April 2005 to March 2007
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- Subprime debacle is hardly a surprise, says research paper
Added April 20, 2007
Nomura Fixed Income Research’s Mark Adelson in a brilliant paper says the subprime debacle is hardly a surprise, as the overheated subprime lending market ignored some very basic principles of moneylending; the current regulatory response may take certain decisions which are counterproductive.
- Securitization trade bodies release self-regulatory guidelines draft
Added April 20, 2007
Call it if you wish a response to the subprime deluge, several trade bodies on securitization released non-mandatory guidelines for retail structured products for comments.
- First quarter ABS volumes slightly slide, but CDOs make up for lost numbers
Added April 3, 2007
The growth in CDOs new issuance on the face of turbulent subprime segments sounds a bit surprising but it seems the alchemistry on Wall Street still has many buyers.
- New Century files for bankruptcy
Added April 3, 2007
Taking the subprime mortgage market to its logical place, New Century filed for Chapter 11 on 2 April.
- Subprime mortgages – just a correction or apocalypse?
Added March 6 2007
As equities of major subprime lenders continued to plunge, and the fate of leading subprime lender New Century remained uncertain, the key question begging for answer is – is this a mere correction or will deepen into a larger crisis.
- Junk mortgages now become a global worry
Added 28 Feb 2007
As the ABX.HE continued to plunge to dismal depths, the feared losses in home equity segments have caused some blood on the street.
- Worries soar and prices sink in the home equity securitization market
Added 21 Feb 2007; updated 24 Feb 2007
As ABX.HE prices have continued to slide, there are indications of trouble with hedge funds, downgrades of several RMBS transactions and so on.
- Securitisation earnings go up quarter-end, to report gains on sale, claim research
Added 10 Feb 2007
Using evidence of quarter end volumes, two accounting professors claim that managers use securitisation to window-dress financial results.
- Subprime worries puncture ABX.HE prices
Added 10 Feb 2007
The credit derivative index ABX.HE prices for the lower rated tranches plummetted this week as news of mounting losses on home equity transactions kept coming.
- UK court of appeal discusses trustees rights in securitisation transactions
Added 2 Feb 2007
In admittedly a first case of its kind, the Court of Appeal in UK discussed trustees’ duties in a securitisation deal, upholding the rights of third parties like MBIA to give directions to the trustees, if the trust deed so provides.
- London Heathrow to be pledged in BAA whole business securitisation
Added 30 Jan 2007
BAA plc, the world’s largest airport operator, is going to do a major whole business securitisation, perhaps the largest in WBS space.
- Americans’ splurge worries S&P, moderately though
Added 25 Jan 2007
Cracks have started appearing in the foundation for consumer credit, and the rating agency S&P is worried, but moderately.
- US financial regulators issue Complex Structured Finance Transactions guidance
Added 15 Jan 2007
US financial regulators issued an inter-agency statement that requires regulated institutions to lay down policies to indentify elevated risk complext structured finance transactions, to document the same and have them audited.
- Mortgage backed securities start trading in Russia
Added 12 Dec 2006
The Russian market recently started trading in mortgage backed securities.
- There is nothing like true asset-backed security:
Moody’s report reveals sponsors impact transaction ratings
Added 12 Dec 2006
If you thought securitization creates asset pools that are independent and self-sustaining, Moody’s report indicates something different.
- Home equity melt down may affect securitization volumes going forward
Added 8 Nov 2006
The strong growth in ABS volumes achieved in 2005 may turn negative in 2007, due to substantial declines in the home equity loans market.
- Ramifications of Housing price deflation worry securitization deals
Added 2 Sept 2006
Will the much-talked-about bursting of the housing bubble have far reaching implications for the RMBS deals? Vinod Kothari explores.
- Asian securitisation market poised for sharp growth
Added 4 Aug 2006
Various securitisation markets within the Asian region are poised for a sharp growth – we take a quick overview of Thailand, Korea, and some other Asian markets.
- Agencies seek public comment on complex structured finance transactions guidance
Added 24th May 2006
Federal regulators had issued, earlier in May, a revised statement on “complex structured finance transactions” for which public comment period expires a month after the issue date.
- Fannie Mae charged $400 m penalty, OFHEO releases report on irregularities
Added 24th May 2006
After the fat Rudman report on Fannie Mae operations, the OFHEO released a report on irregularities, corporate governance issues, and corporate culture at Fannie Mae. Simultaneously, it slapped Fannie with a $400 m penalty.
- National Century executives indicted for securitization frauds
Added 24th May 2006
This is the largest of the securitization frauds so far and one of the most glaring ones, as AAA-rated securities defaulted. The indictment of several executives has been done by the prosecutors recently.
- Securitisation grows in Eastern Europe
Added 31st March 2006
The growing economies of Eastern Europe are fast catching up with the western in experimenting with securitisatsion of various types of cashflows.
