Ignacio López-Balcells, Esq.

BUFETE B. BUIGAS
Abogados asociados
Muntaner, 240, 4º 2ª
08021 Barcelona
Spain
34-93 200 12 77
Fax 34-93-200 24 34

ASSET-BACKED SECURITIZATION IN SPAIN

A. INTRODUCTION
This chapter provides an introduction to a form of financial innovation, and the process of its developing in Spain, which is the relatively recent phenomenon of asset-backed securitization.

B. SECURITIZATION
Generally speaking, this process involves the transforming of an illiquid asset into a security, managing to transform risk by means of separation of good financial assets from a company or financial institution with little loss of revenue. To that effect, corporations and financial institutions sell or assign certain cash flows to a special purpose vehicle (SPV), deemed bankruptcy remote by lawyers because of its isolated entity nature. The SPV conforms its assets with these receivable, and its liabilities will be conformed by different ways of financing, such as commercial paper securities, bonds and medium-term notes, with its assets backing.

The SPV issues the asset-backed securities, which are bonds or notes backed by loan paper, or accounts receivable originated by banks, credit card companies or other providers of credit, often enhanced by bank letter of credit or by insurance coverage provided by an institution other than the issuer. This chapter aims to explain how this finance tool can be used, pointing out its advantages and its developing process in Spain.

1. The Securitization Process

There are two essential parties involved in the securitization process. The first one is the company that sells its receivables, but still managing those receivables with no changes in the client portfolio. The receivables get off the balance sheet, but they are still managed the usual way, so that the selling company continues collecting its receivables and creating new ones, just like before the securitization process. The second party is the SPV, which obtains financing from a third entity, the issuer of top credit quality commercial paper.

The process may be summarized as follows. The company sells its receivables, obtaining the needed liquidity, issuing commercial paper with rating A-1+/P-1 through a channel which, generally, is in charge of carrying out issues for several SPVs. Cash flows sold to the SPV will be improved, as far as its credit quality is concerned, so that the credit quality of the financial assets sold by the SPV is higher than the credit quality of the company that has created the assets. This credit enhancement of the cash flows can be faced by some of the colateralization, mechanisms, letter of credit facility and partial guarantee given by a financial corporation with minimum investment grade rating.

Different forms of securitization are possible in Spain, although they may be different from what securitization is supposed to be in other countries which makes it necessary to establish some features that always have to be kept in mind, when we refer to securitization:

(1) Securities issued proceed from a pooling of a group of similar non-traded financial assets which generate cash-flows on which the profitability of these securities will be based;

(2) The assets are transferred or acquired by an SPV -asset-backed get off the balance sheet of these corporations, which obtain liquidity in consideration.

(3) The SPV issues securities;

(4) Securitization is basically a way of finance so what a company aims at by securitization an asset will not be earnings, but the best financing way that the market can offer;

(5) Securitization involves a cash-flow transformation -first of all, originally cash-flows corresponding to asset-backed do not come straight from payers to final investors, but trough an intermediate entity;

(6) Risk reduction, for example, systematic risk assessment, by diversification or partial guarantees; and

(7) Division of the benefits and the risks among investors on a pro-rata basis.

2. Potential Benefits to Corporations

Without any doubt, securitization involves several advantages for the companies, the main ones are the followings:

(1) Securitization is an off-balance way of finance, and so incomes due to receivables do not have the same treatment as a debt in the balance-sheet -this option of getting the assets off the balance sheet, improving all management ratios, can be used to finance the business developing or to reduce a more expensive financial debt;

(2) Asset-backed deals properly done provide lower-cost financing, despite the high initial expenses;

(3) There are no covenants relating to balance and financial ratios -only the receivables evolutions are analyzed;

(4) Retains a competitive advantage;

(5) Recognition of gains (or losses);

(6) Improves asset/liability management; and

(7) Improves the management of an important asset for any company giving a direct value to the managing of receivable - the better the receivables are managed, the higher the sellable amount will be.

