This article was last revised on 30th Jan 2007
The whole business securitisation is a concept that emerged essentially in the UK at the time of privatisation of businesses by the UK government. Business takeovers are usually funded by leveraged buyouts, which essentially leverage the earning potential of a business. A whole business securitisation (WBS) may be likened to a securitised LBO – that is, it is the value of a business, reflected by the residual cashflows of the business, which is being securitised here.
The WBS transaction is structured based on the residual cashflows of an operating business. Ideally, the business is one which has evinced steady cashflows over time in the past -such that it is possible to evaluate the cashflows similar to those of any other securitised pool. However, as it is difficult to think of isolation of residual cashflows of an operating business, the structure works on creating a security interest on the properties of the business. The business operator takes a loan from a special purpose vehicle, and in security creates a fixed and floating charge over its properties in favour of the SPV. The SPV then issues the securities. In addition to the fixed and floating charges, quite often, there is also a pledge of shares of the operating company created by the holding company, as to enable takeover of the management of the operating company in case of trigger events being hit.
The WBS securitisation is somewhere close to secured lending than to securitisation, both in technique as also in substance. Quite often, one might wonder as to why it is called securitisation at all – why not simply a straight debt issuance by the issuer. Unlike traditional securitisation transactions, there is no isolation of cashflows by transfer of assets. There is no originator-independence as the residual cashflows as obviously originator performance dependent. In traditional cashflows, the originator becomes a servicer post-securitisation; in WBS transactions, the originator remains the operator of the business.
The idea of whole business securitisation developed in the UK during mid 1990s when the cashflows of a nursing home were securitised. Privatisation of businesses during 1990s were also funded by WBS. This led to a spate of transactions including the following popular ones:
- Formula 1
- Madame Tussaud's museum
- Several pubs in the UK
- London City airport
- Marne et Champagne (the French champagne bottles securitisation),
- Really Useful Theatres, etc.
The market for whole business securitisation continues to develop, and it is expected to grow faster than other applications. In a recent article in The Investment Dealers' Digest Nov 13, 2000, Christopher O'Leary regards whole business securitisation as the next big wave to come, once such transactions are transposed to the US markets.
A major shot in the arm for whole business transactions was the mega whole business securitisation in Japan. This was Softban's refinancing of its borrowings for acquisition of Vodafone KK. The deal exceeded USD 12 billion and apart from its mega size, it was one of the first whole business securiitsation deals in Japan.
There were two classes of notes: Class A: 1,150 billion yen, and Class B: 300 billion yen. All the assets of the newly acquired business, as also the shares held by the shareholding companies were pledged.
In Jan 2007, BAA plc, the largest airport operator in the world, announced that it would pledge the assets at London Heathrow, Gatwick and other airports to secure financing by way of whole business securitisation. The size of the deal will exceed that of the Vodafone refinancing deal.
The legal basis:
The legal basis for whole business securitisation is the ability of the SPV to cause the originator to give up his business in favour of an administrator to be appointed by the SPV, should a trigger event take place. This is similar to the concept of a backup servicer in usual securitisations: the originator continues to service the cashflows that he has transferred, but if something wrong happens, the SPV or the security trustee has the power to replace the originator by a backup servicer. In whole business securitisation, the operator or the originator continues to run his business, but if any of the trigger events happen, the trustee may cause the originator to give up the management of his business and hand over the same to an administrator, comparable to a backup servicer.
Is whole business securitisation bankruptcy remote? As there is no transfer of assets from the originator to the SPV, the assets of the originator are a part of the bankruptcy estate of the originator. However, whole business securitisations rely on a legal provision in UK bankruptcy law which allows a person holding a floating charge on the entire business of the bankrupt to ward off the jurisdiction of a bankruptcy receiver, and handover the management of the business to the person holding the floating charge. Thus, the whole business securitisation device is premised on the ability of the SPV, as a holder of floating charge over all the assets of the originator, to assume administration of the business of the originator, should the originator file for bankruptcy.
The common methodology in most whole business securitisations is for the issuer SPV to issue bonds in the market and with the funds so collected, provide a loan to the operator (originator). The originator agrees to repay the loan in fixed instalments of interest and principal – these instalments are in fact used by the SPV to pay off the bonds. The central legal document in the transaction is the loan agreement whereby the SPV gives a loan to the operator. Apart from creating a floating charge on all the assets of the operator, the loan agreement allows the SPV to appoint an administrator to run the business should the trigger events take place. The loan agreement also places several restrictions on the business, borrowing ability, disposal of assets, etc., by the originator.
