Securitization News and Developments

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August 2004 to March 2005

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Egypt instals mortgage finance companies; mulls securitisation

When it comes to modern financial instruments, Egypt is still living in an age slightly more advanced that that of the Pyramids.

Not to speak of concepts like securitisation or secondary mortgage markets, evey primary mortgage markets are still very undeveloped in the country. A mortgage law was enacted in 2001. Since then, only two mortgage firms have been established in the market, in March and October of last year. The first company, Al-Taamir, has only offered a dozen loans during that period, and the other company, Al-Masriya, has made less than five loans. This should not give the impression that there is no housing finance in the country – as several local banks mix housing finance with personal loans.

That has, however, not stopped the government from exuding extraordinary optimism to call 2005 "the year of mortgage finance".

Experts point out that three major problems dog the way of the evolution of a badly needed mortgage system — the lack of expertise in most of activities related to the system (loan officers, appraisers, monitoring the system, etc), a very complicated and expensive system of real estate registration, and the high cost of finance for both the borrower and the mortgage finance companies. Thus, a modern mortgage finance and refinance system is the absolute need of the hour.

Party for the Egypt Financial Services Project, a USAID $32 million five-year project aims to provide technical assistance to establish a developed mortgage finance system.

Links For securitisation in the rest of Africa, see our page here.

Life insurance companies find embedded value in securitization

The concept of securitisation is finding a new buyer – life insurance companies. Not that life insurance companies are known to securitisation. In the past, securitisation of life insurance policies was based on diverse purposes such as raising funding against endowments or funding reserve requirements. But the latest trend is to securitise the embedded value of life insurance policies in force, to monetize the future profit and where accounting standards permit, also to book the same as income.

Insurance companies now seem to reviving the technique tried several years ago by UK insurer called NPI. Two recent instances where monetisation of a defined book of life policies have been successful are the Gracechurch and Box Hill transactions. Gracechurch, which closed in November 2003, involved the monetisation of the VIF of the entire book of life policies of Barclays Life, providing equity capital of £400m. The VIF was reinsured with a Dublin-based captive insurance company, which used it to back a limited recourse loan from a finance vehicle, which itself used that to back the notes of £400m issued to the capital markets. A similar structure was adopted more recently in Box Hill where the VIF of a defined book of life policies, held by Friends Provident, was monetised to provide capital of £380m. In both cases the notes issued to the markets were wrapped by a monoline to provide an AAA rating.

An article by Jennifer Donohue & Peter Hoye in Legal Weekb says that "opportunities abound for more innovative monetisations involving new business, potentially volatile types of business such as annuities and even with profits business. The reduction or elimination of risk in such books of business, but in a way that retains the principle of equity capital, is the next goal to which the alchemists should turn their attention." 

Link For more on securitization of embedded value in life insurance policies, see our page here. 

Swiss Re takes life insurance policies to capital market

While securitisation of insurance risk is not new in the market, taking traditional insurance products, such as life insurance, by packaging the same into securities is an interesting development.

Swiss Re has successfully completed its` first securitisation of future profits from a portfolio of US life insurance policies. The USD 245 million issue benefits Swiss Re by transferring insurance risk to the capital markets, thereby increasing capital fficiency.

Capital efficiency and capital relief are major drivers for banks to securitise, but here, it is an insurance company trying to further its "strategic objective of accelerating the balance sheet through risk securitisation."

The issue, which closed on 20 January 2005, was issued to a variety of institutional investors. It consists of three separate tranches of securities, paying an average pre-tax coupon of 6.96% with an expected maturity ranging between six and 11 years.
The asset backing the securitisation is the expected future profits from five blocks of life insurance business previously acquired by Swiss Re through Admin Re(SM) transactions. Investors' return is subject to various factors that reflect the risks of the underlying business, including mortality, persistency and investment risks.

A company release claims that by transforming insurance risk into a tradeable security Swiss Re is able to turn intangible assets into cash, which otherwise would only emerge over time. The transfer of risk to the capital markets allows Swiss Re to more effectively use its capital. As a result, shareholders' return on the risks flowing through Swiss Re's balance sheet is improved. Seemingly, the securitisation transaction has also been used for upfronting of estimated gains from the insurance contracts, like what is done in other traditional forms of securitisation.

