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Pensive mood prevails at IMN gathering

The asset-backed market has suffered major jolts in the past few months. The latest news of sub-prime auto ABS originator AmeriCredit scaling up its losses due to revaluation of cashflows from auto securitization deals has not surprised many.

The mood at the recently concluded industry event organised by IMN was pensive, with undertones of tension. One participant is reported to have said: ""We are in a critical point of the ABS market. We are paying for the sins of the past. We were hiding behind growth and covering our mistakes."

The ABS market has passed through the largest bankruptcy of an ABS issuer – Conseco Finance. Recently, it also witnessed a case of mismanagement of cashflows in National Century fiasco.

Added to that is the regulatory oversight and increased accounting worries.

Looking forward, much depends on the health of the consumer, speakers at the conference said. But that outlook looks decidedly downbeat. If consumers — whose spending accounts for two-thirds of the U.S. economy — falter, it spells problems not only for the economy, but also for the returns on asset-backed securities, analysts said. "It's going to be a tough year for the ABS market. There's significant likelihood that the consumer in general will be much more distressed," said a panelist from Moody's.

South African legal dispute to put questions on securitisation structure

Over a very short span of development, the South African securitisation market has seen a failed securitisation conduit, as also failed securitisation originators. Soon, it might also see a court ruling either affirming or rejecting the transfer of assets to securitisation SPVs.

A company called Siltek that securitised its assets has gone bankrupt, and its liquidators have pleaded that the transfer of assets to securitisation SPV was a fraud on creditors and the taxmen. The bank that bought the securities in the deal has been issued summons.

The deal was structured by a securitisation conduit called Mettle. The book debts of Siltek were transferred to a vehicle called Xavier.

Also challenged by the liquidator is the tax impact of the transaction, particularly the issue of preference shares by the SPV to Siltek.

Comment On a first look, there seems to be nothing wrong in the structure of the deal. Originators do go bust, and that is why securitisation exists. Issue of preference shares to the originator as a first loss piece is also fine and cannot in any way be dubbed as a tax dodging device.

Germany takes the synthetic route to CLOs

The German Structured Finance public term market doubled its volumes in 2002 compared with 2001. However, looking at the synthetic issuance volume, the notional values nearly tripled over the previous year in 2002.

A recent S&P report provides data about cash versus synthetic deals in Germany. The total volumes (including notional values of unfunded deals) added up to USD 39.3 billion in 2002 compared with $19.6 billion in 200. Howeever, unfunded volumes tripled to $29.7 billion in 2002 compared with $10.6 billion a year earlier. Germany takes a staggering 72% share of the total European unfunded issuance.

From the end of 1999, almost all German CLO, RMBS, and CMBS transactions have been synthetic in nature. The market for these types of transactions was nonexistent prior to 1999 yet now stands at $29.7 billion.

Besides the regular KfW-assisted deals, there were several new features in 2002:

  • There was a deal called Gelt 2002-1, the first synthetic leasing ABS transaction. It was arranged by DZ Bank AG.
  • Non-SPE synthetic structures are increasingly becoming common: the first such deal in Germany was a synthetic RMBS transaction, Building Comfort 2002-1, was arranged by Bayerische Hypo- und Vereinsbank AG (HVB)

SME loan CLOs gather speed in Europe

CLOs backed by thousands of small business loans became a popular asset class in several European countries. Partly with government support, this might be the way to lend to small businesses.

Part of these CLOs were based on the cash structure, but of late, banks have been stressing more on the transfer of risks than raising of liquidity and going for synthetic structures.

A whole lot of such SME loan CLOs have emerged from Germany, where KfW runs a program targeted at SME lending called Promise. [See below for more]. CLOs under the Promise template have become a regular feature in Germany. However, Germany is not the only country to have SME loan CLOs. There have been cash funded deals from Spain, the Netherlands, and UK. The Spanish transaction is also based on a partial guarantee from the government.

