United States: The Future of Auto Lease Securitization ~ Part 2

Two companies have completed public offerings of auto lease-backed securities, World Omni Financial Corp. and Ford Motor Credit Company ¹¹. Each has used a Titling Trust, although there are some differences in the structures. The simple transfer of a beneficial interest in a Titling Trust is used in the World Omni Financial Corp. transactions. A more complicated sale-leaseback structure is used in the Ford Motor Credit Company transaction.

Exhibits 4 and 5 diagram the World Omni and Ford structures and the entities involved. It is worth remembering that the auto lease securitization market is still too new for there to be a preferred structure.

A. World Omni - Transfer Of A Beneficial Interest

World Omni created the first Titling Trust structure for lease securitization. During the period prior to a securitization, all the beneficial interest in the Titling Trust (the Origination Trust) is held by ALFI, L.P., a special-purpose, bankruptcy-remote limited partnership owned entirely by World Omni. This beneficial interest is called an Undivided Trust Interest, or UTI. The UTI is a beneficial interest in all of the leases and vehicles that have not been securitized. The UTI is pledged to certain commercial paper conduits that provide warehouse financing for the leases and vehicles that have not been securitized.

At the time of a securitization, World Omni selects a list of leases and related vehicles for the deal, and creates a new beneficial interest in the Titling Trust called a Special Unit of Beneficial Interest, or "SUBI," which represents a beneficial interest only in the particular leases and vehicles to be securitized. Any leases and vehicles not to be securitized at that time continue to be represented by the UTI. The SUBI is transferred to another special-purpose, bankruptcy-remote limited partnership owned by World Omni called WOLSI, L.P., in a transaction designed to be a true sale. WOLSI, L.P., was created for securitizations.

Following the conventional three steps described at the beginning of this article, WOLSI, L.P., then transfers the SUBI to a Securitization Trust in exchange for securities issued by the Securitization Trust. WOLSI, L.P., thereafter immediately sells the securities to the underwriter in a public offering. Credit enhancement and residual value protection are provided to the transaction by funding a reserve account and the senior classes of securities are further enhanced by the subordination provided by the subordinate classes.

B. Ford - The Sale-Leaseback Structure

In the Ford transaction, the Titling Trust initially was owned by Ford Motor Credit Corporation (Ford Credit) and Ford Credit Leasing, Inc. Ford Credit Leasing holds the 2% general partner interest in the Titling Trust. Initially, Ford Credit and Ford Credit Leasing own Exchangeable Beneficial Certificates, which represent rights in all leases and related vehicles that have not been securitized. The Exchangeable Beneficial Certificates are similar to the UTI in the World Omni transaction.

At the time of the securitization, Ford selected a list of leases and related vehicles for the deal and divided the Exchangeable Beneficial Certificates held by Ford Credit and Ford Credit Leasing to create a new beneficial interest in the Titling Trust called the "Series 1995-1 Certificate" or "Series 1996-1 Certificate," which represents a beneficial interest in only the leases and vehicles to be securitized.

The Series 1995-1 Certificate and Series 1996-1 Certificate (each, a "Series Certificate") are very similar to the SUBIs in the World Omni transactions. Ford Credit and Ford Credit Leasing each transferred their respective interests in the Series Certificates to RCL Trust 1995-1 or RCL 1996-1 Trust (the RCL Trust) in a transaction designed to be a true sale.

After the transfer of the Series Certificate to the RCL Trust, the RCL Trust entered into a sale-leaseback transaction with the Securitization Trust. In a sale-leaseback transaction, the owner of an asset sells the asset to a third party and then leases back the asset. This type of transaction often is a financing vehicle, because the original owner retains use of the asset and receives the sales proceeds, but becomes obligated to make lease payments to the third party.

In the sale-leaseback transaction, the Series Certificate was purportedly sold by the RCL Trust, at least for financial accounting purposes, to the Securitization Trust. The Securitization Trust then entered into a Program Operating Lease of the Series Certificate with the RCL Trust, obligating the RCL Trust to make various payments to the Securitization Trust corresponding to the cash flow received on the underlying leases and vehicles.

