SECURITISATION NEWS AND DEVELOPMENTS – November, 2001

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[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 fed direct into your mailbox]

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

Previous newsletters

Dec, 01…Oct.,2001., Sep.,2001., Aug 2001… July, 2001, .June, 2001, May, 2001,… April 2001…  March 2001 ..Jan. and Feb.2001  Nov. and Dec.2000  Sept. and Oct. 2000  July and August 2000 May and June 2000  April 2000   Feb and March 2000   
For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

 

 

 

Egyptian mortgage law permits securitisation

To the knowledge of an outsider, there is no mortgage securitisation activity in Egypt to date, but a recent mortgage-related law seeks to create the legal environment permitting mortgage securitisation.

The Real Estate Finance Law effective end of September 2001, among other things, provides for securitisation. It permits a bank or mortgage financier to assign his interest in a mortgage, to issue securities and trade in the same. Article 11 of the new law deals with assignment and securitisation.

The said provision specifies that the assignee of the mortgage, which will be the SPV in case of securitisation, shall be responsible for interest and equity servicing of the securities of the SPV, out of such assigned rights. Servicing, however, may be retained by the financier.

There are punitive provisions for defaults on mortgages, which might reduce the time it takes to foreclose a mortgage.

SA Home Loans kickstarts South African securitisation market

In what is claimed as the first South African mortgage securitisation deal, SA Home Loans came out with a Rand 1.25 billion deal that securitises part of the mortgage portfolio of the mortgage lender.

The issuance is in form of floating-rate bonds which have been issued through a special purpose vehicle called the Thekwini Fund and are divided into a R1.15bn Triple A-rated tranche and a R100m Triple B mezzanine debt portion. The higher-rated bonds were priced at a spread of 70 basis points over the Johannesburg inter-bank rate.

According to SA Home Loans, the deal has been oversubscribed, and investors were increasingly interested in lower-rated bond deals.

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

Federal regulators publish new capital rule

US federal banking regulatory bodies on Nov. 29 finally published their new regulatory capital rules relating to recourse, retained residual interests and risk mitigation devices in securitization and credit derivative transactios. The draft rules had been circulated before.

The new rule changes regulatory capital standards to address the treatment of recourse obligations, residual interests and direct credit substitutes that expose banks, bank holding companies, and thrifts (collectively, banking organizations) to credit risk. The rule synthesizes the capital treatment outlined in two notices of proposed rulemakings issued in 2000–"Recourse and Direct Credit Substitutes" and "Residual Interests in Asset Securitizations or Other Transfers of Financial Assets."

The new rule treats recourse obligations and direct credit substitutes more consistently than the agencies' current risk-based capital standards, and introduces a credit ratings-based approach to assigning risk weights within a securitization. The final rule also imposes a "dollar-for-dollar" capital charge on residual interests and a concentration limit on credit-enhancing interest-only strips, a subset of residual interests whereas the extant rules provided for a low-level rule, with a maximum set at the capital required to hold the asset in question.

The rule is effective on January 1, 2002. Any transactions settled on or after January 1, 2002, are subject to this final rule. Banking organizations that enter into transactions before January 1, 2002, may elect early adoption, as of November 29, 2001, of any provision of the final rule that results in a reduced capital requirement. Conversely, banking organizations that have entered into transactions before January 1, 2002, that result in increased capital requirements under the final rule may delay the application of this rule to those transactions until December 31, 2002.

Links See Martin Rosenblatt's article on the new FDIC rules here. See also our page on regulatory issues here.

Australian company launches record RMBS deal

RAMS Mortgage Corp has announced the launch of the biggest ever Australian residential mortgage backed securities. RAMS's current RMBS issue, its 12th, is about A$ 1.45 billion, and is the largest in Australian history. The issue from RAMS was priced at a weighted average margin over time of 38.38 basis points over the one month bank bill swap rate.

Australian domestic RMBS demand is deep enough, as demonstrated by this large domestic issuance. Rating agency Standard and Poor's says more than A$23 billion of Australian RMBS has been issued to date and that looking forward the market remains firmer heading into the next year. The pipeline for new RMBS deals remains strong for early 2002, with most Australian mortgage lenders now having established securitisation programs.

Links See our country page on Australia for more, updated with latest links.

US ABS may end 2001 with a 25% growth rate

With barely 4 weeks to the close of 2001, US ABS market may have yet another record year, the third one in a row and end up with an issuance volume of nearly USD 350 billion. Apart from the staple diet of the market – auto loans, HELs and credit cards, it is the sterling performance of the CDO segment that is accountable for this record performance in a year that otherwise marks gloom everywhere else.

CDO issuance in the USA continued to grow in the face of a growing percentage of high yield defaults. CDO issuance is expected to be down in terms of volume, but much higher in terms of number of issues which only indicates a broader base and augurs well for the future. The dip in volumes is accounted for by a lesser number of balance sheet structures which typically have a huge ticket size each deal.

The auto loan sector is likely to end up with more than 50% growth this year, which goes well with the downgrades of the auto majors in the country. With their corporate ratings down, auto majors tried to increase their presence in securitisation markets to gain a cost advantage. The classic case in point is that of Ford which brought a record deal to the market as it faced increased costs in the corporate bonds.

Links For more on the US market, see our country profile here. Statistics of business volumes are available on this website.

 

Securitisation wave may stay away from Thailand

After 4 years of the passage of the securitisation law in Thailand, securitisation activity has not picked up in Thailand, and a survey by a local Thai rating agency indicates that activity levels may not pick up in the country.

Thai Rating and Information Services conducted a survey of their various clients to check their interest in securitising cashflows. However, Thai banks were reluctant to get into securitisation deals. High margins on retail lending, the bias toward shorter-dated maturities in bank funding structures and adequate capital bases have discouraged banks to look to securitise their loans. Internationally, the drive to securitise assets is partly accounted for by regulatory capital concerns, as securitisation structures are designed to free up regulatory capital.

Since the passage of the securitisation law in 1997, only two deals have been done in the country: Liquor SPV by a group led by Charoen Sirivadhanabhakdi and the Staso deal, involving the Lotus Novotel and Regency Park hotels. Banks who are major players in securitisation business internationally are conspicuous by their absence in Thailand.

Links For more on securitisation in Thailand, see our country profile here. For text of the Thai securitisation law, click here.

 

Japanese banks may go for major off-balance sheet drive

Japan's four major banking groups: Mitsubishi Tokyo Financial Group Inc. , Sumitomo Mitsui Banking Corp , Mizuho Holdings Inc. and UFJ Holdings Inc., may be forced to go for major off balance sheet exercise this year to reduce their regulatory capital. These banks are reportedly facing new pressures on their capital on account of large loan losses.

Securitisation of loans to the tune of Yen 7 -8 trillion or USD 60 billion is expected to take place by these major banks. Japanese securitisation has been growing fast over the last 4 years, at triple digit growth rates, but this year's compelled securitisation drive may surpass the growth record in the past.

