For a number of years securitisation has provided an innovative means for certain companies to raise finance in a cost-effective manner.  Its origins date back to the securitisation by US mortgage lenders of their loan books but in recent years all manner of assets have been securitised to raise capital.  These include credit card receivables, healthcare receivables, royalties and even media revenues.  Virtually any
business which has an asset or pool of assets which can produce a recurring income stream may be a suitable candidate for securitisation. 

Traditionally, a securitisation was in respect of a particular class of assets of the business in question, for example, the rental income from the business’s investment property portfolio or the royalty income from its licensed intellectual property rights.  However, in the last few years the traditional boundaries of securitisation have been stretched.  Instead of just a specific pool of assets being securitised some companies have successfully securitised the cashflows of an entire business unit.  This article provides an overview of the so-called “whole business securitisation” and contrasts it with a traditional securitisation. 

What are the benefits that a whole business securitisation can offer? 

In contrast to a traditional securitisation, the borrowing company does not have to sell the assets securitised to a special purpose vehicle and therefore is able to retain operational control.  The whose business securitisation is particularly attractive for a business which has significant value attaching to assets which it is unable to reflect on its balance sheet, such as brands or other intellectual property rights.  A whole business securitisation enables such a business to realise the value of those assets in a way which would not be possible using more traditional financing methods.  As is the case with the traditional securitisation, the whole business securitisation allows funds to be raised in a cost-competitive manner through the capital markets and provides access for the borrowing company to a potentially wider base of institutional investors.  Whole business securitisation has been used successfully by a number of UK businesses with one of the first being the London City Airport in 1999. 

How does a whole business securitisation differ from a traditional securitisation? 

In the case of a traditional securitisation, the borrowing company sells a pool of assets to a newly established special purpose vehicle (SPV) which pays for the assets by issuing fixed or variable rate interest-bearing bonds to investors through the capital markets.  The SPV finances the payment of principal and interest under the bonds from the income stream derived from the pool of assets purchased from the borrowing
company.  The SPV will also normally grant charges over the pool of assets securitised in favour of a security trustee acting on behalf of the investors. 

In a traditional securitisation the borrowing company, by selling the pool of assets to the SPV, removes those assets from its balance sheet.  For both legal and tax reasons the SPV is normally located in an offshore jurisdiction.  The Cayman Islands is the domicile of choice for most securitisations and structured finance transactions.  This is because of the breadth and depth of the professional infrastructure, particularly the law firms, and the significant experience in this area, thereby providing the critical speed of response necessary for transactions of this nature. The SPV is a special purpose vehicle in the sense that it is established for the sole purpose of acquiring the pool
of assets from the borrowing company and issuing bonds to the investors. 

It is important in a traditional securitisation that the SPV is set up as an orphan company by which is meant that it is not part of the borrowing company’s corporate group.  This is achieved by control of the SPV being vested in either an offshore charitable trust or an offshore non-charitable purpose trust, again usually in the Cayman Islands.  The SPV is also structured in such a way as to make it bankruptcy remote and therefore ensure that the pool of assets is not placed at risk by an insolvency of the SPV or of the borrowing company. 

The key feature of a traditional securitisation is therefore a sale of the assets securitised by the borrowing company.  As mentioned above, this is not the case with a whole business securitisation.  In this case, the securitisation takes the form of a secured loan structure and there is no sale of assets to the SPV.  Instead of purchasing the pool of assets, the SPV makes a loan to the borrowing company and takes security for that loan over the pool of assets retained by the borrowing company.  The SPV funds the loan to the borrowing company by issuing fixed or variable rate interest-bearing bonds to investors through the capital markets.  These bonds are also secured by the SPV creating a charge over all its assets in favour of a security trustee on behalf of the investors.  The only material asset of the SPV will be its right to receive principal and interest under its loan to the borrowing company.  Generally, the loan is made in a series of tranches corresponding to each series of the bond issue offered by the SPV.  Most whole business securitisations (as is the case with a traditional
securitisation) will utilise both liquidity enhancement and credit enhancement. The bonds are always rated by a rating agency such asStandard & Poors and Moody’s for  both regulatory and marketing reasons. A securitisation can usually be structured in such a way as to ensure that a high credit rating can be achieved. 

