asset-backed securitisations secure investment ?
A moderator at an annual meeting of Bond Market Association once quipped that the asset-backed securitisation has "proven to be bankruptcy remote - excep perhaps in the event of bankruptcy".
Though this joke elicited a few chuckles, it is a fact that asset backed securitisation has been an effective form of structured financing for many companies. The illiquid assets like receivables of the company that is on the verge of bankruptcy, are legally transferred to a special purpose entity (SPE). This improves the credit ratings of these securities, which in turn enables companies to sell them as packaged securities.
The potential benefits of ABS increased the demand for such securities since 1999. The asset-backed commercial paper market, which went up from USD 517 billion assets in 1999 to USD 708 billion in April this year, comprises of corporate trade receivables as the major asset class.
Securitisation is cheaper than other modes of direct financing. AAA debt markets are easily accessible to companies at low interest rates. Further, companies need not show funds collected through the process as finances raised, but can simply report them as cash from operations as they are off-balance sheet transactions.
However, this scenario is going to change now with the new accounting rule to be implemented from this month. This rule demands disclosure of SPEs in the companies' balance sheet- a change likely to adversely affect the market. Moreover, the costs for deal sponsoring banks are likely to increase.
It is also likely to affect accessibility to capital markets, which is very crucial for many financially troubled companies. This is because the increasing number of bankruptcies is bringing in more challenges in the securitisation arena. Mark Scoles, Chicago-based Grant Thornton's partner views, "With the uptick in ABS and more big companies going into bankruptcy, it wouldn't surprise me if some of these facilities get tested in the court. There's an awful lot at stake for creditors if they can pierce these structures and bring the assets back into the company".
How the game goes
Securitisation represents the true sale of corporate assets to a third party and a transfer of legal control, but it doesn't represent secured financing. Auditors and credit ratings agencies should obtain a true-sale opinion either for accepting off-balance sheet treatment or rate the separated securities. However, in many cases, these securitisations are not challenged, resulting in losses to investors.
NAL Financial Group, LTV Steel, Contimortgage, Commercial Financial Services, National Century, NextCard are some examples. Consider the case of LTV Steel. The company declared bankruptcy in December 2000. It also filed an emergency motion requesting the court to allow access to securitised receivables, on the grounds that the transactions were just disguised financings but not true sales. Banks were surprised by a court decision that went in LTV's favour. Later the banks proved that securitisation involves a true sale and hence LTV cannot access the assets. Though a potential crisis was averted, the question of whether securitisation amounts to a true sale or not, is left unanswered.
Also there is no consistency in the opinion of rating agencies on the true sale aspect; and the ratings given for securities are at the discretion of the rating agencies. Under these conditions, there is a serious legal risk for parties involved in the securitisation transaction.
Tackling it through legislations
Legislations could help to mitigate the risk to a major extent. An attempt was made in this by proposing an amendment to the bankruptcy legislation in the US. According to this, securitisations were to be protected from bankruptcy if there is a true sale of such securities. And if the securitisations were based on certain specific guidelines, they were to be considered beyond the purview of bankruptcy courts. Bond Market Association (BMA) believes that the cost of funding securitised assets would be reduced with the new amendment as it minimises the uncertainty in deals. It argues that the amendment is required for efficient securitisation, which in turn benefits the economy.
However, the amendment was challenged on the grounds that it would allow some people to clandestinely transfer valuable assets to an SPE and profit from the transaction. This is possible because neither the bankruptcy court not the creditors will be able to review securitisation processes.
Disagreeing with the BMAs argument, Kenneth Kettering at New York Law School stated that first of all, the legally unstable products, however profitable, are created in the financial industry and later when the demand for product picks up, participants insist on legislative support to protect them from risk. He contends that these kinds of measures are like killing one's parents and then wanting sympathy for being an orphan.
Though the amendment has not been passed, this issue is not likely to stop here. This is because the legal cases on the true sale issue are increasing in the court of law and they are likely to increase further if there is no such legislation.
More than the true sale challenge, there are other challenges in the securitisation process, like fraudulent actions by banks and structured finance professionals. They are helping companies to design securitisations in such a way that creditors' access to securitised assets is delayed.
Fighting in the bankruptcy court
Added to this, bankruptcy courts have not helped resolve the securitisation issue. Judges can interpret the terms of securitisation in a manner they deem fit. This has created more problems in protecting securitisations in the bankruptcy court.
Poorly structured deals are the reasons for problems at most companies. Hence what is required for a successful turnaround for a bankruptcy is carefully structured securitisation.
There are two possibilities - to protect securitisation by bringing legislations to this affect or simply curb them by court rulings. But one thing that is unavoidable in the present conditions is the escalating cost of funding securitised assets
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