Lloyds TSB's £12 billion ($22.2 billion) takeover of HBOS averted a Northern Rock-style run on the bank and has, at least for now, secured the performance of the troubled bank's securitization deals.
As market conditions deteriorate, it's likely that U.K. lender Bradford & Bingley (B&B) may have to consider a similar type of merger to get its deals out of trouble.
Fitch Ratings and Standard & Poor's took action on HBOS during a review of the proposed takeover. S&P said that HBOS will be less well positioned with regards to international credit quality compared with other double-A institutions. As such, the rating agency downgraded the banking and insurance firm from 'AA-' to 'A+'. The outlook is now positive. Fitch also lowered its ratings from 'AA+' to 'AA', but kept a negative outlook.
The ratings actions should not affect the triggers to the bank's securitizations under its Permanent Master Issuer, Pendeford or Mound, according to analysts. This is because the triggers have some room to accommodate the present scenario.
"HBOS's announcement is clearly positive, leading to better seller rating and long-term business viability," Deutsche Bank analysts said. "We expect little servicing disruption in any handover and also that the trusts will continue to be kept separate."
Neither ratings agency changed the firm's covered bond ratings. "Investor confidence is suffering due to the turmoil on the equity markets, where the HBOS share has gone through a rollercoaster ride, which was accompanied by media reports on a potential takeover by Lloyds TSB," Dresdner Kleinwort analysts said. "We have received several anxious client queries in this respect."
B&B, on the other hand, remains one of the last U.K. High Street banks standing on its own, although negative downgrade activity continues to take a toll on its securitizations. Moody's Investors Service last week downgraded B&B from 'Baa1'/'P-2' to 'Baa3'/'P-3'. The rating agency cited funding and capital-raising concerns.
Speculation that the Financial Service Authority might be shopping for a takeover proposal for the troubled bank led to further action by S&P and Fitch. Fitch placed on Rating Watch Evolving and downgraded B&B's long-term issuer default rating (IDR) to 'BBB-' from 'BBB+' and short-term IDR to 'F3' from 'F2'. S&P also kept on CreditWatch Negative and downgraded B&B's short-term counterparty rating to 'A-3' from 'A-2'. The agencies said that any further decrease in market confidence would increase pressure on the bank's retail funding base and cause a likely deterioration in asset quality.
"With three agencies and the trustee to convince to waive the loan addition restriction, the company faces dwindling prospects to reset its trust back to a normal status," Royal Bank of Scotland analysts said.
The bank has three ratings-related triggers and has already breached those that pertain to interest rate swaps and liquidity reserves resulting from prior negative rating action. These triggers are in the process of being cured via replacement with an alternative, suitable interest rate swap counterparty and a fully funded liquidity reserve fund.
The third trigger, according to Deutsche Bank analysts, is much more serious because it calls the ability to replenish the trust into question.
RBS said that while the latest rating action does not spark any additional triggers in the Aire Valley Master Trust, it does bar the Trust from adding new mortgages, and specific identification of loan files and deeds is now required.
"The latest B&B downgrade finally halts substitution of mortgages into the trust, effectively changing it from a revolving to a static trust, while suspending any further issuance," Deutsche Bank analysts said.
B&B now faces an increased probability that it will not have enough principal to repay bonds on their scheduled maturity, a result of high or low prepayments. Prepayments are a liquidity risk typically mitigated by replenishment. In a high prepayment scenario, the excess cashflows might be used to redeem the seller share, thereby reordering the bond cashflows and resulting in a breach of the minimum seller share trigger.
"Under such a scenario bond repayment is re-ordered by rating level and then pro rata amongst bonds of an equivalent rating, apart from triple-As which will be paid off in order of legal final," according to Deutsche Bank analysts.
Any takeover of B&B - which has been speculated - where the acquirer is a highly rated entity, would likely lead to the cure of the various trigger breaches, analysts said.
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