South Africa's securitization market is enduring a rite of passage that will attest to either the strength or weakness of transaction structures from the region. Siltek, which securitized its assets through a conduit dubbed Mettle, is putting the young market through its corporate malfeasance paces.

According to market sources, $25.06 million equivalent of Siltek's debt was transferred to the special purpose vehicle Xavier Trading. First Rand Merchant Bank (RMB) issued the SPV $15 million equivalent that would eventually be made available to Siltek. Now that the company has declared bankruptcy, liquidators are challenging the securitization structure on the grounds that the transfer of the assets to the SPV defrauded creditors and evaded tax legislation.

At present, the situation is still considered an inquiry into the transaction; whether a formal court proceeding actually materializes is yet to be determined. The alleged fraud is reportedly based on accusations that some creditors of Siltek schemed to divest the company of its assets prior to the declaration of bankruptcy, making them unavailable to other creditors after the fact.

Furthermore, parties to the SPV stated that it had injected $10 million equivalent of its own cash flow into a preference share design that would eventually have benefited Siltek. But liquidators allege that the $10 million was actually provided by Siltek itself and recycled through the SPV in an effort to reduce its tax liability. According to the liquidator, this allowed the company to appear more profitable while also allowing it to claim tax-free dividends from the share.

Market sources said that if the liquidator should have its day in court, RMB could lose up to $15 million, but noted that the case isn't representative of securitization as a whole. "Each transaction is unique, and even more so in a developing market," said one source at the bank. "However, the South African legal framework is extremely robust, so the greatest impact of the current situation is likely to be on people's perception (on true sale), rather than on the likelihood of further securitization transactions taking place."

The South African securitization market has been considered slow in developing. Up until now deal flow has been spotty, but new securitization regulations enacted early last year have raised the market's pulse. Last year, six transactions were completed with very public profiles and involved very public mechanisms (see ASR 11/18/02). Activity that prevailed before the new securitization legislation of 2001 was generally of a private nature.

At this point, industry participants do not foresee the Siltek inquiry having a great impact on the growth and further development of securitization in South Africa because the market is relatively new. Although it is developing at an increasing rate, constant improvements are being made to the manner in which transactions are structured.

"Although this particular transaction was one of the first to occur, we believe, based on legal advice obtained by both the arranger and the rating agency at the time, that the security structure is sufficiently robust to prevail against the challenge being brought by liquidators of the originator," said one source at RMB.

At first glance, the Mettle structure seems to fall in line with current regulations. The concept of securitization is accepted worldwide, including in South Africa, as an extremely powerful financing strategy with benefits for originators, investors and arrangers. More importantly, securitization strengthens the banking sector by transferring some of the risk to the larger capital markets. As to the issue of preference shares being recycled to the originator, sources said that it is not uncommon to see the originator benefit from these shares as a first loss piece, and that it should not be construed as tax fraud.

"In the end it is possible that some finer legal points regarding the transfer of assets pursuant to securitization transactions might arise," said one source familiar with the case. "The liquidator is seeking to have the securitization arrangement set aside, and it is thus the strength of the security structure in this particular transaction that is the key issue being contested."

Simultaneously developing in the courts is the liquidation of Retail Apparel Group; liquidators allege that banks secured debts owed to them by the failing company before it went bust. The effect such a ruling might have on securitization is minimal because it pertains to competition-related ethics. "In this current court case, the question arises as to whether one needs a competition filing or not in the context of the sale of assets to an SPV," said one market analyst. "That question depends on the depth of each case; our view at the moment is that, according to the current wording of the competition act, a filing will probably not be necessary."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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