ABN AMRO’s asset liability management team clinched two important deals last year: the SMILE transaction, which was executed at tight pricing levels, and the Shield securitisation, which was designed to release risk-weighted capital under Basel I but is also Basel II efficient. Udo van der Linden outlines the transactions.
SMILE case study
In 2005, as part of its capital management activities, the asset liability management (ALM) team at ABN AMRO decided to go ahead with a large securitisation transaction backed by a portfolio of loans to small and medium-sized enterprises (SMEs). The transaction was carried out in a short time frame to execute what became the SMILE 2005 Synthetic B.V. transaction, which was structured as a fully funded synthetic.
SMILE involved an offering of €6.75bn-worth of notes right across the capital structure, from triple-A all the way down to double-B. There was no unrated first loss piece, with the bank instead contributing excess spread to the deal to cover initial losses. This made SMILE the first SME transaction to achieve a structure without an unrated first loss position. The offering was the largest ever SME securitisation in continental Europe.
It soon became clear that the final two months of 2005 were shaping up to be an exceptionally heavy period of issuance in the European asset-backed securities (ABS) market. The SMILE transaction was nonetheless executed at tight pricing levels in December. The €4.28bn-worth of triple-A-rated notes with a weighted average life (WAL) of 2.2 years priced at Euribor plus 14 basis points (bp), and the €2bn-worth of triple-As with a longer WAL of six years were privately placed.
The structural features of the deal were well received and the lower rated tranches also achieved tight pricing. The double-A notes were launched at Euribor plus 23bp, the single-A notes at 37bp, the triple-B notes at 75bp, and the double-B notes at 325bp.
The notes were well distributed to a diverse group of investors: 30.63% were sold in the UK, 29.13% in France, 15.02% in Germany and 8.6% in The Netherlands. Fund managers made up 63.6% of the book, with banks taking most of the rest, although there was also some placement with pension funds and insurance companies.
Key capital management tool
ABN AMRO has had an active securitisation programme since 1997, and has gained plenty of experience doing deals backed by assets off its own balance sheet. The ALM team views securitisation as a key tool for efficient balance sheet and capital management, and the SMILE deal was able to release regulatory capital under the Basel I regulations while also being Basel II efficient, and reducing economic capital. In the Basel II landscape, more banks are expected to undertake securitisation of their portfolios of SME loans.
Over the past five years, ABN AMRO has regularly topped the arranger league tables for euro-denominated ABS/mortgage-backed securities (MBS) out of a variety of jurisdictions.
Shield case study
In 2005, ABN AMRO brought all its experience to bear when it successfully launched the largest residential mortgage-backed securities (RMBS) transaction ever seen in Europe.
The Dutch mortgage assets backing the Shield 1 B.V securitisation came from ABN AMRO’s own balance sheet. The bank regularly uses securitisation as a capital management tool, and both synthetic and cash securitisations can be used to release capital. Because the bank had no need for additional funding, Shield was structured as a synthetic deal, mainly executed in the form of senior credit default swaps (CDSs). The goal was to transfer €22bn-worth of Dutch mortgage risk while keeping the loans on balance sheet.
In the run-up to Basel II, banks need to take care in assessing the effect of doing a deal both under current regulations and under those coming into force in January 2007. Shield was designed to release risk-weighted capital under Basel I but also to be Basel II efficient and to release economic capital.
Senior CDS structure
The deal was structured as a senior CDS, accompanied by €4.016bn-worth of credit-linked notes (CLNs). The notes issued by Shield 1 were rated by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. CLNs, the proceeds of which are used as cash collateral within the Shield structure, were offered across the capital structure in six classes from triple-A all the way down to single-B.
Losses on the portfolio in excess of any synthetic excess spread balance will result in a credit protection payment to the swap counterparty, funded by a cash release from the deposit account. In other words, investors in the credit linked notes are getting paid interest on their notes as usual, and will eventually get principal back. But there will be some losses on the portfolio, which are synthetically calculated. There is an excess spread account building up (ie: the loans made by ABN AMRO may be at 5%, but only 4% is needed to pay investors their interest), but if a large number of loans turn bad then all this calculated cash pile of excess spread will be eaten away.
At this point the bond investors will take a hit, so if 10 million euros of loans default they must pay ABN AMRO this ten million, meaning ABN has got rid of this risk. The amount that ABN has lost on its loans is synthetically calculated via the swap, and the noteholders either have interest payments stopped, or principal payments will be in danger – at which point a downgrade is likely.
The deal was innovative in that the structure did not include the traditional unrated first loss piece, which is usually retained by the originator. Instead, ABN AMRO satisfied the rating agencies by providing excess spread equal to the expected economic losses on the portfolio of mortgage assets.
The strong structural features proved to be highly attractive to investors, and ABN AMRO built a diverse order book.
Although most of the risk transfer was executed via CDSs, the CLNs by themselves constituted one of the larger European ABS offerings of 2005.
Tight pricing
The pricing achieved on the various tranches of CLNs was tight, and particularly noteworthy was the fact that the €3bn-worth of triple-A notes with a WAL of 6.12 years priced at Euribor plus 17bp, in spite of being launched into an exceptionally busy year-end rush of European ABS offerings.
There were participants from more than 15 countries, with The Netherlands, UK, France and Germany leading the way. Fund managers made up 65% of demand, with bank investors accounting for another 29%, and pension funds most of the rest.
Prime mortgage loans remain one of the best forms of collateral to be used by banks looking either to raise triple-A funding or to release regulatory and economic capital via the transfer of risk to third party investors.
RMBS issuance will remain a major tool for capital management in the years to come. And not only can ABN AMRO lay claim to having closed the biggest ever RMBS deal in Europe, but it also used its expertise during 2005 to lead offerings for clients in a variety of jurisdictions, including Banco Comercial Português, HBOS and Unipol Banca.
In the Dutch RMBS asset class, which is regarded as one of the tightest pricing benchmark asset classes in the European ABS market, ABN AMRO has structured and arranged more transactions than any other institution.
Udo van der Linden is head of structured consumer capital, ABN AMRO.
