Springleaf proves AAA subprime RMBS can make perfect sense

by Adam Tempkin

NEW YORK, Sept 2 (IFR) - Nobody versed in the basics of securitization was shocked that the staggering 51.15 percent layer of credit protection guarding the senior notes of the first visible post-crisis subprime RMBS helped it achieve a AAA rating from S&P and price this past week with a 4 percent coupon.

The fact that S&P now rates the U.S. sovereign comparatively lower at AA+, may be somewhat ironic and makes for catchy headlines. But it is irrelevant given that the U.S. downgrade impacted less than 5 percent of the total structured-transaction universe rated by S&P.

A subprime AAA rating may be completely appropriate if a deal is properly structured and sensibly underwritten.

"The AAA rating <on a securitization> is based on the structure and the level of credit enhancement in the deal," said Ralph Mazzeo, a partner at Dechert LLP. "The fact that the U.S. government has been downgraded is not relevant to the analysis in a private deal with no government-guaranteed loans or bonds."

Indeed, the whole concept of structured finance is that the rating is designed to be based on the credit quality of the assets, not the issuer.

What was more striking, however, was that a deal executed with such thick subordination was not only profitable for issuer Springleaf Financial, but may highlight a growing opportunity for other well-capitalized consumer lenders to reignite the U.S. subprime mortgage sector with properly and responsibly underwritten collateral.

"There is a gigantic cohort of people who need credit, but the capital markets -- banks and balance sheets -- are on full-out retreat," said Wesley Edens, co-founder, principal and co-chairman of the board of directors of Fortress Investment Group, which owns 80 percent of Springleaf Financial. "This presents a tremendous market opportunity."

Edens says Springleaf is committed to filling that much-needed subprime mortgage niche, just as banks such as Wells Fargo, Citigroup, and HSBC are leaving the sector.

Springleaf announced IPO plans in a May SEC filing for a new REIT to invest in subprime mortgages.

"There is a lot of demand for the product, no competition, and funding rates are at historic lows," Edens said. "The missing link is, can you get financing at modest leverage and at a reasonable cost?"

Apparently, the answer is yes.

ECONOMICALLY VIABLE

Although Springleaf had to boost credit enhancement above the S&P requirement during the marketing phase for Springleaf Mortgage Trust 2011-1 -- and retain a US$49.7m slice of the US$292m Triple A Tranche sold in 144a format (in addition to about US$143m of bonds below this tranche) -- the company was still able to achieve leveraged returns of about 14 percent on the Bank of America Merrill Lynch and RBS-led issue, Edens said.

This takes into consideration that the deal was executed at 50 percent leverage, with a 4 percent all-in cost, and backed by a US$497m portfolio of mortgages originated with an average interest rate of 9 percent.

The underlying pool comprises more than 5,600 loans that are almost 100 percent fully documented. With an average FICO score of 651 and a current LTV of roughly 96 percent, the offering raised some eyebrows, but the assets are all performing, according to a transaction term sheet, which is nothing short of miraculous for a sub-prime portfolio.

"Any leverage is a good leverage," said Ron D'Vari, CEO of NewOak Capital Advisors. "If an issuer believes in the collateral and cash flows, retains some of the risk, and uses the proceeds as a funding trade, securitization of subprime-mortgage collateral can make economic sense, without a doubt."

"There's a level and a price for everything," added Scott Simon, a managing director at PIMCO who oversees securitized products.

In fact, Springleaf weathered the financial crisis better than its peers, with just 6 percent of serious delinquencies in its subprime book, compared with roughly 42 percent for the broader subprime market.

"There is the potential for a ton of capital formation over the next few years, and heavily capitalized credit providers will have terrific businesses," Edens said.

While the transaction was backed by seasoned loans, Springleaf has about US$11bn of new loans on its balance sheet since it started lending as a Fortress-owned entity nine months ago, and plans to return to the subprime RMBS market in the near future, Edens said.

The company, formerly known as American General Finance, was spun off from a unit of AIG (AIG.N) last November when Fortress took its stake in it. An AIG unit still owns 20 percent.

Springleaf, which has been around for 90 years, is historically a "balance-sheet" lender that believes in an old-fashioned "bricks and mortar" model - in which "the lender sits across the table from the borrower" and has a vested interest in the loans, Edens said.

Securitization allows for cheaper financing and is more flexible and predictable than getting a bank loan, which often contains covenants and terms that are more dynamic.

In fact, Springleaf completed a secured term loan in May that had lower leverage than the current securitization, but a higher cost of funds.

Edens says that Springleaf can still turn a profit despite hugely expensive credit enhancement, and that a subprime mortgage securitization can return "as long as it's done in a responsible way."

But while well-capitalized issuers may see a window of opportunity over the next couple of years, the real question facing the industry is whether other lenders will be willing or able to follow suit.

S&P, Bank of America and RBS declined to comment.

(Reporting by IFR structured finance analyst Adam Tempkin)