Links For more on securitisation in Japan, see our page here. Also see a news item below on Mycal's failure.

Insurance securitisation looks up as reinsurance costs harden

The Sept. 11 event has pushed up the cost of insurance and more so, reinsurance, with the result that the so-long sleeping beauty of the risk securitisation business – insurance securitisation – may now be woken up.

An article in Business Insurance of 5 Nov says that as insurance markets harden, the role of capital markets and other alternative risk transfer vehicles will likely remain a supplement to traditional coverage. Of course, insurance securitisation may not lead to any substantial disintermediation in the insurance markets. The article quotes several practitioners from the market who affirm that they are seeing lot of potential deals since Sept 11.

Yet another article in the same journal confirms that reinsurance world had changed on Sept. 11, which has been universally described by reinsurance brokers as a defining moment. The rates will go north effective Jan 1, particularly on items like terrorism coverage and workmen's compensation.

ART has far remained a beautiful idea thanks easy capacity and rates in the traditional reinsurance market. However, with increasing reinsurance rates, there will be a definitive activity in this segment.

Links For more on risk securitisation including links to several external sites, see our page here.

 

DBS planning synthetic CLO in Singapore

If activity in Hong Kong, Korea, Malaysia, and Singapore is any indication, Asian securitisation scenario is heating up fast and may soon be catching up with the rest of the World.

An article in Finance Asia 4th Nov. says Singapore's DBS is planning a synthetic CLO. There have been very few synthetic CLOs in Asia – the one which is known is ABN Amro's synthetic securitisation of RMBS in Hong Kong.

The indication from the article is that it will be a fully collateralized USD 165 million deal, through which the bank will sell risk on an equal amount of its portfolio. Fully collateralized synthetic CLOs should give 100% capital relief to the originator. The Monetary Authority of Singapore has come out with rules on both securitisation and credit derivatives, and they are genereally in line with those by FSA, UK.

The proposed offering is likely to have an average life of three-and-a-half years and will be multi-tranche.

DBS is a known name in Singapore securitisation scene – it has so far been well known for its CMBS deals, which have been reported on this site.

Links For more on securitisation in Singapore, see our page here. For full text of Singapore's MAS guidelines, see our page here. For MAS guidelines on credit derivatives, see our website here. For more on CLOs, see our page here.

Diamond securitization is on!

Securitization sees the light of diamonds, as diamond securitization sees the light of the day. We had reported about this deal before – see here. Now the deal is in the market.

A report in Financial Times of 6th Nov says that the originator named Rosy Blue, a diamond company based in Antwerp, launched a USD 100 million bond backed by its entire stock of rough and polished diamonds, in a deal brought to the market by Nomura International. The deal was launched on 5ht Nov. The issue was priced at a spread of 95 bps over 3 Ml and has reportedly been bought mostly by banks in Belgium, France and Switzerland, with a few London branches of Asian banks.

The bond is set to mature in July 2008.

This is one more of the whole business variety of securitization deals being structured by Nomura. The whole business structure uses the entire cashflows of an operating business to pay off the investors and is distinct from traditional asset-backed structures.

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

BIS publishes working paper on securitisation: seeks comments by Nov 15

In Oct 2001, BIS put up a working paper on asset securitisation, seeking comments by Nov. 15. The working paper is an elaboration of the IRB approach earlier outline in Jan 2001, and gives details for synthetic securitisations in particular.

The guiding principles of the approach detailed in the working paper are:

 

  • In recognition of asset securitisation as an important source of funding and mechanism for credit risk transference, the IRB approach should be neutral with regard to the capital requirements it produces in order not to create incentives or disincentives for banks to engage in securitisations.
  • The IRB treatment of securitisations should reflect the relative credit risk inherent in the various tranches within a securitisation transaction. That is, IRB banks would be required to hold more capital against retained or purchased subordinate tranches as compared to that required for senior positions within a given securitisation. Whereas the standardised approach to securitisation is based on the application of a small range of risk weights corresponding to external ratings, IRB banks will be required to consider the availability of external ratings and information about the securitised assets in determining the minimum capital requirement.
  • The approach should adequately capture credit risk exposures of securitisations through a combination of minimum capital and operational requirements.

 

Full text of the working paper is at this link.

Earlier this year, BIS had decided to defer the implementation of Jan 2001 proposals to be refined and re-presented by Jan 2002. See our news item here.

 

Mycal's failure hits Japanese ABS market

Mycal Corp., one of Japn's leading national chain retailers, filed for civil rehabilitation proceedings on Sept. 17, 2001. A number of ABS offerings in Japan are directly connected with Mycal and rating agency Fitch has expressed concerns that Mycal's failure has shaken the fast growing ABS market in Japan.

In an article in Global Securitization Quarterly of Oct. 2001, Fitch analysts say that Mycal's failure will affect several CDOs where Mycal's corporate bonds represented a large share of the collateral. Besides, there were some CMBS deals which were based on sale and leaseback of commercial properties owned by Mycal or its subsidiaries. These transactions were rated above the rating of Mycal itself, and in theory, the failure of the originator should not have affected the rating of the deal. However, these CMBS transactions were put on rating watch negative.

Fitch contends that the CMBS rating methodology Fitch uses underscores the fact that anchor tenant or operator of the property is a key factor and unless the rating of such operator is above investment-grade, Fitch will not grant investment-grade rating to the CMBS.

UK insolvency law reform may adversely affect securitisation transactions: legal experts

One of the distinctive features of UK securitisation practice is that a number of securitisation transactions, and almost every whole business securitisation transaction, has been structured on the basis of a secured loan by the SPV to the originator, rather than a true sale as in most other countries. The basis of this practice is the typical structure of the UK insolvency law which allows appointment of an administrative receiver by a secured creditor/s having floating charge over all the assets of the borrower company. The appointment of an administrative receiver takes away the jurisdiction of the Courts to sit over the estate of the bankrupt company.

In July this year, the government has put up a white paper titled Insolvency -A Second Chance. Amid concerns that the existing provisions of law are inclined to favour a section of secured creditors to the prejudice of other creditors, the white paper proposes that "on the grounds of both equity and efficiency, the time has come to make changes which will tip the balance firmly in favour of collective insolvency proceedings ­ proceedings in which all creditors participate, under which a duty is owed to all creditors and in which all creditors may look to an office holder for an account of his dealings with a company's assets. It follows that we believe that administrative receivership should cease to be a major insolvency procedure."

Commenting on these proposals, Ian Field and Jennifer Marshall of Allen and Overy, London write in International Financial Law Review Oct 2001 that the proposed changes will adversely affect the securitisation industry whic in UK increasingly makes use of the secured loan structure, as true sales in UK context involve several legal difficulties and compliance costs. Even though the White Paper does propose exemption from the new regime for certain capital market transactions [Para 2.18], which are not yet detailed, the authors feel that the exception may even create greater uncertainty, one, since the scope of exempt transactions is not known as of date, and two, as to whether a given transaction will qualify for the exemption or not.

