News on Securitisation: China’s First Asset Securitisation in Auto Leasing

China’s First Asset Securitisation in Auto Leasing

December 11, 2013

Xinjiang Guanghui Leasing Company the largest passenger vehicle leasing company in China, successfully issued its first asset securitization product, named the “the yuan issue”, of its specific asset management plan on December 5, marking the first domestic auto leasing company to finance via asset securitization. This was the fourth asset securitization product approved by the China Securities Regulatory Commission (CSRC) and also the first asset securitization product in the field of auto leasing.

By far, a total of 29 asset securitization programs have been under review, which indicates that the CSRC is making an all-out effort to promote the development of asset securitization in the mainland.

Reported by

Shambo Dey

SECURITISATION NEWS AND DEVELOPMENTS

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FASB staff issues FIN 46 clarification on collateral manager's fees

FIN 46, the accounting interpretation that tries to rope in special purpose entities on to the balance sheet of its primary beneficiaries, continues to invite confusion and clarification – arguably more of the former than the latter.

The latest staff position or FSP relates to whether the fees of the collateral manager will be treated as a part of the residual returns of the entity. The collateral manager for most CDOs is vested with discretionery powers of collateral management and can hence be treated as the "decision-maker". Resultantly the fees paid to the decision-maker are treated as a part of the residual returns. This has led to consolidation of many CDOs with their collateral managers as such fees constitute a majority of the residual returns so computed.

The instant clarification provides for the circumstances in which the fees paid to the collateral manager could be excluded residual returns. The FSP 7 provides for 4 cumulative conditions for the exclusion:

1. The fees are compensation for services provided and are commensurate with the level of effort required to provide those services.
2. The fees are at or above the same level of seniority as other operating liabilities of the entity that arise in the normal course of business, such as trade payables.
3. Except for the fees described in conditions 1 and 2, the decision maker and the decision maker's related parties1 do not hold interests in the variable interest entity that individually, or in the aggregate, will absorb more than a trivial amount of the entity's expected losses or receive more than a trivial amount of the entity's expected residual returns.
4. The decision maker is subject to substantive kick-out rights, as that term is described in this FSP. However, substantive kick-out rights alone are not sufficient to allow a decision maker's fees to be excluded from paragraph 8(c) in the calculation of an entity's expected residual returns.

Notably, Point 1 talks about the fees being commensurate with the "level of effort" and not the outcome thereof. Therefore, if the fees are structured or variable in any manner, it would be necessary to establish the link of the variability with the level of effort.

The kick out rights in Point 4 are the substantive rights of the investors or others (let us say, voting right holders) to remove the decision maker. These rights must be exercisable by majority of voters other than the decision-maker himself of his related parties, and there must not be significant barriers to exercise of the kick out option.

The FSP above is expected to be incorporated in the amendment to FIN 46, exposure draft of which has already been circulated.

Link: For more on FIN 46, see our new page on FIN 46 here. For more on accounting issues, see page here.

Hong Kong government to securitise toll revenues

The Hong Kong government is set to raise HK $ 6 billion by securitisation of toll revenues of brides and tunnels owned by it.

Securitisation is apparently high on the agenda of the government for its funding as a government spokesman outlined several securitisation plans: The government is budgeting HK$21 billion in revenue from the sale or securitization of state assets in this fiscal year. It has already made HK$4.8 billion this year from a sale of civil service housing loans to the Hong Kong Mortgage Corp. The government expects to realize another HK$10.9 billion this year from the sale of other loan assets, including home starter loans, to the Hong Kong Mortgage Corp.

For the toll revenues securitisation, reports say that HSBC has been selected as a the lead arranger. HSBC is among the top in bond league tables in Asia, and is prominent for securitisation programs.

The overall securitisation activity in Hong Kong has been subdued for a larger part of this year. There have been some synthetic securitisation deals from Hong Kong, including a synthetic securitisation of light bus and taxi receivables originated by HSBS itself.

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

CDOs set to take off in Asia: experts

Finance Asia 30th Oct 2004 carries an interview of Richard Gugliada and Diane Lam of Standard and Poor's who contend that the CDO market is heating up in Asia. Gugliada says that there were only 9 deals upto Sept. last year, but this year, there have been 35, which is nearly 4 times.

On the type of deals, Gugliada says that the majority of the transactions have been synthetics and of this type, about two thirds have come out of Australia and most of these have been smaller two counterparty type deals. Deals like that are coming out of the rest of the region – especially Hong Kong, Singapore, Taiwan and Korea as well, but they are mostly privately placed. We're seeing some of the funded type structures and the larger, synthetic and syndicated type deals emerging as well.

The experts admitted that Asia has so far been a buyer of CDOs, rather than a seller – but that is how the market evolves.

Diane Lam says that there is a temporary lull in arbitrage activity: "People are using a lot of these structures for arbitrage purposes and trying to make money. What we're hearing is that it is very hard to structure a good, profitable deal right now because spreads have tightened so much recently. That's why we are seeing a pause at the moment. That being said, we've rated a number of transactions this year and with the right timing, deals go to market very quickly. With all the press attention on CDOs, investor awareness is very high in Asia at the moment." But, she continues, "It's a good time for Asia as we have the benefit of looking at deals that didn't happen in the past and we can understand why they did not work out. For instance there are things that we do not like to see in the documentation now that were there before".

Links For more on CDOs, see our page here.

FASB decides to issue draft of FIN 46 amendments: experts say most application difficulties not addressed

The FASB decided to issue an exposure draft of amendments to FIN 46 that will be on a "fast track" – meaning short comment period, and quick effective date. Experts who have been associated with the discussions have felt that most of the operative difficulties of the Interpretation remain unresolved. "For the most part, my personal opinion is that the nature of the modifications fall into the categories of technical corrections, clarifications or slight relaxations that impact only a minority of situations involving the application of fin 46", says Marty Rosenblatt.

By a vote of 4 to 3, the board rejected a suggestion that the proposed modifications not become effective until a complete package of necessary revisions or interpretations or reaffirmations of fin 46 are identified, debated, exposed and resolved. The amendments are likely to become effective Q1, 2004 for public companies.

The crux of changes relating to securitization transactions is as under:

1. Paragraph 8a and 8b which say that a variable interest entity's (VIE) expected losses or residual risk shall include the expected variability in the entity's net income or loss and the expected variability of the entity's assets if it is not included in net income will be replaced by to-be-drafted words intended to communicate something along the lines of: the expected variability in returns which would be available to the variable interest holders over the life of the VIE or perhaps, the life of the variable interests, if the VIE was required to prepare an income-like statement showing such returns, including fees to decision-makers and certain guarantors.

2. The following sentence from paragraph A5 of FIN 46 would be deleted: "If different parties with different rights and obligations are involved, each party would determine its own expected losses and expected residual returns and compare that amount with the total to determine whether it is the primary beneficiary." They would also delete the phrase "if they occur" from the first sentence in paragraph 14 (and other places) which presently reads: "An enterprise shall consolidate a variable interest entity if that enterprise has a variable interest (or combination of variable interests) that will absorb a majority of the entity's expected residual returns if they occur, or both." There has been much confusion in attempting to apply FIN 46 on the method (or methods) to be used to allocate expected losses to the variable interest holders and often the sum of the parts exceeds the whole. FASB has looked at a variety of methods proposed by constituents and thinks more than one might have conceptual support, but has not decided on a single, preferred method to date or whether they would express any preference or requirement. The modification to paragraph A5 is intended to accommodate some flexibility and to eliminate what some say is an internal conflict with paragraph 14 while the Board continues to study this issue, leading perhaps to the issuance of an FSP at some future date.

3. The Board rejected a suggestion to expand the proposed scope exception for situations in which the reporting entity is unable to obtain the necessary information ("the information-out") to also apply to entities created after February 1, 2003.

4. The Board agreed to delete the examples of different types of variable interests in appendix B of fin 46 since it has been pointed out that some of the examples could be viewed as conflicting with other parts of fin 46, were stated in absolute terms without the necessary context or were otherwise confusing or wrong. in its place, the staff will attempt to develop new commentary on examples of different types of variable interests for inclusion in a possible FSP.

