Asset securitization segregates the assets to be securitized from the business of the securitization's sponsor (the "Originator") by transferring them to a special purpose entity ("SPE"), often a trust. The trustee of the trust usually subcontracts the administration and servicing of the securitized assets back to a subsidiary of the originator of the asset pool or a third-party provider. However, the trustee remains responsible for administering the SPE or the trust that holds the securitized assets.
The trustee's primary duty is to protect the interests of the investors who purchase the securities issued pursuant to the securitization and administer the duties of the SPE under the requisite agreements. The nature of the trustee's duties are specifically set forth in the trust agreement, and frequently require more intensive involvement by the trustee if covenants made by the Originator as part of the transaction are breached.
Ensuring title and perfection of security interests
The trustee will see to establishing the trust that will serve as the SPE for the asset securitization. The trustee also must confirm that the trust has received clear title to the assets, free of any claims or charges, actual or implied. When assets are transferred to the SPE at closing, these assets are pledged to the holders of securities issued by the SPE. Since the assets will serve as collateral for the repayment of the securities, the trustee must also confirm that security interests in the assets are perfected in order that the assets will not be vulnerable to the claims of other creditors of the company - that is, they will be "bankruptcy remote." The trustee usually accomplishes this by requiring legal opinions that the security interest has been perfected.
Working with the servicer and administering the trust
The servicer, under a servicing agreement between the trust and the servicer, will typically provide payment collection services, remit payments from collections to the trustee, and provide administrative support to the trustee by preparing informational reports. For example, the servicer will generally provide monthly or periodic reports and details on amounts collected and amounts charged off related to the underlying assets. The servicer also will administer the disposition of trust assets.
The trustee will oversee disbursements to the investors that are due under the terms of the securities issued. The trustee regularly reviews the reports and information provided by the servicer to ascertain whether the assets securitized will produce a cash flow necessary to meet the trust's obligations to the investors. The trustee also will be responsible for managing and investing any funds that come into its hands as trustee. The trustee will see that tax forms required pursuant to administration of the trust are filed.
Ensuring compliance by all parties
One of the most important duties of the trustee is to monitor the compliance by the other parties in the transaction, especially the Originator of the securitized assets, with their respective obligations under the transaction's documents. Although it generally plays a passive role at this stage of the transaction, in the event that the trustee is notified of a breach of these obligations, its duties take on a much more "active" character, as it notifies security-holders of the breach and awaits their instructions regarding next actions on their behalf. The trustee is normally entitled to be protected by the security-holders against costs and expenses of complying with their instructions, and may ask for an appropriate amount of funds prior to proceeding with the requested action.
If problems begin to develop indicating a potential for default, the trustee will notify investors and cooperate with investigations and negotiations (if any) surrounding the matter. The trustee may meet with the servicer concerning actions necessary to avoid default. If the servicer fails to perform its duties in accordance with the agreement, the trustee can replace the servicer. Examples of events that might constitute default include failing to handle or advance funds as required under the servicing agreement, or failure to maintain an acceptable financial condition. If the servicer is replaced, the trustee often serves as a temporary servicer until a replacement servicer can be identified and employed.
Experienced trustees make a difference
Asset securitizations are complex transactions involving multiple parties with multiple interests as well as accountants and legal professionals. An experienced trustee at the center of the transaction performing administrative services for the trust or SPE can help steer the parties smoothly through the process. Experienced trustees are typically better able to ensure that asset securitization will achieve the goals of the originator of the asset pool, whether the company whose assets are being securitized is experienced or is using asset securitization for the first time.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.