The credit crisis has brought the ABS market to near standstill. However, RBS has remained active in the field and used its healthy relationship with VW to good effect, reports Edward Russell-Walling.
The primary market in asset-backed securities (ABS) has been all but closed, for obvious reasons. But half-a-dozen public or private deals have been done this year, backed by asset types that do not make investors feel nervous.
As this market struggles to come back to life, Royal Bank of Scotland (RBS) has been especially visible. Of those six transactions, it has arranged two, or even three (if ABN AMRO now counts as RBS).
Driving force: (clockwise from left) Craig Rydqvist, Jonathan Peberdy, Andrew Lewis and Markus Reule
One was GMAC-RFC’s €250m securitisation of prime Dutch residential mortgages, this year’s first public European residential mortgage-backed securities transaction, with RBS as arranger and sole bookrunner.
The ABN AMRO-arranged deal, priced at the end of January, was the €1.25bn Driver Five securitisation of German car loans originated by Volkswagen’s VW Bank, and RBS was co-manager.
Although RBS now owns most of ABN AMRO’s wholesale operations, the two ABS teams are still working separately and will only be integrated, like the rest of the business, over the next few months. But the Driver Five deal had a distinct bearing on the next securitisation that RBS worked on as arranger and sole bookrunner – Driver UK One.
Driver UK One was VW’s first public transaction to be backed by UK car loans – originated by its wholly-owned subsidiary, VW Financial Services (UK). But this did not mark the start of the bank’s relationship with the German car maker. This dated right back to 2002, when RBS securitised £600m ($$1.2bn) worth of UK car loans for VW, via its Thames Asset Global Securitisation multi-seller conduit.
Funding diversity
What prompted this shift to the term market? One reason was to refinance the conduit and refresh its capacity. Another was to provide funding diversity for investors.
Craig Rydqvist, a director in RBS’s conduit securitisation team, says: “VW felt it had a responsibility to its investor base to be a regular issuer. Other programmes were paying down – and this would provide access to other VW assets as other deals were amortising.”
A year ago, any such exercise would have been concluded as a matter of course, and would have passed almost without notice. But not in today’s climate. Structured products have been at the heart of the current credit storm.
As it gathered force, funds in Europe – where there had already been high levels of ABS issuance in the first half of the year – became heavy sellers of ABS. US subprime mortgages may have started the trouble, but all types of asset-backed commercial paper have had funding problems as a result.
Securitised car loans, however, have the attractions of being short term. They are packaged in very granular pools easily stratified and analysed, which gives investors confidence in the pay-down profile. Moreover, VW is a name to conjure with, in every sense of the word, and the Driver Five issue was an undoubted success.
Order rush
Over its two-day book-building process there was a strong inflow of orders, and the size was increased from an original €1bn to €1.25bn, with both note classes (AAA and A) at the tight end of guidance. The AAA/Aaa/AAA-rated note was priced at 58 basis points (bps) over Euribor and was placed with nearly 40 accounts.
Jonathan Peberdy, RBS head of ABS syndicate, says: “Driver Five executed first, and set a benchmark. We felt that Driver UK could build on the back of the momentum that it created.”
In the broader bond market, the recent tendency has been to launch and price an issue rapidly – in the same day if possible – just in case things turn sour tomorrow. But Driver UK embodied some novelties that persuaded the team to feel its way forward carefully.
Andrew Lewis, a director in the RBS term bond securitisation team that structured the transaction, says: “Pre-marketing was important as Driver UK One had a number of characteristics that were not in the German programme.”
First and foremost, it was planned to be denominated in sterling. It was backed by UK collateral and involved ‘residual value’ risk, an unfamiliar concept in other European markets.
Mr Peberdy says: “Feedback told us that investors were very comfortable with VW and with auto loans as a product.” But it also told them that to issue in sterling only could be difficult in prevailing market conditions, as some investors were worried about prospects for the UK consumer.
Targeting the euro market as well offered greater liquidity, and top-rated notes denominated in euros could also be eligible as European Central Bank collateral – an increasingly attractive feature for bank investors.
Mr Lewis says: “To broaden the investor base, we decided to issue in euro as well as sterling. The combination was a first for VW, but we were ticking as many boxes as we could with the investors.”
The 59,000 or so loans backing the deal include contracts with residual value risk, a first for VW and, indeed, for the UK bond market. Residual value, a common feature of UK consumer motor finance, is the (predetermined) value of the asset at the end of the financing period.
At the end of the contract, the borrower can then pay the residual value and keep the car, take out a new contract with a new vehicle or hand the car back and walk away. The risk for the finance company is if the borrower walks away and the actual value of the vehicle turns out to be less than the residual debt.
Monitoring performance
Markus Reule, the RBS fixed income debt capital markets director responsible for origination and for managing the fixed income debt capital markets relationship with VW, says: “VW monitors the way cars perform in the second-hand market and has processes and systems in place to analyse and manage residual values.”
“It can set residual values three years out, to ensure it does not end up holding cars it cannot sell.” This history of accurate prediction means that VW’s losses due to residual value have been small, another source of comfort to investors.
The greatest source of comfort to investors was the VW brand itself. Investor loyalty to the name was hugely important, and allowed the marketing effort to concentrate on slip-streaming the momentum of Driver Five, and addressing those areas where Driver UK departed from the norm. A roadshow took in five European countries before the books were opened.
Mr Peberdy says: “VW did this deal very openly,” noting that a more common recent approach has been discreet contact with a small number of accounts, going public only when a deal is almost complete. “It was a very positive thing that they felt able to do that.”
Like Driver Five, the deal was split into class A (AAA-rated) and class B (A-rated) notes, although in this case, there were sterling- and euro-denominated versions of each.
Residual value
Credit enhancement, including an element specifically for the residual value risk, was made up of note subordination, a subordinated loan, overcollateralisation and a cash collateral account.
Pricing (in line with guidance) allowed a premium over the German transaction, at 70bps over Libor/Euribor for the class A notes and 160bps (140bps for Driver Five) on the class B. After a two-day book-build, the £500m-equivalent deal was fully placed with some oversubscription in the euro tranches.
The UK absorbed 52% of the deal, Germany 30% and the Netherlands 11%. Banks took 54% of the paper, funds 41% and insurers 5%. There is, as Mr Peberdy says, “no fast money in the ABS market any more”.
The deal was priced tighter than some expected, and the absence of speculative investors served to stabilise the aftermarket rather dramatically. Since the deal priced in February there has been no trading, with investors happy to sit on the paper.
Mr Peberdy is not surprised: “It is a new issue, with a current coupon,” he says. “Investors who bought it were joined in the book by like-minded investors in terms of market outlook, with a long-term view on spreads.”
