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Back-Up Servicing Explained: Essential Questions Answered

Bridgin and UNDP CAP Financial Aggregation Reports

This piece seeks to answer the essential questions on Back-Up Servicing (BUS) in the context of the Off-Grid Solar (OGS) sector in Africa. However, many insights could be transposed to other local industries delivering access to essential services on credit.


Assuming a Distributed Energy Services Company (DESCO) operating under a Pay-as-you-go (Paygo) model benefits from an off-balance sheet arrangement, or has collateralised a loan using part of its receivables book, a back-up servicer would be the entity responsible for taking over: payment collection, Paygo token generation, and customer relationship management, if the distributor failed to repay investors according to transaction terms. 


Having clarified this, let’s delve into the essential questions surrounding BUS:




1. What, exactly, is Back-Up Servicing?


In the context of debt financing, the servicer is the entity responsible for collecting and recording loan and interest payments from a borrower. Quite simply, then, the back-up servicer is the company that takes over those servicing duties for a given portfolio of assets or receivables, should the primary servicer (i) be no longer able to perform its duties and / or (ii) default on its financial obligations to investors.


Back-up servicing (BUS) is relevant for any transaction or financial arrangement where an outstanding portfolio of assets backs the value of the transaction. That means on-balance sheet where such assets are used as collateral for credit facilities; but also, and most importantly,  off-balance sheet (OBS) arrangements - (as explained in question n°4


Simply think of BUS as the cornerstone of a contingency plan aiming at minimising losses, should the servicer default. Driven by the need to enhance investor confidence, manage operational risks and ensure continuity of payment flows, BUS has become an integral part of structured finance transactions in a majority of mature industries, including financial services and mortgage-backed securities, auto finance and student loans.


2. Who benefits from robust Back-Up Servicing?


We’d say - everyone. And more specifically: 


  • Investors: Their financial interests are protected, and losses are minimised in case of the investee’s default.

  • DESCO: The presence of BUS on a deal acts as a risk-mitigation tool, thus increasing the attractiveness of the deal for investors, and lowering the cost of capital.

  • End-customers: If their service provider defaults while their assets still hold value, BUS can help them benefit from continued service and access to essential services they need.

  • The industry at large:  By making off-balance sheet less risky and more attractive, robust BUS can help attract additional capital, mitigate panic and contagion effects in case of DESCO defaults, and build collective trust in innovative financial mechanisms.


3.What is Back-Up Servicing composed of?


In the OGS sector, BUS should be composed of three main pillars: 


  1. Software and technical BUS Objective: Ensuring continuity of payment collection, CRM use, mobile communication with customers and token generation. When Paygo end-customers repays a loan/contract instalment and receives a token to unlock their solar appliance for a given period of time, these payments should still be perceived by the investor (if made on account of purchased receivables), and the token should still be created to effectively activate the device - even when the DESCO’s technical infrastructure has become unavailable.

  2. Field BUS  Objective: Maintaining field contact with the customer through a call centre and a network of agents in charge with systems maintenance and recovery.  Field presence is essential to provide sustained assistance and service access to customers, while collecting repayments or repossessing devices from defaulting accounts.  Field BUS can either be done by (i) transferring those field responsibilities to a another local DESCO, or to a company operating in an affiliated vertical or by (ii) hiring pre-existing staff in an ad-hoc BUS entity

  3. Transversal management Objective: Ensure alignment between stakeholders, as well as administrative, operational and legal preparedness BUS requires thorough planning, coordination, and legal strategy - including to gain security over relevant payment infrastructures that are pivotal to technical BUS (see above). Operational transition roadmaps or manuals, as well as legal agreements between relevant stakeholders, should be produced way ahead of a potential default.


Complementary services can make BUS even more effective. This includes for instance Analytics or Monitoring solutions that can support the prediction and monitoring of a default - helping to potentially price assets to be sold to third-parties if the DESCO defaults, too.


Eventually, let’s add that BUS generally consists of three levels of commitment: cold, warm, live.


  • Cold: The event of a default is judged unlikely. BUS foundations are in place, but it could take several weeks to operate the switch from the primary to the back-up servicer.

  • Warm: A default is becoming more likely. The back-up servicer is getting ready to take over the portfolio shortly - technical infrastructure and legal arrangements are in place,  field discussions are accelerating.

  • Live: The back-up servicer has taken over payment collection; transition is made both on the technical and field aspects.


