Notes on Securitization

Part 1
These notes will be a series of short articles on “securitization” as a
form of financing. The purpose is to familiarize my readers with this manner
of raising funds through a “securitization transaction”, which really is a
cluster of related transactions.
As a way of sourcing funds from the capital market, securitization has
its many benefits, but securitization has not flourished in the Philippines,
even if the Securitization Act has been in place since 2004. So the intention
here is for more people to get familiar with the securitization concept, and
understand how “securitized products” work as investment vehicles.
Expectedly, some are more familiar and some are less familiar with
securitization, but the idea is to make the word a regular part of our common
business vocabulary.
The Securitization Act of 2004 (Republic Act 9267) provides the legal
and regulatory framework for securitization to implement “the policy of the
State to promote the development of the capital market by supporting
securitization”. The law then defines: “Securitization means the process by
which assets are sold on a without-recourse basis by the Seller to a Special
Purpose Entity (SPE) and the issuance of asset-backed securities (ABS) by
the SPE which depend, for their payment, on the cash flow from the assets
sold and in accordance with the Plan [Section 3 (a) of the Act]”.
The securitization transaction starts with an Originator, a person or
entity that is an original obligee, which lends to an original obligor. The
originator would typically be an entity that has generated loans or receivables
or other similar financial assets with an expected future cash-payment stream.
For example, the originator could be a property developer (with receivables
from its installment sale of properties), or a bank (with loan receivables), or a
car dealer (with receivables from its installment sales of cars), or a credit-
card company (with its receivables from credit -card holders).
To pursue the securitization transaction, the originator would sell its
receivables or financial assets to a special purpose entity (SPE) or special
purpose vehicle (SPV), which must be a “true and absolute sale of assets.”
 This SPE or SPV, which is a juridical entity or a duly licensed trust
entity, is created solely for the purpose of securitization.
The SPE/SPV, in turn, issues securities to investors, who purchase
these securities on the promise by the SPE/SPV that these will be paid back
with some return (or interest). The SPE’s promise is backed by the
receivables or financial assets which are the source of the income streams
that are used to pay the obligations/future payments to the investors. In other
words, the originator’s receivables—sold to the SPE—have been
transformed to securities obligations of the SPE, now held by different
investors. The receivables have been securitized.”
In the meantime, the originator has received the payment for its sale of
receivables/financial assets to the SPE. The originator has for now “cashed
in” its receivables/financial assets, from the sale process of the “securitized”
financial assets, through the “structure” of an SPE. Securitization is,
therefore, referred to sometimes as “structured finance”.
An important feature of securitization is that the sale of the financial
assets by the originator to the SPE must be a true and absolute sale of assets.
This is meant to protect the investors of the securitization issue, who depend
on the income streams from the pool of financial assets transferred to the
SPE. The creditors of the originator should not have any access to the
financial assets transferred to the SPE, in case such creditors wish to seek
other assets of the originator for payment to themselves, as when bankruptcy
of the originator occurs. The industry calls this a “bankruptcy remote”
requirement.
This, then, is the basic description of a securitization transaction and
the main participants: (a) an original transaction creating a debt obligation
generating future income streams, initiated by an entity (the original obligee),
aptly called the Originator; (b) an SPE/SPV to whom the financial assets
(which generate the future income streams) are sold/transferred by the
originator, and this SPE/SPV issuing and selling securities against/backed by
these financial assets; and (c) the Investors who purchase these so-called
asset-backed securities.
But there are, of course, other participants to the securitization
transaction. They will be described in the subsequent articles.
Part 2
The pool of financial assets (receivables) transferred to the special-
purpose entity (SPE) or special-purpose vehicle (SPV), generates future
streams of income. This income is used to pay for the securities issued by
the SPE/SPV to investors who purchase or invest in these securities (the
securitized product), and who look forward to receiving back their
investment plus the promised interest or returns.
It is the servicer who performs the general service of making sure the
investors are paid as promised. As the law says, “servicer refers to the entity
designated by the SPE to collect and record payments received on the assets,
to remit such collections to the SPE, and perform such other services as may
be specifically required by the SPE.” (Section 3 [K] These “other services”
include all those administrative functions related to the collection of the
receivables generated by the asset pool, their remittance to the SPE, the
payment by the SPE of the amounts due to investors of the securitized issues
on time and in due course, and the accounting for and reporting of all these
administrative transactions. It’s an essential service.
Many times, the originator entity, which initiated the creation of the
original obligation generating the receivables, is designated as the servicer
because of its familiarity with how the receivables were generated and with
the obligors from whom collections are to be made. But if this is the
arrangement, it is clear that the originator is acting as servicer only and
specifically, and has neither ownership nor claim over such receivables or
collections. If we must recall, the originator in a securitization transaction
has sold financial assets, i.e., the receivables to the SPE that now owns the
pool of assets.
The SPE in a securitization transaction can be a special-purpose trust
(SPT) or a special-purpose corporation (SPC). An SPC is a stock corporation
created solely for the purpose of securitization and to which the
originator/seller makes a true and absolute sale. More frequently, the option
chosen for an SPE is a special-purpose trust (SPT) that is administered by an
entity, usually a bank, duly licensed to perform trust functions under the
general banking law. This is a simpler option, and need not be registered
separately with the Securities Exchange Commission (SEC). In this case, the
Bangko Sentral ng Pilipinas is the regulatory authority that assures the proper
fulfillment of the requirements of the trust/fiduciary responsibilities.
 An important thing to note is that the SPT is a trust constituted for the
sole purpose of purchasing assets, owning and holding the asset pool for a
definite period until all of the asset-backed securities (ABS) issued for that
particular asset pool have been paid.
So now we have identified the major participants in a securitization
transaction: the originator/seller; the SPE, also known as the SPV; and the
servicer.
The SPE is also known as the issuer when it issues the asset-backed
securities (ABS) to the investors through the capital market.
But a major participant in securitization is the financial advisor who
usually effectively initiates the transaction by explaining to the
originator/seller the benefits of securitization and advises on the intricacies of
preparing for and executing the securitization process. Most important, the
financial advisor advises on the “structure” of the securitization to make the
issue acceptable and saleable to prospective investors. When the financial
advisor, at the same time, “guarantees on a firm commitment and/or declared
on best effort basis the distribution and sale of ABS issued by an SPE”, he
assumes the role of underwriter. In the Philippines this role is usually
assumed by an accredited investment house.
Still another participant in securitization transactions is the credit-rating
agency (CRA). A credit rating is an objective, independent third-party credit
opinion on the probability of default of a securitization issue, using an
established, publicized methodology that grades the creditworthiness
according to an established, publicized rating scale. The CRA must be duly
accredited by the SEC to be allowed to issue credit ratings.
Significant to note: “No ABS shall be issued unless such ABS has been
rated by a duly accredited credit rating agency.”(Article VI, Section 43, The
Securitization Act of 2004).