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Demystifying Securitisation and Enforcement
Thursday 11 September 2008 Jonathan Lawrence, Partner, K&L Gates LLPjonathan.lawrence@klgates.com020 7360 8242
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Securitisation
A means of raising finance secured on the back of identifiable and predictable cash flows derived from a particular class of assets (such as rents, receivables, mortgages or operating properties).
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CMBS
Commercial Mortgage Backed Securitisation
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Trustee
Originator/Seller
SPVBorrower
SPVIssuer
SwapCounterparty
SPVBorrower Servicer Liquidity
Provider
InvestorsMortgages
Loans
Mortgages &
Loan Sale
Swap
Secs
Liquidity Loan
£ £
Typical CMBS deal
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Typical CMBS cashflows
IssuerSPV
BorrowersSPVs
Originator
Swap Counterparty
Investors
TenantTenant Tenant
CollectionAccount
IssuerAccount
£ mortgageP & I
£ mortgageP & I
£ noteP & I
Note PurchasePrice
£ Swap payment
rentrent
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Originator / Seller
Creates or acquires receivables e.g. banks making loans Offers lower cost of borrowing e.g. lower margin Remove receivables from balance sheet Redeploy capital
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Issuer
A special purpose vehicle (“SPV”) company Typically shares held by charitable trust i.e.
separate from all other participants Remote from Originator / Seller Established in low-tax or no-tax country e.g. Jersey,
Cayman Islands Issues securities
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Investors
Buy the securities issued by the SPV Receive interest and capital payments e.g. insurance companies, hedge funds, high net
worth individuals Consider yield, liquidity and exposure
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Arranger
Structure transaction Ensure maximum return available on assets Introduce appropriate counterparties Tranching / slicing the securities
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Trustee
Holds benefit of covenants and rights in securities on behalf of Investors
May also hold security over assets on behalf of Investors
Appointed by issuer under a Trust Deed which defines duties, roles and fees
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Servicer
Ensures underlying receivables, e.g. interest and principal repayments, continue to be collected
Issuer may initially perform function in-house or employ third party
Fees must be competitive to enable third party servicer to be appointed
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Swap counterparty
Takes on risks in securitisation in return for fee e.g. interest rate changes, currency exchange rate
movements Will be financial institution
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Liquidity provider
Often bank supplying loan facility to Issuer on a standby basis
Ensure adequate cashflow received by Issuer to meet its payment obligations to Investors
Guard against underlying Bs not paying or late paying
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Securities
Divided into different classes carrying differing rights to payment and differing rates of interest
Given credit rating by credit rating agency e.g. Moody’s, Fitch, Standard & Poor’s
S&P ratings: AAA (extremely strong capacity to pay interest and capital) to D (in default)
Analysis of default likelihood
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Worldwide CMBS issuance 2007 compared to 2008
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CMBS
Advantages:
Liquidity
Favourable financing rates
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CMBS
Disadvantages:
Lack of transparency or financial disclosure
Lack of borrower/property diversity
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UK Real Estate Finance Market - 2007
The banks took on a record level of commercial real estate debt - as much as £247bn
Gross lending totalled £83.7bn, the highest level recorded
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UK Real Estate Finance Market Perspective
2007 represented 3% per cent increase on 2006 levels, which was the lowest since the survey began in 1998, and much lower than the average annual growth of 24% between 1999 and 2006
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Enforcement
B unable to repay loan B has breached its covenants Enforcing security and insolvency procedures
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What is insolvency? When a corporate entity “is unable to pay its debts”
(Section 123 Insolvency Act 1986) Tests
Failure to pay a statutory demand Execution on a judgement is unsatisfied Unable to pay its debts as they fall due (“cash flow”
test) Value of assets less than liabilities (“balance sheet”
test) Threshold amount: £750
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Relevance to Lenders?
Likelihood of repayment of loans if B insolvent? Loan agreement contains safeguards: chiefly
through events of default and acceleration How does acceleration help L?
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Pre-insolvency: Protection for the Lender
Most importantly through security Fixed charge Floating charge
Security Trustee Effect? Enforcement and realisation 100% flawless?
