66 3 Reduction of External Funding Needs
the cash expected from the revenue-generating assets, there should be surplus
funds available within the SPV to cover that shortfall.
Third, the SPV can pay the price of the assets to the originator in tranches
(staggered payments). The use of staggered payments can help to mitigate agency
problems between the SPV and the originator (for the alignment of interests in
general, see Volume I; for credit enhancements in particular, see Volume II).
External credit enhancement. External credit enhancement is based on obliga-
tions undertaken by other parties than the SPV.
The originator can be the source of credit enhancement in a number of ways.
From the perspective of investors, the originator should provide some credit
enhancenemt. If the originator retains little or no risk, the originator has little rea-
son to screen its borrowers and ensure the high quality of the underlying assets. (a)
The originator can therefore make a cash payment to the SPV. (b) The bonds can
also be issued in tranches. The originator may purchase the junior tranche to
reduce the risk for the senior bondholders. Where the junior tranche bears the risk
of all the initial losses, the senior tranches are left with a reduced anticipated
default rate. (c) The originator might also accept an obligation to buy back bad
receivables. On the other hand, such obligations would not be bankruptcy remote
(see above).
Banks are a typical source of credit enhancement. For example, the bond issue
can be backed by a bank guarantee. Risk is often mitigated through hedging.
Covenants. In a securitisation, one of the main purposes of covenants is to
prevent the originator from damaging the revenues on which the success of the
securitisation depends. Covenants should therefore be strict enough.
Covenants are necessary also because the originator often acts as the
administrator of the receivables that it has sold. As condition of sale, the originator
would generally agree: to collect the debts arising under the contracts on the as-
signee’s behalf; not to vary or waive any of the terms of the contracts without the
assignee’s consent; and not to allow any rights of set-off to arise in the obligor’s
favour.^161
However, typical covenants that support securitisations are largely ineffective
where the underlying assets fail to generate enough revenue. In such a case,
bondholders and noteholders may not be able to exit the investment without
suffering serious financial losses.
Securitisation Structures
A securitisation can be structured in various ways. As an alternative to the
standard asset-backed securitisation, the originator may choose, for example, a
secured loan structure or a whole business securitisation structure. One of the
fundamental differences between standard securitisation and secured loan or
whole business securitisation relates to the involvement of the originator. Unlike
(^161) Ambery R, Bowmer S, Why Don King Needs a Haircut - Transfer and Assignment of
Contracts: How to Sell Trade Receivables under English Law, JIBL 15(9) (2000) pp
216–220.