An S&P report gives a list of SME CLOs in Europe as under:

European CLOs of SMEs Transactions
Transactions rated by Standard & Poor's   Originator   Closing date   Maturity date   Issuance (Mil. €)   Funding   Note collateral  
CORE 1999-1 Ltd. Deutsche Bank AG March 1, 1999 March 17, 2009 2,297 Fully funded cash flow SME loans
CORE 1999-2 Ltd. Deutsche Bank AG June 30, 1999 April 30, 2004 1,216 Fully funded cash flow SME loans
GELDILUX 1999-2 Ltd. Bayerische Hypo- und Vereinsbank AG Sept. 16, 1999 Sept. 30, 2003 750 Fully funded synthetic Pfandbriefe, MTN program, and cash deposit
CAST 1999-1 Deutsche Bank AG Dec. 6, 1999 Dec. 31, 2008 392 Partially funded synthetic Pfandbriefe and credit-linked notes
CAST 2000-1 Deutsche Bank AG June 30, 2000 June 20, 2009 340 Partially funded synthetic Pfandbriefe and credit-linked notes
CAST 2000-2 Deutsche Bank AG Dec. 8, 2000 June 20, 2009 220 Partially funded synthetic Credit-linked notes
Promise-I 2000-1 PLC IKB Deutsche Industriebank AG Dec. 19, 2000 Feb. 5, 2010 213 Partially funded synthetic Schuldscheine
Promise-K 2001-1 PLC Dresdner Bank AG May 22, 2001 June 22, 2008 58 Partially funded synthetic Schuldscheine
Promise-Z 2001-1 PLC DZ Bank AG Deutsche Zentral-Genossenschaftsbank Aug. 15, 2001 April 27, 2011 137 Partially funded synthetic Schuldscheine
Promise-I 2002-1 PLC IKB Deutsche Industriebank AG March 26, 2002 Sept. 5, 2009 4,170 Partially funded synthetic Schuldscheine
Promise-A-2002-1 PLC Bayerische Hypo- und Vereinsbank AG March 28, 2002 July 28, 2012 1,620 Partially funded synthetic Schuldscheine
GELDILUX 2002-1 Ltd. Bayerische Hypo- und Vereinsbank AG May 27, 2002 June 17, 2007 3,000 Fully funded synthetic Pfandbriefe and cash deposits
Promise-C 2002-1 PLC Commerzbank AG Nov. 5, 2002 Oct. 28, 2010 119 Partially funded synthetic Schuldscheine
   The Netherlands
SMILE Securitisation Company 2001 B.V. ABN AMRO Bank N.V. Dec. 13, 2001 Nov. 22, 2027 5,000 Fully funded cash flow SME loans
Fondo de Titulización de Activos BBVA-2 Banco Bilbao Vizcaya Argentaria, S.A. Dec. 6, 2000 Jan. 21, 2019 900 Fully funded cash flow SME loans
Melrose Financing No. 1 PLC Bank of Scotland Feb. 27, 2001 Feb. 15, 2011 1,103 Fully funded cash flow SME loans
*CORE 1998-1 Ltd. was redeemed for the full amount in November 2002.

Links For more on CLOs, see our page here.

Spain: 2002 was brilliant, and 2003 is promising

Securitisation activity performed brilliantly in Spain in year 2002, with volumes (including Spain-related assets for cross-border issuances) increasing some 70%. A recent S&P special report says that this is by far the largest volumes achived in Spain. Over just 4 years, the volume of issuance in Spain has quadrupled.

Spain is the 5th largest market in Europe – followed by UK, Italy, Germany and the Netherlands.

In 2002, the growth was pulled mainly by repeat issuances from originators who have already tasted the benefits of securitisation. Besides, securitisation of small business loans, known as PYMEs in Spain, became a strong asset class. However, like in many other countries, RMBS is still the larget component of Spanish ABS.

On the legislative front, the 2002 Spanish Finance Act was passed last November, which created mortgage transfer certificates ("certificados de transmisión de hipoteca"). These, together with mortgage participations, now allow originators to securitize both conforming and nonconforming loans through a fondo de titulización de activos.

According to the S&P report, For the same reasons as in 2002, the Spanish securitization market in 2003 will continue to grow at a brisk pace. Some repeat originators are already working on transactions for the first quarter, others will go to market later in the year. There will be recurrent issuances from established originators and new types of transactions will be structured. Some corporate originators are already looking into the possibility of taking advantage of this source of financing.