- Jersey provides for incorporated cell companies, a new form of legal vehicle
Added 7th Feb 2006
If forming and running several SPVs is giving you jitters, book your tickets to Jersey or think of emulating the Jersey law – a law that provides for one company with several cells, and each such cell with the status of a separate legal entity.
- Bush Budget proposes a new regulator for GSEs
Added 7th Feb 2006
The Bush administration proposes to cut the size of GSEs and have a new regulator in place.
- Indian banks to double-check their securitisation plans; conduit structures, mezzanine risk transfers seem promising
Added 5th Feb 2006
The recent guidelines of the Reserve Bank of India on securitisation will prompt most banks to reconsider their securitisation plans; the market may explore some very new alternatives.
- Indian RBI issues securitisation guidelines: will promote only regulatory arbitrage transactions
Added 2nd Feb 2006
India’s banking supervisor RBI today issued guidelines for securitisation. The guidelines take immediate effect and require capital deduction for the first loss as well second loss piece held by an originator in a securitisation transaction and call for amortization of gains on sale.
- BIS working group investigates housing bubble
Added 1st Feb 2006
Is the surge in the housing finance market world over a bubble, exposing capital markets as also banks to never-before risks? The BIS committee on global financial systems recently investigated. We give extracts and link to the full report.
- India: Committee suggests securitisation-friendly legal environment
Added 31stJan 2006
RH Patil committee, appointed as per Budget 2005 promise, has made several recommendations about bonds market, in particular on securitisation transactions.
- New asset classes emering in ABS world – Fitch
Added 29th Jan 2006
Non-core asset classes are emerging and rating agency Fitch expects that this emergence will not remain a fad but will grow into full blown collateral classes.
- Life insurance securitisation seems to be very promising
Added 25th Jan 2006
With several transactions towards the end of 2005, embedded value of life insurance policies seems to be a very promising application.
- Covered bonds getting increasingly popular in Europe as off balance sheet becomes difficult and unimportant
Added 7th Nov 2005
European mortgage issuers are showing increasing preference to covered bonds as on-balance sheet means of highly rated funding.
- China may soon see wave of securitisation activity
Added 4th Nov 2005
After enigmatically enticing everyone for a long time, China is finally opening up its securitisation markets, and soon, may turn out to be the powerhouse of Asian securitisation.
- CMBS getting globally popular; US and European volumes in 2005 may surpass expectations
Added 4th Nov 2005
Securitisation of commercial properties is increasingly getting popular all over the world, even as the US and European issuance in 2005 may break all previous records.
- European tax arrears securitisations underperform; face downgrades
Added 4th Nov 2005
The Portugese government’s tax arrears securitisation has suffered downgrades; may cast shadow on similar proposals by other EU countries. See also Vinod Kothari’s comments on servicing issues in securitisation transactions.
- Greek tax arrears securitisation may run into problems
Added 7th Oct 2005
The Greek government’s efforts to reduce its fiscal deficit by securitisation of arrears of taxes may not find favour with EU regulators.
- Chinese bank puts together first performing loans CLO
Added 20 Sept 2005
China Development Bank has started making roadshows on the first performing loans CLO in the country.
- Telephone company to pioneer securitisation in China
Added 18th August 2005
China’s second largest telephone operator is expected to pioneer performing assets securitisation in China.
- FASB puts up revised exposure drafts of securitization accounting standards
Added 16th August 2005
Last week, the FASB put up 3 revised exposure drafts of amendments to securitisation accounting standard FAS 140.
- CMBS market see fuelling commercial real estate boom in the USA
Added 29th July 2005
Unprecedented surge in CMBS issuance might be hinting at lowered quality standards of mortgage origination and commercial real estate prices, say analysts.
- Tight regulation of GSEs may be in the offing
Added 29th July 2005
The Bush administration seems to be all set for a tight regulation of the US mortgage agencies, popularly known as the GSEs.
- Phenomenal increase in US RMBS: issuance may cross USD 1 trillion
Added 28th July 2005
Swelling RMBS volumes may spell trouble – cautions S&P in the midst of increasing property prices and relaxed mortgage originations.
- Securitisation volumes surge in Japan and Korea
Added 13th July 2005
2005 promises to be a strong year for Asian securitisation, as is apparent from the data available for Japanese and Korean securitisation volumes.
- Securitisation to develop in China as regulators clear guidelines
Added May 2, 2005
The Chinese guidelines are simple, clear and comprehensive. Surely Chinese banks will like to lap up this new tool
- Securitisation developing as a wave in Thailand
Added May 2, 2005
With due stress being put by the Thai government securitisation is developing as a big wave in Thailand.
- kicks off SME loans securitisation program
Added April 18, 2005
Promoted by Singapore government agencies, the first program for securitisation of SME loans in Singapore kicked off some days ago.
- Indian financial regulator issues draft securitisation guidelines
Added April 18, 2005
The Reserve Bank of India issued draft guidelines on securitisation of standard assets by banks – and Vinod Kothari made some sharp observations.