Links For more on insurance risk securitisation, see our page on alternative risk transfers here. Also, see our page here.

Deutsche structures a USD 2 billion CDO square for Taiwanese insurer

CDOs and CDO squares, which looked like the mindsport of hi-fi investment bankers, are now a regular treasury product in most developed Asian financial centers. Bespoke and specially-structured CDO products are being marketed strongly in Asian markets.

This week, Deutsche gave a big push to CDOs by structuring a $ 2 billion CDO square for Taiwanese insurer Shin Kong Life. It is the bank's first CDO-squared deal in Taiwan, the first managed CDO that Shin Kong has bought and one of the country's biggest CDO deals to date.

A report in Finance Asia says that Taiwanese insurers are becomingly increasingly adventurous with CDO products since they won the go-ahead to invest in them in the middle of 2004. This latest deal for Shin Kong includes a pool of 40 asset-backed securities, in addition to the 250 corporate names included in the CDO pool. The split is 80% CDOs to 20% ABS.

Links For more on CDOs, and CDO squares, see our page on CDOs here. For more on securitisation in Taiwan, see our pagehere.

 AIDS drugs to get securitisation funding

An interesting and innovative use of securitisation funding is to be tried by UK financiers – close to USD 2 billion funding is proposed to be raised by securitisation of the revenues of drugs to be developed.

According to a report in Financial Times says that SecurePharma, the group planning the bond, said a series of bond issues could raise up to $50bn (€38bn, £26bn) over 20 years, to fund the production of medicines for diseases such as AIDS, tuberculosis and malaria that would otherwise be abandoned as uneconomic. The scheme is only in the planning stage, but at least one big pharmaceutical company and a number of biotechnology companies have said they might participate.

Development of drugs is a long-term business – the R&D expenses could be huge and the payback period could be substantially long. Large pharmaceutical companies abandon the development of more drugs than they market, setting a minimum threshold of around $300m of sales a year. Many potential cures for developing world diseases fail to meet this criteria.

HSBC and Deloitte Corporate Finance have appointed as advisors for this interesting securitisation collateral.

Links For more on alternative asset classes in securitisation, see our page here.

Do structured finance ratings reveal all? 
Basel working group seemingly has doubts

Ratings in structured finance have been a very sensitive topic for some time now, but a time when Basle II capital standards rely increasingly on ratings, the paper by a Basle working group suggesting structured finance ratings don't reveal the risk of unexpected losses adequately enough might sound different, if not strange.

A Basle working paper titled "The Role of Ratings in Structured Finance: Issues and Implications" goes into both the reliability or otherwise of the ratings, as also the risks that central banks and regulators need to be concerned about.

The working group, based on a survey of the market participants concludes that the market participants are aware of the limitations of ratings. The reliance on the rating agency's assessment of the pool is inversely proportionate to the sophistication of the investor. "Despite the "value added" by the rating agencies, market participants need to be aware of the limitations of ratings. This applies, in particular, to structured finance and the fact that, due to tranching and the effects of default correlation, the one-dimensional nature of credit ratings based on expected loss or probability of default is not an adequate metric to fully gauge the riskiness of these instruments. As the unexpected loss properties of structured finance products tend to differ significantly from those  of traditional credit portfolios or individual credit exposures, structured finance tranches can be significantly riskier than portfolios with identical weighted average ratings."

Are structured finance products riskier than straight-forward corporate bonds? The working group feels that one of the prime reasons for investors buying them up is for yield pickup, which is essentially a reflection of higher risk. Structured finance instruments may be significantly more leveraged than comparable portfolio investments in traditional corporate credit. As a result, tranched products can have unexpected loss characteristics that differ substantially from those for equally rated bond portfolio exposures.

Links For the full text of the Basle working paper, click here.

Germany's 'true sale initiative' does not find much of initiative

A report in Financial Times says that Germany's true sale initiative still remains largely a "promise" and has not been able to "provide" much tangible results. [Promise and Provide are names of KfW’s programs on securitisation]. The report quotes Commerrzbank data for German securitisation deals which fell from €41.6bn in 2002 to €19.6bn in 2004, although the number of deals done shrank only slightly.

