First French CBO Post-Crisis Launches

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It took two years, but the first French CBO since 2008 was finally launched in late July. The deal's portfolio comprises 19 bonds granted to as many medium-sized companies. As of July 2012, the portfolio's current balance was roughly €30 million ($37.6 million).

Paris-based independent cooperative finance firm Groupe GIAC arranged the €80 million cash transaction. GIAC provides long-term financing to French companies.

GIAC is the originator, underwriter and manager of the CBO's assets and is sponsoring and managing the securitization structure through a wholly-owned fund management company.

Prior to 2008, GIAC easily completed six CLOs, with the difference in these deals being that a bank was used as an intermediary. Although GIAC was the only company doing deals of this type prior to the crisis, there were many German and Spanish banks that were refinancing SME loans through quasi-public programs enhanced by guarantees. This activity had nearly come to a halt since 2008. Currently, the banks that hold most of the SME loans that can be securitized in France and in Europe do not have a motive to access the securitization market since regulators are requiring them to hold 5% of the junior piece in such deals, eliminating one of the major incentives for these offerings. GIAC arranges financing that has a 7% junior deposit which risk is shared across all borrowers. The structure has been approved by the French regulator as meeting the 5% junior holding requirement.

Collateralized bond obligations have never been a common way to fund smaller firms even before the crisis. The reason the GIAC transaction has been structured as a bond deal is because in France, loans to companies must be granted by banks, according to Moody's Investors Service Vice President Ian Perrin, who rated GIAC's transaction. The only way a non-bank company can supply financing is by subscribing to a bond-like instrument, which is issued by the enterprise being funded, Perrin said.

 Bumps Along the Way

The length of time that it took for this CBO to launch gives "a good indication of how complex it was to assemble the crowd of investors and have the rating agencies vet the deal," said Fabrice Pedro-Rousselin, who helped arrange the transaction as adviser to GIAC's chairman. He explained that traditional ABS investors have been hard hit by spiraling secondary spreads and the deteriorating asset quality of pre-crisis transactions and are now wary of investing in any type of SME CDO deal.

"We therefore have to convince new investors, not traditionally involved in the ABS market, but rather government and corporate/FIG bond investors who would like to diversify holdings and are looking for spread pickup in quality paper, which our deal and other SME CDOs would typically offer," Pedro-Rousselin said.

One reason the process took some time is that GIAC does not have warehousing lines to accumulate assets prior to a deal's launch, meaning the portfolio manager largely buys the assets, or "ramps up" the portfolio, post issue.

Pedro-Rousselin said that with GIAC's current origination rate of €100 million, warehousing is not critical to its success. However, it would have been quite useful in the context of the current deal to have such a line as the deal's structuring stretched to close to two years and caused borrowers to be edgy."For the next deal, the critical point is not the availability of warehousing, but if we can get a healthy buyer base to invest into such a transaction," he said.

Moody's said that one of its concerns about the deal was the length of the ramp-up period, which could take as long as 15 months. This adds uncertainty regarding "the exact final characteristics of the portfolio, especially in terms of credit quality and recovery rates," Moody's said.

However, the rating agency took comfort in the deal's covenant to recharge the portfolio with only high-quality obligors. Additionally, GIAC does not intend to deviate from its origination policy of favoring secured bond issues. During the deal ramp-up, collateral manager GIAC Gestion will increase the size of the portfolio on a quarterly basis up to €80 million.

"This deal, unlike a typical CLO transaction, which is usually collateralized at 60% to 80% at closing, was ramped-up at lower levels," Perrin said. "This is also unlike SME CLO transactions originated by banks that have a huge portfolio of loans to select from and are generally fully ramped up at closing. In this deal, we had to assess GIAC's ability to originate loans and get the ramp-up completed. We have also been focusing more on the operational risk aspects of transactions since the crisis, which here derived from the fact that this transaction is not backed by a bank." Perrin added that they also took comfort in the fact that Moody's had rated the firm's six previous deals that came to market before the crisis.

Investor Interest

"The one thing that made this deal finally gel together was that we had investors who were committed to making the deal happen, and they eventually accepted a fixed spread deal for the ramp-up period," Pedro-Rousselin said. "It was a close call, especially when dealing with investors who are highly attuned to the markets and are taking this deal to resell into the secondary market." The initial investors are fully committed to fund the transaction during the ramp-up period.

There were also some other positive factors going for the transaction. In its presale report, Moody's said that one of the deal's strengths is GIAC's experience as an originator, which dates back to 1962, when it was founded. The company has been originating financings to French firms in different sectors since then.

The rating agency also cited the portfolio's sector diversity, with no obligors representing more than 3% of the total portfolio amount. The CBO's assets are simple to understand, with all bonds carrying the same coupon at 305 basis points over the three-month Euribor. They also have the same structural features, with a 10-year term, a five-year interest-only period and a 7% cash collateral guarantee that is mutualized across all bonds to provide for a first-loss protection to investors.

The fund has six tranches, with the two most senior series P1 worth €40 million rated 'Aa3(sf)' and the series P2 worth €10 million rated 'A3(sf)' by Moody's. The third series is fully wrapped by OSEO, a French state bank rated 'Aaa'. The transaction's unrated mezzanine bonds A and B are worth €18.46 million and €4.62 million, respectively. Meanwhile, the deal's unrated mezzanine C units are worth €1.06 million and its junior units are worth €5.60 million.

The securitization has a 7.0% - as a percentage of the total issued notes - guarantee fund, which is funded at closing.

Another delaying factor that Pedro-Rousselin cited is linked to the securitization market's current state, with rating agencies and investors unwilling to vet a deal where the assets' ultimate credit quality is unknown. On the asset side, although there are structural ways around it, ABS spreads and SME credit quality being highly volatile have made "the whole exercise like treading water," he said. The initial investors are fully committed to fund the transaction during the ramp-up period.

Good asset quality is essential, although by the time a potential pool of assets is assembled, spreads usually have moved and SMEs become the more viable alternative. However, these SMEs might not be accepting of the new pricing levels or might have sought financing elsewhere, mostly through banks.

In France, the banking sector provides 80% to 90% of the SME sector's funding needs, although with the current capital constraints, banks are not as willing to step up to the plate for even the perfectly good credits. This makes turning to the CDO market attractive for these firms, which might be more willing to wait for the money if they have limited options elsewhere.

Additionally, in terms of the liability side of the equation, Solvency II capital constraints and sovereign debt issues have forced insurance companies to reorient their investment resources from private equity and sovereign debt to corporate bonds. There is some room and interest from these insurance companies to fill the shoes of banks, according to Pedro-Rousselin.

The funding options that companies like GIAC offer - comprising low-risk corporate bond products with high diversification in terms of sector, company, and region - might be fit for those that do not have the resources and expertise in-house to lend to SMEs.

GIAC is therefore seeing potential to increase its market share in the long-term funding market in France. Any future deal would have to be at least €200 million in size to measure up to the need on both the asset and liability sides.

Meanwhile, Perrin from Moody's said there is some interest in future French SME securitizations, with the country's institutions currently trying to diversify their sources of funding.

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