RBI temporarily relaxes the Guidelines on Securitisation for NBFCs

By Financial Services Division, finserv@vinodkothari.com


In the wake of the recent hues and cries of the entire country in anticipation of a liquidity crisis in the NBFC sector, the Reserve Bank of India, on 29th November, 2018, issued a notification[1] to modify the Securitisation Guidelines.The amendment aims to relax the minimum holding period requirements of the guidelines, subject to conditions, temporarily. Therefore, the changes vide this notification come with an expiry date. The key takeaways of the notification have been discussed below:

a. Relaxation in the MHP requirements: As per the notification, NBFCs will now be allowed to securitise/ assign loans originated by them, with original maturity of more than 5 years, after showing record of recovery of repayments of six monthly instalments or two quarterly instalments (as applicable). Currently, for loans with original maturity more than 5 years, the MHP requirements are repayment of at least twelve monthly instalments or four quarterly instalments (as applicable).

b. Change in MRR requirements for the loans securitised under this notification: The benefit mentioned above will be available only if the NBFC retains at least 20% of the assets securitised/ assigned. Currently, the MRR requirements ranges between 5%-10% depending on the tenure of the loans.

c. Timeline for availing this benefit: As already stated above, this is a temporary measure adopted by the RBI to ease out the tension relating to liquidity issues of the NBFCs; therefore, this comes with an expiry date, which in the present case is six months from the date of issuance of the notification. Therefore, this benefit will be available for only those loans which are securitised/ assigned during a period of six months from the date of issuance of this notification.

The requirements under the guidelines remains intact.

To summarise, the MHP requirements and the MRR requirements on securitisation/ assignment of loans looks as such –

Loans assigned between 29th November, 2018 – 28th May, 2019 Loans assigned after 29th May, 2019
MHP requirements for loans with original maturity less than 5 years Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

MHP requirements for loans with original maturity less than 5 years If revised MRR requirements fulfilled – 6 months


If revised MRR requirements not fulfilled – 12 months

Loans upto 2 years maturity – 3 months


Loans between 2 – 5 years – 6 months

MRR requirements for loans with original maturity of less than 5 years Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%

Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%

MRR requirements for loans with original maturity of more than 5 years If benefit of MHP requirements availed – 20%


If benefit of MHP requirements not availed – 10%

Loans with original maturity upto 2 years – 5%


Loans with original maturity more than 2 years – 10%


Vinod Kothari comments: 

  •  Loans with original maturity of more than 5 years are essentially home loans and LAP loans. Home loans are housed mostly with HFCs. These guidelines ought to have come from NHB rather than RBI, but given the tradition that RBI guidelines are followed in case of HFCs as well, this “relaxation” will be more applicable to HFCs rather than NBFCs.
  • In case of LAP loans, given the current credit scenario prevailing in the country, taking exposure on LAP loans itself is subject to question. Issue is – will the relaxation prompt NBFCs to write LAP loans, or will it simply allow them to package and sell existing pools of lap loans sitting on their books waiting for the MHP of 12 months to get over? It is more likely to be latter than the former.
  • However, the so-called relaxation comes with a give-and-take – the MRR is 20%. The NBFC has, therefore, 2 options – wait for 12 months to be over and just do a transaction with 10% MRR, or avail the so-called relaxation and put in on-balance funding of 20%. Therefore, it is only for those who are desperate for refinancing that the so-called relaxation will seem appealing.
  • Our interaction with leading NBFCs reveals that there are immediate liquidity concerns . Banks are not willing to take on-balance sheet exposure on NBFCs; rather they are willing to take exposure on pools. Therefore, for more than 6 months and less than 12 months seasoned LAP pools, this might provide a temporary packaging opportunity.
  • This is indeed the best time to think of covered bonds. The proposition has been lying unresolved for last few years. If banks are willing to take exposure on pools, why not dual recourse by way of covered bonds? That indeed provides ideal solution, with ring fenced pools providing double layers of protection.

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11422&Mode=0

For more articles on Securitisation and Covered Bonds, refer our page here.

Also refer our article: The name is Bond. Covered Bonds.


GST on assignment of receivables: Wrong path to the right destination

Team Vinod Kothari Consultants P. Ltd


There has been a lot of uncertainty on the issue of exigibility of direct assignments and securitisation transactions to goods and services tax (GST). While on one hand, there have been opinions that assignments of secured debts may be taxable being covered by the circuitous definition of “actionable claims”, there are other views holding such assignments of debts (secured or unsecured) to be non-taxable since an obligation to pay money is nothing but money, and hence, not  “goods” under the GST law[1]. The uncertainty was costing the market heavily[2].

In order to put diverging views to rest, the GST Council came out with a set of Frequently Asked Questions on Financial Services Sector[3], trying to clarify the position of some arguable issues pertaining to transactions undertaken in the financial sector. These FAQs include three separate (and interestingly, mutually unclear) questions on – (a) assignment or sale of secured or secured debts [Q.40], (b) whether assignment of secured debts constitutes a transaction in money [Q.41], and (c) securitisation transactions undertaken by banks [Q.65].

The end-result arising out of these questions is that there will be no GST on securitisation transactions. However, the GST Council has relied on some very intriguing arguments to come to this conclusion – seemingly lost between the meaning of “derivatives”, “securities”, and “actionable claims”. If one does not care about why we reached here, the conclusion is most welcome. However, the FAQs also reflect the serious lack of understanding of financial instruments with the Council, which may potentially create issues in the long run.

In this note[4] we intend to discuss the outcome of the FAQs, but before that let us first understand what the situation of the issue was before this clarification.

Situation before the clarification

  1. GST is chargeable on supply of goods or services or both. Goods have been defined in section 2(52) of the CGST Act in the following manner:

“(52) “goods” means every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply;”

Services have been defined in section 2(102) of the CGST Act oin in the following manner:

““services” means anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;”

Money, is therefore, excludible from the scope of “goods” as well as “services”.

Section 7 details the scope of the expression “supply”. According to the section, “supply” includes “all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of business.” However, activities as specified in Schedule III of the said Act shall not be considered as “supply”.

It may be noted here that “Actionable claims, other than lottery, betting and gambling” are enlisted in entry 6 of Schedule III of the said Act; therefore are not exigible to GST.

  1. There is no doubt that a “receivable” is a movable property. “Receivable” denotes something which one is entitled to receive. Receivable is therefore, a mirror image for “debt”. If a sum of money is receivable for A, the same sum of money must be a debt for B. A debt is an obligation to pay, a receivable is the corresponding right to receive.

Coming to the definition of “money”, it has been defined under section 2(75) as follows –

““money” means the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.”

The definition above enlists all such instruments which have a “value-in-exchange”, so as to represent money. A debt also represents a sum of money and the form in which it can be paid can be any of these forms as enlisted above.

So, in effect, a receivable is also a sum of “money”. As such, receivables shall not be considered as “goods” or “services” for the purpose of GST law.

  1. As mentioned earlier, “actionable claims” have been included in the definition of “goods” under the CGST Act, however, any transfer (i.e. supply) of actionable claim is explicitly excluded from being treated as a supply of either goods or services for the purpose of levy of GST.

Section 2(1) of the CGST Act defines “actionable claim” so as to assign it the same meaning as in section 3 of the Transfer of Property Act, 1882, which in turn, defines “actionable claim” as –

“actionable claim” means a claim to any debt, other than a debt secured by mortgage of immovable property or by hypothecation or pledge of movable property, or to any beneficial interest in movable property not in the possession, either actual or constructive, of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent;”

It may be noted that the inclusion of “actionable claim” is still subject to the exclusion of “money” from the definition of “goods”. The definition of actionable claim travels beyond “claim to a debt” and covers “claim to any beneficial interest in movable property”. Therefore, an actionable claim is definitely more than a “receivable”. Hence, if the actionable claim represents property that is money, it can be held that such form of the actionable claim shall be excluded from the ambit of “goods”.

There were views in the industry which, on the basis of the definition above, distinguish between — (a) a debt secured by mortgage of immovable property, and a debt secured by hypothecation/pledge of movable property on one hand (which are excluded from the definition of actionable claim); and (b) an unsecured debt on the other hand. However, others opined that a debt, whether secured or unsecured, is after all a “debt”, i.e. a property in money; and thus can never be classified as “goods”. Therefore, the entire exercise of making a distinction between secured and unsecured debt may not be relevant at all.

In case it is argued that a receivable which is secured (i.e. a secured debt) shall come within the definition of “goods”, it must be noted that a security granted against a debt is merely a back-up, a collateral against default in repayment of debt.

  1. In one of the background materials on GST published by the Institute of Chartered Accountants of India[5], it has been emphasised that a transaction where a person merely slips into the shoes of another person, the same cannot be termed as supply. As such, unrestricted expansion of the expression “supply” should not be encouraged:

“. . . supply is not a boundless word of uncertain meaning. The inclusive part of the opening words in this clause may be understood to include everything that supply is generally understood to be PLUS the ones that are enlisted. It must be admitted that the general understanding of the world supply is but an amalgam of these 8 forms of supply. Any attempt at expanding this list of 8 forms of supply must be attempted with great caution. Attempting to find other forms of supply has not yielded results however, transactions that do not want to supply have been discovered. Transactions of assignment where one person steps into the shoes of another appears to slip away from the scope of supply as well as transactions where goods are destroyed without a transfer of any kind taking place.”

Also, as already stated, where the object is neither goods nor services, there is no question of being a supply thereof.

  1. Therefore, there was one school of thought which treated as assignment of secured receivables as a supply under the GST regime and another school of thought promoted a view which was contrary to the other one. To clarify the position, representations were made by some of the leading bankers and the Indian Securitisation Foundation.

Situation after the clarification

  1. The GST Council has discussed the issue of assignment and securitisation of receivables through different question, extracts have been reproduced below:


  1. Whether assignment or sale of secured or unsecured debts is liable to GST?

Section 2(52) of the CGST Act, 2017 defines ‘goods’ to mean every kind of movable property other than money and securities but includes actionable claim. Schedule III of the CGST Act, 2017 lists activities or transactions which shall be treated neither as a supply of goods nor a supply of services and actionable claims other than lottery, betting and gambling are included in the said Schedule. Thus, only actionable claims in respect of lottery, betting and gambling would be taxable under GST. Further, where sale, transfer or assignment of debts falls within the purview of actionable claims, the same would not be subject to GST.

Further, any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

  1. Would sale, purchase, acquisition or assignment of a secured debt constitute a transaction in money?

Sale, purchase, acquisition or assignment of a secured debt does not constitute a transaction in money; it is in the nature of a derivative and hence a security.

  1. What is the leviability of GST on securitization transactions undertaken by banks?

Securitized assets are in the nature of securities and hence not liable to GST. However, if some service charges or service fees or documentation fees or broking charges or such like fees or charges are charged, the same would be a consideration for provision of services related to securitization and chargeable to GST.


  1. The fallacy starts with two sequential and separate questions: one dealing with securitisation and the other on assignment transactions. There was absolutely no need for incorporating separate questions for the two, since all securitisation transactions involve an assignment of debt.


  1. Next, the department in Question 40 has clarified that the assignment of actionable claims, other than lottery, betting and gambling forms a part of the list of exclusion under Schedule III of the CGST Act, therefore, are not subject to GST. This was apparent from the reading of law, therefore, there is nothing new in this.


However, the second part of the answer needs further discussion. The second part of the answer states that – any charges collected in the course of transfer or assignment of a debt would be chargeable to GST, being in the nature of consideration for supply of services.

There are multiple charges or fees associated in an assignment or securitisation transaction – such as  servicing fees or excess spread. While it is very clear that the GST will be chargeable on servicing fees charged by the servicer, there is still a confusion on whether GST will be charged on the excess spread or not. Typically, transactions are devised to give residuary sweep to the originator after servicing the PTCs. Therefore, there could be a challenge that sweep right is also a component of servicing fees or consideration for acting as a servicing agent. The meaning of consideration[6] under the CGST Act is consideration in any form and the nomenclature supports the intent of the transaction.

Since, the originator gets the excess spread, question may arise, if excess spread is in the nature of interest.  This indicates the need for proper structuring of transactions, to ensure that either the sweep right is structured as a security, or the same is structured as a right to interest. One commonly followed international structure is credit-enhancing IO strip. The IO strip has not been tried in Indian transactions, and recommendably this structure may alleviate concerns about GST being applied on the excess spread.

  1. Till now, whatever has been discussed was more or less settled before the clarification, question 41 settles the dispute on the contentious question of whether GST will be charged on assigned of secured debt. The answer to question 41 has compared sale, purchase, acquisition or assignment of secured debt with a derivative. The answer has rejected the view, held by the authors, that any right to a payment in money is money itself. The GST Council holds the view that the receivables are in the nature of derivatives, the transaction qualifies to be a security and therefore, exempt from the purview of supply of goods or supply of services.

While the intent of the GST Council is coming out very clear, but this view is lacking supporting logic. Neither the question discusses why assignments of secured receivables are not transactions in money, nor does it state why it is being treated as derivative.

Our humble submission in this regard is that assignment of secured receivables may not be treated as derivatives. The meaning of the term “derivatives” have been drawn from section 2(ac) of the Securities Contracts (Regulation) Act, 1956, which includes the following –

(A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;

(B) a contract which derives its value from the prices, or index of prices, of underlying securities.

In the present case, assignment of receivables do not represent any security nor does it derive its value from anything else. The receivables themselves have an inherent value, which get assigned, the fact that it is backed a collateral security does not make any difference as the value of the receivables also factor the value of the underlying.

Even though the logic is not coming out clear, the intent of the Council is coming out clearly and the efforts made by the Council to clear out the ambiguities is really commendable.


[1] Refer: GST on Securitisation Transactions, by Nidhi Bothra, and Sikha Bansal, at  http://vinodkothari.com/blog/gst-on-securitisation-transactions-2/; pg. last visited on 06.06.2018

[2] At the recently concluded Seventh Securitisation Summit on 25th May, 2018, one leading originator confirmed that his company had kept transactions on hold in view of the GST uncertainty. It was widely believed that the dip in volumes in FY 2017-18 was primarily due to GST uncertainty.

[3] http://www.cbic.gov.in/resources//htdocs-cbec/gst/FAQs_on_Financial_Services_Sector.pdf

[4] Portions of this note have been adopted from the article – GST on Securitisation Transactions, by Nidhi Bothra and Sikha Bansal.

[5] http://idtc-icai.s3.amazonaws.com/download/pdf18/Volume-I(BGM-idtc).pdf; pg. last visited on 19.05.2018

[6] (31) “consideration” in relation to the supply of goods or services or both includes––

(a) any payment made or to be made, whether in money or otherwise, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government;

(b) the monetary value of any act or forbearance, in respect of, in response to, or for the inducement of, the supply of goods or services or both, whether by the recipient or by any other person but shall not include any subsidy given by the Central Government or a State Government:

Provided that a deposit given in respect of the supply of goods or services or both shall not be considered as payment made for such supply unless the supplier applies such deposit as consideration for the said supply;

Indian securitisation market remains stagnant as PSLCs rule the market

Despite the economic slowdown due to GST, the Indian securitization market has performed fairly well, though it has not been able to match the volume of last year. During FY 17-18, the overall volume of the market stood at Rs. 84,000 crores, which is Rs. 1000 crores less than what happened a year back. Of the total volume, there were direct assignments worth Rs. 49000 crores and the remaining were pass through certificates. After the introduction of the securitization distribution tax in 2012, the market shifted towards DAs and the same continued until 2016 when the same was removed. This also reduced the gap between DAs and PTCs, however, the gap has increased once again. The following two graphics show the trend of securitization and the market composition (DAs vs PTCs) during the last few years.

The market showed a 72% YoY growth on issuance of pass through certificates from Rs 25000 crores in FY16 to Rs 43000 crores in FY17 however, and a 24% decrease in FY18 to Rs 34800 crores. The slowdown in securitisation was mainly due to lack of clarity surrounding incidence of Goods & Services Tax on the ‘assignment’ of secured loan receivables as well as a sharp spike in PLCS lending volume.

The volume of PSLC market leapfrogged to around Rs 1.84 lakh crore in FY18 from mere Rs 50,000 crore in FY17. Trading of PSLC was introduced in 2016 and FY18 was the first full year of its use. Here, banks needed to meet priority sector loan targets buy the priority sector obligation certificate from the seller bank without the transfer of risks or loan assets. Seller banks earn a fee without reduction in the loan portfolio unlike in securitization or direct assignment deals. The PLCS are also easier to execute as happens without any real transfer of assets whereas PTCs require pooling of assets and selling it.

Despite a slowdown in the market, several new asset classes were tried during the year. For the first time, asset classes like educational loans, consumer durable loans were tried. The market also witnessed return of Collateralised Loan Obligations.

