ROC Pref III Corp has announced:
its Preferred Shares have been placed on CreditWatch with negative implications. The move comes as a result several downgrades of companies held in the Reference Portfolio including the monoline insurance companies and Residential Capital (“ResCap”) during the past several weeks. The rating on the Preferred Shares reflects the rating on the fixed-rate managed credit linked note issued by The Toronto-Dominion Bank (the “CLN”). The return on the CLN, and thus on the Preferred Shares, is linked to the credit performance of a portfolio of 125 companies (the “Reference Portfolio”). The Reference Portfolio is actively managed by Connor, Clark & Lunn Investment Management Ltd. (the “Investment Manager”). The Investment Manager commented that “we remain confident in the overall portfolio credit quality. The vast majority of the holdings are performing well. Challenges in the US housing and mortgage market have caused a number of the holdings in the Reference Portfolio to be downgraded.
Recently, S&P classified ResCap’s debt restructuring as a “selective default” until they do further analysis. A selective default is not a default from the perspective of the Reference Portfolio and the CLN. If S&P restores ResCap’s rating to CCC, it may result in the removal of the Preferred Shares from CreditWatch.”
The Preferred Shares benefit from the protection of a first loss tranche equal to 3.35% of the Reference Portfolio and from a fixed recovery rate of 40% on any defaults. As a result, ROC Pref III Corp. will be able to sustain 7 defaults, which is approximately 2.5 times the average default rate and 1.3 times the worst default rate experienced in a portfolio of the same credit quality as the Reference Portfolio in any 3.8 year period since 1981. ROC Pref III Corp.’s Preferred Shares pay a fixed quarterly coupon of 4.40% on their $25.00 principal value and will mature on March 22, 2012. The Standard & Poor’s rating addresses the likelihood of full payment of interest and payment of $25.00 principal value per Preferred Share on the maturity date.
CC&L had to make a similar announcement for RPQ.PR.A in May.
RPB.PR.A is not tracked by HIMIPref™.
I recall being asked by a retail investor whether they should buy this pref in IPO a few years back.
When I read the prospectus I was horified by the idea that the “dividend” was based on return of capital and that the pref owners would lose some principal after 3.8% of defaults in the reference portfolio and ALL principal after 4.8% defaults — a form of 100X leverage (1% loss in the underlying causes 100% loss of investment).
I thought at the time that I would much rather own the underlying bonds directly, when 4.8% defaults and 40% recovery would barely scratch my principal. 4.8% defaults was not unlikely over a 7-year holding period which could easily include a recession. If this went down, it would go down hard.
How this issue earned an initial P1-Low rating from S&P I have no idea. Compared with CDO tranching, this looked more like the toxic waste left to provide protection for more senior tranches than a supposedly senior P1 level tranche. S&P’s rating approach must have been EXCEPTIONALLY sensitive to assumptions/model.
Fortunately, my independent prospectus review and disregard of the “implicitly approving” credit rating saved me the 60% losses to date.
Now the chickens are coming home to roost — as in many structured products that even the credit raters could not understand. Me, I’m a simple guy — I saw 100X leverage and ran in the opposite direction.
[…] was placed on Credit-Watch Negative in June. In a development not reported by PrefBlog, it was taken off credit watch and affirmed at P-2(low) […]