Portuguese Securitisation: Developments in the Past 12 Months
Over the last 12 months the Portuguese securitisation market has experienced a significant period of development, embracing innovation in relation to new asset classes and legal structures, while existing asset classes have matured rapidly. This article will review four of the most interesting transactions that have closed in that period: Galp Finance, AR Finance, Explorer 2004 and LTR 5. It will also consider some of the developments that are likely to be seen in the next year.
Before considering the developments in structures and assets that the four transactions mentioned above have brought to the market, some general trends should be noted. These illustrate the growing depth and maturity of the Portuguese securitisation sector.
The most welcome feature has been the return to the market of several banks as repeat issuers. In the last year Banco Espiríto Santo (Lusitano Mortgages No.2 plc), Millennium BCP (Magellan Mortgages No. 2 plc), Banco Totta & Açores (HippoTotta No.2 plc) and Caixa Económico Montepio Geral (Pelican Mortgages No.2 plc) have each undertaken their second residential mortgage securitisation. Of these transactions, HippoTotta 2 ranks as the largest to date, with €3 billion of residential mortgages originated by Crédito Predial Portugues being securitised.
An important entrant to the securitisation market in this period was Portugal’s largest financial institution, Caixa Geral de Dépositos (CGD). CGD closed two transactions in the last quarter of 2003, a residential mortgage securitisation (Nostrum Mortgages 2003-1 plc) and a consumer loan securitisation (Nostrum Consumer Finance plc).
Several repeat issuers returned with consumer finance and auto loan and lease receivables securitisations, including Banco Mais (Bmore 4), BPN (Chaves 4) and Banco Finantia Sofinloc (LTR 5). Finibanco also returned with Aqua Finance No.2 plc in August 2003, which was then tapped in July 2004.
Another indication of the increasing maturity of the market is the advent of “clean-up” calls on some of the earliest Portuguese asset-backed issues. Both LTR Finance No.1 Limited and Nova No.1 Limited, transactions that pre-date the Portuguese Securitisation Law of November 1999 (Decree Law 453/1999 of 5 November, as amended) (the “Portuguese Securitisation Law”), were redeemed within the last year.
Two other developments should be noted. First, 2004 has seen the first use in a public transaction of the securitisation company (“STC” – sociedade de titularização de créditos) structure, the issue of the Explorer 2004 Series 1 Notes by SAGRES STC, S.A. All of the other Portuguese securitisations completed since the legal regime established by the Portuguese Securitisation Law was finalised have used a securitisation fund (“FTC” – fundo de titularização de créditos), in combination with an Irish special purpose company as the bond issuer. The Explorer transaction is considered in more detail below.
The second development is the increasing level of interest in combining Portuguese assets with assets originated in other jurisdictions. This has been a feature of both Finantia Sofinloc’s last two transactions and will certainly be evident in forthcoming deals.
The Galp transaction, arranged jointly by Deutsche Bank and Caixa-Banco de Investimento, was Portugal’s first trade receivables securitisation. The €210 million securitisation involved receivables arising in the supply of oil and related products by Petróleos de Portugal – Petrogal, S.A. to corporate customers throughout Portugal. The nature of the receivables and the originator posed some important legal questions. First, the transaction had to be structured to permit regular redemptions and issues of units by the Portuguese securitisation fund to reflect the rapidly revolving pool of trade receivables. In this respect, the transaction anticipated a change to the Portuguese Securitisation Law that took effect later in 2003, which now permits such issues and redemptions of units without the prior approval of the Portuguese securities commission, the CMVM. To take advantage of this, the regulation establishing the securitisation fund must be drafted with these subsequent issues in mind. Notice of these issues is required to be given to the CMVM.
