The debate about the viability of the super-senior structure in the current environment experiences a resurgence, Fitch Ratings said today.
For instance, the DBUBS 2011-LC3 deal had a Fitch-rated ‘AAAsf’ super-senior class with 30% credit enhancement, which is considerably more than the 21% credit enhancement supporting the junior-senior class. This class is also rated ‘AAAsf’ by the rating agency.
According to Fitch, the re-emergence of this type of structure has caused an old debate to resurface among market participants — whether there is value in dividing a triple-A class into various layers.
"On the one hand, super-senior structures afford an investor extra credit protection against even the most severe stress scenarios," Group Managing Director Huxley Somerville said. "On the other hand, junior-senior bonds have higher ‘loss-given-default’ risk than if the two senior classes were recombined into one.’
Although Fitch’s structured finance ratings address the probability that a bond will have a dollar of loss, Fitch acknowledged that ‘thin’ tranches could see higher-than-anticipated loss severity in extreme stress scenarios.
Specifically in ‘highly rated thin tranches are at heightened risk if high loss severity and potential rating cliffs are inconsistent with the low level of default probability," Somerville said.
Fitch. to account for this risk, uses a series of tests to find the appropriate level of tranche thickness. It considers these recommended tests as transparent and constructive measures that can assist in identifying and mitigating risks that are introduced by excessive tranching.