Triple-A Jump-to-Default!

In what must rank as one of the fastest restructurings on record, Cairn Capital & Barclays have announced:

the successful restructuring of Cairn High Grade Funding I (“CHGF”). The restructuring was made necessary by the closure of the ABCP market on which CHGF had relied for funding.The restructuring has eliminated market value triggers and the reliance of CHGF upon the ABCP market. CHGF has now been converted into a cash flow CDO. As a result, the full notional of outstanding ABCP will be redeemed as it matures and replaced by term funding.

Barclays Capital will provide the senior financing on the restructured transaction and has fully hedged its credit exposure from this financing. This restructuring has received all required investor consent. Investors have agreed to full participation in the costs of the restructuring.

The problem was triggered in a now familiar way: the ABCP market is no longer functional. Barclays is extending a $1.6-billion line.

S&P has announced:

The ratings were placed on CreditWatch with negative implications on Aug. 21, 2007.
The ratings on the original Tier 1 and Tier 2 mezzanine notes were lowered to ‘D’ and removed from CreditWatch negative, since Standard & Poor’s considers the restructuring of the notes in a manner that does not pay accrued interest in accordance with the terms of the notes to be a default.

Under the new structure, the Tier 1 and Tier 2 notes bear no interest, but are entitled to a ratable distribution of excess cash flows after the principal is reduced to $1. Receipts on the underlying asset pool are used first to pay interest on the CP and liquidity facilities and then to pay down the Tier 1 and Tier 2 note principal sequentially until the principal is reduced to $1. Thereafter, the remaining cash flows on the underlying assets are allocated 60% to the Tier 1 notes, 20% to the Tier 2 notes, and 20% to the capital notes. Standard & Poor’s ratings do not address the likelihood of receipt of excess distributions.

US$1,638 million Euro/U.S. commercial paper, US$126 million mezzanine notes and US$36 million capital notes

This may well turn out to be a very good deal for the Tier 1 and Tier 2 noteholders but I wouldn’t want to commit to that statement without ripping apart the structure’s financial statements, which I have no intent of doing!

Essentially, their deal is:

  • They lose the accrued interest on their notes that has been earned but not yet paid. I assume the notes had a semi-annual coupon, but I don’t know this for sure; I will further assume that the notes paid 6%, but I don’t know that for sure either. If both assumptions are true, that’s a maximum 3% loss
  • They are gaining what is, essentially, an equity interest in the underlying portfolio.

The difference between this and the Montreal Proposal is that there is a line being extended to refinance the CP; thus, the underlying portfolio remains leveraged to hell-and-gone, like about 10:1 according to the S&P reporting of the principal amounts … this is almost certainly better for them than the alternative of a forced sale of assets to redeem the CP. Whether or not the Montreal Proposal (in which the CP would not be refinanced, but would gain a proportional interest in the underlying) would be better for the noteholders depends a lot on the quality of assets and on the terms of the Barclays refinancing.

It’s not clear to me how much Barclays is charging for the line, or what the interest rate on the line will be set at … presumably some frightening spread to LIBOR. It’s also not clear from the information above how the principal on the credit line gets paid down. These are kind-of crucial questions!

There will be many who consider the Triple-A Jump-to-Default to be a black eye for S&P … I’ll be the first to agree that it doesn’t make them look good! But here, as we are seeing so much of nowadays, the structure was acting like a bank (borrowing short and lending long) and hence was subject to the great terror of bank treasurers: a run. Depending on the quality of the assets, they have a chance at a recovery after default in excess of 100% … we shall see!

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