An S$224 million transaction was priced yesterday (Wednesday) almost bringing to a close a complex exercise in balance sheet management. The six tranche deal, which represents the mezzanine level of a S$2.8 billion synthetic securitization, priced in line with expectations after a few late minute structural tweaks.
Although originally, there were four mezzanine tranches all denominated in Singapore dollars, joint lead managers DBS and JPMorgan decided to add two additional dollar-denominated tranches to satisfy offshore demand and shift some local investors out to the two top rated tranches and into the two lower rated tranches where there was less overall demand.
Hence the final structure of the deal comprised: S$42 million in BBB rated Class D notes which was priced with a quarterly coupon of 6.70%; S$56 million of A rated Class C notes which priced with a quarterly coupon of 5.20%; S$20 million of AA rated Class B2 notes which priced at 80bp over Sibor; $12.15 million of AA rated Class B1 notes which priced at 85bp over Libor; S$30 million of AAA rated Class A2 notes which priced at 45bp over Sibor and $29.55 million of AAA rated Class A1 notes which priced at 50bp over Libor.
Observers report a total of 20 orders in the book, with a percentage split which saw 40% placed with offshore banks (of which the majority were based in Singapore), 20% to insurance funds and 20% to asset managers.
Like many of the deals undertaken by DBS Bank, the capital management exercise marked a first by any Asian bank and as such involved a huge amount of work to get the correct structure in place. As such, the pricing of mezzanine tranches represented just a small part of what DBS was trying to achieve. For both the bank and lead managers, it was more about getting the right loans to include in the first place, stratifying them, working with three different agencies and finding an investor for the super senior tranche.
It also involved liaising very closely with the MAS developing new regulations which would, for example, allow insurance funds to buy their first ever derivative linked product. Previously insurance funds have only been able to use derivatives for hedging purposes.
In essence, the deal will enable DBS Bank to manage its capital ratios more efficiently as the 100% risk weighting of a portion of its corporate loan portfolio will be reduced by moving credit risk off-balance sheet and into an SPV, which has now sold the credit-linked notes to investors. As a result, the bank will have to commit less capital to cover default risk on the loans and in the process can improve its capital ratios through enhanced capital treatment.
In early November, DBS said that it was hoping to release S$180 million from the transaction and has actually released just over S$200 million.
The CLO itself has three main features and assets remain on balance sheet, with proceeds from the deal being used to purchase collateral underlying the SPV. There is a first loss tranche, which is retained by DBS itself, a mezzanine tranche and a super senior tranche, which has been placed in unfunded form.
The nominal amount of the portfolio is S$2.8 billion ($1.52 billion) and DBS has entered into a credit default swap with the SPV (Alco 1 Ltd) to effect the transfer of credit risk. The first loss tranche, amounting to S$126 million represents 4.5% of the portfolio, while the mezzanine tranches represent 8% and the super senior tranche the remainder.
Proceeds are being used to invest in collateral which will be given to DBS should losses on the underlying portfolio eat through the first loss tranche and into the lowest rated mezzanine tranche.
The issue has been structured with a final maturity of seven-and-a-half years, with a call option after four years. The underlying portfolio has an average life of three-and-a-half years and is 80% exposed to Singapore. Some 80% of the portfolio is also exposed to credits originating from countries with a double-A rating or higher.
Observers say that marketing the deal involved a huge educational process. A number of final investors that did not previously have a large presence in Singapore, were consequently said to be attracted to the fact that they could gain exposure to a local corporate loan book, but save themselves the cost of having to put their own credit systems or lending lines in place.