KBRA Affirms Ratings for South Street Securities Funding, LLC and South Street Securities, LLC

KBRA affirms the issuer and senior unsecured debt ratings of BBB- for South Street Securities Funding, LLC (“SSSF”) as well as the issuer rating of BBB and short-term issuer rating of K2 for South Street Securities, LLC (“SSS”). SSS is an SEC-registered broker-dealer domiciled in New York, NY that offers collateralized finance services to various mortgage REITs, hedge funds, and other financial institutions, in addition to interest rate risk hedging solutions for numerous U.S. residential mortgage companies. SSS is a wholly owned subsidiary of SSSF, an intermediate holding company whose principal assets consist of its equity investment in SSS. The Outlook for all long-term ratings is Negative.

While KBRA’s believes that net earnings have troughed and should begin to improve somewhat, due partly to lower operating expenses, the ongoing Negative rating Outlooks remain premised primarily on the low earnings performance at SSS. (Net earnings in 2023 were impacted by an increase in professional services expenses.) Continued, steady growth in the equity securities lending business and a potential rebound in TBA pipeline hedging volumes (considering the ongoing volatility in interest rates) are catalysts to support or improve the earnings base.

Financial leverage at SSS has increased on both a net and gross basis – a key rating consideration – due to both a sharp increase in reverse repo balances and a decline in members’ equity due to a sizeable distribution (to fund an acquisition at SSSH). KBRA considers financial leverage, in terms of the size of the collateral finance receivables in relation to members’ equity, to be high for the rating category.

The ratings for SSS remain supported by the collective experience of the management team and key business line leaders, with noted expertise in developing and managing all aspects of its longstanding repo-oriented operation. Risk management practices (including stress tests) address key factors for the collateralized finance businesses and are underpinned by the LLC program agreement and the risk management policy. Risk factors, including liquidity, market, and credit, are monitored daily. Unencumbered collateral that can be used to secure funding is tightly managed.

The ratings of SSSF are inextricably linked to SSS, as it effectively represents its principal asset and source of earnings, a meaningful portion of which is needed to service the parent company’s debt burden. Double leverage at SSSF has declined in the past year, in part, due to an equity investment in SSSF by SSSH.

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