Last year, US arranger banks began restructuring or ‘’retranching’’ US SRT transactions by slicing the thicker tranches of US deals. The latter technique allows investors to keep a thinner piece with higher returns and the banks market the rest of the stack in rated format to other buyers.
However, this technique has worked well for highly granular loans such as consumer and auto assets but it hasn’t been tested yet for synthetic securitisations of capital call facilities which are one of the most salient emerging opportunities currently in the US market. Investors have been targeting ratings for these portfolios but confidentiality restrictions remain the most important rating challenge, although a sketch of a solution is beginning to emerge.
US banks will often want to sell the entire and quite typical 0%-12.5% tranche to a single investor for efficiency purposes. Yet many investors are interested in holding only a portion of the 12.5% risk, so they will re-tranche it and sell the other pieces to other investors. A private equity investor for example may want to hold only the first 2.5% of loss, while a pension fund or asset manager may want to hold the next 10%.
The main idea here is to place tranches with ABS buyers or insurers who need ratings, and you do this through an SPV structure. In the US, banks must place thicker tranches given the nature of the capital rules, but many equity investors don’t get their target returns by holding the entire tranche.
If equity investors can’t get their target returns by holding the entire tranche, then they are effectively left with two options which is either retranching or repo leverage. Retranching is preferable because it offers non-MTM, full term, and non-rolling leverage.
Repo is easier to execute but it is usually for a limited term and requires posting margin (see: Retranching gathers steam – 01/05/2024 | RTRA Intelligence Ltd). Bayview’s transaction with SoFi technologies from 2024 is one example of a transaction utilizing this approach (see: BVCLN 2024-EDU1 | RTRA Intelligence Ltd).
The rated format that comes with these structures moreover assist with the wide distribution of risk and transforms subscription lines into assets that are more palatable for real money investors.
Nevertheless, although this technique has worked effectively for highly granular assets such as consumer, autos and student loans, it remains untested for capital call facilities which are one of the most important emerging opportunities in the US market. However, investors have approached rating agencies.
Gabriele Gramazio, senior director at KBRA notes: “We have been approached by investors targeting synthetic structures referencing capital call facilities. However, rating such exposures is still uncharted territory. The short maturity of most subscription facilities, and the revolving nature of these synthetic structures, make credit quality predictability during a reinvestment period a challenge.”
Yet the most important challenge is confidentiality. Indeed, rating agencies need to be made aware of the limited partners (LP) and their commitments in the fund in question, given the importance of these stakeholders in subscription line analysis. The identity of the LPs though remains confidential.
Nevertheless, some rating agencies are mulling solutions that adapt to confidentiality restrictions while enabling them to assess the risk.
Stuart Rothenberg, Morningstar DBRS Senior Vice President explains: ‘Morningstar DBRS has only rated cash capital call loans and cash capital call repack securitizations to date. Regarding synthetic capital call repack transactions, arrangers haven’t proposed structures that provided sufficient information to assign ratings yet, though a few are under consideration.”
He continues: ‘’Morningstar DBRS could theoretically assign capital call ratings generally with anonymized LP data, if the data provider can demonstrate that they track and report anonymized LPs consistently across portfolios. But we still typically need LP borrower type, credit quality, and other key metrics available at sufficient granularity to complete our analysis’’
The approach wouldn’t be that dissimilar to the manner in which SRT investors assess the credit risk of blind pools. Another option could be NDAs.
Matthias Neugebauer, Managing Director at Fitch notes: ‘’our approach to rating capital call securitizations including synthetics is similar to how we rate CLOs. We derive a rating and recovery prospects using Monte Carlo analysis. In terms of data points for the LPs we utilize ratings, facility agreements and a rating analysis of the LPs. We would need to know the identity of the LPs for the analysis but that is why we would sign NDAs for that.’’
Another factor to note is that rating performance and historical data at the portfolio level have been building up which further boosts the case for ratings.
KBRA saw strong rating performance for its subscription facilities, with 27 rating withdrawals after full repayment, nine rating upgrades since inception, and no rating downgrades.
‘’We expect the strong performance to continue, particularly as more capital is called, which creates an increased incentive for limited partners (LP) to meet capital calls, given the typically highly punitive measures that can be applied to a defaulting LP’s interest’’ says the rating agency in a recent report.
KBRA’s portfolio ratings range from AA- to BBB with 93% of deals carrying ratings of A- or higher.
‘’Ratings have been trending higher in recent years, as lenders approached us with many facilities backed by large, diversified investor pools. To date, 62 unique fund managers have utilized sub lines in our rated portfolio, which is more than double the total as of April 2023’’ concludes the agency.
