(Editor's note: This presale report has been republished to show changes made to the capital structure. The class D and E notes have been removed from the opening ratings table and the ratings on them withdrawn. An updated version follows.) U.S. Dollar, Euro-, And Yen-Denominated Secured Credit-Linked Notes (Morro Bay)
This presale report is based on information as of June 2, 2006. The credit ratings shown are preliminary. This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of final credit ratings that differ from the preliminary credit ratings. For further ratings information, call Client Support Europe on (44) 20-7176-7176. Members of the media may contact the Press Office Hotline on (44) 20-7176-3605 or via media_europe@standardandpoors.com. Local media contact numbers are: Paris (33) 1-4420-6657; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow (7) 495-783-4017. Investors are invited to call the SF Investor Hotline on (44) 20-7176-3223.
Series
Prelim. rating*
Prelim. amount
Available credit support (%)
Net loss (%)
Cushion (%)
Rated overcollateralization (%)
Interest
Legal final maturity
JSS
AAA
TBD
10.00
7.05
2.95
103.28
Three-month benchmark plus a margin
June 2013
A
AAA
TBD
7.60
7.05
0.55
100.60
Three-month benchmark plus a margin
June 2013
B
AA-
TBD
6.60
6.21
0.39
100.42
Three-month benchmark plus a margin
June 2013
C
A-
TBD
5.80
5.63
0.17
100.18
Three-month benchmark plus a margin
June 2013
JSS
AAA
TBD
10.60
8.56
2.04
102.28
Three-month benchmark plus a margin
June 2016
A
AAA
TBD
9.30
8.56
0.74
100.82
Three-month benchmark plus a margin
June 2016
B
AA-
TBD
8.35
7.65
0.70
100.76
Three-month benchmark plus a margin
June 2016
C
A-
TBD
7.50
7.00
0.50
100.54
Three-month benchmark plus a margin
June 2016
*The rating on each class of securities is preliminary as of June 2, 2006 and subject to change at any time. Final credit ratings are expected to be assigned on the closing date subject to a satisfactory review of the transaction documents and legal opinion, and completion of a corporate overview. Standard & Poor's ratings address timely interest and ultimate principal on the notes. TBD—To be determined.
Transaction Participants
CDO manager
Pacific Investment Management Co. LLC
Arranger
UBS Ltd.
Trustee
The Law Debenture Trust Corporation PLC
Custodian
UBS AG (London branch)
Bank account provider
UBS AG (London branch)
Paying agent
UBS AG (London branch)
CDS counterparty
UBS Ltd.
Collateral swap counterparty
UBS Ltd.
Supporting Ratings
Institution/role
Ratings
UBS Ltd. as CDS and collateral swap counterparty
AA+/Stable/A-1+
London branch of UBS AG as custodian and bank account provider
AA+/Stable/A-1+
Transaction Key Features
Expected closing date
June 20, 2006
CDO asset type
Bonds
Structure type
Synthetic
Synthetic structure type
Synthetic portfolio CDO - single tranche
Portfolio composition
Corporate names
Purpose of transaction
Arbitrage
Rating approach
Statistical
Portfolio management type
Managed
Level of management
Fully managed
Liability structure
Partially funded
Collateral description
'AAA' rated Pfandbriefe or equivalent
Portfolio weighted-average rating
BBB
Default measure (DM) for the seven-year notes (%)
0.53
Variability measure (VM) for the seven-year notes (%)
0.69
Correlation measure (CM) for the seven-year notes
1.215
Default measure (DM) for the 10-year notes (%)
0.55
Variability measure (VM) for the 10-year notes (%)
0.74
Correlation measure (CM) for the 10-year notes
1.271
Size of trading bucket (annual %)
20
Transaction Summary
Preliminary credit ratings are assigned to the U.S. dollar-, euro-, and yen-denominated secured credit-linked notes (Morro Bay) issued by ELM B.V.
