Deteriorating credit quality among some of Europe's biggest financial names has investors questioning just how exposed securitizations might be to third-party risks. Much of the disquiet - which was prompted by the spate of downgrades of European banks and non-banking financial institutions - are without merit, as the language incorporated within the transaction documents generally address such scenarios, market analysts said.
"It's hard to predict who will be affected and when, but when big names like Dresdner Bank and JPMorgan begin to be affected, it will start to impact confidence," said Olivier Delfour at Fitch Ratings. According to Fitch, many of the banks and non-bank financial institutions that have had ratings volatility participate in a number of credit-sensitive roles in the structured finance market, such as liquidity provider, letter-of-credit provider, trustee, servicer, back-up servicer, derivative counterparty and investment account provider.
In most cases, the downgrade of an entity that provides any of these services to a structured finance transaction is minimal, but to what extent third-party risk might play in a transaction depends on a number of issues: ratings-based guidelines, the degree to which the transaction's rating is dependent on the rating of the counterparty, and the agency's current criteria. "In all of these roles, there is the language within the documents in most cases that addresses what would happen if a bank were to suffer a downgrade, so in most cases the impact is nil," he said. But in certain instances the transaction is directly linked to an entity like Dresdner Bank AG's role in the Silver Tower Funding ABCP program.
Following the downgrade of the counterparty credit rating on Dresdner Bank on October 9, 2002 by Standard & Poor's on October 9, 2002, the ratings of Dresdner's Silver Tower ABCP program suffered a downgrade to an A1' program from an A1+' rating.
"We started to get a lot of questions from investors and we basically saw a need to clarify in what situations a downgrade would be triggered - it's especially sensitive for an F1+' rating," said Delfour.
For ABCP programs with 100% liquidity support, the program rating is closely linked to the rating of the liquidity provider. According to Fitch, those programs rated in the agency's highest short-term rating category of F1+' must have a liquidity provider rated at the same level. "A breach of the F1+' rating would result in collateralization of the exposure, replacement of the liquidity provider or a downgrade," the agency said.
Analysts at Dresdner Kleinwort Wasserstein highlight the potential importance of this link, particularly when it comes to German banks performing the role of liquidity or collateral provider, citing a number of synthetic deals that had been collateralized by Pfandbriefe or MTN's (see ASR 3/4/02). "Due to the deterioration of German banks credit quality, Pfandbriefe ratings have increasingly been affected," reported the bank.
The latest bank to be affected is Bayerische Hypo und Vereinsbank (HVB). Both Moody's Investor Service and S&P placed the un-secured, secured and financial strength ratings of the bank and
its related entities on review for a
possible one-notch downgrade to
single-A minus. Fitch downgraded the long-term rating for HVB to A' from A+' after the bank posted a higher-than-expected long-term third-quarter loss.
A downgrade of HVB will lead to the loss of the company's Aaa' rating of its public-sector Pfandbriefe and the Aa1' rating of its mortgage-sector Pfandbriefe by Moody's, as the agency requires a four-notch maximum differential between the bank's rating and its Pfandbriefe rating, explained Dresdner. HVB's public-sector Pfandbriefe acts as collateral in a number of outstanding deals, which could potentially affect the ratings of these deals.
A similar case is that of WestHyp, which also has its public-sector Pfandbriefe under review for a possible downgrade. As a result, Moody's placed the class A-4 and class B credit-linked notes of Duke 2002, a synthetic CMBS transaction, on review for possible downgrade. WestHyp's public-sector Pfandbriefe acts as collateral for the notes.
This rating confirmation is a response to investor inquiries and is based on Moody's expectation that the Cash Collateral and Additional Cash Collateral enhancement of the public-sector Pfandbriefe provides sufficient protection from a limited downgrade of the public-sector Pfandbriefe in the case of the class A-1, class A-2+, class A-3, and the funding notes. The collateral posted at issuance for the class C notes is well in excess of its current rating, and WestHyp's possibly downgraded senior unsecured MTN rating is expected to be in excess of the class D and class E notes' rating. This relative protection is not available for the class A-4 and class B notes that have been placed on review for possible downgrade, explained Moody's.
The rating agency has also placed the class A and class E notes from the Real Value One program by Westdeutsche Immobilienbank (Westimmo). Westimmo's obligations under all classes of notes are secured by HVB's public-sector Pfandbriefe. "As the class A+ and the class A notes rely on the Aaa' rating of these Pfandbriefe for their rating, these two classes of notes have been placed on review for possible downgrade as well," said Moody's.
Fitch explained that in the case of derivatives and repurchase agreements, the agency requires a minimum A1' rating for the third party in that position. If it falls below that rating, the counterparty is expected to provide collateral against the mark-to-market exposure with some over collateralization. If the counterparty cannot properly collateralize the exposure, a suitably rated replacement counterparty is expected to guarantee or assume the role.
"I think the concern comes from European investors who primarily look at investment-grade issues," said one buyside source. "Because we typically look at investing in mezzanine tranches, the credit linkage is already rated below the bank. We realize that there is some association risk, but it's no new cause of concern."