Fitch Ratings last week announced that it would downgrade by one notch all unwrapped tranches of notes issued under the whole business securitization of Craegmoor Funding No. 2. The rating agency said it remains concerned about several issues connected with the deal, including qualified and late accounts, uncertainty over the accuracy of past performance reports, a lack of clarity on recent and current trading, and a concern that the financial covenant could be breached.

The issue comprised fixed and floating notes issued by Craegmoor Funding No.2 PLC and totaling GBP245 million ($430 million). This amount includes GBP157.5 million ($276.4 million) of triple-A rated paper. Fitch downgraded Craegmoor Funding No. 2's Class M notes to A- from A and the Class B notes to BB+ from BBB-. Fitch is keeping the Class M notes and the Class B notes on Rating Watch Negative. Although the Class A1 and Class A2 notes are wrapped to AAA by MBIA, Fitch downgraded the underlying rating to A from A+.

According to Michael Cox, an analyst on the securitization research team at the Royal Bank of Scotland, the concerns include the following: that past quarterly reports may be inaccurate; that either the failure to file accounts or the filing of qualified accounts may be an event of default under the terms of the issuer/borrower facility or other lending arrangements; that current and future trading may be even worse than that rolling off the annualized figures; and that a breach of the financial covenant may be triggered by the next quarterly report even though the numbers contained therein may be unreliable.

"MBIA is controlling creditor in the securitization, and therefore has the ability to direct the security trustee whether or not to enforce the security over the borrower group," said Cox. "With current owners Legal & General Ventures having appointed new management and making an effort to remedy the situation, we see little benefit in enforcing security immediately over accounting issues. However, should a breach of financial covenant follow, we would expect security to be enforced unless L&G Ventures remedies the breach by posting cash."

Cox estimates that the amount required to be posted would effectively be 24 times the amount by which rolling four quarter net cash flow is below the amount necessary to maintain a debt service coverage ratio of 1.20x. As long as there is value to protect in the business, Cox expects L&G Ventures to seek to protect that value by posting cash.

"Unfortunately, the lack of reliable trading information, made worse by the company's refusal to distribute its performance reports to sell-side analysts, will not help spreads," he said. "Although we expect spreads to be wider, we think that the bonds are underpinned by the value of the business and should not go too wide."

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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