The purpose of this transaction, which is being arranged by UBS Ltd., is to transfer the credit risk associated with a managed CDO to external parties. UBS Ltd. will contract a CDS with the issuer, ELM, which itself will purchase protection against losses through the issue of credit-linked notes referenced to the portfolio (see chart 1).
Each series of notes to be issued will be backed by a portfolio CDS entered into with UBS Ltd. and managed by Pacific Investment Management Co. LLC (PIMCO).
Each series of notes will represent a segregated, limited-recourse obligation of the issuer. At closing, ELM will use the proceeds of the notes to purchase adequately rated collateral from UBS Ltd. Collateral will be denominated in the same currency as the notes. The issuer will enter into a combined collateral and credit swap agreement with UBS Ltd. referencing a portfolio CDS and a portfolio management agreement with PIMCO.
As portfolio manager, PIMCO has an incentive fee structure that permits it to take into account the interests of the noteholders. Its fees will be met in part by the counterparty under the swap agreement and in part at maturity from remaining funds in the trading account.
Changes to the portfolio will be subject to a variety of eligibility criteria and portfolio guidelines. These criteria include a test based on Standard & Poor's CDO Evaluator. This test is geared toward preserving the required subordination for the given rating category.
As portfolio manager, PIMCO may choose:
To trade up to a set percentage of the portfolio notional amount annually;
To trade unlimited "credit-improved" entities (as defined in the portfolio management agreement) subject to the adjustment rules; and
To trade unlimited "credit-impaired" entities.
The notes constitute series issued by ELM under its €15 billion secured-note program. ELM is a segregated multi-issuance SPE.
The notes will be issued in segregated series. The tenor, currency, and rate of interest on the notes will vary between series. The notes will be denominated in U.S. dollars, euros, or yen.
Notable Features
The ELM Morro Bay transaction is the first syndicated synthetic transaction to be managed by PIMCO that references a pool of primarily investment-grade corporates.
The transaction gives PIMCO the flexibility to direct the issuer to buy subordination and increase the attachment point by using the balance of the trading account, subject to certain tests. It also allows the issuer to satisfy cash settlements by first applying the balance of the trading account.
Strengths, Concerns, And Mitigating Factors
Strengths
The manager is highly experienced and has an incentive to work in the interests of noteholders.
The swap mechanics are sound and based on conservative thresholds for each rating category.
The SPE is bankruptcy remote and security is created over the collateral in favor of the noteholder.
There are limited types of credit event applicable under the CDS.
The CDS provides that each cash settlement amount will be satisfied first by application of the balance of the trading account. Other collateral assets will be used only once that balance is exhausted.
Concerns
Payment of interest and principal on the notes depends directly on the counterparty's payments under the swap.
Substitutions are allowed in reference portfolios, which could reduce the credit quality of the pool.
Mitigating factors
UBS Ltd. is highly rated and downgrade language is in place.
The portfolio manager may only substitute entities that meet various criteria, including Standard & Poor's SROC (synthetic rated overcollateralization) test being satisfied. As a result, the ratings on the notes should remain unaffected by substitutions.
Description Of The Issuer
ELM was set up as a limited-liability company under Dutch law on Nov. 14, 1996. Its paid-up share capital of €18,151.21 is entirely owned by Stichting ELM, the share trustee, which holds it on trust for charitable purposes. ELM covenants to limit its activity, to limit its indebtedness, not to merge or dispose of any of its assets, and not to issue any further shares without the consent of The Law Debenture Trust Corp. PLC as note trustee.
ELM meets Standard & Poor's bankruptcy remoteness and segregation criteria. Standard & Poor's is required to confirm the ratings on the notes outstanding upon any new issuance of notes by ELM.
Terms And Conditions Of The Notes
The Morro Bay notes issuance constitutes separate series. As a result, noteholders of a given series have recourse only to the mortgaged property relating to that series, and not to any other assets of the issuer.