- Would Italian government be able to save its securitisation deals?
Added April 1, 2005
One of the Italian government securitisation exercises, SCIP2, goes for refinancing, which is substantively a quasi-default.
- US ABS issue in 1st Quarter 2005 zooms up
Added April 1, 2005
Issuance of asset backed securities in the first quarter of 2005 has zoomed up by some 20%.
Nomura Fixed Income Research’s Mark Adelson and team came out with a very timely paper on the subprime debacle. As may be common intuiation, the subprime lending spree of 2005 and 2006 ignored some very basic principles of money lending and therefore, foreclosures were bound to rise with house values declining. The brilliant is just brilliant, and we bring below the key conclusions of the paper:
There is no sub-prime surprise. High delinquencies and defaults are an inevitable result of the kinds of loans made in 2005 and 2006. Ignoring the Three C’s of lending could produce no other result. Moreover, the warnings were loud and clear. The warnings also were numerous and frequent. And they came from many diverse sources, including the general media.
The current flurry of activity to “do something” about the sub-prime mortgage situation is a day late and a dollar short. Policymakers and market participants who don’t like the current situation should
have acted sooner by taking obvious preventive measures. Both policymakers and market participants share responsibility for the current situation by having ignored the warnings and having failed to act sooner.
Unfortunately, some policymakers are trying to exploit the current situation by pandering to defaulted
borrowers. That conduct is counter-productive. Policymakers and market participants need to come to grips with reality. There likely will be an uncomfortably high level of foreclosures. Despite the best of intentions, rescue attempts on many loans probably will fail. And, lastly and most importantly, policymakers should refrain from taking drastic, ill-conceived actions that ultimately do more harm
than good by unduly reducing the availability of mortgage credit to American families.
While US congressmen continue to examine if things had indeed gone wrong in the way subprime mortgages were packaged and sold, trade bodies got into the act and released draft of self-regulatory non-mandatory guidelines for retail structured products.
The guidelines were released jointly by the Securities Industry and Financial Markets Association, European Securitisation Forum (ESF), the International Capital Market Association (ICMA), the International Swaps and Derivatives Association (ISDA), and the London Investment Bankers Association (LIBA).
The guidelines are applicable when structured products are delivered to retail investors. Retail structured products should always be distributed through distributors. The distributor should understand what he/she is distributing and should take responsibility for the contents of the term sheets. Product providers should likewise understand who the distributors are. Even the distributors should know who the product providers are. The essence is the same as in case of the general “know your counterparty” principles such that people do not hide behind their ignorance about the counterparty.
The guidelines are very general and do not say much that is not sheer commonsense. Like industry codes, they are perhaps overpowered by the desire not to restrictive at all. Like most self regulatory codes, they remain like holy principles of benign conduct which but for the code would be found in religious texts.
Links Full text of the guidelines in draft is here.
With all the turbulence in the home equity market and the resulting impact on several CDOs, the volumes of ABS issued in 1st quarter 2007 is not much lower than the same quarter last year. Data on abalert.com, which compiles global data, shows that the volume for the 1st quarter was Usd 267.6 billion , compared to last year’s 281.8 billion, roughly a decline of 5%. Given the fact that last year was an exceptionally good year, this decline is not very dampening. On the contrary, if one looks at the volume of CDO issuance for the 1st 3 months of 2007, it is USD 132.1 billion, as against only 69.9 billion last year.
A report on Bloomberg citing a Citibank source said the volume of home equity securitization was down sharply -with a decline of over 37%. This is clearly understandable, since, home was at no 1 position in asset backed segment last year, and this year seems to be the year of CDOs.
Even as New Century, one of the one-time leading lenders in the subprime mortgage market filed for bankruptcy protection, the key question in everyone’s mind is – is that the worst? While S&P ran a comparison between subprime deals of 2000 and 2006 vintage, and estimated expected losses of about 7.5%, the worry is if with the lowering house prices, will the defaults increase beyond that level?
New Century, which has been in the news below for almost 2 months now, finally succumbed and filed for Chapter 11. It has set up a new site http://www.ncenrestructuring.com/ where it intends to put further information on the restructuring plan. The company’s press release says it has entered into an agreement to sell its servicing assets and servicing platform to Carrington Capital Management, LLC and its affiliate, subject to the approval of the Bankruptcy Court. The purchase price for the assets is approximately $139 million. In addition, New Century has agreed to sell to Greenwich Capital Financial Products, Inc. certain loans originated by the company, as well as residual interests in certain securitization trusts owned by the company, for an aggregate price of $50 million.
The subprime market has seen several sad spots over the last couple of months or so – see our comments below.
In the meantime, the subprime credit derivatives index ABX.HE BBB- was quoting at 66.59. It is not the least that it has recorded – there was a bit of revival from the trough of 62.25 quoted earlier.
See more of our notes and coverage below.
