Houston-based energy concern Enron Corp. and lead underwriter Salomon Smith Barney brought one of the largest-ever single-name credit-linked notes to the market last week, a structured synthetic that has drawn attention from many investors who typically buy corporate bonds.
The public deal, for $1 billion, is being issued in three currencies in five-year fixed-rate notes, and is being executed out of both London and New York. The deal has been rated by Standard & Poor's, which was putting together a pre-sale report at press time last Thursday.
According to insiders knowledgable about the deal, Enron's intention is to free up some of their bank lines as its bank liquidity begins to dry up. The company, which deals in the sourcing and distribution of energy and gas, has a very capital-intensive business. There is approximately $2.7 billion of Enron paper out in the market right now.
The deal's structure involves a credit swap that takes place between the trust and Citibank, which is the swap counterparty. An SPV issues notes and certificates, the proceeds of which are used to purchase trust investments that are single-A or better. The trust enters into a swap with Citibank, and Citibank pays the trust the equivalent of the coupon on the notes, in exchange for interest payments.
"The embedded credit swap in this synthetic references Enron as a corporate obligor, so if Enron experiences bankruptcy, or failure to pay, other elements of the swap engage," said Terry McCarthy, one of the S&P analysts that is rating the deal. "S&P uses a weak-link approach' to rate such a deal. Citibank's rating as swap counterparty is double-A-minus, the trust investments are A+/A-1 or better, and Enron's senior unsecured debt rating is triple-B-plus. The rating on these notes is linked to the weakest of those three.
"If any one of those three weak links fails to perform, there's a possibility that our note holders will suffer a loss. For example, if one of the trust investments defaults, the note holders may incur a principal loss equal to their pro-rata interest in the defaulted trust investment."
Trust investments are the source of repayment of principal, so they need to mature prior to the maturity of the synthetic, McCarthy added. If that money is not there, the note holders won't get paid full principal; if the swap counterparty is not there, the the coupon will not get paid.
Citibank, in effect, is purchasing credit protection from the SPVs being set up, and the trust is providing the fault protection to Citibank.
"Some investors are looking at this as a five-year Enron corporate," said a market source. "But they have to assess, what's the additional structure risk?" Credit-linked notes typically go to buy-and-hold investors; they are custom-made and usually do not resurface after they are initially issued.
"But there might be a development of a secondary market for this issue," the source said. "I wouldn't be surprised if we see similar deals down the road."