Securitization As An Integral Part Of A Corporate Capital Structure

• Published date: 27 September 2022
• Subject Matter: Finance and Banking, Financial Services, Securitization & Structured Finance
• Law Firm: Shearman & Sterling LLP
• Author: Mr Bjorn Bjerke

Introduction

Companies are increasingly incorporating securitizations and securitization-like financing arrangements as part of their capital structure. Utilizing these types of structured financing arrangements enables companies to diversify their lender base, increase their borrowing capacity, and even lower their financing costs. Securitization techniques may also be used to capture other benefits such as tailoring the financing to desired credit ratings, reducing lenders' regulatory capital charges or achieving particular treatments for tax or accounting purposes.

Asset-based lending complements cash-flow based lending by assigning a lending value to assets that in a cash-flow loan may not add much to a company's borrowing capacity. Cash-flow loans, even if secured, primarily look to a borrower's EBITDA and enterprise value. So long as the company retains sufficient enterprise value that the company is likely to restructure (and not liquidate) in case of any insolvency and cash-flow lenders retain their status as secured lenders in case of any restructuring or other insolvency proceedings, any additional collateral will likely be viewed as boot collateral: nice to have, but not necessary or necessarily particularly additive to the company's borrowing capacity. Secured cashflow lenders also tend to focus on obtaining a security interest in core assets that are important to maintaining the enterprise value of the company. In contrast, asset-based lenders primarily look to the liquidation value of the financed assets and may therefore be able to obtain significant additional borrowing capacity from the very same assets that cash-flow lenders do not give much value or where the asset-based financing does not have any particular adverse impact on the company's EBITDA. Using an asset-based financing for such assets in combination with a cash-flow loan will naturally unlock value and increase borrowing capacity. This is particularly true where the asset-based financing is in the form of a securitization (or uses securitization techniques) to decouple the asset-based financing from the credit risk of the related operating company (at time referred to herein as the "securitization sponsor"). This decoupling is typically achieved by establishing a bankruptcy-remote special purpose entity (the "securitization SPE") that neither provides, nor relies on, credit support to or from the company or its non-SPE affiliates that acquire the relevant assets required to support the securitization debt in a true sale. For some assets, such as ordinary course trade receivables, the impact on the company's EBITDA is minimal, whether the company simply collects its trade receivables directly or receives payment in the form of a combination of cash proceeds and cashflow on equity securities issued by a securitization SPE that has acquired the receivables and even secured cash-flow based loans to highly leveraged companies (i.e. "leveraged loans") typically contain an unlimited or near-unlimited basket for such receivables financings.

The relationship between asset-based lenders and cash-flow lenders is more complex where the underlying asset is of a type that is central to the company's enterprise value or where the securitized asset consists of less liquid operating assets where any full decoupling from the company requires time and additional credit enhancements to investors in the securitization debt. Securitization structures nevertheless may be able to unlock additional value, even for assets that a company is likely to view as important for its business and therefore likely to hang on to in a reorganization. It is, for example, possible to construct a securitization of assets for which the related cash-flows are in the form lease, rent, licensing fees or other payments from the related company and for which the securitization lenders have to be prepared for any third-party sale to take significant time and require a significant discount. However, cash-flow lenders typically include a number of covenants that are intended to protect them in case of securitizations or similar add-on financings of such assets. While it is usually possible to carefully structure a securitization of operating assets to comply with a typical highyield or leveraged loan covenant package, such securitizations will have elements in common with some liability management transactions that are not always viewed favorably by cash-flow lenders. For example, there have been instances where lenders to distressed companies have objected to the use of "drop down" financings to move assets away from the cash-flow lenders. However, while drop-down liability management transactions have many aspects in common with a securitization, there are also important differences where a financing is structured outside such distressed scenario. This will be discussed in more detail below.

Summary of Securitization Features and Character of the Receivables

a. Securitizations - a summary of key features

Securitization, at its core, involves isolating the securitized asset from the originator and its affiliates and obtaining financing secured and serviced by such assets. Typically, such asset isolation will involve a "true sale" of such assets to a "bankruptcy remote" special purpose entity (i.e. the securitization 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 are no longer part of a transferor's property or bankruptcy estate. 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, the greater the likelihood that the transaction would be characterized as a transfer of collateral securing a loan. Some features, such as transferring the economic risks and rewards of ownership, are given greater weight than others in determining whether a purported sale will in fact be respected as such or instead be recharacterized as a loan.

Effectuating a true sale to a securitization 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 combined with its affiliates' bankruptcy estates, whether as a result of the SPE becoming subject to a bankruptcy filing or as a result of the SPE being substantively consolidated with a bankrupt affiliate. It is therefore typical to include various features in the SPE's charter and the relevant transactions documents to limit the likelihood of such events

The risk of the SPE becoming subject to an involuntary bankruptcy is reduced by limiting the SPE's activities to the securitization transaction and requiring transaction parties to waive or limit their right to bring a bankruptcy proceeding against the SPE. Contractual provisions that prevent the SPE from voluntarily filing for bankruptcy protection are not enforceable on public policy grounds. Therefore, the risk of a voluntary filing by the SPE is addressed more indirectly: in part, by limiting the activities of the SPE; in part, requiring the SPE's contract counterparties to agree that their claims against the SPE will be limited to its assets; and in part, by requiring that any bankruptcy filing and certain other material actions require the...