Solving corporate finance problems with securitization. (Letter from the Editors).

I. MATCHED FUNDING

Securitization of leases of commercial property to refinance bank debt and secure long term capital market funding that matches the tenor of their assets, has recently been used by British Land and Canary Wharf. Long term asset backed notes have been issued to refinance commercial properties.

"Our major financing event has been the post year-end Pound (L) 1.54 billion securitisation, arranged by Morgan Stanley Dean Witter and supported by cash flows from the Broadgate Estate. L1.54 billion quite a large number -- represents 73% of the value of the Broadgate assets which have been securitised, reflecting the quality and strength of the long-term underlying leases. The secured element of the Notes is limited to L100 million and there is no recourse to British Land itself, the Notes being obligations of fully ring-fenced subsidiaries. The issue allows British Land to manage its Broadgate business and assets in an effective and financially efficient manner for the foreseeable future, and there is a range of maturities extending out to 2038 with significant early repayment flexibility. Our recent Broadgate building purchases (100 Liverpool Street, 155 and 175 Bishopsgate) were at yields of 7% while the funding cost of the securitisation is 6.15%. . . .During the year we also added a L110 million unsecu red syndicated revolving facility arranged by WestLB Bank and, since the yearend, we increased the amount of the 135 Bishopsgate securitisation to L137.8 million.

Following successful completion of the securitisation we have pushed the weighted average maturity of our borrowings, excluding the joint ventures, out to 23 years (1998 -- 19.9 years) and the weighted average interest rate is down to 7.3% (1998-8.49%). . .In April 1999, the Group announced the launch of the L1,540 million fixed rate Broadgate (Funding) PLC Notes. The proceeds of the securitisation are being used to repay bank debt on revolving facilities, which are then available for redrawing. As part of the securitisation, surplus derivatives which previously hedged bank debt have been closed out resulting in the L68 million exceptional item. Following this innovative financing the Group debt is predominately fixed, although it is expected that the position will revert to a proportion of variable rate in the near term". (British Land PLC, 1999 Annual Report and Accounts)

II. CORPORATE FINANCE: PRIVATIZATIONS AND ACQUISITIONS

In addition to the direct application of securitization by public authorities, privatization has been facilitated by enabling financiers to refinance debt taken out to finance acquisitions by means of securitizing portions of the acquired assets. Retention of a residual interest in the securitized pool offers the acquirer profit associated with efficient management of the assets while freeing up capital that was tied up in financing the capital component of the assets. In the U.K. purchases from the government of student loans and military housing, and rail operating companies have been refinanced with securitization.

In the U.K. the private finance initiative (PFI) seeks to transfer the provision of many public services to the private sector. Private sector consortiums bid for PFI contracts. Part of the criteria for being awarded the contract is the ability to structure and secure long term funding for the project on favorable terms, such that when incorporated into the overall bid, it offers the public sector "value for money". In addition to funding the projects, the private sector is responsible for building, maintaining and operating the facilities or services.

Annington Homes, the group owned by Nomura, Black Rock Capital and the Electra Fleming Fund purchased 55,000 housing units from the Ministry of Defense (MoD) in November 1996 via a Private Finance Initiative tender. Annington homes refinanced its portfolio of MoD housing via two separate securitization transactions: Annington Finance No. 1 (10/96) and Annington Finance No. 4 (12/97). Annington Finance No. 1, a three-tranche deal, is collateralized by the MoD guaranteed rental stream associated with the acquired portfolio of housing. Annington No. 4, a three tranche transaction, is supported by the non-guaranteed portion of the rental stream and proceeds from dispositions of homes. (Annington Finance No. 4 PLC, Residential Mortgage: New Issue, Fitch IBCA, February 9,2000)

Privatization of the British railroad system has sparked a number of innovative securitization transactions by the rail operating companies to refinance portfolios of operating leases on rolling stock. Leases on rolling stock in production have also been refinanced by the lessor through a secured loan securitization structure. In secured loan schemes a secured loan is made by a SPV to a lessor/operating company. An issuing vehicle is established to finance the secured loan in the securities markets.

