The urge to unwrap is pretty strong these days. On both the originating and investing sides of the bench, players are itching to ditch the monoline guarantees that no longer add value.
The Turkish banks that wrapped structured deals en masse from 2004 through 2007 are no different. At least three have taken action on their bonds backed by diversified payment rights (DPRs), refinancing insured tranches with unwrapped deals. In Latin America, Banco Credito del Peru (BCP) has done the same, proving that the pros of unwrapping outweigh the cons in other parts of EM as well.
This exercise has turned out fruitful for players not only by trimming costs but by identifying potentially new investors as well. The examples in Turkey and Peru also highlight why retiring wraps has proven so difficult in the U.S. And for the Turks, most tranches eligible for unwrapping might have already been exchanged, as the costs outweigh the benefits for a number of outstanding tranches. (see table, pg. 31)
The Appeal of Taking It Off
For Turkish originators, the wraps they so avidly sought several years ago are now white elephants. Bonds backed by DPRs and credit card vouchers are generally rated in the triple-B category, well above the wrap of most monolines at this point, with Assured Guaranty as the notable exception.
"There is a benefit for issuers and also for investors if we remove the wrap," said Selcuk Gozuak, head of international banking at VakifBank, which had Standard Bank lead an exchange that swapped out $394 million worth of wrapped DPR paper only a couple of weeks ago (see table, p. 29). "We offered investors a fair additional spread [if] they agreed to join the exchange."
The Turkish de-wraps have basically entailed an originator and investors agreeing to get rid of the guaranty and splitting the premium that would have gone to the monoline. It works when the investor gets more spread, and the all-in cost for the originator is lower.
Naturally, a number of other ingredients have to be in the mix for the economics to make sense. "There's no hard figure," said Steven Baker, director at Standard Chartered, which executed a $691 million unwrapping exchange for Peru's BCP last June. "It depends on a whole host of factors: what the wrap costs are, what the average life is and [whether] the deal is prepayable, [among other conditions]."
The first two factors in some ways work against each other. The costs of a wrap for a Turkish originator declined from the first deals in 2004 to the boom times of 2006 and 2007, so early deals tend to be saddled with more expensive premiums. At the same time, however, younger vintages are more amenable to de-wrapping because they usually have more outstanding.
The latter factor is the overriding force, said Batuhan Tufan, vice president at GarantiBank. "Most of the market transactions we have done were completed in '05 and '06, and we have very limited life in the bonds," he added. "Most have terms of seven or eight years; the outstanding amounts are decreasing every day, and that makes it uneconomical for us. We have only one or two tranches that are economically feasible to unwrap."
"For most deals issued in '05 or before, there's possibly less value in an exchange," said Julian Turner, Director of Institutional and Corporate Services at Standard Bank.
As a matter of course, DPR transactions are prepayable. Indeed, one reason Turkish originators did not approach investors as soon as most monoline wraps slipped below the underlying ratings of their deals was because the prepayment penalty on their transactions hadn't expired, sources said. Once the hurdle was cleared, the economics shifted in favor of de-wrapping a number of the tranches.
The first deals unwrapped in Turkey as well as abroad were those that could be executed by the originator itself because investors were easily identified and very small in number. This typically meant one or two conduits. GarantiBank took this route first in April 2009 and then again last September.
In the first of these exchanges, the originator issued a $225 million, four-year bond to refinance and strip the wrap off an eight-year H tranche issued in 2005 for $250 million. The retired paper was wrapped by Syncora Guarantee, formerly XLCA.
In the more recent trade, the originator closed $214.5 million in 2010-A notes to remove the wrap from a 2006-C tranche, originally for $225 million and wrapped by Ambac Assurance Corp.
"It was easy to negotiate as we were talking to investors directly," said Tufan. "It doesn't require any extra support from an arranger bank to go out and look for investors, find them and get them to agree on something."
With its simplified documentation, this approach is impractical with tranches that have a dispersed group of holders. "They amended, which is must simpler, but you need 100% investor consent," said StanChart's Baker.
Combing the Market for Holders
When investors number more than a few - and may not even know they hold the deal - then a public exchange is in order. This is the route taken by Peru's BCP as well as VakifBank and Yapi Kredi, the former handled by Standard Bank as well.
But as the bankers involved have learned, thanks to the financial crisis, doing an exchange of DPR bonds is more labor-intensive than it would have been only a few years ago. Sending out notices by DTC or Euroclear is only a fraction of the work.