Links For more on accounting issues including articles on FIN 46, see our page here

Panelists on FDIC roundtable laud CMBS for strong CRE performance

Recently, the US Federal Deposit Insurance Corporation (FDIC) organised a roundtable of commercial real estate (CRE) experts to take stock of the performance of CRE during a period of unprecedented weak fundamentals of CRE in the USA. Nevertheless, banks had weathered the storm with a remarkably strong performance in their portfolios. This was said to be partly answered by a large public ownership of CRE lending in form of CMBS transactions.

The FDIC's concerns against CRE lending were brought forcefully by Rich Brown, Chief Economist of FDIC. FDIC holds insurance funds to cover banks' lending losses, and "there is hardly a better way to lose a lot of money in a short period of time" for a bank than CRE lendings, as, "when they collapse, can result in losses of $10 to $20 million at a time".

The panel discussed wide range of issues relating to the CMBS industry – as to how the CMBS has changed the face of commercial mortgage lending. Unlike in RMBS business, in CMBS, there is no residual risk retention by the seller-servicer, as even the B-pieces are sold in the market. The panelists also said that the risks in a CMBS environment are considerably lesser than in the whole loan held by the originating bank.

For full text of the discussions at the roundtable, click here.

Links For more on CMBS, see our page here.

Securitisation without true sales work in Europe: can they work in the rest of the World?

Ian Bell, a legal expert with Standard and Poor's has written a thought-provoking article on the relevance of true sales in securitisation. True sales and securitisation are seen as so closely-knit together that most people in the structured finance market find it difficult to imagine a securitisation without a true sale. This is the legacy of the US securitization practice where, on commonly shared perception, transactions which are not true sales will not provide bankruptcy proofing under the US bankruptcy laws.

However, says, Ian Bell, "This is not what securitization is about. At the heart of securitization is the removal of the seller's corporate risk so that noteholders can measure their risk solely by reference to the relevant assets. Since only a true sale can achieve that result in the U.S., it became the hallmark of all securitizations…And yet, in Europe, transactions have been emerging without true sales, relying instead on various local law security interests." True sale or not, the idea of securitisation is to ensure that investors have unqualified, undeterred rights over certain assets in the event of bankruptcy – in European transactions, that result is achievable by creating security interests of various kinds.

Ian Bell cites the example of the landmark Marne et Champagne deal where security interest was created using the age-old French concept of "gage avec depossession", close to the British law concept of pledge. A pledge is a possessory security interest which common law systems have always held above any non-possessory security interests. The author cites more instances – for example, the Broadgate office buildings CMBS deal which also relied on security interests rather than true sales.

The author concludes to say that " in most European countries true sales are still the cleanest, most efficient way to remove the originator's credit risk. All transactions without a true sale are done for commercial, regulatory, or legal reasons. Second, the legal analysis required to show that the highest ratings can be assigned without a true sale is highly sophisticated. Nevertheless, these transactions are a testament to creativity and flexibility."

Vinod Kothari comments: I have raised a similar, though stronger, issue in a recent editorial – see here. Though most securitisation deals achieve a legally certified true sale, but the fact remains that from a risk rewards perspective, most of them have a financial substance. There are several instances spanning over some 200 years of legal thought that over time, Courts start questioning the spirit of such transactions – one can see the story of Bills of sales in England, hire purchase law all over common law countries, sale and leaseback deals in several countries, financial lease transactions, etc. Harping on the true sale aspects of securitisations is both unnecessary and undesirable: instead, the industry must try understand the basic objective: which is not sale of assets but isolation of assets from bankruptcy risks of the originator. If there are not sound means of achieving this isolation, without a transfer, under existing legal framework (which itself is a misnotion in my view), one must search for that legal framework that would allow isolation without transfers. It is not difficult to visualise such a structure – one where it is possible to create a protected cell within a corporation.

Links See our page on true sales here.

Asian securitisation market is stressed but surviving: Fitch

Rating agency Fitch recently published an overview of the Asian structured finance market. One has to strive to find optimism in the report. At the close of 2002, there were big hopes of repeat issuance and a geographically spreading market with new countries as well as all-time players: Korea, Singapore, Thailand, Malaysia, India and even Hong Kong. The volume for 2002 was estimated at USD 3.8 billion, and was expected to grow in 2003.

However, by end of Q3 of 2003, " it would appear that 2002 was a false dawn, with a flurry of unexpected events prompting a dearth of Asia-originated issuance, both domestic and cross-border. At the close of the first half of 2003, only two internationally-rated ABS transactions had been closed, with a further two unrated ABS
transactions with conduit execution completed in Korea." The only bright spot was the CDO market: "While the first half was fairly quiet in Asia’s securitisation/structured finance markets in general, the one exception was the CDO market, which saw the completion of five publicly announced (although not public in the true sense of the
word) transactions and an increasing interest in synthetic CDOs."

Fitch lists SARS related consequences as having the strongest adverse impact on the Asian securitisation market. In addition, recessionery trends prevailed in Korea, Taiwan, Hong Kong and Singapore. To add to this, the liquidity crisis in the Korean bond market led to ebbing of consumer finance based transactions from Korea. One of the credit card transactions, Plus One, entered into an early amortisation.

Fitch structured finance rating migration study: 2002 was bad

Rating agency Fitch recently published its own structured finance ratings migration report over a 12 year period upto 2002: and the results are not radically different from those published by other similar reports by S&P or Nomura.

As everyone knows, 2002 was a bad year in terms of rating migrations. The Fitch report says there were 747 downgrades, as compared to only 287 in 2001. An interesting feature of Fitch-rated transactions is also the sharp increase in number of upgrades: upgrades nearly quadrupled to 3,404, relative to 2001 levels. This startling upgrade jump is due to the performance of the RMBS segment, where historically low interest rates led to robust performance. Of the upgrades, nearly 3100 upgrades came from the RMBS market.

As for downgrades, the ABS section was responsible for 62% of the downgrades, and within ABS, major contribution came from the manufactured housing segment.

CMBS segment was expected to be affected by the prevailing economic uncertainties and falling occupancy rates: however, despite contrary expectations, CMBS remains extremely strong. Neraly 99% of the investment grade CMBS tranches were not downgraded.

At the end of the day, Fitch, like other rating agencies, concludes that rating stability is far higher in structured finance than in corporate finance: over the long term, Fitch structured finance ratings exhibited less negative rating volatility than corporates. This was especially true for investment-grade tranches, which saw few
incidences of downgrades over an average oneyear horizon through 2002. In fact, more than 97% of investment-grade rated tranches either maintained their rating or were upgraded over a one-year period.

Structured finance players are now concerned with end use of money: NYT article

As a fall out of the Enron debable, structured finance industry is now also concerned with the end-use of the money, says an article in New York Times. The article says that though the device of securitisation and special purpose vehicles was created with good intentions, over time, the device found a use in creating artificial asset sales to merely restructure balance sheets. "In essence, an ethereal marketplace had been created, with "sales" done for the benefit of the company often without a real buyer on the other side of the table. Banks and investment houses eagerly lent money, booking big fees as Enron and other companies used the deals to make their financial performance appear better than it actually was", says the article by Kurt Eichewald.

However, after the Enron story, investment bankers see a whole new layer of reputational risk in what is being done. Therefore, larger players like J. P. Morgan and Citigroup have established their own voluntary standards for structured deals. Transactions with no economic substance that might be used to make a company's performance look better come under tremendous scrutiny.

The pressure comes not only from the government, but from investors as well. Ultimately, the vast majority of structured finance deals are sold as securities to investors; indeed, many individual investors have indirect interests in them through instruments like money market accounts. Now, market participants said, sophisticated investors are playing a large role in pushing for standards and practices intended to reduce the chance that the market will be harmed by another corporation abusing structured finance.

