bp range," they add. "Today, these portfolio replication trades are thicker (5%-10%), higher attaching (7% to 20%) and yet retain attractive spread levels."

Concerns remain over the use of customised structured credit solutions over more standardised products, however. These include impending central clearing requirements (SCI passim) and the prospect of prohibitive capital treatment of trades held by financial institutions.

"With Dodd-Frank implementation at some point - potentially as early as this year - certain standardised CDS transactions will have to be centrally cleared, where margining and collateral will be determined by a central counterparty instead of a specific bank," note the strategists. "Bespokes in derivative form would most likely not be centrally cleared, which means that margining would be non-standard (as it is now), but the capital treatment for bank counterparties to bespoke trades would likely be more onerous than for cleared trades. This can raise the cost of such transactions and potentially lower the liquidity as well, relative to cleared transactions."

AC

CLOs

Structural tweaks strengthen APAC CLOs

Synthetic balance sheet CLOs are one of the few asset classes within the Asia (ex-Japan) structured credit market tipped for growth in 2012 as banks look to employ the structure for regulatory capital relief trades (SCI 23 December 2011). Investor interest in this space may be buoyed by a handful of recent transactions that have incorporated structural tweaks intended to strengthen the deals' credit protection.

Three short-tenor CLOs with portfolios of corporate trade finance obligations were issued late last year: all three transactions enhanced their structures by adjusting stop-replenishment trigger calculations, extending tail periods and by refining the determination of loss rates. Moody's notes that, taken together, these features strengthen credit protection for investors.

By redefining the stop-replenishment trigger, the new transactions keep track of cumulative gross default amounts by aggregating the notional amounts of obligations subject to credit events or classified as equivalent to default according to a bank's own internal rating scores. The replenishment period will terminate early if the cumulative gross defaults surpass the trigger level and remain above this level for 60 consecutive business days.

Moody's explains that in previous transactions the stop-replenishment trigger was based on the cumulative loss amount, which factored in assumed or actual recoveries. "The problem with these transactions is that cumulative losses would be understated if the actual recoveries were lower than the recovery assumption," says the rating agency. "In such a situation, an understated cumulative loss amount cannot terminate the replenishment period in a timely manner. Such delays reduce the effectiveness of the trigger, which is a key structural feature for protecting investors."

With the new approach, the calculation of a cumulative gross defaulted amount is unaffected by this problem because it does not rely on recovery assumptions. Hence, it represents a clearer and more objective criterion on when to terminate the replenishment period early, Moody's notes.

When the replenishment period ends, the portfolio of trade finance obligations will amortise rapidly due to their short-weighted average portfolio life of less than 91 days. In other words, the majority of the risk exposure that investors face diminishes very quickly.

An extended tail period is also credit positive, says Moody's, as it allows more time for the servicer to perform a workout on defaulted loans and lessen the chance of relying on the market quote of the defaulted asset - which may be low. Extending tail periods therefore helps maximise recovery potential. The new transactions have a longer tail of three years compared to one year in historical transactions.

The agency explains that the workout of defaulted obligations in many emerging markets typically takes longer than that in developed countries. If the workout is not completed before the legal maturity of a transaction, recoveries will be determined by both the actual recovered amount and the market quote for the remaining portion.

"Our research shows that ultimate recovery values - i.e. discounted workout values - tend to exceed recovery rates based on a 30-day-post-default market quote," it explains. "Our CLO research also shows that generally the longer managers wait to sell their defaulted obligations, the greater the excess of the market quote over the 30-day-post-default recovery value."

The three new transactions also introduced the use of loan-loss provisions to determine the loss rate of defaulted loans if a workout on a defaulted asset is not completed approximately 60 days prior to the legal maturity date. Moody's sees this as a positive development when compared to a loss rate determined by seeking a market quote for the defaulted loans.

"This is due to the consideration that the underlying trade finance loans in these transactions typically do not have a liquid trading market and dealers are likely to have limited information on the loans or the borrowers," says Moody's. "We believe the use of loan-loss provisions to determine the loss rate is objective because loan-loss provisioning is carried out by the originating bank in accordance with widely accepted accounting principles. In addition, loss provisioning is part of the originating bank's existing operations and is managed by a department independent of the securitisation department."

Ratings on existing synthetic CLOs and CDOs in the region, meanwhile, are expected to remain largely stable throughout 2012. However, S&P warns that events in the US and Europe could have a knock-on effect on ratings, particularly if global financial volatility harms the credit quality of reference entities found in Asian transactions.

AC

CMBS

Loan extensions on the cards

Thirty European CMBS loans, accounting for €1.8bn, are due to mature this month. Issuer notifications regarding these loans have not been positive to date and this trend is expected to continue for the most part.

Of the loans maturing this month, CRE debt analysts at Deutsche Bank anticipate that the Gutperle (securitised in EMC VI), MPC, Caprice, Six Hotels (TITN 2007-2), Deutsche Bahn (TITN 2007-CT1X), Coconut (TMAN 6) and Bach (TMAN 7) loans will be extended. In the case of the larger loans - MPC, Bach, Coconut - a gradual rundown of the portfolio is also likely.

The CAA House loan (WINDM XI) may also be extended. But it is a less clear-cut case, according to the analysts, given that the UK's creditor-friendly legal regime provides the servicer with more options than on the continent.

"We expect when further regulatory notices are filed in the coming days on the status of the residual 22 loans maturing in January, redemptions will be few and far between. In our view, the redemptions that do occur will be focused on the handful of lower sized - i.e. £15m or less - UK loans which redeem," they note.

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CMBS

Fair value in the balance?

The wrangling over the JW Marriott Las Vegas Resort & Spa loan, securitised in CSMC 2007-TFLA, continues. CMBS investors are concerned that the case could set a negative precedent that may result in further artificially low valuations benefitting junior debt holders at the expense of those more senior in the capital structure.

"While the outcome remains unclear, following the GGP bankruptcy investors have learned that preconceived notions can be upset depending on how a judge presiding over the case interprets the facts. This specific case appears to be centred around a theoretical problem in that if the fair market value is so low that the junior debt holder wouldn't get paid if the asset was sold at that price to an independent third party, how can it exercise any control over the workout?" observe CMBS analysts at Bank of America Merrill Lynch.

The loan defaulted when it failed to refinance at maturity in late 2011 and the case revolves around the junior debt holder's bid to take control of the asset at a deeply discounted price. Galante Holdings, which owns US$10m of junior debt collateralised by the property, had intended to buy the entire mortgage on the loan for a 'fair value' price of US$84.5m - approximately US$65m less than the current outstanding balance of the US$150m securitised A-note.

