Monday, December 7, 2009

Synthetic CLOs — gone for good or simply slumbering?

Posted on FT Alphaville by Tracy Alloway:

From Asset-Backed Alert:

A resurgence of synthetic collateralized loan obligations appears to be taking shape in Europe, as banks in the region seek regulatory capital relief.

Working on behalf of clients, big underwriters including Deutsche Bank, RBS and Societe Generale have contacted investors about a number of such deals in the past few weeks. In doing so, they’ve stirred to life a sector of the securitization industry that has seen little movement since the credit market crashed in mid-2007.

The story cites the example of one `sample transaction’ currently being touted by SocGen. The bank has reportedly been passing around marketing documents for a €6.4bn securitisation tied to a client’s corporate loans. CLOs, for those of you who can’t remember, are products in which banks securitise the corporate loans they’ve made, to shift them off balance sheet for the purpose of regulatory capital arbitrage. In synthetic CLOs credit default swaps are used to gain exposure to the underlying reference assets — those corporate loans.

And here’s the basic structure of the purported SocGen deal:

Here’s what’s known about how the deal works: The issuer would designate €6 billion of loans to companies in France and elsewhere in Western Europe to act as a reference portfolio, and would take out a guarantee from the securitization trust allowing it to shed the risk associated with those receivables. The resulting bond issue would consist of €210 million of triple-B-rated mezzanine notes offered to investors, along with a 6 billion super-senior class and a €180 million equity slice that both would be retained.

The deal essentially places the securitization trust ahead of the issuer in absorbing losses on the reference portfolio, even though the issuer would get to keep pocketing payments on the underlying loans. In exchange, mezzanine buyers would receive an annual coupon of 800 bp over Euribor over the lives of their amortizing five-year investments.

And like its forbearers, the structure would also help reduce the amount of capital the bank has to hold against the reference assets — the loans –by as much as 90 per cent, according to one estimate in the article.

Interestingly, one of the things cited by the story as giving these latest deals a boost is the securitisation `skin in the game‘ concept proposed by regulators that originators have to hold some part of the deal, either the equity tranche (the riskiest bit) or a cross-section slice of all the tranches:

The latest offerings come after European banks tried to shed risk by placing a new round of synthetic CLOs late last year. But few of the issues got done, in large part because regulators weren’t keen on the concept. Now, some key changes appear to have won over government officials. For example, the issuers are no longer trying to sell their deals’ equity. That means the institutions still carry some risk, demonstrating that they maintain an interest in the performance of the underlying assets.

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