Securitization As An Integral Part Of A Corporate Capital Structure

• Published date: 07 June 2023
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Financial Services, Securitization & Structured Finance, Corporate and Company Law, Insolvency/Bankruptcy, Contracts and Commercial Law
• 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 in general, and securitization in particular, provides corporate borrowers with borrowing capacity against assets that, from a pure cash-flow-based lending perspective, may have limited to no borrowing value. Securitizations also have the potential for achieving a better regulatory treatment and a higher rating differential compared to the corporate credit rating, compared to more traditional secured financing arrangements. As such, operating companies should consider including securitization structures as part of their capital structure.

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, cashflow lenders primarily look to the protection afforded to secured lenders in a bankruptcy restructuring (i.e. Chapter 11 or equivalent insolvency proceedings). Provided that the collateral securing the cash-flow loan has sufficient value for the lenders to remain fully secured in case of insolvency proceedings, they will likely view any additional collateral as essentially a form for boot collateral: nice to have, but not particularly additive to the company's borrowing capacity. As such, cash-flow lenders will also generally have a greater tolerance, and even preference, for maintaining a security interest in core assets of the borrower that are not likely to be sold during a restructuring. In contrast, asset-based lenders primarily look to the cash-flow associated with particular assets and the liquidation value of such assets as providing the basis for the amount of financing that such lender will be willing to provide against such assets. A borrower may therefore be able to obtain significant additional borrowing capacity from various assets that cash-flow lenders do not give much value or where the asset-based financing does not have any particularly adverse impact on the borrower's EBITDA or, by extension, the borrowing capacity under cash-flow loans. A prudent mix of asset-based and cash-flow borrowing therefor has the potential for unlocking additional access to financing. By utilizing common securitization credit-enhancing techniques to decouple the rating of the asset-based financing from that of the operating company and restricted subsidiaries that would constitute the borrower group under a more traditional cash-flow loan, it is possible to achieve a ratings lift and other potential benefits that overall reduce the borrowing cost while expanding the universe of potential lenders. 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 its non-SPE affiliates.

The cash-flow from the securitization would flow back to the borrower-group through a combination of the up-front purchase price and cash-flow through the securitization SPE equity and, depending on the securitization structure, would typically retain its operating income treatment. As such, the operating income impact of selling receivables or income to a securitization entity is typically minimal, thereby allowing for continued financing under an EBITDA facility generally to the same level as if there was no such receivables securitization. Consequently, it is common for secured cash-flow financings, even when made to highly leveraged companies (i.e. "leveraged loans"), to allow for an unlimited or near-unlimited amount of such receivables securitizations.

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 that makes it difficult to fully decouple the securitization financing from the operating company's credit. 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 require during a reorganization. It is, for example, possible to construct a securitization of assets for which the related cash-flows are in the form of lease, rent, licensing fees or other payments from the related company and where a sale of such asset would require a significant amount of time or a significant discount. However, in those circumstances, the payment obligations (in the form of lease or licensing fees or otherwise) by the operating company that obtained financing through such securitization structure and the potential adverse impact on such company's operations and enterprise value that would result from the sale of core assets away from the company, are such that other creditors would want stronger guardrails around such financings. Cashflow lenders typically include a number of covenants that are intended to protect them in...