FASB meeting agrees on several amendments to FIN 46

FIN 46 is far from FIN-al, and SPEs will continue to be the accountants' nightmare for several months to come. After months of having issued the accounting interpretation that seeks to rope in rudderless and driverless SPEs onto the balance sheet of the backseat driver (decision-maker), the FASB staff issued several FSPs giving the staff's views on certain contentious matters. However, on Wednesday afternoon, the FASB board sought to differ with the staff on some of these matters, and agreed to put up an exposure draft of amendments that would significantly change FIN 46. Thus, FIN 46 continues to sizzle on the front burner.

According to sources closely associated with the Board's FIN 46 deliberations, the Board decided to proceed towards the issuance of an exposure draft of a proposed interpretation modifying FIN 46 in the following ways:

  1. Providing a limited scope-exception for an entity that cannot ensure whose baby it is. This must be an existing SPE on Feb 1,2003 and after due efforts, is uanble to find out the holder of primary beneficial interest in the entity. This exemption comes under the pretention that several variable interest do not have the means to identify their primary beneficiaries as they are not privy to the requisite information.
  2. Specifying that under paragraph 8(c), if a decision maker has no exposure to the expected losses of the entity and no right to expected residual returns except a fee that has no expected variability (it is fixed and not subordinated), then such fee would not be considered part of the expected residual returns of a variable interest entity. The Board discussed but wants to wait until their re-deliberations after the comment period, to conclude on whether "fixed" means it has to be fixed in dollar amount or whether it could also be a fixed number of basis points of assets under management, and if the latter, should that be limited to amortizing pools whose principal amount will not grow. Notably, the FASB staff has issued an FSP on this issue, see report below.
  3. Specifying in paragraph 15 that whenever a variable interest holder acquires additional interests in the entity, it will have to reconsider whether it is the primary beneficiary, not just when such interests are acquired from the primary beneficiary.
  4. Clarifying in paragraph 16.d.(1) with respect to de facto agent status when one party can not sell, transfer, or encumber its interests in the entity without the prior approval of another party, the intent is that the agency relationship exists when the rights of the party holding the interests are constrained from realizing the benefits of that interest. Restrictions on sale so long as the interests can be monetized through a pledge would be OK as would conditions requiring approval of the other party so long as that approval can not be unreasonably withheld.
  5. Modifying the guidance in paragraph 17 to identify that the party in a related party group that should consolidate a variable interest entity if the aggregate interests of the parties would, if held by a single party, identify that party as the primary beneficiary would be the party whose activities are more closely related to the entity.
  6. Expanding the term investor in part (i) of the last sentence of paragraph 5 to include the investor's related parties as indicated in footnote 6.
  7. Changing the second reference to paragraph 5 in paragraph 11 (regarding development stage enterprises) to paragraph 5(a) to clarify that paragraph 11 does not exempt development stage companies from the requirements of paragraph 5(b.)

    There was no indication as to when the Exposure Draft would be available. There will be a 30-day comment period. It will be proposed that restatements of previously issued financial statements would be required upon the effective date of the new Interpretaion, but the Board will specifically solicit comments on whether some other form of transition would be more appropriate.

    The Board also directed the staff to issue a proposed FSP to defer the effective date of FIN 46 until the end of first interim or annual period ending after December 15, 2003, for an interest held by a public entity in a variable interest entity that was not created for a single specified purpose on behalf of a certain party (loosely referred to as not being a special-purpose entity ) and has assets that are predominately nonfinancial. Examples of the types of interest to be considered are franchise arrangements, supplier arrangements and troubled debt restructurings. The Board will continue to work with the staff to develop more precise wording of this limited-scope deferral.

    Sources indicate that two newest Board members (not on the Board when FIN 46 was issued) were vocal supporters of a broader and longer deferral period .

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

Bangladesh grants tax immunity to securitisation vehicles

While a World Bank aided project to usher in securitisation and fixed income securities is yet to see the light of the day in Bangladesh, the government a major positive move. Daily Star Bangladesh reports that In order to facilitate securitised bonds, the government has exempted SPVs, from paying all kinds of taxes including value added tax (VAT), income tax and stamp duty. Three separate notifications of the Ministry of Finance granted these exemptions.

However, the exemption is not available generically: the SPV in question must have approval from the central bank for getting the tax exemption.

Vinod Kothari adds I have been associated as a trainer to several Bangladeshi banks, and have also conducted a course sponsored by the World Bank project mentioned above. The government's move to grant tax exemptions to SPVs is a major bold move and indicates the success of the Financial Insitutions Development Program being run under the aegis of the Bangladesh Bank itself.

With these notifications, the legal hurdles to securitisation are almost over. Hopefully the stamp duty notifications provide for duty relief for both transfers to and transfers by SPVs. With this step, the World Bank project must now be allowed to run in top gear and let transactions happen.

Hope Indian authorites are listening: usually Bangladesh follows Indian law making; this time, India must reciprocate.

Spiegel misreported ABS data, claims investigators

Yet another case goes into the securitisation "hall of shame". Spiegel, a well known US furniture retailer and "catalogue" supplier, was a repeat issuer of private label credit card ABS. Spiegel had earlier filed in March 2003 for bankruptcy protection and hence triggered early amortisation events under all its outstanding securitization deals.

Independent investigations launched at the SEC's behest have revealed that Spiegel misreported the performance of its ABS transactions to avoid hitting the early amortisation triggers, which would have only hastened the bankruptcy process by exacerbating the cash crunch. These observations were made by the independent investigator into Spiegel appointed by SEC.

Investors in Spiegel's ABS also face the decision of the Office of Comptroller of Currency to raise the servicing fees being charged by Spiegel from 2% to 3.5%, thereby squeezing the excess spread.

Links For more on securitisation sad episodes, please see our page here.

US regulatory agencies allow capital relief on ABCP FIN 46 consolidation

As a measure to save banks from having to provide regulatory capital for the ABCP conduits that come in for consolidation due to FIN 46, US bank regulatory agencies allowed banks capital relief.

The interim final rule allows sponsoring banking organizations to remove the consolidated ABCP program assets from their risk-weighted asset bases for the purpose of calculating their risk-based capital ratios.

A hint about this capital relief was given at a Standard and Poor's forum sometime back. The agencies justify the capital relief thus: "The agencies believe that the consolidation of ABCP program assets onto the balance
sheets of sponsoring banking organizations could result in risk-based capital requirements that do not appropriately reflect the risks faced by banking organizations that sponsor these programs. The agencies believe that sponsoring banking organizations generally face limited risk exposure to ABCP programs, which generally is confined to the credit enhancements and liquidity facility arrangements that they provide to these programs. In addition, operational controls and structural provisions, along with overcollateralization or other credit enhancements provided by the companies that sell assets into ABCP programs can further mitigate the risk to which sponsoring banking organizations are exposed. Because of the limited risks, the agencies
believe that it is appropriate to provide an interim risk-based capital treatment that permits sponsoring banking organizations to exclude from risk-weighted assets, on a temporary basis, assets held by ABCP programs that must be consolidated onto the balance sheets of sponsoring banking organizations as a result of FIN 46."

Simultaneously, the regulators have also proposed a revision of the capital rules for ABCP conduits carrying early amortisation triggers, and for liquidity facilities upto a period o 1 year. Under current rules, short term liquidity facilities do not require capital as the credit conversion factor is zero in such cases. However, now the agencies propose a conversion of short term liquidity facilities with 20 % credit conversion factor.

The agecies have also sought comment as to whether capital should be required against securitisations of revolving assets which carry an early amoritisation trigger, in line with the proposals from Basle II. The conversion factors are based on the excess spread or the net margin income, based on Basle II recommendations.

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

Asian market generally dull, but rays of hope: S&P

Problems in the growth zones in Asia persist causing a sobering impact on the structured finance market, but Standard and Poor's sees rays of hope. Major volumes in ex-Japan Asia have been coming from Korea, Taiwan, Singapore and Hong Kong where activity levels have been low of late, due to slower generation of consumer financial assets.

However, S&P pockets of hope are – the new Taiwanese real estate securitisation law, and synthetic activity in Singapore.

