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Government support to Fannie and Freddie should be withdrawn: expert

Wall Street Journal of 17th June 2003 carries an article by Thomas Stanton, who has authored a book titled Government Sponsored Enterprises (GSEs). Freddie Mac, Fannie Mae and Ginnie Mae are GSEs holding the bulk of the US RMBS market. Freedie Mac has recently been in problems – see our news item below.

The author states that the problem with GSEs is that taxpayers and the financial system are at risk, both because of the GSEs' immense size and because of perceived government backing of their obligations and the MBS. Fannie Mae and Freddie Mac together fund over $3 trillion of mortgages in their portfolios and through securitization. Compounding the risk, the government conveys a major benefit to the GSEs by allowing them to maintain significantly lower capital and higher leverage than other firms in the mortgage market.

The author finds no reason as to why GSEs should not be subjected to bank-type capital requirements. Doing so would reduce their leverage. In addition, they should be subjected to full supervision of the SEC, a view which Alan Greenspan seems to support.

"More fundamentally, it is time to begin unwinding the GSE model. Thanks to their government support, the two behemoths double in size every five years. One analyst has projected that the two GSEs could grow their portfolios to a total of $12 trillion by the year 2020, and their mortgage-backed securities by additional trillions of dollars. This creates a growing concentration of financial risk in two highly leveraged companies", says the author.

LinksFor more on the US securitisation market, see our page here.

Are whole business deals turning sour as a whole?

London press is abuzz with stories about Robin Saunders' securitisation deals going sour. Robin, one of the most talked about females in the Citi, isaid to be drawing, in good days, pay packets next after J K Rowling and Madonna, was the head of WestLB's London-based principal finance division, which structured whole business securitisation deals for the bank.

One such deal, Box Clever, went sour contributing heavily to WestLB's near USD 2 billion loss. The result: the 4th largest German bank was reprimanded by German regulators, resulting into the resignation of its CEO. The market expects that Robin might be the next one to resign.

Robin is credited with major whole business deals including Formula 1.

Earlier, we have reported JP Morgan's whole business division being disbanded. Are these isolated cases going bad, or is there a method? Structurally, whole business deals are more like corporate finance than securitisation. The securitisation methods such as liquidity support, SPVs, and structured funding are used in such deals, possibly more to fashion them as regular asset-backed transactions, but in essence, whole business deals are more like securitised LBOs. They depend on the residual value of a business: which is volatile.

At the beginning of the year, Moody's issued a report saying in year 2002, whole business deals were a whopping 28% of European ABS (exclusing MBS and CDOs), adding to Euro 10.4 billion. Moody's was bullish about the 2003 prospects of whole business deals.

However, with revelations about WestLB and the disbanding of JPM's principal finance unit. it is unlikely that whole business deals would continue to remain alluring for investors.

Links For more on whole business deals, see our page here.

US CRE market might get worse before it gets better, warns FDIC article

An article in FDIC newsletter FYI, by Thomas Murray, a Senior Financial Analyst in the Economic Analysis Section of the Division of Insurance and Research, FDIC cautions of the declining occupancy rates in the commercial real estate (CRE) lending in the USA. Notably, about 18% of the CRE exposure is in form of CMBS.

The article explains that the office property segment is undergoing an adversity never seen in the past 20 years: "Performance in most U.S. office markets continues to deteriorate by almost all measures. During eight of the last nine quarters, U.S. office markets have experienced negative net absorption, a situation where the amount of space given up by existing tenants exceeds the amount of space occupied by new tenants. This development is unprecedented in the sense that, prior to 2001, U.S. office markets had never experienced negative net absorption in the 20 years for which comparable data are available".

The problem is not limited to office property alone: vacancies for industrial properties as of first quarter 2003 climbed to 11.3 percent, a record level eclipsing a previous high of 10.7 percent reached in 1992.

