While the categorization of Prudential Covered Trust 2012-1 and the issuer’s motivation behind it were up for speculation even after pricing, market participants did generally agree that the Single A rated issue (Standard & Poor's) might be the first bond of its kind, as it is linked to the corporate credit risk of an insurance company but involves legacy RMBS assets.
Investors' circumspect attitude toward the bond led to a soft initial pricing -- it printed 100bp wider than a typical Prudential coroporate bond -- but on Friday the issue tightened nearly 40bp in the secondary market.
"I guess accounts got a little more comfortable with it!" said one market source.
The unusual deal was tied to the cashflows from a portfolio of 470 subprime RMBS and Re-Remics that a subsidiary of Prudential wanted to get off its balance sheet for the 3.5-year tenure of the bond. Yet the principal and interest were fully guaranteed by the parent company, just like the monoline “wraps” of yesteryear. That’s why S&P simply slapped Pru's Single A rating on the mysterious offering.
But some investors didn’t know what to make of it. Marketed by name as a “covered trust” (a misnomer, sources say), appearing to the naked eye as a simple secured corporate bond, and backed by cashflows of distressed sub-prime RMBS, the issue was an enigma.
“This bond is in no-man’s land,” said Mike Kagawa, a senior ABS portfolio manager at Payden & Rygel. “As an ABS investor, I didn’t even look at it. And given that it priced 100bp wide of Prudential’s corporate bonds with a structure attached to subprime, I’d say that most corporate investors were wary of it as well.”
The offering contains features of both covered bonds and RMBS, but is not truly either. The assets of a covered bond, a structure that is popular in
As with a covered bond, the notes of this week's offering were guaranteed by the parent company and offer semi-annual payments. But unlike most covereds, it pays out sequentially as well as with a fixed bullet of principal, and the payments are contingent on the underlying cashflows from the RMBS.
Underwriters Deutsche Bank (structuring lead), Barclays, and Wells Fargo were particularly tight-lipped about the issue. All the dealers, as well as Prudential, declined to comment.
Tax benefit?
The deal was a Rule 144a issue with no registration rights, and was handled by the leads’ high-grade bond desks, which surprised some in the market who had thought it was more of a structured issue.Originally expected to price 75bp behind Prudential’s corporate bonds, the issue was talked at Treasuries plus 225bp. But it ultimately priced at Treasuries plus 250bp, a full 100bp wider than a standard three-year senior unsecured corporate bond issue from Prudential (typically Treasuries plus 145bp–150bp).
Surprisingly, the bond tightened to Treasuries plus 210bp–215bp in secondary market trading on Friday.
Still, the company’s initial lacklustre execution left market participants puzzled as to why Prudential would pay such a hefty premium to issue a bond like this as opposed to a straight bond offering or a direct trade of the underlying assets into the secondary market.
“It’s purely for tax reasons. It’s not capital arbitrage and it’s not asset liability management, according to the dealers,” explained one investor.
By selling the RMBS assets at market price and “locking in the loss”, the insurance company gains a significant tax benefit, another source suggested.
The source suggested that the tax relief is linked to Prudential's 2010 sale of its minority stake in Wachovia Securities Financial Holdings to Wells Fargo for $4.5 billion in cash.
But some market participants offered other explanations for the wide pricing: the deal was 144a versus Prudential’s public debt; it was amortizing, which high-grade investors charge for; and it was issued out of a trust.
It was also only rated by S&P, and several sources said that the issuer went with the sole rating because other agencies would have taken much longer to rate the trade.
Still others thought the most important factor in pricing was the offering’s illiquid nature. “I think accounts wanted a very steep concession for illiquidity,” an investor said.
Rating risks
S&P analysts said that this was the first deal of its kind, and that there were likely to be similar trades over the next few years. It was rated by the agency’s insurance team, which said it was only concerned about the corporate rating of Prudential, which is providing the guarantee.Despite the fact that the bond was marketed with the name "covered trust", insurance-company ratings analyst do not have a background in covered bonds, according to S&P analysts.
The team was not worried about – nor does it know – the market value of the RMBS assets used as collateral. The notional balance of the RMBS is roughly three times the size of the note issuance, but it’s not clear what the current market value of the distressed RMBS is. However, the analysts said it was not germane to the ratings analysis.
Investors get scheduled principal and interest every six months. At the end of 3.5 years, they receive a final payment to redeem the notes in full. If there is a shortfall when the assets are liquidated, Prudential guarantees payments to investors.
But what happens if Prudential goes under? Analysts say that investors have a security interest in the assets of the trust, so they can make a claim to the assets. But since Prudential is an insurance company in
Adam Tempkin and Andrea Johnson
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