Vinod Kothari adds: To my mind, what is more important is plead for a certain true sale regime, free from notification obligations and the stamp duty irritant. UK had an exceptionally creditor-friendly insolvency law and the reform will bring it more in line with international practice. That certain securitisation transactions that relied on these exceptional legal provisions will be put to problems is not a reason to thwart a larger cause.

Links For full text of the UK insolvecy white paper, click here. For whole business securitisations that use the secured loan structure, click here. For more on securitisation in UK, click here.

 

SECURITISATION NEWS AND DEVELOPMENTS – December, 2001

/in /by

[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 fed direct into your mailbox]

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

Previous newsletters

Jan, 02 .…Nov, 01 .…  Oct.,2001., Sep.,2001., Aug 2001… July, 2001, .June, 2001, May, 2001,… April 2001…  March 2001..Jan. and Feb.2001  Nov. and Dec.2000  Sept. and Oct. 2000 July and August 2000 May and June 2000  April 2000   Feb and March 2000   
For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

 

 

UK: whole business structure used for ferry revenues securitisation

Yet another whole business securitisation deal was completely recently in the UK when JP Morgan Chase raised GBP 43 million for Red Funnel Ferry. The transaction completes the financing for JPMorgan Partners which acquired Red Funnel from Associated British Ports last year.

The transaction incorporates a comprehensive covenant package, which is consistent with existing whole business securitisations. It was lead managed by JPMorgan, which was also the bookrunner; Lloyd's TSB provided liquidity and working capital facilities.

Whole business securitisation is a typical UK structure, based on UK insolvency laws, where an intermediate SPV gives a loan to the operating company and acquired a fixed and floating charge on all the assets of the operating company. Thereby, the lending company is able to prevent the assets of the operating company from being administered by a Court-appointed liquidator, as UK laws empower a charge-holder to appoint an administrative receiver instead.

UK's insolvency laws are due for a recast – a white paper was presented sometime back. The proposal will replace the current administrative receiver structure. But the proposal excludes "certain capital market" transactions details of which are yet not notified.

There have been several whole business securitisations in UK for businesses ranging from museums to car racing to auto garages to nursing homes and pubs.

Links See for more on whole business securitisations here. See for securitisation in UK here.

Workshops Vinod Kothari holds two workshops a year in London. See details of the forthcoming workshop in London here.

India's new foreclosure norms will help securitisation

India will shortly move into a new regulatory regime of foreclosure of residential mortgage property with the National Housing Bank's (NHB) regulations. These regulations received legislative approval with the passage of the NHB Amendment Act of 2000, but have still not been put in place by the NHB. In a recent meeting of Ficci, Finance Minister Yashwant Sinha gave indication that these norms will be cleared soon.

Reportedly, the norms have been framed by NHB but are pending clearance by the Government. For more details on the NHB Act relating to recoveries, see our page here.

Links See our country page on India here. There are some recent articles on Indian securitisation scenario by management students.

Training event: Vinod Kothari offers a world-class training event on securitisation and credit derivatives in Mumbai, India on Jan 24-25, 2002. See details here.

Notching issue heats up: BMA, Moody's propose discussions

When a rating agency gives ratings to a CDO or ABCP, the portfolio held by the conduit consists of several bonds or securities, which may have been rated by other rating agencies. Presumably to align these other ratings to the rating standards of the rating agency, the rating agency adjusts these other ratings, more often than not by adjusting down by a notch or two. This practice is referred to as "notching" in rating industry jargon.

Rating agency Moody's is concerned but because ratings assigned by it to securities have been notched down by competing agencies such as Fitch. On 10th Dec., Moody's issued a press release saying it will sponsor an independent study comparing analytical methodologies and credit assessment accuracy across a range of asset types used in collateralized debt obligations (CDO), structured investment vehicles (SIV) and asset backed commercial paper (ABCP) programs globally. Moody's said the study will review differences in ABS ratings from a number of perspectives, including differences in rating meanings and methodology, differences in ratings on jointly rated collateral, differences in rating transitions, and differences in monitoring practices and investor loss experience. Comparative market share by sector and level of subordination will also be examined, with the goal of understanding why different rating agencies have markedly different market shares in particular asset classes or at particular subordination levels.

Competing rating agencies who have been blamed for notching down Moody;s rating ratings were understandably concerned by Moody's release. However, now it seems the issue has gathered interest of the entire industry and the Bond Market Association has declared intent of organising industry roundtable to discuss the issue. A Bond Market Association release of 19th Dec says notching is an important and topical issue in the structured finance marketplace. The Association says a wide range of views have been expressed by various market partici-pants regarding the need, merits and justification for the specific notching policies and practices that are presently applied by each of the major rating agencies to CDOs, SIVs and the collateral securities that underlie them. Certain of these policies and practices have been criticized, among other reasons, on the grounds that they are not sufficiently justified by empirical data or other evidence that would suggest corresponding differ-ences in the actual credit profile of instruments not directly rated by the agency in question.

The Association has expressed intent of initiating broader industry dialogue on the issue.

 

US securitization trade body to be launched soon

A trade body for the World's largest securitization market may be launched soon, according to a report in Asset backed Alert of 17th Dec. The body, likely to be called American Securitization Forum, will be an independent affiliate of the Bond Market Association.

There are industry bodies elsewhere in the World – the European Securitisation Forum is a body under the Bond Markets Association itself. The Asian Securitization Forum is an independent trade body. The Australian Securitisation Forum is yet another industry body.

The American trade body will represent players in both North and South America. Indications are that Greg Medcraft, global securitization chief at Societe Generale in New York; Jason Kravitt, a partner at Chicago law firm of Mayer Brown; and Vernon Wright, vice chairman at credit card giant MBNA America of Wilmington, Del will take up offices in the new Forum. The Forum may be launched early next year when annual industry meets are organised by SRI and IMN

Vinod Kothari comments: Once the American trade body is formed, let us also look forward to an international council of these bodies.

Bank of America subsidiary launches largest subprime home equity deal

A Standard and Poor's press release says that it has rated Bank of America's Dec. 14 launch of an approximately USD 7 billion transaction collateralized by fixed-rate loans, originated by its wholly owned subsidiary, EquiCredit Corp. This is a part of disinvestment process by Bank of America which is coming out of subprime home equity market.

EquiCredit, the fourth-largest originator of subprime loans in 2000 and one of the largest subprime originators and servicers in the history of the subprime market, ceased its securitization program in August 1999. Prior to that, EquiCredit had completed 39 transactions dating back to 1991. Since August 1999, EquiCredit has originated subprime mortgage products and retained the loans in its portfolio.

Bank of America had previously announced that it was exiting the subprime origination and servicing business and that its approximately USD 23 billion servicing portfolio and platform located in Jacksonville, Fla., would be sold to Fairbanks Capital Corp.

