A recent Standard & Poor's research report highlights that self-insured credit classes, which are credit enhanced through a senior/subordinate cash flow structure, actually perform on average with bond-insured securitizations.
Analysts said this is the first study of its kind to actually statically measure how different types of credit enhancement perform against each other. "There has been a trend that self-insurance is getting more popular and gradually we are seeing the switch to senior subordination we are definitely seeing more interest on that end," said one source.
According to S&P, self-insured classes have been resilient since their beginnings in 1985 and have been as effective a credit enhancement tool as external bond insurance. S&P reported that the strong credit performance of these senior subordinated deals within a recessionary period suggests that such a credit enhancement tool is just as effective and derives its strength from the rigorous loss coverage requirements for the subordinate classes to support senior classes in all economic conditions.
"In terms of structuring you have to carve out a portion of the cash flow to be past the subordinate stress case scenario," explained one source. "You have to cover losses to get rated to triple-A and sometimes the process makes bond insurance more straightforward."
As a result, it's unlikely that a new issuer would opt to try senior subordination because the process would be too lengthy but, said the source, for issuers who were more established, opting for self insurance may provide a less costly alternative that avoids the premiums paid on wraps. "We have had interest for certain products that have been on bond insurance who are now considering this option because they have an established performance history and good default behavior," said the source. "Instead of doing bond insurance, with self-insurance they find that its cheaper."
The source added that some of the interest is generated because investors have become more comfortable with self-insured classes, and traders have noted that a few months ago these tranches started coming in at better spreads with senior subordinated notes not as volatile on the trading desk. "The dynamics are driven by how issuers perceive which one is more economical," he said.