Taiwan recently passed a real estate securitisation law that would promote REIT-type bodies in the country. S&P feels is optimistic about this law: "The impact of this new law is important for Taiwan's financial markets, since many of the nonperforming loans are backed by real estate and the financial industry is overweight with real estate," explained Ms. Daine Lam. "Drawing in new investors and having debt issues and REIT ratings would go a long way in restoring investor confidence in real estate, which has subperformed over the last 12 years due to a combination of economic changes and oversupply."

In Hong Kong, one of the traditional mainstays of Asian securitisation, economic worries continue to weaken securitisation prospects. "Unemployment continues to rise as property prices fall; recent political unrest is beginning to affect investor confidence; an increased percentage of mortgage loans are in negative equity; and most important, signs of increasing numbers of personal bankruptcies have yet to taper off. With this deterioration in consumer confidence comes a noticeable slowdown in issuance for securitization, particularly with mortgage loans and other consumer assets. "

Volumes have been receding in Korea too.

Other markets such as Malaysia, India etc are so far only meant for domestic investors.

Links For more on markets in Asia, see our site here

FASB issues several staff position papers on FIN46

They first make a rule, and then interpret it, and then interpret the interpretations, and then…Over the last few days, Financial Accounting Standards Board has come out with 4 draft FASB Staff positions (FSPs) relating to FIN46. FIN 46 is the interpretation issued by the FASB that applies special consolidation criteria to certain special purpose entities, known as variable interest entities. These FSPs are drafts and are placed for comments.

FSP d, issued on 10th Sept (comments deadline 10th October) outlines the computation of expected residual returns of a variable interest entity based on the fees payable to decision makers and guarantors. These fees will always be variable interests for the purpose of the interpretation, even if the amount of fees is fixed and is not based on a success rate or other variables. This FSP also includes several illustrations for computation of the amount of expected losses or expected residual returns.

FSP c clarifies that the option of the investors (or others) to remove the decision maker (kick out options) will not exclude the fees payable to the decision-maker from variable interest computation.

The other two FSPs defer the application of FIN 46 in certain cases.

Links For more on FIN 46, see our page on accounting issues. Vinod Kothari's Securitisation: The Financial Instrument of the New Millennium includes an elaborate chapter on accounting, including FIN 46.

Moody's publishes NPL securitisation criteria

If you ever wondered how bad apples can be turned into good apples or how you can spin gold from straw, you must look at the structure of a securitisation of non-performing loans. As yields in standard securitisation deals flatten out, there is an increasing urge for such transactions.

Seeing lots of these transactions happen in the World, particularly in Italy, rating agency Moody's has published rating criteria for NPL securitsations. Italy deserves a special mention due to the sheer scale of activity in the country: between the enactment of the securitisation law in June 1999 and April 2003, a total of approximately €31 billion (in gross book value, that is, nominal value of portfolio in originator's account) of NPL portfolios were securitised through 34 transactions, making Italy one of the world’s largest reference markets for this asset class.

The report discusses various types of NPL securitisation structures, including the levels of servicer advances and other collaterals in most transactions. Primarily, the collateral is either secured or unsecured. In case of secured collateral, cashflow modelling is based on the recovery rates and estimated time it would take in the process of recoveries. In case of unsecured collateral, the rating agencies use static pool data based on historical studies.

In either case, however, the key element is the servicer. Apart from the primary servicer, that is, the originator of the defaulted loan, most transactions rely on a special servicer, that is, a specialised recovery agency – there is an increasing trend towards the latter in Italian NPL securitisations.

In all NPL securitisations, credit enhancements are understandably quite high. To get a Aaa (equivalent to S&P AAA) rating, the enhancement in Italian transactions have ranged from 47% to 94%. These percentages are different for Japanese NPLs due to several factors, primarily the time taken in the legal process (converging at around 1 year, whereas it is 7 years in Italy).

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

Equipment leasing delinquency at its least, says Fitch

The leasing industry was once said to be passing through a perfect storm. The Equipment Leasing Association had conducted a study titled The Perfect Storm wherein it analysed the reasons why top 10 of the US leasing entities that failed really failed. A Fitch report now says that the industry is apparently emerging out of the storm. "The U.S. equipment lease and finance industry is
emerging from what the industry has dubbed “The Perfect Storm.” Industry bankruptcies, mergers, and acquisitions, combined with reduced and more costly funding sources during the economic slowdown created a ripe atmosphere for this storm."

That the landscape of the leasing industry is greatly changed is apparent from the following data: During the 1998-2001 period, approx. USD 45.2 billion volume of lease-backed securitisation was generated in the market, from 48 issuers. Of these, only 1/4th are in the securitisation market currently, though this percentage in volumes is 66.5%. The rest have either been wound up, or are no longer securitising. The volume in 2002 was only USD 7.9 billion.

The equipment leasing volumes themselves have been coming down – there was a decline in volumes consistently in 2001 and 2002.

Fitch, however, sees winds of change in 2003. As the leasing sector emerges from the storm that has plagued the industry for several years, positive trends continue to surface. Equipment ABS issuance of $5.9 billion for the first six months of 2003 compares favorably with $7.8 billion of equipment issuance for all of 2002. Consolidation, as well as the frequency and magnitude of equipment ABS rating actions, has slowed considerably."

Links For more on the leasing industry, see Vinod Kothari's website dedicated to leasing at: http://india-financing.com

Time to fix Fannie and Freddie, says columnist

The voices that advocate some sort of a revamping of Fannie Mae and Freddie Mac have been there for long time, but after derivatives accounting discrepancies were discovered in Freddie's reports, these voices have gathered a great force. Robert Stevenson, who writes a well-read column in Washington Post said that Freddie and Fannie are not exactly broke, but it is time that they are fixed.

Fannie Mae and Freddie Mac are the agencies supported by the US government (GSEs or government-sponsored enterprises) that are engaged in securitisation of residential mortgages – the third one being Ginnie Mae which is government corporation. Most of the residential mortgage loans that conform to their guidelines are securitised through the agencies.

The key note of Stevenson's argument is the size of the GSEs. "They have grown so large that if they ever experience serious financial problems, they will almost certainly have to be rescued by the government at immense cost. The potential exposure reflects their huge debt. At the end of 2002 Fannie's and Freddie's combined debt totaled $1.5 trillion. This is equal to almost half the publicly held federal debt, $3.7 trillion". The GSE debt itself is held by some 3000 US banks and the total holding is almost equal to their combined capital.

Stevenson says that the purpose of empowering Freddie and Fannie with special powers was to promote home lending which was a lopsided industry in the late 1960s and early 1970s. Today, securitisation is by itself a very strong market and the government support to the GSEs is not required. ".. paradoxically, Fannie and Freddie are no longer essential for strong housing finance. "Securitization" is now widespread. If Fannie and Freddie vanished, mortgages would still be packaged and bought by investors just as they already buy riskier securitized credits — credit-card debt and auto loans, for instance",says Stevenson.

Links There are more stories on GSEs on this website – use site search. For more on the US RMBS market, see our page here.

Fund managers to take micro credits into securitisation markets

For the first time, micro credits will be taken into the securitisation market by European and US fund managers. Micro credit is a concept of funding pioneered by Pro Mohammed Yunus of Bangla Desh and practiced by several institutions all over the World, with Bangla Desh's Grameen Bank being the model micro credit bank. A micro credit bank typically finances household entrepreneurs at the absolute micro level, such as women running a small household enterprise.

According to a report on Asia Times of Sept 9,in early 2004, Dexia Microcredit Fund of Luxembourg, and Developing World Market of Darien CT, will securitise micro credits and allow European and US investors to invest into the same.

The delinquency rates in micro credits have been something around 4-5%, which is much lower than that in subprime consumer lending in the US markets. Besides micro credit is taken as a device of women empowerment, since it essentially promotes householder enterprises.

National Century's former executive admits fraud

National Century securitisation-related fraud was a bad news to the securitisation industry in 2002: it highlighted how lack of proper surveillance over the cashflows could keep servicer-frauds under cover for quite some time.

