1. DBRS.com 1
While the U.S. term asset-backed securities (ABS) market experienced some
disruption early in 2016, with spreads and volumes recovering as the year progressed,
the availability of capital in the form of bank warehouse facilities remained consistent
throughout the year. This was important as both a bridge during the receding market
and a supply pipeline that drove U.S. term ABS issuances as demand stabilized.
Accordingly, U.S. ABS facilities remain of vital importance to well-functioning
capital markets. This newsletter continues the discussion that details structural and
credit elements unique to warehouse facilities (see Unique Considerations in Rating
Warehouse Facilities and Unique Considerations in Rating Warehouse Facilities II)
and addresses several points of consideration with regard to the treatment of various
expenses in the priority of payments in warehouse facilities.
Sometimes in a warehouse facility the priority of payments will permit payment of
extraordinary expenses ahead of interest and principal with no limitation on the
amount of such expenses. Lenders may prefer to have out-of-pocket expenses, such
as legal fees, fully paid before interest and principal, particularly following an event
of default when enforcement costs could be significant. However, this may complicate
the credit analysis related to payment of timely interest and ultimate principal by
the maturity date of the facility if senior expenses are open ended, which can reduce
available cash for interest and principal payments. Typical expenses that are paid senior
to interest and principal may include hedge termination payments, servicing and other
counterparty fees, indemnities and legal fees. In cases where senior expenses are not
defined by amount, an assumption related to expense levels should be made, which
may be significantly higher than what has been experienced historically.
To mitigate the impact that uncapped expenses might have on a structure’s possible
rating, some lenders have chosen to subordinate all, or a portion of, senior expenses
below the payment of interest and principal. If a lender chooses to subordinate only a
portion of a particular expense, the lender typically fixes an amount of the expense to
be paid senior in the waterfall and allows the remainder of the expense to be paid after
interest and principal, a feature common in U.S. term ABS transactions.
Warehouse facilities may also have provisions that cause interest rates to step up
because of performance triggers, facility usage or other conditions. The step-up
interest may take the form of an increased margin or change to a different index, such
as the prime rate. Furthermore, in the case where a warehouse facility has a floating
interest rate and no accompanying hedging mechanisms, interest rate fluctuations
should be anticipated using forward-looking interest rate curves, such as those
produced by the DBRS Unified Interest Rate Model. Similar to expenses, some lenders
have mitigated this interest rate exposure by subordinating a portion of the interest
to after full payment of note principal during amortization. The senior portion would
again be a fixed amount, and the subordinate interest would address the remainder of
what may be owed and would only be paid after the full payment of principal.
The increased certainty provided by these types of structural mechanisms are credit
positive for warehouses with respect to determining payment of timely interest and
ultimate principal by the warehouse’s maturity date. Furthermore, these features may
helpdefinecreditrisk,whichcanofferenhancedprecisionduringwarehouseevaluation.
For questions or comments, please contact Marcus DiBrito at mdibrito@dbrs.com or
Maxim Berger at mberger@dbrs.com.
Unique Considerations in Evaluating Risk in Warehouse
Facilities: Senior and Subordinate Interest and Expenses
U.S. Structured Finance Newsletter – November 8, 2016
Contacts
Claire J. Mezzanotte
Group Managing Director
Global Structured Finance
+1 212 806 3272
cmezzanotte@dbrs.com
Mike Babick
Senior Vice President
ABS Structured Finance
+1 212 806 3229
mbabick@dbrs.com
Chris D’Onofrio
Senior Vice President, ABS
Structured Finance
+1 212 806 3284
cdonofrio@dbrs.com
Jayce Fox
Vice President
ABS Structured Finance
+1 212 806 3261
jfox@dbrs.com
Lain Gutierrez
Senior Vice President, ABS
Structured Finance
+1 212 806 3922
lgutierrez@dbrs.com
Jerry van Koolbergen
Managing Director
Structured Credit
+1 212 806 3260
jvankoolbergen@dbrs.com
Sergey Moiseenko
Senior Vice President
ABS Structured Finance
+1 212 806 3225
smoiseenko@dbrs.com
Chris O’Connell
Senior Vice President
ABS Structured Finance
+1 212 806 3253
coconnell@dbrs.com
Jon Riber
Senior Vice President
ABS Structured Finance
+1 212 806 3250
jriber@dbrs.com
Quincy Tang
Managing Director
RMBS Structured Finance
+1 212 806 3256
qtang@dbrs.com
Kathleen Tillwitz
Managing Director
Operational Risk,
ABS/RMBS Structured Finance
+1 212 806 3265
ktillwitz@dbrs.com
Chuck Weilamann
Managing Director
ABS Structured Finance
+1 212 806 3226
cweilamann@dbrs.com