Links See also our country page on Spain here.

ISDA and other bodies jointly respond to Basle securitization paper

ISDA, American Securitization Forum, European Securitisation Forum, and International Association of Credit Portfolio Managers recently jointly commented on the second BIS paper on securitization. The second working paper was issued in October 2002 by the Secu-ritisation Group of the Basel Committee on Banking Supervision.

The highlights of the joint response are as under:

  • The proposed risk weightings for lower rated tranches under the RBA remain higher than justified, which will cause significant market disruption. As such, the bodies recommended that the Securitisation Group return to basic principles by aligning the RBA more closely with the underlying credit function and the actual practices of banks and by harmonising ABS risk weights with the Committee’s proposals for corporate positions.
  • Regulatory capital requirements for synthetic securitisations remain too high and dis-criminate against synthetic transactions as compared with traditional securitisations.
  • For super-senior positions in synthetic securitisations, there should be no need to seek external credit protection as the same is unwarranted additional cost for a position at which there is no appreciable risk.
  • With regard to revolving securitisations, the requirement that there be a pro rata sharing of interest, principal, expenses, losses and recoveries based on the beginning of the month balance of receivables out-standing is redundant and too restrictive and should be eliminated.
  • In addition, the 100% credit conversion factor (80% for controlled amortisation) for committed retail and all non-retail exposures implies that no risk is transferred to investors. This requirement should be reduced significantly or at least explained, as it is clear that risk is indeed transferred.

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

New accounting rules to hurt several deals

According to accounting experts, the new US accounting rules on consolidation will hurt several deals including asset backed commercial paper conduits, several CDOs and other complex structured finance transactions.

For full text of the story on Reuters, click here.

On this site, we have posted a presentation by Deloitte Touche on the impact of the new rules, also containing an implementation guide. Martin Rosenblatt of Deloitte, one the World's best experts on securitization accounting, has kindly contributed this presentation. The presentation is available on the premium section of the website. To get access to the premium content, join our premium list here.

National Century investors to lose about 2/3rds

According to reports in US press, National Century will complete winding up in next about 4-5 months, and the investors in the asset-backed bonds may be forced to write off at least 2/3rds of their investments. Of the USD 3.3 billion owned by the company, it is expected to realise only about USD 1.2 billion of assets at most.

In the meantime, investors have already started writing off their investments. Some National Century bondholders have already written off most of the value of their investments. Credit Suisse, which underwrote most of National Century's bond sales, has written off 83 percent of its holdings of National Century debt. The bank said in November its $258 million of securities were worth $44 million, citing "massive fraud" by National Century.

Ambac Financial Group Inc., has also reportedly written down 80 percent of its $174.5 million investments in National Century bonds, more than the 70 percent figure it announced in November.

Links For earlier news items on National Century, see here. For more in the securitization hall of shame, see our page here.

Taiwan joins ABS fray:
First financial ABS deal approved

Taiwan's Ministry of Finance said Monday it has approved the island's first financial asset-backed securities product, which will be issued by Land Bank of Taiwan and comprise assets from the Industrial Bank of Taiwan. Government-owned Land Bank will issue two tranches of bonds totaling NT$3.65 billion (US$1=NT$34.560), backed by 41 loans belonging to Industrial Bank and the loans' guarantees, the ministry said. The first tranche, totaling NT$2.81 billion, will have a maturity of three years and seven months, and will carry a fixed coupon of 2.8%, while the subordinated tranche is worth about NT$840 million, the ministry said. The bonds will be privately placed and the subordinated tranche will be held by Industrial Bank, the ministry said.

The ABS deal included assets from 13 industries, such as semiconductor, communications, construction, retail, flat panel display and compact disc manufacturing, the ministry said. Each of the industries account for between 0.6% and 25% of the total assets, the ministry said. The ministry said the average annual return on the assets is 4.04%.

Taiwan Ratings Corp. will rate the first tranche of the asset-backed securities. Industrial Bank began working last year with SG to develop products for Taiwan's nascent asset-backed securities market.

