A Company can issue bonds to investors secured on the future profits expected to arise from part of its existing life business.
When a pool of financial assets (such as car finance, home or commercial mortgages, corporate loans,royalties, leases, non-performing receivables, and contractually pledged operating revenues) are structured and transferred to a ‘special purpose means or entity'(SPV or SPE) it is known as a Securitisation transaction.
Generally, most securitisation transactions include a two tier transaction in which the originator of the assets to be securitised transfers such assets to a wholly-owned SPV.In turn the SPV transfers or pledges such assets to another entity, which issues rated securities in the capital markets that are collaterised by such assets. This second tier entity can be another SPV or a multi-seller commercial paper conduit and can provide funding by issuing medium term notes or commercial paper.
Types of Securitisation transaction
Usually with securitisation transactions, the move of rights to assets can take one of two main forms, true sale or synthetic securitisation.
1. True Sale securitisation
In a true Sale securitisation, the originator (for example 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 originator continues to collect the principal and interest from the borrowers on behalf of the issuer on such mortgages and see to all default mortgages in addition.
The significance of true sale is that the first-tier sale of the assets from the originator 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. consequently, the issuers are usually incorporated as insolvency far away entities; and may not include into any transactions other than those necessary to effect the securitisation what is known as “limited purpose-concept” by which virtue the SPV will not be allowed to issue any additional debt or go into into mergers or similar transaction.
The transactions can be conducted as conduit, whereby the purchaser purchases and securitises assets from a number of different originators. This is done by by refinancing by issuing commercial paper into the capital market. edges usually include 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 commercial paper is issued.
It must be said here that, the legal characteristics and economic substance of the move will be the dominant calculating factors as whether the transaction is a true sale not a loan.
2. Synthetic Securitisation
In a synthetic securitisation transaction the originator does not sell any assets to the Issuer and consequently does not acquire any funding or liquidity under the transaction. The originator enters into a credit 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 originator an amount equal to any credit losses suffered in respect of such assets or pool of assets. The Issuer’s (SPV) income flows in a synthetic transactions are the fixed amounts paid by the Originator under the credit default swap and interest amounts received on the collateral. These transactions are typically undertaken to move credit risk and to reduce regulatory capital requirements.
3. “Whole-Business” Securitisation
except 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 kind of securitisation originated in the United Kingdom. It involves the provision of a secured loan from an SPV to the applicable Originator. The SPV issues bonds into the capital markets and lends the proceeds to the Originator. The Originator sets its obligations under the loan by the profits generated by its business. The Originator grants security over most of its assets in favour of the investors. In terms of cash flow, there are three most shared types of securitisation transactions:
Collaterised Debt- this is similar to traditional asset-based borrowing. The debt instrument need not match the cash flow configure ration of any of the assets pledged.
Pass-by-this is the simplest way to securitise assets with a regular cash flow, by selling participation in the pool of assets i.e. an ownership interest in the inner assets so that principal and interest in the inner assets collected are given to the security holders;
Pay-by debt instrument-this is borrowing instrument and not participation. Investors in a pay-by bond are not direct owners of the inner assets but simply investors.
One meaningful 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. consequently the SPV in a securitisation will have the strength only to buy the particular receivables contemplated by the transaction, issue the related capital market securities, and make the payments on them and so on.
The reason for these restrictions is thought to keep the risks of the SPV’s own bankruptcy as thin as possible: the smaller the range of the entity’s activities, the smaller the risk of a bankruptcy.
Securitisation is based on the inner assets being securitised. Rating agencies use a lot of time to calculate the credit risk for all inner assets in Securitisation transaction. Other risks considered is the prepayment risk.-the risk that a portion of the assets in the inner pool may be repaid early. Payments and settlements in Ghana are considered to be good. Prepayments can reduce the weighted average life of the pool and as a consequence expose investors to important uncertainty over future cash flows.This can be mitigated by separating the payment of the principal and interest or the conversion of fixed rate returns to floating rate.
Third Party Risk
Collateral is not the only important factor in structured finance transaction. A servicer risk would be particularly strong in Ghana. This is the case that the collection of payments, dispensing to investors and performance tracking will fail. Because in Ghana credit rating is not popular.