However, given such a steep drop in value, the junior debt holder should theoretically have been 'appraised out' and not allowed to take action at the expense of senior debt holders. As such, the senior debt holders - including Winthrop Realty Trust and Angelo, Gordon & Co - have sued to block Galante from buying the mortgage.

Galante claims that, as the directing holder, it has the contractual right to buy the loan at the fair value price - which was determined by TriMont Real Estate Advisors, whom Galante appointed as special servicer at an earlier date. But the plaintiffs claim that a PKF Consulting USA appraisal value of US$98.4m from December puts Galante out-of-the-money and terminates its role as directing holder, thus eliminating its ability to exercise the fair value option.

The case was originally dismissed on the premise that the plaintiffs did not represent 25% of the CMBS noteholders. The latest twist involves the plaintiffs returning to court after recruiting two additional investor groups (reportedly Genworth and PIMCO), with the order now reinstated.

The BAML analysts note that the outcome will ultimately depend on how the judge interprets the inter-creditor agreement, as well as the other facts of the case.

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RMBS

Low expectations for refi initiative

President Obama's State of the Union address yesterday included a section on mortgage refinancing initiatives. However, while MBS valuations could see a knee-jerk reaction as a result, ultimately the chances of this programme winning Congressional passage are believed to be low.

In the State of the Union address, the president pledged to send Congress "a plan that gives every responsible homeowner the chance to save about US$3,000 a year on their mortgage, by refinancing at historically low interest rates". The initiative would be funded by a small tax on the largest financial institutions.

ABS analysts at Barclays Capital note that the programme appears to seek to make the refinancing process as streamlined as possible, targeting both GSE and non-agency loans. One potential option could be to utilise the GSEs or the FHA to facilitate such a programme, but this would likely involve amending the GSE governing statutes. Alternatively, the government could announce a blanket one-time waiver of reps and warranties for loans that banks refinanced.

It is unclear why Congress needs to be involved in the initiative, but the BarCap analysts suggest that one reason could be the administration seeking to defuse the political risk by pushing Congress to take partial ownership of this decision. They believe that, given the inability of Congress to agree on most big issues in the past couple of years, the decision to refer a bill to Congress greatly reduces the chance of a mass refinancing programme happening.

Nevertheless, one of the key risks of such a programme is a significant disruption of the mortgage market, the analysts add. "The TBA market has been one of the most liquid and successful," they explain. "While refinancing policy changes have been absorbed fairly well so far, at some point investors will demand a significant premium for being long policy risk and TBA liquidity could suffer. In particular, this could be the case if the president's programme entails the creation of a very large class of TBA-ineligible securities."

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CDS

You say voluntary, I say mandatory...

Anu Munshi, partner at B&B Structured Finance, explores the impact of debt restructuring on CDS contracts

An old school friend with a great business idea comes to you and three other similarly well-off school friends and asks if you'd lend him money for his business. He needs US$40,000 and expects he can pay it back in one year with 10% interest. The four of you agree to lend him the money, each one giving US$10,000.

In nine months' time, your friend asks to meet all of you for a drink at the pub and tells you that he's behind schedule on payments. His business is going well, but he has just not received money from one of his main clients as they have requested a longer period of time to pay him.

He expects to have the money within the next six months, so asks if you can extend your loan to him to 1.5 years instead of the original one year. He will pay you a higher interest of 15% for the remaining term until he repays the loan.

Your three friends have a good feeling about this business. Your borrower friend's main client is an established institution and is likely to provide solid revenues to your friend's business going forward.

Your friend just needs a bit more time to get the cash from his client and then his business will be self-sustaining. If the group doesn't grant him the extension, he won't have the money to repay the loan, so all of you will recover less than your principal and the higher interest sweetens the deal.

But you have your doubts about whether your friend's main client will pay him. You also need your money back within the original timeframe. But the four of you had initially agreed that a majority vote of 75% on any decisions relating to the loan would bind all of you, so you have to extend your part of the loan as well.

You and your friends are going to feel very differently about this result. Your friends have agreed to extend or restructure the loan as they think they'll get all their money back, albeit a bit later. But you've been coerced into restructuring the loan and have doubts about whether you'll get your money back.

Restructuring works in much the same way in institutional credit markets (though the negotiation happens in boardrooms instead of pubs - sometimes). Investors agree to restructure debt because they would rather wait longer to get repaid in full than demand their money when it's due and recover a fraction of their principal.

But if not all investors agree to restructure the debt and a majority vote binds all holders of the debt, as in the case of collective action clauses (CACs), then the terms of the debt can be restructured anyway. Such restructuring of debt resulting from a deterioration in the issuer's creditworthiness triggers a credit event in a credit default swap (CDS) because it is effectively a default as the terms of the debt have changed due to the issuer being in distress.

If we imagine that a CDS market exists on your borrower friend's creditworthiness, the extension of the loan from its original maturity would trigger a credit event on your borrower friend's CDS because you and your lender friends are all bound by the new terms of being repaid at a later date.

Your borrower friend may be keen to avoid triggering a credit event so as to avoid the stigma and financial consequences of having defaulted. So he asks the four of you, his lender friends, if you would be amenable to an alternative solution where he repays you the loan on the original maturity date but takes out another loan from you on the same date for another six months. The result is the same as extending the loan from its original one-year maturity to 1.5 years, but instead of restructuring the original loan he is repaying the old loan and borrowing money through a new loan.

What's the key difference between these two alternatives? The difference is that you are free to act as you want in the second alternative because the 75% majority vote relates to the original loan.

Any new loan is not automatically bound by the same rules. So, when your friend asks if you are all amenable to the alternative solution of receiving your money back from the original loan and giving out a new loan, you can choose to say, "Sorry mate, but I'm out. I can't give you a new loan."

This is what you could call a 'voluntary' restructuring as it has the effect of restructuring the original debt but it doesn't bind any creditors who don't want the debt to be restructured. Such a 'voluntary' restructuring does not trigger a credit event in a credit default swap because the original debt has not been restructured; rather, the creditors have agreed to an alternative solution that involves new debt because they have made a commercial decision to preserve their capital.

As your other three lender friends are willing to extend the loan, your borrower friend can return the US$40,000 to all of you, re-borrow US$30,000 from your other lender friends for six months more and not trigger a credit event. This alternative solution works as long as US$30,000 is enough for your borrower friend. If he needs the entire US$40,000 for another six months, he has little choice (apart from blackmailing you, emotionally or otherwise) but to restructure the original loan, which forces you to extend your US$10,000 portion of the loan - given the majority vote - and trigger a credit event as a result.