CDOs in blunderland?
Investor to sue CDO managers for alleged mismanagment

According to a news item on on portal of Risk Waters, Jersey-registered collateralised bond obligation (CBO) investor Beaford is suing US investment bank Morgan Stanley and French insurer Axa, along with a number of its subsidiaries, for failing to properly manage three CBOs between 1996 and 2002. Morgan Stanley will contest the allegations, in what could prove a landmark case for CBO arrangers and managers.

The CDO landscape is littered with defaults and downgrades of late. Many of these CDOs contained blind portfolios of obligors, or otherwise, the investors had placed a total reliance on the CDO managers' experience and discretion. It is not unlikely that management of CDOs becomes an increasingly contentious issue in the structured finance market.

Beaford's objections significantly predate the more sophisticated managed CDO structuring taking place today. But the issue of how arrangers and CDO managers deal with investors that have seen significant credit events erode the value of their investment pools is still ongoing.

Links For more on cash and synthetic CDOs, see our page here.

Standard and Poor's bullish about 
Spanish securitisation market

The Spanish securitization market is set to show at least 30% growth in the year ahead after an impressive 2002 performance, according to an article by S&P."2002 was by far the most impressive year for the Spanish securitization market to date," the rating agency said. "Volumes were driven by a combination of repeat issuance and new entrants, which bodes well for future growth."

The Spanish securitization market closed 2002 70% higher at $18.4 billion compared with $10.6 billion a year earlier. A total of 27 transactions closed compared with 18 in 2001. Once again, RMBS was the dominant asset class. Year-end 2002 volumes came in at $10.8 billion, more than double the $5.7 billion seen a year earlier, representing 60% of overall Spanish issuance. A total of 16 transactions closed compared with 10 in 2001 and all were executed on a fully funded basis.

Talking of the prospects for this year, the S&P report says: " While mortgage lenders will remain the market's staple over the course of 2003, other institutions are now actively looking at securitization as a financing tool".

Given the importance and recent growth of synthetic transactions in the European market as a whole, in 2003 Standard & Poor's expects developments in the regulatory and legal frameworks for synthetic securitizations for both Spanish originators and domestic investors, the S&P report commented. "There are restrictions on the issuance of these types of transactions and the effect of such deals on financial institutions' capitalization ratios needs to be clarified," it said. "Additionally, some investors are prohibited by the regulatory authorities from investing in this type of security." In 2003, it is expected that that government guarantee program for SME securitizations will be continued, with a funding allocation that at least matches that of last year.

Link For more on securitisation in Spain, see oure page here.

The promise of Promise to cover Europe

German developmental body KfW has declared intents to cover transactions across Europe as it recently launched its first non-German synthetc securitisation deals to cover originations in Austria.

KfW runs program templates called Promise and Provide, wherein it assists German banks to syntheticall securitise RMBS and SME loan deals. The risks are bought from German banks by KfW which in turn transfers the same to capital markets by issue of credit-linked notes. So far, these programs were limited to German banks.

Promise Austria-2002 Plc.was the first non-German issue toward end of last year.

The popularity of the Promise and Provide programs is evident from the surge in their volumes in 2002: 11 transactions adding up to EUR 19 billion have been concluded under the two programmes in 2002, which is more than double the total amount in the two preceding years combined (altogether nearly EUR 9 billion). A KfW press release says: "KfW will focus not only on standard transactions but on the securitisation of portfolios of smaller institutions, that is, it will apply the multi-seller prototype more frequently. In addition, KfW is prepared to make its securitisation platforms available as a standardised instrument to suitable institutions with appropriate loan types in other European countries. As is the case with securitisations in Germany, it could assume the role of a neutral intermediary for European banks as well. "

Links For more on securitisation in Germany, see our page here. For more on synthetic CDOs, see our page here. The Promise transaction is discussed in Vinod Kothari's training courses on CDOs. For details, see here.

FASB's consolidation rules expected shortly

On coming Wednesday, FASB is holding another meeting to resolve some remaining issues relating to the draft of the rules on consolidation of certain special purpose entities. Thereafter, the final rules should follow.

The term "special purpose entities" is NOT used in the draft. Instead, the draft uses the term Variable Interest Entities (VIE).

