Bank securitisations – A reply to Calum Cashley

Yesterday evening around 8 pm I posted a reply to a comment in a blog post by Calum Cashley, the SNP candidate for Edinburgh north and Leith.  22  hours later Mr Cashley has not moderated my comment, and hence has not published it on his site. My reply was to a comment by Mr Cashley on the topic of bank securitisations which suggested – in reply to a previous comment where I indicated that securitisation of itself was not an ill, but could cause problems when backed up by guarantees (and drew an analogy with debt factoring carried out by small businesses)

"Nope, you’re entirely wrong there in a kind of total way. Any decent Scottish conveyancing lawyer will be able to explain securitisation to you – because it’s what we use rather than the poor version of mortgages used in England. Here in Scotland the Standard Security is used – the creditor owns the heritable property until the debt is discharged (Conveyancing and Feudal Reform Act 1970) which allows the creditor to use the Heritable Securities Act 1894 if necessary. In England it’s "a charge by deed expressed to be by way of legal mortgage" where the debtor owns the property and the creditor only has negotiated rights – which is why court actions in England to recover property are so much more bruising than actions in Scotland (in part). Mortgages in England are shakier debts than mortgages in Scotland, by and large, and LTSB holds a higher percentage of its mortgages in England than does HBoS (a parallel being that Halifax mortgages pre merger are held more in England than BoS mortgages pre merger). When the institution seeks securitisation of assets they are basically remortgaging on a grand scale in the Scottish style – or they are borrowing PFI style depending on what means they use. If they use the assets as collateral against borrowings then they’re in the mortgage area. The other method involves selling the assets to a Special Delivery Vehicle, isolating the institution from the income stream of the assets, the SDV will sell debt securities and use the money to pay the original institution for the assets.  You may have heard about this method as a way of spreading sub-prime lending…"

GIven the tone of his reply I replied in some detail – and as my reply which submitted in the usual way via blogger has not been published on his site some 22 hours later I thought I would post my reply publicly.  I had copied my reply into a locked post here  yesterday (and so some of those on LJ may already have seen it) and it is as follows:

""Thanks for that. As I’m not sure where you’re coming from on some of these issues but I’ll work through this to see where the misunderstanding arises.
"Okay, I take as read the following. If you want a security over land in Scotland then the debtor retains ownership by granting a standard security (introduced in 1970 following the recommendations of the Halliday commission ) . This is a hypothec, a non-possessory security where as you note the debtor retains ownership and the creditor has a subordinate real right, a right in security in the strict sense, in the property owned by the debtor. This is – as you note – unlike an English mortgage. So far, I’ve got you. Why you mention the 1894 Act I’m not sure what point you’re making. The remedies for enforcement of the standard security are found in the 1970 Act on the whole, and in the standard conditions (which cannot be varied in respect of the remedies) – and while the 1894 Act gives some remedies the only one typically used in practice is the right of ejection, utilised through the summary cause procedure in the sheriff court.
"Now, what does this have to do with securitisation?
"Well, you say securitisation is "remortgaging on a grand scale in the Scottish style." Of course what you classify as the Scottish style is the general model of security in continental Europe. I find this line difficult to understand. Are you suggesting that the creditor is borrowing money to be repaid, while retaining ownership of the assets? Or are you suggesting that the party securitising is consolidating its liabilities (viewing debt from the obligational end, rather than the right to payment end) and then reborrowing in order to pay the originals off, while granting security over an asset or assets? 
"I think you mean the former.   If so, what are the assets here? The assets on which money is raised are the rights to payment – a regular income stream. Now where securitisation is by a mortgage lender it could (often did) involve raising money on the loan book (and the standard securities). On your model what you seem to be suggesting is that this involves the creditor in the standard security retaining ownership of that security while borrowing and granting a security (over the right to payment and the security) to the party from whom money is borrowed. This would mean either a standard security over the standard securities (theoretically possible, but not done in practice) or a floating charge over the rights to payment and standard securities. No other form of right in security (in the strict Scottish sense) is possible over rights to payment. So your principal interpretation of securitisation is that this would mean the borrowing of money on an asset or assets, backed up by a floating charge. This is common enough, but my understanding is that this is not generally how the banks securitised their loan books. 
"Securitisation in this sense is the second version you identify in your reply. This involves moving the income stream from the original recipient to a third party. As I said above this is – to a degree – like debt factoring. I did not think you’d want me to explain fully the analogy but to persist. IN factoring this is where the income stream is moved from the original creditor to the factor in return for a payment. And securitisation is like debt factoring in that typically the income stream is moved from the original recipient to a SPV, and like factoring the means of moving the income stream is through assignation of the debt (or rather assignation of the right to payment). Even with asset based securitisation projects (like the BBC Scotland HQ deal) the income stream (for rent in that case) is transferred to a third party. The investors then invest in that third party. This is the SPV. This means the original recipient gets a payment for the assignation, cash raised via the issue of debt stock or other stock in the SPV. IN Scotland the assignation is problematic because our law does not allow assignation without intimation to the debtor – accordingly business gets round this in two ways: either (a) through the writing of the contracts which will be transferred under English law, incredibly common in practice as this allows the use of English equitable assignments under the Rome Convention; or (b) the use of commercial trusts (the preferred vehicle for some Scottish businesses). In the latter the original recipient agrees to hold the income received in trust for the SPV (and indirectly for the investors). This example – the basis of my equivalence to factoring point in my second comment above – is the classic mode of securitisation – and is typically backed up by the CDS agreements or other guarantees because the investors will not invest unless they have some guarantee that the debts transferred into the SPV are going to be paid. It is this mechanism that has typically been used by the banks – and it so happens that it is easier using English law than Scots (because of English equitable assignments), although it is widely used in both systems.
"The benefit to the original recipient is cash now for future payments (which would be recovered over time – but boosts immediate capital which is then reloaned to the market, in the securitisation model, giving more loans with income streams that could be securitised. The investor has a right to regular income (the income streams gathered together, typically backed up by rights in security). And typically will have a further guarantee.
"For reasons of brevity in my second comment I did not pursue the factoring analogy in much detail, but as you suggest I have no understanding of the market "Nope, you’re entirely wrong there in a kind of total way." and then suggest this is something a basic Scottish conveyancing lawyer understands (securitisation in this second sense (the one used by the banking sector) is carried out by half a dozen specialist units in firms within Edinburgh and Glasgow, and many ordinary conveyancers are unaware of the devices used by these teams) I thought I should explain fully where I was coming from. And note again that securitisation in this sense is not an evil – it’s the guarantee, the CDS, which goes with it which causes the problems – and note again that it’s the liability through the CDS agreements that have caused the downgrading of the HBoS credit rating."