C. SECURITIZATION IN SPAIN
Securitization deals carried out in Spain have used different ways of securitizing assets. The first one is known as 'on-balance' securitization: the corporation issues securities with its assets as a guarantee so that the risk of payment default is not transferred, and also the asset and the security remain in the balance sheet. This securitization form is regulated by Act 2/1981of dated March 25, 1981.

The second way of securitizing assets is the 'off-balance-sheet' securitization: the securitization process is carried out by an independent institution, which purchases the assets from the credit institution, and issues securities deemed asset-backed securities. Generally they are fixed-income securities, homogeneous, standardized and capable to be negotiated in the capital market. The relevant fact is that this way to securitizate involves getting the assets off the balance sheet and the risk is transferred to the security holder. When the asset to securitizate is a mortgage credit or loan, it is referred to as a mortgage asset-backed.

Definitively, asset-backed securitization is a consolidated way of financing in the international capital market, although, despite its great business perspectives, its development has not been the same in Spain as in other countries of the world. This is due, basically, to the fact that it has not been clearly and properly regulated until recently, as will become clear in the legal references mentioned below.

1. Asset-Backed Spanish Regulations

As mentioned above, securitization is a relatively recent phenomenon in Spain. 'On-balance sheet' securitization first appeared in 1981, with Act 2/1981 Law, which allowed the mobilizing of mortgage loans, issuing bonds and mortgage bonds. Later, 'off-balance' securitization was regulated, exclusively in the mortgage market, by Act 19/1992 of july 7th, 1992. The model created of mortgage asset-backed was permitted as patrimonios cerrados sin personalidad juridica which transformed mortgages flows into fixed income securities, deemed 'Bonos de Titulación Hipotecaria', with the main purpose of decreasing residential loans.

The model created was based on a trust system, in which some specialized financial entities named management companies of mortgage asset-backed securitization 'Sociedades Gestoras de Fondos de Titulación Hipotecaria' were supposed to manage, under the supervision of the Stock Exchange Authorities 'Comisión Nacional del Mercado de Valores- CNMV', the financial transforming process involving mortgage asset-backed securitization. As these agencies obtain higher degree of competency during the securitization process, their existence is greatly positive, as they provide specialization, transparency, accuracy and information.

This Law dated 1992 is the first step to securitization in Spain, creating the mortgage-asset-backed as the way to transform credits in securities and to canalize flows. The MAB constitution requires to be verified and registered in the CNMV, thus it is not necessary to entry it in the Registro Mercantil (Trade Register). It is important to point out that the (Fondos de Titulación Hipotecaria) were entitled to issue all kind of securities and to contract for other financial instruments, which allowed to transform the financial characters of the flows and to improve the several risks of the securities issued.

Act 19/1992 is the first serious step towards the implementation of securitization in Spain, creating mortgage asset-backed securitization as a way of transforming credits in securities and to canalize flows. The mortgage asset-backed constitution requieres verification and registration with the CNMV. The CNMV, established, as additional obligations to mortgage asset -backed securities, the following:

(1) The securities issuing must be preceded by a previous audit of the mortgage loans securitized;
(2) The need of them beeing qualified by a rating agency, previously recognized by the CNMV; and
(3) The need of the tramos subordinados to quote in an official market

Nevertheless, this regulation was not complete enough to securitize credits other than mortgages, so further regulation was needed to finally provide a sufficient legal framework which gave comfort to the market: Royal Decree Law 3/1993 of February 26,1993, which allowed the Government to draw up the securitization process for other loans and credits, including those derived from leasing operations and from the small-and-medium-sized businesses activities.

