by consumer finance businesses located in Canada.
Gross yields on the consumer contracts vary but are generally
between 29.9% and 39.9%. All consumers are adjudicated by
reviewing their credit histories. Perhaps surprisingly, a significant
majority of the consumers have “good” credit histories.
Consumers have shown a habit of giving the monthly payment
the highest priority in deciding whether to finance their purchase
notwithstanding the cost relative to other forms of credit that
may be cheaper. The convenience of obtaining financing for their
purchase within 24 hours for qualifying consumers, with low
monthly payments, is extremely attractive when compared to the
time and the hoops they would have to jump through to obtain
less expensive financing.
High yielding assets are only part of the picture as high yields
can quickly go out the window if originations were misguided
and collection efforts poorly executed. Our teams of originators
have extensive history in the origination and collection of sub
and near prime receivables. Historical performance of credit card
portfolios that are the closest analogy to the assets pooled by
Beacon have had steady asset performance even in periods of
recession. Losses typically range in the 4 – 7% range with bank
portfolios typically at the lower range and major retailers having
performance in the upper part of this range. Our loss performance
record has been in the lower end of this band even though we do
not have the “advantages” the big banks have of extensive client
information and relationships.
Being unique in of itself confers no real benefit to investors
without the necessary elements of a good investment. Beacon
provides significant diversification benefits to investors in the
exempt market. Firstly, Beacon is structured based on a pool of
diversified, small ticket consumer loan receivables. A large pool
of small items is, statistically, expected to have a much higher
consistency of performance versus a small number of large assets
or as is typical in most exempt market transactions, a single
asset. Roll a dice one time and the probability that it is higher than
a 3 is quite high. Roll the dice 100,000 times and the probability
that the AVERAGE is 4 or higher is virtually nil. Large pools of
consumer assets demonstrate this consistency in performance.
Secondly, unlike most exempt market transactions where the
investor is often taking equity risks as a ‘first loss investor’ (i.e.
leveraged with other peoples’ money which has first claims on
the assets and cash flow), this transaction has BEACON’s money
on the line first and investors have first claims and priority on the
assets and cash flow. All the cash flow of the transaction can
be diverted to satisfy investors’ claims before BEACON receives
repayment (when performance has deteriorated and triggers
have been hit). Very conservative investors also have the choice
of investing in extra secure senior notes that benefit from the
subordination of the subordinated notes.
Investors are not dependent upon asset value or any future
sale of assets (and the resultant uncertainty of future market
conditions). Monthly cash flow from the assets will deliver timely
payment of monthly interest and at maturity, return of principal to
investors in the notes. Every investment has risks, but with the
significant yield and low losses of the portfolio, even significant
deterioration of performance would not affect the required
payments to investors. The notes have a stable value and provide
a significant level of yield far greater than any comparable fixed
income product generally available to investors. Annual rates on
the senior notes are 6.50% and 9.25% on the subordinated notes.
Distributions are made monthly. BeaCH is eligible for registered
accounts (e.g. RRSP’s). Similar institutional notes offered by retail
credit card issuers in Canada have ranged from about 2.4% (for
senior notes) to 3.2% (for subordinated notes).
So how does securitization work? Broadly a Trust (or other
clean special purpose entity) purchases pools of receivables that
meet criteria for purchase – the most important being that the
receivables are as represented and that they are not delinquent or
defaulted receivables. These assets and the cash flow associated
with them are the property of the Trust. Any bankruptcy of the seller
does not affect this ownership or right to the cash flows. Further
the seller of the assets to the trust receives only a fraction of the
value of the assets in cash (i.e. the notes sold to investors) with
the balance being a residual interest in the assets and cash flow
of the trust – i.e. the seller provides a first loss to the transaction.
The larger the size of this first loss piece the safer it is for
investors. Investors in this transaction benefit from a) a minimum
of 10% first loss, as well as b) the excess spread in the transaction
(the yield of the assets net of losses and funding costs) that is
anticipated to be north of 20% per annum. The combination of
these two amounts provides protection against losses that are
significantly higher than anything seen in the Canadian marketplace.
The Trust has legal agreements in place that direct how the
cash flow is applied. Third party trustees (typically subsidiaries
of large banks) administer the operation of the Trust. Cash from
these assets are used to pay investors first, subject to payments
required for the trustees and for collection efforts. Remaining cash
flow is released, if permitted by the agreements. The agreements
have triggers in place (evaluated monthly) that will shut off any
release of cash from the Trust should performance deteriorate.
Should triggers be hit, all cash would be available to pay investors.
To provide additional protection, third party backup servicers are
put in place to ensure a level of redundancy should the existing
servicer be unable to perform their obligations.
In summary, Beacon provides an institutional quality
securitization to investors with a note yield higher than available
in that marketplace despite providing higher levels of protection
to investors and having lower loss levels.
Also, given the “unique” nature of this transaction, investors
get the benefits of portfolio diversification from products more
typically available in the exempt market.
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