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Whole biz ABS riskier than oil and gas deals, Fitch says

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By Jennifer Kang
20 Feb 2020

Investors hungrily eyeing two esoteric ABS subsectors — one booming, the other nascent — may want to look take a second look, as Fitch Ratings this week warns that whole business securitizations are a riskier bet than the budding oil and gas ABS sector.

On Thursday, Fitch issued a commentary comparing the operating risks between oil and gas ABS and whole business securitizations, both sectors that have entered the spotlight recently for the high yields on offer. The two have clear differences, said Fitch managing director Gregory Kabance, but are similar in that they come with operating risk as a result of their structures.

The collateral for oil and gas ABS is typically proven developed producing (PDP) reserves, which represent the estimated remaining volume of resources expected to be extracted from an existing oil and gas well. According to Fitch, PDP reserves are a tangible asset that provide a "stable" cash flow because the rate of depletion is predictable depending on the age of the wells. On the other hand, a whole business securitization is typically backed by a single brand name or a corporate parent, making it more difficult for a backup manager to take over when the parent faces trouble.

"They both have that risk, but the point we're trying to make is that one has a tangible asset, and the other has an intangible asset," said Kabance. "It's questionable whether you can put a backup manager in there to handle [a whole business securitization deal], versus in the oil sector where that has been the case. [There have been cases of] companies that defaulted and production has continued because it's an asset that continues to have cash flow until it is deplete."

Fitch has previously voiced concern over the "overstated" benefits of whole business securitizations, which carry investment grade ratings but are much more highly exposed to corporate risk than a traditional ABS. As implied, these deals securitize the whole business, not just a few assets. 

It is a "concerning trend" that companies with below investment grade corporate ratings are able to issue investment grade ABS debt, Fitch wrote in a note published in December.

The rating agency is not alone in seeing pockets of risk within the whole business ABS sector, specifically regarding the difficulty of transitioning to a replacement operator in the event the corporate parent runs into trouble.

"It's very easy to transfer servicing on direct receivable type transactions, like auto loans or credit card loans, but I think by the nature of whole business securitizations, it's very difficult to replace the operator," said an esoteric ABS lawyer. "The deal is forever going to be linked to the operator. But that being said, I think whole business deals do a good job of isolating the assets and credit risks from the corporate parent."

However, investors are usually well aware of the idiosyncratic risks that come with each franchise ABS deal, and feel as though they are being compensated with higher yields most of the time.

"If it were all cut and dry and simple and all deals and structures were iron clad, you wouldn’t be getting 200+ or more in spreads – they'd be trading at 30 off or 50 off," said John Lloyd, co-head of global credit research and portfolio manager at Janus Henderson. "It’s a little bit of a trade-off, but I do think at this stage, [whole business ABS structures strike] a good compromise between trying to protect investors and not having the structures be too stringent that the companies can't maneuver around the way they manage their business."

By Jennifer Kang
20 Feb 2020