The Securitization Trust financed the purchase of the Series Certificate through the issuance of the securities. In the 1995-1 transaction, residual value protection was provided by recourse against Ford Credit through a Limited Residual Value Guaranty issued by Ford Credit, presumably purchased by the Securitization Trust from Ford Credit on "market" terms and through subordination. In the 1996-1 transaction, the securitization trust issued two classes of senior notes, a class of subordinated notes and a class of certificates. The subordinated notes were retained by RCL Trust. The senior notes were enhanced by the subordination provided by the subordinated notes and the certificates. In addition, certain payments on the subordinated notes are deposited into a cash collateral account, which provides additional credit and residual value enhancement to the transaction.

C. Comparison

In terms of cash flow, the economics of the transfer of the SUBI in the WOFCO transactions and the sale-leaseback in the Ford transaction are exactly the same. In both cases, a Securitization Trust receives the benefits of the securitized vehicles and the cash flows from the related leases. The differences are legal and technical, and perhaps somewhat artificial.

In the WOFCO transactions, those benefits are held directly by the Securitization Trust in the form of a SUBI, a beneficial interest in the specified vehicles and related leases. Consequently, the Securitization Trust directly holds the rights to receive the cash flows from the leases.

In the Ford transaction, after the sale-leaseback, the RCL Trust technically has the rights to the cash flows under the leases, but is obligated to make lease payments to the Securitization Trust in approximately the same aggregate amounts under the Program Operating Lease.

D. Who Gets The Depreciation?

In all the publicly offered lease securitization transactions structured to date, it has been important to the sponsor's economics to retain the benefit of the depreciation deductions from the vehicles. This has been achieved by structuring the transaction so that, for tax purposes, the vehicles continue to be deemed as owned by a member of the sponsor's affiliated group. The sponsor is trying to achieve the seemingly inconsistent goals of a sale for bankruptcy and accounting purposes but maintenance of ownership for tax purposes.

For tax purposes, the vehicles will be deemed to be owned by the party that has the risks and rewards of ownership. The rewards of ownership include the ability to receive the excess cash flows after payment of debt and the ability to realize gains upon the sale of the vehicles. The risks include, among other things, the residual value risk of the vehicle. These were all retained by both the World Omni and the Ford affiliated groups in their respective transactions. In addition, to enhance the likelihood of debt-for-tax treatment, World Omni's transactions included a one-year revolving feature by which collections of principal payments on the leases by the Titling Trust are reinvested in new purchases of leases and related vehicles.

E. Alternatives For Residual Value Protection

Because the securitization finances the residual values of the vehicles, the transaction is exposed, at least to some extent, to the ups and downs of the used car market. The high sticker prices of new cars and the increased ability of consumers to find used cars that are only two or three years old coming off leases have bolstered the used car market. The growing use of leases for used cars is also contributing to a burgeoning used car market. Nonetheless, it is essential to protect against future downturns in the used car market and faulty predictions of future used car values.

There are three methods that have been used to structure residual value support in auto lease securitization transactions: (1) third party residual value insurance, (2) residual value guarantees, (3) reserve accounts, and (4) surety bonds issued by monoline insurers. There are advantages and disadvantages to each.

Most issuers consider third-party residual value insurance to be far too expensive for a transaction to be economical. It may also be difficult to obtain for an extremely large securitization.

A residual value guaranty is a practical solution instead of third-party insurance. The guarantor, however, must be sufficiently creditworthy to be acceptable to the rating agencies to achieve the required rating. The residual value guaranty also is useful for tax purposes to demonstrate that the guarantor and its affiliates own the vehicles for purposes of taking depreciation deductions.

One disadvantage of the residual value guaranty is that at least some of the securities issued in the securitization will obtain a rating no higher than the rating of the guarantor. Because of the residual value guaranty, the rating on the subordinate class in Ford was no higher than Ford Credit's single-A rating.

Another drawback of a residual value guaranty is the additional risk that the vehicles could be deemed to be owned by the guarantor's bankruptcy estate, should the guarantor become a debtor in a bankruptcy proceeding. In distinguishing between a true sale and a secured loan, courts have focused on whether and the extent to which the seller has retained the risk of losses from the assets. If the seller of a beneficial interest in a Titling Trust such as Ford Credit in its first securitization issues a residual value guaranty, there is a risk that the seller may be deemed to have retained sufficient risks that the beneficial interest, and the related vehicles and leases, would be deemed to be owned by the seller's bankruptcy estate.

A third risk of the residual value guaranty is that the issuer's accountants may take the position that the combination of the leaseback obligation plus the residual value guaranty render the leaseback a capital lease rather than an operating lease and thereby precludes operating lease treatment.

