VideoAt the Bond Market Association's annual meeting in New York in April, the moderator of a panel on asset-backed securitization (ABS) joked that this enormously popular form of structured financing has "proven to be bankruptcy remote — except perhaps in the event of bankruptcy."
For CFOs, that's no joke. ABS is popular precisely because transferring illiquid corporate assets (such as receivables) to a bankruptcy-remote entity allows them to be repackaged and sold as securities. Once the underlying assets are legally separated from the company's fortunes — and its creditors — those securities typically carry higher ratings than the company's own debt issues.
Back in 1999, the asset-backed commercial-paper (ABCP) market — in which corporate trade receivables are the dominant asset class — held $517 billion in assets. But use of ABS has soared since then. Because it effectively gives them access to the lower interest rates of the AAA debt markets, many companies find securitization to be an inexpensive alternative to revolvers or other forms of direct financing. The fact that these transactions are off-balance-sheet and the proceeds can be reported in financial statements as cash from operations, rather than financing, only adds to their popularity. The day that joke was delivered at the Bond Market Association (BMA) meeting, the ABCP market held $708 billion in assets.
To most observers, the biggest threat to this booming industry is a new accounting rule that goes into effect next month requiring companies and their banks to bring these bankruptcy-remote vehicles back onto their balance sheets (see "FASB: A Four-Letter Word?" at the end of this article). That has caused a lot of pain — the asset-backed commercial paper market has dropped from its peak of $745 billion since standard setters first began debating the change — and it is certain to raise costs for banks that sponsor the conduits through which ABCP and other securities are sold.
But the greater threat to ABS may be its own success in giving companies — including financially troubled ones — access to capital during tough times. Although the number of public-company bankruptcies fell to 191 from 2001's all-time high of 257, large-company bankruptcies are on the rise. As more of these companies file for Chapter 11, legal challenges to the very structure of securitization are likely to increase. "With the uptick in ABS and more big companies going into bankruptcy, it wouldn't surprise me if some of these [facilities] get tested in court," observes Mark Scoles, a partner with Chicago-based Grant Thornton. "There's an awful lot at stake for creditors if they can pierce these [structures] and bring the assets back into the company."
A Troubling Case
In legal terms, securitization is not viewed (as its name might seem to imply) as a secured financing. Instead, it is considered a "true sale" of the receivables or other corporate assets to a special-purpose entity (SPE). In most cases, companies continue to collect their own receivables, but the idea that legal control of those funds has passed to a third party is essential to the securitization structure. Auditors require a true-sale opinion from an attorney before approving off-balance-sheet treatment of a securitization, and credit rating agencies require the same before they will rate the resulting securities.
To date, this has generally worked. In fact, a trade-receivables securitization went unchallenged in the case of WorldCom, the largest bankruptcy in history. Yet the past decade has seen increasingly frequent attacks on securitization. Although rarely reported in the business press, these attacks have often sent shudders through the industry. Companies whose bankruptcies resulted in challenges to their securitizations or huge losses to investors in the securities include National Century, NAL Financial Group, Heilig-Meyers, LTV Steel, NextCard, Contimortgage, Conseco, Commercial Financial Services, and, of course, Enron.
Most prominent among these was the case of LTV Steel. On December 29, 2000, LTV declared bankruptcy and simultaneously filed an emergency motion asking for access to receivables and inventory that had long been securitized by a consortium of banks. The transactions, argued LTV, were not true sales but "disguised financings." To the collective horror of the banks, the judge allowed LTV interim access to the cash and scheduled a hearing to discuss the merits of LTV's argument. The structured-finance industry predicted dire economic consequences if LTV were to prevail.
Alarmed, Abbey National and the other banks quickly drew up debtor-in-possession (DIP) financing that was contingent on the company's agreeing that the securitization had in fact been a true sale. That averted the crisis, but didn't resolve the issue. Asked recently by CFO whether the true-sale question still posed a challenge to securitization, Tina Brozman, former chief judge of the U.S. Bankruptcy Court for the Southern District of New York, said, "It hasn't been resolved to my knowledge."
To date, however, cases such as LTV generally have been dismissed as aberrations by the securitization industry. Last year, Standard & Poor's insisted that attorneys submitting true-sale opinions to the rating agency stop referring to LTV, noting that the court never made a final decision and that such citations inappropriately cast doubt on the opinion. Seven months later, in a delicately worded press release, S&P withdrew that prohibition — apparently because lawyers refused to ignore such an obvious legal land mine.
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