In Praise of Sara
27 Mar 2017 | Richard Kemmish
I do like Sara. Clever, subtle and useful, Sara lets covered
bond structurers do all sorts of good things. As Im sure
you know I hope you know Sara is the Selected
Assets Required Amount test, frequently included in conditional
pass through programmes. I hope you werent thinking
She is also a bit complicated. When the issuer of a conditional
pass through programme has defaulted there are many possible
scenarios. Bonds might pay down at their scheduled maturity,
they may fail to and therefore enter pass-through or they may
in some programmes only enter pass through before
their scheduled maturity because either, other bonds
have defaulted and there is a cross-acceleration clause between
tranches, or, because the cover pool is worth less than the
bonds (aka an amortisation test failure).
In some of those scenarios Sara comes into her own. When the
trustee is trying to pay down any given series of bonds they
have the option to sell mortgages to a third party if, and only
if, the mortgages can be sold for enough to redeem the bonds
and the mortgages in question are no more than that series of
bonds fair share of the total cover pool. If you take too
many, or too good, mortgages from the cover pool you are
effectively putting yourself senior to the bonds that
havent entered pass through yet.
So far, so good.
But there are two problems with Sara.
Firstly, not all conditional pass through structures are
created equal. The principle of a fair share of assets in the
cover pool might work differently for example, when you have
some bonds in pass through and some still expecting to meet
their scheduled maturity date. Some conditional pass through
programmes have cross acceleration clauses (one enters pass
through, they all enter pass through), some do not, making it
difficult for Sara to be consistent between programmes. To make
it even more difficult for her, not all covered bond programmes
necessarily extend all bonds in the event of a breach of the
amortisation test (that is, no more over collateralisation).
Secondly, perhaps less obviously, Sara might contradict
statutory provisions within covered bond frameworks.
Well-meaning covered bond law writers frequently include
clauses that require the proceeds of asset sales
post-insolvency to be shared pari passu between all tranches of
bonds. This makes perfect sense of course, unless a more
equitable and practical contractual arrangement for the sharing
of proceeds such as Sara is in place to address
the same concern. If it is, this statutory clause will probably
contradict Sara and quite possibly make it impossible to
include her in the bond documentation. This is almost certainly
a bad thing.
By the way, when I say frequently I have to admit that I
havent exactly undertaken a comprehensive survey of
covered bond laws yet. What I really mean is, Ive seen
the mistake twice now, if you happen to be drafting a covered
bond law today, please dont repeat it.
Sara is great, let her work properly.
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