Demystifying Securitisation and Enforcement

1. Demystifying Securitisation and Enforcement Thursday 11 September 2008 Jonathan Lawrence, Partner, K&L Gates LLP jonathan.lawrence@klgates.com 020 7360 8242

2. Securitisation • A means of raising finance secured on the back of identifiable and predictable cash flows derived from a particular class of assets (such as rents, receivables, mortgages or operating properties).

3. CMBS • Commercial Mortgage Backed Securitisation

4. Swap Counterparty Typical CMBS deal Trustee Swap Mortgages & Loan Sale Mortgages SPV Borrower Originator/ Seller SPV Issuer Investors Secs Loans £ £ Liquidity Loan SPV Borrower Servicer Liquidity Provider

5. Originator Issuer SPV Typical CMBS cashflows £ mortgageP & I £ mortgageP & I £ noteP & I Investors Borrowers SPVs Collection Account Issuer Account Note PurchasePrice rent rent Tenant Tenant Tenant £ Swap payment Swap Counterparty

6. Originator / Seller • Creates or acquires receivables • e.g. banks making loans • Offers lower cost of borrowing e.g. lower margin • Remove receivables from balance sheet • Redeploy capital

7. Issuer • A special purpose vehicle (“SPV”) company • Typically shares held by charitable trust i.e. separate from all other participants • Remote from Originator / Seller • Established in low-tax or no-tax country e.g. Jersey, Cayman Islands • Issues securities

8. Investors • Buy the securities issued by the SPV • Receive interest and capital payments • e.g. insurance companies, hedge funds, high net worth individuals • Consider yield, liquidity and exposure

9. Arranger • Structure transaction • Ensure maximum return available on assets • Introduce appropriate counterparties • Tranching / slicing the securities

10. Trustee • Holds benefit of covenants and rights in securities on behalf of Investors • May also hold security over assets on behalf of Investors • Appointed by issuer under a Trust Deed which defines duties, roles and fees

11. Servicer • Ensures underlying receivables, e.g. interest and principal repayments, continue to be collected • Issuer may initially perform function in-house or employ third party • Fees must be competitive to enable third party servicer to be appointed

12. Swap counterparty • Takes on risks in securitisation in return for fee • e.g. interest rate changes, currency exchange rate movements • Will be financial institution

13. Liquidity provider • Often bank supplying loan facility to Issuer on a standby basis • Ensure adequate cashflow received by Issuer to meet its payment obligations to Investors • Guard against underlying Bs not paying or late paying

14. Securities • Divided into different classes carrying differing rights to payment and differing rates of interest • Given credit rating by credit rating agency e.g. Moody’s, Fitch, Standard & Poor’s • S&P ratings: AAA (extremely strong capacity to pay interest and capital) to D (in default) • Analysis of default likelihood

15. Worldwide CMBS issuance 2007 compared to 2008

16. CMBS • Advantages: • Liquidity • Favourable financing rates

17. CMBS • Disadvantages: • Lack of transparency or financial disclosure • Lack of borrower/property diversity

18. UK Real Estate Finance Market - 2007 • The banks took on a record level of commercial real estate debt - as much as £247bn • Gross lending totalled £83.7bn, the highest level recorded

19. UK Real Estate Finance Market Perspective 2007 represented 3% per cent increase on 2006 levels, which was the lowest since the survey began in 1998, and much lower than the average annual growth of 24% between 1999 and 2006

20. Enforcement • B unable to repay loan • B has breached its covenants • Enforcing security and insolvency procedures

21. What is insolvency? • When a corporate entity “is unable to pay its debts” (Section 123 Insolvency Act 1986) • Tests • Failure to pay a statutory demand • Execution on a judgement is unsatisfied • Unable to pay its debts as they fall due (“cash flow” test) • Value of assets less than liabilities (“balance sheet” test) • Threshold amount: £750

22. Relevance to Lenders? • Likelihood of repayment of loans if B insolvent? • Loan agreement contains safeguards: chiefly through events of default and acceleration • How does acceleration help L?