D. LATEST ASSET-BACKED SECURITIZATION REGULATION IN SPAIN
As a consequence of the authorization granted by Royal decree Law 3/1993 mentioned above, the general regulation of asset-backed securitization is now covered by Royal Decree Law 926/1998 of May 14th, , 1998. This new regulation basically maintains the 1992 model, that is, a specific securitization fund (Fondo de Titulación de Activo) and a isolated managing of funds entity are needed, providing a wider regulation of the 'off-balance sheet' securitization, which manages to adapt the securities issuing primary markets and to liberalize financial markets, making them more competitive.

1. Financial Configuration of the Specific Securitization Fund´s Assets

The Spanish legal system is shaped so as to maintain the trust system as a pool of assets and liabilities duly determined without legal personality. Regarding the assets, its financial configuration is composed of financial assets and other rights, admitting both the credit assignments placed in the assets off the assignor and future credit rights, conforming incomes of certain or estimated amount. Its assignment must be documented in a contract, unmistakably proving ownership transmission.

The assets due to securitize, in order to carry out a proper securitization, must be assets which generate income flows with the possibility of generating payment flows to remunerate final investors. Though the law does not determine the assets capable of being securitized, as it only requires them to be "credit rights placed in the assets of the assignor". It is generally accepted with regard to the types of cash flows producing assets, such as:

(1) Loans, since they provide a more or less constant flow;

(2) Leasing agreements;

(3) Rentals;

(4) Collection rights as a consequence of installments;

(5) Auto loans and royalties; and

(6) Tax liens.

2. Financial configuration of the Specific Securitization Fund´s Liabilities

The financial configuration of the liabilities is generally composed by fixed income securities, even though, to facilitate the viability of certain structures, financing by loans given by credit entities is admitted. Generally, financing with securities will have to be over the 5º per cent of the liabilities, unless there are any financial, technical, legal or market causes which justify a minor percentage ,being those determined when the specific securitization fund is already constituted.

E.- SPECIFIC REQUIREMENTS OF CREDIT ASSIGNMENTS
To preserve the transparency and regularity of the credit assignments and their financing Royal Decree Law 926/1998 establishes certain specific requirements, which all credit assignments must comply with.

1. Subjective requirements
The assignor will need to have audited accounts of at least the last three accounting periods, with favorable opinion on the most recent ones, but may be exonerated from this requirement by the CNMV when the assignor entity has been recently constituted.
The assignor must file the annual accounts with the CNMV in order to make them public and available to the market. These two requirements may not be enforced when the guarantor or debtor of the credit assigned in an estate, an autonomous government or an international organization of which Spain is a member.

2. Objectives requirements

The assets´ cession must be full and unconditional for the full remaining term until its expiration. The assignee must not give any guarantee to the assignor, nor ensure the success of the deal. In any case, the assignor will retain the administration and management of the given credit, unless the opposite is agreed.

3. Formal Requirements

The assignments will be formalized in a contractual document to guarantee the business. In all new incorporations of assets to the specific securitization fund, the managing company will file with the CNMV, for its verification, a prospectus, that is, a signed document by the assignor entity which should contain:

(1) Details of the assets to be included and their characteristics; and

(2) A pronouncement of the managing company that the new assets fulfil the requirements established in the constitution of the specific securization fund.

F. STRUCTURES OF SPECIFIC SECURIZATION FUNDS
In order to adjust the different kinds of flows entering the fund securization process, the Spanish rules provide for two kinds of structures:

1. Closed Structures

Closed structures are considered those which, from the moment of their constitution, will not be changed, neither their assets nor liabilities. This structure is similar to the specific securization fund. Nevertheless, asset substitution and rectification rules can be stablished in the case of previous amortization of the gathered assets in the fund, and of rectification of hidden liabilities of the initially composed assets, when it is later proved that they do not have the foreseen attributes in the brochure or in the specific securitization fund constitution public deed. This rule is also to be applied to open funds as set out below.

2. Open Structures

Open specific securitization funs are considered those whose assets, liabilities, or both can be modified after the constitution of the specific securitization fund in some of the following ways:

(1) Modification of the liabilities when the successive issued titles and the agreement for new credits are foreseen.
(2) Modification of the assets when they have a renewable character; and
(3) Enlargement of the assets when the inclusion of new assets can be foreseen and, in consequence, the issue of new titles or the arrangement of new credits.

