Securitization, the old-new alternative financing tool

Market players are talking about reviving the securitization market as an alternative financing solution for corporates in the European market. A few years ago, securitization was blamed for triggering the financial crisis, however, there are now signs of change, with issuers slowly beginning to reconsider the market as investor appetite returns.

What is this magic word “securitization”? It is a method of finance whereby a lender, instead of lending money to a company to finance its general business, and looking to the company to repay that lending from the profits of that business as a whole, agrees to look solely to the assets which are the subject of the securitization for repayment. This should be distinguished from a secured loan: in a classic securitization, the borrower does not borrow money and grant security over an income-producing asset to ensure repayment, he sells the income-producing asset and the money he receives for that sale does not constitute a debt from a legal perspective.

Securitization is a relatively new financial technique, although it now accounts for a large portion of the funds raised in the international capital markets. The first transactions were done in the United States in the 1970s, using first mortgage loans and then credit card receivables. The first European transactions were carried out in the United Kingdom in the late 1980s, and also involved mortgage loans. Nowadays, securitization is a mainstream financing technique employed by almost all financial institutions worldwide and most large corporations in Western Europe. The technique has always been attractive to emerging market participants, allowing them access to cheaper funding than they can otherwise obtain.

STRUCTURE OF SECURITIZATION

In a securitization transaction the entity that is selling the income-producing assets and receives the funds realized by the securitization is the “originator”. 

The income-producing assets sold by the originator are the “receivables”. The list of the types of receivables which have been used for securitizations is long; starting with mortgage loans and credit card receivables, the technique has since been applied to a wide variety of trade receivables, toll road receipts, bank loans, leasing payments, student loans, health care facilities, car loans, non performing loans etc. 

The entity to which the originator sells the assets is the “issuer”, usually a special purpose vehicle (“SPV”) created specifically for the purpose of the transaction. The issuer/SPV raises funds to purchase the receivables from the originator by issuing notes in the capital markets (“asset backed securities” or “ABS”), which are purchased by “investors”.  

In a classic securitization, the transfer of the receivables to the issuer should be done by way of a “true sale” – i.e. should be done in such a manner that it will survive the subsequent insolvency of the originator so that no liquidator or third party creditor of the originator will have a claim to the receivables.

RATIONAL FOR SECURITIZATION

Different market players have different reasons for deciding to use securitization as a financing tool. For some, very large issuers it makes sense to diversify their sources of funds as much as possible. For financial institutions such as banks, mortgage lenders and credit card providers, securitization is an invaluable risk management tool, allowing them to remove assets representing business already done from their balance sheets, freeing up regulatory capital to allow them to do new business and originate new assets. With the advent of the Basel III capital adequacy rules, derecognition is increasingly being superseded by other motivations for securitization. 

For emerging market issuers, the greatest attraction of securitization is almost certainly the cheaper cost of funds they can obtain, as compared to straight unsecured borrowing.

HUNGARY

There have been very few securitization transactions in Hungary and the financial crisis halted the appetite of originators and investors for new transactions. Although there is no dedicated law on securitization in Hungary, those few transactions that were closed before the financial crisis are sound evidence that securitization is possible under Hungarian law. Nevertheless, a separate law – if implemented at all in the future – would give more comfort to the parties to a securitization transaction.