June 6, 2011

The housing stats are troubling. More than 25% of homeowners were already considered “underwater” on their mortgages, before the latest S&P/Case-Shiller index showed another dive in home values in March. No doubt, homeowners were aware of their diminished housing wealth, but for many people negative equity has not yet caused much loss of sleep – that is, until circumstances change and they need to sell their homes. Americans have always prided themselves on personal mobility, and the ability to pick up and move the family to greener pastures at the time and place of their choosing. Increasingly, though, people are simply stuck where they are at, needing to sell their property to make a move possible, and finding no buyer willing to offer a price that doesn’t result in a big loss for the seller. The choices are unsettling; take the loss, move and start over, or juggle two mortgages (if your credit and finances permit) until the right buyer comes along, which could take many, many months. If only there was a third possibility to transfer home and mortgage to your new destination!

When it comes to your derivative transactions, you can take them with you – that is, if you and your counterparties consent to such a move. The concept of “Transfer” is built right into the ISDA Master Agreement, and allows for the movement of one or more transactions from one counterparty to the next. There is even a process to follow, the Novation Protocol, which many (but not all) of the major banks adhere to, that makes for the simplest and most efficient transfer of your transactions. But just because it can be done, doesn’t mean it, well, can be done! Your specific situation, your counterparties, and your ability to solicit and receive consent will determine whether or not you will successfully transfer your positions.

Why transfer? There are several reasons why you may wish to transfer your swap or other derivative to another counterparty, but chief among them are to unwind your position on more favorable terms, or as part of a move to a new banking relationship. In a transfer to unwind, your original counterparty has given you an unwind indication that seems somewhat distant from mid-market pricing. You, of course, know this because you are working with Chatham, and we provided you color on where the termination value is relative to the market. If your counterparty’s indication is far out of line, you may be able to transfer to another bank, which has agreed to charge you less to terminate the very same transaction. This can make a whole lot of sense for larger transactions, where the difference in termination values could be significant. The other major reason to transfer is because you are moving your banking relationship (or perhaps just getting a new replacement loan from a new lender) and you want to bring the swap over as well. Once a transfer is completed under this scenario, the derivative can be modified, as appropriate, to match the terms of your new loan agreement. There are also many simple reasons that would cause a transfer to take place, such as mergers and acquisitions, or consolidations among parent or affiliate entities.

How does it work? The key players in a move like this are the Transferor (the party stepping out), the Transferee (the party stepping in), and the Remaining Party (party to the original and transferred transaction). Once the parties agree, in principle, to consent to the transfer, a transfer date is selected. It is critical to get the first period payment logistics correct because transferring a transaction in the middle of a payment period can be a bit challenging. Typically the easiest way is to make the Full First Calculation Period applicable to the transfer… The transfer is typically kicked off with a formal request by one counterparty (generally the Transferee, but can also be the Remaining Party) via email to the other parties to consent to the transfer. A successful transfer requires all parties to the agreement to consent on the same day, and is followed up by a novation agreement or confirmation to be signed by all parties.

Why consent or withhold consent? Soliciting consent to transfer is the easy part. Getting consent may be an entirely different matter! For one thing, your counterparty is not obligated to say “yes,” but depending on whether or not your transfer language was amended in your ISDA Schedule, could shift the burden of proof either to you to prove that you should be able to assign or the bank to prove that you shouldn’t. There are very valid reasons why consent may not be granted. For one thing, if the transfer somehow burdens your original counterparty with more cost or more risk, they are less likely to grant consent. If you have both an asset position and a liability position on with your counterparty, for example, and you would like to move just the asset position, you could expect your counterparty to scrutinize your request more closely, as they would be left with greater exposure to you. Another reason consent may be withheld is if there is no ISDA currently in place between Transferee and Remaining Party, they would need to go to some expense to negotiate a new agreement. On the other hand, consent may be beneficial to all parties. The Remaining Party may face a better credit in the Transferee, for example, or the transfer could mitigate some of the existing exposure already in place between the two from their other dealings together.

Ok, so why then so few transfers? If conceptually, it’s quite simple, and operationally it’s as easy as 1-(Transferor), 2-(Transferee), 3-(Remaining Party) consenting, then why do we see so few transfers? Practically speaking, most counterparty banks would far rather see trades unwound than transferred, not only for their potential profit (unwinds can be hugely profitable), but because it can reduce their overall credit exposures. Therefore, going through the process of transferring can be a great negotiating tactic for a reduced unwinds cost. However, there will be circumstances where a transfer makes enough sense for all parties to move forward. Please give Chatham a call if you are contemplating an unwind or a transfer, and we can help you make sense of your situation.