As several origination and market trends come together, industry pros are seeing increased potential for a larger visible market of asset-backed securities structured to less than a triple-A rating.
Of course, the investor base for double-A and single-A ABS has grown dramatically in the past few years, with the advent of ABS CDOs. But on the origination end, structurers are using this increased appetite for less-than-perfect bonds to exploit less-than-perfect assets.
"I think this is something that has been developing over time," said Dale W. Lum, an attorney at Sidley Austin Brown & Wood, specializing in ABS. "There are opportunities out there, with good assets and good histories, but there may be a structural issue that will not permit a standalone triple-A. It's a little bit of thinking outside the box,' because we're all used to looking at triple-A deals."
Over the past year Lum has seen increased interest in securitizing assets where a triple-A rating might not be attainable. An asset might fall into this category when the servicing is bundled with the payment, in that the servicer is not only collecting payments but providing a contractual service to the obligors. In such a case, the asset is embedded with servicer and/or corporate risk.
Xerox Corp. brought such a deal via Merrill Lynch in July. That $500 million, equipment lease ABS was structured to A3/A/A (MDY/S&P/FTC), and was unable to score a higher rating because of embedded Xerox corporate risk.
In that transaction, Xerox was not only leasing out the equipment but also providing contractual maintenance, service and supplies. On the maintenance end, proprietary technology associated with some of the newer equipment would make it more difficult for another entity to step in and take over the servicing of the equipment.
According to a presale report for the transaction written by Moody's Investors Service analyst Denise Person, "If there is a change in the maintenance provider, the potential disruption in transitioning maintenance could cause variability in the performance of the pool."
It stands to reason that at least some proportion of the obligors would stop payment if their equipment was not maintained (and not functioning), no matter the duration or terms of the lease contract.
Other true-private equipment deals that were issued below triple-A level include Frontier Leasing and Center Point Leasing, both of which went to market with a backup servicer in place.
Operating assets, which have appeared more frequently in the ABS market over the last few years, are prone to corporate linkage. These include pooled aircraft lease securitizations, intermodel assets such as railcars and shipping containers, and even rental car ABS. The assets in these deals have imbedded corporate risk, either in maintenance or in the necessity of the servicer to re-lease or, essentially, manage the value of the assets.
More "less than whole business" deals?
While the term "whole business securitization" has razzled the imagination of the U.S. ABS market ever since Arby's securitized its logo last fall, an actual pipeline has been slow to materialize.
Something that is taking shape, however, is the increased interest in securitizing assets that have varying degrees of embedded corporate risk.
"ABS transactions could be placed on a continuum, from the point of view of servicer involvement," said Tom Currie of the new assets group at Standard & Poor's. "At one end of the continuum are trade receivable and credit card transactions where servicing is relatively straightforward and delinkage from the credit rating of the seller/servicer is possible. At the other end are whole business transactions, where the servicing function can be very involved and arguments for the delinking of the rating of the securitization can be more difficult to make."
Between these two extremes are transactions such as equipment or car rental transactions, where there is some linkage between the rating of the seller/servicer and the rating of the transaction, but not as much as in a whole business transaction.
In a 1999 Standard & Poor's research report titled Rating Hybrid Securitizations, the agency writes, "A hybrid typically exhibits a securitization structure, but features as its collateral operating assets and leases for their ongoing use, rather than liquidating receivables such as credit cards, mortgage or auto loans."
"In some cases, it may just be impossible to get to a certain rating because of the linkage to the servicer without insurance," Currie said.
Whether or not there will be an increase in ABS structured to lower ratings will depend largely on market dynamics and appetite; reportedly, however, structurers are considering less-than-triple-A a viable option for companies that cannot fully delink corporate risk and who opt not to come to market wrapped.