As prosecutors are still chasing up the defaulters in this case, at least one of the officials has admitted role in the fraud: former National Century executive Sherry Gibson pleaded guilty to her role, including providing false information to investors. Gibson admitted that she was involved in hiding the shortfall in investors' funds by by shuffling funds between bank accounts and sending false reports to investors and auditors. Gibson faces up to five years in prison without parole, a $250,000 fine and three years of supervision following release.

The case reveals that such false reporting was going on since 1995.

The National Century case led to shortfalls of nearly USD 1 billion, on outstandings of nearly USD 3.5 billion in the ABS market.

Links For this and more sad episodes in the ABS market, see our page here.

Industry bodies submit joint response to Basle:

Several industry bodies joined to serve a joint response to Basle's Consultative Paper 3 (CP 3), comment period for which expired 31st July. These are the American Securitization Forum, the Australian Securitisation Forum, The Bond Market Association, the European Securitisation Forum, the International Association of Credit Portfolio Managers, Inc. the International Swaps and Derivatives Association, Inc. and the Japanese Bankers Association.

The industry bodies commented that the Basle's CP 3 proposals relating to securitisation shall, in many cases, cause a divergence between regulatory capital and economic capital. For one, the industry bodies are concerned that the risk-weights in case of ratings-based approach (RBA) are much higher than shown by calibrated results. The industry bodies said that the risk weights under the RBA were based on CDOs and corporate exposures, and they produce a highly exaggerated picture of the risks in case of most retail exposures such as credit cards, auto loans or RMBS deals.The bodies have submitted that Basle comes out with separate RBA tables for significant asset classes: (1) retail revolving credit cards, (2) other retail non-revolving/ auto loans, (3) residential mortgages, (4) corporate exposures / commercial mortgages and (5) collateralised debt obligations.

The bodies also submit that the BIS makes unreasonable discrimination against synthetic transactions while theoretically there is no reason for any such distinction. Current proposals for credit derivatives substitute the risk weight of the protection seller for that of the obligor, and therefore, lead to an exaggerated double-default probability.

The bodies also make suggestions for improvement of the capital treatment to ABCP and revolving credit.

Links Full text of the industry bodies' representation is here. For more on Basel norms, see our page here.

Industry learns tricks to live with FIN 46

The FASB is meeting on 13th August to consider several issues relating to FIN 46, among those, more importantly, whether the decision-maker's residual interest in the VIE should include fixed and unsubordinated fees paid by the entity. In addition, the FASB is also considering the situations important in identifying the holder of a variable interest. However, in the meantime, the market seems to have learnt devices to limit the impact of FIN 46.

A report in Financial Times dated 4 August says that Citigroup is expected to add $5bn to both assets and liabilities as a result of the new rule, down from the $55bn it had previously anticipated. This could obviously be achieved by restructuring the SPEs so as to come out of the definition of variable interest entities..

The report also says that everyone has not been equally successful in coping with FIn 46. General Electric, for example, is expected to consolidate some $51bn in its third-quarter results due to FIN 46. However, the banks' success in restructuring existing transactions means the new accounting rule has not decimated the asset-backed commercial paper market, as had been initially feared.

FIN 46 is an accounting interpretation that uses new consolidation criteria in case of certain entities, called variable interest entities (VIEs). SPEs, other than qualifying SPEs for securitization deals and other excepted ones, are likely to be treated as VIEs.

Links For more on variable interest entities, see our page here.

American securitization body opposes QSPE rules:
says this may be the end of QSPEs

Commenting on the exposure draft of changes to FAS 140 relating to qualifying special puropse entities, the American Securitization Forum (ASF) and The Bond Market Association put up a strong opposition to the proposed amendments. This was not unexpected, as the USD 6 trillion securitization industry in the USA rests largely on the idea of off-balance sheet, non-consolidated SPEs, and anything done to hook up SPEs is bound to raise opposition.

The key note of the joint representation is to oppose the pro-consolidation orientation of the exposure draft. Besides, if implemented literally as it stands, the exposure draft may completely eliminate QSPEs: "In fact, if the Exposure Draft is given its broadest reading, we doubt whether any current qualifying special-purpose entity would qualify under the proposed new standards", says the representation.

Qualifying SPEs are non-substantive, legal fictions which hold securitised assets, and do not come for consolidation under the accounting rules for consolidation, or under the new rule called FIN 46.

The ASF fears that under the garb of making reactive changes in response to experience gained in applying FAS 125/ FAS 140, the US standard setters are reversing the very approach of surrender of control/ financial components, on which the current US (and broadly, also International) accounting standards are based. In other words, the FASB seems to be leaning towards the risks-rewards approach: "The Exposure Draft substantially turns away from that approach (components approach) by importing a number of risks and rewards concepts that do not fit coherently with the basic control standard in Statement 140."

The ASF also made an alternative suggestion, should the FASB not be inclined to budge much. This, by itself is a brave approach: let the US standard-setters adopt the UK-type approach called linked presentation approach. Under the UK-type linked presentation approach, securitised assets generally do not off the books but are netted by amount of funding raised. There is no gain-on-sale booked. Under ASF's modified "matched presentation" approach, the SPE will not be off the balance sheet, but will be a separate section of the asset side of the transferor's balance sheet. Here, the gross assets of the SPE, less all non-recourse liabilities and external equity of the SPE will be reported. The issue of gain-on-sale under the ASF's modified approach remains to be resolved.

Will this brave new approach force the standard-setters at this stage to have a total review of FAS 140? SPEs and off balance sheet accounting have been the "hall of shame" of securitization industry, and may be, a suggestion to include SPEs on the balance sheet of the transferor might instantly appeal to the FASB.

Your comments please Do you have any views on the new approach suggested by ASF? Do write your viewsPlease see some thoughts and questions here for you.

Full text of the comment letter is here.

Related links Please see our page on accounting issues here.

Japanese structured finance market continues to grow

Total annual issuance volume in Japan's structured market could reach JPY5.5 trillion (US$46 billion) by year-end 2003, according to rating agency Standard and Poor's. Residential mortgage transactions, CLOs (both cash and synthetic) and securitisation of non-performing loans continue to dominate the scene in Japan. A positive thrust is expected to be given by the recent decision of the Bank of Japan to start investing in asset-backed securities.

The total annual volume rated by Standard & Poor's was about JPY4.7 trillion in 2002. The rating agency expects securitized transactions in Japan to gradually increase overall in the second half of fiscal 2003 toward the end of March 2004.

Another expected trend is an increase in transactions structured to be beneficial to both originators and investors, such as the master trust transactions. In addition, originators have been keen to structure new types of assets, such as whole businesses or future receivables, which suggests a further expansion of the market.

For the first half of 2003, Standard & Poor's in Japan rated a total of 90 securitized transactions, up 36% compared to the first half of 2002. The aggregate issue amount for these deals of JPY2.08 trillion was an increase of 20%. The first half performance results show that the entire securitization market continued to expand, in both number of transactions and issue amounts. However, in comparison with 2002, the rate of growth has slowed slightly.

In terms of products, ABS and ABCP achieved substantial growth, increasing by 47% or 2.4x in terms of issue amount from the same quarter last year. RMBS increased by 10% in terms of issue amount. One of the key transactions in this period was a CLO deal originated by Sumitomo Mitsui Banking Corp.This CLO is backed by a number of diversified loan receivables extended to SMEs.

Links For more on the Japanese securitisation market, click here

Securitisation funding for port development in Malaysia

Ringgit 1.31 billion will be raised by way of securitisation to development what is expected to be an A-grade trans-shipment hub in Asia. The securitisation exercise is structured following the sale of a piece of land belonging to Kuala Dimensi to Port Kelang Authority (PKA). Kuala Dimensi will undertake the development of the Transshipment Mega Hub. The port, which is modelled after the Jebel Ali Free Zone Port in Dubai, will serve as a regional distribution hub and cargo consolidation centre in line with the Government's objective of making Port Klang a distribution base and a trade and logistics midpoint.

