Fallout from Gedesco deal could have positive impact on wider market

Servicer defaults can happen, and when they do it is important to keep operations running smoothly. However, this isn’t always possible, such as in the case of Gedesco, where broader struggles were at play. 

Commentary from Morningstar DBRS earlier in August took a deeper look into the circumstances surrounding the servicer’s default in the Gedesco Trade Receivables 2020-1 DAC transaction, detailing the timeline of events leading up to the crisis, which escalated in March to April of this year.

“I think it’s a one off event,” says Christian Aufsatz, md for European structured finance ratings at Morningstar DBRS.

The default of the servicer in this transaction has been exacerbated by the criminal investigation into management of Gedesco, further clouding the future of the transaction. Indeed, the issuer has reportedly also discussed potential litigation to recover funds for noteholders.

“The entire situation wasn’t actually servicing related, but Gedesco related,” states Aufsatz, “what worked well was the servicer replacement by the backup servicer – which is actually a really positive sign for the market.”

Litigation is no stranger to any financial market, so there is no sign of this triggering any mass hysteria or concern. In fact, Aufsatz considers it to have the opposite effect on the market – and understands the successful intervention by the back-up servicer in this case could reinforce greater confidence in similar structures moving forward.

“There are several positive things to mention – like the servicer replacement working correctly, and despite all of the troubles the class As being fully repaid. In fact, a very large part of the portfolio was actually repaid in a reasonable amount of time,” he adds.

The class A notes have now been repaid in full, with most borrowers able to meet their repayment obligations. Morningstar DBRS credits the back-up servicer’s swift step-in for keeping things running smoothly and allowing the transaction to continue. However, the commentary also noted that the other tranches may have been impacted differently – depending on their risk profiles.

Gedesco served as both servicer and originator for the transaction – an arrangement understood to be a cause for concern, as the Gedesco case study confirms. 

“As a smaller lender, you’re always more reliant on one particular funding source, so I don’t think it’s uncommon,” Aufsatz explains. “Maybe uncommon was the need for continuous funding as the borrowers needed to roll over their short-term debt, which they could do as long as the securitisation was in its revolving period. We just analysed what can go wrong when there is reliance on one funding source and continuous funding needs.”

Aufsatz also notes that, despite there being multiple issues at play, the whole episode has served to showcase the resilience of securitisation, with a significant portion of the debt still managed to be repaid.

“Ultimately, a lot of the problems were operational and happening at the originator and servicer level – and yet still a large part of the debt was repaid. So, for me, it worked to a big extent as intended by a securitisation structure.”

Back-up servicer provisions are a common feature of transactions in more public markets – such as the securitisation market. “Usually within these structures the smaller the initial servicer is, the tighter the servicing continuity provisions are,” he explains.

Although these provisions aren’t a feature of all deals – particularly in scenarios where the servicer is highly related or indeed a larger bank. These provisions can vary in the details, with some specifying trigger-events for replacement of the servicer. 

As Morningstar DBRS concluded, the Gedesco situation serves as an important case study for the structuring of future transactions, emphasising the importance of tighter servicing continuing provisions. Indeed, given the nuances and unique circumstances of the deal, the rating agency also highlighted the need for greater caution in the market’s approach to servicing playing the dual roles of both servicer and originator moving forward.

Claudia Lewis