Fitch Ratings has downgraded six classes of notes issued by Eastman Hill Funding I, Ltd./Inc. (Eastman Hill) as follows:
--$189,860,135 class A1-FL notes to 'B/RR1' from 'AA'; Rating Watch Evolving;
--$3,708,206 class A1-FX notes to 'B/RR1' from 'AA'; Rating Watch Evolving;
--$193,568,341 class A-2 notes to 'B/RR1' from 'AA'; Rating Watch Evolving;
--$10,000,000 class A-3 notes to 'CCC/RR6' from 'BBB';
--$32,814,300 class B-1 notes to 'CC/RR6' from 'CCC/RR4';
--$25,000,000 combination notes to 'C' from 'CC/RR6'.
Additionally, Fitch has removed classes A1-FL, A1-FX, A-2 and A-3 from Rating Watch Negative.
These rating actions reflect pending litigation that resulted in a court order on Dec. 31, 2008 restricting payments of interest and principal to all notes on the Jan. 2, 2009 payment date. Proceeds, otherwise payable to the notes on Jan. 2, 2009 from the interest and principal collection accounts, are being held in escrow pending the outcome of this litigation.
The ratings of the class A-1FL, A1-FX, and A-2 notes have been downgraded to 'B' indicating this non-payment of interest and the absence of a provision in the governing documents for these notes to be repaid missed interest. RR1 Recovery Ratings have been assigned to these notes indicating Fitch's opinion that ultimately they may receive all of their interest and principal payments thereby sustaining little to no losses.
Furthermore, the class A-3 notes were downgraded to 'CCC' as they continue to receive interest, however, some principal recovery may be expected based on the composition and credit worthiness of the existing portfolio. The class B-1 notes are deferring interest. The class B-1 notes were downgraded to 'CC', reflecting the current litigation and the unlikely payment of future principal. The RR6 rating on the class A-3 and B-1 notes reflect Fitch's low recovery expectation on tranches.
The class A1-FL, A1-FX and A-2 notes have been placed on Rating Watch Evolving pending the outcome and resolution of the litigation. Fitch notes that the current balance reported in the trustee report and noted above reflect anticipated principal distributions being held in escrow as a result of the court order issued Dec. 31, 2008. Future interest calculations and OC and IC performance tests are being calculated using these proforma class balances.
Following the resolution of this litigation, Fitch anticipates actual distributions will be made to the respective noteholders as specified by the courts. At that time Fitch will revisit the ratings of all classes of notes. Fitch anticipates its ratings on the class A-1FL, A-1FX and A-2 will improve following the resolution of the litigation, however, an extended period of litigation and/or further court orders may result in a ratings downgrade.
On Sept. 17, 2008, noteholders of the class B-1 (plaintiff) initiated litigation against the issuer, co-issuer, trustee, asset manager and the senior noteholders (defendants). The plaintiff filed a complaint alleging that the use of various swap transactions did not conform with requirements set forth in Eastman Hill's governing documents. Additionally, the plaintiff has identified $1,015,856 of payments that would have previously been made to it if the swap transactions were not used. The disputed swap transactions provided for more evenly distributed payments of interest proceeds to the notes from one quarterly payment period to the next. Interest proceeds without the swap transactions vary significantly between quarterly payment periods as there are a large percentage of semi-annual pay assets in the portfolio.
If the court rules in favor of the plaintiff and the use of swap transactions is ceased, there may be some nominal future interest payments to the class B-1 notes. If the court rules in favor of the defendants, Fitch does not project future interest or principal payments to the class B-1 notes.
The rating actions also incorporate negative credit migration in the portfolio and incorporate Fitch's recently adjusted default and recovery rate assumptions for analyzing structured finance (SF) collateralized debt obligations (CDOs) as well as updated criteria for corporate CDOs.
The credit quality of the portfolio has deteriorated since the ratings were affirmed in December 2006. The Fitch derived weighted average rating has decreased to the 'BB+/BB' category from the 'BBB/BBB-' category. The portfolio is currently composed of 66.5% corporate bonds, 29.2% government sponsored entity residential mortgage-backed securities (RMBS), 3.4% subprime RMBS from 2003 and 2004 vintages, and 0.9% real estate investment trusts (REITS). The three corporate industries with the highest concentration are telecommunications, automobiles, and utilities representing 23.3%, 10.5% and 5.4% of the portfolio, respectively. Approximately 20.5% of the portfolio is rated below investment grade (16.9% corporate/3.6% SF) and 10.9% is rated 'CCC' and lower (8.9% corporate/2% SF).
Eastman Hill is a cash flow CDO which closed on July 2, 2001. The portfolio is monitored by TCW Asset Management Company. The reinvestment period ended in June 2006.
The rating of the class A-2 notes addresses the likelihood that investors will receive full and timely payments of interest on scheduled interest payment dates. This rating does not address any distribution of principal.
The rating actions resolve the 'Under Analysis' status issued on Oct. 14, 2008 following Fitch's announcement of its proposed criteria revision for analyzing SF CDOs. The revised criteria report, 'Global Rating Criteria for Structured Finance CDOs' was published in its final form on Dec. 16, 2008 along with an updated version of the Fitch Portfolio Credit Model (PCM) that includes additional functionality for analyzing SF CDOs. This transaction was also reviewed in accordance with its updated criteria released on April 30, 2008 for Corporate CDOs. As part of this review, Fitch makes standard adjustments for any structured finance names on Rating Watch Negative or with a Negative Outlook, downgrading such ratings for default analysis purposes by three and one notches, respectively. Fitch also makes standard adjustments for any corporate names on Rating Watch Negative or with a Negative Outlook, downgrading such ratings for default analysis purposes by two and one notches, respectively.
Fitch Ratings, New York
Brian Vorderbrueggen, 212-908-9102
Kevin Kendra, 212-908-0760
Sandro Scenga, 212-908-0278