The present transaction will consist of four loan groups. Each will collateralize one of four triple-'A'-rated senior bonds,'A-1' through 'A-4.' All classes are wrapped by Ambac Assurance Corp. bond insurance policy that will guarantee bondholders timely receipt of interest and ultimate payment of principal. Credit enhancement prior to Ambac's obligation will be in the form of excess spread and overcollateralization.

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

Scope discussion on Accounting interpretation SIC 12 deferred

Corrigendum 20th Dec. 2001 I am sorry for the wrong information relating to SIC 12 carried in the news item put up yesterday. The original news item is below and the corrected information is here: It appears that in meeting of the SIC on 9-11 May 2001, it was decided to review issues relating to the scope of SIC 12 and the difficulties arising out of its application to securitisation transactions. A report from SIC on the May meeting says: "The Committee discussed some scope issues and recent developments arising from the application of SIC-12. The Committee agreed to consider certain aspects further."

The proposed discussion was apparently aimed at giving relief to securitisation transactions. However, the recent news item, as cited in the original piece below, states that such reconsideration has been deferred. In the meantime, the SIC is being reconstituted, and therefore, the proposed reconsideration may be put on the backburner for quite sometime. The issue is: in the meantime, will SIC 12 continue to apply as before? The answer, sadly, is yes.

Do you have any comments on SIC 12 relating to securitisation transactions? Do write to me for publication on this site.

Original item: An accounting interpretation by the interpretation committee of the International Accounting Standards Board (IASB) (formerly Committee) which was seen as very unfriendly for securitisation transactions – SIC 12 – has been dropped. A message on the IASB's website says: "The Committee planned to discuss some scope issues and recent developments arising from the application of SIC-12. In light of recent proposals to amend the mandate and operating procedures of the SIC, further consideration of this issue has been deferred until an agenda committeee has been established."

SIC 12 provided for consolidation of special purpose vehicles, and gave illustrations of situations where an SPV will be treated as a putative subsidiary of an originator. The circumstances included credit support, subordinate bonds participation, etc.

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

Securitization of government revenues booms in Italy

No other government in the World has as skillfully used securitization as a means of upfronting government revenues as Italy. It made headlines last year with the first securitizatio of social security receivables in the INPS deal: recently the Italian government has been in the market with two large securitization offers backed by gambling receivables and real estate.

The Euro 3 billion securitization of gaming receivables and the Euros 2.3 billion securitization of real estate receivables hit the market recently and sold like hot cakes. The property securitisation deal was highly over-collateralised: the two tranches of Triple A rated floating-rate bonds sold through SPV Societa Cartolarizzazzione Immobili Pubblici funding vehicle on behalf of seven state agencies, were backed by a portfolio of property assets worth about Euros 5bn. Domestic banks took a larger part of the issue.

According to an article in Financial Times of 18th Dec., this year should end up with a volume of about Euros 29 billion worth transactions from Italy. Playesr expect that if this trend continues, Italy might well end up as number 1 in Europe. Italy is currently led by UK as the largest player.

There are many signals of the maturity of the market – the number of repeat issuances, wide variety of asset classes ranging from NPLs to the exotic deals originated by the government as above. The Italian law has gone a great length in facilitating securitization transactions while a number of European jurisdictiosn remain hamstrung by incoherent laws.

Finance Minister Tremonti has publicly declared his optimism about the use of securitisation instrument to reduce the government's reliance on deficit financing.

Links For more on Italian securitisation market, click here.

Colombia passes securitization law

  • Colombia has put in place regulatory structure for securitization. According to reports in Colombian paper La Republica, Resolution 775, issued on November 9 by the securities regulator, provides for the issue and trading of securitized mortgages in Colombia's financial system.

    Mortgages can be backed up with collateral in the form of rights over the borrower's home and life insurance as well as property. Financial institutions engaged in the issue of securitized mortgage bonds are required to provide detailed information on the assets of each mortgage so that bondholders are aware of the risk of their investment. The information must be made available in a printed format as well as via the Internet.

    Securitization promises to reduce spreads on mortgages from 400-500 base points to around 350 base points, according to market practitioners in the country. The new system also injects greater liquidity into the market by making mortgage loans tradable financial instruments.

    Vinod Kothari comments: I have been to Colombia for a workshop and was surprised to see that many Colombians have been investing in paper backed by animals, lotteries, viatical life settlements etc. There is plenty of money with investors, and securitization of traditional collateral can only provide the needed outlet for investible resources.

    Philippines to push securitization law

    According to reports in Philippine press today, the government has committed to expedite the passage of several economic measures pending in Congress, that are aimed at attracting more investors to put in their money in the economy. According to National Economic and Development Authority these are the Special Purpose Vehicle Act and Securitization Act, envisioned to speed up the sale of non-performing asset of banks.

    Philippines has been making noises about the proposed securitisation law for quite some time now. See our previous report here.

 


SECURITISATION NEWS AND DEVELOPMENTS – January 2002

/in /by

[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 fed direct into your mailbox]

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

Previous newsletters

Feb., 02...Dec., 01.…Nov, 01 .…  Oct.,2001., Sep.,2001., Aug 2001… July, 2001, .June, 2001, May, 2001,… April 2001… March 2001 ..Jan. and Feb.2001  Nov. and Dec.2000  Sept. and Oct. 2000  July and August 2000 May and June 2000 April 2000   Feb and March 2000   
For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

 

 

 

Can Enron be another LTV Steel?

Can the true sale issue raked up in LTV Steel bankruptcy raise its head in the Enron bankruptcy proceedings? In the LTV Steel proceedings, LTV had filed motion seeking to rewind the transfers of inventory and receivables made by it to subsidiaries from where on the assets has been securitised. While the case shook the securitization industry, there was no final verdict on the motion. See details on our site here.

An article in Private Placement Letter of 21st Jan analyses similar concerns around the Enron debacle.

Enron is a much larger issue, both in amounts involved, ramifactions and the social and political noise it has created. Structured finance market exposure on Enron is substantial, partly direct and partly indirect. There are CMBS deals with Enron office space exposure, CDOs referenced to Enron, substantial ABCP exposure adding upto about USD 1 billion at the time of bankruptcy, etc. Securitization pros are concerned that if true sale of these assets is questioned, it might lead to a backlash to structured finance market. One person is reported to have said: "There's some systematic risk to securitization markets stemming from this. There was a lot of concern in the market last year from the LTV case. It's hard for me to imagine that, for something as large as Enron, there won't be some noise".

Links See our page on true sale and its implications. See here for more on LTV Steel. See below for a related story.

Fitch cautions investors against sale/leaseback CMBS

Rating agency Fitch has cautioned investors against CMBS created out of sale and leaseback of commercial real estate owned by potentially bankrupt companies. A typical such scheme will be one where a company, on the brink of financial distress, sells its commercial real estate and takes it back on the lease, and the leasing unit securitises the lease receivables.

