Given the distress that European structured finance deals are under, they have performed astonishingly well according to one key metric: defaults.
Structured finance deals rated by Standard & Poor’s that were outstanding as of mid-2007 exhibited a cumulative default rate of 1.37%, according to a recent report published by the agency in April. The comparable number for the United States is 16.8%.
That is only €38.1 billion of a total sample of €2,779.0 billion at issuance.
In addition, more than 60% of these legacy transactions have redeemed.
What might be most surprising for structured finance players on this side of the pond is how negligible the cumulative default rate has been for consumer-related legacy deals in Europe: a mere 0.04%.
Andrew South, senior director at S&P, said that, with a few exceptions, defaults in Europe over the last several years have largely reflected how much exposure transactions had to the U.S. housing sector, and more specifically subprime. “The sector that saw the biggest stress was U.S. subprime and some European related-sectors were exposed to that,” South said.
The European sectors that were not exposed to the U.S. were those that S&P put under the bucket of consumer-related deals for purposes of this exercise. This includes consumer bonds and RMBS as well as covered bonds.
The transactions in Europe that were most contaminated by the subprime crisis in the U.S., collateralized debt obligations (CDOs), were particularly prone to defaults, according to South. Indeed, the sector that suffered the highest cumulative defaults of 39.64%, the CDOs of ABS, did so because of exposure to U.S. subprime. (See table below.)
The next highest number of defaults was visited on commercial mortgage-backed securities (CMBS), a sector that did not have a direct relationship to the U.S. mortgage industry. It was in the U.K. where commercial mortgages have been hit particularly hard, South said.
As prices in the U.K.’s commercial real estate market collapsed — dropping 40%-50% from peak to trough — borrowers backing CMBS deals issued in 2006 and 2007 subsequently had a hard time refinancing their loans. “They can’t refinance at the current LTV ratio,” South said. He added that some of these notes have extended their maturities to deal with the challenging environment. This exercise, however, counts as a technical default in S&P’s book. “Some of the senior notes in these deals may still have managed to pay back in full and on time, despite the environment, but now they’ve been restructured we’ll never know,” South said.
CMBS defaults have fared particularly badly of late, as seen in the 12-month rolling rate below.
Although taken in the aggregate structured deals in Europe have experienced few defaults, not every level of the capital structure has been so lucky.
Subordinate tranches have been hit much harder than senior notes. The cumulative default rate for sub-investment grade notes in legacy deals was 9.52% at the end of 2012, more than seven times the 1.32% figure for investment-grade tranches.
The downgrade rate of these transactions has far exceeded the default number, as is usually the case. “Downgrade rates are always higher than default rates because deteriorating creditworthiness is more likely than actual failure to pay,” S&P said in the report. The cumulative downgrade rate for European transactions outstanding in mid-2007 was 34.5% at the end of 2012, meaning that two thirds of deals had stable ratings or were upgraded. CMBS has endured the most downgrades.
The 12-month rolling downgrade rate hit 30.9% at the end of 2012, a result of the drop in Spain’s sovereign rating, a number of bank downgrades, and weaker collateral performance. The rating on structured deals from Spain cannot exceed ‘AA-’ since the move on the country.
The downgrades in Europe are mostly connected to deteriorating counterparty ratings as opposed to deteriorating collateral, South said.
He added that cross-currency and other swaps are more prevalent in European transactions than in U.S. ones; this in turn translates to more linkage to the creditworthiness of counterparties. In addition, the Eurozone crisis has led to sovereign downgrades, which have made country risk more of a constraining factor in European deals. “There’s possibly more factors at play than in U.S. transactions,” South said.
Despite the difficult conditions facing European transactions, a good number of the legacy deals outstanding in mid 2007 have fully paid down, according to a proxy stat used by S&P. The agency said that withdrawals on ratings on notes more or less correspond to redemptions, and that the former figure was 61.9% for these transactions.
But as with performance, asset classes have behaved differently. Ratings withdrawals on structured credit deals were often the result of early termination, while many ABS and covered bonds that were outstanding in mid 2007 would have fully amortized as originally scheduled given the shorter collateral of the former and the bullet maturities of the latter.
And with CMBS deals extending their maturity dates as previously mentioned, the withdrawal rate in this sector is relatively low, at 33.8%. —FO