The transaction, the first of its kind in Malaysia, has been structured by Malaysian International Merchant Bankers (MIMB). To be issued in 11 series, the term of the bonds will range from 4 years to 14 years. The senior bonds are expected to be rated AAA. According to reports, MIMB will also be the initial subscriber to the bonds.

Vinod Kothari adds: The Malaysian ABS market was going through doldrums over the last few months and this deal may help to instil some life in the market. Evidently, Malaysian market is prepared to try out new assets instead of being contented with traditional asset classes such as residential mortgages and auto loans.

Links For more on Malaysia, see our page here.

Training courses in Malaysia Vinod Kothari Consultants with Rating Agency Malaysia regularly hold public and private training courses in Malaysia. For more information, contact us.

Taiwanese real estate securitisation law to push commercial property volumes

Taiwan recently [July 8-10] promulgaged a new law on real estate securitisation that allows either a property owner to put real estate into an authorised trust for the latter to raise funding, or, similar to REITs, for an authorised financial intermediary to raise funding from the capital markets and invest the same in real estate.

This, along with certain other economic laws passed by the Govt recently, are said to have given a positive strength to the current ruling party, as also are expected to push real estate development in the country.

The new law gives important tax benefits to the investment conduits. According to the law, investors will be exempted from paying stock-transaction taxes when buying the certificates, though a 6-percent tax will be levied on other transactions similar to that on financial asset-backed securities. Moreover, investment earnings will not be included in consolidated income or corporate business income taxes of beneficiaries.

According to an evaluation by the Council for Economic Planning and Development, the law will add 0.45 percent to 0.65 percent to economic growth in addition to providing diversified financial products and enlarging capital markets. Furthermore, objectives of securitized ownership, public funding and professional management will be achieved. Market analysts said securitization would be most common for commercial properties that have stable rental or cash incomes such as office buildings, department stores, shopping centers, hotels, exhibition halls and rental apartments.

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

Eurpean securitisation continues to try diverse asset classes, as volumes grow in H1, 2003

European securitisation registered impressive growth in first half of 2003, with securitisation spreading to new countries in the continent and strengthening in the traditional strongholds.

A notable feature is the dominating presence of Italy, which has risen from a one-time position of number 3 to number 1. In the first half of 2003, Italy takes more than half of the total issuance. Indications are that Italy will continue being a strong player, with strong activity by both the government (SCIP and INPS programs) and private players.

Europe can easiy be described as the securitisation laboratory of the World: with the most diverse range of asset classes. With death bonds (bonds backed by funeral fees) to wool, champagne and metals, Europe has done more experiments with asset classes than any other part of the World.

This half, legislative developments continued to take place. Greece passed a new law to encourage securitisation.

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

Latin America: activity shifting to domestic flows

Citing Mexico as an example, S&P sees a growing market for domestic flows in Latin America. This is a shift from the usual future-flows dominance in these markets.

A report dated 16th July states that in Mexican market, for example, there are growing inquiries for auto loan ABS transactions and consumer lending securitizations. The market is showing interest for credit card ABS transactions. The report ascribes this to the changing undercurrents in the Latin American market: "An important shift emerging in the Latin American structured market is that domestic markets are gaining strength. This has been especially true in recent years because domestic interest rates in some countries, particularly Mexico, have been declining, which discourages the need for cross-border transactions. Other reasons for the strengthening of domestic markets include the consolidation of institutional investors, resulting in a more sophisticated local investor base. In addition, transaction costs for domestic deals below $100 million are more affordable than cross-border transactions and local securitization reduces currency risk.

Links For more about Latin American markets, see our country pages here.

2003 to be the best year for US RMBS: S&P

Half-way through, rating agency S&P is already in a mood to celebrate the record breaking volume for the US RMBS industry. In a note of 15th July 2003, S&P says that the 2003 volumes will likely have witnessed its most active year in history, with issuance volume surging to as high as $500 billion, up from $373 billion in 2002. Quite obviously, this is due to historically low interest rates, pushing up mortgage origination volumes. The projected mortgage origination volume for 2003 is $3.2 trillion, up from $2.6 trillion in 2002, and $2.1 trillion in 2001.

Apart from interest rates, S&P analysts also spotted other factors such as rising incomes, baby boomers buying second homes at a record pace, and much of the population continuing to shun other financial assets in favor of investing in their homes.

Links For more on RMBS, see our page here.

BBC looking for CMBS funding

The British Broadcasting Corporation (BBC) is looking for funding to the tune of USD 1.33 billion (GBP 800 million) for the redevelopment of its London headquarters, Broadcasting House.The state-owned broadcaster hired Morgan Stanley to manage the issue.

For securing the CMBS funding, BBC will pledge to bondholders the rental payments on its 150-year lease on its art deco building, shaped like a luxury liner, in London's West End. With a legal maturity of 30 years, the expected maturity is likely to be 22.3 years.

The BBC wants to raise fundin at this opportune time when yields on AAA bonds are at their lowest. The AAA rating of the bonds wil be assured by a monoline wrap from Ambac.

The securities will be sold through Juturna (European Loan Conduit No. 16) PLC, a specially-created company.

Links For more on CMBS, see our page here.

Australian deal proposes revolving funding for construction firm

Everything can be securitised: is the buzz these days. A recent Australian structure seems to exhibit this. This structure proposes a revolving line of credit for a property construction firm which can tap the facility to build, sell what it builds, and then re-use the funds until the amortisation begins.

According to reports, Australian property developer Mirvac Group Ltd. has established a A$500 million pre-sold residential development securitization program. Apparently, the pool allows the developer to tap the funds for construction of specified portfolio of properties. Called Multi Option Pre-sale Securitisation, or MOPS, the program offers a rolling facility to Mirvac for selected residential property developments. Mirvac may draw funds for projects in the portfolio based on the off-the-plan value of those projects and once a project is completed and sold, the sale funds can be used to repay investors and finance further projects.

The structure was reportedly developed by Coudert Bros. Initially, 6 property projects will be covered by the funding. The program allows the special purpose vehicle to issue either MTNs or commercial paper.

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

Workshops We regularly hold training events in Australia: for calendar of courses in offing, see here

Securitization News and Developments

August 2004 to March 2005

[This page lists news and developments in global securitisation markets – please do visit this page

regularly as it is updated almost on a daily basis. Join our mailing list for regular news feed direct

into your mailbox]

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

Previous news pages

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Egypt instals mortgage finance companies; mulls securitisation

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

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

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

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

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

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

Life insurance companies find embedded value in securitization

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

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

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

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

Swiss Re takes life insurance policies to capital market

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

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

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

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

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

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

Deutsche structures a USD 2 billion CDO square for Taiwanese insurer

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

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

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

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

 AIDS drugs to get securitisation funding

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Australia grants financial services license exemption to SPVs

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

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

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

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

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

Taiwan securitisation market to maintain the 2004 growth rate

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

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

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

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

Links: Our new page on Regulation AB – here

Securitisation accounting for failed US bank costs E&Y deer

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

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

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

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

Links

European securitisation volumes zoom

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

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

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

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

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

Israel securitisation market suffers early jolt of bankruptcy

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

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

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

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

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

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

 

Parmalat administrator launches lawsuit against Citibank

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

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

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

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

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

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

Performing loans securitisation makes its mark in China

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

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

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

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

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

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

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

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

Malaysian ABS market picks up

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

Malaysian ABS issues so far

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

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

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

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

Links For more on Malaysia, see our page here.

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

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

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

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

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

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

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

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

 

S&P lists pre-conditions for secondary mortgage markets

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

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

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

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

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

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

Single tranche synthetic CDOs make advent in Taiwan

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

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

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

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

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

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

SPVs in Singapore to qualify for concessional tax regime

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

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

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

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

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

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

Indian securitisation: the shine continues in 2004

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

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

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

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

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

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

IASB issues exposure draft of new disclosure norms for financial instruments

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

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

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

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

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

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

Comments on ED 7 are due by 22 Oct 2004.