In a recent press release, Fitch says it has reviewed several sale/leaseback transactions – where a company sells its commercial real estate assets and then leases them back so that the new owner can securitize the resulting pool of mortgages. This is particularly so if the company is pursuing this financing strategy on the brink of its bankruptcy and may subsequently shut its doors. "In these instances, CMBS investors may have to weather delinquencies and defaults because of an insufficient assessment of the risks involved', cautions Fitch. The deals where a red flag should go up would be ones of sale/leaseback transactions where investment-grade rated proceeds exceed a highly stressed value of the property. Vacant properties are typically sold at a fraction of their original value

In CMBS deals in general, if the assets are not easily fungible or are located in unattractive markets, the investor of CMBS bonds could hold, as collateral, empty buildings for a long period of time. This risk is exacerbated in sale and leaseback transactions due to arbitrary valuations.

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

 

US ABCP volumes rise in 2001: 
to maintain growth in 2002

The US asset-backed commercial paper conduit market continues to rise, and is expected to grow further in year 2002. The ABCP market ended 2001 with about USD 745 billion in commercial paper outstanding, up 16% from USD 641 billion at the start of 2001. In year 2002, rating agency Standard and Poor's, based on a survey of ABCP administrators, expects the market to rise another 13%.

The four major constituents of the ABCP market include: autos representing roughly 18%, trade receivables at 17%, equipment leases and loans at 16%, and credit card receivables at 10% of new commitments. Other constituents include time shares and franchise fees.

The major administrators surveyed by S&P included: Citigroup N.A, ABN-AMRO Bank N.V., Banc One, N.A., JP Morgan Chase, General Electric Capital Corp., Westdeutsche Landesbank Girozentrale, Rabobank Nederland, Liberty Hampshire Co. LLC, Societe Generale, Bank of America National Trust & Savings Association, Canadian Imperial Bank of Commerce, Barclay's Bank PLC, Credit Suisse First Boston, First Union National Bank, Charlotte, Bayerische Landesbank Girozentrale, General Motors Acceptance Corp., Firstar Bank, N.A., and Dresdner Bank AG.

Links For more on ABCP, see our page here.

Upgrades mount up in CMBS: S&P optimistic

In a report on U.S. CMBS rating transitions in 2001, a report released by Standard and Poor's shows upgrades outstripping downgrades by a large margin, with the outlook for rating upgrades in 2002 remaining favorable. U.S. transaction volume in 2001 totaled USD 74.3 billion, almost reaching the record USD 74.5 billion brought to market in 1998.

It may be noted that 1998 was the peak in US CMBS market after which volumes started declining consistently until the last year, largely due to a decline in conduit activity and general sloth in CRE sector.

The S&P report says that undercurrents of weakness began emerging towards the end of 2001, which did not show up in the year-end report.

Links For more on CMBS, please see our page here. See also a story below on non-US CMBS.

Emerging market deals may be affected by global economic sloth

Rating agency Standard and Poor's recently analysed the several emerging market transactions rated by it that may be affected by global economic scenario pursuant to 9-11. For the purposes of this analysis, emerging market deals can be classified into: asset-backed deals, tourism-dependant future flows, commodity future flows, and remittance based future flows.

One of the most significant reasons for weakness of several emerging market deals, unrelated to 9-11, is Argentinan economic crisis. Several of the rated securitization deals originated from Argentina, both existing asset and future flows, are liable to default owing to the peso-to-dollar exchange announced by the Government as also other measures.

Among tourism-related flows are airline ticket sales and credit card voucher payments, both of which are related to travel volumes. The rating agency feels that the transactions backed by sufficient collateralisation may not be affected.

Various commodity-backed transactions backed by export receivables have suffered due to declining prices of commodities.

Japan begins securitization of bad loans

In a major drive to clean up the creaking banking sector burdened with bad debts, the Japanese government has appointed Goldman Sachs and Mitsubishi Trust Bank to securitise loads of bad loans. To begin with, the exercise begins with securitisation of Yen 9.6 billion rated paper, but the deal will go upto Yen 100 billion (USD 744 million) of non-performing loans in what is believed to be the country's first securitisation of bad bank credits. Of course, Morgan Stanley has earlier securitised bad loans bought from Japanese banks, but this is a deal directly aimed at creating a secondary market in bad loans.

The Japanese government had constituted the Resolution and Collection Corp (RCC) on the structure of the Resolution Trust Corp, USA to take over bad loans of Japanese banks and restructure them.

Class A of the 4-tranche notes was rated AAA by Standard and Poor's, on factors such as the mortgage quality, subordination, cash reserves and the sound legal structure of the deal.

The asset-backed bonds are to be placed privately at a total price of about Y10bn.

Links For more on NPL securitization, see our page here. For more on Japan, see our page here.

Off-balance sheet financing comes under fire

The collapse of Barings Bank sent accounting standard setters into making a spate of new accounting standards that gave the World IAS 39 and FAS 133; Enron's debacle will certainly lead to review of some major accounting standards including those on consolidation and off-balance sheet financing.

That a major social opporbrium is building against off-balance sheet financing is a clear indication from the latest article in Business Weekthat hard hits attempts of corporate America in achieving off-balance sheet funding. "Hundreds of respected U.S. companies are ferreting away trillions of dollars in debt in off-balance-sheet subsidiaries, partnerships, and assorted obligations, including leases, pension plans, and take-or-pay contracts with suppliers. Potentially bankrupting contracts are mentioned vaguely in footnotes to company accounts, at best. The goal is to skirt the rules of consolidation, the bedrock of the American financial reporting system and the source of much its credibility", says the Special Report in Jan 28 issue of Business Week.

The article titled "Who else is hiding debt" scorns the use of special purpose vehicles to move away debt. "Because of a gaping loophole in accounting practice, companies create arcane legal structures, often called special-purpose entities (SPEs). Then, the parent can bankroll up to 97% of the initial investment in an SPE without having to consolidate it into its own accounts. "

If you are wondering which accounting rule is the article referring to, it is EITF 90-15 and EITF 97-1.

Link The full text of the Business Week article is available here.

More defaults in a year than together in the past:
Enron causes 6 ABS defaults

You are free to ask: is the beginning, or the end, or the end of a beginning or the beginning of the end. But looking at the number of defaults in asset backed securities, year 2001 has overshadowed 16 years of strong performance of securitized classes. Rating agency S&P has reported 18 defaults in 2001, compared to 11 defaults over a 15 year period for 1985 to 2000. As 1985 was the year when non-mortgage-backed rated securitization made a debut, it is all history on one side, outweighted by a single year.

The 18 defaults composed of synthetic securities (six), franchise loans (nine), retail credit cards (two), manufactured housing loans (one). The 6 synthetic defaults had one name to blame: Enron, whose bankruptcy triggered claims on credit default swaps against the investors. It is notable that in synthetic transactions, the investors are protection providers or guarantors through securitised swaps.