While CRE exposure is largest on bank balance sheets, a substantial part of it is in CMBS form. In the CMBS segment, though default rates are increasing, the same have not reached alarming levels as yet. A recent study performed by FitchRatings on fixed-rate CMBS transactions reports on the growing level of CMBS defaults and found that the cumulative default level on mortgage loans securing CMBS pools were 2.66 percent as of year-end 2002. The study noted that the default rate by loan balance "…has increased steadily since year-end 2000, growing from 1.07 percent at the end of 2000, to 1.75 percent as of year-end 2001, to the current 2.66 percent rate at year-end 2002.

Links For more on the CMBS market, see our page here.

FASB issues exposure draft of new QSPE rules

More rules and more rules and yet more rules. The burden of accounting rules on the securitization industry is mounting, and yet again, the FASB issued an exposure draft of proposed QSPE rules. QSPEs are qualifying special purpose entities: if an entity qualifies as QSPE, it escapes consolidation, escapes Variable interest entity rules under FIN 46, and its securities are not treated as a proxy for the assets transferred by the transferor.

The proposed amendments seek to limit the scope of QSPEs, in particular, to deny QSPE-treatment to those entities which survive on liquidity or credit support from the transferor. In case the liquidity support comes in form of acquisition of beneficial interests, it must come from the senior-most security holders, and must not come from the person holding more than a majority of the certificates.

QSPEs are now restrained from holding equity instruments: which would rule out the growing bank of CFOs from being recognised as QSPEs. [for more on CFOs, see our page here.]

The amendments also seek to add a para below Para 83 of FAS 140, whereby it would be necessary for the second SPE in a two-tier transfer [first transfer to a subsidiary, without credit enhancements, second transfer to the issuer SPE, with credit enhancements] to be a QSPE. If not, the condition of Para 9 (b) will be deemed to have been violated. Para 9 (b) requires that the transferee must have the right to re-sell the assets bought by it – this is not required if the transferee is a QSPE.

Links For full text of the exposure draft, click here. For Martin Rosenblatt's comments on the exposure draft, see our page here. For more on accounting issues in securitization, see our page here.

Securitization, or false sense of security?

In an article in CFO magazine, Tim Reason questions the legal robustness of securiitzation structures. Securitization structures rely on bankruptcy remoteness: which are bankruptcy remote except perhaps in the event of bankruptcy – he cites a joke by an industry practitioner.

Though for now the market is concerned mostly with accounting rules such as FIN 46, there might be more basic challenges to the legal framework on which securiitzation relies: one of hiving off of assets into legal vehicles. These legal vehicles, as accounting rules are getting to realise, are seldom independent or real, exposing them to legal challenges.

Apart from true sale related problems which have surfaced in major bankruptcies, each bankruptcy brings its own unique dimensions. In the case of Conseco Finance, which acted as a servicer in some USD 23 billion worth transactions, Conseco threatened to quit as a servicer unless its fees were increased and were made a prior item in the waterfall. Nextcard's bankruptcy brought a new front: when the bank was put into receivership by the Federal Deposit Insurance Corp. Unable to find a buyer for the bank' s credit-card portfolio, the FDIC shut it down. That turned the assets from a revolving pool to an amortizing one and, again, resulted in losses to bondholders.

"The fact that both the market and rating agencies are increasingly uncertain about the stability of asset-backed securities calls into question one of the most commonly cited market benefits of securitization — that is, that it converts illiquid assets into the sorts of safe, highly rated investment vehicles investors crave", says the author.

Links For more on true sale, the core issue raised in this article, see our page here.

Bank of Japan to buy asset backed paper

In a move which does not have a rival elsewhere, Bank of Japan sought to re-inflate its economy by pumping money into the banking sector. BoJ is willing to buy asset backed paper representing the loan assets of Japanese banks, upto a total of Yen 1 trillion.

These securities could have a rating of upto BB. At the least level, therefore, the securiites have a below-investment grade rating.

Bank lending in Japan is constantly coming down – now for 65 months in a row.