In a Securitisation or structured finance transaction, a lot of third parties are involved who must fulfill their various responsibilities to make the transaction go on successfully .”Time is money”, it is said. Other third party risks include trustee managing series 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; manager responsible to balance the competing interest within a transaction.
Financial Risks (Interest Rate Risks, Foreign Exchange Rate Risks, Devaluation Risk)
Financial risks usually cover interest rates, foreign exchange rate & availability, money and inflation risks. Inflation really affects the originator 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 investment in their country and sometimes prevent the repatriation of funds by foreigners outside. Devaluation and interest rate just like inflation can also affect 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 payment to receivables is sold locally, and paid in local money, using foreign loans creates exposure to the risk of money depreciation.
Because cross-border transactions are conducted such that assets generate cash flows in the domestic money while the securities backed by those assets are denominated in foreign money, there is the risk that in spite of of the credit strength of the inner assets, the issuer might default on the payment. The following applicable known political risks are identified:
The act of taking something from its owner for public use. This involves the act where a government takes over assets or accounts of local parties in the event of financial crisis.
move of business from private to state ownership. This is not usually experienced in the West as in South America and Africa. In relation to Ghana’s political situation, this is not envisaged.
This is the risk that in a national crisis, the government might impose a moratorium on all foreign money debts because of a financial crisis in the country.
Change of law:
The ruling government can change the laws overnight and this can affect a structured finance. Sometimes for economic and political reasons, tax laws are enacted which might not be to the advantage of the originator in terms of the cost increase to certain elements which could increase the buy price of the product 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 affect the complete transaction because tax neutrality is paramount to securitisation transaction.
Legal & Documentation Risks
Following change of law in political risk discussed above, possible legal risks to a Securitisation transaction include inadequate legal, legislative, and regulatory framework on tax, financial and money market & securities. Sometimes the case and administrative laws in the country concerned are not developed. These issues are of great concern to investors and for that matter the originator will have to deal with this risk.
In asset-backed securities(ABS),however, the legal and documentation risks include uncertainty surrounding the move of assets from the seller/originator to the SPV (i.e. ‘true sale’) the need to ensure that holders of ABS receive complete control over the inner assets; the bankruptcy remoteness of the issuing SPV.
This method reviewing all the covenants in relation to the separation of the SPV from the seller; the legal roles of the trustee and servicer across all applicable jurisdiction including Ghana to curtail operational and execution risks associated with the payment and receipts of transactions.
Because of the changes in deal structures and considering the legal and financial framework of Ghana, legal and documentation risk will be very high.
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 associated in which with the tranching or slicing of securities brings conflicting interests which if not checked may disrupt the appropriate dispensing of receivables to end-investors. The meaningful to structured finance transaction is the payment waterfall which set the covenants for paying the interests and principal and allocation of losses among investors. This can be sorted with over-collateralisaton tests which ensure the existence of sufficient collateral in the inner pool of assets to cover principal payments; and interest coverage test to ensure that there are sufficient interest proceeds to cover interest payments to observe holders.
Levels of Risks
Rating agencies usually would have to estimate the totality of the risks envisaged in each transaction before assigning a rating to the security. consequently the possible for any shortfalls in receivables and the adequacy of any credit enhancement to ensure that the end-investors are stated the right level of default risk. Cross-border transactions for example require specific examination regarding the possible limit that could apply to the rating of the notes because of the possible default of a government and the possible application of a moratorium by a government in times of crisis.
Benefits of Securitisation
The use of Securitisation is not limited to one specific asset or income flow. The application stretches beyond the existing bank-funding products and equity funding arrangements. The challenge is the approach with which a Securitisation is considered and the ability to measure the impact thereof on the future of the business. This stems from the fact that Securitisation is cash flow pushed and not earnings-improvement pushed.
Generally, securitisation can offer the following benefits and we would later analyse to see whether or not it would assistance Ghana.
Efficient access to capital markets: when transactions are for example structured with credit ratings by a recognised credit rating agency on most debts, pricing is not tied to the credit rating of the originator. This is very meaningful if the originator is not credit worthy.
Limitation on issuer-specific’s ability 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, credit quality or rating, prepayment assumptions and prevailing market 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 generate additional assets: capital can quickly be raised such as releasing long-term capital for any allowable purposes like completing capital project and purchasing additional assets.