In contrast to a traditional securitisation, in the case of a whole business securitisation, the SPV will not be an orphan company but will in fact be a member of the borrowing company’s corporate group.  In addition, the SPV will, in the case of securitisation involving a UK borrower, commonly be UK resident for tax purposes.  This is driven by UK tax considerations which are beyond the scope of this article.  Even though the SPV will usually be UK tax resident it is still normally incorporated in the Cayman Islands or another suitable offshore jurisdiction.  The principal reason for this is to avoid the problems posed by the financial assistance prohibitions of the UK Companies Act in the case of a whole business securitisation. 

It will therefore be clear that there are certain fundamental structural differences between the two forms of securitisation, notably in the case of the whole business securitisation, first the absence of a sale of the assets to be securitised but instead a secured loan structure and second the corporate grouping of the SPV and the borrowing company. 

Investing in a whole business securitisation 

As explained above, the commercial nature of the two forms of securitisation are fundamentally different.  In the traditional securitisation a discrete pool of assets is the subject matter of the securitisation. The management of those assets should generally be straightforward involving the collection and enforcement of a receivables ledger.  A whole business securitisation involves the securitisation of not just a discrete pool of assets but of the income stream of an entire company or business unit.  The management of a business as compared to a specific pool of assets is obviously far more complex.  As a result, investors in the case of a whole business securitisation have to acknowledge that the covenants imposed on the borrowing company need to allow sufficient flexibility for management with regard to operational and cashflow matters in order that the business can function properly.  However, this is not to suggest that the covenants will not include robust provisions preventing management from straying beyond business parameters agreed at the outset.  Because of the more
flexible approach that has to be adopted a whole business securitisation is unlikely to achieve a triple A rating from the rating agencies. 

A key issue for the investor in a whole business securitisation is to ensure that if the borrowing company were to become insolvent the assets securitised continue to be managed for the term of the bonds by an administrative receiver so that the income streams necessary to service payment of principal and interest under the bonds continue to be generated. In other words, the integrity of the income generating
assets should not be prejudiced or put at risk by any financial difficulties of the borrowing company.  Provision for the appointment of an administrative receiver will be contained in the loan documentation. 

Is a whole business securitisation a suitable financing method for any business? 

The simple answer is, no.   It will only be appropriate where the business can demonstrate stable and predictable income streams.  As mentioned above, it is an essential requirement that a suitable credit rating for the structure is obtained. The rating agencies will analyse carefully the ability of the business to generate consistent and sustained revenues in a variety of economic climates.  For that reason, a whole business securitisation will be of particular interest to businesses which enjoy a particularly strong position in their market and where competitive threat is not acute (for example, regulated industries where the entry of new players is difficult) and businesses which are not materially affected by a general recession (for example bookmakers).  Particular UK examples to date are businesses involved in motorway
service areas, residential care homes, theatres and ferry operators. 

During its relatively short lifespan to date the securitisation concept has shown itself to be a highly adaptable and flexible financial method.  Nowadays the common observation seems to be “if it can generate a steady income stream, it can be securitised.”  Whole business securitisation is merely a further stretching of the boundaries of securitisation and is likely to become more common as businesses with
operations suitable for securitisation look for alternative, cost effective means to raise capital. The year 2001 has brought with it a US down market, and one of the results of this has been that new traditional equity funds have diminished in number, with a corresponding increase in the number of new hedge funds being initiated.  Many are start-ups as money managers leave large institutions and see an opportunity to capitalize on non-traditional investment techniques.
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Solomon Harris
Attorneys-at-Law
P.O. Box 1990 , 
Barclays House
George Town, 
Grand Cayman, 
Cayman Islands 

Phone:  345 949 0488 
Fax:  345 949 0364 
E-mail: solomonharris@candw.ky
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