The start of the week saw shares of subprime mortgage lenders declining further, and the fate leading subprime mortgage lender New Century hang in balance.
New Century is reported to be the second largest subprime mortgage lender after Wells Fargo. On Monday evening, S&P placed New Century into CCC rating, implying high probability of the company filing a bankruptcy petition. Investigations into accounting irregularities have also been launched against the company. “In a residential mortgage market where investors and other participants are rapidly losing confidence, it could be a challenge for the company to work through current credit trends. The investigation and the damage it might do to the company’s reputation create concern about New Century’s ability to maintain its warehouse lending lines, which are necessary to fund mortgage originations”, said S&P. Some analysts commented that Morgan Stanley and UBS AG must continue to provide lines of credit to the company for it to sustain. If the lenders do not consent to renewal of credit lines, its auditor KPMG will possibly give a negative “going concern” opinion. The sharp loss of faith that New Century has seen is evident from its share price history – it traded at $52 last May, and is now about $10.09.
New Century is not the only one in the subprime segment – Fremont has received a cease and desist order on its lending business. Shares of Novastar, Countrywide and Accredited Home Lenders have been falling too, not to speak of a general decline in the financial sector stocks.
Meantime, the subprime securitization index ABX.HE showed a bit of recovery at BBB- levels. the price recovered from the lowest 62.25 to 68.89. However, with bad news about subprime mortgages making global headlines, it is likely that this price will slide once again.
Not only subprime index, even spreads for BBB tranches of CDOs, particularly the structured finance CDOs, have also sharply appreciated. In 2006, the arbitrage activity was particularly brisk in structured finance CDO segment, most of which have exposures in home equity deals. Reuters quoting a Lehmanreport said BBB CDO spreads have widened by 300 bps.
There are bad news, worried voices and negative sentiments litterred all over the place – Economist in 4th March issue apprehended: “In the next few weeks, they should be looking for signs of distress in some of the less liquid areas of the markets, such as high-yield bonds and credit derivatives”.
Warren Buffet in his letter dated 28 Feb 2007 commented on the affordability mortgages: “The slowdown in residential real estate activity stems in part from the weakened lending practices of recent years. The “optional” contracts and “teaser” rates that have been popular have allowed borrowers to make payments in the early years of their mortgages that fall far short of covering normal interest costs. Naturally, there are few defaults when virtually nothing is required of a borrower. As a cynic has said, “A rolling loan gathers no loss.” But payments not made add to principal, and borrowers who can’t afford normal monthly payments early on are hit later with above-normal monthly obligations. This is the Scarlett O’Hara scenario: “I’ll think about that tomorrow.” For many home owners, “tomorrow” has now arrived.”
As for the past couple of weeks or so, we will continue to develop this story – there are related stories below.
Fears of losses that major US banks will suffer as a result of the worsening subprime mortgage sector were exacerbated, as the week opened with losses in global stock markets. Financial stocks were the major losers.
While losses on Chinese equity markets added to create more impact, there were deep scars and scratches on financial stocks – Goldman Sachs tumbling more than 8 per cent, with total losses of 10.4% in three days. Lehman Brothers stock dropped nearly 5 per cent, and a total of almost10 per cent in the past three trading sessions. Bear Stearns was down 4 per cent.
In the meantime, despite Lehman recommending buying of the ABX.HE index, the steep fall in the lower tranches of the ABX.HE index continued unabated. The BBB- tranche, as we reported last, was quoting at 68.5 on 23rd Feb. It fell to 67.27 on 24th Feb, and then precipitated to 62.25 on Monday, the 27th Feb.
The fears of general decline in corporate health affected broader CDS indices too – The Dow Jones CDX North America Crossover Index of 35 U.S. and Canadian companies surged $36,000 per $10 million in bonds to $151,000, according to Deutsche Bank AG in New York. In Europe, contracts based on 10 million euros ($13.2 million) of debt in the iTraxx Crossover Index climbed 28,000 euros to 209,000 euros in extended trading in London.
The theory that the USD 1.3 trillion exposure in junk mortgages has been leveraged many times by credit derivatives trades and therefore, may cause jolts to the entire system, is getting credence as the developments are surfacing.
We will continue to develop this very important story. Please come back to this page.
Link see the news item exactly below.
It is not for the first time that there voices of worry on popular topics like credit derivatives, home equity funding, hedge funds and so on. By human nature, voices of apprehension always get more audience than those of optimism. But this around, there are signs of trouble in each of these segments, so that the worried voices get quite a substance.
First, the ABX.HE index continues to fall. We reported 10 days back that the price for BBB- was at 85.22. It is now down to 81.74 – in other words, a decline of hundreds of basis points in just about 7 days of trading.