Match assets and limitations to minimise risks: a well-structured securitisation transaction could create near perfect matching of term and cash flow locking in an interest rate spread between that earned on the assets and that paid on the debt. This method that Ghanaian business entities can raise enough funds without necessarily providing collateral for security because of the move of risk.
Raise capital without prospectus-kind disclosure: A conduit securitisation transaction allows one to raise capital without disclosure of sensitive information of any sort; in fact information is kept secret.
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 become possible to do away with other business entities which are no longer profitable.
move risk to third parties: Financial risk on loans and other contractual obligations by customers can be slightly transferred to investors under securitisations.
More funding beyond bank lending: A structured Securitisation transaction enables the originator to raise funding while maintaining the right to the profit on the receivables. However, these funds will not be connected to its credit rating but rather the credit rating is on the special purpose entity produced for the Securitisation transaction. By incorporating an offshore SPE, many businesses in Ghana with poor credit rating might potentially raise funds for any purpose.
The overall effect of securitisation of bank loans and credit aggregates is likely to be a reduction in the level of credit extension by the monetary sector and a reduction of similar extent 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 original borrowers nevertheless have obligations but to the SPV not a bank and institutional investors nevertheless own assets which are now tradable securities not M3 deposits.
Structure of Ghana’s Financial System
The financial system 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 Exchange 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 system 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 edges, Universal edges, Commercial edges, development edges,ARB Apex edges, and Rural edges; with a total growth of its assets by 17.62%.
The Non-Banking Financial institutions (NBFI) sector is made up of Savings and Loans Companies, Discount Houses, Finance Companies and Leasing Companies. Total assets for the Non-Banking Financial Institutions also grew by 47.98% which were mainly triggered by loans and advances, investments, other assets and fixed assets. The Discount houses keep up 82.61% of the overall 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, in addition as higher governance standards ensured that edges remained generally compliant with regulatory and prudential requirements.
The Securities Market in Ghana
African stock exchanges confront a number of challenges before they could go into a new phase of rapid growth. The most basic issue is to eliminate existing impediments to institutional developments. These include a wider spread of information in these markets, the implementation of strong electronic trading systems and the adoption of central depository systems. Ghana has since established a central depository system in November, 2004.
The Ghana securities market is regulated by the SEC. The Ghana Stock Exchange is underdeveloped with reference to exchanges in US, Europe and already South Africa. South Africa for example has market capitalisation of $180 billion, one of the largest in the world with Ghana’s market capitalisation of $11 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. already though Securitisation transaction is nevertheless at an early stage of development in South Africa, it has grown rapidly in recent years and it would be a appropriate “benchmark” after which to carve Ghana’s Securitisation transaction.
According to the obtainable 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 by 2000s with Securitisation on trade receivables, similarities, future rebate flows, future cross-border flows and CLOs.
South Africa’s motive for Securitisation transaction was to assistance from more efficient financing and profit 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 nevertheless in its beginning in south Africa, obtainable records show that issuance involving domestic edges in South Africa (i.e. private edges) has increased from R250 million in 1989 to a whopping R26 billion by the end of October 2005. Based on a recent study conducted on the UK market which indicates that Securitisation provides investors the opportunity to reach a higher after tax return in comparison with after tax returns being generated by equity related character investment , Securitisation in South Africa is being applied as an acquisition tool in acquiring similarities and as a portfolio 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 control the manner with which Securitisation assets and income flows are transferred from the originator to the SPV and operational aspects and efficiencies of the SPV.
Different opinions exist in the South African market regarding conformity to Securitisation regulation. One centres on the use of specific words “Bank or place-taking Institution” that only South African edges can originate a securitisation.The other opinion is on non-conformity as appropriate if a company or business other than a bank originates a Securitisation.
The onus of the matter is that Securitisation transaction is also designated within the regulation as an activity which is not limited to the business of a bank under certain conditions; consequently allowing companies other than a bank to embark on Securitisation transaction.
The Ghana Securities Exchange Commission’s annual report for 2004 does not mince words about the position of the Ghana Securities market. It reported that “despite the modest decline in index performance in percentage terms, the GSE nevertheless maintained its position as one of the best performing stock exchanges in the world in 2004 for the second time running.” Market capitalisation of listed Companies on the Ghana Stock Exchange increased by 84.90 trillion cedis to 97.61 trillion cedis from just 12.6 trillion cedis.In dollar terms, market capitalisation went up by 654.0% from US$1.43 billion at the beginning of 2004 to US$10.8 billion at the end of 2004.
