This invention relates to providing an asset-backed investment. In particular, this invention pertains to providing an asset-backed investment that is attractive to a new class of investors, specifically, insurance companies. The asset-backed investment includes a transfer of asset ownership rights and, optionally, a like-kind exchange feature, and/or a Terminal Rental Adjustment Clause (“TRAC provision”).
As reflected by its name, an asset-backed security (“ABS”) is a security, such as a bond or a note, that is backed by a pool of assets, such as automobile loans, automobile leases, railcar leases, airplane leases, credit card receivables, or student loans. A conventional ABS having automobile and light-duty truck leases (collectively, “vehicle leases”) as the underlying assets is illustrated with reference to
To initiate a vehicle lease ABS, the AFC 101 typically instructs the titling trust 102 to create a SUBI for a pool of leased vehicles which now makes up the assets of the ABS. Alternatively, the AFC 101 can directly create a SUBI. The AFC 101 also typically forms a special purpose entity (“SPE”) 103 to which the AFC 101 sells, transfers, and assigns the SUBI. The SPE 103 then typically transfers the SUBI to a newly formed statutory trust (“issuer”) 104 in return for Class A certificates. The Class A certificates represent an equity interest in the issuer 104 and provide credit enhancement for other investors in the issuer 104. The Class A certificates are transferred to Class A certificate holders 106. The issuer 104 is the issuer of the ABS, because it issues notes to term ABS investors 105 in return for cash. Cash flows received by the issuer 104 from the SUBI, i.e., lease payments from the underlying users and residual proceeds from the purchase or disposition of the underlying vehicles, are used to service the obligations of the issuer 104 under the notes. The issuer 104 also pledges its assets to an Indenture Trustee 107 as security for the notes.
An illustrative example of an investor's 105 reporting for a $100 million investment, according to the conventional ABS lease structure of
As illustrated in
The above-described issues are addressed and a technical solution is achieved in the art by an asset-backed investment instrument that, among other things, increases deferred tax liabilities for an investor, and is rated by a Nationally Recognized Statistical Rating Organization (“NRSRO”), and therefore, is attractive to any investor that benefits from deferred tax liabilities and needs rated investments, such as certain insurance companies. Deferred tax liabilities are generated, according to an embodiment of the present invention, due to varying tax payment schedules under GAAP, statutory, and tax reporting. An ABS that generates a deferred tax liability allows, for example, many insurance company investors to generate regulatory capital, known in the art, and allows a longer duration ABS to extend the life of that regulatory capital. A benefit of using rated investments is that such use can facilitate a company's compliance with state investment laws and regulatory capital requirements, as are known to those skilled in the art. A benefit of the present invention is that it attracts insurance company investors that otherwise would not invest in an ABS.
According to an embodiment of the present invention, deferred tax liabilities are increased for an investor by transferring the tax ownership of assets, in whole or in part, underlying an ABS to an investing entity. Ownership of other assets and/or a cash accumulation/reserve account may be retained and pledged as collateral to the investing entity. The investing entity may be an investor, an entity owned at least in part by an investor, or an entity having an ancestor that is owned at least in part by an investor. The investor may be an insurance company or any other investing entity that benefits from deferred tax liabilities. The transferred assets may be automobiles, motorcycles, airplanes, boats, ships, real property, or any other capital asset for which tax depreciation may be claimed. The transferred assets are leased from the investing entity for a predetermined period and may be subleased to consumers. The predetermined period may be based upon a useful life of the transferred assets. According to an embodiment of the present invention, the predetermined period may be up to 80% of the useful economic life of the transferred assets. If the assets are leased automobiles, the predetermined period may be 6 to 8 years, assuming an 8 to 10 year life of an automobile.
To extend the benefits of deferred tax liabilities, an embodiment of the present invention implements a like-kind exchange (“LKE”) feature. According to the LKE feature, when an asset underlying the ABS is sold, for instance, at the end of a lease, the proceeds from the sale are invested in another like-kind asset pursuant to the provisions of IRS Code Sections 1031 and 1033 and the regulations thereto, known in the art. With this feature, the sale of the asset is not a taxable event to the investing entity, taxes are deferred over the remainder of the predetermined period, and tax liability is further deferred.