The issuer will provide credit protection to UBS Ltd. on a reference portfolio of investment- and speculative-grade corporate entities, financial institutions, and sovereigns.
The proceeds of the credit-linked notes will be passed on to UBS Ltd. under the collateral swap, in exchange for which UBS Ltd. will transfer collateral assets to the issuer.
The short-term rating on UBS Ltd. is currently 'A-1+', which will support a 'AAA' rating on the Morro Bay notes. If the short-term rating is downgraded below 'A-1+', and it chooses not to be replaced or find a guarantor, it must post collateral in an amount and form satisfactory to Standard & Poor's. This collateral would include a cash amount equal to the then-outstanding amount of the notes, or collateral securities with a long-term rating at least equal to the rating on the notes and with a face value equal to the then-outstanding amount of the notes.
Payment of interest
The notes will pay quarterly three-month U.S. dollar LIBOR, EURIBOR, or yen LIBOR, plus a margin yet to be determined. The payments will be made from the payments from UBS Ltd. received under the swap agreement.
Principal redemption
Principal repayments on the notes will be made by UBS Ltd. in return for receipt of the collateral under the collateral swap. This amount will be linked to the performance of the reference portfolio and charged assets. It is expected that the notes will mature seven or 10 years after closing. The notes may be redeemed earlier than scheduled under certain circumstances, such as following a tax event.
Early redemption
Events that could trigger mandatory redemption include a default of the swap counterparty under the terms of the swap agreement, default of the collateral, or a tax event.
Events of default
Events of default on the notes are defined as:
Failure to pay under the notes for 14 days;
Failure by the issuer to perform its obligations under the transaction documents;
The bankruptcy of the issuer; and
The winding-up or dissolution of the issuer.
Terms And Conditions Of The Swap Agreement
At closing, the issuer will enter into a swap transaction that combines the credit swap and the collateral swap. Under the swap, the counterparty will be obliged to pay amounts due under the notes and in return will receive amounts relating to interest paid under the collateral securities.
On satisfaction of the conditions to payment with respect to a credit event under the reference portfolio, the issuer will be required to make a payment to the counterparty by reference to a valuation of the defaulted reference obligations. This payment will be satisfied under the collateral swap by releasing to UBS Ltd. an amount of collateral assets equal to the cash settlement amount. In satisfying the cash settlement amounts, the balance of the trading account will be applied first. The balance will be paid using collateral assets only if amounts due are higher.
The credit swap incorporates the 2003 ISDA credit derivative definitions as supplemented by the May 2003 supplement. The swap transaction is expected to mature at the same time as the notes.
Credit events
Applicable credit events will vary according to the geographical location of the reference entity, but are usually expected to include: (i) bankruptcy, (ii) failure to pay, and (iii) restructuring (multiple holder obligation).
Preconditions to payment
Before payment under the CDS can occur, a credit event notice and a notice of publicly available information from two sources must be delivered.
Portfolio Management Agreement
Portfolio manager
Founded in 1971, PIMCO specializes in managing fixed-income portfolios. The company has its headquarters in Newport Beach, California, but its investment professionals also operate from two other offices in North America, two in Europe and four in Asia. It reported assets under management of more than $600 billion in March 2006, of which about 20% was in corporate credit.
PIMCO was acquired by Allianz AG on May 5, 2000, but remains operationally independent and now leads the Allianz group's global fixed-income investment operations. As of December 2005, the Allianz group managed more than €740 billion on behalf of third-party investors.
Morro Bay is PIMCO's fifth investment-grade corporate CDO, but its first synthetic transaction in the asset class. It currently manages about 30 CDOs across a range of asset classes, including U.S. leveraged loans, ABS, European leveraged loans, and emerging market debt.
