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Analysis & Insights

Directors' Cut - Lessons from the Credit Crisis

27 Mar 2019

With the dawn of the credit crisis now a decade behind us, Guy Major, Global Head of Fiduciary, sat down with some of the senior directors in the Maples Group's fiduciary services team to discuss their experiences and the lessons learned from a director's perspective during that time, which reshaped the CLO business and ultimately reinforced the structures in play today.

Setting the Stage

Guy Major ("GM")

As we approach the SFIG conference in Las Vegas this year and look forward to connecting again with our structured finance clients and industry partners there, it’s interesting to look back 10 years to the collapse of Lehman Brothers, which precipitated the financial crisis and subsequent events that tested securitisation structures in ways that previously couldn’t have been anticipated. In fact, the 2009 conference in Vegas was the last to be held there for several years, as the industry retrenched to work through these issues and ride out the credit crisis. 

Many new professionals have since joined the securitisation industry and haven’t had the experience of working on deals in such extreme conditions. The Maples Group’s fiduciary services team is distinguished not only by our size and stability, but also by just how many of our directors actually went through the credit crisis with us and worked with others on solutions to resolve some seismic issues.  For those of us still in the business today, it presents a useful opportunity to reflect on, and share with our industry’s newer joiners, our experiences as directors of special purpose vehicles at that time, and most importantly the lessons we learned.

Firstly, let me introduce some of the senior team that we canvassed, in the fiduciary services team at the Maples Group at the time of the crisis and who are all Senior Vice Presidents in our fiduciary services team in Cayman:

Andrew Dean worked on a broad range of CDO and securitisation deals at that time and was subsequently involved in several defaulted contentious transactions.

Chris Watler, who has been working with us since 2002, has experienced the full spectrum of the credit cycle in the structured finance industry.  Chris worked on NIM structures, CDOs and other securitisation structures and has subsequently been involved in several high profile work outs.

Carrie Bunton is another of our long serving directors, joining in 2001.  Working on a broad range of transactions and matters, she was in the trenches during the heat of the credit crisis and was closely involved in market challenging litigation.  Peter Lundin joined our group in 2007, shortly before the financial markets meltdown and has dealt with many complex issues since, also spending some time working in our European offices.  
GM: Starting with a general question, what do we think the biggest issue was during the credit crisis from the perspective of the directors of the issuer?
Andrew Dean ("AD")

While the market dislocation that followed the crisis clearly presented a multitude of stress related scenarios, such as problems with unenforceable swap documentation, I think issues related to expenses and reserves were paramount from our perspective.  At a basic level, if the deal can't cover its administration expenses or pay service providers, you are effectively handcuffed as a director. As you run into complex issues around events of defaults you need to take advice, and quickly.  The speed at which economic positions changed created something of a domino effect, because noteholders were suddenly facing multi-million dollar losses, often with calls to then remove the manager, leading you into a dispute scenario, where you start getting into voting rights. There was a need to tread extremely carefully when deals were under stress.
From a director's perspective, being able to take advice from competent counsel in that scenario was critical, and vehicles that had expense caps that were too low or no waterfalls at all presented enormous challenges for us.
In response, we worked with the industry to propose a number of improvements to structures, such as ensuring that any cap on expenses is sufficient for a period of at least three years and as an absolute amount rather than a percentage of the principal balance of the notes.  Additionally, or as an alternative to a higher expenses cap, proposals that the indenture should provide an expense reserve account to facilitate payment of fees on dates other than note payment dates, helped to resolve these issues. 
One word of caution though: Post credit crisis we observed that $300,000 was, in our experience at least, generally the right amount for expenses in a CLO type structure, and over time we have noticed these caps coming down. While we do understand the commercial pressures in structuring new deals, we believe that, in the event of a dispute, some of the 2.0 deals with lower caps may struggle with some of the same issues we encountered previously.

GM: What was the most difficult issue for directors to resolve?

Chris Watler ("CW")

I don’t recall many straight forward problems that were easy to resolve so that’s quite a difficult question.  Our philosophy in any challenging scenario was always, and still is, to follow the documents and, where they were ambiguous, take legal advice and be impartial. 

For me though, the most enduring problems revolved around liquidations and terminations.  I think people would be surprised to know that just from our own book we have over 200 "zombie deals" (over a quarter of the total deals in 2008) that are still around from that time and are stuck in limbo.

There have been many underlying factors at play here, ranging from apathetic noteholders suffering economic loss to deals with no clean up call options to deals stuck with illiquid assets and no means to get rid of them.  Whilst we were able to address some of the issues with illiquid assets through our FLP illiquid assets solution, other more systemic issues have still not been resolved.