4. Why is Back-Up Servicing necessary for off-balance sheet transactions?


BUS can be relevant both for on and off-balance sheet transactions. But it’s even more crucial in this latter case: without BUS, OBS transactions cannot dissociate asset and company risk - which jeopardises the very nature of the deal. 


Under a scenario where OBS happens without BUS, the transaction can start to look more like an accounting subtlety, but risk concentration on the originator remains. This bears several risks: 


  • Social risk: Interruption of access to essential services for end-customers - which normally falls under the responsibility of the investor, as the new owner of those assets taken off-balance sheet.


  • Financial risks: Due to the primary servicer’s unavailability, payment collection is interrupted and translates into potentially heavy financial losses for the investor 


  • Legal risk: Without robust BUS and associated legal preparedness, investors can be left with little legal recovery options, since they will have neither a collection relay, nor priority of claims on payment infrastructures (which generally belongs to on-balance sheet investors)


  • Regulatory risk: If off-balance sheet happens without BUS, assets presented as “isolated” could in fact appear less risky than they really are. Under those circumstances, heightened regulatory scrutiny by local authorities could lead to suspicion of balance sheet manipulation, due to the weakness or absence of risk-separation mechanisms. Such claims have already been made on large flagship cases, notably the Spanish financial crisis, where Spanish banks became closely scrutinised for their securitisation practices (concerns were raised that OBS assets might be poorly separated from the originator’s balance sheet, and may simply be considered part of the originator's assets in bankruptcy proceedings). This is of course far beyond the magnitude of the use cases at hand, but the same reasoning could apply. African countries being in the process of fortifying their regulatory frameworks may introduce additional uncertainty: as the volume of OBS transactions in those jurisdictions increases, regulators may intensify scrutiny and implement more stringent rules on true sale qualifications and off-balance sheet regulations. If there is a dispute on the real off-balance sheet nature of those transactions, “isolated” assets may become claimable by on-balance sheet lenders in bankruptcy proceedings. 


  • Fraud risk: Where primary servicer defaults without BUS, or with poorly designed BUS, a detrimental window could be opened for fraud or rogue employees. Service Agents without an employer or income could indeed continue to receive service requests from customers, asking for variable fees and sometimes circumventing the token system through unsafe or detrimental modifications on the devices. The longer it takes for a relay servicer to go live, the higher chances of this irreparable damage to the customers continued payments and therefore portfolio value to be made - problematic, again, both from an impact and financial perspective (if the investors intend to sell the portfolio down the road).



5. What are the challenges with implementing Back-Up Servicing?


While crucial, Back-Up Servicing surely comes with challenges that can both complexify its design, or lead to poor implementation. We bring attention to a few of these aspects below, exploring how they could be solved.


Operational challenges on field BUS


Switching from primary to back-up servicer on the field can be a period of high friction, and take time. Under certain circumstances (very small local markets, very large portfolios, or both), finding a field back-up servicer able to take over the entire serviced portfolio can be complex. If the distressed portfolio has to be transferred to another DESCO, with new IT infrastructure and staff, the takeover can be messy, both from a business and customer perspective.


What can be done?


  • Thorough preparedness cannot bring the field switch delay to zero, but it should help transitioning more smoothly. 


  • Field transition challenges could be mitigated by the creation of an ad-hoc BUS entity, which would be exclusively set-up to hire existing staff to pursue collection - either until the portfolio reaches its completion, or until a buyer has been found.


  • Some adverse effects of complex field transition can be mitigated through solid technical BUS. Although this cannot address the question of field agents, for instance, it still ensures that payments and tokens are received and emitted promptly, safeguarding a large part of investors’ interest and customers’ experience. 


  • Under certain scenarios, agreement can be pre-signed with call centre operators for relay. If customer and payment data have been properly saved under technical BUS and are ready to be transferred, the adverse impact of disruption can be further diminished.


Legal challenges


As mentioned earlier, technical BUS is made even more robust if investors can guarantee security over accounts (MoMo or bank) used in live mode. Ideally, customers in live mode should also keep making payments to the same paybill numbers they used in cold mode, to minimise the impact of BUS activation on payment behaviours.

But those legal aspects can be challenging, especially if there are competing interests over payment accounts with on-balance sheet lenders - who would have already secured priority of claims. 


What can be done?


  • Once more, early preparedness and negotiations with on-balance sheet lenders are key. Let’s remember that investors have a collective interest to build collaborative mechanisms, which can, down the road, support a more attractive capital space. 