7th Securitisation Summit, 2018 & 2nd Indian Securitisation Awards

Vinod Kothari Consultants, along with the Indian Securitisation Foundation, has also announced the 7th Securitisation Summit, 2018 on 25th May, 2018 at World Trade Center, Mumbai. This is an industry forum where stakeholders from the entire industry gather to discuss various issues concerning the market and try to take up issues with the regulatory authorities so as to make the environment facilitating in India. The details of the event can be viewed at: www.vinodkothari.com/secsummit/

Also, during this years’ summit, Indian Securitisation Foundation will also announce the second edition of the Indian Securitisation Awards. There are five categories award – most innovative deal of the year, large and small arrangers of the year, trustee of the year and law firm of the year.  Details can be viewed at:


Chinese securitization market continues to grow – S&P Report

By Nidhi Bothra (finserv@vinodkothari.com)


Amdist slowdown of the Chinese economy, bulging debt load and excessive investments, the impetus has been on securitisation to convert assets into asset-backed bonds. China’s ABS market has wide range of assets such as loans, real estate, toll ways, auto loans, housing loans etc. Read more


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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.


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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 http://india-financing.com/arc/, or http://india-accounting.com/arc/. For a detailed comment by Vinod Kothari, see http://www.india-financing.com/ 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 Financeasia.com 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. "

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

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.

Links For more on true sale, see our page here.


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European structured finance grows in volume and diversity: S&P

Giving its report card for the first half of 2004, rating agency Standard and Poor's says European structured finance transactions in first half of 2004 have grown both in volume and diversity. Both the scale and scope of European securitisation market has grown.

From oil to telecom receivables, the range of assets securitized in Europe in the first half of 2004 continued to broaden," said credit analyst Chris Such, a director in the Structured Finance group. "In addition, the mainstays of autos, credit cards, and leasing deals increased their use of the market in 2004 compared with 2003."

S&P expects the pipeline of transactions for the rest of the year to remain strong for most of the major European ABS sectors, such as leases, credit cards, and auto loans. While the established players in Europe continue to securitize more and diverse assets, new players are preparing to enter the market. Greece remains a potential source of future transactions and interest in structured financing is growing in previously untapped regions such as Eastern Europe and Scandinavia.

Issuance so far this year has proved strong. Funded European ABS issuance rose to €24.1 billion in the first half of 2004 from €14.9 billion in the corresponding period of 2003, with Italy accounting for approximately 43% of the total.

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

The Malaysian government to raise RM 25 billion by securitisation

In our recent write up, we wrote that governments World-over were awakening to the potential of securitisation; we also mentioned about Malaysia's plans for securitisation of housing loans. The plans are now firm.

Malaysian press recently cited Second Finance Minister Tan Sri Nor Mohamed Yakcop having said that the Govt is keen to securitise some RM 25 billion (approx USD 5.5 billion) worth staff housing loans. The move was to further develop the Malaysian bond market, in particular asset backed securities (ABS).

Cagamas, the government-promoted housing securitisation body would be used to carry out this securitisation. 

While the move could be a simply liquidity exercise for the govt and a device to cut its budgetary gaps, the government has been trying to find various justifications for the move. Nor Mohamed said the securitisation exercise would contribute to create a yield curve for MBS with longer maturities that will serve as a benchmark for other ABS issues and put in place a price discovery mechanism to enable investors to price more accurately other types of ABS. The move is also to foster a viable and active secondary market for the ABS issue and promote Malaysia as an issuer of Islamic ABS as the government's housing loan portfolio also constitutes Islamic financing debts.

Links For more on Malaysia, see our page here.

Training courses in Malaysia We hold regular training courses in Malaysia. For our forthcoming training course schedule, see here

Whole business securitisation wasn't 3 cheers for M&C

In our training sessions, when we used to talk about whole business and inventory securitisation, Marne et Champagne was always discussed as a unique example. The deal that won several prizes in 2000 as a landmark securitisation transaction claimed to have used a device that was discovered in 200 years' old French law of pledges. However, the transaction was almost about to hit the avalanche, leading to a near bankruptcy of Marne et Champagne (M&C), the world's second largest champagne producer, before it was rescued.

The rescue did not come free -Caisse Nationale des Caisses d'Epargne (CNCE), a French mutual savings bank took a 44 per cent stake and provided €410m ($508m) in new financing with which M&C could pay its securitisation noteholders. The holdings of the Mora family that owned M&C has been considerably diluted in the process.

A report in Financial Times [10th July] put it thus: "Its (M&C's) problems stemmed from its inability to repay a ground-breaking four-year asset-backed bond it had issued amid much fanfare in March 2000. In a securitisation designed by Nomura, it had over-borrowed, raising €396m against its stock of 60m bottles of champagne in various stages of production…Nomura spotted that wine in production – like many other esoteric assets – could provide attractive collateral for cheap longer-term finance and encouraged M&C to abandon its long-standing reliance on more costly bank finance. Four years later, however, in March 2004, projections made at the height of the stock market bubble had long been discarded. Investor confidence had also been shaken by overstocking prior to the millennium and an accountancy scandal that bankrupted the Bricout- Delbeck champagne house. Unable to roll over the securitisation facility, the Moras found themselves facing the loss of their company."

Since the entire stock of wine bottles had been pledged to trustees for the noteholders, the family could lose the entire stock. Usually there are also covenants in whole business deals for replacement of the servicer of the business – in this case, the existing management would have been removed.

Whole business securitisation device, a mid-way between loans and securitisation, could, in situations of adversity, prove to be noose round the neck for the operator of the business. In terms of ratings, as it does not often provide a ratings-arbitrage, the motives of a business to go for whole business securitisation should be examined carefully.

M&C is not the only example of whole business securitisation deals going sour – there are more examples in London.

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

Securitisation growing fast in China

China might soon emerge as the new growth centre of Asian securitisation. According press reports in Chinese papers, Wu Xiaoling, vice-governor of the People's Bank of China addressed a forum on MBS in China and said that China is gathering pace in the development of asset securitization to provide new financial and investment tools for domestic institutions and foreign investors. She said that the central bank had submitted a proposal on the MBS pilot programme to the State Council.The programme is being reviewed, she said at a forum on MBS in Beijing.

The official was well aware of the fact that current state of Chinese legislation is grossly incomplete to allow securitisation to happen. There is no law on assignment of receivables.

Law or no law, China is already making headway on securitisation of non-performing loans. China has already started some pilot programmes on asset securitization to help State-owned banks and asset management companies (AMC) dispose of non-performing loans (NPLs), including a pioneering deal by China Huarong AMC to repackage 13.2 billion yuan (US$1.6 billion) worth of NPLs into a trust programme last year. But the scale is very limited and MBS programmes are still not generally allowed.

However, the market potential is huge. Being the most populous country on planet earth, China must tap securitisation potential for housing programs.By the end of 2003, China's outstanding individual housing loans were close to 1.2 trillion yuan (US$144.9 billion).

Links For more on securitisation in China, see our country page here. Also, you might be interested to see the China page on our leasing site.

Structured product CDOs a rage in first half 2004

The first half of 2004 has witnessed approximately 20% increase in issuance of asset backed securities in general, but the structured finance CDO market is where the action lay. The issuance of structured finance CDOs, also sometimes known as CDO squared, was up 90% compared to the corresponding period over the previous year. Structured finance CDOs were only 20% of the total CDO issuance last year, but this year, they take about 50% space.

Structured finance CDOs are CDOs that invest, either in cash or synthetically, in other structured products such as CDOs, ABS, MBS or even REITs. They are also sometimes known as resecuritisation.

Structured finance CDOs, like all CDOs, try to capture the pricing inefficiencies of the structured products market.

A report by Nomura Research looking at the future growth potential of structured finance CDOs says: "While this trend (growing numbers) is likely to continue into the second half, we expect the new CDO sub-category to lose some luster in the latter part of the year. Here are two reasons for our skepticism: (1) Arbitrage opportunities may rapidly disappear as more deals get done, and (2) The inevitable rise in interest rates is likely to cause supply of structured debt to ebb in coming months. On the other hand, synthetic SF CDOs might come into vogue as a means of diversification for CDO investors, as liquidity improves and credit default swaps (CDS) referencing ABS become standardized."

Links For more on structured product CDOs, see our page here.

Abu Dhabi bank uses securitisation structure for power project funding

The National Bank of Abu Dhabi has structured what is called " power bonds" to finance a power project. The structure, as it appears from press reports, is either the same as securitisation, or close to it. The instrument is called "participation notes", which seems to be equivalent of participation certificates in syndicated lending.

The power project in question is the Taweelah A2 Power Project, and the total amount of funding raised is approximately AED 500 million (US $ 133.75 million).

The bond issue achieves maturities of 4, 7 and 8 years (three tranches). It is not clear whether typical structured finance principles of subordination or other forms of credit enhancement have been used for the project.

Press reports also suggest that the bond launch is expected to set the ball rolling for subsequent issues related to the power projects set up under the Abu Dhabi Water & Electricity Authority (ADWEA) Privatization Programme. The Issue shall open a new avenue for the pension funds, insurance companies and other institutional investors to participate in ADWEA power project credits which are otherwise limited to Banks. 

Basle II is here !

Travelling by road from Frankfurt to Interlaken, Switerland, and from there to Munich, on en route, you pass through Basle. You never get to realise that this not-so-busy place is abuzz with activity that would sleepless nights to many banks and banking regulators, and tons of cash to technology companies that would invariably be required to compute capital for banks under the new capital requirements. Finally, after 4 years of drawing, detailing, re-drawing, Basle II is here. End-June 2004, the final rules have been laid.

The new framework is to be implemented by year-end 2006, however, for certain advanced approaches one more year is allowed.

As for securitisation transactions, the rules are substantially similar to those in Consultative paper 3, as refined in Jan 2004.

We include a note explaining the capital provisions in Vinod Kothari's article here. In the said page, we also give link to the full text of the BIS II.

More to come Please do follow this page. We will be putting more industry opinions, articles and links on this most important regulatory development of the year.

Philippines bank may launch unique SME securitisation program

Securitisation of SME loans by synthetic transactions is quite common in Germany, but some Asian nations are creating a cash market for SME loans securitisation. Recently, we had reported a similar initiative in Singapore. In Philippines, where a securitisation legislation was passed recently, the state-owned Development Bank of the Philippines (DBP) is in the process of setting up an electronic marketplace where receivables of small and medium enterprises (SMEs) can be sold, thereby creating a secondary market for SME loans.

There is a significant difference between the Filippino model, and those in other countries. In other countries, banks sell SME loans to a central agency, such as KfW in Germany. Under the Filippino model, SME's would sell their receivables to DBP.

90% of Filippino business is SME-based.

The particular securitisation exercise is called Market for SME Receivable Purchases (M4SME-RP). M4SME-RP is an electronic trading facility where SME receivables could be securitized and sold to retail investors and financial institutions. Arguaby, the cost of lending to SMEs will come down thereby, in addition to channelising capital market flows towards the SME sector. Under the M4SME-RP program, accredited SME's could use the facility to auction out their receivables to large company clients, who, in turn, could securitize them into financial instruments that could be sold to investors.

Thus, M4SME-RP serves as a clearing-house, where commercial documents are electronically passed, authenticated, and digitally signed conversion of these securities. The facility allows the exchange of commercial documents using electronic infrastructure. Under the program, SME's would act as sellers of their receivables, large company clients issuers of receivable-backed securities, with the buyers investor participants such as insurance companies, preneed firms, and financial institutions and their roster of retail investors and trust entities.

Governments fidgetting to fill fiscal holes: securitisation to the fore

The Hong Kong government recently securised toll revenues in a transaction that proved highly successful. Not that the message would have been as loud as to be heard in Germany, but there is a sudden awakening of governments to the power of securitisation, with at least 2 governments currently making noise about using securitisation to fill their fiscal holes – Germany and Malaysia.

Take the case of Germany first. The German government wants to raise close to Euro 5 billion by way of securitising Germany loan assistance to Russia. Later, officials deflected the number of Euro 5 billion and said, they don't know how much would the market be willing to offer for this debt, but it is clear that Germany's Paris Club debt to Russia would be securitised. The Berlin government obviously is fill up a fiscal hole – Germany's federal budget for 2004 originally envisaged a deficit of €29.3bn but last month the government said tax revenue for the year, which makes up 80 per cent of total revenues, would be €10bn lower than expected.

Since Margaret Thatcher's privatisation exercise about 20 years ago, governments World-over have used privatisation as the means to shore up government's finances. Securitisation is, in terms of fiscal impact, similar to privatisation. As a matter of fact, governments such as Lebanon perceive securitisation and privatisation as alternatives.

Press reports are not clear as to whether the German securitisation would be a cash securitisation or a synthetic one. Synthetic ecuritisation may only provide fractional funding.

The other government that might seriously considering securitisation is Malaysia. Malaysian press carried reports about Rating Agency Malaysia chief C Rajandram suggesting that the Malaysian government might raise RM 20 billion (approx USD 5.3 billion) by securitising the government's housing loan receivables. The Malaysian government is also facing the problem of successive budgetary deficits, which it has promised to balance out by 2006.

The question of how governments account for the proceeds of securitisation is tricky one. Eurostat has defined rules about securitisation of future flows by governments – that they should form a part of government's borrowing. IMF has also come out with an article that generally criticises collateralisation of future revenues by governments – see our page on future flows here. However, securitisation of existing revenues such as loans may be different. Privatisation accounting principles may apply here and the flows may be taken as a part of capital budget of governments.

Links For more on securitisation of government revenues, see our page here.

First CMBS deal in Taiwan flies

Taiwan had recently enacted a real estate securitization law, and in retrospect, the law has been quite successful. One of the very first issues of CMBS paper sold out on the very first day.

Reports in Taipei Times of June 11 say that the securitized seven-year bonds backed by rent from an office building in downtown Taipei owned by Tong Yang Chia Hsin International sold out on the very first day of the offer. Industrial Bank of Taiwan acted as the sole arranger.

The building is owned by Tong Yang Chia Hsin International Corp, an affiliate of Chia Hsin Cement Corp, and tenants include International Business Machines Corp, ABN Amro Holding NV and J.P. Morgan Chase & Co. Obviously, the building is in posh office area of the city.

The real estate securitisation law in Taiwan was passed in July 2003.

Links For more on securitization in Taiwan, see our country page here. For more on CMBS, click here.

SEC publishes disclosure document for ABS/MBS

The SEC has published the disclosure document that is to introduce a new regime of disclosures for issuers of mortgage backed securities (MBS) and asset backed securities (ABS). The paper is much shorter than expected – about 200 pages in HTM ormat. There is a 60 day period for comments.

The SEC says: "We are proposing new and amended rules and forms to address comprehensively the registration, disclosure and reporting requirements for asset-backed securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. Principally, we are proposing to: update and clarify the Securities Act registration requirements for asset-backed securities offerings, including expanding the types of asset-backed securities that may conduct delayed primary offerings on Form S-3; consolidate and codify existing interpretive positions that allow modified Exchange Act reporting that is more tailored and relevant to asset-backed securities; provide tailored disclosure guidance and requirements for Securities Act and Exchange Act filings involving asset-backed securities; and streamline and codify existing interpretive positions that permit the use of written communications in a registered offering of asset-backed securities in addition to the statutory registration statement prospectus."

Among the major changes, there is a new definition of "asset backed security", which enhances the scope but still does not seem to include synthetic securitization. The document says: "Under our proposal, the basic definition of “asset-backed security” would be “a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the securityholders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases.” There are specific proposals relating to lease-backed ABS and the relevance of residual values thereto.

Master trusts have very commonly been used for several collateral classes. "Our proposal would allow master trust structures to meet the definition of “asset-backed security” without any pre-determined limits".

There are enhanced requirements as to disclosures in prospectus.

The proposal calls for disclosure of static pool data "if material to the transaction to aid in an investor's analysis of current and prior pool performance." The proposal covers the subject extensively under the topic of disclosure about a transaction's sponsor. More specifically, the proposal calls for three years of static pool data. The proposal for static pool data appears to include vintage performance data for revolving asset pools."

Mark Adelson of Nomura Research says: "The proposal includes nearly all of what we hoped to see, but not everything. A little room for improvement remains."

Link For the full text of the SEC document, click here

For detailed articles on the SEC disclosure document, please see our page on US securitization rules.

SEC to present 400 page disclosure document for securitisation

We had recently reported that the SEC might enhance disclosure requirements for MBS/ ABS issuances. And the proposal is shortly forthcoming. On 28th April, the SEC held a meeting wherein the Commissioners unanimously voted for publication of a proposal related to the enhanced disclosures. The publication, expected to run over 400 pages, is expected next week.

Some of the significant changes being proposed are:

  • ABS/MBS disclosure would include static pool performance data.
  • ABS/MBS issuers would be permitted to distribute loan-level data to investors.
  • ABS/MBS disclosure would include expanded information on transaction participants, such as sellers and servicers.
  • The proposal would broaden the definition of "asset-backed security"1 to include securities backed by more kinds of assets, including auto leases.
  • Shelf registration (Form S-3) would be available to the newly expanded class of "asset-backed securities."
  • Shelf registration would be more readily available to foreign ABS/MBS issuers.