Earlier this month, S&P put 18 sub prime RMBS transactions of 2006 vintage on rating watch negative, on account of poor collateral performance, with clear signals that there might be downgrades in near future. The reason for the collateral performance was cited as follows: :”Many of the 2006 transactions may be showing weakness because of
origination issues, such as aggressive residential mortgage loan underwriting, first-time home-buyer programs, piggyback second-lien mortgages, speculative borrowing for investor properties, and the concentration of affordability loans”. Quite obviously, these factors are not new reckonings of enlightenment and were very well known in 2006 itself. In just about few months, if there are indications of trouble in certain transactions, it is quite likely that the trouble might not be limited to just a few transactions.
Hedge funds are suppliers of equity to many of the home equity securitizations, CDOs and so on.Barron’s picked up a Dresdner Kleinwort 50-page report on hedge funds, warning of a “great unwind”.
There is no doubt that there are alarming levels of leverage created by many of the derivatives transactions that do not actually get into any funding but just take positions on actual transactions. ABX.HE deals are not necessarily hedging deals – the sheer volume of credit derivatives unarguably suggests that lots of transactions are merely for trading (read speculative) motive. Hence, there will be, without doubt, multiplied impact of a loss in the system. Not only will the loss be limited to the banking system, but will be widespread.
If things enter a vicious cycle, bad news will breed worse news. For instance, tons of global funding flows into the MBS market. Lot of it flows into more leveraged positions like CDOs and hedge funds. Withdrawal of liquidity from either of these may spell systemic trouble.
We will continue to bring more comments and news about what is happening in the high-finance market.
Updated 22 Feb 2007: We wrote the ABX.HE price as 81.74, but that was yesterday. Today, it was 78.59. This sharp drop was caused by reports of losses on 2006 securitizations by Novastar.
Updated 24 Feb 2007 The prices end of the week on 23 Feb closed at 68.5 – the last two days slide being the steepest slope in the price graph since the inception of the on-the-run index in Jan this year. In the meantime, the FDIC came with 4th quarter 2006 banking data. The magnitude of the situation may be evident from some numbers – the total amount of subprime mortgage debt is roughly USD 1.3 trillion, of which some 700 billion is in outstanding securitization deals. Even a fraction of this going bad, given the leverage levels, may cause a deluge.
Update 28th Feb – there is more news on this issue; see item immediatley above.
Link For a very readable article on the subprime worries causing system jolts, see Knowledge@Wharton article here. Robert J Samuelson, a Washington Times and Newsweek contributing editor also wrote a piece that takes a look at developments over several decades – read here.
Accounting professors of the Michigan University in a working paper claim that it is a commonplace practice among US companies to use securitization at the end of a quarter to improvise quarterly results. Prof Patricia Dechow and Catherine Shakespeare, both of the Michigan University, claim to have found this on study of quarterly results of several US companies.
In their paper, the professors claim, in sum: “Relative to recording securitizations as collateralized borrowings, the “gain on sale” treatment allowable under SFAS 125/140 has several accounting benefits such as reducing leverage,
increasing profits, and improving efficiency ratios. We argue that to maximize these accounting benefits managers will want to engage in securitizations at the end of the quarter. We document that securitization transactions occur with greater frequency in the last few days of the third month of the quarter. We also find that the end-of-quarter effect is stronger after the introduction of SFAS 125 that made it easier for firms to meet criteria for “gain on sale” treatment”.
The US securitization standard FAS 140, like its pervious version FAS 125 permits, or rather, requires, recognition of gain on sale if the securitization satisfies certain conditions. Essetially, if the conditions for off-balance-sheet are being satisfied, those for gain-on-sale are also satisfied.
It is not uncommon for securitizers to report profits out of a securitization, and later make revisions on the ground that losses were not properly apprehended – for instance, in the case of New Century below. The IASB’s IAS 39 has taken a far more conservative view on booking of profits on securitisation. Basle II also does not recognise gains-on-sale for regulatory capital treatment.
While worries about the worsening health of US consumer finance and resulting poor performance of subprime loans have been coming since the beginning of this year (for instance, see the S&P report cited in www.vinodkothari.com), the alarm trigger was pressed hard this week with worrying signals from the major subprime lenders such as HSBC and New Century. The ABX.HE index for the BBB- tranche from a price of 92.01 to 85.22. See markit site with ABX.HE quotes here.
HSBC warned on Wednesday that its loss provisions are expected to be higher at USD 1.75bn. HSBC is one of the biggest subprime lenders in the US market. HSBC warned that not only the percentage of loans more than 60 days due is climbing up, even frauds are increasing.
Similarly, a Form 8K filed by New Century, another major home equity lender, said “During the second and third quarters of 2006, the company’s accounting policies incorrectly applied Statement of Financial Accounting Standards No. 140 – Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. Specifically, the company did not include the expected discount upon disposition of loans when estimating its allowance for loan repurchase losses”.
The ABX.HE index is reflective generally of the state of the US economy. In particular, the BBB and BBB- tranches are likely to suffer losses as excess spread levels in the 20 home equity deals are wiped out and the losses are debited to the lowest of the securities.