According to an embodiment of the present invention, a Terminal Rental Adjustment Clause (“TRAC provision”) is provided to further enhance investment attractiveness to investors. The TRAC provision allows the investors to receive the tax benefits of owning the assets while minimizing the risk of a change to the residual value of the assets. The TRAC may specify that, at the end of the predetermined period, if an actual residual value realized from the sale or disposition of the transferred assets is less than an estimated residual value of the transferred assets at an inception of a lease, a payment (the “TRAC”) is made to the investing entity 105 in an amount corresponding to the difference between the estimated residual value and the actual residual value. Accordingly, if the actual residual value is greater than the estimated residual value at the end of the predetermined period, the SPE 103, or “transferor,” is entitled to such excess. Further, the TRAC provision allows the investors to record a larger residual value estimate since the residual value is effectively guaranteed and therefore requires less ongoing rental payments from the lessee, resulting in a greater deferred tax liability for the investors. According to an embodiment of the present invention, the TRAC provision is structured pursuant to IRS Code Section 7701(h), known in the art.
The present invention will be more readily understood from the detailed description of preferred embodiments presented below considered in conjunction with the attached drawings, of which:
The present invention provides various embodiments of an asset-backed security (“ABS”) to increase deferred tax liabilities for an investor and, therefore, is attractive to any investor that benefits from deferred tax liabilities, such as, certain insurance companies. However, one skilled in the art will appreciate that, any investor may make use of the present invention regardless of whether they benefit from deferred tax liabilities. A deferred tax liability (“DTL”) is a GAAP book account that represents an obligation to pay taxes at a future date. DTLs are generated due to varying tax payment schedules under GAAP and tax reporting. For example, a faster tax depreciation schedule as compared to a company's GAAP schedule can allow a company to defer the payment of taxes that are recognized under GAAP reporting. This would cause the company to have a DTL.
One type of investor that benefits from DTLs are certain insurance companies, because DTLs allow the insurance companies to generate additional statutory surplus, known in the art. Statutory surplus is an accounting measurement that state regulators and rating agencies use to evaluate the solvency of an insurance company. In other words, statutory surplus is a measure of the financial vitality of an insurance company. Accordingly, the higher an insurance company's statutory surplus is, the more attractive the insurance company is to investors.
To elaborate, statutory surplus represents the degree to which an insurer's assets considered liquid by regulators exceed the insurer's liquid liabilities. One form of assets considered liquid is known as admitted deferred tax assets, or admitted “DTAs.” A DTA is a GAAP book account that reflects the recognition for GAAP book purposes of future tax savings. However, not all DTAs contribute towards an insurance company's statutory surplus. Only those DTAs considered liquid by state regulators are admitted into the statutory surplus calculation and, thus, are termed “admitted DTAs.” Therefore, the more admitted DTAs an insurance company has, the higher its statutory surplus will be.
Admitted DTAs are calculated as the sum of: (1) federal income taxes paid in prior years that may be recovered through loss carrybacks for existing temporary differences that reverse by the end of the subsequent calendar year; (2) the lesser of a) the amount of DTAs expected to reverse in one year or b) 10% of statutory surplus; and (3) the amount offset by DTLs. Regarding element (3), the more DTLs an insurance company has, the more admitted DTAs it has, and the more statutory surplus it has. Therefore, certain insurance companies who invest in the asset-backed investment, according to the various embodiments of the present invention, increase their DTLs and, consequently, their statutory surplus.
The manner in which the asset-backed investment, according to an embodiment of the present invention, increases DTLs and is otherwise attractive to investors, will now be described with reference to
The asset-backed investment illustrated in
At step S402, the finance company 301 capitalizes, or funds, the SPE lessee 303 with the sold portfolio, the collateral portfolio, and a cash accumulation/reserve account (“CAA”), known in the art. At step S403, the SPE lessee 303 sells the sold portfolio to the SPE lessor 304, but retains ownership of the collateral portfolio and the CAA. The SPE lessor 304 accordingly pays the SPE lessee 303 the sales price of the sold portfolio. To fund the purchase of the sold portfolio, the investors 305 make a contribution in aggregate equal to 100% of the sale price of the sold portfolio to the SPE lessor 304.
Because the investors 305 are owners of the sold portfolio assets for tax purposes, they may claim tax depreciation based upon those assets. Depreciation is claimed differently for accounting purposes than for tax purposes. For tax purposes, the investors 305 are able to claim large deductions relative to the value of the assets early in the life of the assets, and small deductions later in the life of the assets. For accounting purposes, however, investors 305 account for the assets as financial assets under direct finance lease accounting. For accounting purposes, the investors 305 recognize a stream of income and the TRAC amount from the rent payments received from SPE 303 under the lease agreement. Because the investors 305 take large tax depreciation deductions up front associated with the assets, they are able to shelter more of their taxable income from tax, deferring payment of such taxes until a later time when taxable income requires larger tax payments than income recognized for GAAP purposes. Accordingly, this deferment of tax payment provides the investors 305 with a deferred tax liability (“DTL”).