In addition, it was indicated that the proposal calls for changes in the periodic reporting framework for ABS/MBS. Quarterly reports would emphasize changes in pool composition. The proposal would codify the annual certification requirements for ABS/MBS under § 302 of the Sarbanes-Oxley Act and would establish principles-based criteria for assessing servicing compliance.

The SEC paper is likely to have a 60 day comment period.

Watch out We would be watching out developments as they take place in this front; so, stay connected.

Chinese bank to securitise bad loans

In a novel deal from China, Industrial & Commercial Bank of China (ICBC) has signed up with Credit Suisse First Boston Corp whereby the latter will act as ICBC's adviser in a securitisation backed by non performing loans and sub performing loans valued at 2.6 billion yuan. Securitisation is yet to take off in China to any material extent.

Securitisation of non performing loans is not uncommon globally, but it is largely based on the legal environment for enforcement of security interests backing up the bad loans. Chinese non performing loans have been of global interest way of private sales, but this transaction makes a remarkable difference being by way of securitisation.

Chinese financial institutions had a total of CNY2.44 trillion in bad loans on their books at the end of 2003, or an average of 17.8% of outstanding lending. At 21.3%, ICBC's end-year nonperforming loan ratio was somewhat higher than average.

Links For more on securitisation of bad loans, see our page here.

FASB concerned about isolation: seeks opinions

The US standard setter has set in motion yet another discussion on pre-conditions for off-balance sheet accounting – this time, on the legal certainty of isolation. This relates to the obligor's right of set off, or similar other legal infirmities that might quarrel against the unconditional rights of securitisation investors to transferred assets.

Set off right is essentially a right of netting off. If A owes B an amount, and B owes A an amount, A may net off his obligation aginst his receivable. In context of securitization, a transferor transfers a financial asset representing a claim against an obligor. If the obligor has a corresponding receivable from the transferor, the first receivable is subject to the potential netting off against teh second one. If that is the case, it would be wrong to treat the transfer of the first receivable as a sale. FASB has sought opinions on this issue. A FASB release of 9th April says that "the Board has become aware of an issue related to the isolation of transferred assets that apparently was not explicitly considered when Statement 140 was issued—the ommon-law right of debtors and creditors to set off (net) amounts due to one another if one of the parties defaults, becomes insolvent, or enters into bankruptcy or receivership." If the obligor's right of set off exists, the buyer of receivables buys the same subject to the potential netting off of the claims of the obligor against the originator.

One of the commonest examples of a right of set off is deposit a borrower from a bank holds in the lending bank. The borrower may require the bank to adjust the deposit against the loan.

The scope of the FASB request is not limited to set off – it goes into all the factors that might undermine a sale: "there may be other unidentified legal factors or conditions that transferors and their auditors should consider in reaching conclusions about isolation of transferred assets." The last date for the comments is 30th May.

Links For more on legal issues relating to securitization, click here. For more on accounting issues, click here.

US SEC seeks more disclosures for asset backed securities

We reported about Bowie bonds and similar future flows yesterday. That surely could not have triggered the following, but the nexus is interesting: an SEC official has stated that the SEC would like more disclosures in case of asset-backed securities (ABS). ABS firms would have to disclose more about their past performance under rule changes being considered by regulators. Paula Dubberly, associate director, said As part of an effort to formalize regulations that have grown up with the $1.7-trillion asset-backed market, the SEC staff plans to recommend requiring more disclosure so investors know more about the risks of these unconventional securities. 

The SEC staff plans to recommend disclosure of past performance by both asset-backed securities sponsors and servicers. Sponsors originate or buy assets and then sell them to trusts. Servicers collect the payments from, for example, car buyers and homeowners. 

Recently, the ABS landscape has been marred by frauds, lax servicers, and asset collateral collapse. Investors have also been increasingly concerned that the collateral being pumped into the ABS market is subprime.

European securitisation markets surge

During the first quarter of 2003, Eurpean ABS market surged by some 26 per cent, on the back of a 38 per cent increase last year. A news item in Financial Times, quoting Deutsche Bank, says that this year, securitisation volumes will be bigger than regular bond issuance.

Much of the surge in the first quarter can be attributed to some mega issues during March. Abbey, the UK bank, sold £4bn of mortgage-backed securities. Before this, Volkswagen, the German motor vehicle manufacturer, issued nearly €1bn of securities, backed by vehicle leases.

The European securitisation market expanded by 26 per cent to €54bn in the first quarter of the year, compared with the same period last year, according to preliminary figures from the Forum. Residential mortgage backed-securities account for the majority of the market, with €34bn, or 63 per cent, of the first-quarter issuance having been backed by property mortgages.

The growth extended the trend from 2003, a year in which overall securitisation issuance reached a record level of €217.2bn.

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

Supreme Court of India upholds securitisation law

In a litigation challenging the legal validity of a recent legislation challenging the Constitutional validity of a law called Securitisation Act (briefly, the actual name is much longer), the Supreme Court in an order passed today, upheld the validity of the law.

Lest there should be mistakes, this law does not hold much about securitisation, and securitisation transactions were not the subject matter of the legal debate. The legal debate centered provisions relating to enforcement of security interests (similar to Article 9 of UCC, USA or the PPSA legislation in Canada and New Zealand). These provisions allowed a creditor being a bank to seize collateral in case of a defaulted loan without going to a court. These provisions have been upheld by the Supreme Court.

The law is known as securitisation law because the 3-part legislation also has a part dealing with securitisation transactions. That part, in market parlace, has been largely ineffective because most transactions in the marketplace circumvent the regulatory tone of those provisions.

Links For more on the enforcement of security interest provisions of this law, see our page here. For securitisation in India, see here

Bowie bonds grounded, does it spell tough time for similar future flows?

Bowie bonds, at one time regarded as a brilliant new idea to hit Wall Street, have been grounded. The rating agencies recently reduced them to near-junk grade. Is it just a limited problem, or does it signal tough time for bonds backed by similar cashflows out of assets such as lotteries, music, beauty parlours, food chains, etc?

Bowie bonds, backed by royalty income of rock star David Bowie made headlines in 1997 when USD 55 million was raised against securitisation of future cashflows. David Pullman claimed authorship of the idea, though that claim itself was later dismissed in legal proceedings. Recently, Moody's downgraded the bonds to just one step above junk, citing reasons such as depleting sales and the situation in the music royalty industry.

The trouble with future flows of this nature is that it is almost like equity investment by the investors as they take all the operational risks of an operating business, but it does not have any of the upsides of equity investment. Bond investors get into future flows investments lured by higher returns, but the experience has been quite mixed. While in straight forward asset backed bonds, one is backed by identified pool of assets, future flows are backed by income which is to arise in future, with no certainty today.

Links For more on securitisation of cashflows backed by intellectual property, with several new articles on Intellectual property securitization, see our page here. For more on future flows, see here.

Market ripe for upward securitisation growth curve in India

Indian investment banks have been talking about it for years now, but securitisation was still the mental sport of a very limited coterie of investors, primarily the insurance companies and some mutual funds. But now it seems the commercial banks with their huge liquidity position are ready to accept securitisation. Thus, 2004 may see both increase in volume as also, and more significantly, a growing investor class.

Recently, Citibank wrapped an SME working capital securitisation. The idea of an SME loan securitisation is not new: several countries have done it already. But working capital, which does not have identified cash inflows and works like a revolving credit, is structurally a new thought.

The best part is that not only are institutional investors flocking into the securitisation market, even larger corporate treasurers are finding it interesting. In a recent mortgage backed securitisation issue, for example, a corporate making cables is said to have made investment.

There are several tax infirmities yet to be cleared to enable securitisation to reach a safe harbour – the government made an enactment which is more like a statement of good intentions rather than of any legilative use to securitisation transactions.

Links For more on Indian securitisation market, including recent article by Vinod Kothari, see our page on India here.

Japanese securitisation market looking for new asset classes

The Japanese securitisation market is prepared to look out for new asset classes this year, as interest rates seem to be rising, and hungry for yield-pickups, investors might be prepared to lap up new transactions.

During 2003, the biggest asset backed class in Japan was CDO/ CLOs. According to a recent Moody's report on the state of the Japanese securitisation market, CDOs took Y4,400bn ($42bn) of the Y8,300bn total market last year. Of notable transactions in this segment, Mizuho came out with a mega CLO transaction involving 150 obligors. Most of the CLOs were done more for risk management than for liquidity, and therefore, as problem of bad loans becomes a bit easier, the need for risk management through CLOs might be bit less intensive this year.

Leaving the CDO segment, there were deals of about Y 2200 bn in the asset-backed market, involving lease payments, auto loans and consumer loans.

However, with interest rates of nearly zero, investors are looking for riskier assets. The investor universe is fast expanding: the investors include insurers, mega banks and even shinkin, rural credit associations at home, and hedge funds and investment banks from overseas. There have already been pilot deals in non-traditional classes, involving future flows. For example, annual membership fees of English-language schools and even beauty parlours have been securitised. Bowie Bonds might have been grounded elsewhere in the World, but Japanese investors are still wanting to take a loot at these.

Links For more on the Japanese market, see here

FASB to rewrite FAS 140 on qualifying SPEs

Accounting for securitisation seems to have become a familiar mental sport at the FASB, and it seems it would years before the complexities, not all of which are warrantd, and certainly not wanted, of this accounting standard would be resolved. End-March 2004, the FASB staff has undertaken yet another project to rewrite accounting rules on qualifying SPEs and the condition for isolation of assets, required for off balance sheet treatment to securitization transactions.

A FSAB press release says that the objective of this project is to amend FAS 140, to (1) specify the conditions under which a qualifying special-purpose entity (SPE) is permitted to issue beneficial interests with maturities that are shorter than the maturities of the assets held by the qualifying SPE and roll over those beneficial interests at maturity; (2) clarify or amend other requirements of Statement 140 related to commitments by transferors, their affiliates, and their agents to provide additional assets to fulfill obligations to the beneficial interest holders; and (3) address other issues related to transfers of financial assets that arose during deliberations.

The FASB has reached the following decisions related to legal isolation and accounting for undivided interests:

1. Legal isolation requirements would be applied only to those affiliates included in the consolidated financial statements in which a transferor is reporting the results of a transfer. In some circumstances, the accounting for a transfer in the financial statements of a parent company would be different from the accounting in the separate financial statements of a subsidiary (September 24, 2003 Board meeting).

2. Paragraphs 80–84 and various related paragraphs of Statement 140 would be amended to require that an entity that issues either beneficial interests or undivided interests be a qualifying SPE in order to satisfy the criteria in paragraph 9(b) of that Statement. The Board noted that one implication of its decision would be that a qualifying SPE would be required for any transfer of a portion of a financial asset, not just for multiple-step transactions (October 1, 2003 Board meeting).

The Board has reached the following decision related to transferor support commitments and derivatives:

1. If transferors of financial assets provide support commitments or derivatives either directly to beneficial interest holders or in connection with the beneficial interests, those obligations should be considered in the same manner as if they were provided directly to the qualifying SPE for purposes of evaluating legal isolation. That requirement would include support commitments entered into with third parties who provide “back-to-back” guarantees to beneficial interest holders (October 1, 2003 Board meeting).

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

Singaporean firm to promote securitisation for SME funding

Action Crucible for Financing, a private initiative that focuses on SME development, is trying to use the securitisation template for promoting SME funding in Singapore. Singapore is known for its multinationals and global investment banks, but not for its approach to development of SMEs.

Singapore's approximately 100,000 SMEs face difficulties getting loans from banks which, although flush with cash, can be conservative in their lending to untested companies. The government is also keen to promote entrepreneurship to reinvigorate an economy which is struggling to get back onto its feet.

Currently, the government typically supports smaller firms through the Local Enterprise Financing Scheme, under which the government guarantees 80% of qualifying bank loans. The exact form which the Action intends to use is not clear for now.

Vinod Kothari comments: One of the best examples of use of securitisation for SME funding is the German KfW template. Using either synthetic or cash securitisation structures, KfW does not provide refinance and the developmental agencies in most countries do – KfW merely facilitates the ultimate securitisation of pools of qualifying SME loans.

Links For more on SME funding by way of securitisation, see our page here.

E&Y report identifies securitisation as key real estate trend

A recent report by accounting and consulting major Ernst and Young went into the developments in the global real estate market. Titled Real Estate: The Global Local Economy, E&Y states that in an otherwise globalised economy, real estate is still a local market as there are several factors still inhibiting the globalisation of real estate.

There are, however, several factors contributing to the globalisation of real estate, and securitisation is one. Securitisation and REITs are permitting commoditisation of the ownership of real estate. "One of the key trends prompting increased global investment is the steady march of securitization and transparency in real estate ownership. In fact, REIT legislation — often along the lines of the very successful US format — is now common in both developed and developing nations around the world. In the last three years, France, Korea, Japan, Singapore and Taiwan have all adopted legislation allowing creation of REIT-style investment structures. In addition, the European Union has proposed creation of a EuroREIT and the UK government is also mulling REIT legislation. Not only is this legislation spurring expansion of commercial real estate markets in these countries, it's also promoting more offshore investment by US REITs. This trend is leading to the creation of important joint ventures with local owners and investors. Simon Property Group has entered into a joint venture with Italy's Rinascente Group to develop malls in Italy. Maguire Office Trust, an Australian-listed property trust, and Brandywine Realty Trust, a US REIT, have agreed to invest in office properties on the US East Coast", says the report.

The securitisation of non performing real estate loans is also highlighted as a significant development.

Links For more on securitisation of commercial real estate, see our page here.

Islamic securitisation making headway in the Gulf

Several recent events suggest that Islamic finance in general is gathering strength, and that Islamic securitisation seems like a reality.

On March 10, Beirut (Lebanon)-based BSEC Investment Bank, and the Bahrain based Shamil Bank announced today the groundbreaking launch of a SR 102 Million Shariah compliant investment Sukuk. Caravan I Limited is the region's first inventory fleet securitisation transaction. The three-year maturity Shariah compliant transaction offers investors a right of recourse to the underlying assets. The SR 102 Million Sukuk is backed by a pool of vehicles and vehicle lease agreements purchased from Hanco Rent A Car, a leading Saudi Arabian car leasing and rental company. BSEC acted as the deal arranger and structurer, while Shamil Bank was the underwriter. 

Bemo Securitisation is one the few securitisation-focused entities in the MENA region. Bemo's managing director Iyad Boustany is also the author of a treatise on securitisation written for this market, in French.

Apart from securitisation, other Islamic finance products are also making a strong headway. In a recent Islamic finance meet in Dubai, bankers and investment bankers from all over the World stressed the relevance of Islamic finance, not merely as a theological concept but as one that truly goes near to the concept of asset-based financing known to the entire world.

Islamic finance is based on contracts which do not have interest, and is usually based on sharing of risks and/or rewards.

Links On this site, we have interesting articles on Islamic finance. See our page here.

Are SPEs a risk to credibility of securitisation?
Vinod Kothari

As the Parmalat scandal unfolds, special purpose entities are under a scanner once again. There are lots of similarities between Enron and Parmalat, except for the fact that unlike Enron where US standards did not require consolidation of the special purpose entities, lots of Parmalat SPEs formed a part of the group balance sheet under IAS 27. However, the issues are not limited to consolidation – at stake is a larger issue as to whether special purpose vehicles are inevitable in securitisation, or their existence does damage to the credibility of securitisation.

Writing at CFO.com, Tony McAuley writes: "the fragile situation shows how abuse of SPEs has undermined public confidence, putting development of securitisation markets, one of the great capital markets phenomena of the last two decades, at risk."

Special purpose vehicles imply separation of legal entities, which is presumably required for two purposes: bankruptcy remoteness and off-balance sheet accounting. Bankruptcy remoteness is a concept of law and there is no reason this has to necessarily and permanently depend on legal isolation. Off balance sheet accounting is a means to an end – which is quite often capital relief or higher gearing. If the latter objectives can be achieved by on-balance sheet means, there is no need to devise structures that result into off balance sheet funding. Therefore, SPVs are not quint-essence of securitisation.

On the contrary, SPVs do a lot of damage. As assets and underwritings shift from the balance sheet of the parent bank, the bank's manuals, procedures and discipline becomes less relevant. Much as a bank might see the SPV as a mere extension of the bank's books, the very change of entity does result into relaxed credit. It is a fact that most bankers would agree that bank-sponsored ABCP conduits end up with lots of assets that would have never found their way on the bank's balance sheet. It is not a surprise if it is proved that Parmalat's bankers knew of bogus receivables being sold to the ABCP conduits. It is not that non-existing assets are not funded by banks – but internal controls developed over centuries save the bank – which are unknowingly or deliberately relaxed in case of the conduits. Off balance sheet is off the radar, and therefore, off the discipline, and that makes a tremendous difference. Sleazy assets are funded by securitisation vehicles – doing a double damange – promoting undesirable funding or over-capitalising larger clients, and posing a long-term challenge to the very credibility of securitisation.

