Securitization: What kind of animal is it?

The House and the Senate have each drafted versions of a Securitization Bill. Because only a handful of securitizations have taken place involving Philippine entities, not too many are familiar with the structure and purpose of securitization. Does securitization involve a form of security, as in promissory notes and shares of stock? Or does it involve a form of security, as in chattel mortgage and pledge? The answer is a little of both.

In securitization, a debtor (called an "originator") sells its receivables and chattel paper to an insolvency-remote entity, usually called a "special purpose vehicle" or "SPV." The SPV is set up for the sole purpose of buying the receivables. The SPV then issues debt instruments which it sells in the financial markets to raise funds to pay the originator for the property purchased by the SPV. Securitization enables the originator to transform idle receivables into cash.

The SPV’s only obligation is to pay the debt instruments that it issued to raise funds. The SPV’s obligation is in turn secured by the assets puchased by the SPV from the originator. The value of the security behind the debt instruments is enhanced if the originator guarantees the receivables, by agreeing to either buy back or to replace bad accounts that it sold to the SPV. At times, the receivables are secured by property of the account debtors, as in the case of chattel mortgages that secure receivables arising from motor vehicle financing.

The SPV redeems the debt instruments from their holders out of the proceeds of the receivables, as and they are collected. Because the transaction in essence involves a conversion of income-producing assets into securities, the process came to be known as "securitization."

At first blush, it seems feasible for a company to issue debt instruments secured by its own receivables, without any need for the receivables to pass through an SPV. True. However, many investors would be hesitant to purchase debt instruments of a Philippine company, even if the debt instruments are secured by receivables of the issuer. There are two reasons for this.

The first is because it is next to impossible to create acceptable security over all kinds of receivables. While it is possible to create a chattel mortgage or a pledge over existing receivables, it would not be possible to do so over future receivables or receivables still to be generated. We are perhaps the only country in Asia that does not have in some form a "floating charge" that enables a debtor to create security over movable property not yet in existence.

In the case of a chattel mortgage, the same principle that prohibits a chattel mortgage over future property, also prohibits a chattel mortgage over future receivables. Although one would be able to create separate chattel mortgages over receivables as and when they come into existence, this would be a cumbersome and expensive process. Documentary stamp taxes and chattel mortgage registration fees would accumulate as new chattel mortgages are executed over receivables, as and when they are generated.

In a pledge, unless the receivables are evidenced by some form of instrument, such as a promissory note, the possession of which can be given to the pledgee, it would not be possible to create a valid pledge over receivables. Although it would be possible to create pledges over existing receivables evidenced by promissory notes or some other instrument, it would not be possible to do so in the case of receivables still to be generated. In these cases, pledges would have to be created as and when the receivables are generated, with the same build-up of documentary stamp taxes as each pledge is executed.

Another reason why investors would be hesitant to purchase debt instruments secured only by receivables of the issuing company, is because the receivables would not be insulated from the effects of a petition for suspension of payments with rehabilitation receiver filed by the issuing company and from the claims of other creditors such as the government, in case of the insolvency of the issuing company. In case the issuing company files a petition for suspension of payments with receiver, then all actions that its creditors may bring against the issuer are suspended. Purchasers of debt instruments would always have a sword of Damocles hanging over their head in the form of a possible petition for suspension of payments filed by the issuer.

The receivables are sold to an SPV which has no creditors other than the purchasers of its debt instruments. The reason is because the SPV is created for only one transaction. This alleviates the need for an enforceable security over future receivables. Moreover, the sale of receivables to an SPV in a true sale would insulate the receivables so sold from a petition for suspension of payments by the originator, and also from the claims of all creditors of the originator, including the government. The reason is that upon a sale of receivables to the SPV, the receivables are taken off the balance sheet of the originator. The originator loses all beneficial and legal ownership. However, the sale must be a true sale, one that cannot be characterized as an equitable mortgage.

There were at least two successful securitizations before the onset of the Asian financial crisis. The securitization of the credit-card receivables of Philippine Airlines in 1996 was named the Deal-of-the-Year by the prestigious Euromoney Magazine. In 1997, the first mortgage-backed securitization in the Philippines took place, with the securitization of the loan receivables of the Home Development Mutual Fund (Pag-Ibig) that were secured by real estate mortgages.

Although successful securitizations were possible without any securitization law, many questions arose that had to be decided on the basis of existing laws which were less than adequate. A securitization law would erase doubts where doubts had existed, and substitute certainty for uncertainty. The financial community should support moves in Congress to enact a securitization law.

Scalpers should be scalped. Although a four-time alumnus of the UAAP basketball champions, I join the De la Salle Alumni Association and Quinito Henson in asking the UAAP to explain to the public where all the tickets to the championship series of the UAAP went to. Fortunately, the House committee of former PSC chairman Monico Fuentebella has decided to investigate the matter. For this pernicious practice of scalping has been eating away the fabric of local sports too long, and scalpers continue to prey on a hapless public. Without this investigation, the UAAP may merely sweep the matter under the rug, just like they do in many Old Boy’s Clubs. The rantings of Sonny Paguia of the UAAP’s organizing committee, that he will answer only to the UAAP board and not to the House investigating committee – is not the reaction of one with nothing to hide, especially when no accusations against him have thus for been made. Perhaps someone should explain to him the powers of Congress on matters of investigations in aid of legislation.

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(The author is a senior partner of Abello Concepcion Regala & Cruz Law Offices or ACCRALAW. He may be contacted at tel. 830-8000 or e-mailed at [email protected])