The Royal Bank of Scotland has completed a synthetic CDO transaction with a reference portfolio of up to GBP300 million senior and mezzanine leveraged loans, of which it has already selected 45 per cent. RBS’ structured finance division will act as collateral manager for the transaction and will identify loan obligations for inclusion in the reference portfolio. RBS is not obliged to originate or hold any of the loans.
Synthetics are traditionally transactions in which banks or financial institutions hedge assets using credit derivatives – previous examples in the market have been utilised to improve balance-sheet management and/or transfer risk and even as an indirect method of funding. In a synthetic, assets are not sold into a special purpose vehicle, but the risk from the underlying assets is transferred using a credit default swap to investors in Credit Linked Notes (CLN), so that any losses on the underlying collateral pool will be borne by investors. “For example, if the entity or company to which a referenced loan has been advanced is declared bankrupt or defaults in making payment, the credit default swap will pay out and the principal repaid to the CLN investors at maturity of their Notes will decrease accordingly,” says Nick Rice of RBS Financial Markets.
The synthetic CDO is structured as two linked transactions – a GBP213 million unfunded senior credit default swap and a GBP87 million funded junior credit default swap entered into with Cairngorm Limited, a special purpose vehicle incorporated in Jersey. Cairngorm Limited has raised funds to cover its potential obligations under the subordinated credit default swap and to repay principal by issuing GBP87 million of Notes listed on the Luxembourg Stock Exchange. These notes were rated by Fitch and run from a 28.1 million triple A portion to an unrated portion of GBP30.6 million.
The transaction has a ramp up period of one year, a five year revolving period and a scheduled maturity of 14 years. RBS financial markets’ securitisation team structured the transaction and placed the senior unfunded credit derivative and the notes with investors. Clifford Chance provided legal advice on the transaction.
With a growing number of European institutions showing interest in this kind of structured product, the bank has decided to target only UK and European investors, rather than the more mature US market. Willie Clark, managing director at RBS structured finance, is confident the CDO will reach its target: “The transaction has been well received in the market with strong interest from both UK and European investors.”
It is hoped that this will be the first in a series of such products to come from RBS. Clark said: “CDOs are a growing part of the European debt market. There is growing appetite for this type of investment vehicle. Institutional investors are increasingly looking to get into this asset class and CDOs are a good way of getting a foot in the door via a diversified product.”
RBS is not the only one targeting this growing sector of the credit market. Barclays Capital’s fund management arm, Barclays Capital Asset Management, this summer unveiled three new collaterised debt obligation funds (CDOs), two focusing on the European market and one in the US see evcj September, page 10. Further offerings in the private equity-related CDO market include Duke Street Capital’s E750 million Duchess I fund, boasted as the largest in Europe, and Capital Dynamics’ Prime Edge, a E150 million cross between a traditional high yield CDO and a private equity fund of funds – see evcj July/August, page 4.