Securitisation – An Alternative to Conventional Fund Raising for Businesses in Nigeria
Introduction
Companies, including credit institutions are constantly raising capital from either the banking sector, the capital markets or investors (such as venture capitals, private equity firms and other investors). These funds are raised for working capital, business expansion, acquisition, or refinance of an existing credit line.
Considering the high demand for funds from different sectors, the financial industry is fast evolving to meet these demands and ensure the availability of liquidity in the market for businesses. Thus, new and innovative financial techniques and instruments have been introduced to complement the conventional lending system. These new models have been gaining popularity globally, especially in the U.S. and Europe, while emerging markets like Nigeria and Africa at large have not fully embraced these alternatives. Securitisation is one of the main alternatives to conventional capital raise that companies and credit institutions in the more developed economy now rely on to raise capital and clean their balance sheets.
Securitisation is a transaction or scheme whereby credit risk associated with an exposure or a pool of exposures is tranched and sold to investors as securities. Simply put, Securitisation is the issuance of securities backed by a pool of assets. In other words, Securitisation is where a company tranche or put together a pool of similar assets and issue notes to investors on the back of the assets. The returns from the assets will be used to repay the notes,
interest and other fees and costs associated with the issuance.
Securitisation was used in the past to finance simple assets such as mortgages, but this has changed over the years. Securitisation is now used to finance different assets with stable cash flow, such as credit card loans, car loans
and leases, project finance, receivables from rentals, trade receivables, collateralized loan obligations, non-
performing loans etc.
*Securitisation Market in Nigeria and the Need for Bankruptcy Remoteness of the Issuer SPV*
Compared with other jurisdictions, only a few Securitisation transactions have been executed in the Nigerian market. One of the foremost Securitisation transactions in Nigeria was in 2007 – the FMBN Residential Mortgage
Backed Securities (MBS) of One Hundred Billion Naira (N100 billion), backed by a Guarantee from the Federal Government of Nigeria. Ever since, few other institutions have successfully issued securities through
Securitisation. In 2017, CERPAC Receivables Funding SPV Plc, through Securitisation issued the Combined
Expatriate Residence Permit and Alien Card (CERPAC) Notes Programme of N40Billion. Series 3 of the Programme was issued in 2021.
In structuring a Securitisation transaction, the issuer, usually a special purpose vehicle (the “Issuer SPV”) must be set up to be independent of the originator. The originator and the transaction advisers must ensure that the entity is bankruptcy remote from the originator. To achieve this, it is common for the originator to set up the Issuer SPV as an orphan special purpose company. Where the originator is the shareholder of the Issuer SPV, based on the consolidation of accounts for group companies, the Issuer SPV will be treated as a subsidiary of the originator. Therefore, in the event of the originator’s insolvency, the originator’s liquidator may have the right to liquidate the originator’s assets, which could directly impact the Issuer SPV and the securitised positions. Therefore, transferring the receivables and other underlying collateral from the originator (as the seller) to the Issuer SPV must satisfy all the conditions of a “true sale”.
In a nutshell, bankruptcy remoteness can be achieved by some of these documents: (i) receivables purchase agreement between the Issuer SPV and the originator (as the seller); (ii) servicer agreement among the Issuer SPV, the security trustee and the originator in its capacity as the servicer; and (iii) security trust agreement among the Issuer SPV, the originator and the security trustee.
*Some Benefits of Securitisation*
1. Reduce costs of Funding – Through Securitisation, a company rated BB but maintains high-quality assets
(AAA or AA) can borrow at significantly lower rates, using the high-quality assets as collateral instead of issuing unsecured debt or relying on its balance sheet/cash flow to raise capital from a bank. This is a significant benefit that companies and credit institutions usually derive when they package high-quality
assets, get ratings on the back of the assets and issue them to investors at a lower cost.
2. Diversification – The assets subject to Securitisation are usually pools of assets whereby a default in one of
such assets may not materially affect the entire pool. However, if the assets are sold individually, the chances that an investor might not recoup its money in each receivable are higher than selling them as a pool.
3. Improve Balance Sheet – One major features of traditional Securitisation is that the pool of assets must be
transferred as a “true sale,” i.e., the title and risk must pass to the special purpose vehicle with no right of recourse against the originator (save for breach of representations and warranties). The sale and proceeds
can be recorded as earnings in the seller’s balance sheet. This is very important for regulated institutions such
as credit institutions as it allow banks to transfer credit risk from their balance sheets and thus reduce their regulatory and capital requirements.