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

 

India at number 2 in ex-Japan Asian securitisation

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

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

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

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

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

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

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

 

News on Securitization: Asia-Pacific securitisation reviving, as Singapore registers some securitisation deals

November 30, 2013

The market for asset-backed securities, which went into hibernation post the 2007-8 crisis, seems to be coming back to life. Hong Kong and Singapore and the two main centers of financial activity : most of investment banks in both the places had shut their stops and disbanded their investment banking teams post the sub-prime crisis. However, there are clear signs of activity resurfacing in both the places.

As regards Singapore – there have been 2 deals towards October-November.

One is a CMBS deal with pre-sales of properties under construction. This type of transaction has been done in Singapore long time back and was not seen over more than 6-7 years in the past. This deal, brought by T G Master, pertains to sale of spaces in Skies Miltonia, a property in Singapore. The progress payments on the property have been securitised, thus providing construction finance. This deal was structured and sold by DBS Singapore.

Another deal, brought by Courts Asia, uses two distinct SPVs – one in Malaysia and one in Singapore – to structure a multi-currency multi-jurisdiction transaction.

Hong Kong teams also seem busy structuring transactions for China.

Down South, Macquarie Leasing’s SMART template continues to have new issuances – this pertains to a portfolio of financial and operating leases.

In short, the Asian securitisation market has shown signs of clear revival in 2013, and 2014 may be holding the portents for a promising start.

Reported by: Vinod Kothari

News on Securitization- Home rental securitization deals opens up vistas to a massive market: Analysis of Invitation Homes REO-to-rental securitization

November 30, 2013

A recent $ 278.7 million REO-to-rental securitization deal from Invitation Homes, a subsidiary of Blackstone, has set the pheromone levels of securitization structurers high. If this is a template that one could write on, there is substantial scope for similar deals to follow.

REO, or “real estate owned” is a property that  a lender acquires against a defaulted mortgage loan. The lender puts the property to auction typically at a reserve price equal to the outstanding loan – but if the market value is lower than such reserve price, there may not be takers, and the property then becomes a part of the “owned” stock of the lender – thus called “real estate owned”. REO is a part of the non-performing asset portfolio of the lender. Thanks to the crisis, there were tens-of-thousands of such homes on the books of several lenders which REITs have been acquiring since 2008 –which they rent out. This is the so-called “REO-to-rental” market, having an estimated potential of about $ 1 billion.

The deal structure emulates a typical CMBS transaction, though it has elements of an RMBS inbuilt into it. There are 6 classes of notes, with the bottom two unrated. The over-collateralisation at Class A is approximately 41.8%. The transaction has a term of only 5 years, including 3 one-year extensions. Moody’s rating presale report, detailing the transaction is here: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_SF346785

Reported by: Vinod Kothari

News on Securitization: AIFMD exemption for Irish securitisation companies

November 29, 2013

The Central Bank of Ireland has recently clarified that:

  • securitisation companies that have registered with the Central Bank as “financial vehicle corporations” pursuant to Regulation (EC) No 24/2009 of the European Central Bank[1] (the “FVC Regulation“); and / or
  • securitisation companies funded by way of debt or other non-equity instruments,

are outside the scope of the Alternative Investment Fund Managers Directive (Directive 2011/61/EU)[2] (the AIFMD) and the Commission Delegated Regulation[3] (EU) No 231/2013 as transposed into Irish law under the European Union (Alternative Investment Fund Managers) Regulations, 2013 (the “AIFM Regulations“).Consequently they do not need to seek authorization as, or appoint, an AIFM. The Central Bank of Ireland does not intend to do that at least for so long as ESMA continues its current work on this matter.

Section 110 of the Irish Taxes Consolidation Act 1997[4] creates the legislative framework for securitisation companies in Ireland. Such companies are commonly called “Section 110” companies. Many existing and newly established section 110 companies would be required by the FVC Regulation to register with the Central Bank as “financial vehicle corporations”, by virtue of the fact that they carry out, or intend to carry out, one or more “securitizations” (within the meaning of the FVC Regulation). Following the clarifications, it is now clear that AIFMD and the AIFM Regulations do not apply to such companies.

AIFMD and the AIFM Regulations also do not apply to section 110 companies that are not required to register as FVCs, provided they are not engaged in the activity of issuing shares or units. This would include, section 110 companies that are not FVCs, where they are funded by entering into loans, issuing debt securities, and / or issuing non-debt instruments (such as certificates, warrants and derivative instruments) that do not convert into, and are not convertible into, shares or units giving an ownership interest in the company.

News on Securitization: Bank of England speaks pro-securitisation once again

November 29, 2013

The latest issue of Financial Stability Report[1], released by the Bank of England, speaks  a lot once again by the needed initiatives to revive securitisation.

It notes, of course, that there are visible signs of positive investor interest in the sector in the recent past, evidenced by several proxy measures. First, the volumes of CLOs has been around USD 75 to 80 billion this year, which is close to the pre-Crisis levels. Second, there have been innovative deals – such as residential rental securitisation, securitisation of peer to peer loans, etc. However, with all this, the reduction of securitisation volumes in Europe has been alarming – coming from $ 1.2 trillion in 2008 to $ 322 billion in 2012.

The Report notes: “Better functioning and safe and robust securitisation markets have the potential to diversify banks’ funding sources and create securities that are better tailored to the needs of non-bank investors, such as insurers and pension funds. Securitisation can also transfer risk outside the banking sector. For example, banks that have the expertise to originate loans may not always be best placed to bear the risk of those loans. In those circumstances, banks can free up capital for new lending by securitising loans and selling them to other investors. This process diversifies sources of finance available to the real economy and potentially increases its stability”[2].

The Committee notes the useful purpose served  by “shadow banking” – a term applied to paralller alternative non-banking financial system supplying money to the financial system.

“The provision of finance from outside the traditional bankingsystem can play an important role in the financial system and wider economy but it can also be a source of systemic risk”, notes the Report. The Committee will focus on mitigating these risks, rather than curbing shadow banking.

Vinod Kothari adds: The CLO/CDO volumes, for the first 10 months of this year, is reportedly about $ 68.5 billion, which compares with $ 39.4 billion for the same period in 2012. This is surely a substantial increase. However, considering that there has not been much pick up in traditional asset classes, the aggregate ABS/MBS issuance for 2013 may end up lower than that for 2012.

News on securitization: China resumes Securitization

September 25, 2013:

Historical Developments:

Asset securitizations in China were halted since 2009 after the credit crisis in US markets started developing. However in May 2012, the activity gained round after the PBoC, CBRC and Ministry of Finance jointly issued a Notice on Matters Concerning Further Expansion of Credit Assets Securitization Pilot Program and planned for the launch of its third pilot program with RMB 50bn limit in the interbank market. A year later, in March 2013, as a part of its deregulation objectives, the CSRC upgraded asset securitization activity to a routine business process by issuing Securities Company Asset Securitization Regulations. The following table outlines the historical developments in the Chinese Securitization market:

Current Reforms:

Further to increasing market activity, the State Council executive meeting on August 28, 2013 decided to expand the trial program for securitization of credit assets to make it a more commonplace activity. The Council has allowed the trading of high-quality asset-backed securities on stock exchanges for the first time. The following graph shows that NBFIs in China were acting as virtual conduits for the banks. The move by the State Council to allow securitization activity only legitimizes what is currently happening informally:

Souce: PboC, CEIC, SG Cross Asset Research/Economics

The State Council has called for strict supervision of securitizing credit assets and that the functions and responsibilities of trust companies and accounting firms should further be made clear in this regard. The Chairman of the China Banking Regulatory Commission Shang Fulin has also said that detailed measures should be put in place to enable the expanded credit asset securitization trial to benefit more small and medium enterprises which are cash-strapped. According to the statistics from the CBRC, by the end of July 2013, the outstanding balance of SME loans nationwide amounted to RMB 16.5 trillion. The reforms should also help participating banks expand their funding options. It should also help the government meet funding requirements for infrastructure projects. In addition to this, the CBRC has sent out a circular to insurers to make them actively participate in the pilot. Currently, credit assets that may undergo securitization include credit loans, guarantee loans, small and micro-sized business loans and auto loans.

