Business

Tuesday June 2, 2009

Provisions for Kerisma bonds

By JAGDEV SINGH SIDHU


With likely default today, the future of such CLO issues hangs in the balance

KUALA LUMPUR: Banks would more than likely to have made provisions for Kerisma Bhd bonds, which are heading for a default, when they mature tomorrow but the impact from the default of the bonds, however, would be felt more in the future for such collateralised loan obligation (CLO) issues.

“The CLOs in the market are in trouble and banks will have to make provisions,’’ said a market observer yesterday. “And that will have an impact on demand from investors.’’

The weak economy has impacted on loans in general and with CLOs featuring corporate loans of a variety of backgrounds, the chances of things going sour are high.

“To date, the credit enhancement levels for Kerisma’s senior and mezzanine bonds are 5.1% and 1.6% respectively, which indicate that both classes can only withstand further losses up to about RM45mil and RM15mil,’’ said Malaysia Rating Corp Bhd (MARC) in a email reply on May 28 on the status of the Kerisma bonds.

“As such, if there is one more incident of default by one obligor with a loan exposure of RM50mil, this would lead to insufficient funds being available to fully repay the principal amount for the bonds at maturity.’’

On May 22, MARC said three obligors with loans totalling RM127mil were seeking approval from bondholders to reschedule repayment dates.

The risk of the default has been reflected by the steady downgrade in Kerisma’s ratings and hence, Alliance Financial Group Bhd (AFG), along with the other banks holding the different tranches of the Kerisma bond, have made provisions.

Alliance is reported to have made a provision of RM175mil for the Kerisma bonds, RM240mil for Idaman Capital Bhd bonds and RM10mil for CapOne Bhd bonds.

While details on AFG’s provisions were revealed, banking analysts expect other banks to provide for the CLO issues on their balance sheet.

“If the CLO issues are bought by bond funds they may not have to make provisions,’’ said an analyst.

MARC said negative credit momentum is expected in an environment when economic and business cycles go through a tough period.

“This trend of deteriorating credit quality is not confined to the underlying obligors of CLOs alone, as can be observed from the increased incidence of rating downgrades and negative rating outlooks for corporate issuers in general since the second half of 2008,’’ MARC said. “Restricted access to credit has also led to tight liquidity on the part of obligors, compounding the impact of earnings weakness and stretched balance sheets. The continued deterioration of Kerisma’s collateral performance can be traced to declining financial performance on the part of obligors, pursuit of risky diversification and over-expansion of business activities during earlier periods of economic exuberance.”

Kerisma’s woes are in contrast with Aegis One, a CLO programme that was redeemed in 2007.

“Aegis One’s senior bonds were fully redeemed in 2007 and the effect from the subprime crises was still contained back then as opposed to the current situation. The present difficult macroeconomic situation is reflecting on Kerisma, whose collateral pool is experiencing higher stress than Aegis One which was redeemed in November 2007,’’ MARC said.

“We also expect Kerisma’s obligors to face an added challenge of more restricted access to refinancing. The measure of risk averseness that is currently exhibited by banks clearly stands in contrast to the scenario 18 months ago.”

MARC said since the first three CLO transactions, it has tightened its default and recovery assumptions and improved its collateral pool requirements.

“Apart from rating methodology enhancements, investors’ concerns and market appetite for future CLOs may be addressed via changes to the collateral pool characteristics, i.e. having a pool of seasoned secondary loans in place of newly originated loans; amortising loans as opposed to loans with single bullet maturity to reduce refinancing risk, in addition to higher credit enhancement and heightened recovery or remedial measures for non-performing loans,’’ MARC said.

The rating agency, however, said investor appetite for CLO issues has definitely waned in light of the failure of securitised sub-prime bonds in the US market as well as the general increase in the credit risk profile of corporates in the present economic downturn.

However, MARC believes that “with the tighter structures and subsequent improvements in the economic environment, CLOs will make a comeback to our market in due time.’’

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