CFM72090 - Other tax rules on corporate finance: securitisation: background: SPVs and other common features

Other common features

The diagram at CFM72030 shows the basic principles of the securitisation process. The actual features of a securitisation are generally more complex. The other main features are briefly mentioned below.

Other special purpose vehicles

There is often more than one SPV involved in a securitisation. For instance, an Originator may wish to build up over a period of time a ‘pre-packaged’ portfolio of assets which meet the criteria for eventual securitisation, so the assets will be placed in a bank-funded ‘warehouse company’ over that period. Such companies will all be conduits that enable the securitisation to occur, and like the issuer SPV, they will invariably be designed to ensure that each retains only a nominal residual profit in respect of the process.

Derivatives

Securitisations often involve the use of derivatives. The most common derivatives used are interest rate and/or currency swaps. These are needed to cope with situations, such as where the underlying financial assets yield fixed rate interest, but the securities issued are at floating rate. The purpose of the swaps is to ensure that the income streams from the securitised assets are matched with the SPV’s funding costs (that is, hedging).

Credit enhancement

Credit enhancement distinguishes most securitisations from conventional corporate bonds. Its purpose is to match the credit rating of the bonds to the investor appetite in the particular market in which the bonds are being issued. In other words, the securitisation will be structured in such a way to appeal to a certain class, or classes, of investors. The credit rating of a securitisation bond issue will vary, as will the credit rating of different tranches of debt.

Credit enhancement provides an additional source of funds for the SPV issuer to draw on, to ensure that it can always meet its obligations to the third party investors, and thus potentially improves the rating of the bond and lowers the related finance cost. There are a variety of mechanisms for credit enhancement, such as reserve funds built up out of surplus income from the securitised assets, external letters of credit; guarantees, subordinated tranches of the bonds issued by the SPV etc.

In almost all securitisations, some degree of credit enhancement is provided by over-collateralisation, that is by the SPV holding more assets than it is expected to need solely in order to service its funding and other costs, so that the surplus cashflows are available to meet any losses that may arise and otherwise to be returned to the originator.

Profit extraction

In most securitisations, it is expected that the SPV will receive more income than it needs from the securitised assets to meet its liabilities to the investors and its own nominal profit entitlement. Any such surplus income will be returned to the originator, which is consistent with the securitisation being essentially a method of funding rather than a sale of assets, from the Originator’s perspective.

There are a number of mechanisms to return surplus income to the originator, such as deferred purchase consideration, amortised premiums, variable service and management fees, super-interest on loans, parallel loans, swaps, and ‘seller beneficiary’ interests under Receivables Trusts (CFM72050). The choice will depend on a number of factors including nature of the assets in the pool, type of credit enhancement, timing and accounting treatment of the payments.