The True Sale Initiative, which is jointly supported by cooperative banks, commercial banks and the savings banks’ group seeks to promote the capital-market segment of true sale securitisation, which is still fairly underdeveloped in Germany. On July 9, 2003, Bayerische Landesbank, Citigroup, Commerzbank, DekaBank, Deutsche Bank, Dresdner Bank, DZ BANK, Eurohypo, HSH Nordbank, HVB Group, KfW Group, Landesbank Hessen-Thüringen and WestLB AG signed the Letter of Intent. This Letter of Intent defined the development and design of a securitisation platform in order to execute true sale securitisation. This was the starting signal for the structuring phase.

In a true sale securitisation claims of one or several banks are pooled in a single portfolio, bought up by a special purpose vehicle and after being divided into tranches with different degrees of risk are sold to investors in the capital market. By taking credits off their books, banks will receive liquid funds, reduce the capital charge on their own funds, and increase scope for making fresh loans. Small and medium-sized companies will benefit from this as well .

Only one securitisation has been completed so far using the special framework created by the TSI. Volkswagen Bank, part of the automobile manufacturer, issued €1.1bn worth of bonds backed by car purchase loans in November.

German banks have been complaining of tax and insolvency law hurdles that need to be crossed before the true sale initiative becomes anymore than a dream.

Links For more on securitisation in Germany, as also on the true sale initiative, see our country page.

Australia grants financial services license exemption to SPVs

The regulators' power to exempt is quite often a mixed blessing – it comes with several restraints, and it takes away more than it gives. Special purpose vehicles, being mere legal myths to provide a legal domicile to a securitisation transaction, are hardly engaged in any business at all to require a license, but Australian regulations required it, and now seek to provide exemption.

The Australian securities regulator, ASIC, recently issued conditions for exempting special purpose vehicles from holding a financial services license. Though the conditions are elaborately stated in order CO 04/1526 of 23rd Dec 2004, the primary condition seems to be that securitisation products are not marketed to retail clients.

The regulation seeks to define a 'securitisation entity" (SPV) and a "securitisation product" (asset backed security). The securitisation product has to be a debt instrument, which in turn is defined as a 'chose in action' or actionable claim. It is to be examined whether pass through instruments, which are beneficial interest certificates, will qualify as chose in action under Australian law – if they do not, then, pass-through type transactions which dominate the RMBS market, might have difficulties.

The debate on licensing of special purpose vehicles has been raging for quite a while. In August last year, the ASIC had issued draft proposals for the same, which apparently were discussed with the industry as also with the banking regulator APRA.

Links For more on Australian market, see our Australia page. For more on SPVs, see our page here.

Taiwan securitisation market to maintain the 2004 growth rate

A report in Taiwan Times says that Taiwan's fledgling securitization business is expected to continue its robust growth this year with a wider range of asset classes to be deployed, as well as a larger average transaction value per deal. The report quotes Moody's.

Moody's expects an issuance exceeding USD 1.88 billion in 2005.  The passage of the Financial Asset Securitization Law  in 2002 and the Real Estate Securitization Statute  in 2003 established a framework to help provide low-cost liquidity to asset owners, as well as diversification and higher returns to investors.

The nation saw securities worth over NT$50 billion issued last year, a significant leap from more than NT$30 billion in 2003, according to Moody's.

.Links: For more on Taiwanese securitisation, see our country page here.

Links: Our new page on Regulation AB – here

Securitisation accounting for failed US bank costs E&Y deer

Accounting for residual interests in securitisation transactions may be both tricky and tormenting – accounting major Ernst and Young (E&Y) would have learnt it the hard way. E&Y has agreed to pay a total of USD 125 million in damages in the matter of failure of Chicago-based Superior Bank.

Superior Bank went down in 2001 amidst allegations of wrong accounting of residual interests in securitisation transactions. Superior's balance sheet included massive amounts of retained interests which were not real. Investigations revealed that Superior 's residual interests represented approximately 100 percent of tier 1 capital on June 30, 1995. By June 30, 2000, residual interest represented 348 percent of tier 1 capital, which, put simply, would mean that that the risk on the asset side was 3 1/2 times the risk on the liability side. After all, the first loss risk retained by the originator in a securitisation transaction is comparable to equity in a corporation.

