A company can issue bonds to investors secured on the time to come profits incredible to arise from part of its existing life business.
When a pool of financial assets (such as car finance, home or industrial mortgages, corporate loans,royalties, leases, non-performing receivables, and contractually pledged operating revenues) are structured and transferred to a 'special purpose vehicle or entity'(Spv or Spe) it is known as a Securitisation transaction.
Generally, most securitisation transactions involve a two tier transaction in which the creator of the assets to be securitised transfers such assets to a wholly-owned Spv.In turn the Spv transfers or pledges such assets to an additional one entity, which issues rated securities in the capital markets that are collaterised by such assets. This second tier entity can be an additional one Spv or a multi-seller industrial paper conduit and can provide funding by issuing medium term notes or industrial paper.
Types of Securitisation transaction
Usually with securitisation transactions, the replacement of proprietary to assets can take one of two main forms, true sale or synthetic securitisation.
1. True Sale securitisation
In a true Sale securitisation, the creator (for instance a bank selling mortgages) sells the assets to the Issuer. The assets are serviced by the servicer who happens to be the Originator, with respect to say the mortgages sold to the Issuer(i.e.) and the creator continues to regain the necessary and interest from the borrowers on behalf of the issuer on such mortgages and see to all default mortgages as well.
The significance of true sale is that the first-tier sale of the assets from the creator to the Spv is structured as a "true sale" such that the assets are removed from the originator's bankruptcy or insolvency estate and cannot be recaptured by any trustee. Thus, the issuers are commonly incorporated as insolvency remote entities; and may not engage into any transactions other than those necessary to succeed the securitisation what is known as "limited purpose-concept" by which virtue the Spv will not be allowed to issue any added debt or enter into mergers or similar transaction.
The transactions can be conducted as conduit, whereby the purchaser purchases and securitises assets from a estimate of separate originators. This is done by straight through refinancing by issuing industrial paper into the capital market. Banks commonly engage in conduits by arranging securitisation for their clients, or standalone where the purchaser only purchases assets and issues as asset-backed securities in the context of a single securitisation transaction. No industrial paper is issued.
It must be said here that, the legal characteristics and economic substance of the replacement will be the customary determining factors as whether the transaction is a true sale not a loan.
2. Synthetic Securitisation
In a synthetic securitisation transaction the creator does not sell any assets to the Issuer and therefore does not regain any funding or liquidity under the transaction. The creator enters into a reputation swap with the issuer in respect of an asset or pool of assets, transferring the originator's risk to the issuers. Under this contract, the issuer pays the creator an estimate equal to any reputation losses suffered in respect of such assets or pool of assets. The Issuer's (Spv) earnings streams in a synthetic transactions are the fixed amounts paid by the creator under the reputation default swap and interest amounts received on the collateral. These transactions are typically undertaken to replacement reputation risk and to sacrifice regulatory capital requirements.
3. "Whole-Business" Securitisation
Apart from the main two forms above," whole business" securitisation is sometimes used to finance a stake in private or management buy out of the Originator.
This type of securitisation originated in the United Kingdom. It involves the provision of a secured loan from an Spv to the relevant Originator. The Spv issues bonds into the capital markets and lends the proceeds to the Originator. The creator services its obligations under the loan straight through the profits generated by its business. The creator grants security over most of its assets in favour of the investors. In terms of cash flow, there are three most common types of securitisation transactions:
Collaterised Debt- this is similar to customary asset-based borrowing. The debt instrument need not match the cash flow configure division of any of the assets pledged.
Pass-Through-this is the simplest way to securitise assets with a quarterly cash flow, by selling participation in the pool of assets i.e. An proprietary interest in the basal assets so that necessary and interest in the basal assets collected are given to the security holders;
Pay-Through debt instrument-this is borrowing instrument and not participation. Investors in a pay-through bond are not direct owners of the basal assets but naturally investors.
One necessary thing with Spv is that unlike with ordinary operating companies, whose charters typically provide for maximum flexibility, the charters of Spvs provide for the entity to have only those powers that are necessary to accomplish the purpose of the securitisation transaction. Thus the Spv in a securitisation will have the power only to purchase the single receivables contemplated by the transaction, issue the related capital shop securities, and make the payments on them and so on.
The surmise for these restrictions is understanding to keep the risks of the Spv's own bankruptcy as narrow as possible: the smaller the range of the entity's activities, the smaller the risk of a bankruptcy.