The data excludes two other notable defaults of 2001 – Hollywood Funding and LTV Steel. Hollywood Steel is recognised by S&P as a UK ABS. In LTV Steel, securitization funding was replaced by DIP funding, which is counted as an exchange and not a default by S&P.

Links

 

  • For full text of the S&P article, click here.
  • The LTV case is covered by our news items here and here.
  • Several other ABS defaults including Hollywood Funding and sad episodes are covered on our page here.

 

ABS Rating Downgrades abound in 2001;
most relate to collateral

Standard and Poor's has recently published a rating migration report for ABS ratings for year 2001. While this report reflects a murky scenario with downgrades reaching all time high, the rating agencies are still going strong on the fact that ABS issuance has for the first time waded through a recession, and most of the downgrades relate to performance of the collateral.

Out of a total of 320 rating changes by S&P (which is less than 7% of all outstanding classes), there were 245 downgrades and 75 upgrades, compared to year 2000, where there were 183 downgrades and 63 downgrades. However, S&P underscores the fact that most of these downgrades related to collateral performance (by the way, there are not too many other possible reasons for a downgrade, other than credit enhancer or counterparty downgrade).

S&P says that the major downgrades this related to synthetic securities [84 downgrades] where corporate downgrades worst affected the ratings of the synthetic securities, referenced to such corporates. Next in order were CDOs where the subordinate classes could not escape a downgrade, once again due to downgrade of the constituent corporates.

Links For full text of the S&P article, click here.

Auto majors increasingly look at ABS

The key feature of the US ABS market for the first two weeks of 2002 has been increasing presence of auto majors for new ABS issuance. Last week, Ford Motor company jumpstarted the market with a USD 5 billion ABS deal. This week, General Motors Corp. and Toyota Motor Corp. have joined the fray.

Everyone in the market was expecting increased supply of auto paper, since the rating downgrades of the manufacturers has pushed up their costs of corporate bonds. Asset backed deals, on the other hand, provide them cheaper and easier access to funds.

European papers have also reported plans by several European auto majors to package auto loan ABS rather than to look at unsecured corporate bonds.

Links For more on auto loan ABS, see our page here.

 

Non-US activity may push global CMBS growth

Commercial MBS volumes originating in the USA have been steadily declining since 1998, and non-US CMBS volumes have been growing fast. During year 2001, issuance outside the USA grew 87% from USD 12.1 billion in 2000 to USD 22.7 billion. As for year 2002, analysts expect the growth rate in non-US CMBS to be maintained.

Europe In the non-US market, Europe is seen as the growth engine. In UK alone, in year 2001, volume more than doubled to USD 10.7 billion, bolstered by some mega CMBS issues such as Canary Wharf and British Land. There was substantive activity from Italy as well, primarily comprising of a mega issue from the Italian government.

In year 2002, European activity will see a spike as some jumbo deals likely to be priced in the first quarter will add up to a volume of USD 5 billion. Moody's also concurs that the growth rate in European CMBS will continue in year 2002 – press release of 4th Jan.

Japan The Japanese CMBS market did very well in year 2000 when the issuance tripled over 1999, but in year 2001, the volume grew by meagre 20%. In year 2002, there might be a number of real estate NPL securitisations by banks, but CMBS as such may continue the same way as in 2001. Number of JREITs have been formed this year, which may get active in the CMBS market.

Rest of the world: Analysts expect CMBS debutante deals in South Korea, South Africa and New Zealand this year.

Links See for more on CMBS our page here.

 

CDOs : Asset managers' money machine

An article in journal Pension and Investments 7th Jan 2002 says CDOs are asset managers' latest money machine as they rake in fixed income over a substantially leveraged asset base. With the growing CDOs volumes and diversity in CDO classes (for example, see below about hedge fund CDOs), asset managers continue to make their moolah out of CDOs.

CDOs continue to attract well-known asset managers. In 2001, Guardian Trust Co., Nicholas-Applegate Capital Management and Pareto Partners were among the firms that launched CDOs. Sources said other big-name firms, including Fidelity Investments, are also planning to join the bandwagon.

The typical CDO fees are 40 bps with an additional 10 bps linked to performance. However, the equity stake usually required is only 5% and managers have to contribute only a part of it. True, there are more risks in managing CDOs as there are several triggers and ratios to keep track of.

US CDO volumes have continued to grow, despite the jump up in high-yield default rate from 6.3% to 8.9%.

There may be lessons to learn, but volumes will continue to grow: S&P

A press release of 9th Jan by S&P says that despite all problems and all critique, there might be lessons to learn, but the CDO volumes in 2002 will continue to rise. Transactions originated in 2002 will continue to incorporate structural innovations and mechanisms to further protect investors from pronounced credit deterioration within the portfolios.

Specifically, lessons learned from earlier-vintage CDOs include the need for longer warehouse facilities, less aggressive equity assumptions, and longer ramp-up periods for managers to accumulate collateral post closing. But chief among the observations made is the need to prevent excess spread from leaving a transaction upon early signs of credit deterioration.

Links: For more on CDOs, see our page here.

Japanese securitisation may grow 40% in 2002: S&P

Inspite of a falling economy, Japanese securitisation volume may grow 40% in year 2002, as regulatory pressure will continue to force banks to reduce their balance sheet risks. Total issuance in 2001 was estimated at JPY3.2 trillion.

S&P expects that if 2002 proves to be a repeat of 1998 and 1999 when a banking crisis forced companies to look to the securitization market as a source of funds, issuance may reach JPY5 trillion.

Growth will likely be focused on bank repackagings of loans to create cash and synthetic CDOs. Bank CLOs may increase due to regulatory pressures on banks who may look at these as a means of balance sheet management, and risk management in the form of credit default swap transactions. In addition, issuance in 2002 will also include its share of debt backed by real estate assets and securitization of various loans in the consumer finance sector.

Consumer finance securitization was the highlight of 2001 as finance companies found it to be a very effective means of funding. Consumer finance securitization accounted for about 17% of total ABS issuance in 2001, compared with less than 3% in 2000.

In MBS segment, there has been substantial CMBS activity fired by real estate portfolios of failed insurance companies, notably Chiyoda Life and Daihakyu Life. In year 2002, there may be lot of non-performing real estate loans being securitised. The work of Japan's Resolution and Collection Corp. to liquefy some of the defaulted real estate assets it has purchased from Japanese banks, as well as balance sheet management by some financial institutions, will contribute to the increase in NPL securitizations. Meanwhile, some of the repositioned real estate assets from the insolvent insurance portfolios will be purchased by sponsors of the newly formed J-REITs as they seek to amass their real estate portfolios.

Links For more on securitization in Japan, see our country page here.

Mexican securitisation grows 290% in 2001, to maintain growth over 2002: S&P

According to a S&P press release of 9th Jan, llow interest rates and legislative measures should assist Mexico's domestic securitization market to grow over year 2002. Year 2001 was a record year in terms of volume, with 290% spike over 2000.