A second concern that had to be addressed was the impact that the insolvency of Petrogal would have on the transaction. This concern was brought into focus by two issues. First, the revolving nature of the entire pool exposed the transaction to the risk of a significant shortfall were the collections trapped in the bankruptcy of Petrogal for any extended period of time. The position could be contrasted with a traditional residential or consumer loan securitisation where the shortfall in such circumstances would be limited, perhaps, to one or two interest period collections. The second, related issue turned on the potential exercise of set-off rights by Petrogal’s customers in the event of Petrogal’s insolvency. This concern arose because Petrogal is not a bank or financial institution and does not, therefore, have the benefit of the Portuguese Securitisation Law’s provisions which deem the assignment of receivables by a bank or financial institution to take effect without notice to the obligor of the assigned receivable. Instead, the assignment by Petrogal will bind its customers only when notice of the assignment is given to them. Until that time, the securitisation transaction is exposed to the risk that the obligors will continue to accrue rights of set-off that may be exercised against Petrogal to the detriment of the securitisation.
These risks were addressed in the transaction structure by a series of dynamic reserves, including a set-off reserve, by the inclusion of a back-up servicer in the structure, by the provision of a liquidity facility to cover six months of interest on the notes plus senior expenses and by a close analysis of the likely course of legal events if Petrogal were to become subject to insolvency proceedings. It was clear that a period of at least 35 days would be available between the commencement of bankruptcy proceedings and a declaration of bankruptcy. The rating agencies took the view that this period should be sufficient for the back-up servicer to take over the servicing function and for notices of assignment to be given to Petrogal’s customers so as to crystallise any rights of set-off and to divert collections away from accounts that might remain frozen for an extended period while a bankruptcy official considered the securitisation fund’s request for the release to it of collections. In the event that collections were trapped for some time before an insolvency administrator acceded to the fund’s request for their release, the transaction would have the benefit of the liquidity facility to meet potential shortfalls on interest payments under the notes.
The issue by AR Finance 1 plc of €100 million of notes in December 2003, jointly arranged by BNP Paribas and Espírito Santo Investment, brought to the market one of the most diverse pools of assets yet seen in a Portuguese transaction. The receivables, which were originated by Banco Alves Rebeiro, S.A., included residential and commercial mortgage loans and real estate leases. Some of the commercial mortgage loans had been extended to finance the acquisition of pharmacies, a business sector that is highly regulated in Portugal, which gave rise to certain legal issues that are beyond the scope of this article.
The inclusion of real estate leases required an analysis of the effect of the originator’s bankruptcy on the security for the transaction. Although these were finance leases, and Portuguese counsel was confident that the collection of the assigned payments could be enforced by the securitisation fund in an insolvency of Banco Alves Rebeiro, the underlying property remained an important part of the fund’s security, particularly in the event that a lessee defaulted on its payment obligations. During the life of the lease, title to the leased property remains with the originator/lessor. It was necessary, therefore, to ensure that the transaction included a mechanism for the securitisation fund’s interests in the underlying lease property to be protected in the originator’s insolvency. This was achieved by providing for either a transfer of the title to the property to a nominated entity (which might be the fund) or the registration of a first ranking mortgage over the property for the benefit of the fund. The transaction documentation allows for either step to be taken with the minimum of additional documentation and/or satisfaction of notice requirements. The robustness of this mechanism came under careful scrutiny by the rating agencies.
AR Finance was also notable in that both classes of rated notes were rated ‘AAA’. In the case of the Class B Notes this was achieved with the benefit of a guarantee provided by the European Investment Fund. This was the first public assetbacked transaction in Portugal with the benefit of a credit enhancement of this nature.
The AR Finance transaction includes provision for the note issue to be tapped before 15 December 2004.
The Explorer transaction, arranged by Citigroup, was a very significant securitisation for the Portuguese market in several respects. It was the first securitisation to be undertaken by the Republic of Portugal. It is believed to have been the first ever securitisation of tax payments in Europe. It was also the first use of an STC (securitisation company structure) in a public transaction.
SAGRES STC, S.A., which is owned by an entity within the Citigroup Group, issued a €1.7 billion series of rated notes and applied the proceeds of the note issue in acquiring a €11.44 billion portfolio of tax and social security payments due from individuals and companies in Portugal which are currently in default. These assets are held by SAGRES STC, S.A. on a segregated basis from any assets that may be acquired in future with the proceeds of unrelated note issues. Payments of deferred purchase price will be made by SAGRES STC, S.A. from collections received to the extent that funds are available having met other senior commitments.