By the same token, however, scouring the market for this paper has yielded other rewards that speak to the longer-term viability of this asset class. A number of investors indifferent to this product a few years ago are now holders through the dislocations of the crisis, and being approached for an exchange has made them better acquainted with the product, whether they participate or not.
In the Yapi Kredi and Vakif deals, where the success rate was 63% and 72%, respectively, it was a challenge to locate investors after bonds shifted around with the unwinding of portfolios, but in the end the vast majority of investors were identified. "An initial investor may have been an SIV, for instance, but the SIV may no longer be around," said Standard Bank's Turner. "The bonds might have moved from an SIV to balance sheet, and you have to locate who's managing the portfolio. And in many cases bonds had traded and we had to find the new holder."
DPR paper has also been dispersed into accounts following the vertical slicing of SIV paper.
"Some portfolio managers just ended up holding the paper without investing in it intentionally because their parent purchased a portfolio from a bank," said Garanti's Tufan.
Because of their more in-depth knowledge of the asset class, Turkish buyers have also been unusually active in the secondary market over the last few years, sources said. These investors could be the originators themselves, purchasing their own deals or those of other originators, or other, third-party investors.
Turner said that the different acceptance rates between the Yapi Kredi and Vakif exchanges could be explained by the fact that Yapi Kredi was Reg S only and Vakif was 144A and Reg S eligible. U.S. investors were therefore not eligible for the Yapi exchange.
For both, other factors in acceptance included decision-making ability - investors could be constrained by secondary wraps or by the sign-off process.
One factor that was not material was the particular monoline wrapping each tranche, according to Turner. The exchanges covered all major monolines, with the exception of Assured.
Apart from VakifBank, Yapi Kredi and GarantiBank, there has been talk that Akbank essentially unwrapped a conduit-held $200 million DPR deal due 2016 in tandem with the Turkish bank's $862 million DPR transaction issued in August. Akbank officials declined to comment.
Isbank, another major issuer in this sector, is understood to not have unwrapped any of its DPR deals.
Reasons to Stay Wrapped in America
The DPR exchanges raise the question of why unwrapping has apparently not been as prevalent in other markets, such as the U.S. While an official at one bank said they were actively looking at unwrapping U.S. transactions where the economics make sense, the consensus is that in many sectors this will not work and it is likely that unwraps will continue to be no more than one-off deals.
Comparing Turkish DPRs with the character of the wrapped market in the U.S. sheds light on why this might be the case. The strength and viability of the issuer in question, for instance, is a major impetus for unwrapping. In the Turkish exchanges, you have robust banks with an interest in keeping the DPR business going and the ability to negotiate directly - or indirectly via an arranger - with investors. For many wrapped U.S. deals, the originator is either struggling to stay afloat or basically gone. "The transaction itself could be in some kind of disrepair," said one banker. "In the mortgage arena, you have orphan deals, bad wraps and no originators [while] trustees and lawyers [are] running the show." The mix of ingredients is not conducive to unwrapping.
For healthier originators in the U.S., there may be a prepayment penalty that either does not expire at all or expires too late for unwrapping to be practical. Deal documentation might also prohibit exchanges.
New DPR Deals
In Turkey, the exchanges have piqued talk of fresh issuance, especially with a potentially wider pool of investors having DPRs on their radar.
While new products from Turkey have been few and far between since the crisis hit - Akbank's deal in August was the first since 2009 - the exchanges might be whetting appetites, sources said.
The problem, as usual, is having investors and originators meet eye to eye on pricing.
"[In the VakifBank exchange] there was interest for fresh DPR issuance, but the pricing was not parallel to our expectations," said VakifBank's Gozuak.
By merely executing an exchange, an entirely new crowd of DPR investors was brought into the open. "Alongside the delivery of additional value to investors and the originator banks, part of the reason for executing the exchange offers was to update the books for DPR transactions," Turner said. "[By] having located current investors with appetite for DPR product, this enhances our ability to look at new issuance solutions for clients. Investors continue to value the product; it's a question of a bank's demand for new funding."
Apart from pricing issues, an additional potential deterrent has emerged in the form of Eurobonds, which may give Turkish banks yet another reason to put off issuing DPR paper. Akbank was the first of its peers to issue a Eurobond in July for $1 billion. The five-year transaction is considered a landmark and could open the door to more similar transactions. But while sources say this may reduce pressure to issue DPRs, it's not directly competitive with the structured deals. Eurobonds are bullet, whereas DPR bonds amortize.
On the other hand, one salient downside of the DPR product vis-Ã -vis Eurobonds is that it is illiquid. Sources said an active market-making of DPR bonds might help kindle the interest of Eurobond-style investors that require more liquidity.