Your daily dose of structured finance acronymic hindsight available right here, in a TruPS CDO edition.
From Fitch Ratings on February 12:
Fitch Ratings has placed 179 notes from 72 bank trust preferred (TruPS) collateralized debt obligations (CDOs) on Rating Watch Negative to reflect the increased default and deferral activity in bank TruPS assets. In many portfolios the recent default and deferral activity has now exceeded Fitch’s expectations from the portfolio review in April 2009. Consequently, 295 notes from 76 TruPS CDOs have been downgraded reflecting realized losses from defaulted assets and anticipated losses from deferring assets in the respective portfolios.
TruPS are basically a type of preferred security issued by banks and companies. They proved popular since they combined debt and equity characteristics, and came with all sorts of tax and accounting benefits. And they were also popular as fodder for collateralised debt obligations (CDOs).
From about 2000 onwards, TruPS CDOs became an easy way for smaller banks and insurance companies to raise money. For investors, they were pitched as a relatively safe play on middle-market bank lending. Sometimes they were even pitched as “indirect investment” in US commercial real estate (CRE), with more protection (subordination) than commercial mortgage-backed securities (CMBS).
Small wonder then, that as small and regional banks collapse en masse in the States, these TruPS go into default — with the defaults feeding into the circa $40bn TruPS CDO market.
Here’s some comment from Mark Pibl at specialist advisory service New Oak Capital:
“Just in the past month there have been seven new bank defaults and 20 banks began deferring interest payments on their TruPS. What a lot of people don’t realize is how pervasive these bank trust preferred securities were packaged into CDOs. The cumulative default and deferral rate now exceeds 27%. These CDO structures were not set up to withstand that level of deferrals. To give you an idea how concentrated these deals are, the 24 largest bank TruPS (out of 1,800 issuers) issued $6 billion which amounted to nearly 20% of all bank collateral. More importantly, these 24 accounted for over 66% of the collateral that is either in default or deferring.”
In fact that Fitch downgrade came just two days (February 12) after the rating agency issued a report showing that US bank TruPS CDO defaults were nearing 11 per cent. That’s from the virtually non-existent default level of 0.1 per cent at the start of 2008, and up from 10.8 per cent in January.
The issue, as Pibl’s commentary suggests, is that these TruPS CDOs simply weren’t designed to handle defaults and deferrals in their current numbers. This, for instance, is a theoretical TruPS CDO example, drawn up in 2004 by Merrill Lynch:
The senior ‘AAA’ class can withstand a constant annual default rate (CADR) of 11.9% before breaking its yield. The junior ‘AAA’ and ‘A’ classes can withstand CADRs of 8.5% and 2.4%, respectively. These CADRs compare favorably with the 1970-2003 historical average of 38 bp (peak of 204 bp). The coverage multiple above the historical average failure rate that the senior AAA- and A-rated tranches can withstand before breaking yield is 29.8x and 5.9x, respectively.
So, CDO TruPS trip-ups. CDO TruPS troubles. Not so top-TruPS CDOs. Etc.
Filed under structured finance –> hindsight –> oops.
Related links:
TruPS CDOs Resource Center
`More bad news’ on banks CDO exposures to come, BofAML says – FT Alphaville
CPDOs, a structured finance post-mortem – FT Alphaville