Type of management
PIMCO will enter into a portfolio management agreement with respect to each series of notes, under which it is permitted to make changes to the reference portfolio, subject to criteria. These include the portfolio guidelines, eligibility criteria, and passing Standard & Poor's SROC test. The amount of substitutions not including credit-impaired/credit-improved entities is limited to 20% of the total portfolio notional per year. The portfolio manager is not allowed to remove an entity after an event determination date in respect of that entity.
The manager will effect substitutions by adjusting subordination or using amounts standing to the balance of the trading account. Any substitution apart from those involving credit-impaired entities will be subject to passing Standard & Poor's benchmark for surveilling synthetic CDO transactions, SROC. Calculated for each class, SROC is a measure of the sensitivity of each class to future rating action, expressed as a percentage. An SROC of more than 100% suggests that there is at least sufficient support from the threshold to maintain the rating on the notes. An SROC of less than 100% suggests that there may not be sufficient support to maintain the rating and that a downgrade could be imminent.
Reference Pool Characteristics
At closing, the portfolio under the swap consisted of 127 names referencing corporate entities, sovereigns, and financial institutions domiciled in Western Europe, North America, South America, and Asia (see tables 1 and 2).
Table 1 Distribution By Industry
(%)
Telecommunications
14.34
Chemical/plastics
9.31
Insurance
8.61
Finance intermediaries
7.07
Automotive
6.13
Sovereign
4.43
Conglomerates
4.05
Business equipment and services
3.64
Beverage and tobacco
3.18
Cable television
3.15
Publishing
2.89
Industrial equipment
2.80
Building and development
2.59
Food products
2.59
Utilities
2.39
Broadcast radio and television
2.25
Drugs
2.05
Other*
18.54
*This represents 16 industry categories, which constitute less than 2% each.
Table 2 Distribution By Country
(%)
U.S.
40.38
U.K.
10.56
Germany
9.22
France
5.77
Switzerland
5.23
Mexico
3.75
Sweden
3.68
The Netherlands
3.39
Italy
2.89
Australia
2.39
Korea
2.39
Russia
1.30
Greece
1.00
Other
8.06
The portfolio may change over the life of the transaction, in accordance with the discretion of the portfolio manager and the portfolio guidelines. The guidelines state that:
There must be no fewer than 100 and no more than 140 reference entities.
The notional amount for any reference entity must any increment of 0.25% of portfolio notional up to 2.00%.
The maximum notional of a single investment grade obligor is 2% and the maximum notional of a single speculative-grade obligor is 1%.
The maximum concentration in emerging market entities (i.e., in a jurisdiction rated lower than 'AA-') is 10%.
No more than 15% of reference entities may have a speculative-grade rating.
No more than 15% of reference entities may be from one industry sector, and no more than two industry sectors may account for 12% or more of the aggregate portfolio notional.
Collateral Description
The collateral intended to secure ELM's obligations under the Morro Bay notes and under the swap transaction will be 'AAA' rated Pfandbriefe or equivalent. Standard & Poor's will review the terms of the collateral to ensure that it is suitable for the transaction, particularly with respect to the payment characteristics, tax positioning, and credit quality.
Criteria Referenced
"Criteria for Rating Synthetic CDO Transactions/Credit Derivative Criteria" (published on Sept. 12, 2003).
"Global Cash Flow and Synthetic Criteria" (published on March 21, 2002).
"European Legal Criteria for Structured Finance Transactions" (published on March 23, 2005).
Related Articles
"Global SROC Report" (published monthly).
"Recovery Rates for Credits in Global Synthetic CDOs" (published quarterly).
"Surveillance Policy Clarified for Events of Default in Synthetic CDO Transactions" (published on Aug. 18, 2003).
"Synthetic ROC and the Surveillance of Synthetic CDOs" (published on March 15, 2004).
All criteria and related articles are available on RatingsDirect, Standard & Poor's Web-based credit analysis system, at www.ratingsdirect.com. The criteria can also be found on Standard & Poor's Web site at www.standardandpoors.com.
