Dec 06 - Fitch Ratings says potential disincentives on behalf of the borrowers in the Preps collateralised loan obligation transactions (Preps 2005-2, Preps 2006-1 and Preps 2007-1 ) are mitigated following the noteholders’ consent to the issuers’ proposal to revise the payment waterfall to pay expense reserves senior in the priority of payments.
The expenses reserves will be capped at EUR2m each. Given their senior position in the waterfalls following the noteholders’ consent, cash in the amount up to EUR2m will be retained in the expenses reserves on the respective scheduled redemption date of each transaction. These funds will not be available for repaying class A principal and class B interest and principal. In Fitch’s view, retaining cash up to EUR2m in the expenses reserve will have an immediate detrimental impact on the rated notes since this cash could otherwise be applied to the rated notes. However, Fitch believes that holding the expenses reserve until legal final maturity will not affect the notes’ current ratings.
Additionally, the agency believes that retaining cash in the expenses reserves will have a positive impact on the overall transactions’ performance. The expenses reserves will increase the transactions’ ability to operate after the scheduled redemption date and facilitate the execution of documents related to recoveries and workouts. In the agency’s view, the availability of funded expenses reserves helps reduce the moral hazard problem - that is the risk of companies not having incentives to repay their loans by anticipating that the issuer has no funds to proceed against them.
Fitch acknowledges that any remaining amounts on the expenses reserves will be applied on the legal final maturity date of the respective transaction to redeem any outstanding positions according to the priorities of payments.
The expenses reserves in all three transactions are meant to cover the costs that can occur between the scheduled redemption dates and the legal final dates as a result of actions to recover amounts due but unpaid by the portfolio companies on their loan contracts.
Prior to the noteholders’ consent, the expenses reserves were ranking junior to the interest and principal payments of the rated class A and class B notes in the transactions’ priorities of payments. Accordingly, they could be funded only if the underlying loan pools generated cash in excess of the amounts needed to repay the class A and class B interest and principal. Given the high amounts of defaults in these transactions, Fitch believes it is unlikely to fully repay the class B notes’ principal. See “Fitch Downgrades Three Classes of Notes From Preps Series”, published on 12 April 2012 at www.fitchratings.com. In case the class B notes are not fully repaid, no excess cash would be available to fund the expenses reserves.
Fitch notes that, following the noteholders’ consent which became effective on 29 November 2012, the transactions’ priority of payments will be amended such that the expenses reserves will become senior to class A principal and class B interest and principal. Therefore, the expenses reserves become likely to be funded through the waterfalls on the scheduled redemption date of the respective transaction.
Fitch continues to monitor developments across the Preps transactions.