It took two years to complete, but the first French CBO since the financial crisis was finally launched in late July. The deal’s portfolio comprises 19 bonds granted to as many small and medium-sized enterprises (SMEs).
As of July 2012, the portfolio’s current balance was roughly €30 million.
Paris-based independent cooperative finance firm Groupe GIAC arranged the €80 million ($99.5 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 completed six similar transactions. Although GIAC was the only company doing deals of this type prior to the crisis, there were a lot of German and Spanish banks that were refinancing SME loans through quasi-public programs enhanced by guarantees, but this activity had nearly come to a halt.
Currently the banks that hold most SME loans eligible to 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.
GIAC arranges financing that has a 7% junior deposit whose risk is shared across all borrowers. The structure has been approved by the French regulator as meeting the 5% junior holding requirement.
CBOs have never been a common way to fund smaller firms even before the crisis. GIAC transactions have been structured as bond deals because in France, only banks can lend to companies, according to Ian Perrin, a vice president at Moody’s Investors Service who rated GIAC’s transaction. The only way a nonbank can lend is by subscribing to a bond, which is issued by the enterprise being funded, Perrin said.
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.
Pedro-Rousselin explained that traditional ABS investors have been hard hit by spiraling secondary spreads and deteriorating asset quality of pre-crisis transactions and are now wary of investing in any type of SME CDO.
“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 pick-up in quality paper, which our deal and other SME CDOs would typically offer,” he said.
Another reason for the lengthy time to market was the fact that GIAC does not have warehousing lines to finance the accumulate assets prior to a deal’s launch. However, Pedro-Rousselin said that with GIAC’s current origination rate of €100 million, warehousing is not critical to its success.
“For the next deal, the critical point is not the availability of warehousing but if we can get a healthy investor base to invest into such a transaction,” he said.
Moody’s cited the length of the deal’s ramp-up period, which could be as long as 15 months, as a concern. It said this adds uncertainty regarding “the exact final characteristics of the portfolio, especially in terms of credit quality and recovery rates.”
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 favoring secured bond issues.
Moody’s also gained comfort in the fact that it had rated GIAC’s six earlier deals, Perrin said.
An Original Originator
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; no obligor represents more than 3% of the total portfolio. 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 is 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—guaranty fund, 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 given current capital constraints they are less willing to step up to the plate, even for good credits. This makes the CDO market attractive for companies that might be more willing to wait for the money if they have limited options elsewhere.
Additionally, 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-Roussellin. GIAC therefore sees the potential to increase its market share in the long term funding market in France.
However, any future deal would have to be at least €200 million in size to meet the needs of both the asset and liability sides.