Securitisation is based on the basal assets being securitised. Rating agencies spend a lot of time to estimate the reputation risk for all basal assets in Securitisation transaction. Other risks considered is the prepayment risk.-the risk that a part of the assets in the basal pool may be repaid early. Payments and settlements in Ghana are considered to be good. Prepayments can sacrifice the weighted median life of the pool and as a succeed expose investors to necessary uncertainty over time to come cash flows.This can be mitigated by separating the cost of the necessary and interest or the conversion of fixed rate returns to floating rate.
Third Party Risk
Collateral is not the only leading factor in structured finance transaction. A servicer risk would be particularly strong in Ghana. This is the case that the variety of payments, distribution to investors and execution tracking will fail. Because in Ghana reputation rating is not popular.
In a Securitisation or structured finance transaction, a lot of third parties are complicated who must fulfill their assorted responsibilities to make the transaction go on successfully ."Time is money", it is said. Other third party risks comprise trustee managing succession of servicing in case of servicer default, notifying investors and rating agencies of breaches and defaults, and holding cash payments to prevent servicer misuse of cash flows; boss responsible to balance the competing interest within a transaction.
Financial Risks (Interest Rate Risks, Foreign replacement Rate Risks, Devaluation Risk)
Financial risks commonly cover interest rates, foreign replacement rate & availability, currency and inflation risks. Inflation no ifs ands or buts affects the creator in a Securitisation transaction for reasons like raising the cost of the transaction which can delay its completion. Some governments are also sceptical about foreign venture in their country and sometimes prevent the repatriation of funds by foreigners outside. Devaluation and interest rate just like inflation can also sway Securitisation negatively especially when provision has not been made in the transaction deal for that. Russia is a good example. International funds are often cheaper than local ones, but given the fact that the cost to receivables is sold locally, and paid in local currency, using foreign loans creates exposure to the risk of currency depreciation.
Political Risk
Because cross-border transactions are conducted such that assets create cash flows in the domestic currency while the securities backed by those assets are denominated in foreign currency, there is the risk that regardless of the reputation compel of the basal assets, the issuer might default on the payment. The following relevant known political risks are identified:
Expropriation risk:
The act of taking something from its owner for collective use. This involves the act where a government takes over assets or accounts of local parties in the event of financial crisis.
Nationalisation:
Transfer of company from private to state ownership. This is not commonly experienced in the West as in South America and Africa. In relation to Ghana's political situation, this is not envisaged.
Convertibility risk:
This is the risk that in a national crisis, the government might levy a moratorium on all foreign currency debts because of a financial crisis in the country.
Change of law:
The ruling government can turn the laws overnight and this can sway a structured finance. Sometimes for economic and political reasons, tax laws are enacted which might not be to the advantage of the creator in terms of the cost increase to inevitable elements which could increase the purchase price of the stock on completion and can jeopardise the securitisation transaction which must be made cheaper if it is to succeed. For example an increase in the fuel tax can sway the whole transaction because tax neutrality is notable to securitisation transaction.
Legal & Documentation Risks
Following turn of law in political risk discussed above, inherent legal risks to a Securitisation transaction comprise inadequate legal, legislative, and regulatory framework on tax, financial and money shop & securities. Sometimes the case and administrative laws in the country involved are not developed. These issues are of great concern to investors and for that matter the creator will have to deal with this risk.
In asset-backed securities(Abs),however, the legal and documentation risks comprise uncertainty surrounding the replacement of assets from the seller/originator to the Spv (i.e. 'true sale') the need to ensure that holders of Abs receive full control over the basal assets; the bankruptcy remoteness of the issuing Spv.
This means reviewing all the covenants in relation to the disjunction of the Spv from the seller; the legal roles of the trustee and servicer over all relevant jurisdiction including Ghana to curtail operational and execution risks related with the cost and receipts of transactions.
Because of the changes in deal structures and inspecting the legal and financial framework of Ghana, legal and documentation risk will be very high.
Regulatory Risk
The risk that originators and other lenders will not be treated fairly. There should be a laid down regulation on profit-sharing, regulations on the rated instruments and most importantly what structure should the Spv that issues the securities be.
Liability structure Risk
This risk is the issues related in which with the tranching or slicing of securities brings conflicting interests which if not checked may disrupt the acceptable distribution of receivables to end-investors. The key to structured finance transaction is the cost waterfall which set the covenants for paying the interests and necessary and budget of losses among investors. This can be sorted with over-collateralisaton tests which ensure the existence of enough collateral in the basal pool of assets to cover necessary payments; and interest coverage test to ensure that there are enough interest proceeds to cover interest payments to note holders.