To this – written in some degree of haste, hence a few grammatical slips and typos, I would add that securitisation was an effective mechanism to raise capital for further lending – however, when concerns were expressed about general bank lending practices and whether repayment was guaranteed this has an impact on drying up the market for potential investors, denying a source of capital to banks, and consequently impacting on lending policy.

Additionally, the comment written in haste was trying not to suggest directly that Mr Cashley failed to grasp what securitisation in a bank context was – especially when his second attempt, "THe other meaning" was in point.  Anyway, to help Mr Cashley and his understanding of how the Scottish banking system (that he is so keen to preserve through objection to the potential Lloyds TSB – HBoS merger) works here’s a definition of securitisation for him.

"Asset securitization is the process of pooling and repackaging loans into securities, which are then sold to investors.   …  IN effect what a bank is doing in securitizing its loans is raising money on the security of some of its assets, ie its loans.  The securities issued to investors, giving them an interest in the pool, are said to be "asset backed", because payment on them is based on the flow of payments by borrowers on the underlying loans."  Cranston, Principles of Banking Law (2nd edn) p 369.  To avoid any further confusion for Mr Cashley when they use the word "securities" here it means shares or stock – not the Scottish security he identified in his comment.  Cranston even has a helpful diagram on p 371 to show you how it works in basic terms. 

And a final note to Mr Cashley – the tone of your reply, implying the ignorance of  a commenter about whom and whose professional expertise you know nothing, does little to promote you or your party.  It compares badly with those in your party such as Jeff at SNP tactical voting or Richard Thomson, who engage with commenters of whatever political persuasion courteously and constructively with good humour and good grace.

ETA – I’ve just noticed on rereading Mr Cashley’s orginal comment that I did him too much justice in my reply,  as he doesn’t understand standard securities.  As I note in my response it is the debtor (although a security need not be granted by a debtor, it could be for a third party’s debt) who retains ownership of the land and buildings – the creditor has a jus in re aliena, a real right in property owned by someone else).  Mr Cashley has confused the debtor and creditor in his response.  What he describes as the Scottish system was one type of Scottish security that existed before 1970, the ex facie absolute disposition in security – as he would have discovered if he’d asked any decent conveyancer or read any decent conveyancing textbook. 

About loveandgarbage

I watch the telly and read when not doing law stuff and plugging my decade and a half old unwatched Edinburgh fringe show.
This entry was posted in credit crunch, economy, scottish politics, Uncategorized. Bookmark the permalink.

3 Responses to Bank securitisations – A reply to Calum Cashley

  1. Anonymous says:

    Good piece. Well argued.
    One small point. Your lines of text are very long which makes for a more difficult read on screen. Is there any way your blogger software could make them a little shorter? 13 to a5 would be better than 20. Check your books it’s what they generally run at 🙂

  2. Anonymous says:
    That would be 13 to 15! Sorry

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