As anticipated, 12b-1 fee ABS have graduated from the traditional private placement market, with last week's closing of the first-ever Rule 144A mutual fund fee securitization from Citibank N.A. Making this jump possible is the integration of equity index put options into a securitization structure, buttressing collateral performance from sustained downturns in stock markets (see ASR 11/04/02).
Citibank's deal, $256 million of notes from the Hedged Mutual Fund Fee Trust 2003-1 via Salomon Smith Barney, consisted of $191.75 million of single-A rated, A class notes and $64.25 million of B class notes, also rated single-A. Both tranches have a seven-year term. Both remaining 12b-1 fee ABS issuers - Citibank and Constellation Financial Management - now use puts as hedges against stock-market volatility.
The new product incorporates index put options that act as a hedge against poor market performance. "With the new structure, which we're packaging for much broader complexes, it looks much more like a traditional fixed-income security," said Paul Donlin, managing director, global head of securitization at Citibank. Donlin estimated that his firm will help finance $25 billion in mutual fund sales in 2003.
Hedging schemes have changed the landscape of securitization; traditional bond structures allowed investors to carry "naked risk," said Constellation managing director of asset-backed structuring Joe D'Anna. After being mauled by a two-year bear market, investors are interested in avoiding such risk.
This structure seems to have saved the market for 12b-1 fee ABS. In October, 2002, Financial Research Corp. of Boston predicted the impending demise of B shares, the fees for which back these transaction. The sector as a whole accounted for 16.6% of the traditional ABS market's 102 downgrades in the 1H02, according to Moody's Investors Service.
"Last year, the market was pretty dry for this asset class," said Lily Cheung, director at Standard & Poor's in New York. However, securitization may be on the rise, in part because of new hedging structures, Cheung added.
"We developed a structure that develops puts on baskets or market indices that transfers the market risk component of the mutual fund fees out to an investment bank and then leaves behind the more traditional bond type risk," D'Anna explained. "The market's been pretty receptive to that."
All this repackaging is a good thing for mutual fund companies, who are facing growing concerns about risk management and the new-found vagaries of the stock market. "The demand has increased significantly from the mutual fund complexes," Donlin said.
Both Citibank and Constellation see 12b-1 fee securitization on the rise. D'Anna said, "Only a tenth of mutual fund B share sellers utilize an outside party for financing or risk transfer. We think that fraction is going to increase."
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