Levels of Risks
Rating agencies commonly would have to correlate the totality of the risks envisaged in each transaction before assigning a rating to the security. Thus the inherent for any shortfalls in receivables and the adequacy of any reputation enhancement to ensure that the end-investors are assigned the right level of default risk. Cross-border transactions for example require specific prognosis with regard to the inherent limit that could apply to the rating of the notes because of the inherent default of a government and the inherent application of a moratorium by a government in times of crisis.
Benefits of Securitisation
The use of Securitisation is not wee to one specific asset or earnings flow. The application stretches beyond the existing bank-funding products and equity funding arrangements. The challenge is the coming with which a Securitisation is considered and the capability to part the impact thereof on the time to come of the business. This stems from the fact that Securitisation is cash flow driven and not earnings-improvement driven.
Generally, securitisation can offer the following benefits and we would later analyse to see whether or not it would advantage Ghana.
Efficient passage to capital markets: when transactions are for example structured with reputation ratings by a recognised reputation rating department on most debts, pricing is not tied to the reputation rating of the originator. This is very necessary if the creator is not reputation worthy.
Limitation on issuer-specific's capability to raise capital is reduced: securitisations can minimise an entity's inability to raise capital because capital raised under securitisation becomes a function of the terms, reputation capability or rating, prepayment assumptions and prevailing shop conditions.
Illiquid assets are converted to cash: Securitisation makes it easier to combine assets which otherwise could not be sold on their own, to create a diversified collateral pool against which debt can be issued.
Raise capital to create added assets: capital can quickly be raised such as releasing long-term capital for any allowable purposes like completing capital task and purchasing added assets.
Match assets and liabilities to minimise risks: a well-structured securitisation transaction could create near perfect matching of term and cash flow locking in an interest rate spread in the middle of that earned on the assets and that paid on the debt. This means that Ghanaian company entities can raise enough funds without necessarily providing collateral for security because of the replacement of risk.
Raise capital without prospectus-type disclosure: A conduit securitisation transaction allows one to raise capital without disclosure of sensitive facts of any sort; in fact facts is kept confidential.
Complete mergers and acquisitions, & divestitures more efficiently: Assets can be combined or divested efficiently under Securitisation transaction. By dividing assets into smaller parts against which debt is issued it can come to be inherent to do away with other company entities which are no longer profitable.
Transfer risk to third parties: Financial risk on loans and other contractual obligations by customers can be partially transferred to investors under securitisations.
More funding beyond bank lending: A structured Securitisation transaction enables the creator to raise funding while maintaining the right to the behalf on the receivables. However, these funds will not be related to its reputation rating but rather the reputation rating is on the extra purpose entity created for the Securitisation transaction. By incorporating an offshore Spe, many businesses in Ghana with poor reputation rating might potentially raise funds for any purpose.
The wide succeed of securitisation of bank loans and reputation aggregates is likely to be a allowance in the level of reputation prolongation by the monetary sector and a allowance of similar magnitude in the M3 money supply. This is to say that the banking sector closes its balance sheet by setting off some loans against some M3 deposits.However,the customary borrowers still have obligations but to the Spv not a bank and institutional investors still own assets which are now tradable securities not M3 deposits.
Structure of Ghana's Financial ideas
The financial ideas comprises of
1. Bank of Ghana
I. Savings and loans bank
Ii. Discount houses
Iii. Finance houses
Iv. Leasing companies
V. Forex Bureaux
2. Securities and replacement Commission
I. Stock Exchange
Ii. Brokerage firms
Iii. Investment management companies
Iv. Trustees and Custodians
3. National insurance Commission
I. Insurance Companies
Ii. Insurance Brokers
Iii. Reinsurance Companies
The banking ideas in Ghana is structured to serve the needs of all citizens as much as possible. At the end of 2005,the banking industry was made up of Merchant banks, Universal banks, industrial banks, amelioration Banks,Arb Apex banks, and Rural Banks; with a total increase of its assets by 17.62%.
The Non-Banking Financial institutions (Nbfi) sector is made up of Savings and Loans Companies, allowance Houses, Finance companies and Leasing Companies. Total assets for the Non-Banking Financial Institutions also grew by 47.98% which were generally triggered by loans and advances, investments, other assets and fixed assets. The allowance houses hold 82.61% of the wide total investments of the Nbfi sector.