So, if you think about it, all restructuring of debt is voluntary to a large extent as it depends on an agreement from all or a majority of creditors. But any restructuring that binds all holders to its terms is mandatory for even those who did not opt for the new terms, whereas any restructuring that doesn't bind all holders to its terms is truly voluntary.

There has been a lot of talk of late about CDS not serving as an efficient hedge in the context of a voluntary restructuring on Greek debt, as it would not trigger the CDS contract and therefore would not reflect the true loss. But it is by no means certain that enough creditors will agree to a voluntary restructuring of Greek debt to raise the funds that Greece needs, so Greece may not be able to pull off a voluntary restructuring.

More importantly, even if enough creditors agree to a voluntary restructuring the first time around, the general feeling is that Greece will be back asking for another round of restructuring in a few months' time. Creditors may not see the commercial benefit of deferring the date when they get their money back the second time around, at which point it will be difficult to orchestrate another voluntary restructuring. If your borrower friend comes back in 1.5 years and asks the group of three lender friends for another extension, they are unlikely to feel as confident about the prospects of being repaid in full and may decide to cut their losses.

So, where an entity is seen as being unlikely to repay its debts, a voluntary restructuring today very likely only defers an ultimate mandatory restructuring, which will trigger a credit event on the CDS contract.

Interestingly, the market already seems to be pricing in the full loss on Greek debt today. To buy US$10m CDS protection on Greece today, you need to pay approximately US$6m - or 60% of the notional amount of the CDS contract - on day one.

If Greece were to default tomorrow, you would need to receive at least US$6m as compensation to make it worth paying 60% upfront to buy protection. Based on the CDS payout of par minus recovery, this implies a recovery value on Greek debt of around 40%, which looks pretty close to a likely recovery value on Greek debt. In other words, the CDS contract already reflects the likely full loss amount on Greek debt.

People can debate all they want about voluntary versus mandatory, but in the case of Greece, it's just a matter of time before the sovereign defaults. You say voluntary, I say mandatory. But the market has spoken; politicians should listen.

Structured Finance

New member for NY law firm

Kleinberg, Kaplan, Wolff & Cohen has made Euchung Ung a member of the firm, effective from the start of this year. Ung practices in the firm's real estate group in New York.

Ung advises on the acquisition, disposition, development, management and leasing of office, retail, commercial and hotel properties. He also advises hedge funds and private equity funds on the purchase and sale of real estate mortgage and mezzanine debt, and the negotiating and structuring of complex workout arrangements in connection with the ownership or foreclosure of real property assets.

Structured Finance

Mortgage servicer enters CRE space

Oakwood Global Finance has hired Emily Hadley as head of CRE loan servicing, marking the company's first foray into the CRE sector. The mortgage servicer already has £2.5bn AUM in the residential space.

Hadley joins from American Appraisal where she was director and head of debt advisory in the UK. She has previously managed distressed CRE debt at Barclays Capital Mortgage Servicing and served as vp at Hatfield Philips.

Structured Finance

Securitisation lawyer hired

Deborah Festa has joined Milbank, Tweed, Hadley & McCloy as a partner in its Los Angeles office. She joins from O'Melveny & Myers, where she was also a partner.

Festa's practice covers securitisations, complex domestic and off-shore financing arrangements in various asset classes, and cash flow, market value and synthetic CLO transactions. Prior to O'Melveny & Myers she served as an attorney at both Edison International and Southern California Edison. Festa began her career as an associate at Fried Frank.

Structured Finance

Henderson names new credit head

Colin Fleury, head of ABS at Henderson, is being promoted to head of structured products and advisory, which is being renamed secured credit. Former structured products head Jim Irvine is also being promoted and becomes head of fixed income.

Structured Finance

PIMCO promotes in SF

PIMCO has announced a raft of promotions, including a number of senior structured finance positions. Four members of the firm become evp at PIMCO's Newport Beach office.

Marco van Akkeren becomes evp and portfolio manager, focusing on ABS and MBS. He joined the firm in 2008 and previously worked at Goldman Sachs and Morgan Stanley.

Mohit Mittal becomes evp and portfolio manager. He currently helps manage investment grade credit portfolios focusing on both cash bonds and credit derivatives. He joined in 2007 and previously served as a senior consultant at Deloitte.

John Murray also becomes evp and portfolio manager, focusing on CRE and CMBS. He joined the firm in 2009 and previously worked at JER Partners.

Finally, Krishnamoorthy Narasimhan becomes evp and global structured finance and credit specialist in PIMCO's advisory group. He joined the firm in 2010 and was previously head of CRE and CMBS valuation in the credit advisory group of Algorithmics.

CDS

Potential SEF adds svp

TeraExchange has appointed Marti Tirinnanzi as business development svp. She will be head of the firm's Washington DC office.

Tirinnanzi was most recently chairman of the FHFA's clearinghouse working group. She has worked with the US Congress, CFTC and other regulatory agencies and helped draft Title VII of the Dodd-Frank Act.

TeraExchange is a service of Spring Trading, which has filed notice with the CFTC of its intention to operate as an Exempt Board of Trade (EBOT) and intends to apply to become a SEF for swaps and other OTC cleared derivatives once CFTC and US SEC rules are finalised (SCI 31 October 2011).

CDS

Credit hedge fund team strengthened

Avoca Capital Holdings has hired Rachel Black as head of capital raising for its credit hedge fund team in London. Black has over 15 years of sales experience and joins from Concerto Asset Management. She has previously held positions at Deutsche Bank and JPMorgan.

CDS

Law firm beefs up APAC team

Aaron Comerford has joined Clifford Chance's Tokyo office as counsel on the derivatives and structured products team. He was previously at Allen & Overy and specialises in structured credit derivatives transactions, financial guarantee products, synthetic instruments and structured equity derivatives.

Wendy Yeo has also been promoted to counsel. She focuses on derivatives and structured products and advises investment banks, dealers, intermediaries and end-users operating in the Tokyo market.

CDS

Credit manager hires for distressed team

Avenue Capital Group has hired Stephen Trevor to lead a new initiative focusing on US and European distressed-for-control investments. Trevor joins the company from Morgan Stanley Investment Management as senior md.

CMBS

Restructuring firm renamed

Guardian Solutions has changed its name to Alliance Commercial Group. The firm will continue to specialise in CMBS restructuring and resolution advisory services.

Alliance has also established a new division offering access to private and institutional capital for clients requiring financing alternatives. It believes these options can benefit clients facing a near term or past due maturity date or those seeking to purchase or pay off a note at a discount.

RMBS

Listing first for RMBS fund

Alternative investment fund marketplace AlphaMetrix Global Marketplace (AGM) has listed its first dedicated RMBS fund. The fund is managed by Performance Trust Investment Advisors (PTIA), headed by cio Peter Cook and president Douglas Rothschild.