So, it is time to think hard whether these phantom entities are required at all?

Links There are several SPV-related materials and links on our page here. For more on accounting for securitisation, click here.

IAS 39 rouses mixed reactions: more bad than good

While accounting experts and securitisation practitioners across the world are still trying to understand what the revised IAS 39 means to them, the initial feedback has more tears than cheers.

The revised IAS 39 was issued recently by the International Accounting Standards Board, and replaces the existing IAS39. The revised standard contains accounting rules for financial instruments in general, including derivatives, securitisation, etc. The revised standard has changed the basic approach to one in which a transfer is reviewed under various steps in a hierarchy, including transfer of risk and rewards, surrender of control and continuing involment. The last approach arises where there is no surrender of control, and the latter arises where there is no complete transfer of risk and rewards. Accounting professionals carry a feeling that the last condition of continuing involvement, coupled with consolidation rules of IAS 27/ SIC 12 will block off balance sheet accounting for several real life transactions.

Martin Rosenblatt, international accounting expert, along with Jim Mountain, published a recent article detailing the revised derecognition requirement. Martin feels that revolving transactions would particularly seem to fail the required derecognition tests: "Provision (c) above will likely have the effect of causing all revolving structures to fail to qualify for derecognition. Although it has been argued that revolving structures effectively represent the investors' purchasing new assets with the proceeds of those that have been collected, the new assets would not be investments in cash or cash equivalents. Also, transactions in which the transferor receives the float from temporary investments will not qualify for derecognition."

Accounting firm Price Waterhouse Coopers also recently released a publication titled Financial Instruments under IFRS. In case of securitisation transactions, the publication claims that "The new derecognition model will probably have a significant impact on securitisation structures. A classic receivables securitisation programme, where a company sells its receivables
to a multi-seller vehicle on a revolving basis, is likely to encounter .. difficulties"

Links For more on the revised IAS 39 including Vinod Kothari's quick notes, Martin Rosenblatt's article and link to the PWC publication, see our page on accounting issues.

Rating volatility in Q4 much lesser

Rating agency Standard and Poor's recently produced its customary tally of ratings activity during the 4th quarter of 2003, as also for 2003 as a whole. Though the picture on a holistic basis is mixed, Q4 was much more comfortable than the rest of 2003.

CDOs: The major source of ratings volatility is the CDO sector. In Q4 of 2003, the US CDO market had a total of 103 downgrades, which is considerably less than the nearly-250 downgrades in the previous quarters. This reflects the reduced extent of ratings downgrades of the corporates whose obligations these CDOs buy. Across the Atlantic, European CDOs registered both upgrades and downgrades, the former largely due to transaction seasoning. In the downgrades, a major contributor was the bankruptcy of Parmalat, which was a reference entity for several CDOs. The S&P report says that Parmalat was a reference entity in some 80 CDO transactions (note, not classes) which reiterates the high degree of correlation existing in the CDO market. Parmalat affect not merely European CDOs but those in the Pacific – 12 CLNs from Australia and New Zealand got lowered due to Parmalat.

Defaults: From the viewpoint of defaults, 2003 was particularly a bad year. This year alone accounted for nearly 33% of all defaults to date in US ABS/CDO transactions. There was a total of 48 defaults across 40 transactions from 7 issuers in the US market. Most defaults (37) during 2003 emanated from the manufactured housing segment, followed by synthetic CDOs (4) and franchise loans (4).

CMBS and RMBS The US CMBS market registered a record number of upgrades in the 4th quarter. The RMBS continued to have a great year with 319 performance-related upgrades. "The outstanding rating performance of RMBS securities during 2003 was largely due to a record level of prepayments that resulted from unprecedented low mortgage rates in the U.S. In addition, while there is concern about many areas of the economy, the housing market has been, and continues to be, very strong", notes the rating agency. Upgrades were noted in the European market as well.

Basle II on securitisation: BIS makes changes in proposals

As the Bank for International Settlements continues to inch its way toward finalising Basle II, set to replace the way in which and extent to which banks around the world maintain capital, there is already a quick idea of the far reaching changes related to securitisation. This is possibly the n-th time the proposals relating to securitisation have been amended. The initial draft of Basle II that came in mid 1999 had only a few paragraphs on securitisation, culminating in the latest consultative paper CP 3 which contained pages and pages dealing with securitisation. Implicitly indicating that the global banking supevisor does not have a handy tool to regulate the complex and highly innovative securitisation market, the latest set of proposals on securitisation indicate a high degree of acceptance of the demands made by securitisation industry.

In the consultative paper CP3, the computation of capital and capital relief in case of securitisation transactions where the underlyng assets were risk weighted under the internal ratings-based (IRB) approach was unduly complicated particularly in case of unrated exposures. There was a complex and recursive formula for working out the capital charge in such cases called supervisory formula (SF). The present changes simply the supervisory formula, and introduce a new approach called Internal assessment approach (IAA) in case of credit enhancements and liquidity support to ABCP conduits.

In addition, the changes also seek to introduce consistency between capital treatment applicable to an originating bank and that for the investing bank.

The proposals fortify the principle found in CP3 that the capital relief in case of securitisation will be applicable only where there is a risk mitigation by the originating bank.

The BIS has promised to "shortly" come out with the details of the changes.

Links For Vinod Kothari's article on the proposed changes, see here.

For full text of the BIS press release, click here.

Reading material A methodical discussion of the Basle II and other regulatory standards (upto CP3) is available in Vinod Kothari's book on securitisation. See here for details and orders.

Europe CDO volumes go synthetic

The European synthetic market has registered strong growth in 2003, and very largely, due to synthetic structures.

About 93% of European CDOs in 2003 were synthetic – up from 85% in 2002. Of that too, most synthetic CDOs were arbitrage transactions – with balance sheet transactions taking merely 5% of all.

Another prominent fact that underscores European arbitrage CDO growth is the prevalence of single-tranche synthetic CDOs – approximately 64% of the arbitrage issuance used single-tranche methodology. These trends, according to a recent report by Standard and Poor's, are likely to continue.

CDOs are essentially leveraged investment vehicles that invest in specific debt assets, either bonds or loans or similar obligations, with the objective of making arbitrage returns on the equity investment in the vehicle. Synthetic CDOs acquire these assets synthetically – that is, by selling protection under credit derivatives trades [see more on our site http://credit-deriv.com]. When a CDO acquires the assets off the balance sheet of a specific seller, it is a balance sheet transaction; where the assets are pooled from the market, it is an arbitrage deal. Single tranche synthetic CDOs are a relatively new product where the CDO issues only a specific tranche of investment product (credit linked notes) transferring risk of a particular level, and manages the rest of the risk using its own risk-management policy.

Another notably developing segment is the CDO of ABS, also sometimes called CDO squares. There were several issuances of CDO squares in both the cash and the synthetic segment.

A major concern in the CDO investments is the rating volatility – which is understandably for a highly leveraged product. The rating performance of European synthetic CDO transactions improved in 2003, with increasing numbers of upgrades toward the end of the year. To the end of November, 84 classes of synthetic CDOs were downgraded, representing 18% of the classes outstanding at the beginning of the year. This compares favorably with 28% for 2002. Moreover, 4% of classes received upgrades, compared with only 1% in the previous year. Overall, this brought the downgrade-to-upgrade ratio to 5.6x for the year to date, an improvement on 38.7x for 2002. It is noteworthy that this ratio improved to 2.5x for the second half of the year from 18.0x for the first half.

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

Workshops: Vinod Kothari offers standard as well as customised training courses, public and private, on CDOs. See our calendar of courses and contact us for any privately-tailored course.

CMBS company launched in the Gulf

A joint venture between three leading UAE banks has created a consortium for commercial real estate securitisation and mortgage lending. Dubai Islamic Bank, Istithmar and Island Capital Group have launched a major initiative which will draw in $1 billion in the next six months to boost mortgage lending and the local property sector.

The trio have linked up to set up Emirates National Securitisation and Finance Corporation (ENSFC). ENSFC will issue commercial mortgage backed securities (CMBS) that are listed and traded on regional and international markets, including the US and Europe.

Currently, mortgage securitisation, either residential or commercial, is conspicuous by its absence in the Gulf. There have been stray attempts at Islamic securitisation, but nothing to be of a globally noticeable scale. This itself should be surprising, given the fact that enormous amounts are invested by high net worth individuals based in the Gulf into US CDOs and private equity funds.

Asian securitisation market for 2004 look impressive: S&P

Rating agency Standard and Poor's (S&P) in its customary outlook of securitisation for 2004 evinced optimism. "Asia's debt markets will continue to be transformed in 2004 by securitization using innovative products for raising capital, alternative risk transfer, and the creation of customized investment opportunities. Moreover, Asia-Pacific, excluding Japan, has reached the stage in which the markets are finally primed to fully exploit the benefits of structured financings, especially synthetic structures and CDOs," says Diane Lam.

Talking specifically of the pockets of growth, S&P sees a revival of activity in Hong Kong, once viewed as the mecca of Asian securitisation, where the Lion Synthetic deal (synthetic securitisation of bus and taxi receivables) and several RMBS deals from HKMC were noted in 2003. The REIT activity, promoted by the recent law, might spur CMBS deals in the country.

The focus of attention in Asia was, however, Taiwan, where recent legislation resulted into clear spurt of activity all around – CLOs, RMBS, credit cards, etc. "Taiwan's securitization is quickly scaling the learning curve, and numerous new asset types are being considered", says S&P.

Singapore continues to be the hub of Asian securitisation, particularly in the synthetic sphere. Several CDO transactions hit the market in 2003 -, with OCBC Asset Management, UOB Asset Management, DBS Asset Management, ST Asset Management, and HVB Asset Management sponsoring transactions.

Philippines with some introductory transactions and the Malaysian market also look promising. 

A sad spot in this picture is the Korean credit card market where credit problems have already stranded some transactions.

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

Parmalat probe covers Citibank's ABCP conduit

If there is a fallen corporate or financial debacle, there might be a securitisation angle somewhere or the other. Enron exposed the special purpose vehicles, and Parmalat, it seems, is going to do a damage to asset backed commercial paper (ABCP) conduits. The Parmalat probe is examining whether there were sham sales of receivables by Parmlat affiliates to Eureka Securitization Plc, an ABCP conduit being run by Citibank.

Parmalat is the Italian dairy company that recently filed for bankruptcy – this case is popularly dubbed as the Enron of Europe. There are apprehensions that several billions of Euros are missing from Parmalat assets. At least 10 arrests have been made by Parmalat investigators so far.

Asset backed commercial paper conduits typically buy trade receivables of corporates. They are backed, and often liquidity-supported by banks, but most ABCP conduits are off the balance sheet (leave aside FIN 46) of the sponsoring bank. Eureka Securitization Plc and Eureka Securitisation Ltd are European ABCP conduits sponsored by Citibank.

The ABCP angle in Parmalat debacle is as under: there are apprehensions that Parmalat affiliates raised inflated invoices to create dummy trade receivables which were then sold to Eureka. This funding was used by the affiliates to create paper profits in Parmalat. There are reports of some 30 such affiliates having sold receivables to Eureka.

The Parmalat probe, in a brief period after Enron, exposes the susceptibility of securitisation conduits to sham deals. Truly, Citibank or Eureka would most likely be victims rather than perpetrators or accomplices in this fraud but the issue that would remain is one of vulnerability. Since ABCP conduits or securitisation vehicles are not banks and are not covered by mainstream banking discipline, can they be used by unscrupulous clients, possibly with the help of optmistic or aggressive bank officers, to acquire debts that the bank wouldn't have bought itself.

In the meantime, the BIS is currently meeting in Basle, Switzerland to complete the process of finalising BIS-II, which is likely to be affected by the shadow of Parmalat.

International accounting standard on de-recognition changed

There is an all-new accounting standard now that deals with accounting for financial instruments, and hence, rules relating to acconting for securitisation have also been changed.

Securitisation accounting in many countries earlier followed an international accounting standard called IAS 39, issued by International Accounting Standards Board. Proposals were issued several months back in form an of exposure draft for re-writing of IAS 39 (and a related accounting standard on presentation, IAS 32). The revised IAS 39 was issued in late December. The revised standard is applicable for accounting periods beginning on or after 1st Jan 2005.

IAS 39 deals with both derivatives accounting and de-recognition. De-recognition is applied for most securitisation transactions, as these transactions relate to sale of financial assets. De-recognition principles determine whether and when financial assets should be removed from books on their sale.

The rules relating to securitisation partly introduce a new approach, and partly amplify the existing guidance on fractional transfers, computation of gains on sale, etc. A significant change is the synthesis of the approach based on transfer of risks and rewards, characteristic of the UK standard FRS 5, and that based on surrender of control, found in the US standard FAS 140. The revised IAS 39 applies both these approaches, in a step function.

A quick note by Vinod Kothari on the provisions relating to securitisation is here. We will come out with more material in due course.

Links For more on accounting for securitisation, click here.

Revised FIN 46 issued

The US standard setters have re-issued accounting interpretation FIN 46 applicable to variable interest entities. The full text of the revised interpretation is available on FASB website – click here

The accounting standard on variable interest entities has been as obscure as variable interest entities themselves. Shortly after its promulgation, various doubts began to appear leading to several clarifications in form of staff positions. Lots of issues were debated and discussed, and finally the Board decided to reissue the interpretation.

The Board explains the revised statement as intended to provide more guidance required on the subject. The revised statement runs over 92 pages including 6 appendices.

Links For more on FIN 46, see our page here.

FIN 46 in for a rewrite

Neither the standard-setters nor the standard-followers have had any sleep at all on accounting for special purpose entities. With several FSPs relating to several issues on FIN 46, we are going to have a new FIN 46, to be called FIN 46-R.

At its recent meeting, FASB decided by a 5 to 2 vote to proceed towards issuance of an FASB Interpretation which will be called FIN 46-Revised (FIN 46-R), by the end of December. There was open acknowledgment that the SEC strongly urged fasb that fin 46-R be effective this year-end for public companies, with the exception of small business issuers.

Public companies who are not small business issuers must apply the provisions of either fin 46 or fin 46-R, at their choice, to all variable interest entities of the type that would have been considered to be “SPEs” under EITF D-14, 96-12, etc. at the end of the first interim or annual period ending after December 15, 2003 (in other words, 12/31/03 for calendar year public companies who are not small business issuers). If the company elects to apply fin 46, rather than fin 46-R, there would have to be a true-up at the end of the first quarter of 2004.

Public companies who are not small business issuers would have to apply the provisions of fin 46-R to all variable interest entities of the type that would not have been considered to be “SPEs” under EITF D-14, 96-12, etc. (i.e. operating entities that do not qualify as voting interest entities) no later than the end of the first interim or annual period ending after March 15, 2004 (in other words, 3/31/04 for most public companies who are not small business issuers).

Earlier application is encouraged and restatement of prior period financial statements is permitted but not required.

The transition rules applicable to public companies who are small business issuers and to private companies will be described in a notice to be posted to the FASB website. [Source: Martin Rosenblatt]

We will be tracking and putting a link to the notice on this site.

Vinod Kothari comments: I am aware that it is not for the first time that I am saying this, but it is important to say. In the labyrinth of rules relating to special purpose entities, we seem to have lost track of some very basic issues. "Do we need those special purpose entities at all?", is a more fundamental question than "do we need separate set of rules for special purpose entities". After all, special purpose entities are not structurally different from other business entities. If they are needed, it is time to create a separate orgainsational structure called "special purpose entities". If they are not structurally different from other entities, there is no scope for a discrimination in the rules that apply to these and other business entities. For example, if the accounting rules recognise, as FIN 46 seeks to do, that beneficial interest in the company is different from its legal equity, then the legal equity is a myth and should be ignored for all purposes, not merely for accounting purposes. At the same time, if the legal equity in commercial entities does not represent its beneficial ownership, there is no reason why the legal equity should still be the basis for consolidation of those entities.

Joint stock companies emerged sometime in the 16th century: and since then, we have still had the same forms of business organisations. If a new organisational forms such as special purpose entities are needed, they need to be created as distinct organisational forms, not merely a company that is treated differently for accounting purposes.

Links For more on FIN 46, see our dedicated page here. For more on accounting issues, see our page here.


April 2005 to March 2007

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Subprime debacle hardly surprising, says paper

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.

Trade bodies release draft of self-regulatory non-mandatory guidelines
for retail structured products

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.

Home equity down surely,
but ABS volumes are almost unfazed in Q1, 2007

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.

New Century files for bankruptcy

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.

Subprime mortgages – is it a mere correction or the start of apocalypse?

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.

Junk mortgages now become a global worry

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.

Prices sink and worries soar in the home equity securitization market

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.

Researcers claim securitization accounting used
for cosmetic quarterly results

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.

