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Home-Equity Issuers Forced to Relax Triggers
Asset Backed Alert, Harrison Scott Publications Inc. (September 26, 2003)
A growing number of home-equity lenders are taking steps to make their securitizations friendlier to buyers of subordinate bonds.
The lenders are trying to fight a trend in which climbing delinquencies and losses among their deals' collateral pools have increasingly set off triggers that force them to skip installments to junior bondholders. In fact, researchers at Credit Suisse First Boston recently found that 57% of insured home-equity-loan securitizations have hit those triggers, along with 48% of senior-subordinate issues.
One solution, used by Ameriquest Mortgage, has been to relax the triggers in a way that allows cash to flow to subordinate bonds even when delinquencies and losses among the underlying loans begin to climb. The Orange, Calif., mortgage lender is now preparing its second issue using the revamped structure. That $1 billion deal is expected to hit the market next week.
"It's a trend [junior] investors are asking for," said Ketan Tarekh, a vice president in Ameriquest's capital-markets area.
The triggers are said to "fail" when losses and delinquencies among securitized loans are higher than thresholds outlined in the covenants of the bonds they support. Such failures activate new payment schedules to boost credit enhancement for senior notes. For example, payments could be diverted to senior bondholders from the subordinate classes, or an issuer could tap into a deal's excess spread to make payments on its triple-A-rated bonds. Meanwhile, payments on junior bonds would halt until delinquencies and losses abate.
According to First Boston's researchers, who studied 540 deals, the high rate of activation for triggers could be the result of overly optimistic projections for losses and delinquencies among securitized home-equity loans. And while they're set off by rising losses, the failures don't necessarily indicate excessive defaults. "Setting of triggers is more art than science and, therefore, failed triggers may reflect poorly designed triggers as much as poorly performing deals," they wrote in a report released this week.
Market players have encouraged rating agencies and bond insurers - the two institutions that are largely responsible for setting loss thresholds - to come up with more-realistic payment triggers. The rating agencies counter that triggers merely reflect the ability of a deal's subordination to protect against losses. That being the case, some analysts believe that more subordination should be built into deals, rather than relaxing triggers for the benefit of junior bondholders.
Ameriquest is attempting to solve the problem by using "dynamic" triggers. The structure would allow Ameriquest to calculate delinquencies and losses in relation to the amount of principal due on the senior notes, rather than employing fixed, or "static" triggers. The dynamic triggers would not fail as easily because as the principal on senior bonds is paid down, the deals would require less credit enhancement and the triggers would become less sensitive.
"You're less likely to see static triggers today than you would 12 or 24 months ago," said Glenn Costello, a researcher at Merrill Lynch.
Costello said that if issuers do not relax their payment triggers, investors will start to demand wider spreads on lower-rated securities. "I think they're demanding pricing that reflects that risk. When you look at spreads today, you see investors want to get paid for the risk of trigger failure," he said.