Holding the accounting firm responsible for the overvaluation of the residual interests, FDIC filed a USD 2 billion claim against E &Y. The claim has been finally been settled for USD 135 million, of which part will be paid to FDIC as damages, and part to thrifts supervisory as restitution claims.

Accounting for securitisation has a contentious, critical item – valuation of residual interests of the originator. Like all valuations, this valuation is also subjective. But the key difference here is that valuation of gains/losses on sale in securitisation transactions is primarily based on the value of this residual interest, which is like an unrealised profit on sale. However, instead of leaving this profit unrealised, accounting standards require this profit to be reported upfront.

Links

European securitisation volumes zoom

Securitisation in Europe is zooming. Data published recently by the European Securitisation Forum reveal that there has been substantial increase in activity in almost every asset class. The volume for the first 3 quarters of the year is likely to reach €179.2
billion which is 33.0 percent higher than the €134.7 billion a year ago. At this pace, it will surpass the record of €217.2 billion set in 2003.

The favorable financial market environment facilitated by the European Central Bank’s decision to maintain a target interest rate of 2.0 percent supports an expectation that issuance this year will set another record, says the Forum.

The increase is spread all across. Issuance in mortgage backed market grew 23.5% over the numbers for the last year. However, the real pick up is in the non-mortgage market, where the growth rate has been 47.4%.

In terms of countries, UK, Italy and Spain remain significant centres of activity.

Links For more on European securitisation, see our page here.

Israel securitisation market suffers early jolt of bankruptcy

Securitisation is not very well known in Israel, but soon after its inception, there has been a bankruptcy of an auto lease securitisation originator.

The originator in question is Car and Go. Strangely enough, the bonds entered into a default on its very first interest payment, though the bonds had been given a AA rating by Maalot rating company.

The company has completely shut down its operations, and the liquidator was appointed mainly to ensure that bondholders and other creditors do not start seizing cars from Car & Go's unprotected lots to protect their interests.

Car & Go, one of the country's smallest leasing firms, issued bonds less than a year ago in order to raise money. Most of the bonds were bought by provident funds and insurance companies: Funds belonging to Israel Discount Bank and Bank Yahav, for instance, bought NIS 20 million worth of bonds apiece

Amidst allegations of breach of duty by the accounting firm Brightman Almagor, the transaction would throw into tizzy the very nascent securitisation market in the country.

Links For more on securitization in Israel, see here. For more on instances of default in securitisation, see our page here.

 

Parmalat administrator launches lawsuit against Citibank

Securitisation is bankruptcy-remote, as long as the originator is not in bankruptcy. Every major bankruptcy hurls some or the other legal trouble to most mega financial deals, and of late, attacking structured finance and other "complex" financial deals is in latest fashion.

Enrico Bondi, the administrator of Parmalat, the fallen Italian dairy giant, is pursuing a two-pronged strategy: to seek billions of dollars in damages from banks on the grounds that they knowingly hid the true state of Parmalat's finances, while using the same charge of insider knowledge to revoke billions of euros in debt.

At the centre of the litigation against Citibank is a securitisation deal where asset-backed commercial paper conduits run by Citibank were buying receivables generated by Parma – these receivables were actually duplicated by false invoicing. The suit filed against Citibank in a New Jersey court seeks damages close of USD 10 billion, on the ground that Citibank officials were hand-in-glove in the securitisation transaction that, among others, was responsible for overleveraging of Parma, finally leading to its collapse. The law suit charges that officers of Citibank knew, from the deal's inception in 1994, that receivables being securitised and sold to investors — through special purpose companies called Eureka and Archimede — were being counted twice. In 1994, Citibank's relationship manager was Alberto Ferraris, who joined Parmalat in 1997, becoming CFO from March to November 2003, just before the collapse. The lawsuit claims Ferraris proposed or was aware of many of the transactions, which expanded rapidly under CFO Fausto Tonna from 2000, and continued through 2003. The lawsuit provides Citibank's due diligence memos, from 1994 and 1995, about how the invoices for the receivables were being counted twice.

Parma's petition claims: "The securitisation programme was intended to, and did, create the false impression that Parmalat was generating nearly twice as much cash flow from its operations."