Links Also see our credit derivatives page for more reports and links
In a recent ruling, the UK Court of Appeal had the occasion to discuss the rights and obligations of the trustee in a securitisation transaction. As the Court itself has noted, this is one of the first cases dealing with the rights of trustees in securitisation deals. The case Citibank v. MBIA and another  EWCA Civ 11 was decided on 22 Jan 2007.
The transction relates to the famous securitisation of Eurotunnel’s debt. Tier 3 debt of Eurotunnel was held by an SP called Fixed-Link Finance (FLF). Three classes of notes were issued in the transaction and it seems that some of these were guaranteed by MBIA. The subordinated notes were held, inter alia, by a hedge fund called QVT Financial (QVT). Citibank was a trustee for the noteholders – accordingly, Citibank held security interest on the assets of FLF. MBIA as a guarantor was called the Note Controlling Entity and had several powers in the documentation, including the trust deed. It was clear in the documentation that so long as MBIA continued to be the note controlling entity, it had power to give directions to the trustee, and the trustee would be obliged to abide by the same. The documentation also provided that if, Citibank acting on the directions of MBIA took any actions, it would not be liable to the beneficiaries.
The crux of the argument in the case related to whether Citibank as a trustee was bound to abide by such directions. It was argued that there is something called “irreducible core” in a trust, and the trustee cannot be reduced to a simple figurehead. If the trustee did not have basic obligations to ensure the beneficial interest, there was no trust at all.
The case ran through Cancery decision – Justice Mann held that
There is no doubt that while MBIA is the Note Controlling Party it is given a very large degree of control over the subject matter of the trust. It can give directions as to the taking or non-taking of enforcement action; it can direct the substitution of another debtor on the Notes; it can direct certain modifications of the Notes; and it can do a lot of other things, some of which one would expect that a trustee might decide to do, and others which would be more in the realm of matters for the beneficiaries to decide. However, even taken together, they do not contravene Millett LJ’s principle. The trust regime as a regime remains intact. The trust property is still held on identifiable trusts; Citibank still has functions as trustee; if MBIA does not give directions when entitled to, or when MBIA ceases to be the Note Controlling Party, Citibank will have even more functions. What has happened is that various powers have been surrendered to MBIA for the time being, but that was done as a matter of commerce. The position would look less unusual if the directions were to come from the G Noteholders (who are likely to have similar interests to MBIA), but would still be in substance the same. The Noteholders all take their commercial interests on terms that, and knowing that, MBIA wields the power that it wields. Whether or not this is good business, it is certainly not inimical to a trust structure. It is what the Noteholders have agreed should be the case.
Accordingly the Cancery Court held that Citi was bound to accept the directions of the insurance company.
The appeal court upheld the argument. The essential crux of the matter, that a trustee ceases to be of any relevance if all discretion was to be exercised by someone other than either the trustee or the beneficiary, was not discussed at length in the case, but the ruling hinged more on enforcing what the parties had agreed.
Vinod Kothari comments: In English law, trust is not a form of entity but a form of holding property. The trustee holds it for the benefit of someone else, viz., the beneficiary. If the beneficiary is the one who gives directions to the trustee and the trustee simply abides by the same, the trustee is not needed, because the very essence of the trust is that the beneficiary for whatever reasons was not able to exercise discretion, and therefore, the trustee was “entrusted” to do so for the benefit of the beneficiary. Trustees who do not have any discretion would possibly not have any obligation as well; if there is no obligation attached to property, there is no trust at all.
The case here was an intersting occasion to analyse the whole concept of non-discretionary trust – since the trust form not devised as a mere device of creating a facade that hides the real owner of the property. However, those key questions have unfortunately been skipped in the present case, possibly in view of commercial exigencies of the Eurotunnel restructuring.
Links For more caselaw on securitisation, see our page here.
BAA plc., the World’s largest airport operator, has announced plans to go through a major whole business securitisation exercise, perhaps the largest in this collateral class. In its execution, properties at Heathrow, Gatwick and Stansed airports will be pledged.
The size of the deal is likely to exceed USD 12 billion. Late in 2006, Japanese Softbank had done a mega whole business securitisation deal – the BAA deal is going to beat the record.
Whole business securitisation [WBS], also known as corporate securitisation or operating revenes securitisation, repackages the residual profits of an operating enterprise, typically an oligopoly, into bonds which will be paid from out of such residual profits. The WBS device has so far been mainly used in UK owing to special features of UK insolvency law, but several people argue that it can be used in lots of other countries too.
Links For more on whole business securitisation, see our page here.
In the face of declining home prices, American consumers are still borrowing more, both in absolute terms as also as a percentage of their income. Rating agency S&P in a recent report sees cracks in the foundation of consumer credit. The household saving rate has remained negative for consecutively 6 quarters, and this is for the first time since 1933.
