Is there a link between issuer rating and trade receivables notes’ rating?
Securitizations of trade receivables can be divided into ABS or ABCP. Corporate companies use securitization mainly as a funding instrument.
ABS (asset backed securities) are bonds issued by a special purpose vehicle (SPV) directly or indirectly linked to the originator. They have maturity which varies depending on the maturity of the underlying assets.
The SPV goes to the market issuing different types of notes: the main difference among them is their implicit risk and remuneration offered to subscribers.
In detail: “A” notes are senior notes, meaning that in the securitization-waterfall their capital and interest portions are paid to investors before other notes. The low risk they carry is counterbalanced by a lower remuneration vis à vis other notes.
“B” notes are so called junior notes: their capital and interest portion is remunerated after “A” notes, but they offer higher remuneration.
In ABCP (Asset-backed commercial paper) structures, funding is raised via issuance of commercial papers by conduits, which acquire notes collateralized by trade receivables and indirectly issued by different originators.
In an ABCP securitization conduits acquire only notes representing the senior (i.e. best) portion of total securitized assets (i.e. senior notes), the remaining portion (junior or subordinated notes) is retained by the issuer. In some cases, a portion of junior notes can be sold to a third investor.
The principles of the waterfall in ABS and ABCP are the same, so we can conclude that in both ABS and ABCP, securitized portfolio is divided into portions that carry different risk. How are portions calculated? Why do some portions carry higher risk?
In structuring a securitization, potential sold portfolio is carefully analyzed to determine the maximum amount that potentially will remain unpaid and therefore represents a risk for the investor.
Analysis is done from several perspectives: in addition to historical default and write-off performance, excessive concentration on specific products or geographic area or customers are key elements.
The credit enhancement required in the form of subordinated note is the sum of rate of reserve for losses, dilution and fx risk (if any) and interest.
Rating and credit standing of the originated company is directly linked to the final amount of over-collateral required to support the transaction: the higher the rating of the originated company, the lower the stress parameter (or rating multiplier) utilized to determine reserves and in turn portions of junior notes.
But structural considerations are also essential to isolate the structure from the originator company and its rating, and are designated to protect final investors from any deteriorations of assets and servicing capabilities.
In detail, legal true sale of receivables from the originator to the special purpose vehicle (SPV) confirmed by ad hoc legal opinion, mitigates any relationship between status of the seller and rating of the structure. Assignability and eligibility criteria of assets to be transferred moves any risk from the originator company to the assets to be sold. In this respect, mitigated material adverse effect clauses (MAC) on the underlying assets are a valid solution to focus the attention on the ability to continue to originate (and service) good receivables, rather than on economic or financial parameters of the originator company. Key items of a mitigated MAC regulate termination of purchaser appointment and declare an early termination event of the whole structure, in case an event occurs which has a material adverse effect on the ability of the sellers to originate valid and sellable receivables, and on the ability of the servicer to collect and enforce sold receivables. Servicing of the receivables and the ability and speed in transferring cash to the SPV, are key elements in assessing a securitization.
In case the originator company is not investment grade and is not supported by a guarantee of an investment grade subsidiary, security on collection accounts (i.e. pledge) or on the servicing entity (back up servicer) are requested to ensure that the structure is “bankruptcy remote”.
Security on the collection account allows the investors to get their money back if the servicer goes bankrupt, while the role of the back-up servicer is to take over the servicing activity in the event of bankruptcy of the servicer or of the originator, or in the case of a sensitive down-rating of the originator or servicer occurring.
We can assess that, although there is mitigation to separate rating of the originating company from rating of notes issued for final investor, if a company is rated below investment grade, its securitizations are penalized by requests for high over-collateral, security over its assets and back- up servicer.
