Introduction
Securitization transactions are an important aspect of the financial industry, allowing companies to raise funds by selling off their future cash flows. These transactions involve the issuance of debt instruments, which are backed by receivables that the issuer expects to generate in the future. In order to assess the creditworthiness of these transactions, credit rating agencies play a crucial role. In this guide, we will explore the key aspects of credit rating assessment for securitization transactions, providing you with a comprehensive understanding of the process.
Securitization transactions involve the creation of debt instruments backed by future cash flows. These cash flows can arise from various sources such as property rental receivables, toll receivables, credit card receivables, and oil and gas sale receivables. Unlike traditional funding methods, securitization allows issuers to borrow at lower costs and for longer terms. The credit rating of these debt instruments plays a crucial role in determining the cost of funds for the issuer.
Credit rating agencies, such as CRISIL, assess the creditworthiness of securitization transactions. They evaluate various factors including the issuer's creditworthiness, the creditworthiness of obligors (counterparties), and the impact of the transaction on the issuer's other obligations. Additionally, they analyze the structure of the transaction, the mode of collection, and the schedule of payments to investors to assess the strength of the future cash flow. Let's delve deeper into each of these factors.
The creditworthiness of the issuer is a crucial factor in determining the credit rating of securitization transactions. The issuer's ability to generate future cash flow over the life of the instrument is of paramount importance. Credit rating agencies analyze the extent of linkage between the future cash flow and the issuer's operating performance. They assess the issuer's operational and financial performance, as well as its ability to continue operations in a financial distress scenario. Additionally, they consider the issuer's track record and ability to meet its debt obligations in a timely manner.
The creditworthiness of the obligor, or counterparty, from whom the cash flow to service the rated debt is received is another important aspect of credit rating assessment. If there is a single obligor, the rating on the instrument may be constrained by the rating of the obligor. In the case of multiple obligors, the rating is determined based on the individual ratings and their contribution to the future cash flow. Retail future-flow securitization transactions with a large number of obligors are assessed based on the diversity of the retail pool and the track record of collection efficiency.
Securitization transactions involve prioritization within the total cash flow available to the issuer. If a significant portion of the future cash flow is used to meet the rated debt obligation, this may put pressure on the issuer's free cash flow, impacting its ability to meet other operational and financial obligations. Credit rating agencies evaluate the size of the rated transaction in relation to the issuer's scale of operations, the application of the proceeds of the rated debt, and the adequacy of residual cash flow to meet operating commitments and any remaining debt obligations.
The structure and payment risk analysis involves a detailed study of factors such as the structure of the transaction, the mode of collection, and the schedule of payments to investors. Credit rating agencies examine the agreements with obligors, the historical collection pattern, and the assumptions made for projecting future cash flow. They also assess the co-mingling risk, which refers to the mingling of the identified future cash flow with the issuer's other cash flow. Additionally, they consider other factors that can result in variability in future cash flow.
The robustness of the transaction's legal framework is a crucial factor in determining the credit rating of securitization transactions. Credit rating agencies assess the likelihood of full and timely payment on the rated instrument based on the legal framework of the transaction. Future-flow structures may be treated as executory contracts in the event of the originator's bankruptcy. The rating on the instrument takes into account the probability of discontinuation of operations and the probability of timely payment on other rated debt.
In future-flow transactions, the issuer must maintain an escrow account into which all amounts due on the instrument are deposited. The servicing of the debt instrument depends on payments from the escrowed cash flow, making it essential for the cash flow to be accessible to investors at all times. Credit rating agencies require the escrow account to be under the control of the trustee and consider whether the cash flow is charged in favor of any other creditors of the issuer. They also review the presence of any prior encumbrances and the necessary consents or pari passu letters.
Future-flow securitization transactions can be structured with or without recourse to the issuer. When the instrument is with recourse, the rating is subject to the floor of the issuer's rating, as the issuer is obliged to make the debt payment in the event of a shortfall in collection. Non-recourse instruments, on the other hand, do not have a floor rating and are more common when the linkage between future cash flow and the issuer's performance is weak and the cash flow certainty is high. In such cases, cash collateral or over-collateralization is required to protect investors' interests.
Proper documentation is essential for future-flow securitization transactions. Credit rating agencies require a tripartite agreement between the trustee, the issuer, and the account bank, incorporating the payment structure and establishing the trustee's rights over the cash flow. They also review the trustee agreement or trust deed and the offer document, which should contain the payment mechanism. Adequate liquidity and a sufficient debt service coverage ratio are necessary to mitigate risks.
Credit rating agencies play a crucial role in assessing the creditworthiness of securitization transactions. By evaluating various factors such as the issuer's creditworthiness, the obligor's creditworthiness, and the impact on the issuer's other obligations, they provide valuable insights into the strength of the future cash flow. Additionally, they analyze the structure of the transaction, the mode of collection, and the schedule of payments to investors, ensuring the robustness of the securitization process. Understanding the credit rating assessment process is essential for both issuers and investors involved in securitization transactions.
H. Burak Erten