"We are extremely excited to list our RMBS opportunity funds on the AlphaMetrix Global Marketplace, as it provides us the opportunity to present our unique strategy to a community not currently known to PTIA," Rothschild comments.

ABS

Low loss rates predicted for auto ABS

Losses fell for both prime and subprime US auto loan ABS last month. Fitch expects more of the same for the first half of 2012, based on its latest index results for the sector.

Performance has been supported by two consecutive months of stronger used vehicle values and some positive economic data in the US. With these factors supporting asset performance, Fitch expects auto loan ABS to produce low loss rates in the first half of 2012 consistent with 2009-2011, with a positive rating outlook.

The agency expects used vehicle values to continue to benefit from low supply and healthy demand in 2012, supporting elevated recovery rates in defaulted and repossessed auto loans securitised in auto ABS transactions, containing loss levels.

Annualised net losses (ANL) on prime auto loan ABS improved by 7.6% in December month-over-month (MOM) to 0.49%. ANL closed out 2011 41% below December 2010. The low for the year was 0.41% in June, a new record low, while the high was 0.93% back in January.

The average monthly prime ANL was 0.58% in 2011, the lowest on record to date, easily beating out the previous low of 0.77% recorded in 2006. 60+ days delinquencies were 0.50% in December, up over November by 8.7% but 12.3% below December 2010. Consistent with 2011, loss frequency is still the focus for performance in the first half of the year, given the ongoing European debt crisis and its potential impact on the US economy.

In the subprime sector, 60+ days delinquencies moved 6.3% higher in December over the prior month to 3.19%, but were still 4% below 2010 levels. ANL crept lower to 6.36% in December over November, down by 4.9% MOM, and were 4.1% lower than in the same period in 2010.

ABS

FFELP SLABS targeted

Moody's has issued an RFC on a proposed update to the cashflow assumptions it uses when rating FFELP student loan securitisations. If implemented, the agency warns that it would expect to downgrade the ratings of approximately US$20bn of outstanding FFELP student-loan backed transactions - about 10% of the FFELP securities it rates.

The key cashflow assumptions Moody's proposes updating are cumulative default rates, voluntary prepayment rates, interest rates and net reject rates. The agency would expect only the proposed updates of cumulative default rates and interest rates to impact ratings, with each affecting approximately US$10bn in securities.

"We propose to increase our expected cumulative default assumptions for FFELP loans significantly, based on our view that borrowers will continue to face poor employment prospects, which will prolong the period of high defaults. However, we expect net losses to remain less than 1% due to the government's guarantee on the loans," says Barbara Lambotte, a Moody's vp and senior credit officer.

For example, the assumed expected cumulative defaults used in Moody's risk model for unseasoned four-year Stafford loans that entered repayment in or after 2007 would increase to 17% from 8%. Net losses could increase to 0.70% at the high end, up from 0.4%.

The increase in the cumulative default assumptions would affect the ratings of securitisations that contain relatively new Stafford and Plus loans, which have not yet experienced significant defaults to date. Senior notes of these securitisations currently rated Aaa could be downgraded to Aa.

Equally, Moody's proposed addition of a high-interest rate scenario for monitoring student loan ABS would lead to rating downgrades on some securitisations that issued tax-exempt auction rate securities. On these securities, the agency may expect to downgrade Aaa ratings by up to nine notches to Baa.

"We expect the change to affect only securitisations that issued tax-exempt auction rate securities, as these are particularly vulnerable to high interest rate scenarios," adds Lambotte.

Comments on the proposed assumptions should be received by 20 February, with a final report due in March 2012.

ABS

Credit card delinquencies hit new lows

US credit card charge-offs declined by 34bp in December to 5.04%, according to Moody's latest credit card indices. Also during the month delinquencies fell to new record lows, pointing to further declines in charge-offs in the months ahead.

Moody's expects the charge-off rate to continue to fall well into the coming year, eventually moving to below 4% by the end of 2012. "We expect improvement in credit card performance to continue into 2012, although the rate of improvement in performance will slow as the year goes on," says Jeffrey Hibbs, a Moody's avp and analyst.

By falling to 5.04%, the charge-off rate finished the year three percentage points lower than its 8.03% level at year-end 2010. The drop in 2011 was the sharpest calendar year decline in the history of Moody's credit card indices.

With each of the 'big six' credit card trusts posting monthly declines, the delinquency rate fell to an all-time low of 2.91% in December. Early-stage delinquencies also showed improvement, falling to 0.80% during the month.

Moody's says December is a seasonally strong month for delinquencies, as holiday shopping drives up balances, lowering the share of these balances on which consumers are delinquent. The agency expects delinquencies to post a slight seasonal increase in January, as higher credit quality obligors pay down their holiday credit card spending, which leaves outstanding a pool of receivables from overall weaker credit quality obligors. Despite this expected seasonal up-tick next month, delinquencies have declined substantially over the past year and are now at an historically low level.

After four consecutive months of decline, the payment rate index increased in December, rising to 21.58% - just 33bp below the all-time high it set in August 2011. Meanwhile, the yield index declined slightly to 19.13% - more than two percentage points below its 2010 year-end level - due to the lower boost from principal receivables discounting.

Lower charge-offs more than offset the decline in yield, leading to a 27bp increase in the excess spread index to 11.30%, keeping it near its all-time high.

ABS

Second Embarcadero Re marketing

The latest catastrophe bond from the California Earthquake Authority's (CEA) Embarcadero Re programme is being marketed by Deutsche Bank. The series 2012-I deal is again a single-tranche offering targeting US$150m with a preliminary ratings from S&P of double-B minus.

Embarcadero Re is based on CEA's ultimate net losses. CEA policies do not cover certain perils usually included in earthquake cat bonds, such as fire following an earthquake. The CEA policies only provide coverage for losses directly resulting from the shake damage of the earthquake. The earthquake epicentre does not have to be within California to be a covered event and commercial properties are not covered.

The notes cover losses from first and subsequent earthquakes in California on an aggregate basis over three annual loss occurrence periods (LOP). The attachment and exhaustion points for the first LOP are US$2.91bn and US$3.21bn, respectively.

For the first LOP, to the extent the sum of ultimate net losses from earthquakes is less than US$350m, the attachment point will be reset to maintain a probability of attachment of 2.36%. If the sum of ultimate net losses for the first LOP exceeds US$350m but is less than US$2.910bn, the attachment point for the second LOP will be reduced by the amount of the ultimate net loss, though only to a level to maintain a maximum probability of attachment of 3.50%. This equates to a maximum loss of US$1.013bn and the new attachment point would be US$1.897bn (assuming no change in underlying exposure, in this example). Annual losses in excess of US$2.910bn for the first LOP would result in a loss of principal to note holders.