As Parma's bankruptcy resolution unfolds, there might be some painful lessons for the structured finance industry to learn.

Links Vinod Kothari's lectures on bankruptcy laws are here.

Performing loans securitisation makes its mark in China

Is this an isolated deal, or has the dragon finally arrived? The global securitisation industry looks with tremendous interest at China – where loan originations, lease transactions, auto finance, housing finance, are all on a steep upward curve. But where is securitisation happening? That loan originations should continue to go up but not securitisation is surprising. Particularly so where China prepares to host the next Olympics.

In our comment here some days ago, we asked this question.

Amd the silence has been broken by Industrial and Commercial Bank of China (ICBC) hives off a pool of residential mortgages, something that has never been done before in the country, while Cinda Asset Management plans another non-performing loan (NPL) sale. ICBC's maiden deal is small, marking the caution associated with the maiden entry.

Experts point out tax uncertainties. [See, however, Vinod Kothari's comments in the previous story below]

But more than regulatory issues, the market is worried on more substantive issues. Proper securitisation requires a long credit history to evaluate risk well – which is not the case in China since more credits starting exploding only fairly recently. Does a green unburnt portfolio create more risks? There are reasons to differ, based on empirical experience world over, but then, the fear of dealing with something not known is always understandable.

To resolve the problem of inadequate data, companies have been taking the over-collateralisation route. But that is certainly not an efficient or preferred way to deal with securitisation deals. The other option, used in developed markets, is to have an outside guarantor like MBNA to agree to top up a failing securitisation for a fee.

Clearly, Chinese securitisation has a long way to go, but it seems it will go a long way, if it does not go the wrong way.

Links For more on securitisation in China, see here. For training workshops in China, public or private, do get in touch with us.

Malaysian ABS market picks up

The market for private debt securities, called PDS market in Malaysia, remains dull – with the total issuance estimated at about RM 25 billion for the whole of 2004. However, interest in asset-backed securities continues to be strong.

Malaysian ABS issues so far

Prisma Assets Berhad RM225 mil 
CBO One Berhad RM385mil 
Securita ABS One Berhad RM310 mil 
ABS Real Estate Berhad RM450mil 
Aegis One Berhad RM1bil 
Road Asset Vehicle Berhad RM350 mil 
Auito ABS One Berhad RM510 mil 
Ambang Sentosa Sdn Bhd RM1.049bil 
Soeial Port Vehicle Bhd RM1.310bil 
Astute Assets Bhd RM699mil 
Domayne Asset Corporation Bhd RM100mil 
Synergy Track Berhad RM152 mil 
ABS Land abd Properties Bhd RM109 mil 
Kerisma Bhd RM1bil

Market players state that the total number of issues upto August this year (from the very start) was 14, involving a total size of RM 7.65 billion. Since the number is cumulative, it is not a number to boast of. Of course, the issue size this year is influenced by the first-time entry of housing sector giant Cagamas into the ABS market for the first time. But then, quite likely, Cagamas would like to stay in the securitisation field.

Market players expect further activity in motor vehicle loan receivables, credit card receivables, housing loans and property rental.

Activity in traditional retail loan pools is often associated with interert rate curve. As interest rates start falling, banks and originators typically try to capture the profits of their past glorious years into their current books by selling off pools. But as interest rates rise, players would prefer to wait than to securitise.

Links For more on Malaysia, see our page here.

Will China remain limited to NPL securitisations, even as massive opportunities knock at the door?

A recent report by Standard and Poor's looks at China's securitisation potential, and laments that despite massive opportunities, so far, there has not been any tangible performing assets securitisation deals in China. The so-called NPL securitisations are closer to asset sales or liquidating securitisations, than securitisations in true sense.

First, take a look at the NPL securitisation market. Two domestic NPL securitizations have been completed; these have caught the attention of participants in the Asian securitization market. In June 2003, China Huarong Asset Management Co., one of the four Chinese AMCs, securitized a portfolio of 256 NPLs, raising Chinese renminbi (RMB) 1 billion. In April 2004, Industrial Commercial Bank of China (ICBC) securitized a RMB2.6 billion portfolio of nonperforming and subperforming loans for the ICBC branch in Ningbo. Both NPL securitizations issued senior-rated certificates by a trust created under China's trust laws. In addition, in June 2004, China Construction Bank (CCB) successfully completed a global auction of its real estate holdings with a face value of US$483 million to international buyers, recouping US$171 million. There is promise of more auctions and securitizations to follow.