The new Banking Law, Act 673, which became operational in 2005 with its higher Capital Adequacy Ratio requirements, new sanctions regime, as well as higher governance standards ensured that banks remained commonly compliant with regulatory and prudential requirements.
The Securities shop in Ghana
African stock exchanges face a estimate of challenges before they could enter a new phase of rapid growth. The most necessary issue is to eliminate existing impediments to institutional developments. These comprise a wider dissemination of facts in these markets, the implementation of robust electronic trading systems and the adoption of central depository systems. Ghana has since established a central depository ideas in November, 2004.
The Ghana securities shop is regulated by the Sec. The Ghana Stock replacement is underdeveloped with reference to exchanges in Us, Europe and even South Africa. South Africa for example has shop capitalisation of 0 billion, one of the largest in the world with Ghana's shop capitalisation of billion.
Considering that Ghana has had just one Securitisation transaction -structured finance-with no records for research, and the position of Ghana's macro-economic situation, it was found expedient to look at the Securitisation transaction in South Africa. Even though Securitisation transaction is still at an early stage of amelioration in South Africa, it has grown rapidly in modern years and it would be a suitable "benchmark" after which to carve Ghana's Securitisation transaction.
According to the ready information, the first Securitisation in South Africa was aimed at mortgage Securitisation; developments were very slow over the 11 years. Then in 1992 Securitisation was applied to corporate equipment rentals and leases up until 1997 straight through 2000s with Securitisation on trade receivables, properties, time to come rebate flows, time to come cross-border flows and Clos.
South Africa's motive for Securitisation transaction was to advantage from more effective financing and behalf maximisation; improved balance sheet structure and finance ratios; improved risk management; and lower economic and regulatory capital requirements among others.
Although the Securitisation transaction is still in its infancy in south Africa, ready records show that issuance spicy domestic banks in South Africa (i.e. private banks) has increased from R250 million in 1989 to a whopping R26 billion by the end of October 2005. Based on a modern study conducted on the Uk shop which suggests that Securitisation provides investors the opening to attain a higher after tax return in comparison with after tax returns being generated by equity related property venture , Securitisation in South Africa is being applied as an acquisition tool in acquiring properties and as a folder optimisation and value unleashing tool.
Securitisation regulations in South Africa compares to international Regulatory Practices similar to those in the United States of America and regulate the manner with which Securitisation assets and earnings flows are transferred from the creator to the Spv and operational aspects and efficiencies of the Spv.
Different opinions exist in the South African shop with regard to conformity to Securitisation regulation. One centres on the use of specific words "Bank or deposit-taking Institution" that only South African banks can create a securitisation.The other understanding is on non-conformity as acceptable if a company or company other than a bank originates a Securitisation.
The onus of the matter is that Securitisation transaction is also designated within the regulation as an action which is not wee to the company of a bank under inevitable conditions; thus allowing companies other than a bank to embark on Securitisation transaction.
The Ghana Securities replacement Commission's annual narrative for 2004 does not mince words about the position of the Ghana Securities market. It reported that "despite the modest decline in index execution in division terms, the Gse still maintained its position as one of the best performing stock exchanges in the world in 2004 for the second time running." shop capitalisation of listed companies on the Ghana Stock replacement increased by 84.90 trillion cedis to 97.61 trillion cedis from just 12.6 trillion cedis.In dollar terms, shop capitalisation went up by 654.0% from Us.43 billion at the starting of 2004 to Us.8 billion at the end of 2004.
Unlike the stock market, the bond shop in 2004 was relatively low posing "a serious shop amelioration challenge to the commission". The turnover value of listed corporate bonds in 2004 declined from Us6,600 in 2003 to Us,414 a decline of 87% whilst government bonds also declined by 71%.The value of listed corporate bonds in 2004 was Us.79 million compared to Us8.98 million in 2003.
The corporate bond shop remained relatively quiet. However, the Us dollar denominated corporate bonds traded on the shop increased by ,783 to 5,200.
The government of Ghana is considered to use municipal, corporate, government and department bonds to enhance action in the customary market. As a succeed of that, the Bank increased accountability and transparency in line with International Financial reporting Standards (Ifrs) best practices in its financial reporting and disclosures in 2005.
Coupled with this, other relevant Government policies were strengthened to reinvigorate earnings collections and combine collective expenditure aimed at reducing the domestic debt in relation to Gdp .As a succeed of that the government started a programme of reducing domestic debt in relation to Gdp to enable the private sector passage reputation and lead the increase process.