In the 3rd quarter of 2006, the average household debt was 136% of after-tax income. Nearly 76% of all debt is mortgage debt, which is apparently incurred to buy a home, but home financing data clearly show that large part of this borrowing is for investment homes and home equity lending.
S&P seems moderately worried by this data but the situation might become more alarming if the current trend towards declining home prices continues. The other reason for worry is the adjustable rate home loans which were aggressively sold by most mortgage lenders over the last 3-4 years. With rates of interest increasing, these loans will start costing more. Many of them had negative amortization feature, which necessarily entails growing payments over time.
While the performance of most rated securitisation deals over 2006 has been very satisfactory, the signals of weakening health of subprime transactions are already seen. The spreads on ABX.HE index consisting of BBB and BBB- tranches of credit default swaps on home equity deals has continued to zoom up over time..
Earlier this month, US financial regulators issued an inter agency statement on Complex structured finance transactions (CSFTs). The final statement is a culmination of a process that has been going on for over 2 years. US regulators gathered experience after Enron fall that several top US financial institutions were actively structuring products for clients which helped clients to dress up their financial statements. Ever since then, CSFT has been a regulatory buzzword.
Complexity is a relative term, but structured finance transactions other than mortgage backed securities, retail asset backed products, hedging-type derivatives and CLOs, may be seen as “complex” as per the statement. Not all that is complex is risky, but the aim of the statement is to require banks’ internal controls to identify the elevated risks caused by such complex structured finance deals. Examples of deals that lead to such elevated risks are deals that:
- lackeconomic substance or business purpose;
- Be designed or used primarily for questionable accounting, regulatory, or tax objectives, particularly when the transactions are executed at
year end or at the end of a reporting period for the customer;
- Raise concerns that the client will report or disclose the transaction in its public filings or financial statements in a manner that is materially
misleading or inconsistent with the substance of the transaction or applicable regulatory or accounting requirements;
- Involve circular transfers of risk (either between the financial institution and the customer or between the customer and other related
parties) that lack economic substance or business purpose;
- Involve oral or undocumented agreements that, when taken into account, would have a material impact on the regulatory, tax, or accounting treatment of the related transaction, or the client’s disclosure obligations;
- Have material economic terms that are inconsistent with market norms (e.g., deep “in the money” options or historic rate rollovers); or
- Provide the financial institution with compensation that appears substantially disproportionate to the services provided or investment made by the financial institution or to the credit, market or operational risk assumed by the institution.
The guidelines require banks to have internal processes, particularly audit checks that identify and avoid such transactions.
Links The text of the guidelines is here.
While interest in securitization transactions in Russia has been there for sometime now, there seems to be lot of activity happening as of now. On Dec 8, 2006, the Moscow Interbank Currency Exchange started trading collateralized mortgage obligations. This is surely a new milestone in the development of securitization in the country.
Earlier this year, an IFC-assisted transaction Russian Mortgage Backed Securities 2006-1 S.A. was labelled as the first MBS transaction from the country. The transaction was originated by VTB, Russia’s second largest bank. The deal size was USD 88.3 million.
The MBS law was passed late in 2003; however, there have not been many transactions since then until recently.
Asset backed securities are supposed to be asset-backed, and independent of originators’ risks or ratings. That is the key assumption on which securitization transactions are premised. But originator or sponsor risk continues to be of relevance to securitization transactions, as the recent Moody’s special report titled Deal Sponsor and Credit Risk of US ABS and MBS Securities says.
The Moody’s report is not a revelation. It would be difficult to believe that assets can perform on their own, as assets are inanimate and do not mean much absence of entities that drive them. There are entities that work on assets, service assets, at times, even nurse and nurture assets. There was an S&P report earlier that talked about commoditization of asset classes, and said in several collateral classes, servicer risk continues to be significant. In almost the same vein, Moody’s draws regression lines to find significant relation between the ratings of the sponsor/originator and the possibilities of downgrades of a securitization transaction.
Among the highlights of the study are:
- While the data reveals some interesting correlations between credit performance and sponsor type, the analysis does not discriminate among the many possible explanations for the findings, which include:
– Competitive forces may cause lower rated sponsors and specialty finance companies to be most active in market segments where collateral is risky and pool performance is hard to predict.
– Collateral performance may be inversely related to the credit quality of the sponsor since the pool’s underlying obligors may be less likely to service their debts if the servicer is bankrupt.
– Agency problems may be less severe for more highly rated sponsors and for some banks, security firms, and captive finance companies if their expected long-term participation in the securitization market makes them more likely to be consistent in their underwriting standards, selection of assets, and servicing.
An interesting fact that comes out from the report is that there are 8,914 US ABS and MBS transactions in the study, all issued during the period from 1993 to 2006H1. A total of 520 sponsors were identified for 8,377, or 94% of the total, transactions. Of the 520 sponsors, 210 had
Moody’s senior unsecured (or estimated) rating histories. Of the 520 rated sponsors, 55% were unrated, and 10% had speculative grade ratings. In fact, only 9% had ratings of Aa or above.