At step S404, the SPE lessor 304 leases the sold portfolio assets to the SPE lessee 303 for a predetermined period. The predetermined period may be based upon a useful economic life of the “sold portfolio” of assets. According to an embodiment of the present invention, the predetermined period is generally up to 80% of the useful economic life of the transferred assets. If the assets are leased automobiles, the predetermined period is generally up to 6 to 8 years, assuming an 8 to 10 year economic life for a given automobile. Although the predetermined period may is generally up to 80% of the useful economic life of the transferred assets according to an embodiment of the present invention, the predetermined period may be longer and may be determined independent of a useful economic life of the transferred assets. As part of the lease, the SPE lessee 303 may pledge the collateral portfolio and the CAA as security for its obligations under its lease with the SPE lessor 304. Separately or in addition, the FC 301 may provide indemnities and/or guarantees to the SPE lessor 304 in the event that the SPE lessee 303 is unable to meet its obligations under the lease. At step S405, the SPE lessee 303 may sublease the sold portfolio assets to user lessees 306, which may be consumers.
The lease may include a like-kind exchange (“LKE”) feature. The LKE feature requires that, upon a sale of a leased asset, the proceeds of the sale be reinvested into a new like-kind asset to be leased. In the case of vehicles, pursuant to the provisions of IRS Code Section 1031 or 1033, a like-kind asset may be a vehicle in the same class (e.g. a passenger automobile for another passenger automobile, a light truck for another light truck) as the asset sold. Under the conventional ABS lease structure, which does not incorporate an LKE feature, a sale of an asset, which typically occurs at the end of a lease, results in a taxable event. In other words, the proceeds received from the sale of the asset are taxed. However, by reinvesting the proceeds of the sale into a like-kind asset, the sale is not counted as a taxable event. Further, by continually re-investing the proceeds of asset sales at lease termination, no taxable events occur during the lease between the SPE lessor 304 and the SPE lessee 303 as a result of a termination or maturity of an underlying lease with an end user. Accordingly, the duration of the lease between the SPE lessor 304 and the SPE lessee 303 may be extended beyond the length of a typical retail lease to an end user or sublease, in this case, which generally is two to four years. A longer lease duration between the SPE lessor 304 and the SPE lessee 303 means an increase in time that the investors 305 are able to extend their DTLs, thereby enhancing the effects of their DTLs.
The lease also may include a Terminal Rental Adjustment Clause (“TRAC provision”). The TRAC provision may be pursuant to IRS Code Section 7701(h) and allows the investor to retain the tax ownership of the automobiles while minimizing the risk of a change to the projected or estimated residual value of the automobiles. At the inception of the lease, the sold portfolio assets have an estimated residual value, or “TRAC amount”, that indicates the estimated value of the assets at the end of the lease. Because the investors 305 are the owners of the sold portfolio assets (via the SPE lessor 304), the investors rely upon this estimated residual value as an indicator of the value of their investment upon termination of the lease. The TRAC provision requires that a payment be made from the SPE lessee 303 to the SPE lessor 304 if the actual residual value of the sold portfolio assets at the end of the lease is less than the TRAC amount. The payment may be in an amount corresponding to the difference between the TRAC amount and the actual residual value and may be capped at a predetermined percentage of the price that the SPE lessor 304 paid to the SPE lessee 303 at inception for the sold portfolio assets, such as 22-23%, for example.
In contrast to the conventional investment illustrated in
Implementation and management of the various embodiments of the present invention may be supported by the use of computers and software. For instance, accounting and tax information generated in accordance with the present invention may be generated and/or stored with the use of computers. Contracts and/or other documents needed to implement the invention may be generated and/or stored with the use of computers. Functionality to support billing, keeping track of accounts receivable, and other financial management tasks needed to manage the leases between the SPE Lessor 304 and the SPE Lessee 303, and/or the SPE Lessee 303 and the User Lessees 306, may be provided, at least in part, by computers. Accordingly, one skilled in the art will appreciate that computers may be used to support nearly any aspect of the present invention. However, one skilled in the art also will appreciate that the invention is not limited to any particular arrangement of computers used to support the invention. The term “computer” is intended to include any data processing device, such as a desktop computer, a laptop computer, a mainframe computer, a personal digital assistant, a Blackberry, and/or any other device for processing data, whether implemented with electrical and/or magnetic and/or optical and/or biological components, or otherwise.
It is to be understood that the exemplary embodiments are merely illustrative of the present invention and that many variations of the above-described embodiments can be devised by one skilled in the art without departing from the scope of the invention. It is therefore intended that all such variations be included within the scope of the following claims and their equivalents.