The transaction was also significant in that it prompted the enactment by the Portuguese Government of two pieces of legislation with more general application. The first of these was an amendment to the Portuguese Securitisation Law. Amongst other provisions, this amendment clarified and expanded the role of the “common representative” of the bondholders. This long-standing feature of domestic Portuguese bond transactions has now some similarities to the role played by a bond trustee in a transaction governed by English law. In the Explorer transaction the role was filled by The Law Debenture Trust Corporation p.l.c.
The second legislative change was to amend the Portuguese Securitisation Tax Law of August 2001 (Decree Law 21/2001 of 4 August) (The “Portuguese Securitisation Tax Law”). These amendments introduced a procedure which enables an issuer to rely on a certificate as to non-Portuguese tax residence obtained by the international clearing systems from bondholders so as to make interest payments free of Portuguese withholding tax. This change removed a major impediment to the structuring of direct issues of notes, whether by an STC or an FTC, out of Portugal.
At present SAGRES remains the only STC that has been authorised by the CMVM. It is expected that further note issues by SAGRES will be forthcoming in the second half of 2004.
The LTR 5 transaction, arranged by HSBC, was a €210 million securitisation of vehicle and equipment loans and leases and vehicle long term rental contracts originated in Portugal and Spain by members of the Banco Finantia group. This transaction is significant in that it combines in a single structure for the first time the use of a Portuguese securitisation fund (FTC) and a Spanish securitisation fund (“FTA” – fundo de titulización de activos). The transaction benefits, therefore, from the provisions of both the Portuguese and Spanish legal regimes facilitating securitisation.
The transaction involves both funds issuing units (in the case of the FTC) and bonds (in the case of the FTA) to an Irish special purpose company, which in turn issues bonds into the capital markets. The structure permits (subject to certain limits) the reallocation of principal between the Portuguese and Spanish funds during the revolving period in the event of a shortfall in receivables being offered for sale by either the Portuguese or Spanish originator.
While completion of the transaction involved obtaining approval from both the Portuguese securities commission, the CMVM, and its Spanish counterparty, the CNMV, for the establishment of the Portuguese and Spanish funds, respectively, the additional regulatory burden is off-set by a robust legal structure in both jurisdictions that is favourably treated by the securitisation laws of those countries.
After a period of considerable activity and innovation it would be reasonable to expect a phase of consolidation in the Portuguese market. However, that does not appear very likely with developments in the market continuing apace. Four strands to these developments can be identified.
First, the range of asset classes will continue to expand and deepen. It is likely that the Portuguese Republic and entities connected with the State will embark on further securitisations. It is also likely that more activity will be seen in the trade receivables sector.
Secondly, the likely enactment of legislation permitting the issue of covered bonds by Portuguese banks will provide a useful alternative to residential mortgage securitisations. Several of the leading banks have already indicated their interest in the use of covered bonds; whether covered bond issuance has an immediate impact on the popularity of residential mortgage securitisation will depend on the speed with which the necessary legislation to provide for covered bond issuance is finalised by the Portuguese Government.
Thirdly, after in excess of 25 transactions involving the repackaging of the units issued by a securitisation fund (FTC) through an Irish special purpose company, it is increasingly likely that a direct issue of FTC units into the capital markets will be structured shortly. Issues of listed and rated units by French and Spanish securitisation funds are now relatively commonplace. The changes discussed above to the Portuguese Securitisation Tax Law have removed a significant obstacle to direct issuance. The reception for the SAGRES STC issue of the Explorer notes has shown the market’s willingness to purchase notes issued directly by a Portuguese vehicle. The first direct issuance by an FTC cannot be very far away.
Finally, Portuguese originators remain interested in the possibility of synthetic transactions and at least one such transaction is widely known to be in the deal pipeline. With this and other developments likely in the near future, it would appear that the next 12 months will be at least as interesting as the last in Portugal.