Securitisation: Transforming Your Balance Sheet
by Dave Sinclair and Direen Eraman, Debt Capital Markets team, Rand Merchant Bank
Securitisation is simply a form of secured financing; no dark arts, no magic.
Securitisation is an efficient technique for raising capital and transferring risk from originators of financial assets to the capital markets. Financial assets, such as individual loans, are pooled, repackaged and sold off as notes to investors. The process transforms a large pool of illiquid assets into tradeable, liquid securities allowing investors to purchase a small share of the larger asset pool. More importantly, it allows companies to free up their balance sheets by turning to the capital markets as a complementary source of funding, rather than relying solely on banks. Following the collapse of the American sub-prime mortgage market in 2007 and the ensuing global financial crisis, securitisation fell out of favour globally. However it is far too useful to be banished for good and, over the past year there has been a significant international revival. Fortunately lessons have been learned and unlike the complex and opaque structures pre-crisis, the securitisations of today are structured to be transparent, simple, easy to implement and used primarily for funding purposes. South Africa is no exception to the trend and securitisation represents a significant opportunity for companies looking for alternative sources of funding.
Over the past year there has been a significant international revival in securitisation.
The asset types that were historically pooled within a securitisation typically include residential and commercial mortgages, auto loans, credit card receivables and corporate loans. But why stop there? Provided that the underlying assets are ‘high quality’, a securitisation structure can be used to unlock funding and liquidity for a company by pooling a variety of assets. High quality assets must be clearly identifiable, have defined terms of repayment, legally transferable, quantifiable revenue streams and a transparent history of how the underlying assets have performed. Entities are able to securitise a number of different assets or income streams such as mobile handset receivables, operating lease charges, rental streams, insurance premiums, medical aid contributions, municipal rates payments, customs revenue streams and airline ticket sales. This allows a company to transform its balance sheet and create the funding and liquidity for much needed growth.
Benefits of securitisation
Banks have long dominated the funding for companies, but the implementation of Basel III regulation for banks has put pressure on their lending activities. Banks are required to hold more capital and liquidity buffers, which results in an increase in banking costs and a consequential increase in interest rates charged to borrowers.
Reduction in funding costs
By using a securitisation structure, to isolate a portfolio of high quality assets, a company may be able to lower its funding cost compared to that of traditional bank or vanilla capital market funding. A securitisation transfers the assets from the originator’s balance sheet into a ring-fenced, bankruptcy remote, separate legal entity or Special Purpose Vehicle (SPV). This reduces risk for both the originator and the investor. The originator is protected from claims from the investor as the originator no longer owns the assets or income stream as these have been legally sold to the SPV. The investor may only claim against the performance of the assets or income stream in the ring-fenced bankruptcy remote SPV. Investors benefit as they are not exposed to a possible default by the originator and have a direct claim on the assets housed in the SPV. By separating the assets from the originator, the investor is better able to evaluate the risks involved. This simpler, more transparent structure reduces the risk for the investor allowing the originator to raise funding at lower interest rates. Often the senior notes issued by the SPV have a higher credit rating than the originator.
Diversified funding base
Originators can gain access to alternative, complementary funding sources. Where companies have previously relied on banks and traditional financing facilities, they can now source funding directly from institutional investors and asset managers in the capital market. As the public place more of their savings in pension and life products than bank deposits, asset managers have a growing amount of funds that they need to invest. Asset managers seek alternative investment products that provide consistent, predetermined cash flows that are backed by the high quality assets that have the lowest possible risk. Securitisations provide this product to asset managers allowing a company to raise funding from non-bank sources. Instead of relying on a handful of banks, securitisations allow a company to access a broader universe of funding channels by tapping the large number of pension funds and life insurance companies in the South African financial sector.
This funding channel can also be used by banks. Banks can securitise their own illiquid assets by selling them to institutional investors, creating liquidity and funding capacity for new business origination.