Links For more on accounting for securitization, see our page here. Get a copy of the above articles form SSRN here.

Apprehended home equity losses puncture ABX.HE index

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

UK Court of Appeal discusses trustees’ rights in securitisation deals
Significant ruling for non-discretionary trusts

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 [2007] 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.

London Heathrow to be pledged in the largest whole business securitisation deal

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.

Cracks in foundation for consumer credit

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..

US financial regulators issue statement on
Complex Structured Finance Transactions

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.

Mortgage backed securities start trading in Russia

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.

Links See our country page on Russia here. Our earlier report on this is here.

There is nothing like true asset-backed security:
Moody’s report reveals sponsors do impact ratings

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.

Ramifications of housing price deflation worry securitization deals

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 poised for a sharp growth

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


[This page lists news and developments in

International securitisation markets – please

do visit this page regularly as it is updated

almost on a daily basis.]


All news added on or after 9th November has been posted in a separate page – click here 

For News items added prior 3rd August, 1999, click here to access

Read on for chronological listing of events, most recent on top:

  • Largest franchise loans securitisation deal 
    Added on 5th Nov., 1999 
    Franchise Finance Corporation of USA recently closed a franchise loan securitisation deal which is the largest issue of its kind so far.
  • Malaysia to scrap stamp duty on securitisation 
    Added on 5th Nov., 1999 
    In a bid to encourage securitisation, Malaysian Budget 2000 proposes to scrap stamp duty on real estate securitisation from Oct 31 onwards.
  • Securitisation changing the face of retail lending in Europe 
    Added on 28th Oct., 1999 
    The decision of Abbey National to securitise large part of its mortgage portfolio is only a signal of the changes securitisation is surely and steadily causing to mortgage lending in Europe.
  • Lehman Re pools catastrophe risk for securitisation 
    Added on 28th Oct., 1999 
    This is a further remarkable development in the risk securitisation market – Lehman Re has acquired catastrophe risks, and intends developing a portfolio, similar to Fannie Mae in the USA, for securitisation.
  • After cat bonds, it is weather bonds now 
    Added on 28th Oct., 1999 
    Two US companies, Enron and Koch Industries, are in the market with bonds that seek to protect against weather risks. Though they are finding it difficult to market the offer, it surely indicates a move that would lead to development of risk securitization.
  • New York launches tobacco bonds 
    Added on 28th Oct., 1999 
    As was predicted in the news item yesterday, New York has announced USD 700 million worth tobacco bonds.
  • Pakistan Telecom deal downgraded 
    Added on 27th Oct., 1999 
    Political uncertainty in Pakistan has led to downgrading of the Pakistan Telecom future flows securitisation transaction by Duff and Phelps..
  • Mortgage securitisation takes off in Hong Kong 
    Added on 27th Oct., 1999 
    Securitisation of mortgage loans by Hong Kong Mortgage Corporation has taken off with an inaugural issue of mortgages originated by Dao Heng Bank..
  • US Tobacco bonds rated A by S&P 
    Added on 27th Oct., 1999 
    The tobacco bonds to be issued by various US states have been rated A by Standard and Poor – this will now clear the way for issue of tobacco bonds.
  • UK infrastructure owner to securitise rent income 
    Added on 27th Oct., 1999 
    Railtrack, railway infrastructure owner in the UK, proposes to securitise rental income from arches it has rented out.
  • Abbey National to launch 4 billion stlg MBS issue 
    Added on 12th Oct., 1999 
    Abbey National, a UK-based mortgage bank, is to launch a 4 billion pound mortgage-backed bond issue to take approximately 10% of its mortgage portfolio off its books.
  • Barclays Bank to launch European credit card securitization 
    Added on 12th Oct., 1999 
    Barclays PLC is to launch a credit card securitisation bond issue of 1 billion pounds, close to 1.66 billion USD, which would be the largest issue by a European issuer.
  • Fully electronic mortgage lending closes legal documentation in 5 hours 
    Added on 8th Oct., 1999 
    This could well be a major innovation leading to e-commerce – legal documents leading to creation of mortgages and lending thereon can now be completed in totally electronic format and the whole process would take just 5 hours, instead of 45 days in the manual mode.
  • New York to issue tobacco settlement bonds in November 
    Added on 8th Oct., 1999 
    The New York City's the Tobacco Settlement Asset Securitization Corp. proposes to issue USD 680 million bonds backed by tobacco settlement dues in November this year..
  • Model Cat bonds law approved in USA 
    Added on 7th Oct., 1999 
    A report says that the National Association of Insurance Commissioners have approved a model law for Catastrophe bonds for the USA.
  • Pakistan to have SPV law by end of October 
    Added on 4th Oct., 1999 
    A report in Business Recorder, a Pakistani financial paper says Pakistan's securities regulator has constituted a body to finalise securitisation SPV law by end-October.
  • Ever heard of securitisation of air? 
    Added on 1st Oct., 1999 
    This really has nothing to do with securitisation in the sense capital markets view it, but next time, someone talks about securitisation of air, you should not be stunned.
  • Italian bank to securitise all its non-performing assets 
    Added on 1st Oct., 1999 
    Italian securitisation market continues to be 4th gear with major securitization deal by yet another bank – Italfondiario SpA.
  • Mexican steel company defaults on future flow securitization 
    Added on 29th Sept., 1999 
    This is apparently the first case of default on future flow securitization – Ahmsa, a Mexican company recently defaulted on a future flow securitization of export receivables.
  • Obligations fonciers in France on recent legal support 
    Added on 28th Sept., 1999 
    The French mortgage securitisation product, obligations foncieresis coming of age. In this report, we discuss salient features of this market, the law that backs them, and compare them with US pass throughts and German pfandbriefe.
  • CIBC World Markets named best securitisation bank in Asia 
    Added on 28th Sept., 1999 
    Journal Global Finance  has named CIBC World Markets the best bank for securitisation and was handed over an award at the IMF/World Bank meeting in Washington on 27th Sept.
  • Securitisation of exchange risks holds potential: Peter Drucker 
    Added on 25th Sept., 1999 
    The noted management and business economics expert, Peter Drucker, sees potential in securitisation of foreign exchange risks and in outsourcing financial arrangements for mid-sized firms. Drucker stresses on the need for innovation in financial services, in an article in The Economist, Sept. 25, 1999.
  • Yet another bank goes bust on securitisation accounting lapses 
    Added on 25th Sept., 1999 
    The reasons for the collapse of First National Bank of Keystone included, according to FDIC, wrong accounting for residuary interests in securitised loans.
  • CRIIMI MAE applies for reorganisation 
    Added on 25th Sept., 1999 
    CRIIMI Mae, the US commercial mortgage securitisation company that filed for protection under Chapter 11 has now applied for reorganisation.
  • David Pullman securitises Ron Isley catalogs 
    Added on 25th Sept., 1999 
    The father of music industry securitisation, David Pullman, has pulled Ron Isley's catalogs into his Pullman Bonds series, with over 200 songs in it.
  • DCR sees potential in Indian securitisation market; identifies problem areas 
    Added on 23nd Sept., 1999 
    Duff and Phelps Credit Rating recently released a report on securitisation market in India: a market that has a lot of potential but still constrained by several trifling problems.
  • Bank closed for securitisation accounting fraud 
    Added on 22nd Sept., 1999 
    A bank that did not remove from its balance sheets loans which had been securitised has been closed by US bank regulators.
  • First tax ruling on FASIT law 
    Added on 22nd Sept., 1999 
    This is the first-ever ruling on the US FASIT law, and it would have far reaching impact on tax treatment of investors in FASIT-based securitizations.
  • First soccer revenues securitisation 
    Added on 22nd Sept., 1999 
    In the first reported case of soccer club revenues, a UK football club sold its future ticket sales and corporate hospitality receipts.
  • Pakistan International Airlines in the first domestic future flows securitisation 
    Added on 21th Sept., 1999 
    In a remarkable development, Pakistan International Airlines has signed a Rs. 3 billion future flows securitisation with Citibank.This is reportedly a local future flows securitisation of aviation revenues.
  • First securitisation of personal credit receivables in Canada 
    Added on 21th Sept., 1999 
    Bank of Nova Scotia, Canada will use a special purpose trust to securitise its personal credit receivables in a transaction priced at $ 905 million.
  • World Bank to promote securitisation in Bangladesh 
    Added on 21th Sept., 1999 
    The World Bank on 20th Sept. announced a USD 46.9 million credit to Bangladesh for development of financial institutions in the country – this includes a proposal to promote securitisation by such institutions.
  • FASB issues technical bulletin on consolidation of SPVs 
    Added on 21th Sept., 1999 
    The US FASB has issued the draft of a Technical Bulletin to clarify situations in which consolidation of securitisation SPVs will be made with the originator. This report also gives link to the FASB site for downloading the FASB document.
  • Philippines to securitise amusement park revenues 
    Added on 20th Sept., 1999 
    The Philippines government proposes to issue asset-backed notes in the last quarter with revenues from an amusement park and a gas project under implementation.
  • Massive bank securitisation deal in Italy 
    Added on 20th Sept., 1999 
    Reports indicate that an Italian bank Banca Nazionale Del Lavoro is planning securitisation of Lira 3000 billion – this would certainly be the largest deal in Italy, and perhaps the largest single transaction in Europe.
  • Explosive growth in Japanese securitisation 
    Added on 20th Sept., 1999 
    Japanese securitisation market is witnessing explosive growth and analysts contend that the level of interest is even higher than was seen in USA in early 1990s.
  • Gain on sale accounting confounding finance companies' accounts 
    Added on 17th Sept., 1999 
    A recent article in American Banker Online claims that upfront recognition of gains on securitisation as per FASB 125 is confounding financial statements of companies that are regularly into securitisation.
  • US MBS issuance in first half '99 exceeds USD 400 billion 
    Added on 16th Sept., 1999 
    Volumes in agency mortgage-backed securities in the USA surged in first half of 1999 to over USD 400 billion, registering a 29.6% increase over comparable period in the previous year.
  • Charles Schwab to set up mutual fund to invest in asset-backed market 
    Added on 16th Sept., 1999 
    Indicating the increasing investor demand for diversified ABS portfolio, Charles Schwab, the noted US fund manager, has unveiled plans to set up a mutual fund to invest in mortgage and asset-backed securities..
  • Thailand Secondary Mortgage Corporation starts buying mortgage loans 
    Added on 16th Sept., 1999 
    The Secondary Mortgage Corporation of Thailand, modelled on the pattern of US Fannie Mae, has started acquiring mortgage loans for the purpose of securitising them.
  • Asian securitisation yet to gather pace 
    Added on 10th Sept., 1999 
    The securitisation market was completely snuffed out in the Asian crisis of 1997, and while there are strong recovery signals in equity and debt markets, securitisation is yet to emerge from the shadows where it was consigned..
  • Re-insurers in securitisation 
    Added on 10th Sept., 1999 
    A report in Financial Times recently discussed how re-insurance companies are taking increased exposures in credit risk insurance thereby helping securitisation.
  • And securitisers in re-insurance 
    Added on 10th Sept., 1999 
    Read this news with the one right above, and you see a fusion of insurance and capital markets – a recent article in Financial Timestakes a look at how securitisation is serving a notice to traditional reinsurers.
  • Italy the new mecca of securitisation 
    Added on 22nd August, 1999 
    A feature on CNN recently carried a detailed report on how securitisation is capturing tremendous interest in Italy.
  • India's apex housing finance body to try pilot mortgage securitisation 
    Added on 18th August, 1999 
    National Housing Bank, India's apex mortgage finance body, may soon come out with a pilot project of mortgage securitisation, as various taxation bottlenecks are being removed.
  • Downgrades galore in US ABS markets 
    Added on 18th August, 1999 
    The rate of downgrades in US ABS market is alarming, and there is a new trend visible – downgrades due to internal weaknesses in the portfolio.
  • US mortgage financiers taking over UK market 
    Added on 17th August, 1999 
    David Pullman, the father of intellectual property securitisation who first brought Bowie Bonds to the Wall Street considers his own IPO.
  • David Pullman to bring IPO 
    Added on 16th August, 1999 
    David Pullman, the father of intellectual property securitisation who first brought Bowie Bonds to the Wall Street considers his own IPO.
  • First ABS transaction in Poland 
    Added on 14th August, 1999 
    BRE Bank, based in Warsaw, Poland recently launched the first ABCP deal in Poland. This is also reportedly the first ABS transaction in the country.
  • Why mortgages do not attract capital in China 
    Added on 13th August, 1999 
    In sharp contrast to United States, lenders in mainland China do not love mortgage lending – this article in South China Morning Postexplores reasons which include poor mortgage foreclosure laws.
  • Hong Kong Mortgage Corporation to issue RMBS 
    Added on 10th August, 1999 
    The Fannie-Mae type body set up by the Hong Kong authorities has already begun acquiring mortgage receivables and is likely to issue RMBS in last quarter.
  • New political insurance product to boost emerging market investments 
    Added on 10th August, 1999 
    Overseas Private Investment Corporation has launched a political risk insurance which will enable emerging market corporates to substantially eliminate sovereign risk.
  • US ABS volumes rise marginally in first half of 1999 
    Added on 6th August, 1999 
    The ABS volume in USA grew about 4.5% in first half of 1999, while growth outside USA has been very impressive.
  • CMBS volumes are falling 
    Added on 6th August, 1999 
    There is a fall in volume of commercial mortgage backed securities and the total issuance is 1999 is expected to end up about 25% lower than volumes last year. 


Largest franchise finance securitisation

Franchise Finance Corporation of America priced and sold approximately $607 million of secured franchise loan asset-backed securities. The securities are backed by 996 loans originated by FFCA, all of which were held in a loan sale facility with a third party pending securitization. The loans, having an outstanding aggregate principal balance of approximately $674 million, include 929 chain store mortgage loans, 61 chain store equipment loans, and six commercial loans secured by real estate, equipment or other property related to the operation of chain store facilities.

This is the largest reported transaction in franchise loans segment.

Malaysia to scrap stamp duty on securitisation

Malaysian government presented Budget 2000 which is hailed as expansionary and growth oriented. Among a number of measures to boost capital markets, there is a proposal to encourage companies to opt for securitisation.

Securitisation involves transfer of receivables for which the instrument of assignment to be executed is currently subject to stamp duty at ad valorem rates and if the asset involves real property, real property gains tax (RPGT). Budget 2000 proposed that the instrument used in the transfer of assets be exempted from stamp duty and RPGT from October 30 1999 to December 31 2000.

For details of securitisation activity in Malaysia, see our country profile – link on the Index page.

Securitisation changing the face of retail lending in Europe

Abbey National recently decided to securitise a large chunk of its mortgage loans portfolio – see news item below. This was only an indication of the steady but sure change securitisation is bringing about in mortgage lending in Europe. A report in European Report of 27th Oct says that to keep their low-cost competitive edge, direct mortgage lenders are being impelled towards securitisation to raise their funding. Also, retail banks will be pushed in the same direction. They have traditionally raised much of their funds for retail lending by taking retail deposits. But recent entrants into the personal deposit market – particularly with the emergence of banking activities by non-bank operations with high consumer throughput, such as supermarkets – are absorbing much of the traditional banks' traditional deposit sources, forcing them to raise their interest rates to attract savers, or to seek alternative funding sources. In addition, the booming consumer credit market across much of Europe is also pushing banks to clean up their balance sheets as much as possible so they can take advantage of the boom – and securitisation offers them a way to do this.

With the advent of the Euro, the potential for securitisation has tremendously gone up in Europe – the size of the potential Pan-European market is now being estimated at 1 1/2 times that of USA.

This site has comprehensive resources on securitisation in Europe. An editorial is devoted to Europe – see the front page. See also the Index page for country profiles and a special write up on Europe. 

Lehman Re to pool and securitise risks

This is application of the mortgage-backed securitisation technique to cat bonds, and the result is a unique product that would be securitisation of a bundle of risks, not just one risk. In a ground-breaking move for the Lloyd's market, a syndicate has reinsured a substantial property catastrophe exposure with Lehman Re, based in Bermuda, for onward securitisation in the capital markets.

Due to its structure as a reinsurance company, unlike many corporate finance players involved in such deals, Lehman Re does not have to transform the risks which it underwrites into a capital market product immediately in order to pass it on to investors. Instead, it can hold risk like a conventional reinsurer and gather together a portfolio of similar risks from different cedants until sufficient scale has been achieved to warrant a securitisation. In this way, Lehman Re is using a similar concept to that which was used by US mortgage lenders in the very early to mid-1980s and British mortgage lenders in the mid- to late-1980s, when mortgage-backed securitisations first started to take off.

For references to further materials on cat bonds, see the news item exactly below this.

After cat bonds, it is now weather bonds

Some say they are in rough weather as they have not been finding investors. But it surely indicates a new development in risk securitisation technlogy that was first developed in the catastrophe risk insurance market.

