Rating agencies do not often react with a change in outlook to positive when a borrower announces a debt transaction (unless the deal is M&A related). But Standard & Poor’s placed Northern Rock’s A credit rating on positive outlook in reaction to the UK motgage bank’s Whinstone Capital Management deal. At just €422.7 million this credit-linked note via Barclays Capital and Lehman Brothers is far from the biggest deal in European structured finance but it is certainly one of the more significant from a capital and risk management perspective.
It is a funded synthetic securitization of the first-loss position of Northern Rock’s Granite RMBS programme. It is designed to cut the risk relating to the Granite programme that is retained by Northern Rock, hence S&P’s rapid move.
On any RMBS transaction the originator, after selling off triple A, single A and triple B notes, retains a substantial stub of risk called the first-loss piece. S&P accepted the funding benefits from Northern Rock’s Granite programme, a little under $70 billion raised in six years, but did not give it much recognition for credit risk transfer.
At £500 million ($881 million), Northern Rock’s first-loss position was substantial. At the end of June 2005, the bank’s adjusted common equity (ACE) was £1.36 billion in absolute terms while its ratio of ACE to assets (including securitized) was a low 1.9%. After this transaction, the best meaningful measure is ACE (less the residual retained first-loss position) to risk-weighted assets. And this ratio now stands at just over 5% according to Nigel Greenwood, associate director, financial services ratings at S&P.
Whinstone Capital Management is a particularly useful product for a bank such as Northern Rock. “First, they are such heavy users of securitization and secondly, the benefit from this transaction is greater for them than for most others,” says Greenwood.
S&P also warn that the benefit of this transaction will wane. This suggests that the bank will need to conduct a repeat issue at a later date.
Capital is just one component in a bank’s rating but because of Northern Rock’s high-growth strategy its capital base had been weakening. “The fact that we now feel more positive about this resulted in the change in outlook,” explains Greenwood. “How can this apply to other institutions?” he ponders. “Clearly we look at each one on a case-by-case basis.”
| Securitization and Northern Rock’s funding |
