The recently announced Lonestar German nonperforming loan (NPL) securitization deal may bring to mind predictions made roughly two years ago about the German NPL securitization market booming. However, market sources said that the sector's inaugural deal is likely to be a one-off, at least in the near term.

Lonestar's 1.34 billion ($1.78 billion) Bluebonnet Finance plc is backed by a mixture of nonperforming (50%), subperforming (26%) and performing (24%) loans acquired by the private equity firm Lonestar, which has been very active in the German NPL sector in recent years. It is the first transaction of its kind for Germany and the largest NPL issued in Europe to date.

This transaction represents the securitization of a secured note issued by LSF5 Olympic, LLC to Citibank's, London branch, which is sold consequently to the issuer. The LSF5 note issuer will apply the net receipts from a portfolio of nonperforming, sub-performing and performing loans and their related collateral to meet its payment obligations under the LSF5 senior notes. The loans are mostly secured by mortgages on commercial and residential (largely multifamily) properties located in Germany.

The structure differs from Italian NPL securitizations because under the Italian structure, the issuer purchases all the subperforming loans. The notes there are prepaid by recovery proceeds of the loan, said Moody's Investors Service analysts, who rated the deal. The Bluebonnet transaction follows a two-tier structure, with a U.S. SPV owning the loans. Bluebonnet Finance holds a debt security issued by this U.S. entity. Therefore, the investor has no direct access to the loans, but only indirectly through the underlying bond collateral. In contrast, in most Italian transactions, the loans are owned directly by the issuing SPV.

Key strengths

The key strengths of the transaction include the experience of Hudson Advisors Germany GmbH in servicing and working out such loan portfolios, the loan diversity, property diversity in terms of number, types and locations. The main weaknesses of the transaction, said Moody's analysts, are the dependence on Hudson Advisors Germany in servicing and working out the portfolio, certain legal and tax risks associated with the corporate and transaction structure; potential cash flow allocation to junior lenders of the LSF5 Note Issuer, and swap termination in case of enforcement of the LSF5 Senior Notes upon default.

"The performance of Italian NPL securitizations, barring one or two blips, has been good, although the majority of deals have now paid down substantially or have been called," Dresdner Kleinwort analysts said recently. "As such, despite the fact that year-end is rapidly approaching and the deal will require some intensive credit work, we would expect the deal to be meet significant interest as a diversity play for investors, assuming the price is right of course."

While the deal is largely slated to be well received, making the case for a German NPL securitization boom is harder because potential German issuers are still accessing cheaper financing via the bank markets.

"Two years ago, market participants were expecting a big market for multifamily and NPL securitization transactions to develop as many market players acquired substantial portfolios of multifamily properties and non-performing loans," a Moody's analyst said. "The multifamily market has taken off as expected but it hasn't been the case for NPLs, nor do we expect that the Bluebonnet deal will be a starting point for a significant development of this market in terms of size."

Securitization is still seen as a difficult tool because it is not as competitive as the traditional method of funding. Moody's analysts said that the Lonestar deal benefits from size and therefore from economies of scale, which is crucial to make securitization a worthwhile venture for potential issuers going forward. "A lot of big banks offer alternative sources of funding so there is not ... pressure to refinance via the securitization market," the Moody's source said.

Clarence Dixon, managing director at Crown Mortgage Management Gmbh, also saw the deal as a one-off for this year and doesn't expect to see the market really heat up until the latter part of 2007.

"I think this deal is what has been needed because it gives issuers a flavor of what the requirements are to get these deals done," Dixon said. "Many of these portfolios are securitizable but I think the strategy has moved from buy, buy and buy to recover, recover, recover and then it will shift to securitization."

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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