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A version of this article first appeared in Total Derivatives.
Total Derivatives is the prime source of real-time news and analysis of the global fixed income derivatives markets.
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In the second such venture between the German state-guaranteed funding agency and Sumitomo Mitsui Banking Corp Europe (SMBCE), KfW has again provided the platform for a securitization of PFI deals by SMBCE. The collateralized loan obligation deal is a victory for fans of structured finance transactions but also quite a good thing for ordinary people in the UK, and elsewhere, who expect one day to go to hospital, or perhaps to send their children to school.
The Smart PFI 2007 synthetic securitization transaction was co-arranged by Deutsche Bank in London and consists of a SMBCE-originated portfolio of 46 senior secured loans from 34 UK PFI/PPP projects. The loans in the portfolio are used to finance a range of hospitals and healthcare facilities (41.4%), schools (38%) and a wide variety of other public infrastructure projects (20.6%).
Part of the risk on the SMBCE balance sheet of this £388.8 million portfolio has synthetically been transferred to international investors via KfW by means of CDS (92%) and credit-linked notes (6.3%). The outstanding threshold amount (1.7%) is retained by SMBCE. The senior risk (senior swap) and the other cash tranches were successfully placed with investors by Deutsche Bank.
It is understood that there are significant inflation-linked exposures in some of the underlying securities, as is common with UK PPP/PFI deals. In both transactions the RPI swap hedges were not securitized as part of the transaction. "Some of the investors were keen we retained an interest in the underlying loans – including all the RPI swaps," says Peter Twidale of SMBCE.
More in the pipeline, reckons KfW...
KfW’s securitization officials Claudia Holtze and Jörg-Andreas Dürr hope the KfW platform will be used in at least another two or three infrastructure transactions this year, representing a rising rate of frequency for the KfW platform in infrastructure transactions since it was first outsourced in a Depfa/EPIC securitization in 2005.
Dürr says there are a number of reasons for the growing popularity of the KfW platform. "First, by using it, securitizers benefit from minimizing the risk weighting, and therefore get the maximum capital relief, which in turn maximizes their capacity for disbursing new infrastructure loans." Secondly, he says that by using the KfW platform, you get "a standardized platform that is well known in the market and which, because its core features are well known, makes it easier for deals to be understood. Investors can therefore focus on the analysis of the portfolio."
...which is good news for public services
These loan-to-swap-to-CDS risk-weighting-driven transactions are hard to simplify in a way that, say, would allow one’s elderly maiden aunt to quickly grasp the intricacies of the transaction.
But ratings agency S&P had a good stab at it with a presales report that says: "The purpose of this transaction is to transfer the credit risk associated with an initial pool of approximately £388.8 million of public infrastructure loans. All investors run the risk that Smart PFI 2007 will have to write down the principal of the notes during the life of the transaction as a result of realized losses and losses on interest (up to a maximum of 5% of the principal) in the underlying reference pool being allocated to the notes."
Peter Twidale, of SMBCE, explains: "The assets remain on our books, including transactions which may have RPI hedges as many PFI-linked loans do. It is just the credit risk that is hedged".
And this is the nub of what is really interesting about these deals. The KfW platform enables lenders to the PFI market to claw back risk-weighting capital but not just for the sake of it. KfW intermediates on the firm condition that the money is reinvested in PFI projects.
Standard & Poor’s notes that this structure is based on a pool of UK PFI loans used to fund public infrastructure assets and is the third to be securitized in a publicly rated debt transaction: "Essential Public Infrastructure Capital was the first transaction involving only this UK asset class and was completed by Depfa Bank in December 2004. The second was Stichting Profile Securitisation I, completed by SMBCE in December 2005." Since then, Depfa’s Epic and now SMBCE have followed up those debut deals, to bring the total size of the market for this innovative CLO structure to just four.
And it isn’t just the UK that is in on the act. The first Depfa Epic deal was founded on UK PFI deals but the second was more international. PFI is a British invention that is achieving popularity all over the world.
The second Depfa Epic deal reflected this, with PFI loans to countries in western and eastern Europe and as far afield as Australia. Peter Twidale reflects that the CLO issue is "a balance sheet exercise by SMBCE to release regulatory capital for reinvestment into the UK PFI sector." Which means schools and hospitals.
So why aren’t more people doing this type of deal? Twidale notes: "The KfW platform can be used for various classes of transaction – one of which is PFI – but it is up to individual banks how they manage their balance sheets."
At S&P there is a sense of optimism for the future of this sector. Jonathan Manley, a senior credit analyst, says: "It is very early days for this sector. A lot of names have enquired about executing this type of PFI-linked CLO but so far only two have stepped up to the plate."
He says that the structure is very well suited for a market where there are a lot of participants with PFI loan books that, in the case of the UK, have been building up for as long as 10 years. Also there are a lot of public sector projects sized between £50 million and £100 million that would fit perfectly into the blind pools of loans that underpin these transactions.