A-Mark, a precious metals trading company based in El Segundo, Calif., is turning to the securitization market in order to boost margin lending to its clients.
The company is selling $100 million of bonds backed by a revolving pool of loans secured by precious metals as well as some of its own inventory of cash and gold, silver, platinum, and palladium.
It’s an asset class that was pioneered at another precious metals company, Monex, in Newport Beach Calif., which has completed nine deals to date. Two bankers who worked on Monex’s transactions while at Piper Jaffray, Chris Flannery and Tom Baurle, are leading A-Mark’s deal from their new firm, Oak Ridge Financial.
The practice of using a commodity as collateral for a loan is being litigated by the Commodity Futures Trading Commission, which sued Monex last year, claiming it was engaged in illegal, off-exchange transactions. In May, however, a California federal judge rejected the CFTC’s claims, ruling Monex’s trading fell outside the agency’s authority.
Morningstar Credit Ratings, which rated Monex’s most recent securitization, in 2016, is rating A-Mark’s deal as well. In its presale report, the rating agency stated that the litigation is unlikely to pose a risk to A-Mark’s transaction, even if the CFTC appeals.
AM Capital Funding Series 2018-1 consists of two tranches of notes maturing in December 2023; a $72 million senior tranche is provisionally rated AA – the same rating as the senior tranche of Monex’s most recent transaction – and a $28 million subordinate tranche is rated BB.
A-Mark plans to transfer approximately 70% of its loan book to the securitization trust, according to its bankers. This will allow the company to do more lending and also diversify its sources of funding. Right now it relies on large lines of credit with banks.
There are two different types of loans in the pool, according to Morningstar: on-demand loans with a maximum term of five-year term and shorter-term loans that are usually payable within 180 days. To obtain either type of loan, the borrower must invest a minimum of 20% equity and must maintain a minimum 10% equity.
The collateral will revolve over most of the five-year term of the transaction, followed by a six-month wind-down.
Credit enhancement consists of a cash reserve and the value of the collateral in excess of the note balance, marked to market daily. This means that the sponsor may have to contribute additional assets in the event of a decline in metals prices; alternatively, it can remove collateral from the trust in the event metals prices appreciate.
“If there are insufficient assets to cover notes, not only can you liquidate inventory, you can increase margin requirements [on the loans] or liquidate the loans,” Flannery, a managing director at Oak Ridge, said in a telephone interview. “That’s different from a deal backed by mortgages or auto loans.”
One difference between the structure of A-Mark’s deal and deals completed by Monex, according to Flannery, is that A-Mark’s deal has the ability to hedge the value of inventory.
Morningstar notes in its presale report that the securitization trust will establish a futures brokerage account with ADM Investor Services to hedge the metals inventory with net short futures positions. While the trust is not obligated to hedge, hedged metals inventory will be valued at 95% of the wholesale value and unhedged metals inventory will be valued at 80% of the wholesale value.
Among other strengths of the deal, in Morningstar’s view, are the liquidity of the collateral – silver, gold, platinum and palladium – which is traded around the clock on different exchanges, and the strong performance of A-Mark’s loan portfolio, which has yet to sustain a loss.
The exposure to any single obligor is limited to 5% of all eligible loans plus metals inventory, and total exposure to obligors outside U.S. and Canada is limited to 10% of all eligible loans and metals inventory. There is also a 5% country limit to the aggregate exposures of obligors in any single country that is not U.S. or Canada. Any amount over the concentration limits will not count toward the adjusted eligible pool balance.
However, the transaction does not set concentration limits on the underlying metals collateral. In its presale report, Morningstar noted that changing consumer preferences may significantly alter the concentrations of the four metals. In analyzing the riskiness of the transaction, it assumed that the pool consists entirely of silver, the price of which historically has been the most volatile of the four eligible metals.
Other risks include a potential change in margin call level and possible delays in liquidation during servicing transfer.
Then there’s the regulatory risk.
In its lawsuit against Monex, the CFTC asserted that the documents transferring title to the metal held in a third-party depository does not constitute an actual delivery. If that were the case, the agency would have jurisdiction over the transfer and sale of the metals as off-exchange futures transactions.
If the CFTC eventually wins its case against Monex, A-Mark’s transaction will wind down in an orderly liquidation of the issuer’s assets, according to Morningstar. The transaction will be able to pay timely interest and principal prior to the legal final maturity date.
In its presale report, Morningstar noted that A-Mark delivers metal to a depository of the customers choosing, pursuant to a consent order with the CFTC; therefore the rating agency believes that the theory raised by the CFTC in the Monex litigation would be unlikely to pose the same risk to A-Mark’s transaction.
Nevertheless, the CFTC remains active in enforcing these boundaries, and litigation against A-Mark's transaction could even result in an event of default, the presale report states.