Though this decision has made international headlines, market players are not sure about is real impact, in view of the small amount involved. In addition, a securitisation exercise merely contributes to liquidity, which is not a problem in the Japanese economy.

Links For securitisation in Japan, see our page here.

Freddie Mac under potential misconduct probe

Federal prosecutors have opened a criminal investigation into possible misconduct at Freddie Mac. Federal Home Loan Mortgage Corporation or Freddie Mac is one of the 3 government-sponsored enterprises (GSEs) which are engaged in securitisation of residential mortgage loans in the USA. Freddie is the second largest, after Fannie Mae.

Freddie Mac's accounting is already under a probe relating to its accounting practices. The probe was launched when Freddie wanted to re-state its earnings for past 3 years due to derivatives-related valuation. This was expected to increase its earnings, but render more volatility. The Office of Federal Housing Enterprise Oversight (OFHEO) has deputed an oversight representative to review the re-audit. On 9th June, the company announces it fired President and Chief Operating Officer David Glenn, 59, for failing to cooperate with its board's audit committee counsel in a review of its earnings. It says Chairman and Chief Executive Leland Brendsel, 61, retired and Chief Financial Officer Vaughn Clarke, 48, resigned.

A day later, Alan Greenspan reportedly stated that the securities of Freddie should be registered with the SEC.

The present probe has further thickened the mystery over Freddie. The diaries of David Glenn, the company's president who was fired on Monday, are drawing interest. Wednesday's news of the criminal inquiry came two days after the government-sponsored company shook up its top leadership because of accounting problems, jolting the stock market and raising concern about a possible impact on the housing market. "The U.S. Attorney's Office in the Eastern District of Virginia has initiated an investigation involving Freddie Mac," U.S. Attorney Paul McNulty said.

Links For more on the US GSEs relating to RMBS market, see our page here.

Private equity CFOs boom as AIG raises USD 250million

Couple of years ago, securitisation of private equity investments seemed like an outlandish idea, but now it seems this market is booming. American International Group (AIG) recently raised USD 1 billion by way of collateralized financial obligations (CFOs) and there are suggestions that there are more deals in the pipeline.

CFOs are a device similar to CDOs or CLOs, with the difference that the collateral here is not a pool of debts or bonds but investments in private equity, hedge funds or similar venture financings.

AIG raised USD 250 million backed by revenues from a USD 1billion investment in private equity. It is for the first time that without an insurance wrap, the deal has been given a AAA rating. It is reported that the collateral consists of 64 private equity firms representing 910 underlying investments The AIG deal was structured by Swiss investment bank CapitalDynamics, which also was involved in one of the few previous private equity securitizations called Prime Edge.

Links For more on CFOs, see our page here.

JPM disbands whole business securitisation team

As per a news that made headlines on financial press World over, JP Morgan London office has disbanded its whole team that looked after operating revenues or whole business securitisation. The exact implications of this move or the reasons that prompted it are not clear.

According to press reports, JP Morgan said Tamara Adler, who was head of corporate structured finance, and two other managing directors, Richard Tray and Jeff May, have been redeployed elsewhere in the bank, though it declined to say if they had been offered specific roles.

Whole business securitisation emerged as an idea around 1997 when LBOs were converted into securiites by investment bankers. Guy Hands was often cited as the leading proponent of this idea. Over recent times, some of the whole business deals in the past have suffered downgrades, but overall, it is difficult to say whether the idea has flopped. Rating agencies have always seen whole business securitisation as closer to corporate finance than to securitisation. There were also fears that bankruptcy law reforms in the UK as also rulings of the House of Lords in Brumark and Cosslett have reduced the strength of the floating charges on while whole business securitisation was essentially based.

It is not clear as to whether the JPM move is at all associated with any difficulties in the whole business sphere or is just an organisational restructuring.

Links For more on whole business securitisation, see here.