Entities are separated into two populations: (1) those for which voting interests are used to determine consolidation (this is the most common situation) and (2) those for which variable interests are used to determine consolidation (the subject of this Interpretation).

An entity shall be treated as a VIE and subject to consolidation according to the these rules, if, by design, either of the following conditions exists:

  • The total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support. That is, the equity investment at risk is not greater than the expected losses of the entity. "Equity investment at risk" is not just legal equity carrying voting right but the first loss or residual economic interest class of the enterprise.
  • The equity investors lack any one of the following three characteristics of a controlling finncial interest: 
    (1) The direct or indirect ability to make decisions about an entity's activities through voting rights or similar rights. The investors do not have that ability if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership). 
    (2) The obligation to absorb the expected losses of the entity if they occur. The investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the entity itself or by other parties involved with the entity. 
    (3) The right to receive the expected residual returns of the entity if they occur. The investors do not have that right if their return is limited by the entity's governing documents or agreements with other variable interest holders or the entity.

Highlights of the draft of the interpretation are avalable here.

We will continue to report developments as they take place.

Links For more on accounting issues related to securitisation, see our page here

Singapore securitisation market looks forward to more activity

The securitisation market in Singapore is looking forward to increased activity in 2003, says a report by S&P. Until now, the potential for growth in Singapore's securitization market has been restrained because issuers have had access to less expensive funding from Singapore's banking system. Recently, however, the securitization market in Singapore has begun to realize its growth potential, due in part to its innovation, and 2003 could be something of a turning point for the area.

During 2002, Singaporean securitisation market was predominated by CDOs and CMBS deals. Of the 4 deals that S&P rated, there was one global collateralized debt obligation (CDO) transaction managed by United Overseas Bank Ltd. (UOB) Asset Management. The other transactions were property-related and sponsored by the leading Singapore developers, CapitaLand Ltd. and Keppel Land Ltd.

As to the potential of CDO market in Singapore, S&P official says Singapore's asset managers have been quick to realize how CDOs complement their traditional fund management business and form a good platform for expanding and building experience and establishing a track record. Other Asian-based asset managers may follow in their footsteps.

Besides CDOs and CMBS, S&P expects more activity in synthetic RMBS and consumer finance segment as well.

Links: For more on securitisation market in Singapore, see our page here.

US senate committee attacks structured finance

The U.S. Senate Permanent Subcommittee on Investigations : Four Enron Transactions ((Fishtail, Bacchus, Sundance, and Slapshot) Funded and Facilitated by U.S. Financial Institutions has submitted its report on 2 Jan 2003. The report attacks structured finance transactions and has called for penal action against financial intermediaries that help public companies produce misleading financial reports by means of deceptive financial products or transactions.

The transactions in question are Fishtail, Bacchus, Sundance, and Slapshot. These transactions related to Enron’s new business venture in pulp and paper trading, and according to the sub-committee were actively assisted by JPM and Citibank's SSB.

Major recommendations of the sub-committee include a review of structured finance deals by banks. The Federal Reserve, OCC, and SEC should immediately initiate a one-time, joint review of banks and securities firms participating in complex structured finance products with U.S. public companies to identify those structured finance products, transactions, or practices which facilitate a U.S. public company’s use of deceptive accounting in its financial statements or reports. By June 2003, these agencies should issue joint guidance on acceptable and unacceptable structured finance products, transactions and practices. By the end of 2003, the Federal Reserve, OCC and SEC should each take all necessary steps to ensure the financial institutions they oversee have stopped participating in unacceptable structured finance products, transactions, or practices.

It calls for stricter examination of structured finance transactions by bank examiners. It expects routine examiners to evaluate a bank’s structured finance activities to determine whether such activity appears to constitute a violation of the SEC policy and, if so, to declare that activity also constitutes an unsafe and unsound banking practice.

Full text of the 41-page report is available here.

Indian securitisation law passed

The upper house of the Indian Parliament passed the securitisation bill, which has been understood more as a law related to non-performing assets. All discussions in the house related to the non-performing assets part.