G. LEGAL REQUIREMENTS FOR THE SPECIFIC SECURITIZATION FUND CONSTITUTION
The constitution of the specific securitization find must be carried out by means of a public deed, in which the assets integrated in the specific securitization fund, the manegement rules, the collection management and, if necessary, the substitution rules will be determined. Legal, economic and financial characteristics must also be detailed, as well as the balances, incomes, financial flows, collection condition, maturity dates and amortization systems. In the case of future credit rights, bases and hypotheses used to estimate and quantify them must be specified.

Financial characteristics of the titles due for issue must also be determined, as well as the ones of credits and contributions. The rest of the rules for regulating the specific securitization fund will be established determining the operations which are to be carried out on its behalf, with the purpose of increasing security and regularity in the payment of the income obtained from the issued titles, and also with the purpose of neutralizing the interest rates differences between assets incorporated to the specific securitization fund and the issued titles charged and other liabilities.

When the constitution of a specific securitization fund of renewable or expandable assets is pretended, the public deed must also determine the assignor or kind of assignor entities of the assets which the specific securitization fund is due to acquire, either initially or later. Also, it must specify how long the specific securitization fund is supposed to exist and the maximum amount in the case of expandable assets, as well as planned measures to protect investors from any of the assets' hidden contingencies or liabilities. In all cases, the constitution of the specific securitization fund is subject to the prior observance of the following requirements:

(1) The constitution project must be communicated to the CNMV

(2) All documents needed for the specific securitization fund constitution and reports of the pool of assets to be securitized must be provided to and registered with the CNMV;

(3) Reports made by management entities, expert independent auditors or any other experts must be prepared according to the CNMV's criteria.

(4) Reports made by agencies involved in the credit quality rating must be provided if necessary; and

(5) Verification and registration by the CNMV of a prospectus regarding the specific securitization fund constitution and the liabilities which finance it.

The specific securitization fund annual accounts must be field yearly at the Companies Register, but it is not compulsory to register the specific securitization fund itself.

H. CONSEQUENCES OF THE FUTURE EXPANSION OF THE SPECIFIC SECURIZATION FUND.
Despite steady issuance since the mid-1980s, the volume of securitization in Europe and, more specifically, in Spain has lagged behind United States rates for a variety of reasons. Many institutions have not faced strong incentives to remove assets from their balance sheets because of favorable funding and excess capital. Also, the severe recession in the early 1990s led to a sharp drop in loan origination, further diminishing pressure on balance sheets, as well as a lack of legal and regulatory frameworks hindering securitization, few analytic tools and lack of infrastructure.

Nevertheless, many of these impediments to growth have been diminishing. The introduction of the Euro currency is having a major impact and will gradually eliminate much of the existing sovereign bond markets, shifting investor attention to spread products, specially mortgage-backed securities and asset-backed securities. This process will obviously also influence the Spanish market, and the announced expansion of the specific securitization fund will contribute to increasing the private fixed income market, that has actually are not developed as it and needs to be developed as it should and needs to be developed, in a context of slower growing public debts issues and expansion of titles.

This process will also compensate the financial imbalance of credit entities, especially important during 1997 and mid-1998, as a consequence of lowering bank deposits derived from the great expansion of investment funds and the increase in bank credit.

Clearly, the new and recent Spanish regulation has brought the chance to transform assets without real guarantees, such as commercial credit, personal loans, leasing contracts, credit card receivables and bad debtor's accounts receivables, giving all of them a higher amount (Pta. 34.4 billion) than a mortgage credits (Pta. 25 billion). Finally, the above briefly analyzed Spanish law and regulations should allow a considerably increased volume of asset-backed operations of monetary intervention as specific securitization fund liabilities are located in credit entities' portfolios.