WholeBusinessSecuritisations

Hold on a minute ... according to OnSecuritisation the idea is for investors to 'pick and choose' the best assets to secure their lending. So what is a whole business securitisation (WBS)?

Maybe not a securitisation at all? Though one obvious feature it shares with other ABS types is the creation of a bond-issuing Special Purpose Vehicle (SPV) as an intermediary between borrower and investors.

In a WBS the agents and their key roles are:

Borrower: generally a corporate. Borrows an amount of money from the SPV in a loan secured against all (or most) of the business's assets - i.e., if the borrower can't meet a repayment, has to sell assets - and in the last resort go bankrupt and sell everything to pay the SPV. The SPV will have priority over other lenders and shareholders.

Issuer: the SPV. Makes a secured loan to the borrower. Issues bonds to investors. Repays bonds out of the repayments it receives from the borrower.

Investors: buy bonds from the SPV.

So the difference with a standard (pure sale) securitisation is that the SPV doesn't own any assets (other than its loan to the borrower, that is.) This is really just a kind of two-step loan. But what is the difference between this and the corporate simply borrowing directly from investors by issuing a corporate bond itself? Why does it need the SPV?

Whether or not this is a form of securitisation, it is certainly a form of 'structured finance'. What is meant by 'structuring' here, is that the SPV structure is used as a legal means to introduce new restrictions on the borrower, and new powers for the lenders. All of these mean that the bond is seen as less risky than a normal corporate bond, and so gets a better credit rating. Corporates are then able to borrow more than they would without WBS. How it works:

Charges and receivers

Whilst most forms of securitisation were pioneered in the US, WBS started out as a very british affair. As the idea catches on, financiers find ways to adapt it to different countries' legal regimes, but at least at the start it was a particular feature of the UK corporate legal system that made this so attractive.

In this classic WBS, the exact structure of SPV's secured loan to the borrower is important. In UK law, a 'charge' is a (partial) repayment of a secured loan. A 'fixed charge' is a repayment that is tied to a particular asset - the borrower cannot sell or replace that asset without the lender's permission, the asset must be retained until the loan is fully repaid - or sold to meet the debt in case of default. A 'floating charge' is not tied to any one asset - the borrower can sell assets and buy new ones to replace them, which then take their place as collateral for the loan. It is secured by all of (or a large proportion of) the firm's assets.

If the business goes bust (without getting technical about receivership, bankruptcy and distinctions within all this etc.), in general a first obligation is to pay the fixed charges by selling the assets they are tied to. Floating charge creditors may be further down the queue, but they have other important rights. In particular, they have one very strong power - if the debtor defaults they can, without needing to go to court, appoint an administrative receiver to take over the company and run it in the floating charge holders' interests (or rather - the 'trustee' of the floating charge appoints the receiver in the investors' interest).

In general the SPV in a WBS gets both fixed and floating charges. Fixed charges give it certain rights to get in on particular assets before other creditors. Floating charges give it the threat of appointing a receiver. These 'charge' structures (as I understand it) give the SPV, and through it the bond-holders, more power over the borrower than standard corporate bond-holders would have - and certainly more than shareholders in time of trouble.

In addition to these legal powers of the SPV, the deal is set up with additional 'structuring' to make it still more attractive to investors ...

Financial Covenants. Terms ('covenants') are written into the loan agreement between the SPV and the borrower that allow eg. receivership to be enforced even before actual default takes place. Commonly - a key measure of credit risk is the 'DebtServiceCoverageRatio' (DSCR) = income that can be used to cover debt / forthcoming repayments.

The covenant may state: if this ratio falls below a certain level (eg 1.1) for a certain time (eg. 90 days), the SPV can act as if default has occurred.

Liquidity Facilities. (I think -) the firm is obliged to put an amount aside to cover debt repayments in the event of a 'stress situation' where its income is not sufficient to meet its obligations.

Operating restrictions. The loan agreement can impose restrictions on eg. what disposals (asset sales) it is allowed to make; what kinds of new assets it is allowed to buy. It can also place restrictions on when the the company is allowed to issue dividends to shareholders - eg. only if DSCR is above a certain ratio.

All this 'structuring' - restrictions on the firm's activities written into the loan agreement - are justified by the creditors' rights to safeguard its investment, which is secured against the whole business: all of the company's assets.

To determine a credit rating for the bond, ratings agencies assess all these details of 'structural enhancement' against their own criteria.

Types of deals

Only certain kinds of business are amenable to these techniques. Basically this is used for companies with steady - even boring, maybe even declining, but steadily declining - revenue streams. Where more turbulent businesses use ABS to cash in the borrowing potential of their more reliable business lines, in boring industries all assets are susceptible.

Pubs and motorway service stations. As the UK government specifies the minimum spacing of motorway servioce stations, as these spacing limits are reached, and as motorways are near inescapable, service station cashflows are pretty well determined by the number of cars passing them - which is steady, even steadily increasing. No one really wants to buy shares in pubs - a pretty stagnant industry - but dependence on beer guarantees enough regular cashflow to make WBS attractive.

DariusSokolov