Esoteric ABS spotlight shines on oil and gas royalties

Market participants are taking a closer look at emerging asset classes with large capital needs not yet serviced by securitization, particularly oil and gas royalties, said panellists speaking at day one of ABS East.

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Although oil and gas royalty securitizations have been seen in emerging markets such as Latin America and the Middle East, the asset class has been dormant in the US, panellists said, but circumstances have shifted. Small oil and gas operators as well as private equity funds are looking to tap the ABS market as reserve based lending (RBL) facilities they traditionally relied on in the high yield market or the equity market have largely dried up. Securitizations backed by proven developed and producing (PDP) reserves may surface as soon as this year.

“[Oil and gas royalties] match up well with securitization fundamentals,” said Gregory Kabance, managing director at Fitch Ratings. “There’s a real unleashing of value there for capital markets or traditional insurance companies because you are looking at 10 years —maybe five years — of a steady stream of cash flows that line up very well with bond financing. The stars are really aligning in some way.”

Fitch Ratings has been working on bringing together knowledge from players across the market, from structured and corporate finance to energy finance, Kabance added, to create a comprehensive rating analysis of oil and gas royalties. Earlier in February, Fitch published a report on the outlook for oil and gas royalties, saying that it was working on improving its framework.

“Revenues generated from PDP volumes are proving to be stable sources of cash flow,” Fitch said in the report. “That, coupled with very predictable depletion rates on diversified portfolios, aligns oil and gas royalties with securitization fundamentals.”

The rating agency had said it expected oil and gas royalties to gain traction in 2019.

Ratings Fitch would assign to an oil and gas transaction would be somewhere between a single-A and triple-B, taking into consideration the operational risks, the February report said.

“You are not dealing with a traditional, passive asset. Unlike credit cards or mortgages, the oil doesn’t exist until people who do the drilling extract it out of the ground. It may be a minor risk but it [results in the asset class having] limitations in achieving a high rating,” Kabance told GlobalCapital. Some other risks include the operator going bankrupt, oil production not being as high as expected and oil price volatility.

“There are lots of different groups within this area starting to investigate, ‘how do you go about putting [oil and gas royalties ABS] together and what kind of analysis is needed’ — we are seeing that across the platform,” said Tricia San Cristobal, chief product officer at T-REX, pointing to the growing interest she has seen in the asset class.

On top of oil and gas securitizations, moderator Jeffrey Stern, co-chair of structured finance at Winston & Strawn LLP, said he has noticed a theme of hybrid structures on the rise in the natural resources market, including helium, rare minerals, or the use of PACE for water infrastructure.

Another asset class that came under the spotlight is whole business securitization. This year’s new issue volume in the sector has already surpassed that of 2018, with 10 deals adding up to $7.4bn, according to Finsight. Throughout all of last year, the market saw 10 whole business deals totalling $6.1bn.

“Whole business securitizations have been around before, pre-crisis,” said Robert Sannicandro, managing director at Deutsche Bank. “[The sector] has validated that the structure of those deals can go through a crisis.”

On the contrary, some panellists questioned the reliability of certain deals within whole business ABS, particularly those that are in the non-restaurant franchise category.

For example, niche deals such as MassageEnvy tend to carry more risk, especially since the corporate parent faces headline risks around sexual harassment allegations.

On the other hand, Wendy’s may go bankrupt, but the replaceability of the management makes the franchise more likely to be able to reorganise itself, said Stacey Schacter, chief executive officer at Vion Investments.

“The phrase whole business is a bit of an oxymoron when it comes to securitization,” said Kabance. “You’re securitizing the entire business and technically a securitization is taking a set of assets and trying to remove that risk. There’s a bit of arbitrage in that space.”

Apart from oil and gas royalties and whole business securitizations, the audience suggested a number of different emerging esoteric ABS they expect to see emerge as well, including electric vehicle battery lease, agricultural real estate and sports contracts.