Rating Action

Johannesburg, 13 October 2020 – GCR Ratings (“GCR”) has assigned the following short-term issue credit rating to the following Notes that were issued by AB Finco 2 (RF) Limited on 5 October 2020:

The credit rating relates to timely payment of interest and ultimate payment of principal by Final Redemption Date. The rating excludes an assessment of the ability of the Issuer to pay either any (early repayment) penalties or any default interest rate penalties.

The credit rating of the Notes is linked to the credit rating of Absa Bank Limited (“Absa Bank”). A change of the short-term national scale credit rating of Absa Bank may or may not lead to a change of the credit rating of the Notes. This linkage is explained further later in this announcement.

Transaction Summary

AB Finco 2 (RF) Limited (the “Issuer”) issued R1.0bn of Notes under the AB Finco Multi-Issuer Note Programme, administered by Absa Corporate and Investment Banking (“Absa CIB”) on 5 October 2020. The notes were issued under the second Transaction (“Transaction 2”) entered into by the Issuer, which is, in turn, the second Issuer to issue Notes under the Multi-Issuer Notes Programme. As such, the Terms and Conditions of the Programme apply, including the Priority of Payments.

The Issuer used the proceeds of the issuance to acquire Participating Assets (being Government Bonds). A typical security structure is in place, whereby AB Finco 2 Security SPV has executed a limited recourse Guarantee in favour of the Noteholders and the Issuer has indemnified the Security SPV in respect of claims that can be made under the Guarantee. The Issuer has granted a cession in security over the Assets to the Security SPV as security for the Indemnity.

Additionally, as for Transaction 1, the Issuer has entered into a master bond Total Return Swap (“TRS”) confirmation agreement with Absa CIB as Derivative Counterparty. Under the TRS, the Issuer swaps income earned on the Participating Assets for a specified return (calculated by applying the swap “Floating Rate”) each half-year. This is the “income return” leg of the TRS.

Upon termination of the TRS, the Issuer will dispose of the Participating Assets it holds, pay to or receive from the Derivative Counterparty a Total Return Amount based on the difference between the initial price of the Participating Assets as at Notes Issue Date and their final price as at TRS termination, and redeem the Notes, having the requisite funds to do so through the Total Return Amount. This is the “price return” leg of the swap.

Also in terms of the TRS, “Credit Support” is to be posted on a daily basis. The amount of Credit Support to be posted equals 100% of the daily price change of the Participating Assets, with the Credit Support Minimum Transfer Amount set at R1m. The Derivative Counterparty is to post Credit Support in the form of Government Bonds to the Issuer when the price of the Participating Assets decreases, and the Issuer is to release Participating Assets as Credit Support to the Derivative Counterparty when the price of the Participating Assets increases compared to their initial price. In this way, the market value of Participating Assets held by the Issuer will be kept constant daily, to equal (roughly, within the Minimum Transfer Amount of R1m) the principal value of the Notes issued.

TRS termination can take place, inter alia, on failure to pay or deliver (including failure to post Credit Support) by either party. The TRS will likewise terminate simultaneously with redemption of the Notes that occurs for any reason. Conversely, the Notes are to be redeemed on termination of the TRS, whatever the reason therefor.

The interest rate on the Notes is to be reset by the Issuer each half-year. Such reset would take effect for the upcoming half-year when the Issuer delivers an Interest Rate Adjustment Notice to the Noteholders and the Noteholders respond by agreeing to such adjustment. Should a Noteholder not explicitly agree to the proposed reset, then, at the beginning of the upcoming half-year, the TRS will be terminated, and the Issuer will dispose of the Participating Assets and mandatorily redeem all of the Notes.

The Derivative Counterparty is entitled to adjust the TRS Floating Rate, which is used to calculate the biannual payment it makes to the Issuer. Such adjustment is intended to be made in line with the current market rates for similar Government Bond TRS transactions. However, should the Issuer determine that the spread between the TRS Floating Rate and the Notes’ Interest Rate is insufficient to cover the projected Senior Expenses for the upcoming half-year, the Issuer will be required to deliver an Interest Rate Adjustment Notice to propose a reset of the Notes’ Interest Rate to a level such that the spread would suffice. For the Transaction’s first half-year, the TRS Floating Rate less the Initial Interest Rate paid by the Issuer on the Notes is equal to 0.04%.

GCR has received a schedule of projected Senior Expenses that the Issuer will pay over the life of the Notes. The 0.04% spread to be received by the Issuer is enough to cover these Expenses (incorporating a buffer for unexpected costs), noting however that a portion of ongoing Expenses that relate to the Transaction is not intended to be carried by the Issuer. Rather the relevant counterpart(y/ies) to which this portion of Expenses is due will invoice Absa Bank on a continuous basis, at which time Absa Bank intends to pay these Expenses.