OCC may consider capital relief for FIN 46

At a recent structured finance forum organised by Standard and Poor's, Greg Coleman of the Office of the Comptroller of the Currency, participating as a panelists, acknowledged that his agency and other regulatory bodies are likely going to put together a proposal during the next month outlining their plan to supply temporary capital relief to U.S. banks impacted by FIN 46. The regulatory capital relief would last either through year-end or through March 2004, Coleman said. Mr. Coleman also indicated that the existing regulatory treatment of banks' leverage ratios is unlikely to change, however.

This would be a short-term approach to how the OCC will address the issue of regulatory capital associated with the FIN 46 rule. According to Coleman, the regulatory bodies' long-term strategy will be a "risk-sensitive approach," seeking out risk-sensitive alternatives for asset-backed commercial paper conduits.

At this panel discussion dedicated to FIN 46, it was clear that the market was desperately looking for solutions to FIN 46. According to the panelists, the leading solution being proposed by members of the structured finance market for both ABCP and CDOs is the creation of an "expected loss tranche" that will be sold to a single entity, who will be exposed to the losses of the VIE. Other possible solutions for ABCP conduits include the formation of joint ventures, whereby each participating bank shares some of the risk, and the conversion of multiseller CP conduits to Qualified Special Purpose Entities (QSPEs).

For the CDO market, panelists agreed that the simplest solution would be for a collateral manager to find a willing buyer of the majority of the equity class of the CDO, who would then consolidate. While such a strategy is rare nowadays, there is an added incentive to find such a buyer now that consolidation under FIN 46 is mandatory, panelists said.

Links For more on FIN 46, see our page on accounting issues. Also see Vinod Kothari's article on FIN 46 here. There are more materials on FIN 46 in our premium section –click here to join. There are more FIN4-related news items below.

FASB reconsiders QSPE amendments

There is a partial reconsideration of earlier FASB decisions on amending the QSPE conditions and some other provisions of FAS 140. See the earlier news item below.

As per FASB Action alert of May 7, the FASB reaffirmed its decision to issue an Exposure Draft that would amend FAS 140, but changed its decisions about certain of the provisions that Exposure Draft. The Board decided that the comment period for the Exposure Draft would end on July 31, 2003, based on an expectation that the Exposure Draft will be issued by early June, and decided to hold public roundtable meeting or meetings shortly thereafter.

The Board reversed its earlier decisions about commitments to provide assets to make payments to beneficial interest holders and parties that made decisions about reissuing beneficial interests and decided replace them with the following:

  • A qualifying special-purpose entity (SPE) would be prohibited from being a party to a swap with the transferor (or its affiliates or agents) if such a swap transfers substantially all of the types of risks inherent in the assets back to the transferor. The apparent reference is to a total rate of return swap. For more on total rate of return swaps, see our site on credit derivatives.
  • A qualifying SPE would be prohibited from holding commitments from the transferor and its related parties to provide cash or other assets to make payments due to beneficial interest holders. Obviously, this is not to deny the servicer advances from the transferor who is also a servicer, but the idea is a liquidity or other firm commitmnet. Also excluded, apparently, is the initial credit enhancement provided by the transferor. The FASB also intends to put other limits on provision on liquidity facility in case the term of the securities is shorter than the term of the assets.

Links For more on accounting issues, see our page here.

Basle II issues third consultative paper

On 29th April, the BIS came out with its Third, and presumably the last consultative paper before the new capital standards are finalised. The consultative paper gives 3 months for comments, and it is expected that the new standard will be finalised by the end of the calendar year, to be implemented by year-end 2006.

Despite vehement opposition by the industry and rating agencies, the BIS contiues to provide for higher capital for unrated and low-rated securitisation tranches as compared to direct credit exposures. The consultative paper says: "One noteworthy point is the difference in treatment of lower quality and unrated securitisations vis-à-vis comparable corporate exposures. In a securitisation, such positions are generally designed to absorb all losses on the underlying pool of exposures up to a certain level. Accordingly, the Committee believes this concentration of risk warrants higher capital requirements. In particular, for banks using the standardised approach, unrated securitisation positions must be deducted from capital."