For the second reset (or third LOP):

• If the CEA's aggregate paid ultimate net loss as of the third LOP from all loss occurrences that commence during the first LOP and the second LOP is equal to or less than US$350m, the third LOP retention will be set at the highest dollar amount rounded to one million dollars that does not exceed the dollar amount identified by AIR as corresponding to the initial modelled annual aggregate attachment probability derived using the retention reset information.

• If the CEA's aggregate paid ultimate net loss as of the third LOP from all loss occurrences with dates of occurrence during the first LOP and second LOP exceeds US$350m, the third LOP retention will be set at a level equal to the greater of the following amounts:

• The highest dollar amount rounded to one million dollars that does not exceed the dollar amount identified by the reset agent as corresponding to a probability of attachment of 3.50% derived using the retention reset information; or

• The dollar amount derived using the retention reset information identified by the Reset Agent as corresponding to the third LOP modified attachment probability.

The 'Third LOP Modified Attachment Probability' is that percentage that would have been the second LOP modelled annual aggregate attachment probability derived using the second LOP retention reset information had the second LOP retention been set at an amount equal to the second LOP retention actually reported by the reset agent minus the aggregate paid ultimate net loss as of the third LOP reset calculation date from all loss occurrences with dates of occurrence during the second LOP.

The deal's collateral will be invested in US Treasury money market funds.

Structured Finance

Lead arranger announced

The rankings in the SCI league tables for bank arrangers in the structured credit and ABS markets have been finalised for 2011, with JPMorgan taking top spot on both sides of the Atlantic. The year saw a total of US$263.5bn qualifying deals completed in the US and €89.5bn in UK/Europe.

Overall, JPMorgan retained a commanding lead in both the US and UK/Europe tables throughout the bulk the year. However, the battle for the pecking order below top place remained close in parts of the top-ten on both sides of the Atlantic right up until December.

The league tables cover primary market transactions for asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS) and collateralised debt/loan obligations (CDOs/CLOs). Qualifying deals are full primary securitisations that were publicly marketed and sold to third-party investors; i.e. were not privately placed or issuer/arranger retained or re-issues or re-securitisations.

SCI publishes its league tables on a monthly basis. The numbers are based on the SCI deal database and are, where possible, corroborated with the firms involved.

The tables for the year to end-December 2011 are available here.

Structured Finance

Sovereign-linked ratings impacted

S&P has taken various credit rating actions on 340 tranches in 235 European structured finance transactions. The move follows the agency's 13 January rating actions on 16 eurozone members - Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovak Republic, Slovenia and Spain.

Specifically, S&P has lowered and removed from credit watch negative its ratings on:

• 17 tranches in 10 transactions with exposure to France;
• 158 tranches in 133 transactions (as well as lowered and kept on credit watch negative its rating on one tranche in one transaction) with exposure to Italy;
• 81 tranches in 50 transactions with exposure to Portugal; and
• two tranches in two transactions with exposure to Spain.

In addition, the agency has affirmed and removed from credit watch negative its ratings on 53 tranches in 25 transactions with exposure to Belgium, Germany, Ireland and the Netherlands. It has also affirmed and removed from credit watch negative the ratings on 28 tranches in 14 transactions with exposure to KfW.

The rating actions either reflect what S&P considers to be a direct ratings link to the sovereign or related entity rating, or reflect the maximum structured finance ratings that it would assign under the criteria for structured finance ratings following the sovereign downgrades. Under these criteria, the highest rating the agency would assign to a structured finance transaction is six notches above the investment-grade rating on the country in which the securitised assets are located. If the rating on the sovereign is in the speculative-grade category, the maximum uplift is five notches.

The conclusion of S&P's review of the eurozone sovereign ratings previously on credit watch negative resulted in the downgrade of its long-term ratings on Cyprus, Italy, Portugal and Spain by two notches, and the downgrade of Austria, France, Malta, Slovakia and Slovenia by one notch. It also affirmed its long-term ratings on Belgium, Estonia, Finland, Germany, Ireland, Luxembourg and the Netherlands. None of the sovereign ratings are now on credit watch.

Following these rating actions, the maximum structured finance ratings that S&P would assign under its criteria have changed for Italy and Portugal: for Italy, the six-notch uplift would be to double-A plus; and for Portugal, the five-notch uplift would be to single-A minus. Accordingly, the agency has lowered to these maximum ratings and removed from credit watch negative its ratings on tranches backed by Italian and Portuguese assets.

Structured Finance

Asset correlation to increase in importance

Greater investor scrutiny of individual assets within structured finance portfolios is a growing trend that could in time help to restore confidence in financial institutions' funding and investment, according to the 2012 Market Insight report by Bishopsfield Capital Partners. The report also argues that 'cherry picking' of assets by investors will increasingly dictate strategies available to banks as they continue to deleverage their balance sheets via portfolio disposals.

"Asset correlation within structured finance portfolios has often been underestimated in the past. We believe increasing individual asset risk analysis will provide a second line of defence for investors and may ultimately help to restore confidence of investors who lend to or invest in banks and financial institutions," says Steve Curry, partner of Bishopsfield Capital Partners. "However, this trend will pose important considerations for banks seeking to deleverage via portfolio disposals and for commercial real estate companies seeking to refinance their property portfolios."

Despite a drop in M&A activity in the second half of last year, the firm believes that corporates should be more ambitious in seeking out acquisition opportunities given the financial strength of the sector, especially in essential industries. Access to debt markets to fund such acquisitions will be available to well-known borrowers, but it will be increasingly important for them to build an investor following and cultivate relationships with their 'house' banks.

"Many corporates have managed to ride out the storms very well for a significant period of time now and we think that, for the bold, this will be a point in the cycle where corporates could make strategically important acquisitions at relatively attractive prices," adds Mike Nawas, also a Bishopsfield partner.

The report suggests that reduced bank funding will create the potential for a larger number of senior debt funds to emerge and it also argues that eurozone issues have challenged conventional thinking about the gap between the risk profile of the eurozone versus larger emerging markets.

Structured Finance

Credit opportunities fund minted

AnaCap Financial Partners has held a successful first round of closings of its Credit Opportunities Fund II, with commitments already at £265m after five months of marketing. The fund - which has a hard cap of £350m - targets performing, semi-performing or non-performing consumer and SME debt, including loans, leases, securities or other obligations requiring active asset management.

