The Lehman Brothers bankruptcy has proved to have long-reaching repercussions for the European ABS market.
The latest development - a U.K. court case brought by A3 note holders of the Eurosail 2007-3BL Plc subprime RMBS deal.
On July 30, the U.K. courts ruled against the claim made by the A3 noteholders that an event of default had taken place and that the transaction should now be paying as per the post-enforcement waterfall.
Before this ruling, another similar case came up in August when Dankse Bank Group withdrew liquidity support to Eurosail 2007-4. Dankse said the default could have a material adverse effect on the business, assets or conditions of the issuer and restrict the issuer's ability to perform its obligations under the facility agreement.
The court judgment found that the issuer was not insolvent, which prevented the A3 note holders from declaring an event of default. As a result, the waterfall of payments will remain unchanged according to the pre-enforcement status.
The most recent ruling on the 2007-3BL deal has set a new precedent for European ABS structures.
The ruling suggested that the existence of a post-enforcement call option (PECO) has no effect on whether an issuer can become balance sheet insolvent.
Structures using a PECO go back to 2005 when the U.K. fiscal regime was modified, preventing securitization to create structures with limited recourse notes, Deutsche Bank analysts said.
After 2005, a limited recourse structure would be subject to severe fiscal treatment that would negate the tax neutrality of a securitization. The status of limited recourse, however, was necessary for rating agencies to rate structured transactions. As a result, structures started to include PECO. Barclays Capital analysts said that there are many U.K. transactions that contain a PECO.
The ruling in the case of the existence of a PECO brings up questions regarding how protected the issuer will be from being insolvent as a result of asset impairment and based on the fact that any calculation of an insolvency test would never result in an imbalance between asset value and liabilities value.
Until the ruling happened, the rating agencies had assumed that the issuer was protected under the terms of the PECO. The judgment by the court forces the rating agencies to reconsider their position.
Moody's Investors Services stated in a press release that it will examine the underlying legal documentation to determine the likelihood of a balance sheet insolvency. Moody's believes that the asset classes most likely to be affected are RMBS, CMBS and ABS.
In the meantime, the Class A3 noteholders of Eurosail 07-3 have moved to file an appeal against the July 30 U.K. high court ruling.
"While the trustee for the former appears to be suggesting noteholders consider not contesting the liquidity withdrawal given the onerous legal costs of doing so, a negative ruling for the latter (for example, a strict application of accounting asset impairment) could have wider negative consequences for U.K. domiciled issuers," Deutsche analysts said.