For year 2002, the rating agency expects securitizations within a diversified pool of asset types, including federal tax participation flows, partial credit guarantee, construction bridge loans, and mortgages, as well as commercial real estate. As far as tax participation flows are concerned, recent legislation has allowed Mexican states and cities to securitize their federal tax participation flows through bond offerings.

The low-income housing industry is another sector that will continue to be an active issuer of structured finance debt in 2002. Both construction companies and mortgage banks ("Sofoles") have made great efforts to start addressing Mexico's estimated 6-million-unit housing deficit, and the need for additional funds is becoming more pressing. To overcome this need, issuers will continue securitizing construction bridge loans such as the one issued by Corporacion GEO, as well as other bridge financing like Hipotecaria Su Casita's issuance, until they have generated enough assets to make mortgage securitization feasible.

In addition, the creation in October 2001 of Mexico's federal mortgage bank will foster the development of primary and secondary mortgage markets in Mexico during 2002 and in the years to come.

Driven by Mexico's macroeconomic conditions, the dynamics of the commercial real-estate market are bound to change. Transactions that have typically been financed by private investments will most likely begin to be financed by debt issuances as market interest rates continue to be a competitive alternative for developers and construction companies. Therefore, commercial real-estate securitization will develop in the short term. It is very likely that these issuances will find an appetite among institutional investors who require instruments with tenors similar to the ones of traditional commercial real-estate securities.

Links For more on securitization in Mexico, see our country page here.

Spanish securitisation grows 52%

Securitisation volume in Spain in year 2001 added up to Euros 17.673 billion, which is 52 per cent higher than the volume last year. This data was published by AIAF, the Spanish association of financial asset brokers.

According to the trade body, this year has been one of the best for the sector, which has seen the volume of issues increase more than fourfold since 1998, when this stood at Euros 3.96 billion. Securitisation has benefited from not being closely linked to stock markets and from its attractiveness to companies. Thus, difficulties in the equity market have not percolated down to the ABS markets.

In terms of composition, of the total securitised asset issues this year, 5.112bn euros correspond to securitised mortgage bonds; 6.684bn euros to other securitised assets and 5.876bn euros to securitised bonds. The securitisatio activity has benefited from a new law which allows assets other than mortgages to be securitised, which has opened up the sector to institutions other than financial ones.

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

Citi tops 2001 ABS underwriter positions

It was a close one-on-one between Citigroup and Credit Suisse First Boston, but Citigroup finished as the top underwriter for 2001, for the second year in a row. According to data published by Thomson Financial [Investment Dealer’s Digest, Jan 7], Citigroup's Salomon Smith Barney ended up with a total underwriting volume of USD 49.232 billion, while CSFB added up to USD 48.793 billion. These numbers take into account public offerings as also rule 144A, including asset-backed and CDO deals.

The two top underwriters between them share about 30% of the US ABS market. JP Morgan Chase ended up with USD 43.4 billion.

 

Alternative investment CDOs to be strongest growth idea of 2002: S&P

CDOs that invest in private equity and hedge funds are going to be strongest growing CDO segment in 2002, says S&P. In a Press Release of 7th Jan, S&P expects alternative investment CDOs to be be the strongest growing segment in CDOs.

"In 2002 our biggest growth will come from alternative investments," said Soody Nelson, managing director of Standard & Poor's Structured Finance market value group in New York. "Specifically, the growth will be from securitizations of private equity fund of funds and hedge fund of funds, otherwise known as alternative investment collateralized debt obligations."

Such investments are an alternative to the capital markets, which include the public bond and equity markets and are generally open to all investors. The chief difference is that the capital markets are regulated and transparent and offer investors the same opportunities, while the private equity and hedge fund industries are opaque and unregulated, creating the opportunity for greater returns, though matched by greater and structured risks.

In the first half of 2001, Prime Edge became a notable CDO to invest in private equity. We covered this development in our report here. Subsequently, both S&P and Fitch came out with rating methodologies for such vehicles. Bouyed by the fast-growing hedge fund industry, the rating agencies are trying hard to push CDOs of hedge funds. The creation of hedge fund or private equity fund CDOs allows creation of debt investments that go into riskier equity investments.

 

Auto ABS should continue to grow in 2002: S&P

One of the majors drivers of the growth in ABS market in 2001 was the strong performance of the auto ABS – see our story here. Looking at 2002, rating agency S&P projects that "Current conditions in the auto asset-backed securities market should result in 2002 being another record year for the sector, with as much as a 7% rise in issuance over 2001 to $74 billion".

The Big Three automakers, General Motors Corp., DaimlerChrysler AG, and Ford Motor Co., were downgraded in late 2001 Resultingly, their cost of borrowing in regular debt markets went up, forcing them to look increasingly at the ABS market..

The securitization market also benefited from robust car sales in 2001 – the second best year ever, with sales supported by rebates and low-rate financing. The Big Three engaged in fierce competitive pricing, including the 0% financing deals designed to maintain or recapture market share. Zero-percent financing deals offered post Sept. 11 will also likely accelerate new car purchase decisions for many consumers and may cause auto ABS issuance to be front-loaded in 2002.

The current windfall will surely taper off as the reality of recession sets in, but would not have a detrimental effect on securitizations. Although the economy will put a damper on car sales and loan growth will likely decline, issuers will have a greater incentive to make securitization a larger share of the funding mix. Also, subvention, or below-market rate financing, popular among captive finance companies in a down market, should stimulate additional loan origination. Subvention rate financing will also attract loan obligors who may have otherwise made a cash purchase and improve the obligor mix, thus, at least, partially offsetting the adverse effects of a weaker economy.

Links For more on auto ABS, see our page here.

Australian RMBS holds promise: Fitch

Australian ABS market continues to be predominantly focused on RMBS, and the rating agencies project that in 2002, there may not be too much of non-RMBS activity, but RMBS holds a strong promise. RMBS issuance in 2001 added up to some USD 11.89 billion.

2001 witnessed historically one of the lowest interest rates in the country.. As the domestic economy begins to pick up over 2002, interest rates are likely to rise and that will probably dampen demand for new home loans. However, Fitch believes any reduction in the demand for new home loans will be offset by more of them being securitised thus ensuring 2002 issuance is comparable with 2001 levels.

Offshore issuance is expected to continue to be the dominant factor in the market, although new entrants are unlikely at present. RMBS is also expected to benefit from changes in withholding tax, which will enable Australian owned offshore companies to repatriate more dividends locally, should help the RMBS market also.

In the non-RMBS market the outlook is a little more cautious. CMBS and ABCP may not be quite as popular as the RMBS. The CMBS market is expected to struggle Australian investors are not comfortable with low-rated CMBS tranches. The ABCP market is expected to be maintained with corporates accessing it to facilitate funding requirements, accessing arbitrage opportunities and watching balance sheets. While the market is expected to grow there is concern about the depth in the market which may lead to the establishment of some US dollar ABCP.