GCR notes that a new provision has been added to the Applicable Pricing Supplement of Transaction 2, which did not appear in that of Transaction 1. This provision, as interpreted by GCR, stipulates that receipts under the TRS must suffice to provide an excess of 0.04% over projected Expenses and Notes interest according to the biannual Determination to be made by the Issuer in proposing the Notes Interest Rate to apply for the upcoming half-year. On the basis of a different commercial interpretation of the clause, the Administrator does not intend to abide by the provision understood as such, but rather to maintain a minimum 0.04% spread between the TRS Floating Rate and the Notes’ Interest Rate in order to cover Expenses throughout the life of the Transaction, which would mitigate the risk of Absa Bank taking on any additional costs that it is not currently covering in future. The divergence between the provision as interpreted by GCR and the Administrator’s intention is viewed as a point of concern.

Rating Rationale

Derivative Counterparty

Transaction Documentation provides for Required Credit Ratings and remedial periods for the replacement of all counterparties to the Transaction should their credit ratings be downgraded below such Required Ratings. These are in line with GCR’s Criteria for Rating Structured Finance Transactions. Of particular importance in this regard is the Derivative Counterparty. Should the credit rating of the Derivative Counterparty be downgraded below its Required Rating of A1_(ZA), the Issuer is required to replace it within 30 days with a new Derivative Counterparty that has the Required Rating. GCR notes that the Transaction’s provision for mandatory Interest Rate Adjustment to maintain a spread that will cover whatever Senior Expenses the Issuer determines it will need to pay over the upcoming half-year secures the adequacy of the new TRS Floating Rate that may be offered by a replacement Derivative Counterparty. As such, in GCR’s assessment, there is no dependency on the current Derivative Counterparty that might introduce a credit linkage thereto.

Cost Coverage

The fact that Absa Bank will pay a portion of the costs that relate to the Transaction on a continuous basis has been taken into consideration by GCR. The Interest Rate Adjustment mechanism should, in most foreseeable scenarios, ensure that sufficient funds are received by the Issuer in terms of the TRS to provide for repayment in full of Notes interest and principal even in the event of Absa Bank’s ceasing to cover the costs it currently covers. GCR understands that, in terms of the current arrangement, only the cost of the corporate administration services provided by Maitland Outsourced Securitisation Services (Pty) Ltd (“Maitland”) is being covered by Absa Bank under an agreement directly between Absa Bank and Maitland. Under this arrangement, should Absa Bank not make a payment that it agreed to make to Maitland for services already provided to the Transaction, Maitland will have no recourse to the Issuer to claim payment. Should Absa Bank end its coverage of this cost, the Issuer will need to include the cost in its Determination and propose a Notes Interest Rate Adjustment accordingly, which if not accepted by a Noteholder would lead to TRS termination and Notes redemption, for which sufficient funds are expected to be available through the TRS Total Return Amount as described above. Nevertheless, some degree of uncertainty exists as to whether payments due on the Notes might be compromised should Absa Bank no longer be able to support the Transaction, especially, but not only, in the event that it takes on further costs in addition to that of corporate administration services in future. GCR does not consider Transaction 2’s new contractual provision to provide for a 0.04% minimum excess to be earned as described above to be a contractual mitigant, as the Administrator’s intention differs from GCR’s understanding of the provision as contracted. Additionally, and despite the mitigant that would be in place should a provision that correctly reflects the intention as described above be added to the Transaction Documentation, it is GCR’s view that even the existing arrangement for Absa Bank to carry the cost of the corporate administration services provided by Maitland presents a remote operational risk of interruption in the provision of corporate administration services that precludes a complete credit de-linkage from Absa Bank.

Conclusion

In consideration of the subsidisation of a portion of the Transaction’s costs by Absa Bank and the substance of the Transaction as being interconnected with Absa Bank as described above, the Notes have been accorded a short-term national scale issue credit rating of A1+_(ZA)(sf), commensurate with the A1+_(ZA) short-term national scale credit rating of Absa Bank. GCR takes note of the various provisions that mitigate the perceived credit linkage to Absa Bank and therefore a change of the short-term national scale credit rating of Absa Bank may not necessarily lead to a change of the credit rating of the Notes. Rather, GCR would analyse the relevant factors at that time.

Analytical Contacts

Related Criteria and Research

GLOSSARY OF TERMS/ACRONYMS USED IN THIS DOCUMENT AS PER GCR’S GLOSSARY

For a detailed glossary of terms utilised in this announcement please click here.

SALIENT POINTS OF ACCORDED RATINGS

GCR affirms that a.) no part of the ratings was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, securities or financial instruments being rated; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, securities or financial instruments.

The credit ratings have been disclosed to the Arranger. The ratings above were solicited by, or on behalf of, the Issuer and therefore, GCR is compensated for the provision of the ratings.

Information received from Absa Bank Limited to accord the credit ratings includes:

• Complete suite of transaction documentation,
• Cost model and
• Legal opinion.

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