Downgrades could derail ABS market revival, threaten corporate investments.
The long shadow of the Lehman Brothers bankruptcy may cause corporate treasurers problems anew in the wake of a US court ruling last week. The bankruptcy court for the Southern District of Manhattan issued a ruling that reversed the liquidation priority mechanism in deals where a swap counterparty goes toes up. Previously, that would have subordinated the swap counterparty’s (in this case, Lehman’s) claim below noteholders. The court, addressing the status of a credit-linked note program called Dante, said the ipso facto clause of the Bankruptcy Code did not allow it to change the seniority of a claim just because its counterparty became insolvent.
When ratings agencies digested the news late last week, they reported that the ruling could lead to widespread downgrades of transactions that, up to now, looked like they were holding up.
While the ABS market meltdown in 2008 caused most treasurers to pull cash out of all but the shortest maturity, gilt-edged structured finance ABS, downgrades across the board due to the ruling could have repercussions that could shut off this investment class altogether. On the funding side, further blows to the SF ABS market could negatively affect liquidity in the cash securitization markets that many companies rely upon.
Fitch Ratings said it would scour its ratings on SF ABS and the likelihood of a downgrade would depend on whether the US laws apply, if the ratings of the securitized notes exceed that of the counterparty and whether other structural mitigants help offset the risk to noteholders. The rating firm said that European SF transactions may be most impacted by the court’s decision because they extensively use derivatives to hedge interest rate and FX risk.