Ford Credit tried to avoid some of these risks in its first securitization by causing its Securitization Trust to pay a fee for the guaranty that was intended to approximate market value. Ford would argue that there are in theory two entirely separate transactions: a purchase by the Securitization Trust of the guaranty for fair value, and a sale and leaseback of the Series 1995-1 Certificate. Unfortunately, there is no market for such guarantees. Consequently, there is a significant risk that a court might find that fair value was not paid for the guaranty, that the guaranty is an integral part of the sale of the Series 1995-1 Certificate, and that Ford Credit should be deemed still to own the Series 1995-1 Certificate for bankruptcy purposes. One way to alleviate this risk might be to have the Limited Residual Value Guaranty come from the RCL Trust rather than Ford Credit ¹². In addition, because accountants tend to strictly apply the tests of an operating lease in FAS ¹³, there is a significant risk that accountants might reject the off-balance sheet treatment of the vehicles.

The third way to protect against residual value risk is through a reserve account structured like reserve accounts for credit losses in other securitizations. The rating agencies would use historical residual value losses and other factors, to determine the amount of enhancement required for the applicable rating level.

World Omni used this approach. A 4% cash reserve account was established initially, to be doubled to 8% if certain residual value, charge-off rate, and delinquency tests were triggered. The rating agencies were willing to accept a reserve account of only 4% because they gave significant credit to World Omni's proactive contract termination programs.

In its "New Issue Report" on the transaction, Moody's notes: Vehicle turn-ins appear to be markedly affected by such factors as contract duration and "proactive" contract termination programs. Moody's observed that short-term contracts, up to 36 months, are less likely to result in a return of the leased vehicle [at the end of the lease]. If the leased vehicle is returned under a short-term contract, the average loss per full term is less than that of other, longer full term returns.

WOFCO implemented its proactive contract termination program in 1990. The purpose of the program is to avoid contracts reaching full term. WOFCO estimates that in the past three years approximately 86% of its lease contracts have terminated prior to maturity. Lessees with less than 12 months remaining to contract maturity are encouraged to buy, trade in, or refinance their leased vehicles. The securitization trust benefits if the lessee decides to do any of the foregoing. The purchase, trade-in, or refinancing of the leased vehicle results in a prepayment to the securitization trust and the avoidance of residual value risk upon turn-in at maturity. Notably, the shorter the contract term, the more likely the lessee is to participate in this program.

It appears likely that the rating agencies will similarly reward to future securitizers that have similar proactive and successful contract termination programs.

The Ford 1996-1 transaction also involved a reserve account which was funded by an initial deposit and built up to 3.25% of the transaction.

The fourth approach to residual value enhancement is a surety bond provided by a monoline insurer. In August 1996, Westar Financial of Olympia, Washington announced that they had completed a $9 million private placement of auto lease backed certificates using a titling trust. Although the deal was very small in size, it had a powerful new feature in an auto lease securitization -- a surety bond issued by MBIA. Although the details of the transaction were not made publicly available, MBIA insured principal and interest on the certificates. In other words, although Westar had to enhance the transaction for MBIA, and the amount of this enhancement was not disclosed, Westar successfully made MBIA comfortable with the residual value risk inherent in the transaction. MBIA and other credit enhancers probably will be an important source of enhancement for auto lease securitizations in the future.

F. Accounting Issues

The most important accounting issue is getting the vehicles off the sponsor's consolidated balance sheet. In other types of securitizations, accountants generally rely on Statement of Financial Accounting Standards No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, of the Financial Accounting Standards Board. Statement No. 125 generally permits the seller of financial assets to treat the assets as sold and to remove them from the balance sheet if the following conditions are met:

A transfer of financial assets (or all or a portion of a financial asset) in which the transferor surrenders control over those financial assets shall be accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The transferor has surrendered control over transferred assets if and only if all of the following conditions are met. (emphasis removed)

a. The transferred assets have been isolated from the transferor - put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership (paragraphs 23 and 24).

b. Either (1) each transferee obtains the right - free of conditions that constrain it from taking advantage of that right (paragraph 25) - to pledge or exchange the transferred assets or (2) the transferee is a qualifying special-purpose entity (paragraph 26) and the holders of beneficial interests in that entity have the right - free of conditions that constrain them from taking advantage of that right (paragraph 25) - to pledge or exchange those interests.