However, on the performing assets side, despite massive opportunities, transactions have so far been evasive. Possibly, lack of a legal framework is missing, or as quite often happens, people are waiting for a precedent, and so also is the precedent-setter.

There are massive opportunities in Chinese real estate sector. Apart from commercial real estate, there has been double digit growth in the volume of residential mortgage loans. Recent data published by S&P demonstrate the housing loans have grown only in pace with the growth of GDP in the country.

The S&P report gets into what is missing in China. "Presently, not only does China lack a clear-cut set of laws (including tax laws) specifically governing securitization, it is still unclear which regulatory body would oversee securitization transactions." And further, "From a credit analysis perspective, the weak judiciary system and enforcement of creditors' rights mean that it is very difficult to assign recovery values to defaulted assets. This is true for corporate loans, corporate bonds, and consumer loans. It is likely that changes will be accelerated in this area. For instance, the ultimate enactment of a revamped bankruptcy law, which would strengthen creditor's rights under China's legal system, would be a major milestone on the road to reform. The increased activity by foreign investors in the NPL market bodes well as these investors contribute new skills and practices, such as credit underwriting, credit monitoring, work outs and bad loan resolution, and increased efficiency in the judiciary process. This has already been observed in many Asian countries, including Japan, Korea, and Taiwan, which will help rating agencies and investors alike to gauge the likelihood and quantum of recovery."

Vinod Kothari comments: Lawyers talk about two things – law and practice. China has thrived more on practice than on law – strong legal system was never the strong point of China. In fact, in many cases, the absence of clear laws fuelled activity than foiled it. However, on capital-market front, a more systematic approach to risk evaluation, mortgage foreclosure and bankruptcy resolution is required. The S&P report also says that synthetic transactions might precede cash transaction – but that would be highly surprising. In a growing market, what is required is funding or refinancing, which synthetics fail to answer.

Links For more on China, click here. For more on NPL securitisations, click here.

 

S&P lists pre-conditions for secondary mortgage markets

Unarguably, residential mortgage markets where securitisation is the most important – and countries need secondary mortgage markets to promote housing finance. Among all asset classes, RMBS is surely the one that is most significant for macro-economic development.

Rating agency Standard and Poor's (S&P) listed the pre-conditions for RMBS markets. Of these, the most significant condition is the existence of an appropriate legal system. The system must have the following requisite features:

  • Recognition of true sale: This is needed to insulate investors from any insolvency of the mortgage originator.
  • Trust or special-purpose entity: This entity must be bankruptcy remote, with the single purpose of buying assets and issuing the MBS. In Mexico, Argentina, Spain, and France, special funds or trusts had to be created for MBS. In Sweden, trusts were recognized, but because those with assets of less than US$50,000 were subject to taxes, issuing vehicles were set up offshore.
  • Mortgage-registration process: The registration of loans to the new owner should be easy and inexpensive. In some countries this may require the elimination of the requirement to notify the borrower about the loan transfer and the elimination of expensive stamp duties. Before states in Mexico modified their civil codes, stamp duties on the sale or transfer of mortgages were prohibitively expensive for securitization.
  • Set-off risk: Laws need to address the risk that a mortgagor could offset any payments it owes on a loan against money owed to it by the lender (such as a bank account deposit).
  • Consumer privacy laws: These laws may prohibit the sharing of mortgagor information with the trustee and rating agency.
  • Debtor- versus creditor-friendly environment: Some countries have laws that are friendlier to consumers; these can impede a lender's ability to foreclose on a bad loan.
  • National versus state differences: One securitization law may not work for an entire country. For example, in Argentina, the law that was passed in 1995 worked for all provinces, but in Mexico, state-specific laws were needed.

Apart from the legal framework, it is also important to have loan and documentation standardisation. Standardization of underwriting criteria and contracts better provides for homogeneous assets; these ease the analysis of portfolio risk and makes future performance easier to predict.