Now that the Bill has been cleared by both the houses, the only legal formality is the assent of the President. Normally that should only be a matter of days.

Please see our story below for more details and links.

Bankruptcy of National Century smears more tar on ABS business

Off balance sheet funding was already a dirty word, and now, asset-backed securities might also start straining the eyebrow. National Century Financial Enterprises that filed for bankruptcy recently (see also our story below) undoubtedly puts a question or two on the balance of multi-agency surveillance that ABS transactions work on. After all, it is being alleged that bonds to the extent of more than USD 1 billion were not backed by any assets at all.

After all, all corporate financings are asset-backed at the end of the day – because if the corporate does not have any assets, the liabilities have no meaning. But what has always been, and should continue to be, unique to ABS is the predominant asset backing that the bond investors get. To constantly monitor the asset backing, several independent agencies are brought in – trustees, rating agencies, auditors and so on. But National Century case, like similar cases in the past, must ultimately lead to some of these agencies sharing responsibility.

Thus, US financial press is justified in questioning, as Forbes does, in its article titled Why Wasn't NCFE's Collapse Predicted Sooner? by Seth Lubove, dated Nov 21. The articles contends, as is perhaps a fact, that as recently as in August, Moody's had affirmed its ratings for the securities of National Century.

Bank One, the trustee for the bonds, had alleged National of a "systematic trickery". An article in New York Times says: "Investors in asset-backed securities are still questioning how bonds that had carried a top credit rating could now be worth just a fraction of their face value. Moody's Investors Service rated National Century's bonds AAA until Oct. 25. Credit Suisse First Boston underwrote the bonds, and J. P. Morgan Chase had two bankers on the National Century board, including Hal Pote, head of the audit committee. Deloitte & Touche audited the books. Both Bank One and J. P. Morgan were bond trustees."

A story in Washington Post titled A Mystery Over Missing Funds went into the personal life style of the bosses of National Century.

Links For more sad episodes on asset backed securities, see our page here.

Pakistan central bank issues securitisation regulations

The State Bank of Pakistan has recently formulated reguatory standards for capita lrelief on securitisation deals. The rules dated 14th Nov allow banks and depository financial institutions to securitise assets through SPVs, speling out the requirements, prudential standards and capital relief conditions.

Several safeguards have been put in place which are reflective of the prudential standards in place in most other countries by banking regulators. The originating bnak is not allowed to hold equity in the SPV, nor to make it out that the SPV belongs to the bank.

The guidelines provide that banks can securitize their assets relating to lease financing (with acknowledged assignment of lease rental proceeds), mortgage financing and toll financing (for infrastructure developmental projects). Other assets may be securitized by banks with prior approval of State Bank, on a case to case basis. The regulations further provide that a fixed amount of consideration for the securitized assets must be received not later than the time of the transfer of the assets. This is, in fact, contrary to the market practice whereby banks retain an interest in securitised assets by way of a deferred sale consideration.

The SEC's rules on securitisation have been in place for quite some time, though the level of activity on securitisation is still quite limited.

Links For full text of the Prudential guidelines, click here. For more on securitisation in Pakistan, including a recent article on the state of the market, click here. For text of Pakistan SPV rules, click here

Indian securitisation law makes headway

The combo piece of Indian law on securitisation which combines provisions on enforcement of security interests by bankers has been passed by the lower house of the Parliament, Lok Sabha or house of commons and would most likely be passed soon by the upper house as well. It is, thus, expected that it would become law very soon.

The Indian law is a curious mixture of three unrelated things – securitisation, asset management companies and enforcement of security interests on loan defaults to banks. From the proceedings in the House during the discussion on the bill, much of the debate was centered on the provisions relating to enforcement of security interests. The Press has also generally coloured securitisation bill as a law relating to non-performing assets.

As far as securitisation transactions are concerned, the Bill did not, in its Ordinance form, help or hinder much See our earlier comments/ article on this issue here. Apparently some amendments have been made at the time of its introduction in the Lok Sabha.

Links For proceedings in the Parliament while discussions on the Bill took place, click here. See our India page here. The text of the original Ordinance law is here

Future flows have been safer than corporate finance: S&P

Enriched by experience of recent sovereign problems in Argentina and impact on future flow transactions, rating agency S&P says emerging market future flows are safer than corporate finance.