These conditions provide reliable criteria for issuers of receivable-backed securities to obtain sale treatment and remove the assets from their balance sheets. For operating leases, the assets on the balance sheet are vehicles, however, not receivables. SFAS No. 13, Accounting for Leases, provides as follows:

The sale of property subject to an operating lease, or of property that is leased by or intended to be leased by the third-party purchaser to another party, shall not be treated as a sale if the seller ... retains substantial risks of ownership in the leased property.

Consequently, the accounting industry will not apply SFAS No. 125 to the sale of equipment subject to operating leases.

Accountants have developed two approaches to get the assets off the sponsor's balance sheet. The first is the sale-leaseback structure. Under Issue Summary 93-8 of the Emerging Issues Task Force, the EITF indicates that a party will obtain sale treatment for a sale-leaseback transaction involving vehicles that already are subject to leases. Ford relied on this Issue Summary in structuring its transactions.

We also understand that some accountants have taken the position that a leasing company that sells true leases and the related vehicles will also obtain sale treatment, and be able to remove the assets from its balance sheet, if it has obtained sufficient residual value insurance with respect to the vehicles. In effect, the accountants have said that, with residual value insurance, the leasing company has given up enough of the risk of the vehicle that the lease should be treated as a "direct financing lease," and consequently, it is acceptable to treat the vehicle and lease together as a financial asset and to apply SFAS No. 125 to the sale. To obtain treatment as a direct financing lease, the lessor must have purchased an amount of residual value insurance such that the present value of the lease payments plus the guaranteed portion of the vehicle's residual value generally must exceed 90% of the fair market value of the vehicle.13 These residual value insurance policies have become known as "SFAS No. 13 Policies." The residual value insurance need not be first loss protection.

G. Special Issues for Banks

Lending Limit Issues. One of the most complex bank regulatory issues raised by Titling Trusts of banks revolves around federal and state lending limit restrictions ¹⁴. The risk presented by the applicability of lending limits is that the Titling Trust itself (i.e., both the UTI and SUBI portions) would be treated as one "obligor." If so, the bank's funding of the UTI could be limited to a relatively small amount, 15% of the bank's capital and surplus under for national banks. This result could have material and disruptive consequences for a Bank's securitization program. This problem has proven to be difficult, but solvable by experienced and creative counsel, and the solutions do not require regulatory approval.

Regulatory Accounting. Prior to 1997, regulatory accounting principles for banks ("RAP") provided that assets are not deemed to be sold unless the bank retained no recourse or risks whatsoever with respect to the sold assets. Consequently, one of the most complicated issues for banks was how, on the one hand, to provide credit and residual value enhancements so that some or all securities can be rated triple-A and so that the bank's consolidated group will be deemed to have sufficient risks of ownership of the vehicles to be treated as the owner for tax purposes while, on the other hand, the bank seeks to achieve off-balance sheet "sale" treatment for RAP purposes. Effective January 1, 1997, all federal bank regulatory agencies began using generally accepted accounting principles as RAP. In other words, if a bank can obtain off-balance sheet treatment for its assets in a securitization for financial accounting purposes after January 1, 1997, it will automatically achieve off-balance sheet treatment for RAP purposes. Consequently, it has become somewhat easier for banks to securitize their auto leases because, except for risk-based capital calculations (discussed below) they need only concern themselves with one set of accounting principles.

Risk-Based Capital Requirements. Under federal regulatory capital requirements, the provision of a guarantee or certain other credit or residual value enhancement by a bank in connection with the sale of its assets may be considered an "asset sale with recourse." In turn, current regulatory capital rules treat an asset sale with recourse as a financing and not a sale. Therefore, banks which transfer assets "with recourse" are required to hold leverage and risk-based capital against the amount of the assets transferred as if they remained on the bank's books. If the assignment of a SUBI is treated as an indirect transfer of Bank assets, the Bank's provision of credit enhancement might oblige the Bank to hold capital against the leases and vehicles transferred in this manner. The adoption of generally accepted accounting principles for RAP has caused a great deal of confusion among lawyers and accountants about whether risk based capital is required to be maintained against the assets sold if they will be off-balance sheet for GAAP and RAP purposes. The OCC recently confirmed that, for risk-based capital purposes, a reserve account in connection with a securitization transaction will be deemed to cause the sale of the assets to be deemed a sale with recourse and consequently to require capital to be held equal to the lesser of the amount of the reserve account and 8% of the assets sold ¹⁵.

