Structured financing is a reliable source of funds for Mexican Nonbank Financial Companies (known in Mexico as SOFOMs). It provides SOFOMs access to certain lenders and rates that traditional financing may not provide them. It also grants additional protections to lenders in the event of a financial stressful event or insolvency of the SOFOM (the originator).
The insolvency of several important players has put the structuring of financing involving the participation of SOFOMs under scrutiny, as well as the terms and conditions of their legal documents. During 2022, structuring agents, lenders and rating agencies doubled their efforts to ensure that the terms of these financing structures and their legal documentation contain the required elements to withstand stressful events and provide adequate warnings based on the underlying portfolio’s behavior.
The financing can be public, i.e. placed in a stock market, or private. Public financing generally involves additional elements in their structure and additional parties participating, while private financing tends to be simpler. For example, public financing requires the participation of one or more rating agencies, while in private financing their participation is not required (although certain institutional lenders may require certain ratings).
In the following paragraphs we describe relevant concepts of the legal structure of a private structured financing involving the participation of a SOFOM.
Key Players
Originator. Originates collection rights that serve as the source of payment for the financing (e.g., the SOFOM).
Issuing Trustee. The financial institution with which the issuing trust is formed. The originator’s collection rights are transferred to such trust, and with these collection rights in its trust estate, the trust issues or incurs debt. It is important to have a financial institution with experience in this type of transactions and that has a reliable team, both in structuring and operating the trust.
Lenders. They fund the issuing trust; they can be banks, other SOFOMs, insurance companies, or other vehicles, domestic or foreign. Applicable withholding tax on interest payments must be considered in the event that a foreign lender participates in the transaction.
Master Servicer. Provides portfolio administration services, reports on its performance (e.g. borrowing base, delinquency rate), and registrations before the Registro Único de Garantías Mobiliarias. Certain lenders have their own portfolio management area and do not require the services of a master servicer.
Structuring Agent. It collaborates in the structuring of the financing, preparing financial projections and obtaining a credit rating, among other activities. Some lenders have their own, if required, structuring department and do not require the services of a structuring agent.
Credit Rating Agencies. They evaluate the payment risk of the debt structure and issue a rating in this regard. Having one or more ratings allows access to certain types of lenders and rates. Certain lenders, typically international, but also national, have their own methodology for rating the debt structure and do not require a credit rating agency, eliminating the cost of their participation.
Common Representative or Administrative Agent. They are necessary when there is plurality of lenders within the same financing. They represent the interests and act on behalf of the lenders.
Lawyers. According to the type of structure, there may be different lawyers advising the originator, the lenders, and the credit rating agencies (if the financing has a credit rating).
Relevant Documents
Trust Agreement. Regulates the transfer or acquisition of collection rights, the issuance of debt, the waterfall contemplating the application of funds, the payment of debt and accelerated amortization events.
Factoring or Assignment Agreement. Regulates the periodic transfer of collection rights by the originator to the trust during the revolving period contemplated for the financing.
Servicing Agreement. Regulates the collection and managing services rendered by the originator to the trust, considering that, once the collection rights are transferred to the trust, they are no longer property of the originator. The agreement contemplates the delivery of reports from the originator to the master servicer, the events for substituting the originator as servicer and the substitution procedure.
Master Servicing Agreement. Regulates the rendering of services by the master servicer to the trust, including the delivery of reports and monitoring of the portfolio's performance.
Debt Instruments. They regulate the incurrence and payment of debt, including principal amount, rate and maturity. The debt could be documented through a loan agreement or promissory notes. They are executed by the trust, as debtor.
Master Collection Trust
It is convenient for a SOFOM that has more than one outstanding structured financings. This trust consolidates all the collection of the SOFOM and distributes it to the debt-issuing trusts. Any portion of the collection not assigned to a financing is distributed to the SOFOM.
The participation of a master servicer in the collection distribution carried out by the master trust provides certainty and transparency to the lenders participating in the various outstanding structured financings.
Collection
In structuring the financing, an in-depth analysis of the collection method and process used by the SOFOM should be made. In the analysis, is important to consider the existence of a master collection trust and if the collection is carried out through payroll deductions by governmental entities or employers, bank domiciliation or through electronic payment fund institutions, among other methods.
It is crucial that lenders have clarity in the flow of the collection proceeds and that, depending on the type and strength of the financing structure, collections are not deposited in the originator's accounts prior to reaching the trust's accounts.
Relevant Provisions
Eligibility Criteria. They regulate the criteria and requirements that collection rights must comply to be considered as part of the collateral ratio or borrowing base. Depending on the type of product, eligibility criteria may include minimum or maximum rates, credit stabilization or criteria that limit portfolio concentrations based on geographical zones, certain credit products, payment entities, clients or client ages.
Financial Ratios. They allow the monitoring of the portfolio’s performance, which serves as the source of payment for the debt. Among others, financing documents may contemplate ratios that measure the collateral coverage or borrowing base considering receivables that meet eligibility criteria, the portfolio’s delinquency rate or the debt service coverage provided by the collections deposited in the trust accounts.
Waterfall. Contemplated in the issuing trust agreement, it regulates the application of collection proceeds, including the payment of trust expenses, the creation of payments interest or expense reserves, debt service, the acquisition of additional receivables, and the distribution of residuals to the originator.
Acceleration. Acceleration clauses grant the lenders the right to accelerate the scheduled debt repayment upon the occurrence of certain events. Among others, financing documents contemplate events such as failure to pay, non-compliance with financial ratios, originator’s insolvency, material defaults by the originator or a certain decrease in the credit ratings (if the financing contemplates them).
Interest Hedge
The structure of the transaction may require the execution of a derivative instrument (e.g. cap, swap) to hedge variations in the interest rate. The hedge counterparty would have to meet certain acceptable requirements for lenders and, if applicable, for rating agencies.
Portfolio Management and Reports
The originator will continue managing the portfolio and its collection. The master servicer will audit the existence of collection rights, review the portfolio’s performance and issue periodic reports (e.g. biweekly, monthly). The reports will measure compliance with financial ratios, including the collateral coverage ratio or borrowing base and the portfolio’s delinquency rate, and will serve as a guide to determine distributions in the application of the waterfall.
Relevant Considerations
As mentioned in the introduction, the insolvency of certain relevant players has stressed the financing market for SOFOMs. In structuring and documenting these financings, it is important to: (i) prevent deficiencies in the transfer of collection rights to the issuing trust that may put at risk the true sale of such collection rights to the trust, (ii) prevent deficiencies in the flow of collections, i.e. that proceeds derived from collection rights are not deposited in accounts controlled by the originator, and ensure that funds are effectively transferred to the trust accounts, (iii) analyze the financial stress that the funding may cause to the SOFOM, considering its ability to originate loans in a promptly manner once funded by the lender, and (iv) effectively audit the portfolio’s existence and constantly monitor of its performance.