Another notable change in CP3 is in relation to liquidity facilities for ABCP conduitsl Changes have been made to the securitisation framework concerning the treatment of liquidity facilities. Criteria for recognising eligible liquidity facilities have been amended. A further change to the capital treatment has been introduced for IRB banks. Such bank providers of liquidity facilities are required to calculate KIRB for exposures in the underlying pool on an ongoing basis.

Where a deduction from capital is required under the norms, the deduction is split 50:50 between Tier I and Tier II capital.

For more details of the new consultative paper, see our page here.

Delinquencies mount up in US CMBS; 
investor interest still strong

US CMBS segment is suffering from delinquencies and negative rating actions, but investor interest still continues to be strong.

Rating agency S&P released its first quarter 2003 review of US CMBS showing increasing delinquencies and declining property values. Continuing job losses, travel curtailment, and uncertainty regarding the economy's direction in the aftermath of the Iraq war are all factors influencing property performance and contributing to higher delinquency levels. Although not all property sectors and markets are feeling the stress equally, the overall decline is broad based.

During the first quarter, the delinquency rate in rated CMBS deals was 1.56%, 5 bps higher than that in the previous quarter. While the delinquencies were broad-based, the U.S. CMBS office delinquency rate remained at low levels despite the problems in the sector. The current rate, 0.70%, although an increase of 20% from last quarter, is the lowest delinquency rate of all property classes.

Inspite of the above, investors are still showing strong interest in CMBS. A recent survey by Barron's/John B. Levy & Company indicated that CMBS issuance was close to the levels seen in the go-go year of 1998. The first-quarter collateralized mortgage-backed securities volume was just short of $18 billion, up from $14.7 billion during the same period last year

Link: For more on CMBS, see our page here.

Italy sits on a massive pipeline in 2003

The Italian market is expected to be the centerpiece of securitisation activity in Europe in 2003, says a report in Reuters dated May 1.

The first quarter numbers reveal Italy occupies second place in Europe with a total securitisation volume of USD 10.7 billion (including synthetic deals), behind the UK with USD 26.6 billion. The 2003 remaining pipeline includes a whole lot of RMBS deals, deals from the Government, and a variety of other asset classes.

As for issues in the Government sector, there was a recent deal on April 28 of Euro 683 million, backed by water and water disposal and water transport assets. This 4-tranche deal is the 11th publicly rated asset-backed deal from government utilities.

U.S. investors have been actively investing in European ABS issues this year. This is good news for Italy, whose banks want to recapitalise and whose government would like to reduce its exposure to public sector assets

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

FASB proposes amendments to QSPE conditions

It is the FASB in action again. The Board has now decided, unanimously, to amend the conditions relating to QSPEs and make them a bit more elaborate. The FASB affirmed these amendments on 30th April, which will be in form of an amendment to FAS 140. According to Martin Rosenblatt of Deloitte, these amendments are likely to be issued in Exposure Draft form by end of May or early June, with a comment period to expire in next 30 days or so.

The proposed changes are as follows:

  • Paragraph 35.c. of FAS 140 which lists the types of assets, derivatives and guarantees that a QSPE may hold would be expanded to say that in transactions where reissuance of beneficial interests is required, a QSPE may only hold a financial asset such as a liquidity commitment that supports the repayment of the beneficial interests if such commitment is provided by parties OTHER THAN