The easiest solution to this issue is for the Bank to obtain third-party residual value insurance or a third-party guarantee, which will present no issues under applicable regulatory capital regulations; however, the arrangement needs to be carefully structured to assure that for tax purposes the bank's consolidated group will continue to be deemed to own the vehicles and be entitled to depreciation. If the provider of the enhancement is the Bank's holding company or a nonbank affiliate, however, the enhancement may cause the SUBI assets to treated as asset sales with recourse by the consolidated group and therefore remain on the balance sheet of the parent holding company for regulatory capital purposes. The creation by the holding company or an affiliate, however, of a reserve account can be used as an enhancement without adverse regulatory accounting or capital consequences for the bank or adverse financial accounting consequences for the holding company, but regulatory capital will need to maintain capital against the assets sold.

H. Securitizing Fleet Leases and TRAC Leases.

Unlike consumer leases, many commercial auto and truck fleets are leased under master leases. The master lease sets out the basic terms of each lease, and one or more schedules are attached to the master lease from time to time which set out the specific vehicles that are subject to the lease and any special terms relating to those vehicles. An interesting issue in every fleet lease securitization is determining how to separate the rights under the master lease with respect to the securitized vehicles from the rights with respect to the vehicles not securitized. Another important issue is dealing with the end user lessee concentrations that are likely to arise in a fleet leasing program because fleet lessors often have a few very important large corporate customers.

Many fleet leases are TRAC leases. These leases contain a terminal rental adjustment clause, or "TRAC" feature. A terminal rental adjustment clause is similar to a residual value guarantee by the lessee. The Internal Revenue Code specifically permits the lessor under a TRAC lease of motor vehicles to be treated as the owner of the vehicles for tax purposes. See Internal Revenue Code Section 7701(h) (1996). Part of every TRAC lease securitization involves assuring that the lessor/originator either can continue to obtain the depreciation benefits of the vehicles or can obtain the pricing benefits from transferring the tax benefits.

The most prominent fleet lease securitization transactions have been the two private placements by Leasing Associates Inc.

V. A Look At The Future

As the auto lease securitization market continues to broaden, there appear to be several new developments which have the potential to increase the size of the market exponentially. These new developments include (a) the transfer of tax benefits in a securitization structure and (b) the potential for cross border auto leasing.

A. Transfer of Tax Benefits

The most important new development of 1996 has been the use of titling trusts in transactions designed to transfer tax benefits to one or more investors. Because ownership of the vehicles for tax purposes requires the owner to have the risks and rewards of ownership, including some residual value risk, transfers of tax benefits have been difficult. After all, securitization investors normally purchase highly rated instruments, not unrated investments which carry meaningful risks.

The transfer of tax benefits requires a true marriage of securitization and traditional leasing technology. The investors that are willing to accept the residual value risk necessary to receive tax benefits are not securitization investors, but the kinds of investors that already invest in aircraft and railcar leases.

Several securitization and sale-leaseback transactions occurred in 1996. These transactions can be expected to increase in volume as the trend toward leasing continues and more leasing companies find themselves in alternative minimum tax positions with more depreciation and other deductions than their taxable income.

1. Sale of SUBI

There are several structures which can be employed. Most are extremely complicated and intended to time various cash flows to "optimize" the investment of the "owner participant," the holder of the equity. The simplest is to sell a SUBI to an equity investor without in transaction not designed to be bankruptcy remote. This is just a sale of the vehicles subject to the leases. Because the buyer has purchased the vehicles, the buyer will obtain the tax benefits associated with ownership of the vehicles. A somewhat more complicated transaction would be a "two-tier" transfer to a trust (i.e., first a true sale to a bankruptcy remote entity, then a contribution of the assets by the bankruptcy remote entity to the trust), which issues certificates and notes. The notes are rated triple-A based on the subordination provided by the unrated certificates. The certificates may approach 20% of the capital structure of the trust. The holder of the certificates may seek to protect against some of his residual value risk with insurance or other third party support, but there is a tension between his protection against risk and the strength of his tax ownership of the vehicles. The more risk the certificateholder is exposed to, the greater the likelihood that he will be treated as the owner of the property for tax purposes.

2. Sale-Leaseback.

Another simple structure is a sale leaseback. Many traditional sale-leaseback transactions, which have not involved a bankruptcy-remote structure, have occurred over the past twenty-five years involving aircraft, railcars, real estate and other assets. Transactions involving vehicles historically have been difficult for the same reasons set forth above that have made securitization transactions involving vehicles difficult, particularly the Retitling Problem. Many vehicle lessors today are beginning to think about sale-leasebacks of their vehicles.