Two US companies, Enron and Koch Industries are in the market with weather bonds, which pass on to the investors weather-related risks. The technlogy is the same as has been used in case of cat bonds some years ago. [See the Risk securitisation section of this website for more article and links on cat bonds. See also several news items on this page].

Enron, based in Houston, provides weather risk management services to clients such as snowmobile manufacturer, an ice-cream maker and a computer services company. Koch is based in Kansas.

Enron's Dollars 105m deal is being underwritten by Merrill Lynch. Koch Industries' USD 200 million offer is underwritten by Goldman Sachs.

Reports in Financial Times 27th Oct. indicate that both the issues have not found active investors interest, perhaps due to a complex set of instrument features, and possibly because they are in the market at almost the same time.   

 New York announces tobacco bonds

A groundbreaking deal in issue of tobacco bonds has been announced by New York to open on 3rd November. We predicted yesterday (see news item below) that with S&P rating already in place, New York may be the first to issue the bonds.

Tobacco bonds represent securitisation of the sums that major tobacco companies in the USA will pay to the governments of 46 States as a settlement of the court suits against the tobacco companies. This site contains more details of tobacco bonds – click here and here.

The issue, which would be the first of its kind, is likely to be followed shortly by Nassau County in New York state, which desperately needs the funds to plug a hole in its finances.

Pakistan Telecom securitisation downgraded

The political uncertainty has taken its toll on the only future flow deal already transacted so far by Pakistan Telecom. Duff and Phelps has downgraded the transaction from BB+ to BB with rating watch down.

The downgrade reflects the increasing financial pressures that could arise out of the current political situation in Pakistan, namely the potential loss of multilateral loan disbursements, as well as the uncertainty regarding the government's ongoing debt reschedulings.

The rating agency believes that the transaction might weather the current stress through which Pakistan is passing.

This website contains ample resources about securitisation activity in Pakistan – see Pakistan country profile on the Index page and the draft rules for securitisation on the Securitisation laws page.

Mortgage securitisation takes off in Hong Kong

The Hong Kong Mortgage Corporation has begun securitisation of mortgages. The inaugural transaction was launched on 23rd October with the Corporation buying mortgages originated by Dao Heng Bank. Under the agreement, Dao Heng will sell eligible mortgages on a back-to-back basis to the corporation, which will transfer them to a special-purpose company, the HKMC Funding Group. The company will then issue the securities to Dao Heng Bank, with a guarantee from the corporation for timely payment of principal and interest. Dao Heng can keep the securities as part of its investment portfolio or trade them with professional institutional investors.

The corporation has plans to issue USD 5 billion worth of securities collateralised on mortgage loans next year.

Click here for an earlier news about RMBS issues in Hong Kong.

Tobacco bonds rated A by S&P

The tobacco bonds that securitise the tobacco settlement proceeds payable by 4 leading tobacco companies to various US states have been rated A by Standard and Poor. 46 US states are to receive USD 205 billion in tobacco settlements.

See earlier reports on tobacco bonds – click here and here.

Nassau County in New York state and New York City are expected to be the first to issue the tobacco-backed bonds, with many of the 46 states involved in the settlement waiting in the wings. Nassau County urgently needs the funds to plug a gap in its finances, and is already said to be marketing a Dollars 275m offering to investors.

UK infrastructure owner to securitise rent income

Railtrack, owner of the UK's rail infrastructure, is studying plans to raise up to pounds 400 million by parcelling up the rents it receives from 6,000 arches in south-east England and swapping that income stream for a lump sum.

Rents from the arches traditionally used by motor mechanics, small engineers and businesses unconcerned by condensation and lack of light total around pounds 40m a year. The money raised in the form of a securitised bond would be used for improving the rail network.

Abbey National in 6.5 billion USD MBS issue

Mortgage-securitisation wave hitting UK market

Abbey National, a leading mortgage bank in the UK, is to launch a 4 billion pounds mortgage-backed securitisation issue, in a bid to free up about 10% of its balance sheet portfolio of mortgages.

The bank is planning to bring a series of MBS issues spread over the year. The bond issues will allow Abbey to free up extra capital and reduce the cost of funding mortgages. Abbey is understood to be planning to use securitisation, which is widely used in America, to allow it to offer a range of new and more competitive products, reports The Sunday Telegraph.

The trend to securitise mortgage loans is catching up fast among British housing financiers. Last month Northern Rock, the former building society turned bank, launched a £600m mortgage securitisation, giving it a new source of funding and the chance to increase its share of new lending. Woolwich has also announced a joint venture with Countrywide Credit, the American lender, to securitise mortgages. 

Barclays Bank to launch largest European credit card securitisation

British banking group Barclays Plc is set to launch a bond secured against debt owed by customers of its credit card subsidiary, based on a report in the Financial Times.

The bond issue is likely to be 1 billion pounds, or 1.66 billion USD which makes it the largest issue by a European issuer.

Market analysts feel that this is only the first of what will be a series of securitisation issues by European banks.

Fully electronic mortgage lending announced

Legal documents completed over the Net in 5 hours

eOriginal Inc. announced on 7th October the implementation of a fully electronic creation, processing, recording and closing of a mortgage transaction that takes 5 hours flat, whereas the same process in the manual mode takes 45 days and costs USD 750 per deal more.

This patented legal documentation procedure creates legally enforceable mortgage rights and completes the required public recording of documents, in a completely electronic form, via the Net. The pilot project was carried out in Florida, USA and is the first electronic creation of a mortgage document.

The pilot program envisages an Electronic Original mortgage paper. The mortgage documentation was delivered via the Internet to the consumer who signed all the traditional forms for the mortgage and conveyance of the home, but the signing was performed online–not with pen and ink. The deed and mortgage instruments were then transmitted on the Internet to the Broward County Recorder's Office where they were registered. Once recorded, the Electronic Original documents were returned to the consumer and instantly accessible on the mortgage recording  system, via the Internet, to secondary market participant GMAC-RFC. While all homebuyers elected to receive a paper copy of loan closing documents, the authoritative Electronic Original documents were stored digitally in a trusted repository.

For more about e-original's Internet-based work, click on their website –http://www.eoriginal.com 

 New York to issue tobacco bonds in November

The New York City local body formed specially for the purpose of securitizing tobacco settlement proceeds,  Tobacco Settlement Asset Securitization Corp. , proposes to issue USD 680 million worth bonds in mid to late November this year. The agency is likely to issue circulars regarding the forthcoming offer today, that is, 8th October. The agency will hold road shows during the third week of October.

Salomon Smith Barney will serve as book-running senior manager on the agency's initial bond issue. Bear, Stearns &Co., J.P. Morgan & Co. will be co-senior managers on a rotating basis. In addition, the designated senior co-managers are Goldman, Sachs & Co., Morgan Stanley Dean Witter and PaineWebber Inc.

The tobacco settlement is the result of litigation against 4 major tobacco companies which resulted into a settlement on Nov 23, 1998. According to the temrs of the master settlement agreement, the tobacco majors are to pay $206 billion over the next 25 years to 46 US states.

For more news on the tobacco bonds, click here.

Model Cat bonds law approved in the USA

A report on BestWire says that the National Association of Insurance Commissioners have approved, recently in Kansas City, a model law for catastrophe bonds. This law is a model law, supposed to be enacted by individual states.

The law would make it possible for US insurance companies to use securitisation SPVs to sell re-insurance contracts to the capital markets using the catastrophe bond instrument. The model law among other things also clarifies the tax issues on such bonds.

Reports indicate that the model law is similar to the one already enacted by Illinois in July.

Catastrophe insurance securitisations originate from the United States but are mostly carried through jurisdictions like Cayman Islands for tax reasons.

This site has comprehensive resources on insurance risk securitisation.Click here to visit section on insurance risk securitisation. Click here to read briefly about what are cat bonds.

Pakistan to have SPV laws by month-end

Business Recorder dated 4th October 1999 reports that Pakistan's Securities Exchange Commission (SECP) has constituted a board under the chairmanship of the head of Pakistan Credit Rating Agency to finalise securitisation rules for the country by the end of October '99.. Under these rules, it is likely that securitisation SPVs will be organised as companies under the Companies Ordinance and will issue debt securities in the nature of term finance certificates to investors. Withholding tax will also be applicable to the payments made by the SPVs. The securities issued by the SPVs will be allowed to be listed on recognised stock exchanges.

Analysts see a Rs. 16 billion potential in securitisation business in the country, taking care of receivables of modarbas, leasing companies, credit cards, housing finance etc. Obviously, the volume does not take into account the tremendous potential in bank securitisation and future flows securitisation.

More on securitisation in Pakistan: Draft rules earlier framed by the SEC Pakistan are on our securitisation laws section  – click here to visit. See also our country profile on securitisation in Paksitan – click here. News about Pakistan International airlines securitising its receivables was flashed on this site – click here

Securitisation of air !

Exchanges trading in securitised "rights to pollute"

About a couple of years ago, a journalist said – Wall Street can securitise anything! He did not mean air, but it is a fact that clean air and environment are being securitised and traded on commodities exchanges.

The concept goes something like this -the State or a private initiative makes investments in forests. The investment is funded by issuing emission credits or sequestration credits in form of units or securities. Typically, one credit certificate allows the holder to pollute the environment equal to 1 ton of carbon dioxide. These credits are bought by highly polluting industries. Therefore, the more the required emission by an industry, the more the number of certificates it exhausts. The purchase of credits or creation of credits by investing in forests is the creation of a "pollution asset" or the right to pollute, and the actual emission of gases into air is the consumption of the credits. Hence, there is placed in the market a security representing clean air, used by leaving unclean air.

Recently, the Sydney Futures Exchange announced plans to allow trading of such certificates. Already, trading in these certificates is on on the Chicago Board of Trade.

A few years ago, Costa Rica, by agreeing to protect a portion of its rainforest from logging, issued certificates that bestow the right to pollute.

So, in some time, clean air will be a product to be traded in, hoarded and speculated!

Italian bank to securitise its non-performing loans

Earlier on this page, we have reported fervent activity in securitization taking place in Italy. The Italian newspaper IL SOLE 24 ORE reports that Italfondiario SpA, the Italian bank that deals with credit and leasing, is to securitise all of its non-performing credits, worth around L2,500bn, with the assistance of Greenwich Natwest Ltd.

More on securitisation of non-performing assets in Italy  – On our Italian securitisation page, new inputs have been added dealing specifically with securitisation of non-performing assets in Italy. 
Click here to visit.

Mexican company defaults on future flow securitization in a first noted case of default

No securitization structure is iron-clad, and investors must appreciate the risks, particularly the legal fragility of the structure, before exposing themselves.

This is a loud and clear signal from the recent case of default on a securitization of future flows. Ahmsa, a Mexican steel company had securitised future export receivables in a transaction worth USD 300 million. The company recently defaulted on the deal. This was an unrated securitisation transaction.

Generally speaking, in asset-backed securitization, investors would not be concerned with the default or distress of the originator – however, not so in case of future flow securitization. In future flows deal, investors are exposed to risk of performace of the originator, as also possible action, deliberate or forced, in diverting the exports to an entity which has not affirmed the deal. Typically, in export receivables securitization, the originator assigns future revenue from export proceeds from importers. The importers abroad sign an acknowledgment of the assignment thus binding them to pay to the overseas collection account. If the exporter diverts the exports to other importers, who have not given any such acknowledgement, legally they cannot be bound to pay into the collection account as the assignment of a future flow takes place only prospectively and does not create rights of the investors against the obligors.

The irony is that in such a situation, the investors may not even have a fall-back option against the originator's assets.

The above case of default is the first reported instance of a future flow securitization deal going bust, and may be it is only such difficult situations that the legal strength of such transactions can be tested.

Oligations fonciers developing in France

Recent legislation responsible for the development

Obligations fonciers (OFs) are French mortgage-backed securities. These on-balance sheet debt securities are essentially mortgage-backed bonds, with the important feature that the bondholders have a issuer-bankruptcy-protected right to the mortgages. OFs are issued by Societé de Crédit Foncier (SCF), a specialised lending institution. SCFs have a restricted sphere of operation to acquiring and granting of mortgage loans only. OFs are essential debt securities and they appear on the books of the SCF, unlike the US mortgage pass throughs. In this sense, OFs are similar to German pfandbriefes.

The legal framework for SCFs and OFs is set out in Law 99-532 of June 25, 1999 relating to savings and financial security, published in the Journal Officiel on June 29.

The quality of the loans originated by SCFs is tightly regulated by law: for example the loans have to be secured by first mortgage on real estate, with a certain minimum loan-to-value ratio. Regulations are also in place to control the asset liability mismatches, reporting, real esatate valuation, etc.

SCF under law is a separate entity, distinct from its owner or manager. The law provides a protection that the bankruptcy of the owner of the SCF cannot lead to the bankruptcy or liquidation of the SCF. Upon the bankruptcy of the manager of the SCF, the management contract can be assigned to another manager. The bondholders are priority creditors and other creditors have a suboridinated claim over the assets of the SCF.

The supervision of SCF is primarily with the bank supervisory body, Commission Bancaire.

Two issues of OFs are notable in France: Crédit Foncier de France and Crédit Foncier et Communal d'Alsace et de Lorraine.

For more on securitization in France, refer to the country profile on our Index page – click here to visit.

CIBC named best securitisation bank in Asia

Global Finance has named CIBC World Markets the "Best Bank in Securitization in Asia". The award was made to David Bonsall, Head of International Securitization on behalf of the firm at a ceremony held today at the IMF/World Bank meeting in Washington. Global Finance canvassed its readers and did extensive research among major users of banking services and analysts who follow the banking sector in order to select CIBC.

CIBC set up its Singapore office in 1998 and currently has over 100 professionals looking after securitisation.

Securitisation of exchange risks holds potential: Peter Drucker

Visionary guru laments lack of innovation in financial services

The noted management guru Peter Drucker has written an article in The Economist [25th Sept., 1999]  where he feels there is tremendous potential for someone assimilating exchange rate risks and securitising the same.

Innovate or die, says Drucker, who is going to celebrate his 90th birthday this November. The guru of what he calls "creative self-destruction" ( a modification of the famous phrase coined by Schumpeter)  laments the fact that over past 30 years in the financial services industry, there has been no major innovation except the euro-dollar and the euro-bond, which were essentially forced by regulation. Credit card was the third major innvoation of our times. Drucker, however, does not regard derivatives as any sustainable innovation, since these are "not designed to provide a service to customers. They are designed to make the trader’s speculations more profitable and at the same time less risky—surely a violation of the basic laws of risk and unlikely to work. In fact, they are unlikely to work better than the inveterate gambler’s equally "scientific" systems for beating the odds at Monte Carlo or Las Vegas—as a good many traders have already found out."

Talking of the opportunities for innovation, the visionary management thinker gives examples of 3 possible areas of innovation: 2 out of the three involve securitisation.

Drucker sees potential in outsourcing the financial management of medium sized enterprises. These enterprises form the backbone of most economies, and it is common today for most of them to outsource their EDP, housekeeping, routine personnel management, etc. "How long will it be before they are ready to outsource the management of the money in their business?", asks Drucker.

There lies an opportunity: "The rewards for building a firm providing these medium-sized businesses with financial management might be enormous—not only from fees but also through substantial profits from "securitising" the financial needs of the clients, ie, converting them into investment products that should be particularly attractive to the ageing middle-class "retail" investor."

The other opportunity lies in assimilating catastrophic exchange risks and securitising them: devising "financial instruments that protect a business against catastrophic foreign—exchange losses by converting currency risks into an ordinary cost of doing business, with an affordable and fixed premium, maybe no more than 3-5% of a firm’s currency exposure." A firm that provides such catastrophe risk protection "would also be able to "securitise" its portfolio and thereby create attractive investments for the new financial retail market."

For full text of the article, go to The Economist website: click here.

Yet another bank goes bust: securitisation accounting lapse cited as reason

We had recently carried, on this site (click here), news of a bank forced to close by regulators due to a faulty securitisation accounting practice. We had also carried extracts from an article that US banks are not as healthy as they look, as they have securitised their prize assets and are possibly sitting on inferior quality assets. A similar concern was expressed in case of finance companies.

Here is yet another case of bank going bust: First National Bank of Keystone. In this failure that is going to cost the government upto USD 800 million, the FDIC blamed the unusually high losses on the disappearance of $512 million of loans that bank officials had counted as assets, and on the bank's inflated estimate of the value of its residual interest in loans it securitized and sold. 

What is residuary interest in loans sold?: In most CLO/ CBO structures (see our section on CBOs/CLOs – click here), the originating bank issues bonds collateralised on the loan portfolio that it transfers, but retains residuary interest in the portfolio, essentially a subordinated, equity-type interest. The size of the retained residuary interest depends upon the level of rating for the senior notes. According to accounting standards, the bank is supposed to retain on its books the fair value of the retained interest, and remove the rest of the loan portfolio. As the valuation is subjective, it is likely that a bank may place unfair values to the retained interest. 