Porterbrook is one of the three U.K. Rolling Stock Operating Companies (ROSCO) that was privatized by the U.K. government in 1995. Porterbrook was initially purchased by Charterhouse Development Capital and Porterhouse Management. In 1996 Porterbrook was acquired by Stagecoach Holdings a U.K. based multinational transportation company. In April of 2000 Porterbrook was sold to Abbey National.

Porterbrook and Angel Trains, two of the three ROSCO's, have used securitization to refinance leases on existing rolling stock and future leases on rolling stock in production. The securitization transactions undertaken by Porterbrook and Angel Trains have been based on the secure loan structure. Porterbrook's first securitization of operating leases on rolling stock was in 1996. Two special purpose vehicles were established to refinance the leases. Rolling Stock 1 PLC and Rolling Stock 2 PLC. Rolling Stock 1 financed the government guaranteed portion of the leases while Rolling Stock 2 refinanced the non-guaranteed portion. Stagecoach used securitization in the first instance to refinance debt that was issued to finance its acquisition of Porterbrook.

"The Stagecoach offer for Porterbrook of L475 million together with debt of L330 million was funded through a L200 million vendor share issue, L75 million of the rights issue proceeds, and debt of L530 million. The total debt requirement was lower than anticipated as a result of the strong cashflow generation of the business prior to completion. The debt was funded on an interim basis by a bridging loan but refinanced in October 1996 through a L545 million bond issue secured on the underlying capital lease rental streams payable by the Train Operating Companies (TOCs) and the related UK government underpinning of 80% of these rental payments.

The use of a securitisation structure has provided the group with a number of significant benefits:

* Low cost of funds (all in fixed cost of 7.4% per annum) with maximum proceeds raised.

* Funding with no recourse to Stagecoach and only limited recourse to Porterbrook.

* TOC default risk (and related UK government underpinning) transferred to bondholders.

* Primarily AAA/Aaa rated structure.

* Long term funding with repayment profile matching underlying cashflows.

Whilst this debt is all shown in the balance sheet in accordance with accounting standards, commercially it is effectively off-balance sheet in terms of risk to the Stagecoach group." (Stagecoach Holdings PLC, 1997 Annual Reports and Accounts)

The securities issued by Rolling Stock are secured by fixed and floating charges over the Rolling Stocks assets which primarily consist of a secured loan to Porterbrook which is secured by a fixed and floating charge over the leases and underlying rolling stock. In the U.K. the beneficiary of fixed and floating charges gives the security trustee "the right to appoint an administrative receiver and block the appointment of an ordinary administrator by other creditors." (West Coast Train Finance: New Financing Report, Duff & Phelps Credit Rating Company, 9/7/99)

In addition to the risk of obligor default, in this case the Train Operating Companies that lease rolling stock, securitizing operating leases on specialized equipment entails the risk that the equipment can not be released without costly delays in the event of a lessee default or when the lease expires. This risk is mitigated by the public value that the Train Operating Companies supply. Liquidity enhancements are established to bridge expected delays that would arise in releasing. When the leases are on Rolling Stock that has not been constructed, completion risk must be added to the risk equation. Securitization of leases on trains that have not yet been built or delivered is a future flow transaction much like the transactions that securitize receivables that will be generated by the future production and export of commodities.

"On 1 May 1998 L363.0 million of financing was raised by Porterbrook to fund new train orders. This was the first ever public financing of passenger rolling stock in Europe and consisted of a L90 million corporate facility provided by UBS and the Royal Bank of Scotland, and a L273 million securitisation. This will provide non recourse financing to both Stagecoach and Porterbrook and provides long term funding to 2011 at an interest rate of 7.5%. At 30 April 1999 the corporate facility was L23 million utilised and L124.1 million of the securitisation proceeds were included in restricted pre-funding cash deposits. The corporate facility will be utilised to make stage payments to manufacturers whilst the pre-funding deposits are released to make payments on the final manufacture of the rolling stock". (Stagecoach Holdings PLC, 1999 Annual Report and Accounts)

Charles A. Stone, Universite Paris Dauphine Anne Zissu, Temple University