  • If there is no way for the OBS lender to assume security over key accounts, or if negotiations with on-balance sheet lender are lengthy, changing payment channels in live mode can be a solution - while this could come with negative effects on customers’ payment behaviours, it is still less risky than being left with no legal recourse over cash flows belonging to OBS investors.


  • BUS agreements must be clear, to avoid disputes. The lack of enforcement mechanisms must be considered as a risk early on, if it exists.


Risk appetite or aversion? 


As with any risk tool, the more preparedness and anticipation there is, the lower the negative impact of an adverse event leading to activating the insurance mechanism should be. 


For BUS, on the technical side, systems integration, data transfer, re-routing of payment mechanisms all require to be properly anticipated for a smooth takeover. Same applies to the field aspects.


But the more preparedness and robustness there is, the higher costs can be. This raises the eternal question at the heart of any risk mitigation strategy: how to confront certain costs vs. uncertain benefits? 


This boils down to investors carefully weighing their risk appetite, and understanding the losses they would be willing to assume depending on the commercial BUS option they choose. 


  • The best risk-mitigating BUS options should ensure smooth transition, with almost instant switch possibility on the technical side, and a clear action plan on the field.  Since this will require more solid infrastructure to be already available in cold mode, as well as a thorough diagnosis to ensure transition on the field, cold mode costs are expected to be higher.


  • Lighter BUS solutions will be more cost-effective in cold mode, but can come with more lengthy activation delays upon default. This can impact collection at activation, as well as customer behaviour (and, more broadly, the general ability of the BUS to ensure continuity).


What can be done?


  • Investors must be well informed about the benefits, costs and risks associated with the BUS scenario they choose, ensuring that it effectively accomplishes the BUS objectives they are pursuing. More importantly, they must be aligned with their own financiers on those goals. Note that well-informed decisions can also support more robust financial modelling, to better anticipate the impact of defaults on projected returns under different BUS options.


  • If an investor opts for a more comprehensive BUS approach, rigorous controls and updates must be put in place, to ensure that the service is properly implemented and will deliver on the value proposition the investor is paying for.



BUS Business Model


The business model of the Back-Up Servicer can be up to debate. Whether a back-up servicer should have “skin in the game” in live mode (bearing costs and assuming risk) must be carefully considered. 

  • Where all live mode collection costs are covered by the investor, a lack of incentives can lead to poorer collection from the back-up servicer


  • Where the back-up servicer must assume collection risks in live mode, this can 1) create a disincentive for back-up servicers to even consider insuring the portfolio at all if the risk sounds too high or 2) lead the back-up servicer to stop collection as soon as the portfolio reaches a tail-end where collection costs exceeds revenues. The latter point makes sense from a financial perspective, but becomes problematic from an impact one: what about customers actually needing this servicing?


What can be done?


  • Careful discussions must take place between investors and BUS providers to find alignment on a model that is sustainable and viable for both parties


  • Industry discussions can help lead collective brainstorming on ways to solve challenges associated with both models


  • Where back-up servicers are expected to carry all collection risks, at the potential expense of impact considerations, DFIs or foundations could have a role to play in providing back-up servicers with assurance of minimal payments for service, until all contracts are terminated. Fair mechanisms where customer debts are written off and systems unlocked permanently could also be considered - past a certain customer repayment threshold and / or if no other DESCO is buying out the portfolio. Eventually, ad-hoc servicers could be available at a fee, to carry out repairs.



We’d like to conclude on a reminder: Live BUS is not designed to maintain an equivalent level of collection and service in love and cold mode. Disruptions will take place if the primary servicer defaults. The questions to answer is how far the Back-Up servicer is able to mitigate those - and how willing investors are to accept some lossest. 


As it stands, BUS is a crucial risk mitigation tool to really unlock the potential of receivables financing on OBS or collateralised transactions.


Our platform can help mitigate collection risks by guaranteeing a relay for collection and maintenance on the field and software sides. We hope the efforts we are making in that sense at Bridgin will contribute to take this objective forward. 


Contact us for more information about our vision and value proposition on back-up servicing, including technical BUS, auditing of existing BUS infrastructure, and payment management solutions.


 

About Bridgin


Bridgin is Solaris Offgrid's Receivable Financing Solution. Conceived as an online trading platform for accounts receivables, it allows distributors of essential services to unlock liquidity over assets through the sale of their outstanding invoices to investors, offering investors a unique chance to tap into a previously untapped asset class at a lower risk.

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