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Lloyds’ £1.5bn PFI CLO canned

Bad memories of structured investment vehicles and a pricing mismatch between the underlying loans and the margins investors were demanding are said to have ultimately derailed the bank’s efforts to securitise £1.5bn of PFI loans.

UK bank Lloyds’ attempt to offload £1.5 billion (€1.7 billion; $2.4 billion) of project finance initiative (PFI) loans to the capital markets via a collateralised loan obligation (CLO) has failed, after investor interest was deemed insufficient to proceed with the deal.

“Although this is an attractive proposition with transparency and look-through to a high-quality portfolio of rated performing public-private partnership (PPP) assets, it is effectively a structured CLO and some investors are still connecting this with the ills of the past, such as SIVs [structured investment vehicles],” a source familiar with the securitisation said.

The bank was trying to sell a £1.5 billion CLO, named Gable Funding, backed by loans to UK PFI projects. PFI is the UK’s standardised procurement method for PPPs. PFI projects are backed by availability payments from the UK government, in exchange for making assets available in good condition.

The CLO had been well rated by rating agency Fitch in a pre-sale report which assigned a AAA-rating to three of Gable Funding’s tranches and an A-rating to a fourth tranche. The CLO also had a £204 million equity portion.

But despite the high-ratings and the low-risk nature of the underlying assets, Gable Funding suffered from a price mismatch between the low interest rates paid by the underlying deals, most of which were structured prior to the global financial crisis, and the margins investors were demanding from the CLO.

Reuters reports that investors were demanding margins of over 200 basis points from the CLO, which is backed by pre-credit crunch loans paying sub-100 basis point margins. Lloyds had planned for this mismatch with a first loss piece of 25 percent, retained by the bank, and a £135 million yield reserve account.

The latter was due to fund the difference between the pricing of the loans and the final interest to be paid by the CLO, if necessary. But when investors started demanding Gable Funding pay margins north of 200 basis points, Lloyds cancelled the deal, the news agency said.

Several banks have been tapping the market to sell their project finance portfolios. Bank of Ireland has recently announced the sale of a €3 billion international project finance portfolio. Portuguese bank BES is also currently selling about €2.6 billion of project finance debt. And Britain’s RBS sold €4.5 billion of project finance loans to Japan’s Bank of Tokyo-Mitsubishi in November 2010.