23. Pre-insolvency: Protection for the Lender • Most importantly through security • Fixed charge • Floating charge • Security Trustee • Effect? Enforcement and realisation • 100% flawless? • No…

24. Deficiencies with taking security • Floating charges and the “prescribed part” • Statutory order of priority of proceeds • Moratorium (with certain insolvency proceedings) • Deficiencies in realisation

25. Insolvency Procedures • Liquidation • Administration • Administrative receivership and fixed asset receivers (e.g. LPA receiver) • Compromise arrangements

26. Background to the Enterprise Act 2002 • Came into force on 15 September 2003 • Promotion of “rescue culture” • Abolition of Crown preference • Creation of the prescribed part

27. Receiverships, Administrations and Company Voluntary Arrangements in England and Wales registered at Companies House (figures from the Insolvency Service website) Year Receivership Administrator In Administration Company Appointments Appointments (Enterprise Act Voluntary 2002) Arrangements 1997 1,837 196 : 629 1998 1,713 338 : 470 1999 1,618 440 : 475 2000 1,595 438 : 557 2001 1,914 698 : 597 2002 1,541 643 : 651 2003 1,261 497 247 726 2004 864 1 1,601 597 2005 590 4 2,257 604 2006 588 0 3,560 534 2007 477 2 2,327 399

28. Insolvency Procedures: Administration • Active businesses, significant assets, potential • Statutory “purposes” brought in by Enterprise Act 2002 • Rescue company as a going concern • Achieve a better result than in liquidation • Realise property for secured (or preferential) creditor • Moratorium • Appointment is by notice (company, directors or QFC, who has overriding powers) or by application to court (company, directors, all creditors) • First ranking QFC can appoint its own choice of administrator • Administrator owes duties to all creditors

29. Insolvency Procedures: Receivership • The appointment of a person to administer (i.e. sell) specific property charged to a creditor • Administrative Receivership, now relatively rare – Enterprise Act 2002 limits this to security created before 15 September 2003 and certain other exceptions • Realise certain assets of B charged to appointor to repay indebtedness to appointor • No moratorium • Appointment by a qualifying floating charge holder with a floating charge over all, or substantially all, of the assets of the debtor company • Administrative receiver owes duties solely to appointor • Blocks appointment of administrator • LPA Receivership and Fixed Charge Receivership

30. Moratorium Duty to act in the interests of all creditors Deemed agent of the company Administrators must provide proposals and information to all creditors Lasts for 12 months unless extended Administrator has wider statutory powers e.g. to dismiss/appoint directors call meetings No Moratorium Main duty is to appointor (i.e. to chargeholder) Also deemed to be the agent of the company Administration vs Administrative Receivership

31. Insolvency Procedures: Liquidation • Terminal procedure • Appointment? Shareholder resolution (voluntary liquidation) or court order (compulsory liquidation) • Realisation, distribution, dissolution • Order of priorities • Delay in enforcement

32. Insolvency Procedures: Compromise Arrangements • Creditors agree procedure for B’s survival • Two main types: • Scheme of arrangement • Requires application to court for an order that a meeting of creditors is summoned • Need ¾ by value and simple majority of creditors to agree to the scheme • Binding on all creditors once approved by the court • Company voluntary arrangement (CVA) • 75% of creditors by value and simple majority of members to agree to the arrangement • Not binding on secured creditors unless they have agreed to the arrangement • Supervised by an insolvency practitioner • No automatic moratorium

33. Administrative Receivership • May be appointed by: • Holder of floating charge (created before 15 September 2003) over whole/substantially the whole of assets • Holder of floating charge (created after 15 September 2003) over whole/substantially the whole of assets where a statutory exception applies • Floating charge crystallises • Control and management passes to administrative receiver (“AR”)

34. Administrative Receivership • No moratorium triggered • AR’s principal duty – realise property in order to repay debt owing to appointer • Often results in quick sale at price sufficient to discharge secured creditor only • Company then usually placed in liquidation

35. Administration • Company’s assets can be reorganised or assets realised under the protection of a moratorium • Enterprise Act 2002 – floating charge holder prohibited from appointing an administrative receiver

36. Administration • Moratorium only possible where one of the statutory purposes of administration is likely to be achieved • rescuing the company as a going concern • Achieving a better result for company’s creditors as a whole • Realising property to make distribution to one or more secured or preferential creditors • N.B. hierarchy

37. Administration • Appointment of administrator • By court - (company/company directors/creditor etc can apply) • Out of court – company/company directors/holder of “qualifying floating charge” • N.B. restrictions/notice • Officer of the court • Interests of ALL creditors

38. LPA Receivership • L with fixed charge over property can enforce by appointing an LPA receiver • LPA receiver will act as B’s agent to sell the charged property/collect rental income for L’s account • Advantages: • Alternative to L taking possession of property • LPA receiver often an experienced property professional • Quicker and cheaper for L

39. Liquidation • Assets of company realised and distributed to creditors in statutory order of priority • Company is then dissolved • Compulsory liquidation (court order) OR • Voluntary liquidation (shareholder resolution) • Can be a slow process