    • (1) the transferor, its affiliates or its agents;
    • (2) parties who are responsible for making decisions regarding the reissuance of beneficial interests; and
    • (3) holders of subordinated classes of beneficial interests who would have a vested interest in whether the refinancing goes well or goes poorly.
  • Further, no single eligible party would be allowed to provide more than 50% of such a financial arrangement (eg liquidity commitment) to the entity.
  • The board also decided that a QSPE could not be a party to a swap with the transferor (or its affiliates or agents), if such swap transferred [substantially] all of the [types of] risks inherent in the assets back to the transferor. they referred to total return swaps, but will try to avoid using that term in the exposure draft.
  • A qualifying SPE may not hold assets without contractual maturities or with contractual maturities extending beyond the end of the planned life of the entity unless the governing documents include a prespecified date of sale within the entity's planned life. .
  • Paragraph 9(a) of Statement 140 will be amended to clarify that derecognition of transferred assets is appropriate only if the assets would be beyond the reach of a bankruptcy trustee or other receiver for the transferor or any other consolidated affiliate of the transferor that is not an SPE designed to make remote the possibility that it would enter bankruptcy or other receivership. .

Links For more on accounting issues, see our page here.

FASB staff positions on FIN 46

Call them interpretations on the interpretation – FASB has come out with 6 FSPs on FIN 46. An FSP is the position that the FASB staff takes on a matter which is expected to be contentious. FIN 46 is the interpretation issued by FASB that relates to consolidation of certain SPVs based on variable interests, and not based on voting interests as is the common rule in case of consolidation.

The first of the FSPs is clarificatory – that a non-for-profit entity, usually exempt from FIN 46, would be subjected to the interpretation if it is used for running a business transaction.

The FASB staff also clarifies that the term "expected losses" as a criteria for identification of variable interest is not necessarily related to "losses" in financial accounting sense, but every loss of profit, that is, unfavourable variability of the results or asset values of the enterprise.

Another interpretation clarifies that where the variable interest that would absorb the expected losses of the enterprise can be identified, it would not be necessary to identify the beneficiary of the residual returns.

On a question to whether a group of assets withint a variable entity should be reported as a separate sub-entity, if such assets and related liabilities are isolated from other assets/liabilities of the entity, the FASB staff clarifies that that would be required only if the assets are "effectively separate", which should mean something similar to a protected cell company.

We have reported elsewhere that the structured finance community is already intrigued by FIN 46 and sees this more as an evil.

Links Full text of the FASB FSPs is here. On the premium section of our site, we have several presentations/ articles on FIN 46. The premium section is accessible to subscribers to the premium list, which only requires a nominal contribution.

India's central bank announces securitisation guidelines

A set of 6 notifications brought into force the securitisation guidelines in India on 23rd April, nearly 11 months after the promulgation of the law. These guidelines will regulate what in Indian jargon is called "securitisatio and asset reconstruction companies" (SARCs) (gladly different from either SARS, or even sharks).

A SARC under the Indian framework is supposed to be engaged in both securitisation and asset reconstruction – the latter term refers to concerted efforts at realisation of non-performing loans of banks. It is evident that the combined infrastructure would most likely be used for asset reconstruction rather than for securitisation of performing assets.

By look and structure, these guidelines have no semblance to bank regulatory guidelines anywhere else in the World – as the minds of the regulator was largely pre-occupied with the asset reconstruction activity.

An SARC can conduct securitisation activities by setting up trusts – this imparts a great deal of flexibility particularly for securitisation. The SARC itself needs a capital base of 15% of its risk weighted assets, or Rs 2 crores at least, but the trusts are exempted from such requirement. So, obviously, real-life transactions would be routed through the umbrella body SARC, which will act as a trustee to various trusts each of which will be an SPV.

The real difficulty created by the guidelines is for the transferring banks which must be paid for the assets transferred to the SARC either in cash, or in non-contingent securities such as bonds/debentures. The guidelines have at various places talked about paying for the consideration in form of pass-through certificates, but since it clearly prescribes an unconditional undertaking on the part of the SARC to pay for the same, it is evident that the transferring bank cannot be part-paid in form of junior securities. The consequence of this is that the transferring bank will suffer a write off, both in regulatory capital, as also in financial books, for the subordinated stake it holds in the SARC, as the only way the subordinated stake could be held under the guidelines is in form of profit-sharing.