No…
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Deficiencies with taking security
Floating charges and the “prescribed part” Statutory order of priority of proceeds Moratorium (with certain insolvency proceedings) Deficiencies in realisation
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Insolvency Procedures
Liquidation Administration Administrative receivership and fixed asset
receivers (e.g. LPA receiver) Compromise arrangements
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Background to the Enterprise Act 2002
Came into force on 15 September 2003 Promotion of “rescue culture” Abolition of Crown preference Creation of the prescribed part
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Receiverships, Administrations and Company Voluntary Arrangements in England and Wales registered at Companies House (figures from the Insolvency Service website)
Year Receivership Administrator In Administration CompanyAppointments Appointments (Enterprise Act Voluntary
2002) Arrangements
1997 1,837 196 : 6291998 1,713 338 : 4701999 1,618 440 : 4752000 1,595 438 : 5572001 1,914 698 : 5972002 1,541 643 : 6512003 1,261 497 247 7262004 864 1 1,601 5972005 590 4 2,257 6042006 588 0 3,560 5342007 477 2 2,327 399
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Insolvency Procedures: Administration Active businesses, significant assets, potential Statutory “purposes” brought in by Enterprise Act 2002
Rescue company as a going concern Achieve a better result than in liquidation Realise property for secured (or preferential) creditor
Moratorium Appointment is by notice (company, directors or QFC, who
has overriding powers) or by application to court (company, directors, all creditors)
First ranking QFC can appoint its own choice of administrator Administrator owes duties to all creditors
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Insolvency Procedures: Receivership The appointment of a person to administer (i.e. sell) specific
property charged to a creditor Administrative Receivership, now relatively rare – Enterprise Act
2002 limits this to security created before 15 September 2003 and certain other exceptions
Realise certain assets of B charged to appointor to repay indebtedness to appointor
No moratorium Appointment by a qualifying floating charge holder with a floating
charge over all, or substantially all, of the assets of the debtor company
Administrative receiver owes duties solely to appointor Blocks appointment of administrator LPA Receivership and Fixed Charge Receivership
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Administration vs Administrative Receivership
Moratorium Duty to act in the interests of all
creditors Deemed agent of the company Administrators must provide
proposals and information to all creditors
Lasts for 12 months unless extended
Administrator has wider statutory powers e.g. to dismiss/appoint directors call meetings
No Moratorium Main duty is to appointor (i.e. to
chargeholder) Also deemed to be the agent of
the company
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Insolvency Procedures: Liquidation
Terminal procedure Appointment? Shareholder resolution (voluntary
liquidation) or court order (compulsory liquidation) Realisation, distribution, dissolution Order of priorities Delay in enforcement
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Insolvency Procedures: Compromise Arrangements
Creditors agree procedure for B’s survival Two main types:
Scheme of arrangement Requires application to court for an order that a meeting of creditors is
summoned Need ¾ by value and simple majority of creditors to agree to the scheme Binding on all creditors once approved by the court
Company voluntary arrangement (CVA) 75% of creditors by value and simple majority of members to agree to the
arrangement Not binding on secured creditors unless they have agreed to the
arrangement Supervised by an insolvency practitioner
No automatic moratorium
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Administrative Receivership May be appointed by:
Holder of floating charge (created before 15 September 2003) over whole/substantially the whole of assets
Holder of floating charge (created after 15 September 2003) over whole/substantially the whole of assets where a statutory exception applies
Floating charge crystallises Control and management passes to administrative
receiver (“AR”)
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Administrative Receivership No moratorium triggered AR’s principal duty – realise property in order to repay
debt owing to appointer Often results in quick sale at price sufficient to discharge
secured creditor only Company then usually placed in liquidation
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Administration
Company’s assets can be reorganised or assets realised under the protection of a moratorium
Enterprise Act 2002 – floating charge holder prohibited from appointing an administrative receiver
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Administration
Moratorium only possible where one of the statutory purposes of administration is likely to be achieved rescuing the company as a going concern Achieving a better result for company’s creditors as a
whole Realising property to make distribution to one or
more secured or preferential creditors N.B. hierarchy
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Administration
Appointment of administrator By court - (company/company directors/creditor etc
can apply) Out of court – company/company directors/holder of
“qualifying floating charge” N.B. restrictions/notice Officer of the court Interests of ALL creditors
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LPA Receivership L with fixed charge over property can enforce by
appointing an LPA receiver LPA receiver will act as B’s agent to sell the
charged property/collect rental income for L’s account
Advantages: Alternative to L taking possession of property LPA receiver often an experienced property
professional Quicker and cheaper for L
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Liquidation
Assets of company realised and distributed to creditors in statutory order of priority
Company is then dissolved Compulsory liquidation (court order) OR Voluntary liquidation (shareholder resolution) Can be a slow process