Remaining Challenges:

Some analysts feel that although the reforms may boost liquidity through stock exchange trading and improve regulatory oversight over the banking sector, it may not spurge activity in this sector, given the illiquid nature of these products and that large scale transfer of NPLs from banks may not be easy because of pricing issues. If volume of issuances increases in the future and the cost of issuances falls, then products will become more liquid.

TIMELINE OF MAJOR SECURITISATION EVENTS

Year

Interbank Market regulated by CBRC

Securities Companies regulated by CSRC

2005

Initial Pilot program launched by PBoC and CBRC; Limit of RMB 15 bn for interbank market

Pilot securitization program launched with the CICC’s securitization program China Unicom

First issue of ABS made by China Development Bank

2007

 Second Pilot Program launched with limit of RMB 60 bn

2009

Activity halted due to financial crisis

CSRC issued Manual for Securities Company Corporate Assets Securitization Pilot Program

2012

Third Pilot Program launched with RMB 50 bn limit

2013

PBoC, CBRC and Ministry of Finance jointly issued the Notice on Matters Concerning Further Expansion of Credit Assets Securitization Pilot Program.

State Council issued Guidelines on Financial Support for Adjusting, Transforming and Upgrading the Economic Structure

** The information has been prepared from information in CSRC, CBRC website and Nomura Research Institute.

To read more on the China Regulations please click here

Reported by: Shambo Dey

News on Securitization: Islamic Finance Growing

October 6, 2013:

With the backdrop of conventional financing methods going bust and investors burning their hands, global markets are seemingly wanting to get a taste of Islamic finance. Further, ever since the sub-prime crisis of 2007, time and again there have been discussion on need for finding alternative modes of financing and Islamic finance has been ever increasingly accepted as the next best alternative known.

The need of funds for infrastructural development are one of the factors leading countries to scout for funds and are now wanting to attract Middle East investors by adopting Shariah compliant products. From business perspective as well Islamic structures are gaining popularity because ownership structures offered in Shariah compliant products are less risky and more ethical following the proponents of Islam.

In Africa, several countries have made sukuk issuances in 2012 for infrastructural development. The need for development in the continent demands funds and African nations are looking to tap investors from Middle East [1]. Being in the embryonic state of developing capital markets, the intent of tapping funds through Shariah compliant products may establish the Islamic Finance industry in the continent.

African governments are beginning to address the legal obstacles to Islamic finance by putting in place the necessary regulatory measures. However, having appropriate regulations in place alone is not sufficient. For any African country looking to establish itself as an Islamic finance hub of the future, that country must overcome a number of other challenges to create an environment conducive for Islamic finance to take root, including investing in education, capital markets infrastructure and political stability.

India too has opened gates for Islamic Finance with the recent decision of Reserve Bank of India to allow Kerala based non-banking financial company to develop Shariah compliant business. With a large Muslim population, India embracing Islamic finance was a no brainer.

On the other hand, Scotland is positioning itself to be potential hub for Islamic Finance. Scotland is becoming the niche market for Shariah compliant products with an estimated growth of 15-20% annually. Acceptance of the Shariah compliant products is well established in Scotland and its popularity is increasing particularly in the limited access to conventional sources of funding in the market. With a strong fundamental to Islamic Finance in Scotland and growing demand of Islamic finance products amongst businesses and consumers in Scotland, the country may indeed be the centre for Islamic finance activity.

With U.K hosting the World Islamic Economic Forum, setting up an Islamic Finance Task Force and eyeing to become the Western Capital of Islamic Finance, Islamic Finance is increasing gaining recognition and is here to become the next big thing in the capital markets.

[ 1 : According to a Reuters report on Oct 2, 2013, Nigeria’s Osun State issued a 10 billion naira ($62 mn) sukuk yielding 14.75 percent. It is the first Islamic bond from a major economy in sub-Saharan Africa. ]

 Reported by Nidhi Bothra

 

News on Securitization: US Federal Agencies Propose “Revised” Risk Retention Requirements

October 7, 2013:

Right after the financial crisis the regulators had geared up to tighten the regulatory noose for securitisation transaction. The retention of skin in the game was considered to be critical for sustenance of securitisation transaction. In this pretext, in the U.S., the risk retention requirements were coined in 2010 and were deliberated upon. The proposed rules (“Original Rules”) formed a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

In the Original Rules, it was proposed that the excess proceeds from the sale of commercial mortgage through securitisation should remain in a “premium capture cash reserve account” and shall remain subordinated to other bonds to be captured over a period of time. Thereafter several countries took cue from the proposal and either adopted the risk retention requirements or made a proposal for a regulatory amendment.

Several of the industry players had expressed concerns on the Original Rules stating that the rules will lead to increase in cost for sponsors significantly discouraging new securitisation transactions. Considering the industry players concerns, very recently, in August, 2013 the six federal agencies — Board of Governors of the Federal Reserve System, the Department of Housing and Urban Development, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency, and the Securities Exchange Commission in the U.S. proposed an amendment to the risk retention requirements and have relaxed the rules governing risk retention in certain ways.

Comparative Analysis of the Original Rules and Revised Proposal:

Original Proposal

Revised proposal

Issuer to retain a 5% piece at par value and could be a vertical or horizontal piece or L-shaped piece in 50-50 proportion

The residuary interest is to be calculated on fair value instead of par value and the residuary interest can be held in any combination of vertical and horizontal piece. The fair value calculation would be determined as of the day on which the price of the ABS interests to be sold to third parties is determined [1]

The retained piece to be held for the life of the transaction

The parties will be able to trade in the retained piece after 5 years [2]

For a residential mortgage loan to be treated as a QRM, it would have to have a maximum 80% loan-to-value (“LTV”) ratio, a minimum 20% down payment, front-end and back-end debt-to-income(“DTI”) ratios of 28% and 36% or less respectively, and meet certain credit history requirements.

The proposed rule links the definition of QRMs to the definition of a “qualified mortgage” as defined by the Consumer Financial Protection Bureau. The QM rule does not include underwriting based on credit history, loan-to-value (LTV), or down payment. It does, however, include an analysis of the borrower’s ability to repay, with a maximum DTI of 43 percent. Loan terms could not exceed 30 years. The QM definition also prohibits interest-only loans, balloon payments, and negatively amortizing loans. The new proposal also requests comment on an alternative definition of QRM that would include certain underwriting standards in addition to the qualified mortgage criteria. [3]

ABSs to be excluded from the proposed rule’s credit risk retention requirements include (1) commercial loans, (2) commercial mortgages, and (3) low credit risk auto loans,

Same as original proposal

Unsecured REIT loans not be classified as commercial real estate loans

Same as original proposal

Full guarantee on payments of principal and interest provided by Fannie Mae and Freddie Mac for their residential mortgage-backed securities as meeting the risk retention requirements while Fannie Mae and Freddie Mac are in conservatorship or receivership and have capital support from the U.S. government.

Same as original proposal

Only CLO manager to retain risk

Lead arranger in the underlying loan also permitted to retain risk. [4]

Several of the industry players had expressed concerns on the proposed rules stating that the rules will lead to increase in cost for sponsors significantly discouraging new securitisation transactions. Considering the industry players concerns, very recently, in August, 2013 the Federal regulators in the U.S. proposed an amendment to the risk retention requirements and have relaxed the rules governing risk retention.

The revised rules are open for comments till 30th October, 2013.

Notes :

  1. To read more on this, see http://www.crenews.com/top_stories_-_free/federal-regulators-relax-proposed-risk-retention-rules.html
  2. http://www.fdic.gov/news/board/2013/2013-08-28_notice_dis_a_res.pdf
  3. See, http://www.fdic.gov/news/board/2013/2013-08-28_notice_dis_a_res.pdf
  4. See, http://www.federalreserve.gov/newsevents/press/bcreg/20130828a.htm

Reported by: Shambo Dey