(The solid lines in the diagram depict cash flows while the broken lines indicate legal contractual relationships.)
Diagram 2.7 depicts a typical export receivables transaction (Dresdner Kleinwort Wasserstein, 2004:15). The exporter trade as normal with importers who make payments via their bankers to the exporter’s designated correspondent bank, which directs all payments to the foreign domiciled SPV’s bank account under control of the security trustee. Usually the structure is revolving and once investors’ interest is paid, the SPV purchases new receivables from the exporter. Towards the end of the transaction, payments are accumulated so as to repay the note principal.
Other types of international future flow receivables transactions include the securitisation of airline ticket receivables, international telephone settlement receivables, and financial future flows. A financial future flow securitisation is backed future cash flows to financial institutions, such as credit card receivables, trade payment rights, electronic transfers, cheque remittances, and workers’ remittances. Generally, financial institutions securitise the cash flows and arrange and facilitate these types of transactions (Albers et al., 2000:1).
7.8 Trade Receivables Securitisation
Trade receivables are obligations generated when one business sells goods or services to another business. They are unsecured claims on obligors, and, unlike an auto loan or equipment lease, there is no underlying hard asset that can be repossessed in the event of non-payment. Since there are seldom finance charges, there is a reduced incentive for obligors to pay on time, and therefore
Importer (Obligor) Exporter
(Originator) Foreign SPV Foreign investors
Importer’s bank in foreign country
Sale of receivables Coupon
Security trustee Payment Funding Purchase price Goods Payment Exporter’s bank in foreign country Payment Collections bank account controlled by trustee Security
delinquencies can be quite high. As trade receivables are generally unsecured obligations of obligors, a 100% loss severity often results if an obligor defaults (Dornhofer and Pilcer, 2002:3).
The legal structure used in trade receivable securitisations is comparable to that of other asset securitisation transactions. The receivables are sold to a bankruptcy-remote SPV, which issues asset- backed securities to fund the purchase. Like any securitisation, the structure of the transaction should be able to withstand the bankruptcy of the originator, servicer or any debtor. There are, however, certain key structural issues that are particularly relevant to trade receivable transactions (Agarwala et
al., 2001:2 -4).
− Short-Term Nature: The maturity of a trade receivable is a combination of the credit term given by the originator and the additional time taken by the debtor to pay the account. Due to the short- term nature of trade receivables, the securitisation thereof is revolving, with collections being used to purchase newly created receivables on a frequent basis.
− Seasonality: Typically, trade receivables will follow a recognisable seasonal trend. As a result, the securitisation will follow one of two patterns to cope with these fluctuations:
− the originator will sell all receivables generated, and receive a fluctuating amount of proceeds throughout the year; or
− the originator will segregate a pre-determined core level of receivables and receive a level amount of funding throughout the year.
− Fluctuating Asset Balances: If the originator chooses to sell all receivables generated, the trade receivables pool purchased by the SPV will vary in size throughout the year. The transaction structure will therefore have to take into account whether collections are sufficient to purchase new levels of receivables. Conversely, when collections are high but new receivables generated are at a low level, the structure must have the flexibility to return collections to the originator, while maintaining sufficient reserves to avoid reinvestment losses on the unutilised cash.
− Revolving Sales: Since trade receivable securitisations are structured as revolving transactions, given that receivables are generated on a daily or weekly basis, the transfer of the receivables to the SPV must be valid at each sale date. The governing law of the trade receivable is important in
determining how that transfer takes place and whether the receivable must be specifically identifiable in law.
− Non-Interest Bearing: Because trade receivables are non-interest bearing, there is no excess spread available to credit enhance the securitisation transaction. The SPV therefore purchases trade receivables from the originator at a discount to provide the required yield, and also credit enhancement through overcollateralisation (Dornhofer and Pilcer, 2002:4).
