Securitization As An Integral Part Of A Corporate Capital Structure

Corporate borrowers are increasingly using securitizations to optimize their debt structure. Securitization allows companies to use assets that are only given limited lending value in traditional corporate loans, to obtain financing in the investment grade assetbased lending market. As such, securitizations may diversify a company's lender group, reduce borrowing cost, and increase borrowing capacity. The non-recourse nature and the segregation of the assets that are subject to securitization also provide for a good interface with traditional corporate debt facilities, whether in the form of investment grade bonds or secured leveraged loans.

Securitizations can be used to finance a wide range of assets and receivables generated by such assets, including trade receivables, secured and unsecured loans, leases, royalty payments and other licensing fees. Securitizations can finance assets with a single payment stream or with a broadly diversified pool of receivables. The value proposition that securitizations may offer a corporate borrower will depend on a number of factors, including the types of assets available for securitizations, the rating of the company, its alternative borrowing availibility and costs and the quality of its receivables.

Companies with captive finance companies or significant embedded seller financing, may find that its pool of receivables is similar in scope and diversification to what would be a typical securitization by a financial lending institution. However, securitization of trade receivables and non-financial assets present several unique issues. This chapter summarizes some of the issues that a corporate borrower contemplating securitizations may want to consider. The first part of this chapter looks at the rights of set-off and recoupment that a company's customer may have and how such rights may affect the company's trade receivables. The second part of this chapter discusses the extent to which securitization of various assets will fit within the company's existing corporate debt structure. However, first, it is worth summarizing at a high level the salient features of typical securitization structures as well as typical bond and credit agreement covenants that may impact particular securitization transactions.

Summary of Securitization Features and Relevant Debt Covenants

1. Securitizations - a summary of key features

   Securitization, at its core, involves isolating the asset to be securitized from the credit risk of the originator and other affiliates of the securitization issuer and obtaining financing secured and serviced by such assets. Typically, such asset isolation will be effected by transferring the relevant assets in a "true sale" to a "bankruptcy remote" special purpose entity ("SPE"). True sale is a legal and accounting concept intended to capture a transfer that will be respected in a potential bankruptcy of the transferor, such that the transferred assets would not be part of the transferor's estate if the transferor were to become subject to bankruptcy proceedings. That analysis hinges on whether the attributes of the transaction have more in common with a sale than a secured loan. Not surprisingly, the more attributes the relevant transfer has in common with a typical sale transaction, the more likely it is that a court will determine the transfer to be a true sale. Conversely, the more the transaction includes features that are more typical of a loan transaction, the greater the likelihood that the transaction would be characterized as a loan.

   Effectuating a true sale to an SPE that is affiliated with the transferor would not be of much use in effectuating isolation of the assets, if the SPE itself would be likely to file for bankruptcy protection or be consolidated with the transferor as part of the transferor's bankruptcy proceedings. It is therefore typical to include various features in the SPE's charter and the relevant transaction's documents to limit the likelihood that the SPE itself will seek voluntary bankruptcy protection or that the transaction creditors of the SPE would seek to involuntarily put the SPE into bankruptcy. In addition, in order to avoid the SPE from becoming part of its affiliates' bankruptcy proceedings through the equitable substantive consolidation doctrine, the SPE will also be subject to a number of separateness provisions intended to limit activities of the SPE and to ensure that its separate legal existence is respected by its affiliates and its creditors. The formulation of the substantive consolidation analysis used by the courts varies somewhat between the U.S. circuits. Generally, each formulation reflects the concept that the separateness of the SPE should be respected where it has been treated as a separate entity by its affiliates and the reasonable expectations of the investors in the SPE and the investors in its affiliates, is that the assets of the SPE are not available to support the credit of the SPE's affiliates.

   Securitization structures are typically able to issue debt with credit ratings significantly higher than that of its sponsor. In part, because of the credit isolation, and in part because of other available credit enhancements. Such credit enhancements may include some or all of the following:

   bankruptcy remoteness; tranching of debt; overcollateralization reflecting the amount of collateral in excess of the relevant debt obligation (i.e. the SPE's equity in case of the SPE's lowest tranche of debt, and the sum of the equity and each subordinated tranche of debt in the case of any senior debt tranches); excess spread, reflecting any excess in the amount of periodic payments over the amounts required to service the relevant debt; diversification of payment risk by virtue of pool of collateral; and amortization triggers that trap cash and accelerate the pay down. b. Typical corporate debt covenants

   Corporate lenders generally look to the corporate group's earnings and enterprise value for its credit analysis. As such, much of the focus on corporate credit covenants is to make...