HMRC internal manual

Corporate Finance Manual

Understanding corporate finance: raising finance: securitisation

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Securitisation

Instead of selling its debt assets, a company could generate further funds from the debt assets without selling them outright.

Where a company has debt assets which are generating a flow of income, the company could use this flow of income to back the issue of securities.

A credit card company has a continuous flow of income - the payments from credit card holders. If it wants to raise further funds it could similarly use its credit card receivables to back securities issued into the market, meeting the interest and capital repayments that need to make on these new securities with the payments coming from the credit card holders. In cash flow terms, the credit card company has acquired new funds, but will be using the income from its old lending to fund the new borrowing.

In these arrangements, it is normal for the assets concerned or the rights to the cash flow from the receivables to be assigned by the “originating company” to a special purpose vehicle (‘SPV’) that issues securities into the market backed by the underlying assets or receivables. The SPV is more often not a member of the issuer’s group but an entity whose shares are held in trust. The essence of the arrangements is contractual and the documentation is usually complex. The recourse of the investor is generally restricted to the securitised assets or cash flows; it does not usually have direct rights over the assets of the originator.

Mortgage lenders have in the past been important originators in securitisations and a mortgage securitisation is described below.

The lender holds large numbers of debt assets which produce a steady stream of income. While they produce income the repayment term may mean that there will be a long wait before further capital comes into the mortgage company to enable it to make further loans. (In addition banking regulations restrict the amount a company can lend by reference to its capital base.) It became common for mortgage companies to bundle up large numbers of individual residential mortgages. These bundles of mortgages are then sold to a special purpose vehicle (SPV) which issued securities to fund this purchase. The SPV meets the interest and capital repayments on its own borrowings by using the interest and capital repayments received on the residential mortgages. As a result:

  • new money has come to the mortgage lender from the transfer of the loans
  • the SPV holds the mortgages and uses the income from the loans to fund its own borrowing
  • the borrowings of the SPV will be secured on the assets and therefore will carry a lower rate of interest than unsecured borrowings.
  • the possible risks in the original mortgage lending are removed from the mortgage lender
  • the mortgage company has reduced its lending exposure and is thus permitted by banking regulations to make further loans.

The mortgages, some of which may have been likely to default, have been transformed into tradable securities.

Securitisation has not been without its commercial problems. Usually the debt issued has limited recourse only to the securitised assets. Whilst this gives the originator some protection from potential creditors, this also has the effect that, in difficult financial conditions, a company may find that it is unable to securitise further assets, leading to major liquidity problems and even a total collapse of the originator’s business. This was a significant issue in the 2008 financial crisis.

Securitisation is not limited to debts. Wherever there is a fairly certain stream of income, it may be possible to securitise it. So, a landlord with a stream of rental income might be able to issue marketable securities backed by the income stream from the rented properties. A pop star about to embark on a world tour might be able to issue marketable securities, backed by the anticipated income stream from the ticket sales for the tour.

CFM72000 has more on the commercial background to securitisation and on the special tax rules that apply to it.