When determining the credit enhancement, usually via a reserve fund, that is required for a receivables transaction, it is necessary to undertake a trend analysis of how the receivables have performed historically, typically looking at monthly data for the previous three to five years. A default analysis and a dilution analysis of the portfolio to determine the credit enhancement that would be required for the transaction are also needed (Agarwala et al., 2001:3):
− Default Analysis: A technical default date is selected, after which the receivable is deemed to be in default. This typically may be set at 60 to 90 days past the original due date of the receivable. A historic analysis is conducted whereby the amount of receivables becoming defaulted in any month is compared to the sales levels in the month when the receivables were generated, and a loss ratio is determined.
− Dilution Analysis: Dilution occurs when a credit note is issued to a debtor to compensate for an incorrectly billed receivable or faulty goods. Once a credit note is issued, the value of the related trade receivable is reduced to zero. If that receivable has been sold to the securitisation SPV, there is a direct deduction in the expected cash flow. The levels of dilution experienced in a particular pool of receivables during the previous three to five years must therefore be analysed, and credit enhancement provided to cater for the dilution risk.
A critical element associated with the development of trade receivables as a securitisation asset class has been the use of a dynamic reserve mechanism, which is a formula-driven form of credit enhancement that constantly adjusts the amount held in the reserve fund in response to changes in the pool’s performance. From both the investors’ and the issuer’s perspective, the dynamic reserve is preferable to a static reserve. From the investors’ perspective, a dynamic reserve results in credit enhancement that automatically adjusts based on the performance of the underlying assets, taking into account changes in pool characteristics and protecting against rapid deterioration of the pool. From the issuer’s perspective, a dynamic reserve results in an enhancement formula that is more cost
effective than a static one. Agarwala et al., (2001:7) explain how the dynamic reserve, which may be subject to a minimum required reserve floor, is calculated.
Dynamic reserve = Loss reserve + dilution reserve + carrying cost reserve, where the:
Loss reserve = (A x B x C x D) + E, with:
A = Rating multiplier
B = Default ratio
C = Default horizon stress
D = Payment terms factor
E = Default volatility factor
Rating multiplier: The rating multiplier is used to add a multiple of stress commensurate with the
transaction’s rating level, to the other loss reserve components; for example:
Required rating Multiplier
AAA 2.5 AA 2.25 A 2.0
Table 2.2: Rating multipliers
Default ratio: The default ratio is the highest three-month rolling average of the receivables default
percentage.
Default horizon stress: The default horizon stress is calculated as the sum of the weighted-average
payment terms and the number of days delinquent used to approximate losses (e.g. 90 days past due date).
Payment terms factor: The payment terms factor is determined by the current weighted-average payment
terms divided by the original weighted-average payment terms.
Default volatility factor: The default volatility factor is the 12-month sample standard deviation of the
monthly default percentage multiplied by the Z value. A Z value of 1.96, therefore, suggests a confidence interval of 95% for all rating categories.
Dilution reserve = [(A x B) + E] x C x D, which is calculated on the same basis as the loss reserve by
substituting dilutions for defaults in the terms of the equation:
A = Rating multiplier
B = Dilution ratio
C = Dilution horizon stress
D = Payment terms factor
E = Dilution volatility factor
Carrying cost reserve: This is the reserve designed to cover interest and expenses during an amortisation
period.
7.9 Inventory Securitisation
Inventory securitisation originated in Europe in the year 2000 with the securitisation of inventories of luxury goods, specifically champagne and diamonds (Yomtov, 2002:1). Both have characteristics that maintain or increase in value over time, elements that can also be found in other asset classes that have a regulated market with generally high barriers to entry, liquidity and tradability of the inventory, and which constitute durable goods. These characteristics are not specific to luxury goods and could apply to other assets such as commodities. Perishable goods, however, are not suitable for inventory securitisation. The inventory could be either finished or semi-finished products. Inventory securitisation can be implemented through a secured loan structure or a true sale structure:
7.9.1 Secured Loan Structure
In terms of a secured loan structure a bank initially grants a loan secured by a pledge24 over the inventory to an originator. The bank sells the secured loan, together with the pledge as security, to a bankruptcy-remote SPV. The SPV issues notes to fund the purchase of the secured loan. Interest and principal repayments on the loan fund the note coupon and note amortisation. The SPV pledges all its assets, being the secured loan and the pledge over the inventory, to a security trustee who provides a guarantee to the investors.