Links For full text of the Guidelines, as also a dedicated page on SARC, see, or For a detailed comment by Vinod Kothari, see Vinod Kothari's book on securitisation and asset reconstruction discusses the Indian law at length – see here for details

KfW to steer Germany's largest multi-seller CLO

Under the aegis of KfW, 5 of the top German banks will pool a huge amount of their performing loans and come out with asset-backed securities. It is a plan that has made international headlines.

The banks that will participate in this "joint venture" are Deutsche Bank, Dresdner Bank, Commerzbank, HVB Group, and DZ Bank. All of these have participated in KfW's Promise or Provide programs earlier. However, the proposed multi-seller CLO is different. Here, these banks will initially raise a funding of some USD 5 billion, but over a period of time, the target is for USD 50 billion worth assets to go off the books of the transferring banks.

KfW, it may be noted, has the status of a sovereign in German law, and is rated AAA. The securities, though backed by the loans transferred by the banks, will bear the stamp of KfW which will increase their market acceptability. On the other hands, the transferring banks lighten their balance sheets with USD 50 billion worth assets over a period of time.

The move comes at a time when the health of German banking is at an all time since World War II.

Soon after the announcement of the move, there were signals from the European Commission that the Commission might be opposed to any kind of implicit or explicit guarantee put in by KfW for the securities. Some people also felt that the multi-seller conduit was the replica of the "bad bank" that German bankers were envisaging for a while – a bank that will pool bad loans of German banks.

The present transaction has drawn quick headlines all over the World. The BBC said German banks are huddling together for warmth.

In the meantime, some tax law changes making SPVs tax neutral are also reportedly in the offing – see our country page on Germany

Links KfW's synthetic deals have been discussed off and on on this site as also on our credit derivatives site. Use search to browse. For more on securitization in Germany, click here.

First Quarter 2003: rating downgrades decline, but certain sectors still in the woods: S&P

Rating agency S&P has come out with its quarterly round up of rating actions for 1st Quarter of 2003 and says that while negative rating activity decreased somewhat in the U.S. ABS and European ABS markets during the first quarter, there was no shortage of downgrades, as a few specific asset types continue to bear the brunt of a sluggish economy.

Of the sectors seemingly badly affected in the MBS segment, US and Canadian CMBS reported a total of 21 upgrades and 49 downgrades in the first quarter, which is the higest downgrade to upgrade ratio in the recent past.

In all, there were 133 downgrades in US ABS transactions. However, S&P draws comfort from an emerging trend: with 279 downgrades in Q3, 2002, lower to 176 downgrades in Q4, 2002 and is further lowered at 133 downgrades in Q1 of 2003.

In the ABS segment, the leader of the pack was CDOs with a total of 56 downgrades, comprised mainly of high yield cashflow CDOs with 41 downgrades.

Manufactured housing was another weak spot with 31 downgrades. There were 27 downgrades in the synthetic segment.

There were 18 ABS defaults from 4 issues during the quarter. This, again, is awesome if one looks at the past where there were only 12 defaults over all the years together before 2001, and 18 defaults during the whole of 2001. Larger part of these defaults (16) relate to subordinated tranches of Conseco's originations.

In Europe, 20 asset classes were downgraded. CDOs contributed to 11 downgrades, and of these, 10 were synthetic CDOs.

FIN 46 frustrates securitization professionals

If they could just borrow some strong words from a stronger personality, they would call it "weapons of mass destruction". We are referring to what the securitization industry thinks about the recent US accounting rules regarding SPE consolidation. Exaggeration? Okay, let us use better words, and quote S&P: "the majority of securitization professionals worldwide report that they are overwhelmingly frustrated, skeptical and confused by the new set of rules for off-balance-sheet financing, characterizing it as an unnecessary and costly burden on an otherwise healthy market."