Recommendations from BIS, still under consultative state, suggest that if the retained interest is either unrated or rated below B+, it should be completely deducted from the bank's capital. This, however, is regulatory accounting and may not be followed in the general financial statements of the bank.


CRIIMI MAE applies for reorganisation

CRIIMI MAE, the US commerical mortgage securitisation company that applied for protection under Chapter 11 of Bankruptcy Code last October has now applied for re-organisation.The Plan contemplates recapitalization financing of approximately $910 million consisting of $50 million  of a new series of convertible preferred stock to be purchased by an affiliate of Apollo Real Estate Advisors IV, approximately $435 million of debt financing, a portion of which would come from certain existing debtholders, and $425 million of additional amounts, the bulk of which would result from the sale of certain commercial mortgage-backed securities (CMBS).

Before applying for protection against potential bankruptcy, the company was engaged in acquisition and securitisation of commercial mortgages. Named after US govt.-backed residential mortgage securitisation agencies (Ginnie Mae and Fannie Mae), the company ran into problems due to bad assets.

This website has a separate section devoted to CMBS: click here.

 David Pullman securitises Ron Isley catalogue

David Pullman, the father of securitisation in entertainment industry, announced on 24th Sept. the signing of Ron Isley and his Isley Brothers catalog. Isley joins the band of music-securitised bonds created by Pullman: others who have signed by Pullman before include David Bowie, Holland Dozier Holland, Ashford & Simpson and James Brown.

David Pullman created sensation in capital markets when he introduced, for the first time, bonds backed by music royalties. David Bowie was his first case in 1997. Since then, Pullman did not have to look back. In 1999, he claims to have finalised deals worth USD 1 billion.

This website contains a special section on intellectual property securitisation: click here. 

DCR comments on Indian securitisation potential

Duff and Phelps Credit Rating (DCR) issued on Sept. 22 a report on securitisation in India. The following is largely an extract from DCR press release. Please see Vinod Kothari's comments below.

India's securitization market is in a nascent stage, exhibiting only elements of established securitizations, according to DCR. To date, all completed transactions have utilized onshore assets and distributed into the domestic market; no international capital markets securitization has yet come to fruition.

The regulatory constraints, as well as overall sluggish Indian international-capital-markets issuance over the last two to three years, have been a barrier to the growth of cross-border securitization in India. The Reserve Bank of India (RBI) has strict rules for companies that would like to borrow from abroad, and the lack of a well-developed swap market prevents the long-dated swaps necessary for certain cross-border transactions.

The relaxation of regulatory guidelines and a focus by issuers to explore securitization financing alternatives–once they realize its benefits — should provide a boost to cross-border securitizations. This is in light of the fact that although cross-border securitization is possible within the current ambit of the legal environment, the existing regulations restrict the universe of companies that can securitize.

Though still in a developmental stage, DCR believes international securitization in India holds potential. "India's credit rating is not investment-grade, but the same structures used in Latin America (i.e., future-flow transactions, preferred-creditor transactions and political risk insured transactions) could pave the way for Indian issuers to achieve investment-grade ratings," said Gregory J. Kabance, a DCR vice president.

There have been several completed domestic securitizations in the Indian market, but these structures do not incorporate all the characteristics a typical securitization structure used in developed markets. A large proportion of domestic transactions involves the direct sale of receivables to a single buyer. This variant of traditional securitization structure is utilized, as the traditional route of forming a special-purpose vehicle (SPV) and issue of securities is yet to be widely recognized in India due to regulatory and tax constraints.

The market is dominated by consumer finance securitization — particularly auto loan receivables. Infrastructure receivables such as electricity and tolls are also being increasingly securitized. Mortgage-backed securitization, though holding vast potential, has yet to gain a firm foothold in Indian markets due to regulatory difficulties such as inadequate foreclosure norms and high stamp duty on immovable assets.

Though it is possible to achieve a true-sale structure, most transactions remain linked to the credit quality of the originator. This linkage stems from issues including the lack of backup servicers and the co-mingling risk inherent in these structures. This reliance on the originator could cause potential problems in the event of an originator's bankruptcy. Therefore, transactions should be done with only creditworthy originators. This dependence on the originator could limit the depth of the market as the benefits of securitization cannot be realized by all potential originators.

While there remains certain legal and regulatory constraints, the market should be a securitization-friendly environment. The Indian legal system is based on a common law system primarily derived from English law, and is more securitization-friendly than civil law countries. The issue of true sale and bankruptcy remoteness is well accepted by Indian laws. Due to the growing interest in securitization, the regulatory authorities are drafting guidelines that should reduce some of the existing hurdles that prohibit the full development of the product. Included in the outstanding issues that should be addressed are:

The difficulties and uncertainty regarding the registration of charge on the underlying assets; Further clarification on the legal nature of the SPV; Uncertainty surrounding the SPV's ability to act as a receiving and paying agent and its ability to file legal suits in certain circumstances; and Foreclosure of mortgage-backed loans remains difficult and thesecurity of the underlying asset is not available for practical purposes.

In addition to these legal issues, there are certain tax issues as well as the lack of accounting standards that properly address the treatment of securitization. DCR notes that certain Indian states have reduced stamp duty on securitization transactions. However, to facilitate greater participation, the initiative should be extended to other states as well. In regard to international issuance, the hurdles are more on the economic side and, with the lack of a developed swap market, dollar-funded existing asset transactions will be a challenge. Rather than the traditional asset-backed transaction, the market is more conducive to future flow transactions, preferred-creditor transactions, and political risk guaranteed transactions. Each of these transactions can allow the originator to achieve investment-grade ratings that could be a way for these companies to access long-term low cost funding.

The depth of the future-flow market is limited because these transactions rely on the generation of offshore receivables and are dependent on the originator's performance risk. There are not that many companies with turnover that is large enough for these transactions. For some of these companies with the requisite size, the performance risk could be an issue.

But for certain strong Indian corporates with large exports, future flow can be a very attractive financing option. From a legal perspective, DCR has performed initial reviews of some cross-border future-flow transactions and believes structuring should be achievable with the Indian legal framework.

Vinod Kothari comments:

True, Indian securitisation market is still nascent but tremendous interest is being shown in various parts of the country. The only SPV structure has been 1997 Citibank's securitisation of auto loans. Privately, there have been number of deals but most of them border on secured lending. The State electricity monopolies are soon likely to securitise their revenues.

Mortgage foreclosure laws in India are essentially the same as in common law countries, but enforcement is a great hassle. However, inspite of these snags, there have been rare instances where housing financiers have had to legally foreclose a mortgage: moral persuasion is found to be a better way. What stifles mortgage securitisation in India is the fact that there are limited mortgage financiers existing today, the Govt.-sponsored housing finance body National Housing Bank prefers to see itself as a financier rather than facilitator of securitisation.

As a common law country, the legal framework is generally supportive and there are no serious tax or legal issues that should hamper securitisations. Future flows documentation should be very careful to prevent the investors from being eventually worse than even a secured lender.

Bank closed for alleged securitisation accounting fraud

First National Bank of Keystone, West Virginia was closed by US bank regulators after finding evidence of an apparent fraud that had depleted the bank's capital.

The Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency took the action after finding $515 million in loans still being carried on the bank's books that should have been removed after they were securitized and sold.

First tax ruling on FASIT investor tax treatment

District court contrasts FASIT with a mutual fund

A US District Court has contrasted a Financial Asset Securitization Investment Trust (FASIT) with a mutual fund and has framed principles that would affect the tax treatment of a FASIT investor. The case is significant as this is the first ever ruling on tax treatment of securitisation investors in FASITs. 

What is a FASIT

A FASIT is essentially a securitisation SPV under the US Financial Assets Securitization Investment Trust law. The law is basically certain sections in the Inland Revenue Code (sections 860H onwards) The law was enacted to create tax transparent entities for non-mortgage securitizations, similar to real estate investment trusts (REITs).

In Community Trust Bancorp, Inc. v. U.S., Civ. Act. No. 98-249, (US DC ED Ky. 1999), the Kentucky Court considered whether a bank which invested in mutual fund scrips could claim the loss on sale thereof as a business loss rather than capital loss. The bank's contention was that the mutual fund in turn had invested in debt securities, and the mutual fund was nothing but a collection of various investors: therefore, the nature of the loss suffered by the mutual fund would determine the loss suffered by the fund investors.

Disallowing the bank's claim, the Court contrasted a mutual fund from a FASIT: the court held that the two were distinct as that is the reason why the Congress created a separate law for FASITs while the regulated investment company law (for mutual funds) already existed. By implication, this means that in case of FASITs, the tax treatment would be applied to investors based on the nature of their own activity. A FASIT for tax purposes would be taken as a mere conduit: therefore, the loss suffered on FASIT securities by a bank or an investment company would be a trading loss while a corporate would take it as a capital loss.

UK soccer club securitises revenues:

First securitisation of its kind

You have read about securitisation of revenues from songs to be sung, or races to be run: the ever-increasing application of securitisation now reaches the sports arena. A UK soccer club is arguably the first to securitise its future ticket sales.

According to a report in Financial Times London, dated 21st September '99, Newcastle United has become the first club in football to securitise its commercial revenue streams by issuing a £55m bond that will be backed by income from future ticket sales and corporate hospitality receipts.

The financing will help pay for the reconstruction of the club's St James Park stadium, which is already under way. Previously funded by a £40m bank loan, the development will increase the stadium's seating capacity from 38,000 to 51,000 by next August.

Note that Formula -1 was among the first cases of securitisation of receivables in the sports area. However, sports businesses are regarded as promising vehicles for securitisation issues because their revenues from TV rights and sponsorship deals tend to be secured by long-term deals. Ticket sales are also seen as a dependable source of income.

The 17-year Newcastle United bond has a weighted average fixed interest rate of 7.43 per cent and is repayable in annual instalments of £6m – initially representing £4m of interest and £2m of capital – between 2001-2016.


Pakistan International Airlines signs first domestic future flows deal

[This report was contributed by Dr Tariqullah Khan from Saudi Arabia]

According to a report in Business Recorder, Pakistan International Airlines on Monday 20th September signed with Citibank Pakistan for a Rs. 3 billion future flows securitisation deal. This is the first local current future sales receivables securitisation in Pakistan and banking circles believe that such structured finance facilities will go a long way in developing securitisation and 
factoring in Pakistan.

The United Bank is the lead manager and Muslim Commercial Bank and Citibank are the co-lead managers. Other participants include ANZ Grindlays Bank, Askari Commercial Bank, Bank Al-Falah, Saudi Pak Investment Company, Pakistan Kuwait Investment Corporation and Mashreq Bank.   

More on securitisation in Pakistan  
This website has rich resources about securitisation in Pakistan: 

For a profile of the transactions done, etc., see country profile of Pakistan on the Index page. For the securitisation rules of SEC, Pakistan, click our securitisation laws page

The facility is structured so that all ticket and cargo sales of PIA in Karachi and Lahore, for a three-year period, will be assigned and routed through a collection account with the agent bank of the syndicate.

Vinod Kothari  comments: 
The deal is remarkable from many viewpoints:

  • Pakistan is quite a novice in securitisation market: the only reported transaction so far is the international future flows securitisation by Pakistan Telecom.
  • It is only in June this year that SEC, Pakistan announced draft securitisation rules. Securitisation activity is yet to gather pace in Pakistan: in this backdrop, a future flows securitisation is an outstanding achievement.
  • Domestic future flows securitisation itself is a rarity. International flows are securitised using a trapping mechanism in a foreign country. But in  a local transaction, it is the laws of the country that will matter. Given the fact that Pakistan is a common law country, assignability of a future flow itself is a serious legal issue, and it would be interesting to know how the local lawyers have viewed the transaction. But then, chalti kaa naam gari (what is a car? – well, what runs is a car), as they say.

First securitisation of personal credit receivables in Canada

Bank of Nova Scotia will be issuing $ 905 million worth notes to securitise its receivables from personal credit loans. According to a report in Financial Post, Canada, the Bank will use Hollis Receivables Term Trust, a special purpose trust created to securitize portfolios for this purpose.

The issue was a public offer and was led by ScotiaMcLeod.

From the bank's perspective, the financing helps it achieve some of its securitization goals of facilitating greater access to funding and liquidity; of optimizing its capital structure and of being pro-active about the management of its balance sheet. 

 World Bank gives credit to promote securitisation in Bangladesh

The World Bank on 20th September announced USD 46.9 million credit for Bangladesh for development of financial institutions in the country. Called the a Financial Institutions Development Project, the credit aims at improving financial intermediation in banks, non-bank financial institutions, and capital markets in general.

The Facility granted by the World Bank will also support issuance of bonds and securitised instruments by the banks and financial institutions participating in the scheme. The government has also agreed, as a preliminary requirement, to create a suitable regulatory framework for regulation of financial institutions in the country.

The facility will seek to encourage financial institutions to stand on their own by either a direct debt issue or by securitisation, but provide a standby support till the market is able to accept the securitised instruments. Total project costs are US$57.69 million. The US$46.9 million equivalent credit is provided by the International Development Association (IDA), the World Bank's concessionary lending arm, on standard IDA terms with 40 years to maturity and a 10 year grace period. The Government of Bangladesh will contribute US$5.41 million. Financial Intermediaries will also contribute US$5.08 million to the project costs. Assistance has also been provided by the International Monetary Fund for the development of the government bond market that will have a positive impact on the project.

FASB issues bulletin on consolidation of securitisation SPVs

[I have been a little in catching up with this news, but it is important. ]

The US Financial Accounting Standards Board (FASB) the draft of a Technical Bulletin no 99-a on Classification and Measurement of Financial Assets Securitized Using a Special-Purpose Entity.

Issued on August 11, 1999, the FASB has invited comments on the draft Bulletin. The last date for comments is September 25, 1999.

Essentially the draft deals with situations in which transfers of securitised assets to SPVs will be treated as transfers, or will retain their original character. The bulletin talks of 4 situations with various parameters.

Full text of the proposed bulletin is available for download upto 25th Sept – click here for download.

Philippines proposes to ses to securitise amusement park revenues

Securitisation is gathering lot of interest in Philippines. The government of Phiippines itself has evinced interest in using securitisation to partly cover its budgetary shortfall. The government proposes to issue asset-backed securities in the fourth quarter to raise up to USD 500tfall. The government proposes to issue asset-backed securities in the fourth quarter to raise up to USD 500 million, reports  Inquirer daily, quoting Finance Secretary Edgardo Espiritu.

Among the options being looked at are the future earnings of the Philippine Amusement and Gaming Corp and potential revenues from the Malampaya natural gas project, which the government is implementing in partnership with the Shell Group.

Massive bank securitisation transaction in Italy

Banca Nazionale Del Lavoro proposes the largest ever issue in Italy

We had commented sometime back on this page that Italy is fast emerging as the mecca of European securitisation (see here) . The recent spate of transactions and the levels of interest in Italy reaffirm the statement.

According a report in Corriere della Sera 17 Sept., 1999, the Italian banking group Banca Nazionale Del Lavoro SpA (Bnl) is looking to perform a massive securitisation operation for a value of around L3,000bn. This would understandably be the largest securitisation issue in Italy and arguably the largest single issuance in Europe.

It is notable that Italy had passed an enabling law on securitisation in April this year, and since then, there has been tremendous interest in securitisation both among bank as well as non-bank issuers.

This website has comprehensive resources about Italian securitisation. For a country profile on Italy, click here. For text of Italian securitisation law, click here. For several news items on Italian securitisation, browse the present page and the previous securitisation page.

Do you know more about the above transaction, or about securitisation in Italy? Your contributions will be appreciated: click here to send an e-mail.

Explosive growth in Japanese securitisation

Analysts compare the rate of growth with US early 1990s

The Japanese securitisation market is growing at an amazing pace. Though Japan was a late starter, the present levels of interest have even belittled the US growth rates in the early 1990s. The Ministry of International Trade and Industry (MITI) has put annual issuance during financial year 1998-99 at USD 15.5 billion which is still a fraction of the US annual volumes, but given the fact that the Japanese volumes have grown at the rate of over 80%, all eyes are drawn to the Japanese market.

The burgeoning market for asset-backed securities is a sign of the times in Japan: With bank lending on the decline, companies and financial institutions are starting to explore ways to wean themselves from reliance on bank credit. Those firms are turning to the asset-backed market for their capital lifeblood.

Among those who are particularly interested in securitisation in Japan are the Japanese banks. These banks' needs for regulatory capital relief and corporates' needs for non-bank liquidity have led to record issuance of securitized transactions in the Japanese capital market. First-time issuers and new asset classes are emerging as issuers and arrangers innovate.

This rapid development can primarily be attributed to regulatory support, the urgent need for financial institutions to meet capital guidelines, and companies’ demand for alternative source of funds.