This poses an interesting question – is securitization the last resort of the laggards?
Declining home equity originations may cause ABS volumes to slide in 2007
Most of the participants at the ABS East conference at Florida seemed to agree that the volumes of asset backed securitizations in 2007 may decline due to declining volumes of home equity deals. Last year, the explosive growth in ABS issuance was caused largely by home equity deals. Panelists have predicted a 10% decline in volumes in 2007.
Data published by Thomson Financial show that upto the 3rd quarter of 2006, the volume of ABS issuance was nearly USD 880 billion, only 3.7% higher than what it was last year.
The downgrades in home equity loans, particularly the subprime one, have been growing rapidly. S&P’s rating movements history upto 3rd quarter of 2006 shows the downgrades in subprime home equity to hvae increased to 87 in the 3rd quarter, from 34 and 46 in the 1st and 2nd quarter respectively.
A recent report by UBS also has the same story to say. In fact, the price index for BBB ABX.HE has also consistently been falling.
One of the most intensively talked about worries of the recent past has been the bursting of the “housing bubble”. Several people contend that the bubble has already burst. Whether it is bursting of the bubble or its oozing out, there are enough indications of a slow down in mortgage origination and decline in housing prices. The ramifications of these trends on the existing securitization deals, and the volumes in the current year, may be widespread.
First, a quick look at the “bursting of the bubble” phenomenon. The Times, Aug 29, carried an article titled Housing Bubble is Finally at Bursting Point, wherein it reported about new house sales in July 2006 having come down by something like 11 – 23% as compared to last year. If the housing market is indeed in retreat, it might have long term implications for the entire US economy, since housing has been responsible for some 40% jobs taking into account various housing-related employments. Previous periods of weakness in the property market have been associated with widespread collapses in the banking segment – for example, the S&L crisis. Currently, as the risks are diffused through the securitization process, such casualties are less likely, but there will be strain on the balance sheets of lots of MBS investors.
The Center for Economic Policy Research has come up several articles on the housing bubble. A June 2006 paper came with 10 indicators which evidence that the bursting of the bubble impact.
While the declining house prices increase the default rates on mortgages, there is yet another impact which may be felt strongly over the coming months. This is the impact of the ARM products on the default rates. The latest issue of Business Week [Sept 11, 2006] comes out with an article titledNightmare Mortgages. The article contends that most ARMs, which were sold over the past few years on the lure of affordability, have actually taken borrowers by a shocking surprice as most of them have substantially reset their payments a year after they were originated. Option ARMs typically have a negative amortization feature – wherein the borrower pays lesser instalment than the interest on the loan, leading to an increase in the mortgage balance. Once a trigger of LTV ratios is hit, the payments are reset. Declining housing prices would only mean the triggers will be hit faster – either the banks reset the instalments or face increased losses on account of foreclosures.
Given the way ARM loans have been hard-sold, it is very likely that the picture that emerges actually will be much less beautiful than was imagined at the time of origination.
The levels of credit enhancements for RMBS transactions have come down to historically low levels in 2003 and 2004 – which was obvious as the rating agencies were getting bolder by the month with experience of past transactions. However, the past had a unilateral history of increase in house prices, which pulled down defaults and foreclosure losses. The key question that remains is – if LTV ratios worsen with reduced housing prices, would the credit enhancements modelled at the time of AAA ratings would still be enough? The future holds the answer to the question, and painfully, the answer may negative.
Links: For articles on the housing bubble on the site of Center for Economic Policy Research, see here.
Asian securitisation markets seem to be poised for a sharp growth, as most of the economies in the region are doing quite well. The situation easily reminds one of the environment that prevailed pre-1997 crisis.
Take a look at Thailand. For several years, no securitisation transactions were taking place in the country, and several factors, including taxation difficulties, were pointed as being responsible. In 2006, Thai securitisation market seems to be taking big strides. A recent article in Bangkok Post quoting an official of the Bond Electronic Exchange said the value of outstanding securitisation bonds is expected to reach 1.5 trillion baht within five years. The volumes in this year are likley to grow thanks to some mega transactions in the offing. Thailand’s Government Housing Bank (GHB), plans to raise at least Bt40bn ($1.06bn) in a deal that is likely to come to market in the first or second quarter of next year. This deal would beat that of China Network Communication Group, which sold a $1.01bn commercial mortgage backed deal at the start of April this year.
The Malaysian market is also seemingly doing well with the active support of the Government that pledges to promote Islamic financing. Securitisation transactions are being structured as Sharia-compliant sukuk or musharaka transactions and being sold as Islamic bonds.
A completely new wave of activity is discrenible in the Middle East region which had not hitherto tried securitisation to any substantial extent. With the amount of commercial real estate and project work in place in UAE and other countries in the region, securitisation seems to be just the right way to raise resources. These countries are also using Islamic