Philip Paschalides of Walkers looks at the significance of hybrid transactions in today's economic climate.
"The hybrid sovereign/structured transaction reflects the particular needs of investors at this time. It may be that it also reflects the particular needs of governments. If so, we can expect continued development of these structures in the near future."
In capital markets circles in 2012, the word “crisis” was never too far from bankers’ lips. A combination of the deepest recession in generations, a banking sector on its knees and the spectre of sovereign defaults weighed heavily on sentiment in the bond markets. The lingering death of the monoline sector over the previous few years had already significantly complicated certain types of pure ABS issuance. Investor hunger for yield, meanwhile, endured but within an interest rate environment that allowed for only meagre returns. Out of these unique conditions, certain interesting hybrid structures have been brought to market, which may provide an interesting template for future transactions.
One of the lasting impacts of the financial crisis for those structuring capital markets transactions has been a mistrust on the part of investors of highly engineered structures, traditionally viewed as a guarantee of greater security. On the other hand, sovereign debt, often considered the safest investment of all and the very basis for the ratings ceiling of other debt issued from within a jurisdiction, has lost its shine. In the course of the crisis, with nationalisations and the growth of already oversized deficits (and other unfunded liabilities on the horizon), sovereign debt itself looked to be a bubble ripe for bursting. And burst it did, when holders of Greek sovereign debt were hit by a 74 per cent haircut to their investment in March 2012 and the hallowed triple-A ratings were wrestled back from the likes of France, the UK and the US amid a series of sovereign downgrades. In light of such developments, the notion of an obligation being “full faith and credit” to a sovereign sounds like a quaint phrase from a fairy tale. Interesting, then, that one of the more notable capital markets transactions to close this year is a synthesis of these two aforementioned positions.
HYBRID SOVEREIGN/STRUCTURED TRANSACTIONS
In March 2013, Eole Finance SPC, a Cayman Islands segregated portfolio company, used one of its segregated portfolios to raise $187.1 million in a AAA-rated notes issuance to finance an Airbus A380-800 aircraft leased to Emirates. What set this deal apart from more traditional asset backed transactions was that the credit support for the issuer’s obligations in this case was a guarantee provided by Compagnie Française d’Assurance Pour le Commerce Exterieur (Coface), the French export credit agency, acting on behalf of and with the guarantee of the French state. The Republic of France is, of course, one of the founding partners in the Airbus joint venture, and Emirates is one of Airbus’ major customers for its flagship A380 “double-decker” aircraft. The issuance was arranged by JP Morgan Securities plc.
The typical Export Credit Agency (ECA)-backed airfinance structure would see an ECA-supported loan from banks made into a Cayman Islands exempted company, which acts as a special purpose vehicle borrower (SPV), using the loan proceeds to buy the aircraft that it then leases to an airline. In its essential elements, it is a relatively straightforward structure (depending on the jurisdictions involved).The rental payments from the airline under the lease will broadly equate to the loan payments, enabling the SPV to repay its financing over the term.
The Eole Finance transaction involved a two-tier/two-stage structure in which an ECA-supported loan was made to a segregated portfolio of the SPC (the issuer), which then used the proceeds to make a second loan to an SPV borrower, which in turn leased the aircraft to the carrier. The second stage involved a refinancing of the ECA supported loan through a capital markets issuance. Fitch, which rated the issuance, based its analysis on France’s sovereign rating and formed no credit opinion on the loan agreement between the issuer and the SPV borrower.
The end result was a hybrid structure – part structured, part sovereign – in which investors gained exposure to a quality financial asset with a premier underlying obligor, enjoyed the benefits of an insolvency remote ABS transaction with “old-fashioned” credit support and also gained quasi-sovereign exposure, traditionally the “safest” place for an investment. It was a collection of features which, together, offset the “weaknesses” represented by each of its individual elements. At closing, the other transaction parties had gained, variously, the transfer of a financial asset off balance sheet liberating capacity for new business generation (the lending bank), attractive funding (the airline) and the active support of industry for the benefit of a national economy and workforce (Coface).
Over the last 18 months or so, the political climate has been dominated by a period of austerity for governments in Europe. More recently, however, the watch word has been “growth”. Governments are all too aware that their electorates are now looking to them to deliver that growth sooner rather than later, and holding them to account if it does not materialise; witness recent social unrest in Brazil, a few years ago touted as the most vibrant economy in media reports. In the quest for growth (and the political imperative to be seen to be doing everything to achieve it) the stage may well be set for a greater level of state sponsorship and backing of capital raising activities which may result in economic expansion.
This would suit the politicians in power as much as it would suit the investment professionals seeking reward without too much risk.
The hybrid sovereign/structured transaction reflects the particular needs of investors at this time. It may be that it also reflects the particular needs of governments. If so, we can expect continued development of these structures in the near future.