Future flow structures provide some protection against sovereign- and corporate-related risks particular to emerging markets. However, no future flow structure (with the exception of one benefiting from a full financial guaranty) can completely insulate against all risks, particularly sovereign risks. Ratings assigned to future flow structures are dependent on a company's ability to generate future receivables and the level of sovereign risk mitigation provided by the structure. This dependency creates a linkage with corporate and sovereign ratings that may require rating adjustments that are commensurate with the rating adjustments that occur on the underlying corporate or sovereign rating.

While ratings on future flows are strongly linked with the local currency rating of a corporate, it is the sovereign rating ceilings that future flow transactions seek to pierce.

A lowering of a sovereign foreign currency rating will not automatically result in a lowering of a future flow rating because Standard & Poor's does not view the sovereign foreign currency rating as a direct link to the rating on a cross-border future flow transaction. The decision to lower or affirm a future flow rating following a sovereign rating change requires a review of the factors that led to the sovereign rating change and how these factors affect the probability of sovereign interference in the future flow structure. The decision to adjust a future flow transaction rating will depend on an assessment of two factors: the extent to which the structure protects against direct sovereign risk, and the extent to which the company is able to isolate its operations from direct and indirect sovereign risk.

Links For more on future flows, see our page here.

Health care securitization company's goof up spills: causes bankruptcy

An apparently small issue in one section of the market can snowball into larger issues of due diligence and fiduciary responsibilities at a time when larger bankruptcies have already made it a sensitive issue.

National Century Financial Enterprises, an Ohio-based health care receivables securitization company was recently found wrongly tapping into reserve funds to buy new accounts and was brought to book by due diligence auditors. In response, National Century failed to pay for the health care bills it had securitized. National Financial had arranged more than USD 3 billion of financing for health care companies.

The result is a major chaos that is seeming spilling. So much so that more thant one health care company has already filed for bankruptcy protection. PhyAmerica Physician Corp., the Durham company that runs nearly 200 hospital emergency rooms in 29 states, has filed for Chapter 11 protection.

There were also reports in US press that Med Diversified Inc., a home health-care provider, announced that its Tender Loving Care Health Services Inc. subsidiary had filed for bankruptcy protection. In addition, Med Diversified said it plans to seek a damage award of up to $1 billion in its planned lawsuit against National Century's service providers. The company said it planned to file complaints against Bank One Corp. and J.P. Morgan Chase & Co., trustees of some of National Century's bond funds, as well as National Century auditor Deloitte & Touche LLC.

FASB reaching finality on SPE consolidation standard

After marathon deliberations spanning over several weeks, the US standard setters are finally reaching a stage where the final interpretation on consolidation of SPEs will be issued soon. At the meeting yesterday, the Board instructed the staff to draft the final rule.

According to reliable sources, the following are the main conclusions reached during the discussions:

1. Special purpose entities are more appropriately called variable interest entities, as it is now getting increasingly clear that the consolidation rule will not be limited in application to SPEs only. While applying consolidation rules, it will be necessary to decide whether consolidation will be based on voting interests or variable interests.

2. In case of new variable interest entities, the new Interpretation would be effective immediately. For all existing entites, the Interpretation would be effective as of fiscal periods beginning after June 15, 2003, (i.e. the third quarter of next year for calendar year companies). There will be no grandfathering provisions. Restatement of prior year financial statements would be permitted.

2. In case of QSPEs under FAS 140, it was decided that it would be better for all parties involved in a QSPE to adopt the financial components approach rather than full consolidation of the entity, with the only exception being if a non-transferor had put himself in a position that would have precluded the transferor from achieving sale accounting. In other words, the components approach, which is the general theme of the securitization accounting standard, would continue to apply as a consolidation would go against the very theme. here was a caution from the board chairman that the attributes of a qspe have to be met and that the board would resist any efforts to broaden the definition of a q to accommodate other transactions.

In view of the major immunity granted to QSPEs, the Board would insist that there are no deliberate attempts to broaden the scope of QSPEs over what is contained in FAS 140.