4. Risk transfer – Risks in the pool of assets are usually transferred to the investors. Sometimes, the notes issued by the Issuer SPV are issued on a limited recourse basis. Therefore, if funds generated from the pool of assets are insufficient to meet the obligations of the Issuer SPV to the investors, the investors will not
have recourse to the originator (seller to the Issuer SPV) or to other assets of the Issuer SPV if the issuer has more than one compartments of notes it issued to different investors.
5. Risk retention – from an investor’s perspective, the originator may be partaking in the risk associated with the assets. In some jurisdictions (such as in the EU), the originator or the original lender must retain at least five percent (5%) of the net economic interest in the Securitisation position on an ongoing basis. This allows for risk sharing between the investors and the originator, or original lender, provided that if either of the retainers of such risk is a financial institution regulated in the EU, the risk can be retained within its group
on a consolidated basis.
*Some Structures of Securitisation*
This is mainly dependent on what is being packaged and the Securitisation regulations. In this article, I will consider a plain vanilla mortgage loans Securitisation from a Nigerian bank.
Assuming Bank ABC has different mortgage loans it has granted to its customers due in 20 years. However, the
bank wants to clean up its books, or it needs capital for other businesses. Bank ABC may package 200 of those loans (together with the collateral underlying the loans), set up an SPV and the Bank acting as the Seller, sells its receivables to the SPV. The SPV, on the back of the assets, will issue notes to investors, and the proceeds from the issuance will be used to pay for the purchase of the receivables from Bank ABC.
Since the SPV does not provide banking services and has no direct relationship with the customers (the Issuer SPV cannot also have employees), the SPV can appoint ABC Bank to act as servicer, who will manage the
relationship with the mortgage customers. The servicer will have the power to enforce all the rights that would ideally be accruable to the SPV. Special accounts will be set up for the collection and payments of interest and
principal repayments to the investors, together with the cost associated with the transaction.
The SPV may engage other professional advisers to provide different services for the transaction. Some of these
professionals will include the arrangers (financial advisers and issuing houses) who will arrange for investors who buy the notes. Security trustee will hold the collateral and other security interest on behalf of the secured parties.
Law firms will assist with the structuring, advising on regulatory-related matters and drafting of the transaction
documentation.
An inherent material risk is yet to be addressed from the structure above. There could be a cash shortage in the relevant collection account to pay the investors on the interest payment date or principal payment date (if the notes are amortised). It is very common in transactions of this nature for the Issuer SPV to take up a revolving credit
facility (in most cases, from the originator if the originator is a financial institution) which can only be drawn if there is a shortfall in the relevant accounts. This will eliminate the risk of cash shortage to pay the investors as at when due.
*Nigeria Securitisation Regime vis-à-vis EU Securitisation Regulations*
The Securitisation market in the EU is one of the most advanced compared to other markets worldwide. This has helped the regulators better understand the industry; as such, they have come up with more robust regulations that cater to both EU and non-EU companies investing in securitised assets within the EU. The operational guideline for Securitisation in the EU is the Regulation (EU) 2017/2402 of the European Parliament and of the Council (the
“EU Securitisation Regulations”). This regulation applies to all EU Member States and overrides any local law
inconsistent with the regulation. There are some sharp distinctions between the EU Securitisation Regulations and
the Rules on Securitisation (“Nigeria Rules on Securitisation”) issued by the Securities and Exchange
Commission and the Securitisation Bill before the National Assembly (the “Securitisation Bill”).
Some of the major differences are set out below:
1. Risk Retention Requirement – under the EU Securitisation Regulations, either the original lender or the originator must retain at least five percent (5%) of the material economic interest in the Securitisation
position on an ongoing basis. The originator or original lender that is a financial institution incorporated in the EU may retain the risk within its group on a consolidated basis. The common practice in some markets in the EU is for the Issuer SPV to issue at least two classes of notes and have one of them subordinated. The subordinated notes will comprise at least five percent (5%) of the total notes issued. Like any subordinated
instrument, the interest rate will be higher than other note classes. Either the originator or original lender will
subscribe to the subordinated notes and hold the risk on a continuous basis until the transaction is terminated.
While risk retention is mandatory in the EU to ensure that the sponsor (originator or the original lender) of
Securitisation transactions has a skin in the game, it is left at the discretion of originators under the Nigeria
Rules on Securitisation and in the Securitisation Bill. Therefore, companies sponsoring Securitisation in
Nigeria have no obligations to participate in the Securitisation risk exposures.
2. Credit-risk mitigation or hedging of retained risk – the sponsoring party that retained the five percent
(5%) material economic interest in Securitisation position is generally prohibited from hedging the risk
exposure it has retained. However, hedging may be allowed where:
(a) what is being hedged is not the credit risk of the retained Securitisation exposure;
(b) it was undertaken before the Securitisation transaction as a legitimate and prudent element of credit granting or risk management and did not create a differentiation for the retainer’s benefit between the credit risk of the retained Securitisation exposures and the Securitisation exposures of the investors; and
(c) the retainer commits more than the minimum material economic interest of five percent (5%), hedging for the excess is allowed if such circumstances are disclosed in the final offering documents.