Gain-on-sale accounting on securitisation making finance companies' accounts unreadable

Article comes down heavily on FASB 125

A recent article in American Banker Online [16th Sept., 1999] has come down heavily on the gains-on-sale accounting for securitisation transactions by finance companies. Lawrence M. Benveniste, the author, says: "After a series of missteps and failures by several specialty finance companies that depended on asset-backed securitization as their primary funding source and "gain-on-sale" accounting, the equity markets have become wary of the quality of earnings reported by these companies". The author seemingly agrees to some analysts who favour the view of "forcing all finance companies to account for profit on a "flow" or "portfolio" basis (and perhaps even stop funding their business via securitization)" as this  is the only way to accurately represent earnings and restore investor confidence.  

What is gain-on-sale accounting:  
The accounting method talked about in this article is the one prescribed by FASB 125 on securitisations: accourding to FASB 125, if certain conditions are fulfilled, a securitisation of assets should result into removal of the assets from the balance sheet and recognition of upfront gain/loss on the transfer of assets. The conditions have to do with whether the originator has retained any significant control on the assets, and whether the transfer is to a qualifying SPV. 

The other accounting standard relevant to securitisation is IAS 32/39 which adopts retention of risks/rewards approach. FASB is considered to be more liberal in allowing originators to book upfront gains as compared to IAS.


The author claims that securitizers that apply gain-on-sale accounting have the power to fool the markets (and themselves) by booking illusory profits based on error-plagued and unrealistic assumptions and projections about future losses and prepayments. But, as we have seen recently in the specialty finance industry, investors can quickly identify and punish these companies. When their investors withheld capital, several of these companies failed and are no longer in business.

US MBS issuance exceeds USD 400 billion in first half 1999

While the asset-backed securities market remained dull, there was a surge in volumes for agency-backed mortgage backed securities. The first half of 1999 data recorded an issue of USD 420.3 billion, marking an increase of over 29% over the comparable period in the 1998. The total volume for 1998 was USD 726.9 billion: the second half of 1999 may not see a very impressive business due to Y2K concerns, but there is a good potential to cross the issuance levels of 1998.

Data published in a research paper of the Bond Market Association state that all the three agencies, Fannie Mae, Ginnie Mae and Freddie Mac registered double digit gains in their issuance levels. Fannie Mae led the way, with $185.0 billion in issuance in the first half of the year, a 30.2% increase over the $142.1 billion sold in the year-ago period. Issuance by Freddie Mac rose 34.4%, to $152.2 billion, as compared to the $113.2 billion issued in the same period last year. Ginnie Mae reported a 20.7% increase over year-earlier levels, with issuance totaling $83.1 billion in the first half of this year, up from the $68.8 billion sold in the first half of 1998.

Another interesting side of the story is the secondary market activity. Trading in mortgage-related securities remained vibrant in the first half of this year, with daily trading volume averaging $73.7 billion in the period, a 9.9% increase over the $67.1 billion average reported for the first half of last year.

Charles Schwab setting up mutual fund to invest in asset-backed instruments

Charles Schwab and Co. proposes to introduce on Oct 1, 1999 a mutual fund that will in part invest in asset-backed and mortgage backed investments. Schwab, managing a USD 66.8 billion of funds, targets initially raising a corpus of USD 100 million for asset-backed investments for this mutual fund.

The YieldPlus fund is a step away from Schwab’s usual money-market funds, dealing with slightly larger risks and more diversity. Until now, Schwab’s investment strategists have shied away from asset-backeds outside the commercial-paper market, and have focused primarily on commercial mortgage-backed securities. Asset-backed securities are riskier than money market instruments, but investors do not perceive them as equal risk since the average life in small maturity instruments is one year or less.

Thailand Secondary Mortage Corporation starts buying mortgage loans

The Secondary Mortgage Corporation (SMC) of Thailand has started buying mortgage loans with the intent of securitising them. SMC expects strong interest among local financial institutions in its four-billion-baht securitisation deal to purchase mortgage loans. The scheme is part of the August 10 economic stimulus package of the government.

The sale of the mortgage loans by the loan originators, mainly banks and financial companies, will be a swap against government bonds. Thus, on one hand, SMC does not have to shell off any cash for the loans, on the other hand, the selling institutions get a long term government paper which helps them to take care of their maturity mismatches as well as capital adequacy requirements.

The loans to bonds swap scheme is an innovative exercise as it frees up regulatory capital for the selling institutions, and at the same time does not allow the selling institution any freed liquidity to be used at its discretion.

SMC, modelled on the US Fannie Mae pattern, will be shortly going for securitisation of the loans thus acquired.

Securitisation in Asia still feeble

The securitisation market was snuffed out completely in the SE Asian crisis of  1997 and while there are strong recovery signals in equity and debt markets, securitisation is yet to come out of the shadows where it was consigned. During the haydays of Asian boom, investment banks, institutions and law firms had sent securitisation experts to settle in Hong Kong: they have now been relocated to Japan or simply called back, says a report in Financial Times August 31.

Apart from a smattering of deals, mainly in Hong Kong, all the recent Asian issuance has come from Japan. The problem with Asian countries is the complexity of local laws – unlike Europe, or say, even Latin America,  most of the governments are yet to take any positive measures to promote securitisation by legislative action.

The development has been feeble inspite of the fact that the crisis was the surest proof of securitisation ring fencing. Transactions in Thailand and Indonesia have survived the crisis. Analytics quoted in the report look at China as the next most important securitisation stop for Asia, after Japan.

For more about securitisation in Asia, see our country profile – click on the Index page where you find country links. 

Re-insurers in securitisation

Credit risk reinsurance is a big business and these companies guarantee repayments on secuiritisation structures, particularly in case of banks CLO/ CBOs. A report in Financial Times Sept. 3, 1999 says that the turmoil in capital markets last year as a result of the continuing Asian crisis, Russia's default and the collapse of Long Term Capital Management's hedge fund led to a higher risk premium in bond markets – and a new role for reinsurers.

With conditions in the casualty insurance market remaining soft, re-insurers are likely to look at credit risk insurance. This is so inspite of the fact that most insurance companies know very little about credit markets.

And securitisers in re-insurance

Read this news item with the one directly above, and you see the strange way securitisation and re-insurance markets are making roads into one another. While insurance is providing a credit support to securitisation, securitisation is placing the reinsurance product in the capital market.

A recent article in the Financial Times Sept. 3, 1999 noted this trend when it said: "Reinsurers are waking up to the fact that far from being just one of the latest industry buzzwords, securitisation of insurance risk is here to stay. When, in April this year, the owners of Tokyo Disneyland bypassed the traditional insurance and reinsurance markets and sought earthquake protection in the form of catastrophe bonds, reinsurers were served another warning that insurance securitisation is a form of risk transfer that simply cannot be ignored."

Right as of now, casualty re-insurance rates are going soft and there is little incentive for reinsurance companies or other users to look at insurance securitisation, but most reinsurance companies are looking at the securitisation option in some way or the other.

Securitisation may not replace traditional reinsurance, but it is certainly a force to reckon with. Most of the risks securitised so far have been catastrophe risks, but motor risk, life insurance risk, and credit risk have also been taken to the capital markets.

On this website, a number of news stories on insurance risk securitisation have been carried. Also see our insurance risk securitisation page  – click here.

Italy the new mecca of securitisation

New law heightens interest, says CNN feature

Securitisation has been the money spinner of 1990s everywhere in the world, except Italy. But it is only after the new law was passed [see our Securitisation law page – click here] that Italy has joined the bandwagon. In fact, a feature on CNN August 20, 1999 described Italy as the new mecca of securitisation activity.

The potential is enormous: raising cash on the back of anything from sports stadium receipts, rock stars' royalties or pub rents to film revenues, mortgages and catastrophe insurance — anywhere where there's a flow of money.

But the most exciting prospect for Italy right now is the simple securitisation of loans — giving banks with some of the highest non-performing debt in Europe the chance to clean up balance sheets at a critical time for sector consolidation.

Until now, a lack of legal framework for securitisation has seen Italy lag its euro-zone fellows. As a result, while the U.S. and Britain have been churning out deals since the 1980s, the first Italian bank securitisation came less than two years ago.

But a tax-friendly law passed in May gives issuers a new blueprint to work from. [See securitisation laws page] Now, a bank contemplating a loan securitisation can simply park a portfolio of loans in a new Italian company which then issues asset-backed securities.

Previously, the bank would have had to patch together its own complicated ad hoc rules which would have involved setting up a new company abroad and provided no tax perks.

The Italian government has valued the potential market at some 100 billion euros ($105.4 billion) and banks are already diving in.

Among non-bank issuers, the Italian government is leading the pack. [This news was featured on this website – click hereIn what is expected to be one of Europe's largest operations, Italy is planning to securitise delinquent social security receivables to help cut its mammoth deficit. In its 1999 budget, Italy promised to raise 5.3 trillion lire ($2.9 billion) from securitising outstanding pension contributions belonging to state pensions body INPS.

INPS had around 54 trillion lire of outstanding pensions contributions in 1998 and the Treasury expects to eventually recover 20 trillion of that.

For more on securitisation in Italy, refer to our country profile – click here.

For more news items on Italian securtisation, refer to our past securitisation news page – click here.

India's housing finance body plans mortgage securitisation

Stamp duty hurdles being cleared in most states

National Housing Bank (NHB), India's apex housing finance institution, plans to create a secondary market in mortgages by issuing mortgage backed bonds or pass through certificates. This will be the first mortgage backed securitisation in India.

NHB will buy mortgage loans originated by individual housing finance bodies, pool them and issue the securities. A team at the instance of NHB visited Fannie Mae, USA and other securitisers there to study their systems. However, it is stamp duties and legal hurdles back home that is holding NHB from coming out with the pilot project. Stamp duties apart, there are certain clarifications that NHB wants from tax authorities as well. This concerns the continuing eligibility of a housing finance customer to claim tax benefit for repayment of a housing loan, as post-securitisation, the loan gets transferred to an SPV which may not be an eligible housing finance body.

Stamp duties on securitisation in several states has been reduced to 0.1%.

Rate of downgrades in US ABS market increasing

Far more downgrades than upgrades

There has been an alarming rate of downgrades in US ABS market, according to a report by Moody's. Between August 1, 1998 and June 30, 1999, there have been 137 downgrades and 81 upgrades of asset-backed securities, according to the rating agency.

Of the 137 ABS downgrades, 69 were the result of poor asset performance. Downgrading of ABS due to weak asset performance continues a trend that began in 1997.

In the period surveyed, credit enhancer downgrades remained a significant factor, resulting in 57 of the 137 ABS downgrades.

Since the market's inception in 1986, there have been 234 upgrades affecting $14 billion in ABS and 311 downgrades covering $42 billion, according to Moody's.

US mortgage financiers capture UK markets

Technology and experience help the US firms

US companies such as Countrywise and HomeSide have made forays into the UK mortgage finance market and given their tremendous back office skills, technology and experience, they are likely to capture the UK mortgage market. A recent report in American Banker Online says that " U.S. lenders view the United Kingdom today in much the same way Britain once viewed its colonies — as a market for more civilized procedures and technology."

The entry of US majors has triggered competition in UK markets bringing down rates. At the same time, the US firms have started something that they practice widely back home, that is, subprime lending.

David Pullman considering IPO

The father of Bowie bonds eyes New York SE

DAVID Pullman, the Wall Street financier who brought the world "Bowie bonds", is planning to bring part of his star-studded business empire to the New York Stock Exchange, says a report in Financial Times, UK.

The 37-year-old millionaire caused a sensation two years ago by raising $55m by issuing bonds secured upon Bowie's future royalties. He has since secured similar deals for the Godfather of Soul James Brown, Motown songwriters Holland-Dozier-Holland and rhythm and blues duo Ashford & Simpson.

Mr Pullman says he has future deals lined up to securitise West End and Broadway shows and TV, films and literary assets.

He is also confident of further music deals, and says he has established good contacts with legendary names ranging from Michael Jackson to the Rolling Stones.

For more on intellectual property securitisation, click here.


First ABCP offer in Poland

BRE Bank launches the first issue

On 13th July 1999 Urtica Finanse S.A. launched via BRE BANK S.A. first issue of Asset – backed Commercial Papers under The PLN 50 Mio trade receivables securitisation programme.

URTICA Finanse SA is a bankruptcy-remote Special Purpose Company (SPC) established only for buying ("true sale") and administrating of trade receivables from URTICA SA. These receivables arise from delivery of medicines and drugs to hospitals located in Poland. In order to refinance the purchase of receivables, URTICA Finanse SA will issue asset backed CP. The ABCP are collateralized by trade receivables previously bought from URTICA SA. Proposed structure contains recommended by Standards and Poor's credit enhancements like: overcollateralisation, spread account, limited recourse to URTICA S.A. and liquidity enhancement like put option that gives SPC right to sell receivables to liquidity provider and liquidity line granted by BRE BANK S.A.

The ABCP has been granted short term credit rating – CP-1 (the highest domestic short term rating) by local rating agency – CERA S.A.- subsidiary of Thomson Financial BankWatch.

This information has been provided by Martin Tarnicki, Project Manager of the above Bank. Martin is a participant in our e-mail list.

Why lenders do not like mortgage funding in China

Mortgage funding is considered to be the safest in USA and most popular among small lenders, while lenders in mainland China do not value them much. Patrick Randolph in an article in South China Morning Post[12th August 1999] examined the reasons.

Apart from problems in enforcing mortgage foreclosures which involve anecdotal delays, there are other possible explanations. "The most obvious is market uncertainty. Lenders value security that is "counter-cyclical" – that it will have value precisely at the time that the economic fortunes of their borrowers have drooped", argues the author. This means that mortgage lenders look at real estate as a hedge against cyclical movements in industry.

Another significant reason is the lack of experience – "Western lenders have a long experience with the device, and rely upon armies of specialists who appraise, underwrite and, where necessary, seize and manage real estate security". This is lacking with lenders in China.

The author feels that a buoyant mortgage market is created out of financial crisis. For example, much of the development in US securitisation market came about with the efforts of the Resolution Trust Corporation taking over assets of failed lenders in 1980s.

RMBS issue likely by Hong Kong Mortgage Corporation

The Hong Kong Mortgage Corp, which was set up in March 1997 to acquire mortgage loans from banks and free up their books for new lending, had acquired HK$10.33 billion in mortgages as at end June 1999.

It will issue its first mortgage-backed securities of about HK$1 billion in size in the fourth quarter of this year.

In the meantime, there is a growing interest in mortgage funding both by the banks as also the non-banking finance companies such as  GE Capital and General Motors. Banks find mortgage funding one of their safest invesment options.

For more on securitisation in Hong Kong, see our Hong Kong country profile – click here. 

 New insurance product to cut political risk in emerging market investments

One of the reasons for development of emerging market future flows securitisation was the ability to eliminate sovereign risks by trapping cashflows outside the country of origin. Overseas Private Investment Corporation (OPIC) has launched an insurance product that would allow emerging market corporates to pierce their sovereign rating. The product entails the following methodology – an emerging market company wanting to issue debt securities to foreign investors would issue the securities to an SPV ( a trust) in an investment grade country. The trust in turn would issue its own securities to the investors. The trust buys an insurance with OPIC, which obliges OPIC to make payments that the original issuer could not make to the SPV on account of foreign exchange control or a debt moratorium slapped by the originator's sovereign. Thus, the investors continue to get serviced inspite of the sovereign's redirection or moratorium orders.

OPIC is an agency of the US government.

The insurance policy does not cover any credit risk. Investors bear the full risk of default because of credit reasons.

US ABS issue shows modest growth in first half 1999

Markets outside the USA take the shine

Growth of any financial innovation is seen to follow the S-curve – the evolutionary or introduction phase shows low growth rate; followed by abrupt increase in explosive growth phase, finally slowing down to a plateau in the stabilisation stage. Has US securitisation issuance reached its plateau? Not sure, but markets in Europe and Asia, also Latin America, have surely reached the explosive growth stage.

US ABS issue in the first half of 1999 grew about 4.6% to a volume of USD 101.1 billion, as compared to USD 96.7 billion during the same period in 1998 (as per data published in Structured Finance Monitor). As against this, there has been surge in volumes in Japan, Australia and Europe – see reports on our Securitisation news page.. US data traditionally exclude mortgage-backed securities.

The data reveals that the highest share in total ABS issuance (about 32%) is taken by home equity loans. About 22% each is shared by credit cards and auto finance receivables.

CMBS volumes seen declining sharply in 1999

Moody's Mortgage-Finance analysts project that 1999 commercial mortgage-backed securities (CMBS) will total around $60 billion, roughly 25% below last year's level. For the rest of 1999, they expect an active third quarter, with a possible fourth-quarter slowdown in reaction to Y2K-related concerns.

As deals have become smaller and the overall quality of credit has improved, commercial mortgage-backed securities (CMBS) volume for the first half of 1999 was down 20% from the volume of the first half of 1998, as deals became smaller and overall credit quality improved, say Mortgage Finance analysts in a recent report.