Volume 42 | Number 3 Summer 2007
Page 2 of 5
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I. Introduction
Securitization is a financing instrument that has been used in the West for many years. In transactions of this kind, a business that has many debtors sells all or some of the indebtedness of its debtors to a third party. These debts are repaid in monthly installments to the third party over many years, and the third party pays the seller a lump sum. The third party, the buyer, is usually a corporation created specifically for the purpose of the securitization transaction. This corporation has no business history, and the certificate of incorporation prohibits any future transactions, apart from the securitization transaction for which the corporation was created. This designated corporate entity, generally known as a special purpose vehicle (SPV), issues debentures or stock to raise money on the capital market. From the legal perspective, the issuance of debentures on the stock exchange constitutes a loan. The SPV borrows money from the public and creates a security interest in the only asset it owns—the financial rights it acquired from the seller. As in other issuances of debentures, the security interest is created by appointing a trustee. In some cases, the money is raised on the stock exchange through the issuance of stock. Either way, the SPV uses the money borrowed or raised to pay the seller for the interests it acquires.
As mentioned, the SPV’s certificate of incorporation bars the SPV from transacting any other business other than the purchase of financial assets from a specific seller; these are the only assets that the SPV owns. Therefore, the SPV is not expected to post any financial losses or have any new creditors. Given the low risk involved in SPVs, they normally receive a relatively high credit rating, which facilitates the distribution of SPV stock or debentures.
In addition to the sale agreement, the seller and the SPV also execute a service agreement. The SPV has no employees and is unable to collect the debts it acquired from the seller independently. The seller, on the other hand, is specialized in its field, has communication channels with its debtors, and has an efficient collection system. The seller and the SPV enter a service agreement whereby the seller provides the SPV with collection services in consideration of an agreed payment. Under this agreement, the seller continues to collect the debts, holds the money in trust for the SPV, and transfers the money to the SPV as soon as possible. This trust structure bars the seller’s creditors from arguing that the SPV is an ordinary creditor, rather than simply a holder of a property right.
The seller does not issue stock or debentures to the investors directly, because this would expose the investors to the risks inherent in the seller’s general and ongoing operations and create competition between the investors and the seller’s other creditors. The SPV isolates the seller’s rights against the debtors from the seller’s other assets, and prevents the SPV’s ordinary creditors from collecting against these rights.
Securitization started in the mortgage sectors of Great Britain and the United States. These transactions were called “secondary mortgages,” rather than primary mortgages, which are secured loans granted by banks or other lenders to home buyers. Securitization then spread to other businesses that had financial means or long term accounts receivables. Examples of securitized assets include the indebtedness owed to suppliers by issuers of credit card transactions and the financial rights of an industrial plant against its existing and future customers.
The first securitization transactions in Israel took place a few years ago, mostly in the mortgage sector. The first part of this paper will focus on the securitization of mortgages and will also explain the problems characteristic of such transactions. The second part of this paper describes the standard structure of securitization transactions in Israel, analyzes them from a legal perspective, and addresses additional questions, such as registration and notice to borrowers. The third part of this paper deals with an issue of great practical significance: the need to register the SPV as a mortgagee in order to perfect the mortgage.
Securitization is seen in Israel in two other areas. First, automobile leasing companies and local governments have recently started securitizing their accounts receivables. Leasing companies lease various assets, mainly cars, in consideration of monthly payments by the lessees, for an average period of three to five years. Several leasing companies started to securitize this indebtedness. This securitization takes place through an SPV. The SPV creates a buffer between the leasing company and the investors. The competition in the leasing industry in Israel is fierce, and a leasing company might face financing problems if it is unable to lease all of its fleet. These problems do not affect the SPV, which is not exposed to the company’s general business operations; the SPV only acquires the rights that the leasing company has against existing customers. At the end of 2004, a small leasing company collapsed after the controlling shareholder embezzled the money he had received from lessees, which the leasing company was supposed to hold in trust for the SPV. This affair exposed the need for appropriate monitoring and slowed down the securitization process in the leasing industry. The investors, however, did not suffer any materially adverse effect and continued to receive the leasing fees paid by lessees thereafter.
The second sector in which securitization transactions have become popular in Israel is local government. The local government initiates development programs and then requires financing that exceeds the income it generates from both taxes and the contribution of the central government. Until recently, the exclusive source of financing used in these cases was loans from commercial banks. A few years ago, many local governments encountered financial difficulties, causing the banks to increase their interest rates. Consequently, the local governments started to raise money on the capital market. A strong local government can issue municipal bonds without collateral. Several local governments have recently securitized their income from the municipal tax revenue expected over the next few years, or on the future income from real estate, such as parking lots. Once local governments discovered this alternative method of financing, the banks reduced their interest rates almost immediately.1
As noted, securitization only started in Israel a few years ago. The relevant legislation is scarce, and most problems that emerge in this field must therefore be resolved through the general body of law. The most important law in this context is the 1969 Transfer of Obligations Law. There is still no case law addressing securitization, except for one case relating to the securitization of rights against lessees of automobiles.2 The securitization transactions that took place in Israel in the last few years were not as complex as those implemented in other countries. The Tel Aviv Stock Exchange has yet to issue debentures or shares of SPVs. When SPVs were being created, the players did not raise money from the general public through the stock exchange, but rather from institutional investors through private channels. It seems, however, that the first public issuance in the mortgage sector is forthcoming.