The increase in Canadian asset-backed activity has led some market players to look at doing cross-border transactions, though adverse tax consequences has limited the growth in the area, experts say.
"On the one hand, billions of dollars of Canadian receivables are being securitized in off-shore capital markets," said Martin Fingerhut, a partner at Blake, Cassels & Graydon LLP. "In addition, non-resident liquidity and enhancement facilities are beginning to support Canadian securitization transactions."
Blake, Cassels & Graydon recently closed a transaction in which a U.S. lender extended a sizeable liquidity facility to support a Canadian multi-seller commercial paper program. Fingerhut also cited the fact that monoline insurance companies are being called on to credit-enhance numerous Canadian single-seller programs.
On Tax Laws
A hindrance to the growth in cross-border transactions are the tax laws in Canada.
"The tax rules are difficult," said Barbara Hooper, managing director of asset securitization at TD Securities.
In Canada, if an entity issues bonds off-shore then a certain percentage of that interest must be withheld from payment to the off-shore investor. The exemption does not apply to long-term corporate debt though. This is because if more than 75% of the principal debt is repaid after five years from the date of issuance then the withholding tax does not apply.
The problem is most special purpose vehicles in Canada are trusts, and the tax exemption for long-term corporate debt does not apply to trusts. However, a capital tax, which is based on the amount of assets found on a company's balance sheet, is not payable by trusts.
"The choice is either to issue longer-term asset-backed cross border and not pay the withholding tax or to issue locally using a trust, save the capital tax, but to pay withholding tax," said Hooper. "I think on balance it has been found that it is more beneficial to have the capital tax and perhaps pay up a bit in terms of spread in order to place the paper locally."
Fingerhut said that there's a way around these tax difficulties.
"The challenge is to structure a deal in such a way that withholding tax is not incurred," he said. "The issue normally revolves around the type of asset being securitized. To date, solutions have been found for a number of asset classes."
Trade receivables, franchisee loans, commercial mortgage-backed securities, inventory floor plan loans and government insured residential mortgages are examples of asset classes that have been secrutiized cross-border.
He noted that the special withholding tax exemption for long-term corporate debt allowed Blake to structure a cross-border loan program for Burger King's Canadian franchise.
And for short-term corporate debt, such as floor plan receivables, "We are able to fund a revolving domestic securitization with long-term cross-border structured debt in order to access the 25%/five-year withholding tax exemption," he said.
On Liquidity and Enhancement
The growth in Canadian securitization has led to a need for much larger liquidity and enhancement facilities, which are beginning to be supplied by off-shore lenders and monoline insurers.
"It used to be that $100 million was a very respectable deal size for a Canadian securitization," Fingerhut said. "Now that the Canadian banks and other issuers have begun to securitize in earnest, we are seeing numerous multi-billion dollar transactions."
Due to the increased issuance, Fingerhut said that the commercial paper programs and term structures are therefore beginning to require quite significant liquidity and enhancement facilities that are straining the capacity of domestic sources. Because of this, Canadian transactions are more frequently obtaining these facilities from off-shore suppliers.
Another impetus for accessing off-shore liquidity is a change in the Office of Superintendent's (OFSI) view of capital treatment.
"Previously, the bank's thought they were on the right side in terms of their capital treatment," said Greg Nelson senior vice president of structured finance at Dominion Bond Rating Service.
After OFSI redefined liquidity, "There was a need for the banks to get a fair bit of liquidity. They couldn't do that all at once so they were forced into the off-shore market," Nelson added.
Meanwhile on the credit-enhancement side, the rush towards accessing off-shore credit enhancement was caused by several factors.
One of them is the size of the deals involved. "Since the transactions have been fairly small, and you have a small level of enhancement associated with them, it's hard to get people interested."
He added that since Canadian investors are fairly conservative, they tend not to invest in double-B and triple-B notes. "That's one impetus in terms of finding off-shore purchasers of these sub notes or credit enhancement."
Another reason to access off-shore credit enhancement sources is that the local companies or banks who withdrew from providing liquidity also withdrew from providing credit enhancement - thus the need for foreign sources of credit enhancement.
Advantages to Cross-Border Deals
Despite the tax consequences associated with cross-border transactions, there are distinct advantages to accessing foreign markets.
In the U.S., for instance, "There a much deeper investor base and one can much more readily issue asset-backed paper into the U.S., often, at lower spreads," said T.D.'s Hooper.
She added that in Canada there isn't a very deep market to issue lower-rated paper.
"For example, if you want to issue sub-investment grade asset-backed paper, that would be very difficult to place in Canada at any price whereas in the U.S. there's a fairly deep market for it," Hooper added.