FIN 46 is an accounting interpretation from the FASB that requires consolidation of certain SPEs on a basis other than voting control – which the normal basis for consolidation of subsidiaries. The structured finance world, which uses SPEs in almost every securitization deal, feels these rules are confusing, confused and would cloud out the purpose for which they were made. The purpose, unarguably, was to search for the real beneficiary of SPEs formed with thin capital where the voting control did not indicate the true ownership. So, the securitization world calls it "wrong solution for a right problem".

So strong is the concern of the structured finance industry, that Iraq is only a much smaller issue. The S&P survey indicates that more than two-thirds of participants consider the FASB proposals/rules to be the most significant current concern in the market, more important than rating transitions (32%), the role of servicers (21%), the impact of the war in Iraq (19%) and the role of trustees (16%).

When asked how well they understood the ramifications of FIN 46 for ABCP conduits, CDOs, and ABS, it was notable that there is still a distinct lack of clarity for the CDO sector: 60% of survey participants did not yet understand the exact impact of FIN 46 on CDOs, while 55% had an understanding of how ABCP would be affected. The level of comprehension for the ABS market was roughly split down the middle.

Links For more stories on FIN46, see below. Also see our page on accounting issuesThere is a detailed presentation on FIN 46 on the premium section of our website- click here to join as a premium member. For more on SPEs, click here.

Indonesia sees some securitisation deals

Indonesia is really nowhere in the Asian securitisation map, but if some recent deals are of any indication, it could be a welcome addition to the league of Asian nations that are going gung-ho on securitisation.

Rob Davies of reports that news has emerged from Jakarta of two potential transactions by state-owned organisations. Pertamina, the oil and gas giant, and Bank Negara Indonesia (BNI), the largest publicly traded bank in Indonesia, have both held roadshows for potential ABS deals in the last couple of months, where both foreign and local houses have been invited to pitch in.

These deals will be the first one over the last 5 years or so. One of the first Indonesian ABS deals was when PT Astra International in August 1996 securitised auto loans with a $200 million issue backed via Barclays Capital. The currency crisis of 1997 punctured the Indonesian economy and so also the securitisation activity which has never picked up since then, except for the relieving news above.

Links For more on Indonesia, see our country page here.

FIN 46 forcing US firms to restructure SPEs

As major US financial and non-financial firms make disclosures about the possible impact of the new accounting interpretation on consolidation of SPEs, SPE structures seem to be heading for changes which will possibly prevent their consolidation with their putative parents.

For instance, JP Morgan Chase is associated with several SPEs for traditional asset-backed and mortgage backed securities, which, it holds, will not require consolidation since they are structured as QSPEs under FAS 140. However, the multiseller ABCP conduits do not so quality, and may be regarded as variable interest entities. "The Firm is analyzing restructuring options for the multi-seller conduits". Similarly Citigroup has entities which may be regarded as variable interest entities and their consolidation could bring back on the balance sheet as much as USD 55 billion of assets – but it is considering restructuring options.

At least some of them, like General Electric, are holding the view that "The complexity of the new consolidation rules and their evolving clarification make forecasting [their] effect impracticable." Even GE sees the restructuring possibility: "It is also clear that many alternative structures for sales of financial assets would continue to be reported as sales under FIN 46 with the assets qualifying for sale not consolidated. We are evaluating whether characteristics of those structures can cost-beneficially be applied to our arrangements before the July 1 effective date. "

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Canadian ruling affirms securitization true sale

In an extremely well-reasoned ruling, the Supreme Court of Justice of Ontario, Canada has given a ruling on the truth of the sale of receivables in a securitization transaction. The significance of the ruling lies in the fact that the Court had benefited itself from leading cases on both sides of the Atlantic. This ruling might be the reference point for future disputes on true sale all over the World.

The ruling in a case called BC Tel has analysed various factors such as the extent of recourse, retention of risks/rewards by the originator, continuation of servicing by the originator etc. The ruling concluded that if the intent of the transaction is visibly a transfer of assets by the originator, the transaction would be treated as such.

The ruling reviews caselaw in USA as well as UK.

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