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