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 affirms the issuer rating of BBB and the short-term issuer rating of K2 for South Street Securities, LLC (“SSS”). SSS is an SEC-registered and member of FINRA 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 asset consist of its equity investment in SSS. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings for SSS are underpinned by management’s extensive collateralized fixed income finance experience and performance record, in addition to its risk management practices, which have proved effective, across varied market environments. Key risk factors, especially liquidity, are monitored daily to ensure excess, unencumbered collateral exists to maintain access to FICC clearing and bilateral funding. The Program Agreement includes risk attributes, including gross financial leverage (exclusive of netting).

The ratings are counterbalanced by SSS’ focused business profile, modest, albeit improving, profitability, and high financial leverage (measured on a gross and net basis), relative to the averages for KBRA rated securities firms, including those that specialize in collateralized finance.

The trend in profitability has improved in recent quarters, due primarily to improved net fixed income finance margins (UST & MBS), focused pricing efforts, and collateral margining and financing efficiencies.

Leverage has increased during the past few years and remains high on both a net and gross basis – a key rating consideration – due to generally steady growth in reverse repo balances and only a modest increase in members’ equity.

The ratings of SSSF are inextricably linked to SSS, as it effectively represents its key 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 been maintained below 150% the past two years; KBRA anticipates that it will be maintained in this range going forward. The parent’s ratings are currently positioned one level lower than SSS' issuer rating due to structural subordination and the bankruptcy-remote status of SSS per the terms of the Program Agreement.

Rating Sensitivities

The ratings for SSS are unlikely to be changed in the intermediate term. Conversely, the ratings would most likely be pressured if profitability eroded such that periodic net losses occurred or were likely to occur from its core collateralized finance business (including TBA finance) and proprietary investment and trading activities, or if gross and net balance sheet leverage (total assets-to-members’ equity) were to increase beyond the current range. The ratings for SSSF are tied to SSS’ issuer rating; a sustained increase in leverage at or a weakening of the FCCR ratio could lead to a re-evaluation of the parent’s one-level rating differential.

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Methodologies