Barclays Capital analysts have found that structural "surprises" in securitized deals found over the past several years have highlighted inefficiencies within transactions.
In a report published last month, analysts said that structures sometimes work differently from investor perception and, in some cases, exhibit inherent problems within the structures. More of such surprises are expected to emerge as these structures continue to be tested.
"Securitization structures in Europe are not as standardized as in the U.S. due to jurisdictional differences across countries and the shorter history of the sector in Europe," analysts said. "The European securitization market grew strongly over the past decade, with little precedent to rely on as to how structures would work in practice."
In 2008, the RMBS and consumer ABS sectors saw a number of transactions suffer due to the problems with third-party providers and counterparties in a transaction. Lehman Brothers' bankruptcy filing, for example, meant that no gradual triggers were breached and various supporting measures were not used, as would be the case in the normal course of action.
Typically, according to Barclays, if the swap counterparty is downgraded, then that entity would be required to post collateral or find a guarantor or a replacement. The main problem with the bankruptcy was the "jump to default" of the entity, whereby Lehman was effectively removed from the market overnight.
"We do not envisage the same issue recurring, given the level of systemic support provided by the governments, but caution investors on the effects of multi-notch downgrades on counterparties," Barclays analysts said.
Another aspect of the effect of failing counterparties is the provision of the liquidity facility. In a number of cases, the structural provisions have acted as expected, meaning transactions have not suffered, and some have even benefited. However, there are some instances where a transaction is left without a liquidity facility and without a valuable source of comfort for investors.
In May 2008, the first non-renewal of a facility by the provider occurred in the U.K. nonconforming Newgate 2006-1 transaction. It was a 364-day committed facility that was drawable to pay senior costs and expenses of the issuer and certain note coupons depending on various trigger events.
Following the non-renewal of the facility, the contract required the issuer to draw down on the full amount of the standby facility and therefore pay the higher drawn fee to the provider. The issuer has access to the full drawn amount until it finds a replacement provider or all the notes are redeemed, after which the remainder of the facility is returned to the original liquidity facility provider.
"The result is negative carry on the transaction due to the increased fee, but the effect is minimal given the size of the facility," Barclays analysts said. Fitch Ratings estimated the increased cost in this transaction would be four basis points.
The second instance of a non-renewal was due to a possible administrative error.
Issuers need to keep track of when liquidity facilities and other third-party provisions expire to renew them within the time specified in the transaction documentation. Failure to do so risks a fundamental support to the transaction being removed and, consequently, could lead to rating downgrades.
Barclays analysts said that there is a need to reform the industry. For example, by requiring that legally binding documentation be disclosed in the public domain. There is also a need for investors to look closely at the deals' exposure to counterparties.
"Guidance or standards from industry groups that could help market participants deal with these unanticipated surprises would be useful in avoiding potentially harmful legal issues in the future," analysts said.
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