Not all the consequences of the recent Spectrum Plus ruling (see ASR, 10/10/05) on U.K. securitization have been worked out, but the case has produced a clear winner: the invoice finance or asset-backed lending market. This is the consensus from a survey which securitization specialist Demica conducted among the leading commercial U.K. lawyers on the impact of the decision of National Westminster Bank plc v Spectrum Plus Lt.
Among the lawyers participating, 90% of respondents believed that the case would lead to banks lending more frequently through invoice financing - be it factoring, invoice discounting or ABS. It is unlikely that asset-based lending itself will replace much of the current ABS volume since, in terms of scale, the former is an option more favoured by smaller companies, whereas ABS is only viable at the very top end of the scale, due to the huge structuring costs required, explained Phillip Kerle, CEO of Demica.
He added that they can both be part of a financing strategy, but are implemented with different goals in mind. Asset based lending is often used as a liquidity tool, while ABS - in the case of trade receivables securitization - is good for restructuring debt, reducing amortization pressures and accessing lines of credit. Compared with mezzanine finance that costs 300 to 500 basis points over Libor, securitizations price at around 100 basis points over Libor, Kerle said.
"The real issue the ruling actually raises is whether the Lords might at some stage rule that charges held over book debts (and their proceeds placed in an account) in securitization transactions should now be considered as floating rather than fixed charges," Kerle said.
In a trade receivables securitization, a charge will be taken over the assets - in this case invoices - that are then paid into an account. Under the contractual terms of the arrangement, the account would be paid out to the noteholders and other secured creditors of the issuer according to an agreed priority of payments. The judges in Spectrum Plus reasoned that the essential characteristic of a floating charge is that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of a future event. In the meantime, the issuer is free to use the asset as it desires and could remove it from the security, explained Kerle. To be regarded as fixed, a charge must fasten on to ascertained and definite property.' For this to happen, the debt's proceeds must be paid into an account from which the issuer is free to draw from in the ordinary course of business.
Many lawyers have argued that the charges in securitization transactions can still be characterized as fixed rather than floating charges. However, without any clear guidance from the House of Lords as to exactly how much control must be exercised for a fixed charge to be created, it is not possible to reach any definite conclusion. "When it comes to securitizations, we do not know how far the Spectrum Plus ruling can be applied," said Kerle. "At this stage, however, the ruling has not technically been extended to ABS."
Kerle said that it was possible that the issue of how the ruling affects ABS will be later argued in the House of Lords. What is clear at the moment is that this shift is likely to lead to more opportunities for the asset-based lending market. Both factoring and invoice discounting are based on the purchase of a customer's debts by a financier, which represents a change in ownership of the debts, rather than just a grant of security over debts. "In the knowledge that no other creditor can lay prior claim to these book of debts, invoice financiers can provide higher levels of funding than banks," explained the Demica survey. "Those offering factoring and invoice discounting services are set to receive more business as banks are forced to offer more expensive funding. Because of the good security achievable through invoice finance, banks too are increasingly encouraging borrowers to factor or discount their debts through the banks' own asset-based lending divisions."
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