However, because the Nigeria Rules on Securitisation did not mandate originators to retain any risk exposures, this EU provision is not in Nigeria’s regulation and the Securitisation Bill. Therefore, where a
Nigerian sponsoring party decides to retain any portion of the risk exposure (for commercial reasons), it can
hedge its risk, including entering into any form of derivative arrangements to protect itself.
3. Due Diligence Requirements – in the EU, institutional investors are subjected to stringent due diligence
requirements to be conducted on the originator and the original lender before holding Securitisation positions. This also involve regularly performing stress tests on the cash flows and collateral value supporting the underlying exposures, among other measures. There are no similar provisions in the Nigeria Rules on Securitisation and the Securitisation Bill.
This should not be a problem for institutional investors investing in a Securitisation position in Nigeria. A prudent institutional investor will ordinarily conduct extensive due diligence on the originator, the Issuer SPV, and the underlying assets. It should also have some internal mechanism in place to perform stress tests from time to time or upon the occurrence of certain events on the cash flows and collateral value supporting the underlying assets.
For retail investors (in the EU), the Issuer SPV can only sell Securitisation positions to retail clients if certain conditions are satisfied, such as (i) performing a suitability test on the clients; and (ii) communicating in a report to the retail client the outcome of the suitability test. The EU Regulations cap how much retail investors can invest in a Securitisation position.
The Nigeria regulations and the Bill before the National Assembly do not contain similar provisions. This is undoubtedly a problem for retail clients. Therefore, there should be some form of responsibility on the originator and the Issuer SPV to conduct a suitability test for retail clients before investing in Securitisation position.
4. Data Trustee Structure – while Nigeria has data protection laws and an enforcement agency in place, the impact is yet to be heavily felt by data subjects. In the Nigeria Rules for Securitisation and the Securitisation
Bill, no obligation is imposed on either the originator or the Issuer SPV to protect sensitive data of the debtors. In view of this, data protection of debtors, in most cases, is not properly considered by the originator and the Issuer SPV when structuring Securitisation transactions. This is definitely not the case in the EU with the EU Data Protection Regulation in place.
In Germany for instance, if the debtors are natural persons, the practice is to set up a structure where the original lender and the originator (as a seller of receivables) provide the Issuer SPV with a list of the receivables which entail debtors’ information only in an encrypted form. A notary, financial institution or
similar reliable institution is appointed as data trustee, and the originator will provide the data trustee with a
decryption key of the encrypted debtors’ information. The data trustee will pass on the decryption key to the Issuer SPV or the security trustee only if the originator/servicer defaults on servicing or where the debtors
default on receivables payment owed by them.
5. Synthetic Securitisations – the EU Regulations recognised another special form of Securitisation-synthetic Securitisation. In a synthetic Securitisation, there is no initial sale or transfer of the underlying assets. Instead, there will be a contractual arrangement between the originator and the SPV, which may take various forms,
including a participation, a credit default swap or credit-linked note, pursuant to which only the economic
risk associated with ownership of the assets is transferred contractually by the originator to the SPV. Synthetic structure may not be suitable for all types of assets or originators and may not allow the originator to derecognise those assets from an accounting perspective. In particular, the contractual counterparty, such as the SPV, takes full contractual, and credit risk of the originator. Since the risk of the assets has not been
isolated from the originator, the relevant counterparty will take both the credit risk associated with the assets’ performance as well as that of the originator. Therefore, synthetic Securitisations have typically been used
by more highly rated originators (such as rated banks and investment firms) and involve carefully structured
SPVs.
Conclusion
Securitisation is gaining traction globally. Companies rely heavily on it to raise capital and to “clean up” their
balance sheets. While the mortgage market in Nigeria is still developing, Securitisation can be used for many other forms of asset portfolios. Financial institutions can repackage their loan receivables, while real estate companies can securitise their future rent receivables. Car loan companies will also find this financing option
valuable. Lastly, it is hoped that the 10th National Assembly will make necessary amendments to the Securitisation Bill to bring it in line with global best practices and pass the same into law before the expiration of their tenure.
Author: John Sunday Okeluwe is a corporate finance lawyer with extensive experience in advising international
and local clients on cutting-edge financing transactions and assisting investors navigate Nigeria and EU business
terrain.
Email: Sundayjohn170@gmail.com
LinkedIn: www.linkedin.com/in/john-sunday-okeluwe-ba1a43150/