In addition, another central feature of whole business securitisations is the creation of an external liquidity facility to meet the bond repayments in the event of a delay in the takeover of business. Rating agencies require several months' servicing to be pooled in the liquidity facility.
Whole busines securitisation in the USA
The idea of WBS still remains predominantly a UK idea, but there are increasing instances of the device being used in the US markets, particularly for intellectual property, trade marks, etc. In an article dated 15th April 2004 at CFO.com, it was reported that "about 25 WCS deals have been completed in the United States since the Days Inn deal, and the proceeds have been small — usually between $25 million and $100 million". The Days Inn case is one of the cases of default in such transactions.
In US transactions, there is a bit of difference in methodology. Since the legal fraternity is not so sure about the secured loan structure working under the US bankruptcy laws, the core property of the business is in fact transferred to a shell company, call it an SPV. The nature of credit enhancements in the US market is also different – mostly the senior notes are elevated to a AAA rating with the guarantee of a monoline insurer or a bond guarantee company. For example, the Arby's franchine revenues securitisation was backed by a guarantee from Ambac.
Why would you go for it?
The essential advantage in any securitisation over traditional balance sheet funding is increased leverage, resulting into lower cost of funding. WBS is not an off balance sheet funding method – therefore, the benefits of off balance sheet are not applicable here. Ratings of the transaction are mostly affected by performance risk of the business, unless third party credit enhancers are used. The transaction has to cover against all the operational risks of the operating business – so the argument of "narrowed risks, higher leverage" that applies to a traditional securitisation does not work here. The appeal for WBS is, therefore, either the fact that the methodology allows businesses which are not generally popular among banks and investors to tap funding, or that the tenure of funding may be typically longer than that permitted by traditional banking finance. Partly undoing those advantages are the upfront costs of setting up a WBS, which might require substantial legal costs, restructuring of the ownership structure etc to pledge the shares, and so on.
Whole business transactions have not been tested in bankruptcy courts as yet. The robustness of the legal structure remains to be tested.
In a report, Standard and Poor's cites the following advantages of a WBS (also called corporate securitisation): "Corporate securitizations offer corporate borrowers a number of financial benefits relative to standard secured financing. The benefits arise from the transaction structure's enhanced financial capacity to service debt, which in turn is due to features borrowed from asset securitization techniques. Corporate securitizations tend to support greater financial leverage due to their enhanced debt servicing capacity; they often entail a lower average cost of debt due to higher credit ratings; and they may incur less refinancing risk due to longer terms to maturity.
Noteholders benefit from covenants, controls, and credit supports embedded in the transaction structure. Credit supports such as cash reserves and dedicated liquidity facilities can provide cash resources to meet timely debt repayment in circumstances when operating cash flows experience a temporary shortfall. Covenants and controls provide periodic signals of the operator's financial performance and the potential vulnerability of the debt to financial distress. Signals can include the fundamental message about payment capacity embedded in an amortizing, rather than a bullet, debt structure, threshold benchmarks that can trigger early amortization or remedial action, and financial reports."
Similar safeguards can be incorporated in a straight debenture issuance as well – so, the advantages are more a matter of features of the transaction than features of the methodology itself.
The House of Lords has recently given 2 rulings, closely in succession which have considerably weakened the strength of fixed charges on all the assets of the operating company that whole business securitisations have mostly resorted to.
In the first case in Brumark (Agnew vs Inland Revenue Commissioner) the case arose in appeal against a New Zealand ruling wherein the HL discussed the nature of a floating charges arising out of the age-old rulings of Lord Macnaughten. A floating charge necessarily implies a floating stock of property – mostly expressed as present and future property. When a charge allows the chargor the liberty to dispose of assets without the consent of the chargeholder, the charge must be construed as a floating charge.
This was a ruling in context of receivables. The HL extended the same ruling in case of machinery and equipment as well, in Cosslett's case . If the intent of the parties is that the chargor can dispose of assets, the charge in case of fixed assets should also be recharacterized as a floating charge.
Judicial recharacterization of a fixed charge into a floating charge may cast serious issues for whole business transactions which are premised on fixed and floating charge on the entire assets of an operating business. The fixed part will almost surely get recharacterized as a floating charge, if the intent were to allow the chargor to deal with the assets in normal course of business. If that is done, that allows the chargor the liberty to create other fixed charges which rank in priority to the claims of the securitzation investors. Of course this may be structured as an event of default, but quite often, this default is only like bolting the stable door after the horse has run away.
The idea of a charge creation is an inter-creditor arrangment. If the arrangement is such that a section of creditors has a claim over all the assets of the corporation, it is, by definition, a general claim. A specific charge is a specific claim, and should run faster than a general claim. The HL rulings have only refreshed this age-old concept of floating charges.