- not quite as sexy as Bankers like to think.
Adapted from an article published in the October 2000 edition
of The Treasurer by Brian Welch of The UserCare Treasury Consultancy and Gill
Rowe, Treasurer of Arval PHH.
Securitisations convert bundles of assets into structured
financial instruments which are then negotiable (or tradeable). They
raise funds which are backed by specific assets or by income flows, and
a particular feature is the strict ‘ring fencing’ of
particular assets or cash flows. This means that the financial
instruments – such as medium term loans or commercial paper
– can be assigned a higher credit rating than the actual borrower
could command in their own right. This makes this kind of facility
attractive to borrowers which are either unrated or have low ratings.
As a result the issues usually need to be rated by the rating agencies
– Moody’s and Standard and Poor’s. Road shows or
presentations have to be prepared to explain in detail the activities
and financial background to the company and the proposed loans, to
those agencies and potential investors.
The important feature which gives the debt issue a higher
rating, is the guarantee to the investor that if the borrower ceases
trading for any reason, their loan is secure and will still be repaid.
Whilst there is a place for securitisations in mortgage
backed, property, and some other specialist sectors, there are serious
drawbacks associated with managing them which means that they are not
so suitable for more traditionally structured companies.
are the drawbacks?
As their description
suggests, securitisation or structured finance carries with it a very
specific structure, which can be very complex and may restrict the
borrower from having immediate access to some of its day to day cash
flows. This also means strict adherence of a whole series of ratios,
focussing on optimum cash generation.
The securitisation structure
will probably require the establishment of new “bankruptcy
remote” companies to issue the debt, to receive the proceeds of
the loans, and to handle the receivables. These companies each need
access to bank accounts and, more importantly, the accounting needs to
be more specific than within the conventional company structure. The
assets eligible for the securitisation would need to be separated into
these bankruptcy remote companies both in a legal and accounting sense. The cash flows will also have to be
segregated. The bank accounts may also need to be able to provide a
range of sub accounts to cover reserves which may have to be made to
cover a series of different provisions which the structure required.
If the existing accounting
function is run in the typically frugal manner, additional personnel
will almost certainly need to be employed because of the immediacy and
detail of the reporting and accounting which is required.
The structure is managed for
the borrower by the security trustee which will probably be provided by
the lead bank, and the structure may well result in pools of cash being
held separately within the ‘ring fence’ which can be
managed to earn interest in a specified manner.
The documentation is voluminous in the extreme, often
requiring several dozen interrelated agreements.
The complexity of the
documentation requires a much higher degree of reporting than under
more usual banking facilities. Daily, weekly and monthly reporting of
cash positions and asset information including relevant ratios is
required. Information on assets will include details of individual
assets providing the underlying security, both fixed assets and current
assets, in order to determine the borrowing base. Eligibility
assessments against the assets and daily reporting of cash collections
and billings is a standard feature. The ratios may be further affected
by the level of debt payment defaults, and other business data specific
to the borrower or securitised assets.
3. Cash Flow
Perhaps the most significant disadvantage is that, because of the fragmented nature of
the cash flows which are either within or outside the arrangement, it
is no longer possible to manage the corporate liquidity using
conventional treasury techniques of pooling bank account balances. Bank
accounts handling the cash on the securitised assets will be segregated
from general pooling arrangements, although they may be allowed to be
pooled amongst themselves. As the cash flows relating to the
securitised assets or revenues pass straight to the security trustee,
the amount of cash being passed on to the borrower by the security
trustee may not be known, and certainly not received until well into
the working day, by which time interest rates on the money markets are
often past their best. Similarly payments relating to the operation of
the company may have to be delayed until the cash flows are received
from the security trustee.
4. Activities outside of the Securitisation
Although other company
activities may continue outside of the securitisation, it could be that
they will be restricted, by the existence of a prior charge over the
entire company’s assets, or by the fact that all of the
borrower’s ‘good’ assets are tied up in the
securitisation. This could impact on existing bank relationships, other
borrowing facilities including overdrafts, and the ability to negotiate
new business outside of the facility.
5. Additional Advisors
Securitisations carry with
them a multitude of professional advisors starting with the lead bank,
which will probably also act as the funding agent and the security
trustee. That bank will appoint its own lawyers which will also act for
the other banks, but the borrowing company also needs to be advised by
its own lawyers. There may also be the need for other professional
trustees, and tax advice including reference of specific points to
counsel. Other parties to the documentation, such as the main clearing
bank will also consult its own lawyers concerning their own aspects of
In addition, the
borrower’s auditors are likely to be called upon not only to
undertake audits of the assets and the reports, but also to provide
various certificates concerning the assets and cash flows, tax
positions and contingent liabilities. Auditors in general are becoming
increasingly unhappy about these certificates because of the reliance
which is being placed on them, and therefore need to be involved in the
negotiations at a fairly early stage.
As previously described, the
rating agencies play a big role in the structure of the deal and
considerable management time will need to be spent with the lead bank
and Standard & Poor’s and Moody’s.
Needless to say all of these
advisers have to be paid for (most of them, whether the transaction is
completed or not).
6. Contingency Arrangements
The documentation for a
securitisation is based on ensuring that the loans will be repaid if
the borrower fails. To date, only one company which had securitised its
borrowings has failed, and the structures which had been created
enabled all of the lenders to be repaid in full. However, it does mean
that very detailed contingency plans need to be prepared to assure the
security trustee that it is able to step in to realise its security if
necessary. As a result, very difficult issues may need to be raised
with trading partners, suppliers and service providers to assure the
security trustee that the operations will continue to function to
enable the assets or revenues to be realised in the event of a failure.
Companies only usually start
to ask such questions if there is some risk of the possibility of
failure, and the mere asking of the question can cause unjustified
Complexity and reporting
requirements are the true (and heavy) aspects of securitisation, but
they can be useful and have positive effects on the business
information systems, accounting and management tools of the company.
Indeed, undertaking a securitisation can force you to understand and
organise better, and in more depth, the business you are doing, the way
you are doing it and the risks you are taking. Securitisation can help
enhance the information systems and organisation of a company and makes
full sense if integrated into the company’s forward strategy.
Clearly securitisation can only be used for large volume operations,
and repeat deals…….because the economies of scale are
Bankers predict that
the growth in securitisation is set to continue, as the awareness of
the technique on behalf of borrowers increases. This outline of the
disadvantages in this response should enable potential borrowers to
make a balanced judgement on this technique.
For a rosier picture of Securitisations, see Securitisation – a safe bet for
your assets in The September edition of The Treasurer, by
Stephen Moller of Simmons and Simmons