The rating agency also notes that sometimes, efforts to develop RMBS are also hamstrung by the inability of the originators to churn the required data. Critical information includes historical loan delinquencies, defaults, foreclosures (recovery amounts and related expenses), and prepayments. It has been very difficult to get data on the volatility of house values, especially through different economic cycles. In addition, emerging market lenders have difficulty accessing borrower payment history when national credit bureaus do not exist.

Links We posted a similar article relative to Germany – appropriate legal structure for German securitisation market which makes an interesting reading. For more on RMBS, see here. For more on legal issues, see here. Also see Vinod Kothari's article on legal structure of securitisation.

Single tranche synthetic CDOs make advent in Taiwan

Clearly indicating the growing comfortability of Asian investors with synthetic CDOs, Deutsche Bank recently sold an AA-rated piece of a synthetic CDO to a Taiwanese bank. The ease with which Asian banks are picking up synthetic CDO positions is sure to fuel the explosion of synthetic CDOs in Asia.

According to news report in Finance Asia of 16th Sept., Deutsche Bank structured a synthetic CDO referenced to 100 international names. The notional amount of the CDO portfolio is $2.36 billion and the three-year bullet notes are credit-linked to the AA tranche of the CDO. The notes were placed privately with Jih Sun International Bank, which in turn will sell them to a group of corporate and high-net worth clients.

The deal has been structured as a fixed-rate, three-year static deal to take advantage of this continuing environment of low short-term interest rates, tightening credit spreads and fewer corporate defaults.

A synthetic CDO synthetically assimilates a portfolio of diversified credits. In a single tranche deal, instead of buying protection for all tranches of the synthetic CDO, the CDO merely buys protection at a particular level, like at the AA-level in this case, and thereafter delta-hedges the rest of the portfolio based on its own model of the portfolio's delta.

Securitisation market is growing fast in Taiwan, particularly after the legislations passsed last year. CDOs are a new craze.

Links For more on Taiwan, click here. For more on synthetic CDOs, see our page here. See also our site on credit derivativeshere. 

SPVs in Singapore to qualify for concessional tax regime

In a bid to provide tax neutrality to securitisation transactions, the Singapore government proposes a concessional rate of tax to special purpose vehicles. A Budget 2004 pronouncement proposed a lower rate of tax for securitisation vehicles. The Budget proposal said:

"To provide greater regulatory certainty, MAS issued regulatory guidelines to financial institutions participating in asset-backed securitisation and credit derivative transactions in 2000. As a complement to these measures, a concessionary tax treatment will be conferred on Special Purpose Vehicles (SPVs) engaged in asset securitisation. This concessionary tax treatment will apply to SPVs set up for asset securitisation on or after the date of Budget announcement. It will address and mitigate tax disadvantages that an asset securitisation SPV may face as a result of mismatches in timing between the receipt of income and the payment of expenses."

The Inland Revenue Authority has, however, deferred the notification implementing the lower rate of tax to October 2004. A note posted on IRAS website does not provide any reasons for the deferral, but quite obviously, the delay is due to inconclusive deliberations as to what are the securitisation transactions that should benefit out of this concessional tax, and what are the defining features of a special purpose vehicles.

Special purpose vehicles, easily understandable as a notion, are indeed very difficult to identify in law – the US accounting rule FIN 46 (now FIN 46 R) has to spend lot of energy to identify special purpose entitites.

Links For more on Singapore securitisation, see our page here. For more on taxation issues in securitisation, see here.

Workshops in Singapore : We offer several training events in Singapore round the year – for our latest offerings, see this page.

Indian securitisation: the shine continues in 2004

We reported recently about India having reached position no 2 in ex-Japan Asian securitisation. 2004 is going to be much better.

Nithya Easwaran of Citibank reports that the volumes for the first half of 2003 have already exceeded to the entire year's volume in 2003, and looking at the strong pipeline, it is quite clear that 2004 will be a landmark year.

The volume for the first half of 2004 is Rs. 77.65 billion (Rs 45 = 1 USD). The volume for the entire year 2003 was Rs. 69.31 billion, composed of ABS Rs. 41.01, MBS Rs 5.71, and CLO Rs 22.59, all in billions.

This year so far, the number of deals the number of deals is about half that of the last year but the volume has already exceeded – which obviously indicates appetite for larger deal sizes.