3. Leveraged Lease Structures.

A leveraged lease structure looks very much like the sale-leaseback structure, except that some of the purchase price of the assets (often more than 80%) is financed through the issuance of debt. In a leveraged lease, the equity investor not only obtains the depreciation benefits of 100% of the vehicles, he also obtains an interest deduction for the interest paid on the debt. There is also a significant accounting benefit to the lessor of a leveraged lease. Rather than hold the full amount of the assets purchased on its balance sheet as an asset and the full amount of the debt as a liability, FAS 13 permits lessors of leveraged leases to record only their net investment in the property as an asset and to avoid recording any liability for the debt. Leveraged lease structures will probably be necessary for any large transaction. In an asset-backed leveraged lease structure, the originator would sell a SUBI to a bankruptcy-remote subsidiary in a transaction designed to be a true sale, then the subsidiary would do a sale leaseback transaction with a trust. The trust issues all of its certificates to an equity investor and issues debt to the underwriters or investors in a private placement or public offering. The certificates would be privately placed to a leasing investor with an appetite for tax benefits. The notes issued by the trust could be rated triple-A based in part on the significant equity provided by the certificates. The certificates would be unrated. Many large auto lessors are currently looking at similar structures.

4. TRAC Structures.

One way to permit the transfer of tax benefits without requiring the investor to accept residual value risk is to use a sale-leaseback structure, except that the operating lease would have a terminal rental adjustment clause, or "TRAC" feature. TRAC leases are described earlier in this article. A disadvantage of TRAC structures is that it is very difficult for the leaseback obligation to be viewed for accounting purposes as an operating lease, and consequently, off-balance sheet treatment is hard to obtain.

B. Cross-Border "Double-Dip" Structures

Cross-Border double-dip financing structures have been used in aircraft leasing for decades. The invention of the Titling Trust may make double dip securitization and headlease structures possible to finance U.S. auto leases. At this time, no auto lease double dip transactions have been completed, however, this remains an exciting possibility for the future.

"Double-dip" means that two persons in different jurisdictions are each able to obtain depreciation deductions from the same asset in their respective jurisdictions. This "tax arbitrage" is available by taking advantage of the differences between the tax laws in the two jurisdictions. Many non-U.S. jurisdictions look to "form" over "substance" and treat the title holder as the owner of the property entitled to depreciation deductions, whether or not the title holder has any risks or rewards of ownership. In the U.S., however, the owner of depreciable property is determined by looking at "substance" rather than "form." In other words, the owner of the property for U.S. tax purposes is the party that has the risks and rewards of ownership. That person need not be the title holder. For example, in both the World Omni and Ford structures, although the SUBI (or Series 1995-1 Certificate) is held by a securitization trust owned by third parties, Ford and World Omni were both treated as the owner of the property for U.S. tax purposes because the transactions were structured to be debt for tax purposes. Double dip sale-leaseback and other financing transactions have been used for aircraft and other assets in which mere title is held by a non-U.S. party and the risks and rewards of ownership, particularly residual value risks, have been held by a U.S. party.

1. A Simplified Structure

One reason double dip structures seem enticing at the moment is because existing lease securitization structures might require little modification to be used for a double dip. One possible simple structure that could be used is a variation on the World Omni structure. Currently, after a true sale of the SUBI to WOLSI, L.P., a bankruptcy remote subsidiary limited partnership, WOLSI, L.P. transfers the SUBI to a securitization trust based in the U.S. and WOLSI, L.P. provides some additional credit and residual value enhancements. If WOLSI, L.P. instead were to transfer the SUBI to a corporation, partnership or trust formed under the laws of a foreign jurisdiction and owned entirely by one or more foreign investors, it is possible that the foreign investors could be able to obtain depreciation deductions in their home country.

2. Important Issues

Selecting the Non-U.S. Jurisdiction. Because no non-U.S. jurisdiction has a tax law that looks only to form and entirely disregards substance, a significant effort will be required to investigate the tax laws of each non-U.S. jurisdiction to determine whether any structure will work under that jurisdiction's laws. In addition, investment bankers will need to determine whether investors in these non-U.S. jurisdictions will want to invest in these structures and whether the pricing of these transactions will make them more advantageous to U.S. vehicle lessors than existing securitization and financing structures in the U.S.

