Smart SME CLO noteholders claim several breaches in credit default swap

By Tali Rackner

Norfolk, Va., Dec. 1 – Smart SME CLO 2006-1 Ltd. said holders of its $84 million class F principal only notes due 2016 have raised issues with respect to a credit default swap between Smart SME and Deutsche Bank, AG, and the bank account agreement, according to a filing with the London Stock Exchange.

The noteholders brought up the following issues to the issuer and trustee Bank of New York, London Branch:

• The holders claim that the potential disposal of non-performing assets, as described in the issuer's July 4 notice, is in breach of the terms of the credit default swap and would be a violation of the servicing standards and credit collection policies. Deutsche Bank denies any breaches or violation of the relevant transaction documents. The trustee said it is not aware whether or not a disposal has occurred to date;

• The holders claim that there have been multiple breaches of the conditions to settlement under the credit default swap, resulting in the improper payment of floating amounts to the swap counterparty. They assert that these improper payments give rise to an obligation on Deutsche Bank to reimburse the issuer for those amounts;

• The holders claim that certain reference obligations were taken out of the reference portfolio because they either failed to satisfy the reference obligation eligibility criteria and/or replenishment conditions at the time they were added to the reference portfolio or were otherwise incorrectly included in the reference portfolio for the time that they comprised part of it; and

• The holders claim failures by Deutsche Bank as swap counterparty and as deposit bank to take timely actions as directed in the credit default swap and bank account agreement upon Deutsche Bank’s credit ratings being downgraded below the required ratings set out in the credit default swap and the bank account agreement.

In response, Smart SME advised the trustee on Oct. 28 that, to the best of its knowledge, the deposit bank failed to fulfil its remedial obligations within the approved time frames and that an event of default had occurred.

This type of a default gives the trustee the right to withdraw sums standing to the credit of the Smart Account and deposit those amounts in an account established with a replacement bank nominated by Deutsche Bank. The trustee asked Deutsche Bank to nominate a suitable replacement bank on Nov. 7. On Nov. 18, the Deutsche Bank contested the ability to enforce the right to withdraw the balance of the Smart Account.

In response to the issues raised by the noteholders, Bank of New York requested that Smart SME provide an officer's certificate confirming that all parties have been and remain in compliance with all relevant terms of the Credit default swap, the indenture and all other relevant transaction documents, the filing said.

Smart SME did not provide the requested certificate, although it provided the trustee with an officer's certificate of compliance in accordance with its obligation in section 7.9 (statement as to compliance) of the indenture covering the year ending Dec. 31, 2015.

Under the notes indenture, the trustee is not required to open any investigations, but, “upon written direction of the majority of the controlling class or either rating agency, shall make such further inquiry or investigation, into such facts or matters as it may see fit or as it shall be directed; provided, however, that if payment within a reasonable time of the expenses and liabilities of such inquiry or investigation is, in the opinion of the trustee, not reasonably assured to the trustee by the security afforded to it by the terms of this indenture, the trustee may, as a condition to proceeding with such inquiry or investigation, require indemnity satisfactory to it against such expenses and liabilities."

Bank of New York has not received any such written direction or indemnity.

Questions may be directed to The Bank of New York Mellon, London Branch, at dagemea@bnymellon.com.

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