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Move highlights impact of spread leverage
UBS has restructured two of the three series of Financial Basket TYGER CPDO notes issued by its ELM vehicle that had their ratings withdrawn by Moody's last month (see SCI issue 53). The move is in response to recent spread widening on financial names underlying the notes, which has negatively impacted their net asset values.
The motivation behind the restructuring was partly driven by the deals' exposure to financials – financials widened much more than the rest of the market, and the portfolios contained names that widened the most thanks to their exposure to US sub-prime. But, says Mehdi Kheloufi-Trabaud, associate analyst at Moody's, it was also driven by the concept of spread leverage – which is the leverage of the deal (note notional) multiplied by the duration of the contract.
"The duration of the standard TYGER transaction is approximately eight years (ten year contracts) and the leverage 10x, which equals a spread leverage of 80x – compared to, say, a standard rolling Globoxx deal which has one of 60x (15x leverage multiplied by a duration of approximately four years). The original TYGER deal is then the most leveraged CPDO at a triple-A rating we've seen," he adds.
The €80m Series 103 notes have been partially restructured into triple-A rated Series 116 and 117 notes. €7.5m of Series 103 has been cancelled and restructured into Series 116, for which the leverage has been halved from 10x via a €7.5m notional increase from the noteholders. The notes consequently have a notional amount of €15m and pay a coupon of 50bp over Euribor.
Similarly, €20m of Series 103 has been cancelled and restructured into Series 117, following the removal from the portfolio of five names that have showed the greatest spread widening recently (Ambac, CIT, Radiant, MGIC and PMI). As a result, the leverage of the transaction has been reduced by 10% from 10x to 9x, with a notional amount of €20m and an unchanged coupon of 100bp over.
With €5m also having been bought back by the issuer and cancelled, €47.5m of Series 103 remains unaffected by the various restructurings and has been downgraded by Moody's from Aaa to Aa3.
Additionally, Series 104 has been fully restructured, with the leverage halved via a €45m notional increase from the noteholders. As a consequence, €90m of triple-A rated notes are now outstanding, paying a coupon of 37.5bp.
Moody's notes that the Aa2 rated CPDO CDS entered into by UBS has also been fully restructured, with the leverage halved from 18x via a €50m notional increase from the noteholders and the removal from the portfolio of Ambac, CIT, Radiant, MGIC and PMI. The swap now amounts to €100m and pays a coupon of 125bp.
However, the €100m Series 115 notes have not been restructured and have consequently been downgraded by Moody's from Aaa to Aa3.
The initial rationale behind the deal was to benefit from the stability of financials, but the spread widening on such names seen in August is considered by Moody's to be exceptional. At closing in April 2007, the average spread of the original portfolios were approximately 30bp; at one point in mid-August they had more than quadrupled, going over 120bp and driving the NAV of the deals as low as 40%. They are now in the range of 90bp.
The transaction was in danger of hitting its cash-out trigger, so investors preferred to halve their principal and move the deal away from the trigger level rather than run the risk of losing their investment. None of the transactions were forced to crystallise these mark-to-market movements and so, as spreads returned to more moderate levels, their NAVs have improved accordingly.
Moody's has been discussing the concept of spread leverage with investors because it often isn't clear where leverage levels are. As Kheloufi-Trabaud explains: "The duration effect is neglected often, but it's important because it is possible to re-leverage the portfolio in some transactions by increasing the maturity of the CDS contract. Certainly we've seen this feature being used in some CPPI deals."
The agency doesn't expect to conduct a review of the sector in the near future, but will continue to monitor transactions outstanding – particularly in light of the forthcoming index roll and potential volatility on financial spreads due to the news flow expected on this market over the next few weeks.