Several non-U.S. countries have been involved in aircraft double dip transactions, including Japan, the United Kingdom, France, Sweden, Denmark, Hong Kong and Germany. We understand that double dip structures may also be possible with Brazil, Ireland, Belgium and other countries. A detailed discussion of the tax laws of these jurisdictions is beyond the scope of this article, and it is certain that significant additional tax research will be required to get the first auto double dip transaction off the ground.

Effect of Titling Trust. The most important issue will arise from the fact that the non-U.S. investor will not hold vehicles and related leases but instead will hold a beneficial interest in a Titling Trust representing the rights in vehicles and the related leases. Under U.S. tax law, if the Titling Trust is properly structured, the Titling Trust is disregarded as a mere nominee and the holder of the transferred SUBI is entitled to depreciation deductions if it has the risks and rewards of ownership. It is likely that under the laws of at least some non-U.S. jurisdictions, the purchase by the non-U.S. entity of a SUBI issued by a U.S. Titling Trust will be treated as a nondepreciable minority investment in securities issued by a non-U.S. company rather than a depreciable investment in vehicles.

3. Other Structures.

There are many variations on the simple structure above, all of which require a detailed analysis of the tax and other laws of the non-U.S. jurisdiction which is beyond the scope of this article. The following are a few examples:

Using Debt: The "Owner Trust" Structure. A variation on the simplified structure described above is to transfer the SUBI to a non-U.S. entity that issues both debt and equity securities. The equity investor therefore would not be required to provide all of the financing for the transaction. In addition, the subordination provided by the equity may enable the debt to be more highly rated by credit rating agencies. Depending on the laws of the non-U.S. jurisdiction, it is possible that the debt could be sold to both non-U.S. and U.S. investors.

The Sale-Leaseback Structure. Another variation would be a sale-leaseback with a non-U.S. entity. The leaseback arrangement would be structured to be a debt for tax transaction for U.S. tax purposes in which the U.S. vehicle lessor (or its BR Sub) would assume all risks and rewards of ownership. In addition to residual value guarantees, ways to achieve a debt for tax transaction for U.S. purposes might include a residual value guarantee, an automatic title transfer or a bargain purchase option at the end of the leaseback (subject to the rights of customer lessees under the customer leases).

Selling the U.S. Tax Benefits. After implementing a double dip structure, perhaps it may be possible for the U.S. vehicle lessor to subsequently transfer the U.S. tax benefits. For example, if the vehicles are deemed to be owned by a BR Sub, that entity could sell some or all of its assets, or the entire entity could be sold, to a third party.

VI. Postscript

The future promises new developments for auto leasing companies, as more companies form Titling Trusts, and the securitization market for auto leasing companies continues to develop. The advancement of the auto lease securitization market has brought new ideas to vehicle lease financing. Today, we are seeing a merger of leasing and securitization technology to create global financing structures to provide low cost financing to vehicle lessors. It is an exciting time to be a CFO of a vehicle lessor or a participant in vehicle financing transactions.

¹¹ See Prospectuses, World Omni 1994-A Automobile Lease Securitization Trust, World Omni 1994-B Automobile Lease Securitization Trust, World Omni 1995-A Automobile Lease Securitization Trust, World Omni 1996-A Automobile Lease Securitization Trust, World Omni 1996-B Automobile Lease Securitization Trust, Ford Credit Auto Lease Trust 1995-1 and Ford Credit Auto Lease Trust 1996-1.

¹² Of course, the Transferor would need to be adequately capitalized to perform its obligations under the guaranty. 13 SFAS No. 13, Accounting for Leases, provides that, among other things, a lease must satisfy at least one of the following criteria to be a direct financing lease:

1. The lease transfers ownership of the property to the lessee by the end of the lease term
.
2. The lease contains a bargain purchase option.
3. The lease term is equal to 75 percent or more of the estimated economic life of the leased property.
4. The present value at the beginning of the lease term of the minimum lease payments ... equals or exceeds 90 percent of the ... fair value of the leased property at the inception of the lease.

¹³ See, 12 U.S.C. § 84 (national bank lending limits).

¹⁴ SR 96-30 (SUP) - Risk-Based Capital Treatment for Spread Accounts that Provide Credit Enhancement for Securitized Receivables.

¹⁵ See, 12 C.F.R. Part 225, Appendices A and B (risk-based and leverage capital requirements for bank holding companies).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.