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 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 revised to Stable from Negative.

Key Credit Considerations

The Outlook revision at SSS is primarily connected to the gradual rebound in earnings performance in 2024 compared to 2023, which also coincided with significant volume growth in the fixed-income collateralized finance business. The noted improvement stems primarily from improved lending margins and somewhat lower operating expenses compared to 2023. Continued growth over time in the equity securities lending business, coupled with a potential rebound in TBA pipeline hedging volumes (considering the ongoing volatility in interest rates) are catalysts to support or improve the earnings base.

The ratings for SSS remain supported by the collective experience of the management team and key business line leaders, who have 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 monitored.

Compared to 2022, financial leverage at SSS has increased on both a net and gross basis – a key rating consideration – due to an increase in reverse repo balances and a decline in members’ equity following a sizeable distribution in 1Q24. KBRA considers financial leverage (assets/equity) high for the current rating.

The ratings of SSSF are inextricably linked to SSS, as it effectively represents its key asset and primary source of earnings, a meaningful portion of which is required to service the parent company’s debt. Positively, double leverage at SSSF has declined to less than 150%, in line with KBRA’s expectation. KBRA anticipates that double leverage will be maintained in the range of 150%, which is a key rating constraint for SSSF.

Rating Sensitivities

Given the Outlook revision, the ratings at SSS are unlikely to change in the intermediate term.

The ratings at SSS would be pressured if profitability deteriorated to the extent that periodic net losses occurred or were likely to occur, or if balance sheet leverage (total assets-to-members’ equity) increased beyond the current range. The ratings of SSSF are tied to SSS’ issuer rating; therefore, any negative rating pressure at SSS would most likely transfer to SSSF. Additionally, a sustained increase in leverage at SSSF or a weakening of the FCCR ratio could lead to a re-evaluation of the ratings.

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Methodologies