It will seek to capitalise on the rapidly evolving market opportunity in this space, driven by the need for financial institutions to de-lever. Justin Sulger, partner and head of credit opportunities at AnaCap, comments: "Financial institutions face a massive refinancing wall and increased capital requirements in the coming years, which - combined with a deteriorating capital-raising environment - makes significant deleveraging inevitable. The fund will benefit from AnaCap's track record as a financial services specialist, including our extensive experience investing in regulated businesses, and building and managing servicing platforms."

The fund has a three-year investment period and an eight-year life. Investors include the State of New Jersey, Hamilton Lane and OPERS.

Structured Finance

Greek deals cut on rising risk of disorderly default

Moody's has downgraded 22 notes in 11 Greek structured finance transactions, including two tranches of two ABS, 19 tranches of eight RMBS and one tranche in one CLO. The rating action concludes the review initiated on 11 November 2011 on the back of the increased risk of a disorderly default of Greece on its debt, which would increase the likelihood of high severity events that would have a material impact on both probability of default and loss given default on structured finance transactions.

The action reflects Moody's assessment of the increased probability and severity of a disorderly default by Greece on its debt and the implications of such a default for Greek structured finance transactions. While the agency has already taken into account certain high severity scenarios in rating Greek structured finance transactions, these scenarios did not attribute a high likelihood to a disorderly default by Greece on its debt.

In the event of a disorderly default, the functioning of the banking system and the state could be materially impaired and the economy would very likely experience a further sharp contraction. A disorderly default would also increase the likelihood of Greece exiting the euro area, accompanied by a return to a deeply devalued national currency.

While such an event is not Moody's central case view, the probability of it occurring is rising. In that event, economic conditions would dramatically deteriorate and the ability for Greek borrowers to repay their debt would weaken significantly more than already assumed. Even taking into account the low likelihood of this scenario, its impact would be such that the agency has concluded that the rating for any Greek structured finance notes could be no higher than B1.

Structured finance transactions are issued by non-Greek issuers under UK law. In the remote event of a redenomination in Greece, only the underlying assets backing the notes may be converted into the national currency, whereas the rated notes will still be denominated in euro. In that scenario and for a given asset performance level, notes will suffer different level of losses arising from the redenomination risk, depending on the credit enhancement levels.

CDO

ABS CDO tendered

Following a tender offer announced on 19 December, €8m Faxtor ABS 2004-1 class A1 notes have been repurchased at an aggregate price of €4.36m. The repurchase was funded by principal proceeds in the principal account of the issuer received from amortising portfolio assets. Payment of accrued interest on the repurchased notes was funded by interest proceeds in the interest account of the issuer.

CDS

Kodak credit event called

ISDA's Americas Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Eastman Kodak Company. An auction will be held in respect of outstanding CDS transactions on the name.

CDS

LEI test file released

The GFMA has posted a test file of provisional legal entity identifiers (LEIs), created by the DTCC and SWIFT. This information is being made available so that member firms and other financial market participants can begin to evaluate, understand and test the operational implications for their businesses of recently enacted and impending regulatory reporting requirements that include legal entity identification.

This new rulemaking is in accordance with mandates from the G20 for improved transparency around OTC derivatives activity, as well as other regulatory initiatives. A uniform, globally consistent LEI solution will provide regulators with a powerful tool to better monitor systemic risk and enable individual firms to more effectively measure counterparty exposure, the GFMA says.

CLOs

Up-tick in CLO issuance expected

Aside from a few patches of volatility and a marginal late-year uptick in defaults, the US CLO market exhibited more stability in 2011 than in recent years, according to S&P. The improved performance of the transactions - which are primarily collateralised by corporate loans - highlights the strengthening credit of the corporate obligors whose loans back them, the agency says.

"The improving performance of corporate loans since 2008 and 2009 has translated into upgrades for many rated CLOs," says S&P credit analyst Robert Chiriani. "And many of the upgrades we've initiated have restored the triple-A ratings of CLO notes that we previously downgraded because of performance and criteria changes."

In addition to fueling a string of upgrades in 2011, the stronger credit at the loan level also boosted overcollateralisation (O/C) ratios within the CLO structures. "By December 2011, the concentration of D rated assets in CLO transactions had declined to 1.2% from the high point of 6.4% in September 2009," adds Chiriani. "The concentration of assets rated at the lower end of the speculative-grade spectrum has generally declined."

The stronger subordinate O/C ratios allowed the transactions to continue making equity distributions throughout 2011 using excess interest proceeds. Chiriani observes that subordinate O/C cushions even grew to approach pre-financial crisis levels last year.

Heading into 2012, S&P believes that increased stability will foster an up-tick in CLO issuance compared with last year's volume. While considerable uncertainty remains in the global financial markets, the agency's outlook for CLOs is for continued stable to positive rating performance.

CLOs

ACA CLO buy-back underway

Barclays Bank has commenced a tender offer to purchase for cash all outstanding class A2L, A3L, B1L and B2L notes, as well as four million preferred shares of ACA CLO 2005-1. The notes are being offered at between US$900-US$950 for each US$1,000 principal amount tendered or 63 cents (70 cents if tendered early) per preferred share.

The offer will expire on 17 February, unless extended. The 'early tender time' expires on 2 February, unless extended.

The offer is subject to certain conditions, including the condition that the offeror must receive valid tenders of 4,037,630 preferred shares (equal to a notional amount of US$4m).

CMBS

DQT edges up 5bp

The delinquency rate on loans included in US CMBS conduit/fusion transactions increased by 5bp in December to 9.32%, according to Moody's Delinquency Tracker (DQT). The rate of loans in special servicing, as measured by Moody's Specially Serviced Loan Tracker, declined by 13bp in December, to 11.97%.

December was the 12th consecutive month that delinquencies in the US have been above 9%, according to Moody's. New delinquencies in December slightly exceeded the resolutions of delinquent loans, the agency says.

Specifically in December, there were US$3.7bn of newly delinquent loans, while US$3.5bn in loans were resolved or worked out. The US$5.5bn of seasoned loan dispositions and pay-offs more than offset the US$1.4bn of new CMBS conduit deals in December, resulting in a net decline of the CMBS universe in the US to $582.8bn, Moody's says.

Bank of America Plaza in Atlanta, Georgia with an outstanding balance of US$363m was the largest newly delinquent loan in December and also became the seventh largest delinquent loan overall. By property type, the hotel and multifamily sectors were the only two to see declines in their delinquency rates in December. The hotel sector recorded the greatest decline, a 58bp drop to 12.96%, while multifamily posted a 43bp drop to 14.44%, still the highest rate among the core asset classes.

Office and retail, the largest sectors by share of total CMBS outstanding, both recorded increased delinquency rates in December. Office delinquencies increased by 26bp to 8.65%, while retail delinquencies increased by 25bp to 7.22%.

