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
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.