Consumer finance companies (CFCs) have become an increasingly important source of retail credit in Japan. The problem they have faced is how best to free up balance sheets to do further business following the recent credit crunch. Securitization provides an increasingly important alternative to traditional bank financing. In 1992, non-bank companies regulated by Japan’s ministry of international trade and industry (MITI) became able, by virtue of MITI-sponsored legislation, to use securitization structures that overcame many of the legal obstacles to securitization prevalent in Japan.
Essentially, this permitted MITI-regulated companies to perfect assignments of certain types of receivables without giving individual notice to each obligor. Since then, there has been a spate of securitizations by MITI-regulated companies involving lease receivables, auto-loan receivables and installment credits.
Those originators regulated by the finance ministry (MoF), such as CFCs, were required to have recourse to Japan’s civil code to ensure properly perfected assignments, a cumbersome and potentially costly process. Companies that did securitize used techniques, such as conveying to the assignee legal title to the rights assigned, that fell short of actually giving notice to the customers whose loans were the subject of the assignment to the special purpose vehicle (SPV). These contingent sales were perfected, that is, notice is required to be given only when a default is imminent or has happened. In most other deals, non-MITI-regulated companies relied on guarantees to avoid having to perfect. However, on occasion the only fail-safe solution was to give actual notice to customers under the lengthy, expensive, civil-code procedures.
Then, last year the exception law was passed, simplifying procedures for MoF-regulated entities such as CFCs to perfect the transfer of debt obligations, so creating new opportunities to securitize a new range of assets. “This does not make it completely plain sailing,” says Salim Nathoo, a securitization specialist in the Tokyo office of international law firm Allen & Overy. “For instance, Japanese law is uncertain as to the ability to transfer future receivables generated under a presently existing contract. Japanese law restricts the ability of a special-purpose vehicle to outsource the collection of debt obligations to non-regulated third parties. And while the exception law simplifies procedures for perfection as against third parties, it leaves open certain opportunities for customers to exercise set-off.”
For CFCs other features have to be factored in. Robert Ryan, who heads the securitization team at CIBC World Markets in Tokyo, says: “The fact that the consumer loans may be revolved and the amount of any drawings by a particular borrower may vary each month with repayments and further borrowing – usually done through the originator’s branch network or its ATMs – means the principal amount of the consumer loans that requires funding can be unpredictable, within certain parameters.”
There are tax considerations too. “The high rates of interest that CFCs typically charge mean that the SPV will have significant taxable income that needs to be passed back to the originator in a tax-efficient manner,” says Nathoo, “In addition, factors typical to most securitizations also need to be taken into account, including segregation of assets, establishing clear origination and collection policies for the consumer loans and establishing appropriate cash-management procedures.”
A transaction in February structured by CIBC World Markets for Nice Co (a medium-size unlisted CFC) involved the sale of all the loans generated under particular eligible master consumer loan contracts originated with a consumer before the financing, together with all loans made under those contracts after the financing date, to the Japanese branch of Major Capital, a SPV established in the Cayman Islands. The sale of the consumer loans is perfected first by including acknowledgments of, and consents to, the transfer to Major Capital by borrowers in the consumer loan contracts themselves; second, by making a central filing at the legal affairs bureau in Tokyo under the exception law, which made the transfer effective against third-party creditors of Nice; and third by incorporating changes to Nice’s lending procedures so that when borrowers draw money from Nice (through its branches or its ATMs) they are specifically informed of the transfer to Major Capital.
“To ensure that the sale of future consumer loans generated under the contracts could be sold despite reservations under Japanese law,” explains Nathoo, “precautionary measures will be taken to refresh the assignments on each anniversary of the financing date.”
Major Capital funded the purchase price of the loans (their outstanding principal amount) by issuing senior bonds to Major Asset Finance (Cayman), another Cayman Islands SPV, and subordinated bonds to Nice. Major Asset Finance funds the purchase of the senior bonds by a Euronote issue. “The double SPV structure is now a well-worn path to avoid the application of Japanese withholding tax,” explains Nathoo.
So that Major Capital is able to fund further purchases of consumer loans – for instance, as individual customers increase their borrowings – it has available to it receipts of principal repayments (where customers have repaid part of the outstanding loan) during the life of the deal. Major Capital also has available to it part of the interest stream from the consumer loans and a subordinated revolving loan from Nice.
Nice is appointed initial servicer to collect payments of principal and interest from customers and regularly to account for these to CIBC which was appointed cash manager to act on behalf of Major Capital. Should Nice become insolvent, its servicing function would be immediately transferred to a nominated third party that would act as servicer itself or would appoint a further CFC to do so.
“Recent changes in the regulatory environment which took effect on May 20 of this year mean that the larger consumer finance companies can now even use the proceeds of securitization in their lending business,” says Ryan. “This is expected to increase these types of securitization significantly. Those first few transactions have attracted a lot of interest.”
