In a recent report, Moody's Investors Service declared co-ownership structures, commonly used in Canadian ABS securitizations, as risk-neutral.
"The use of the co-ownership structure does not introduce additional risk to a securitization," said Latonia Dukes, vice president and senior analyst at Moody's, who focuses on the Canadian asset-backed term market.
According to the report, the use of co-ownership structures legally removes the underlying assets from potential claims by the seller's creditors, which is the critical purpose of the legal structure in an asset-backed transaction.
"In Canada, the law is much clearer that the transfer of assets to a custodian counts as a true sale," said Stephen Macy, vice president and senior credit officer at Moody's. "So the Canadian context is better from that point of view than the typical U.S. context which is much more touchy-feely about whether something is a sale or not."
Furthermore, the report stated that the risk of substantive consolidation is negligible in Canadian securitizations.
"Basically Canadian courts just have not gone down the substantive consolidation road nearly as often as U.S. courts have," said Macy. "So Canadian structured finance deals are, from that point of view, legally stronger than American securitizations."
Co-ownership structures, when set up properly, do not have adverse tax consequences because there is no entity to be subject to entity-level taxation.
Canadian dealers say that the lack of adverse tax consequences is the driving force for using the co-ownership trust structure.
"The co-ownership structure is a little bit more conservative for tax purposes," said Darcy Doherty, director of securitization at Scotia Capital, which used the co-ownership structure for Bank of Nova Scotia's Hollis Receivables Trust offering. "I think that's what really drives the use of co-ownership structures."
Initially, Canadian issuers used the Master Trust structure for large, revolving-pool bullet transactions.
David Allan, managing director at CIBC World Markets, said that the problem with using the Master Trust structure is that the interest that's taken back by the originator is deemed characterized as a debt interest.
"The yield on an originator's interest in securitized, high-coupon assets can be so high that it looks far more like an equity return than an interest," he said. "The problem with deeming the debt to be equity is the distribution on equity is not tax deductable. This means the trust loses a deduction and will have taxable income."
Realizing the tax consequences inherent in Master Trust structures, about two years ago CIBC decided to use the co-ownership structure for its Card Trust offering and set a precedent for other issuers.
Aside from Scotiabank's Hollis Receivables deal, recent securiitizations that have used the co-ownership structure are Canada Trust's two Genesis Trust transactions, which were led by BMO Nesbitt Burns and TD Securities respectively, as well as Honda Canada's HART deal, which was led by CIBC.