The Reserve Bank of India has recently notified that investment in mortgage backed securities satisfying certain criteria will be regarded as priority sector lending by banks. The criteria themselves are worded like a maze and are literally dificult to achieve. The Securitisation Act in India does lots of things except securitisation – therefore, the market growth is unaffected by regulatory moves.

Links For more on securitisation in India, see our India page. For training courses in India, see our training calendar.

IASB issues exposure draft of new disclosure norms for financial instruments

Accounting Standards on financial instruments, it seems, will never be complete – the standard setters have a tremendous penchant for writing! Even as the ink is yet to dry on IAS 39 (FAS 140/FAS 1115/ FAS 133 in the USA), there is a new exposure draft of an accounting standard that would require further disclosures in case of financial instruments.

Exposure draft 7 (ED 7) is prepartory to issuance of the IFRS series of accounting standards.

ED 7 proposes additional disclosures in case of financial instruments and is specifically aimed at enhanced information about the liquidity, credit and operational risks inherent in financial instruments. This would be a standard that would correspond to the existing IAS 30 and IAS 32 and would be a part of the IFRS series (IAS 30 would be withdrawn and IAS 32 will be amended). The [draft] IFRS requires qualitative and quantitative disclosures about exposure to risks arising from financial instruments. The qualitative disclosures describe management’s objectives, policies and processes for managing those risks. The quantitative disclosures provide information about the extent to which the entity is exposed to risk, based on information provided internally to the entity’s key management personnel. Together, these disclosures provide an overview of the entity’s use of financial instruments and the exposures to risks they create.

The proposed IFRS is to apply to all entities including non-financial entities.

Relative to securitisation transactions, ED 7 has certain provisions relating to derecognition – most securitisation transactions result into derecognition of the whole or a part of the asset. In case of derecognisd assets, the entity would disclose the following:

a) the nature of the asset;
(b) the nature of the risks and rewards of ownership to which the entity remains exposed;
(c) when the entity continues to recognise all of the asset, the carrying amounts of the asset and of the associated liability; and
(d) when the entity continues to recognise the asset to the extent of its continuing involvement, the total amount of the asset, the amount of the asset that the entity continues to recognise and the carrying amount of the associated liability.

Comments on ED 7 are due by 22 Oct 2004.

Links For more on accounting for securitisation, see our page here.

 

India at number 2 in ex-Japan Asian securitisation

Startling – India has come to be the second largest securitisation market in ex-Japan Asia. Typically, while analysing Asian volumes, we never include Japan as Japan is a world by itself. But in ex-Japan Asia, Korea is the largest, and India is at number two in 2003, up from nowhere.

India was never talked about in global securitisation scene – as it was a dot in a spectrum. But last year's mega deals have catapulted India to a significant position.

There is a quite a gap between position number 1 – that of Korea, and position number 2. Korean market is about 10 times the size of India, but the potential for India is huge. In fact, the transaction volumes in 2004 have been encouraging though the recent upward move of interest rates is a dampening factor.

An S&P report titled A True Asia-Pacific Securitization Market Emerges says: "Asian securitization volumes from these countries (Taiwan, Hong Kong, South Korea, Thailand, Malaysia, India, and Singapore) now exceed the equivalent of US$46 billion. (This figure includes only public deals, and therefore, likely understates the true volumes, which may include numerous conduits bought by ABS and synthetic CDOs). In the early years, so-called Asian securitization was really a misnomer as deal flows came from only one or two countries. In 2002 and 2003, for instance, the market was mostly limited to Korean credit card securitizations. Recently, securitization platforms have successfully been established in many more Asian countries and at a rapid pace."

Another notable development in the Asian market is the rapidly establishing CMBS market: "Commercial real estate securitization is starting to take hold in several Asian markets. For a long time, aggressive bank lending to real estate restricted CMBS in Singapore and Hong Kong. However, with the influence of market discipline, the REITs market has brought a level of realism to the market, closing the real estate valuation gap and the expectation of funding proceeds based on gearing ratios that reflect the risks of property financing and refinancing."

Links For more on securitisation in India, see our country page here.

Workshops: We regularly hold securitisation training workshops in several Asian locations. For schedule of our forthcoming workshops, click here