Overview

The following provides a brief overview of sinking funds, integral to our asset-backed securitized issuances, facilitating non-recourse project financing. Our approach to asset securitization and the utilization of sinking funds remains consistent across various asset classes. However, for the purpose of this overview, the emphasis is placed specifically on project finance.

A sinking fund is a designated fund, account, or investment established for the purpose of repaying a loan. Throughout history, sinking funds have played crucial roles, particularly in assisting sovereign governments with the repayment of war bonds and the reduction of national debts. While mentions of sinking funds trace back to the Italian city-states of the Middle Ages, the concept is commonly associated with initiatives undertaken by the English crown during the 17th and 18th centuries.

Sinking fund programs have gained popularity among governments and organizations as a means to finance various financial obligations, including interest payments, dividends, issuance maturity obligations, and infrastructure investments, among others. By accumulating funds gradually over time, sinking funds enable the financing of future capital obligations, thereby ensuring that the required funds are readily available when needed.

Singapore's Central Provident Fund (CPF) stands as one of the world's most successful sinking fund programs. Established in 1955, it has evolved into a cornerstone of Singapore's social security framework. The CPF operates as a mandatory savings scheme, compelling both employers and employees to allocate a portion of their earnings to the fund. These contributions are subsequently invested across diverse assets, encompassing government bonds, stocks, and real estate. Notably, the CPF has played a pivotal role in funding Singapore's infrastructure development, contributing significantly to the establishment and upkeep of its renowned public transportation system.

Japan's Postal Savings System stands as another exemplary sinking fund program. Originating in the late 1800s, it has burgeoned into one of the globe's largest financial institutions. The system permits individuals to deposit funds into savings accounts, which are subsequently utilized to support government initiatives and investments. Notably, the Postal Savings System has played a pivotal role in funding Japan's infrastructure projects, notably contributing to the development of its renowned high-speed rail network.

New York City's Capital Stabilization Fund, instituted in 2006, serves as a pivotal mechanism for financing the city's capital projects. Funded through a portion of the annual budget surplus, it supports infrastructure investments crucial for the city's growth, including the construction of schools, parks, and transportation systems. This fund has proven highly effective in providing a consistent and reliable source of funding for New York City's infrastructure requirements. Importantly, it mitigates budgetary constraints, ensuring that essential projects proceed unhindered.

Sinking Funds Play Critical Role

Sinking funds play a crucial role beyond government programs, extending their utility across various financial instruments and sectors. They are notably prevalent in sovereign debt instruments, mortgage-backed securities, credit card issuances, real estate investments, and synthetic asset-backed collateralized structures..

In today's financial landscape, sinking funds have emerged as indispensable tools for major industry players, including Visa, MasterCard, American Express, numerous banks, and institutions involved in mortgages, car loans, aircraft and yacht financing, insurances and corporates. These entities rely significantly on sinking funds to facilitate prompt repayment of obligations and furnish investors with payment assurances, thereby serving as a safeguard against defaults.

The widespread adoption of cash backed safety in sinking fund provisions underscores their versatility, and reliability in diverse financial contexts, highlighting their importance in maintaining stability and confidence within the financial system.

Types of Sinking Fund Bonds

• Sinking Fund Bonds for Callable Bonds. These bonds are utilized when a company holds callable bonds and desires to repurchase them from bondholders at a premium due to declining interest rates. Sinking fund bonds serve as a financial mechanism to facilitate such repurchases by providing the necessary cash reserve for the company.


• Sinking Fund Bonds for Aligned Objectives and Purposes. Companies often have specific future objectives and purposes that require financial support. Sinking fund bonds can be strategically employed to secure funds for these upcoming objectives, ensuring the company's financial preparedness to meet its goals.

• Sinking Fund Bonds for Bond Repurchase. In instances where companies aim to retire their debt obligations ahead of schedule, sinking fund bonds are established for the purpose of repurchasing existing bonds from bondholders. This allows companies to efficiently manage their debt and optimize their financial positions.

Sinking Fund Oversight

Sinking Fund Managers are responsible for the comprehensive oversight of funds and ensuring adherence to the terms outlined in offering agreements. Furthermore, an independent Protector, with access to the funds' financial records, is appointed to supervise fund management activities. This structured approach enables systematic fund management and fosters the funds growth to effectively retire outstanding par/maturity obligations.

Mandatory Call Option

In our issuances, a mandatory call option is embedded and triggered when the sinking funds reach the total outstanding redemption obligation. These sinking funds are meticulously crafted to achieve the issuance redemption value well in advance of the maturity date. As a result, investors benefit from a significantly higher yield to call compared to yield to maturity.

Funding Sinking Funds

Essentially, the distinction between a sinking fund and a savings account lies in their intended purpose and usage, despite both involving setting aside money for the future.

A sinking fund is established for a specific purpose and with a predetermined timeframe for utilization. Its primary aim is to accumulate funds over time to meet future financial obligations, such as debt repayment or planned expenditures like capital projects.

On the other hand, a savings account is a more general financial tool, for accumulating funds for various purposes without any specific earmarking or time constraint.

Sinking funds are established by earmarking funds from various sources. The issuer typically makes regular contributions to a dedicated fund, known as the sinking fund, utilizing revenues generated from its operations. As these contributions accumulate over time, the sinking fund grows, ultimately intended to repurchase (retire) portions or the entirety of the outstanding debt.

In instances involving interest-bearing collateral like credit cards or mortgage-backed securities, the interest payments derived from the underlying collateral can be channeled directly into the sinking fund. Alternatively, in other cases, the sinking fund may be financed directly through the proceeds obtained from the sale of the bond itself. This flexible approach to funding sinking funds underscores their adaptability to diverse financial arrangements and instruments.

Funded from Sale Proceeds

The sale proceeds are delineated within the offering's waterfall structures, where cash flows to senior tranches are disbursed only after meeting payment obligations to securitization servicers, such as auditors or custodian banks. In our issuances, following the defined waterfall structure, proceeds from the asset-backed securitized Note sale are allocated into two primary categories: (i) net proceeds for project build-out in its entirety; and (ii) three classes of sinking funds, comprising two institutional public funds and one high-yield private fund. These funds are strategically crafted to facilitate both annual dividend/coupon payments and to accumulate reserves. Over time, they are intended to grow to trigger the mandatory call option, thereby fulfilling the ABS Note/Share maturity redemption obligations.

Summary

The sinking fund framework stands as the strategic cornerstone, providing investors with assurances and opportunities for higher-yield call redemptions, while also furnishing large-scale projects with unencumbered financing to complete their endeavors fully and without recourse.

Our "sinkable" Asset Backed Securitized offerings create a win-win scenario for both the asset owner and issuance holders. For the asset owner, the project is fully financed from sale proceeds without recourse, ensuring comprehensive funding. Meanwhile, issuance holders gain the security of sinking fund trustee oversight and the assurance of repayment obligations.

OVO can guide you on the journey ahead. OVO is proud to offer an institutional team for securitization, through exit and post exit funding structures. Starting with your initial data, we execute initial compliance, structuring set-up, securitization, issued financial instruments, exit and post securitization sinking fund deployment.

Contact us to learn more.