The significance of Bank of Ghana in the financial ideas is that the bank is the provider of technical keep for the legal and regulatory reform of the financial ideas to minimise risks and ensure legal certainty especially for electronic transactions; and also monitor assorted financial laws at separate stages of development.
There is no doubt that habitancy learn from experiences of others so do nations about the successes and failures of other nations especially with regard to something new and complicated like the understanding of Securitisation transaction. It is recommended that Securitisation in Ghana is modeled on the experience of South Africa's Securitisation transactions with some changes in the legislations to fit the situation in Ghana.
Ghana's private sector is beset with many constraints for no doubt, however, the other side is that, there are so many opportunities whether untapped or unidentified comparative as well as other natural and mineral resources already in large quantities. There is inherent for more effective exploitation of these endowments. But prolonged belief on a few commodities with low prices and wages subject to fierce international competition in slow global markets have left the country vulnerable to hardship. These products could be structured and securitised.
Training of players of Securitisation transactions like, the originator, servicer, legal advisers, accounting adviser, tax advisers and others must be continuous about the technicalities of Securitisation transaction from now till the take-off. There should not be any mediocrity as is the characteristics of government and government agencies.
Investors and inherent originators must also be educated on the benefits of Securitisation as an alternative for customary capital formation also equity and debt which is common to the Ghanaian company community. Providing better insight of, cash flow drivers behind Securitisation transactions, reputation rating agencies and also reputation enhancement issues. This would trigger a strong desire for this form of capital formation to put Ghanaian businesses in the race to compete favourably on the international scene.
The technicalities of grasping the intrinsic techniques of properly analysing the segregation of assets and earnings flows from the company that owns them to the Spv which is meant to control the assets for the advantage of investors, must be well understood by the venture community.
A lack of genuine insight of the drivers behind a Securitisation transaction, the capability to part the impact on time to come operations as well as the preliminary costs complicated in Securitisation creates difficulty in clearly defining the true incentives for conducting Securitisation among South African companies. Thus a wide insight of such among Ghanaian companies will boost Securitisation transaction.
One issue that needs to be tackled very well is the Tax Laws to make the Securitisation transaction work. Ghana operates a free-zone task and this can be extended to encourage Securitisation transaction. inevitable areas within the country could be assigned as 'free zone for Securitisation'and 'use as tax haven' to take care of and groom Securitisation in Ghana.
The regulatory environment straight through which Securitisation is conducted, coupled with capital shop infrastructure to keep enough pricing of all risks related with all forms of Securitisation transaction-conduit, synthetic or "whole-business".
Finally, it is recommended that, study into the legal framework on bankruptcy, tax, and industrial laws relating to structured finance and Securitisation in single should be encouraged among the Ghanaian academia.
Ghana no ifs ands or buts has an enabling environment suitable for Securitisation transaction. Key issues to drive this on might comprise as mentioned above prolongation of existing laws like Tax, Bankruptcy and industrial Laws to comprise medicine of Securitisation transaction.
Ghanaians are strong-willed, forceful and patient. When the expertise is acquired for Securitisation with the training of the players above, good governance of the other key government policies like Midr and Strategy for 2004-2008, correction on the Ghana School Financing activity they will serve as catalyst for Securitisation.
Considering the experience of South Africa over the past decade, the experience of the industrialized economies in Securitisation transaction and the macroeconomic and the venture atmosphere continue to enhance as it is now ,in the next 10 years, Ghana will not be too farther away from spicy in Securitisation transaction if not already there.
Reference:
1. 'Securitisation in South Africa-a revolution for local funding', by Bagley et al(2003) Fitch Ratings ready online accessed 20/07/2007
2. 'Securitisation: A collective tool?' Treasury working paper, by Davis,N ,available online treasury.govt.nz/workingpapers/ accessed on 20/07/2007
3. 'Securitization.'Wikipedia, the free encyclopaedia. Reference.com accessed 25 Feb. 2007.
4. "Consider Securitisation to enhance liquidity in the South African property market" by Eugene G van den Berg, accessed on vinodkothari.com accessed on 04/08/07
5. "Note on the impact of securitisation transaction on reputation prolongation by banks" in quarterly Bulletin December 2005 by N. Gumata and J .Mokoena
6. "The awakening of securitisation in south Africa", by Van Vuuren online ready vinodkothari.com/secafric.htm
7. Africa -Ghana organising in the informal sector(on line) ready from oecd.org/dataoecd/html (accessed 29th April 2006)