Depfa has securitized a portfolio of monoline-wrapped bonds via a £666 million ($1.33 billion) synthetic collateralised bond obligation (CBO). The deal is designed to improve its capital adequacy and its return on equity, but it is also a test of investor appetite as the first project debt portfolio securitization since the credit crunch.

As in Depfa's previous deals – EPIC I and EPIC II – KfW is an intermediary between Depfa and the issuing special purpose vehicle, providing a 0% counterparty risk weighting. However, unlike the other deals this portfolio is monoline wrapped, a sign that anything other than triple-A debt would have demanded a significant premium, even with KfW intermediation.

The £666 million issue initially comprises 19 monoline wrapped bond investments made by Depfa to finance a combination of UK electricity distribution and water utilities, and UK PFI projects in the health and education sectors. Like its previous securitizations, Depfa has the right to call the transaction in December 2010 so that the bank can gain from the upside of compliance with Basel II, although the scheduled maturity is in 2059.

Essentially Depfa is transferring the major part of the credit risk of the assets in the pool by purchasing credit protection from KfW, which then in turn purchases credit protection on the reference pool from a number of banks and ultimately institutional investors.

The £598 million super senior tranche (rated Aaa/AAA by Moody's and S&P respectively) has been insured by Assured Guaranty. Unlike most of its competitors, Assured Guaranty has stayed out of the CDO squared market, and so should be unaffected as losses unfold.

The tranches of the issue below the super senior tranche (also rated Aaa/AAA by Moody's and S&P), in aggregate amounting to £58 million, take the form of floating rate credit-linked notes issued by Third Essential Public Infrastructure Capital GmbH, a special purpose company registered in Germany.

The tranches comprise an A+, £1 million portion with a coupon of 65bp over 3 month Libor; an A1, £33 million tranche at 65bp over Libor and an A2, £24 million tranche at 70bp. The margins are around double what Dexia achieved for its securitization that was closed pre-crunch.

In December 2006 Dexia completed the first securitization of AAA-wrapped infrastructure bonds – WISE. Dexia's portfolio amounted to £1.47 billion ($2.86 billion) and could be replenished up to a total of £1.5 billion. WISE 2006-1, the SPV, issued three tranches, ranging from AAA/Aaa to AA-/Aa3 (S&P and Moody's respectively), pricing from 30bp to 39bp over Euribor; a £30 million AAA-rated class A; a £22.5 million AA-rated class B; and a £11.25 million AA-rated class C.

For EPIC III the pool assets will remain on Depfa's balance sheet, which will continue to administer and manage them. Depfa will retain the first-loss interest of £10 million in the transaction that could have been completely sold on in better market conditions.

As in the previous EPIC deals, EPIC III is replenishable conditional on certain tests. These include: the project's underlying rating must be Baa3/BBB- or higher; there is no exposure to non-sterling obligations or non-UK projects; single monoline concentration must not exceed 45%; a single asset shall not exceed 10% of the pool amount; the monoline must be rated Aaa; projects with construction risk must be less than 50% of the pool.

Like the Dexia securitization the buyers of the notes will be protected by the inbuilt double-default structure, whereby a default at both the project and monoline is required before a loss. Many monlines are in precarious shape, but none have yet to pay out on securitization insurance claims. But Moody's and S&P both stressed in their presale reports that the deal is "highly exposed" to the credit ratings of the monoline guarantors.

While fallout from the credit crunch has led to criticism of the rating agencies' approach to securitisations, the crunch also highlights the way that long-only investors such as monolines have to mark-to-market unrealized losses in the same way short-term traders such as hedge funds mark the sum of their long and short positions. Whether or not this regime is too draconian for long-term investors, it is unlikely to change, and monolines such as CIFG may need further capitalization to service unrealized losses to preserve their AAA ratings.

Despite the potential changes among the monolines, securitization and the freeing up of capital is a cornerstone of Depfa's business model. And with KfW's presence as a 0% risk weighting, backed by the German Government, the economics of the deal still made perfect sense, despite the inflated coupons and the equity piece held on to by Depfa.

The deal clears the path in the post-crunch era for other project debt securitizations, especially for new asset classes, such as SMBC and Calyon's securitization of their Middle East debt books, which has been in the pipeline for some time. Indeed, at the beginning of 2008, ABN Amro and BES closed, but did not sell down, a Eu1.1 billion cash collateralised loan obligation for BES's transport debt book – the first project cash CLO for six years.

Securitizations of project debt portfolios are likely to become more commonplace among project finance banks as their books reach a critical mass pre-Basel II. Despite the compelling advantages of using KfW, the Dexia and BES deals have shown that there is likely to be some variance in the structuring.

EPIC III
Status: Closed 20 December 2007
Description: £666 million synthetic collateralised loan obligation with underlying AAA-rated infrastructure assets
Sponsor: Depfa Bank
Arranger: Merrill Lynch International
Counterparty: KfW
Monoline: Assured Guaranty
Legal adviser to Depfa and KfW: Linklaters and A&L Goodbody
Legal adviser to monoline: Clifford Chance
Legal adviser to intermediary: Freshfields