Unlike the stock market, the bond market in 2004 was comparatively low posing “a serious market development challenge to the commission”. The turnover value of listed corporate bonds in 2004 declined from US$606,600 in 2003 to US$73,414 a decline of 87% whilst government bonds also declined by 71%.The value of listed corporate bonds in 2004 was US$6.79 million compared to US8.98 million in 2003.
The corporate bond market remained comparatively quiet. However, the US dollar denominated corporate bonds traded on the market increased by $41,783 to $115,200.
The government of Ghana is determined to use municipal, corporate, government and agency bonds to enhance activity in the dominant market. As a consequence 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 applicable Government policies were strengthened to reinvigorate revenue collections and consolidate public expenditure aimed at reducing the domestic debt in relation to GDP .As a consequence of that the government started a programme of reducing domestic debt in relation to GDP to permit the private sector access credit and rule the growth course of action.
The significance of Bank of Ghana in the financial system is that the bank is the provider of technical sustain for the legal and regulatory reform of the financial system to minimise risks and ensure legal certainty especially for electronic transactions; and also monitor various financial laws at different stages of development.
There is no doubt that people learn from experiences of others so do nations about the successes and failures of other nations especially with regard to something new and complicate like the concept 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 either untapped or unidentified comparative in addition as other natural and mineral resources already in large quantities. There is possible for more effective exploitation of these endowments. But continued reliance on a few commodities with low prices and wages unprotected to fierce international competition in slow global markets have left the country unprotected 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 possible originators must also be educated on the benefits of Securitisation as an different for traditional capital formation besides equity and debt which is shared to the Ghanaian business community. Providing better understanding of, cash flow drivers behind Securitisation transactions, credit rating agencies and also credit enhancement issues. This would cause 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 inherent techniques of properly analysing the segregation of assets and income flows from the company that owns them to the SPV which is meant to control the assets for the assistance of investors, must be well understood by the investment community.
A without of genuine understanding of the drivers behind a Securitisation transaction, the ability to measure the impact on future operations in addition as the initial costs involved in Securitisation creates difficulty in clearly defining the true incentives for conducting Securitisation amongst South African companies. consequently a comprehensive understanding of such amongst Ghanaian companies will raise 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 scheme and this can be extended to encourage Securitisation transaction. Certain areas within the country could be stated as ‘free zone for Securitisation’and ‘use as tax haven’ to nurture and groom Securitisation in Ghana.
The regulatory ecosystem by which Securitisation is conducted, coupled with capital market infrastructure to sustain adequate pricing of all risks associated with all forms of Securitisation transaction-conduit, synthetic or “whole-business”.
Finally, it is recommended that, research into the legal framework on bankruptcy, tax, and commercial laws relating to structured finance and Securitisation in particular should be promoted among the Ghanaian academia.
Ghana indeed has an enabling ecosystem appropriate for Securitisation transaction. meaningful issues to excursion this on might include as mentioned above extension of existing laws like Tax, Bankruptcy and commercial Laws to include treatment of Securitisation transaction.
Ghanaians are strong-willed, forceful and patient. When the skill is acquired for Securitisation with the training of the players above, good governance of the other meaningful government policies like MIDR and Strategy for 2004-2008, improvement 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 developed economies in Securitisation transaction and the macroeconomic and the investment climate continue to enhance as it is now ,in the next 10 years, Ghana will not be too farther away from engaging in Securitisation transaction if not already there.
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2. ‘Securitisation: A public tool?’ Treasury working paper, by Davis,N ,obtainable online treasury.govt.nz/workingpapers/ accessed on 20/07/2007
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4. “Consider Securitisation to enhance liquidity in the South African character market” by Eugene G van den Berg, accessed on vinodkothari.com accessed on 04/08/07
5. “observe on the impact of securitisation transaction on credit extension by edges” in Quarterly Bulletin December 2005 by N. Gumata and J .Mokoena
6. “The awakening of securitisation in south Africa”, by Van Vuuren online obtainable vinodkothari.com/secafric.htm
7. Africa -Ghana organising in the informal sector(on line) obtainable from oecd.org/dataoecd/html (accessed 29th April 2006)