The industrial sector recorded the largest increase in delinquency rate, rising 59bp to 12.09%, the highest delinquency rate reported for the sector to date. By state, Nevada continues to have the highest delinquency rate, at around 20%.

CMBS

PPIP capital supporting CMBS

Oaktree was the only firm to deploy additional Public Private Investment Program (PPIP) capital in Q4, according to the US Treasury Department's latest update on the programme. The fund deployed about US$29m in equity, increasing the total gross paid in capital by US$116mn (including Treasury equity and Treasury debt). As a result, Oaktree's reported utilisation ratio increased to 31.8% in 4Q11 from 29.3% in Q2.

ABS analysts at Barclays Capital point out that Oaktree's increased activity is especially important because its PPIP fund has historically run at a lower utilisation ratio, indicating that it still has a larger investment capacity in the future. The PPIP fund focuses on CMBS, in particular.

CMBS securities currently account for about US$5.1bn, or around 25%, of all PPIP holdings by market value. As in the prior quarter, the majority of CMBS funds were invested in AM tranches (accounting for 51% of total CMBS holdings or about US$2.6bn), followed by AJs (28% or US$1.5bn). Dupers account for only 8% of all CMBS holdings, surpassed even by 'other' CMBS paper (13% or US$650m).

Overall CMBS holdings increased by about US$400m in Q4, according to the BarCap analysts, with almost all of the increase coming from the AM sector. Some of the appreciation is due to higher AM prices in Q4, as well as additional AM purchases made during the quarter.

The median holding price for super-senior CMBS securities in Q4 was reported at US$106.4 - the second-highest level since January 2010, when the first quarterly report for PPIP holdings was released. This is about US$3.3 higher than the US$103.1 median holding duper price reported in Q3. The increase in dollar prices was visible mostly in AM tranches, which rose from US$87.5 in Q3 to US$93.9 in Q4.

Risk Management

Regulatory reporting service enhanced

OpenLink Financial has rolled out initiatives focused on accelerating compliance with Dodd-Frank regulatory milestones scheduled for 2012. Among these initiatives are: a Dodd-Frank regulatory compliance reporting package; CFTC position limits monitoring, in aggregate for both OTC and exchange-traded products; swap data repository (SDR) reporting; and OTC trade processing workflows, which have been extended for the lifecycle of cleared derivative products. Connectivity options to CCPs and clearing houses are also available.

Risk Management

OTC valuation tool enhanced

CMA has released CMA NAVigate 1.9, which introduces the ability to upload counterparty marks, set reporting tolerance levels and generate portfolio variance reports. The solution aims to provide customers with the environment, data and tools to manage the generation of independent OTC derivative valuation reports.

Other key features of the service include the ability to: examine all underlying cashflows, discount factors and risk measures; create on-demand historical valuations and bespoke reports; and create an audit trail of all valuation results and challenges. Gareth Moody, CMA NAVigate product owner, comments: "As a direct result of feedback from our clients, we adapted the workflow to allow users to compare valuations from third parties with those received from their counterparties. By including this functionality, we allow our clients to use CMA NAVigate to formalise their existing pricing practices and streamline technology and processes. Ultimately we envisage CMA NAVigate as a tool for centralising a lot of these functions in a fully managed and data-populated environment."

RMBS

ML II sale completed

The New York Fed has sold US$7bn in face amount of assets from its Maiden Lane II (ML II) portfolio to Credit Suisse through a competitive process. The regulator says the transaction was prompted by an unsolicited offer from Goldman Sachs to BlackRock Solutions, the investment manager for ML II, in January 2012 to buy a portion of ML II assets.

Consistent with its March 2011 announcement regarding the disposition procedures for ML II, which allowed for these types of reverse inquiries, the New York Fed directed BlackRock Solutions to conduct a sale via a competitive process. The four broker-dealers included in the competitive process were Barclays Capital, Credit Suisse, Goldman Sachs and Merrill Lynch. The broker-dealers were selected based on their previous expressions of interest for large parcels of the portfolio and/or their participation in the ML II bid-list process conducted last year.

The New York Fed decided to move forward with the transaction only after determining that the winning bid represented good value for the public. The transaction substantially reduces the ML II portfolio and loan at a desirable price, it says. Furthermore, the transaction is consistent with ML II's stated investment objective.

The New York Fed, through BlackRock Solutions, will dispose of the remaining securities in the ML II portfolio individually and in segments over time as market conditions warrant through a competitive sales process, while taking appropriate care to avoid market disruption. There will be no fixed timeframe for the sales; at each stage, the Fed will only transact if the best available bid represents good value for the public.

RMBS

SEMT 2012-1 qualities highlighted

S&P has published an unsolicited comment on the Sequoia Mortgage Trust 2012-1 RMBS, which is expected to close on 27 January. The agency has reviewed the preliminary term sheet filed with the SEC and the publicly available loan-level data on this transaction, and says that the collateral characteristics compare favourably to an S&P archetypical pool.

Further, the agency notes the relatively high credit quality of the loans in the pool, which have weighted average FICO scores of 767, CLTVs of 65 and a DTI ratio of 29. The mortgage pool was 100% current at the time of analysis.

The transaction employs a shifting interest structure, according to S&P. The senior class has 8.25% of hard credit enhancement, a five-year lockout period for principal prepayments, a subordination floor of 1.05% of the original balance, and delinquency and realised loss performance tests. This hard credit enhancement level compares to 7.4% for SEMT 2011-2, 7.5% for SEMT 2011-1 and 6.50% for SEMT 2010-H1.

The subordination floor is not allowed to step down, which provides further protection to the senior classes.

In addition, the agency views the provision for binding arbitration by an independent third-party to resolve repurchase disputes to be of particular value to investors in SEMT transactions. It believes that binding arbitration will likely limit future costs and provide for timely and efficient resolution.

RMBS

Stable outlook for UK prime RMBS

Moody's expects the performance of UK RMBS master trusts containing prime mortgages to remain stable, experiencing only a marginal deterioration in 2012 as a result of the slow domestic economic recovery. Performance in master trusts with a high proportion of buy-to-let or non-conforming collateral (such as Aire Valley, Mound or Pendeford), or prime collateral with riskier characteristics (such as Granite) will deteriorate marginally as a result of limited refinancing opportunities available to such borrowers.

The performance of the trusts remained stable in 2011. However, Moody's has a stable/deteriorating outlook on the UK prime RMBS sector and a negative outlook on the UK banking sector.

"In 2012, stable collateral performance will be driven by stable house prices, stable mortgage rates, a relatively small increase in the unemployment rate and continued lender forbearance," says Jonathan Livingstone, a Moody's vp-senior analyst. To a lesser extent, asset additions and flexible credit products will suppress some delinquencies.