3. In determination of the key question as to whether to apply the variable interest approach, parties should first determine the entity has any identifiable "decision maker". A decision maker is any party that has the authority to purchase OR sell assets or makes other operating decisions that significantly affect the revenues, expenses, gains, and losses of the variable interest entity. If there is a decision maker and that party either holds variable interests that would absorb a majority of the expected losses or holds variable interests that allow the decision maker to obtain a majority of the residual benefits from the entity's operations, that party is the primary beneficiary. If, based on these criteria, the decision maker is not the primary beneficiary, then other parties to variable interest entities should determine whether their variable interests will absorb a majority of the variability, focusing first on expected losses if they were to occur and then on whether they are entitled to a majority of the residual benefit, if any.

The discussions have also made some rules relating to consolidation of conduit entities.

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

Malaysia sees first primary market CLO

The first primary market CLO was introduced in Malaysia a couple of days ago by Anfin.

While a traditional CLO is made of loans originated by a bank or banks, which are bought and securitised by the CLO, a primary market CLO is one which itself gives loans to borrowers, and funds itself by issuing securities. Primary market CLOs have been operating in Korea for sometime.

Affin Bank and Nomura Advisory Services (M) Sdn Bhd wrapped up a collateralised loan obligation (CLO) deal that would see the 25 companies from 16 different industries get access to RM1bil from the capital market through the sale of new loans to a special purpose vehicle. Technically, under Malaysian SC guidelines, since there has to be a sale of the loans to an SPV, it seems the bank will give the loans and immediately sell them off to the SPV.

There are two remarkable features of the CLO – one, the loans are not seasoned, and two, the level of subordination in the transaction is only 10% whereas earlier CDOs from Malaysia have had far higher levels of subordination.

This is probably due to the ratings of the borrowing companies: the amounts of money borrowed by the 25 companies range between RM25mil and RM45mil and Malaysian Rating Corp Bhd has rated each company. The minimum credit rating of any of the 25 companies involved in the deal is BBB.

Vinod Kothari comments: on the face of it, this is like each of the 25 borrowers going together to the capital market. The role of the SPV and that of the arranger is minimal – that of merely putting up the whole show together. The subordinated investment also, in all likelihood, will be bought up the borrowers themselves, which, in essence, will mean the borrowers get 90% cash funding for what is their loan on paper.

It is not clear from the report whether the loans are secured or unsecured. If the 10% equity in the transaction has not been put up by the arranger, then this type of transaction for unseasoned, unsecured loans opens avenues for subprime lending trough capital market vehicles. That securitisation can be used as a device of promoting lending which banks would hate to keep on their balance sheets is an often-aired criticism of securitisation, and transactions like this give strength to this belief.

The regulators should view this transaction not as a securitisation, but as direct debt issuance by the end borrowers.Besides, subordination is meaningless if it held back by the borrowers themselves. Of course, who will be holding the subordinated investment is not clear from the press report.

Links For more on Malaysia, see our page here. For more on CLOs, see our page here.

Accounting firm to face USD 2 billion claim on securitization accounting issue

US regulators on Friday filed a USD 2 billion suit against accounting firm Ernst and Young for failing to disclose wrong accounting of retained interests of failed thrift Superior Bank that was ordered to be closed last year for securitization accounting lapses.Evidently, this is a big jolt for securitization and securitization accounting, after Enron.

The claim is directly connected with accounting for securitized interest. Superior Bank, which was aggressive in securiitizing subprime loans, continued to report residual interests at inflated numbers, though its first loss in such loans exceeded three its own equity.

A report on Financial Times says a US banking regulator on Friday filed a $2bn suit against Ernst & Young for its role in a bank failure, saying the firm covered up improper accounting work so it could "buy time" for the sale of its consulting arm to Cap Gemini of France. The suit filed by the Federal Deposit Insurance Corporation stems from the failure of Superior Bank, based in the Chicago suburb of Hinsdale, Illlinois, in July 2001. The failure cost the FDIC $750m.

Recently, US investigators had submitted a report on Superior Bank failure.

Links For more on the Superior Bank case, see our page here. For more on securitization accounting,see our page here.