There were also a number of static deals that ran into problems where someone had to make the hard decisions.  In these scenarios as a director you need to have integrity and do your best to resolve the problems, albeit that you don’t have the power in the documentation to do so.  Fund legal maturity for these zombie deals can't come quickly enough.

AD: Ambiguous, inconsistent or uncomprehensive documentation from the pre-credit crisis era, often templated and not taking into account special circumstances, caused a slew of issues for transactions.  As Chris just mentioned with zombie deals, documents were structured with no real end result possible.  The point here is that you need an exit plan and now when we are reviewing documents, it’s something we review closely. If noteholders know they have zero chance of getting any economic value, we find that if you have to reach out to them, they are difficult to find and are understandably apathetic in helping issuers resolve structural problems.

Other areas that caused us problems included negative consent mechanisms, which were often unclear, and affiliate / principal trades where documents did not set out mechanics clearly.

GM: It's interesting to look again at the challenges we faced from a fiduciary standpoint, but turning to investment managers, Carrie, what do you think the most difficult issue was for them?
Carrie Bunton ("CB")

Collateral managers of these types of deals all faced similar challenges from the dislocation in the credit market, but I think for smaller managers in particular, the biggest problem was their inability to remove themselves from problem deals or ultimately sell their businesses when they were non-performing.  Deal documentation made it difficult for them to be replaced and you felt some of them effectively became trapped.  In some cases there were creative solutions around delegation and sub-delegation at the manager or transaction level.  Things would definitely have been improved on some deals if documentation had more clearly addressed this issue.

CW: Tell-tale signs for managers undergoing stress included significant levels of staff turnover, downsizing and fees being squeezed.  That's where we started to see the writing on the wall and it's a real pressure for a manager who has not got the staff to then deal with the complex issues that were coming up.  When the manager cannot consolidate quickly or cannot get hold of noteholders to facilitate a sale of their business, or where the documentation was unclear, it was a big problem for them, especially when their own financial interests were at stake in deals.

GM: The credit crisis was such a difficult environment for managers of all sizes and relationships easily became strained when tough decisions had to be taken.  Peter, what was the most contentious issue you faced as a director?
Peter Lundin ("PL")

Again, there were many.  However, flipping the discussion around from managers who wanted to get off deals, the forced removal of managers raised a number of important issues for fiduciaries.  I recall a few highly contentious situations where we were receiving conflicting instructions from different stakeholders, but with no one advising us, it placed the issuers and us as directors in a very difficult position. In some cases a super majority is required for removal of the manager but I can, for example, recall an instance where 66 and two thirds percent was needed and we got 66 and one third.  There was little margin for error.

Abandonment of notes, which in turn affected performance ratios with significant implications for the deal, was another perennially contentious issue, often resulting in stand offs between investors, managers, issuers and trustees.  At the time this was somewhat of a novel concept, but I think the good news is that it should be fully addressed in 2.0 deals.  The industry has moved towards a workable solution where provisions specifically addressing the abandonment of notes have been commercially agreed.  Significantly, the provisions now usually address the procedure required, including the requirement for the Trustee to cancel the abandoned notes and to reduce the amount of notes outstanding for the purpose of the Trustee reports, or otherwise make it clear that the notes cannot be abandoned.  That certainty of position in the documents is always welcomed.

GM: Thanks Peter - some important improvements to documents there.  To finish up I’d like to look at the biggest issue from the credit crisis that could still be improved today.

I think it's been a fascinating exercise to go back and revisit some of the issues that arose with structured finance transactions as the credit markets ground to a halt, particularly with some background of how the industry made amendments to bring us CLO 2.0 structures.  From my own perspective, the biggest issue that could still do with some evolution is communication with note holders via the clearing systems. As we saw in the discussion above, noteholders are often the key to resolving many issues. In most CLOs the majority of notes are issued in global form. Consequently, not knowing who they are and being unable to communicate directly with them, especially in relation to unexpected issues, it makes it much harder to get a solution than with respect to an investment fund, for example, where you can more easily convene a shareholders meeting.

Whilst clearing systems have made improvements since then and communications platforms such as Bloomberg and Deal Vector have helped, there are still issues over truly effective communication to all holders.  We read with interest SFIG’s initiative to advance bondholder communication which is an encouraging development and we welcome their focus on this issue.

On a more personal level, I am extremely proud that our entire team of Senior Vice Presidents and many more of our 30 directors here in the Cayman Islands were in the fiduciary
business before, during and after the credit crisis and we hope that our clients take great comfort from our tested experience.



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