"We believe there is the potential for the performance on UK prime RMBS to deteriorate slightly due to reduced government spending and increased taxes," adds Livingstone. Further, a slower-than-expected economic recovery - which could result from a worsening of the euro area sovereign crisis - would adversely affect performance in the sector.

Three-month arrears for the UK prime RMBS sector remained at around 1.8% over the past 12 months. Weighted-average repossessions during the period have increased slightly to 0.29% from 0.25%, mainly due to the increase of repossessions in the Granite master trust. Similarly, there has been an increase in loss severities to 23.3% in 2011 from 20.4% in 2010.

The weighted-average current LTV ratio of the trusts has remained fairly constant at 66.5%, although the indexed LTV has increased slightly to 68.9% compared with 66.9% in the previous year. The proportion of borrowers in negative equity has increased to 8.3% in 2011 from 6.5% in 2010.

RMBS

Mortgage servicer performance deteriorates

As measured by total loans cured and cashflows from their loans, the performance of residential mortgage servicers deteriorated in 3Q11, according to Moody's latest Servicer Dashboard report. The agency says a lower volume of loan modifications contributed to the deterioration.

"Servicers have worked through the majority of delinquent loans and are shifting their focus to liquidation strategies, such as short sales and deeds in lieu of foreclosure," says William Fricke, a Moody's vp and senior credit officer.

The Dashboard also shows that the volume of foreclosure sales declined sharply with the onset of the robo-signing issue in October 2010, but has since been recovering slowly. "Foreclosure volumes should be recovering now, but for most servicers are well below what they were in October 2010," adds Fricke.

Pending foreclosure volumes remain high for all types of residential mortgages. The amount of time on average before a foreclosure sale improved in the third quarter, as states with judicial foreclosures continued to work through their significant backlogs of foreclosed loans and the servicers completed their robo-signing reviews.

Regarding the performance of individual servicers, Moody's notes that Chase and Bank of America continued to have performance metrics that lagged those of peers in the third quarter. "Chase and Bank of America are still facing an unprecedented volume of defaulted loans that they need to resolve, as well as regulatory scrutiny on several fronts," continues Fricke.

However, the agency notes that the foreclosure sale timelines of Chase and Wells Fargo decreased significantly. The performance of Ocwen modified loans over a one-year period, meanwhile, indicates that it is re-modifying loans at a far greater pace than its peers.

RMBS

Distressed property tool offered

DataQuick has released RiskFinder Distress, a tool designed to provide investors, lenders and servicers with the ability to search and analyse the risk levels of distressed properties nationwide. The service enables users to track key distress events throughout the lifecycle of a loan, allowing them to determine the impact of distressed sales on loss severity estimates, drive loss mitigation strategies and identify markets that are starting to recover. Trends can be analysed by geographic level and time period, with coverage available nationwide and by ZIP code.

RMBS

Granite re-rated

S&P has taken various rating actions on all classes of notes in the Granite UK RMBS master trust. The move follows the agency's counterparty analysis, as well as credit and cashflow analysis of the most recent transaction information that it has received.

The master trust consists of five 'capitalist' issuers (Granite Mortgages 03-2, 03-3, 04-1, 04-2 and 04-3) and a 'socialist' issuer (Granite Master Issuer), where nine issuances remain outstanding. S&P on 12 December placed its ratings on all classes of notes on credit watch negative in relation to its updated RMBS criteria, as arrears levels are high relative to arrears levels in similar transactions.

In the agency's opinion, the collateral pool has exhibited relatively stable performance over the past year, with arrears greater than 180 days remaining at about 3.5% since January 2011. Repossessions have also stabilised at about 0.69%. Additionally, credit enhancement continues to increase for all tranches and all reserve funds are either fully funded or above 97% of the target level and continually topping up.

As a result of these factors, S&P's credit and cashflow analysis indicates that after applying its updated RMBS criteria, all classes of notes pass the cashflow scenarios at higher rating levels. Therefore, the agency has raised its ratings on the class C notes in the capitalist series, as well as on the class M and C notes in the socialist series.

However, S&P doesn't consider the issuer bank agreements for the capitalist series to be in line with its 2010 counterparty criteria, as there is no timeframe for replacement. Therefore, under this criteria, the highest potential rating on these notes is equal to the long-term issuer credit rating (ICR) on the bank account provider - Citibank - which the agency recently lowered to A/Negative/A-1 from A+/Negative/A-1. S&P's ratings on the capitalist series of notes are consequently capped by its rating on Citibank and it has lowered its ratings on the class A, B and M notes accordingly.

The agency doesn't consider the funding swap agreements to be in line with its 2010 counterparty criteria either. Rather, the swap agreement reflects replacement language in line with its previous counterparty criteria.

Therefore, under the criteria, the highest potential rating on these notes is equal to the ICR on the swap provider - Northern Rock Asset Management (A/Stable/A-1) - plus one notch. S&P's rating on the lender remains unchanged; in light of this, it has affirmed its ratings on the class A and B notes for the socialist series.

Finally, Granite Master Issuer's Rule 2a-7 money-market notes - the series 2006-1 class A1 notes, series 2006-3 class A4s and series 2007-2 class 4A1s - have been affected by S&P's rating actions. As well as long-term ratings, the agency has assigned short-term ratings to these notes.

On each anniversary of the closing date for each transaction, these notes are remarketed by the remarketing bank - Barclays Bank. If any notes are unable to be resold, a conditional purchaser (Barclays Bank) is contractually obliged to purchase the notes.

Therefore, the ratings on these notes are linked to the rating on the conditional purchaser. As such, following S&P's recent downgrade of Barclays Bank to A+/Stable/A-1 from AA-/Negative/A-1+, the agency has lowered the short-term ratings on these notes to A-1 from A-1+.

RMBS

Busted swap claim mooted

A meeting has been convened on 17 February for Eurosail Prime-UK 2007-A class A noteholders to consider, and if appropriate, pass an extraordinary resolution to terminate the hedging agreement with Lehman Brothers Holding Inc (LBHI) and agree to a stipulated and 'Agreed Claim Amount' of US$106m. European asset-backed analysts at RBS note that the move is significant because it is believed to be only the second Lehman busted swap transaction to reach an agreed claim amount.

The agreed claim amount is larger than the initial claim of US$97.28m reported on 29 September 2009 but smaller than the revised claim of US$144.85m as of 9 February 2011. The RBS analysts suggest that, based on the revised claim, this result for the size of the agreed claim (73.2%) is consistent with the result for Eurosail-UK 2007-6NC (74.7%).