Wednesday, March 28, 2012

Prudential bond: a mixture of covered bond and RMBS

The International Financing Review ran an article describing a bond being offered by a unit of Prudential Financial Inc.  The bond is a mixture of a covered bond and a residential mortgage-backed security (RMBS).

What makes this bond interesting is it highlights the need for ultra transparency and why structured finance securities must be required to disclose on an observable event basis the underlying collateral performance.

The offering, titled Prudential Covered Trust 2012-1, was given a Single A rating by Standard & Poor’s, and may be the first bond of its kind: linked to the corporate credit risk of an insurance company, but involving legacy RMBS assets....
Underwriters Deutsche Bank (structuring lead), Barclays, and Wells Fargo launched the 3.5-year issue this afternoon and were set to price it at Treasuries plus 250bp, nearly 100bp wider than a standard three-year senior unsecured corporate bond issue from Prudential (typically Treasuries plus 145bp to 150bp). 
The offering contains features of both covered bonds and RMBS, but is not truly either. 
The assets of a covered bond remain on the balance sheet of the issuer throughout the tenure of the issue. MBS issues, for the most part, are off balance sheet, given the sale of the assets to a special purpose vehicle (SPV), or trust. 
The Prudential transaction is fully guaranteed by PFI and offers semi-annual payments, making it closer to a covered bond. 
However, it differs from covered bonds in several ways: it offers sequential payments to investors, instead of a fixed bullet; the RMBS collateral is off balance sheet, and the payments are contingent on the underlying cashflows from the RMBS. 
The rating on the deal is solely linked to the credit rating of Prudential. 
PFI deposits RMBS into a trust and then issues notes and certificates to investors.  The 470 underlying RMBS issues – mostly subprime, including some Re-Remic bonds – are provided by a unit of PFI, called Prudential Insurance Co. of America. 
The issue was rated by the Insurance Ratings team at S&P, who are only concerned about the corporate rating of PFI, which is providing the guarantee. 
However, the raters are not concerned – nor do they know – the market value of the RMBS assets used as collateral. It is not germaine to the ratings analysis, they say. The notional, or original balance, of the RMBS is approximately three times the size of the note issuance, but it’s not clear what the current market value of the distressed RMBS is.
Without information on the current performance of the underlying collateral provided by ultra transparency, the 470 underlying RMBS issues cannot be independently valued by market participants.  As a result, there is no market for these issues.

Since there is no way to value the underlying RMBS issues, the bond needs the guarantee from Prudential.

The question is why would Prudential pay a premium to issue a bond like this as oppose to a straight bond offering?  Capital arbitrage?


Anonymous said...

Bo - they are doing this for tax purposes

Richard Field said...

I have seen the speculation that it is being done for tax purposes. However, the speculation is not convincing.

Specifically, I have seen the idea that the structure of this deal allows them to recognize a loss on the underlying RMBS for tax purposes.

However, that involves "sale" of the securities. Hard to see how these securities pass that test because Prudential is still on the hook for 100% of the economic outcome of the underlying RMBS.