Berisford Grey, Contributor
SECURITISATION IS essentially a financial engineering technique whereby a company issues a bond, which is collateralised by a particular asset or a pool of assets.
Typically, the assets are sold into a legal entity such as a trust or a Special Purpose Vehicle (SPV) that is bankruptcy-remote from the originator of the assets.
The SPV then issues a bond that is backed by the receivables or assets and passes through the bond proceeds to the originator as payment for the assets.
The cashflows generated by the assets held in the SPV is used to service the bond.
Transferring the assets to the SPV without recourse to the originator is termed "true sale" and once this is perfected, the credit risk of the assets are isolated from that of the originator.
Consequently, the credit rating of the resulting bond is independent of the credit rating of the originator and depends on the credit quality of the assets in the SPV.
These bonds are widely called asset-backed security (ABS) of which the most popular are: MBS (mortgage backed securities), CLO (collateralised loan obligations), CBO (collateralised bond obligation) and CDO (collateralised debt obligation).
BENEFIT OF SECURITISATION
The key benefits of securitisation to companies can be summarised as follows:
Lowering funding costs: One of the most important benefits of securitisation is that it lowers the funding cost for a project, an asset or that of a company because the rated bonds generally have a higher credit rating than the originating company.
Transfer credit risk to the capital markets and regulatory capital relief: Securitisation in recent years has become one of the most effective tools for banks to transfer their credit risk exposure to investors in the capital market.
Diversify funding sources: Securitisation allows companies to tap the capital market for new sources of funding, access investors with different risk appetite, as well as diversify its funding source from traditional sources such as commercial banks.
Matching funding or basis risk mitigation: Many organisations including banks have mismatch in the duration of their asset and liabilities. The risk associated with this situation is called basis risk and was one of the contributors to the Jamaica financial crisis in the early 1990s. Securitisation mitigates basis risk since the features of a securitised bond (the liability) can be customised to match the features (e.g. maturity) of the underlying collateral (the asset) that is being funded.
Debt management and converting of illiquidity assets into liquid: Securitisation offers off-balance sheet funding which can be used to pay off on balance sheet obligations, hence decreasing the debt-to-equity ratio of a company. Securitisation makes a firm's balance sheet more liquid by turning long-term assets such as mortgages, corporate loans, real estate or receivables into cash. With a more liquid balance sheet the company can grow its business more aggressively, e.g. a bank can increase mortgage origination.
SECURITISATION IN THE JAMAICAN CONTEXT
Though securitisation is the fastest growing means of tapping the international debt capital market, there has been only very limited use of securitisation in Jamaica.
The most recent securitisation transactions emanating from Jamaica were a USD 125 million transaction backed by credit card voucher payments and a USD 125 million bond collateralised by aluminium export, issued by National Commercial Bank Jamaica Ltd (NCB) and the Bauxite and Alumina Trading Company of Jamaica Ltd, respectively. The former transaction was issued in 2001 while the later was executed in 2000.
These transactions are indications that certain local companies can effectively use securitisation to finance their operations via the international, regional or local capital markets markets.
Some of the obstacles that must be overcome
Despite the potential opportunities identified above there are obvious obstacles to the development of securitisation as a financing alternative in Jamaica. These include:
Historically high interest and inflation rate volatility which causes difficulties in forecasting and establishing rates of return (real), reliable cashflow, hedging considerations, etc. Market conditions of this nature also implies that investors are adverse to medium to long tenor debt instruments.
Shortage of experience structurers and a small number of servicers and trustees and other counterparties that are necessary in a securitisation transaction.
Jamaica's low sovereign rating implies that structural considerations to pierce the sovereign ceiling in case of an international bond issue would have to be considered and this will make the transaction more costly.
Lack of high quality information on historical loan performance, property valuations, debtors' credit record, as well as the possibility that institutions might not be willing to furnish sufficient information on their portfolios for competitive reasons.
Non-existence of a specific local legal framework governing securitisation
The average funding needs of companies and projects are small thus making wide scale use of securitisation uneconomical.
Finally, unfamiliarity of local investors with highly structured debt products
Mr. Grey is an Associate Director at FirstCaribbean Capital Markets. The views expressed in this article are personal and not necessarily those of his employer.