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

Korean ISP's future revenues securitised

The strong current of activity in Korean securitisation market [see our story below] was kept going by a remarkable future flows deal where an ISP's future revenues were securitised to raise Won 120 billion.

Korea Thrunet Co., Ltd. ("Thrunet"), Korea's largest cable modem broadband Internet-access services provider and a major provider of enterprise network services, has issued in Jan 2002 asset-backed securities in adding up to Won 120 billion. Bank of America's Asian Asset Securitization Team in Hong Kong acted as structuring agent, while Hyundai Securities privately placed the ABS amongst Korean institutional investors.

The securities are backed by Thrunet 's future receivables from certain corporate customers in the Enterprise Network Business for the next three years and were offered to domestic institutional investors. It is not known if the deal was rated.

Thrunet is a major provider of broadband Internet access services and enterprise network services in Korea. The first to offer broadband Internet services in Korea, with 1,267,516 paying end-users at the end of November 2001, Korea Thrunet's network currently passes over 8.3 million homes. Thrunet service features "always-on" Internet access at speeds up to 100 times faster than traditional dial-up Internet access.

There have not been many future flow deals in Asia so far – so this one is a remarkable precedent and adds up to the bevy of deals originating from Korea.

Links For more on securitisation in Korea, see our country page here. For more on future flows, see our page here.

ABS one of the best investment options in 2001

Amid faltering markets and deteriorating corporate credit, investing in asset-backed securities was one of the best investment option in 2001. A Financial Times [Jan 7] story by Jenny Wiggins says investors ended up with some 10 per cent return on asset backed investments, which is slightly less than what could be expected out of corporate bonds, but in a year of overall uncertainty, the protection that asset-backed investments provided held a strong appeal with the investors. That is how 2001 ABS volumes ended with a strong performance – see story below.

There have been some weak spots in 2001. One of the most disturbing features was the rate of downgrades. According to rating agencies, most of the downgrades came from 3 sources: CDOs, franchise loans and manufactured homes segment, and airlines related securities. Several EETCs based on aircraft funding have been downgraded recently. The downgrades in CDO tranches are obviously connected with declining corporate credits.

Credit card delinquencies are rising, but so far, the performance in this sector has been quite strong. Barring the bankruptcy of Heilig-Myers [see our page here], there were no defaults duing the year.

All said and done, investor demand for ABS continues to be strong.

Your views please As a participant in the structured finance industry, how do you see the ABS market behaving in 2002? Write your views.

Links There are several articles on investing in ABS on our articles page – see here.

Lehman commits USD 1 billion for Philippine market

Philippine media quoted House Speaker Jose de Venecia, Jr. as saying that Lehman Brothers has committed to invest USD l billion in a Philippine Recovery Fund will invest in securitisation of mass housing projects in the country, as also acquire the non-performing assets of the commercial banking system. The Fund would be used to participate in the securitization of the Malampaya natural gas and housing mortgages and to finance new housing projects and new economic development programs of the government.

If this proposed investment materialises, it will surely be a major boost to the government's ongoing efforts to introduce securitisation in the troubled economy. Efforts are on to implement a securitisation law in the country -see our news report here.

BusinessWorld (Philippines) of Jan 2 also notes the progress of the securitization bill. The Philippine Stock Exchange has reportedly supported the Bill. The House economic affairs committee is conducting hearings on House Bill 2733, which provides for a legal and procedural framework for securitization. In addition, the stock exchange has also recommended tax incentives for investors investing in the securities.

 

High hopes on 2002 as yet another year of high growth closes

In an otherwise insecure world, securitisation continues to prosper. Year 2001 ended with impressive growth in securitisation volumes on both sides of the Atlantic, and market players have rung in the new year with the same optimism.

Website abalert.com which tracks securitization data regularly reported a total (US and non-US) issuance of USD 418.3 billion for 2001, as compared to USD 354.5 for 2000. The US volume grew from little over YSD 270 billion in 2000 to above USD 306 billion in 2001.

A news report in Financial Times of Jan 2 quotes market practitioners who expect the US volume to reach USD 365 billion in 2002, inspite of pressures on credit quality and corporate earnings. As to general decline in credit quality, in auto receivables segment, rating downgrades of the auto majors only increased their presence in the securitisation market to reduce costs.

Most impressive growth in global securitization in 2001 was achieved in Europe where volumes grew by 126% to Euros 42.1 billion. With more European governments passing pro-securitization laws, the growth may only accelerate in 2002.

The primary drivers of growth in Europe were a near tripling of volume in the Italian market, strong performance from France, Germany and Portugal, and some particularly large new transactions in the Netherlands, Greece and Austria.

Asian markets are also expected to wake up 2002, as more investment bankers realise arbitrage opportunities and banks use securitisation as a tool to tidy their balance sheets.

 

Korean securitisation growth exemplary

The growth of securitisation in Asia, minus Japan, has been tardy – everyone agrees. And everyone also agrees that the news emanating from Korea is very heartening. Korea has been at the centrestage of Asian securitisation scenario over 2001. In an article in AsiamoneyNov. 2001, Fiona Haddock reviews the developments in Korean market and remarkable deals in the recent months.

In October 2001, Hanvit Bank deal was brought into the market by ABN Amro bank. This USD 216 million deal was the 10th securitisation deal by the originator, and was the first Korean ABS issue to be backed by documentary credits granted by the bank to its manfacturing clients. Remarkably, this deal also included certain non-performing loans granted by the originator, and unlike the deals in the past, there was no third-party guarantee to back up the deal. The three tranche deal's senior class was rated AA and was sold 20 bps above likeable corporate bonds. The second and third class were rated BB- and B- respectively and were sold at 12% and 13% respectively. The main investors were pension funds, investment trust companies and two life insurance companies.

A little later, Morgan Stanley brought a real-estate NPL deal to the market. This Won 174.9 billion Korean deal was issued through the Resurgence Korea One special purpose vehicle. The underlying assets consisted of a pool of loans and properties purchased from Kamco. Morgan Stanley, it is notable, has bought non-performing loans in Japan for securitising them, and they have been doing it Italy as well. This was the first securitisation of non-performing loans bought on a commercial basis for securitisation. The AAA tranche of this deal was sold at 5.57%. See article by Rob Davies on this deal here.

Investment banks in Korea are upbeat on future prospects as more cross border investors indicate appetite for Korean assets.

Links For more on securitization in Korea, see our country page here. There are a number of recent links on this page. For securitization activity in Asia [updated Jan 2002], see our page here.

 


SECURITISATION NEWS AND DEVELOPMENTS – February 2002

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[This page lists news and developments in

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For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

 

 

FASB's consolidation norms to exclude securitisation SPVs

As per decisions reached at the meeting on 27th Feb (tentative and unofficial), the new accounting standards on consolidation are intended to exclude qualifying SPVs under securitization accounting. FAS 140 puts certain conditions in order for an SPV to be treated as a qualifying SPV. For details, refer to our page on accounting.

The new consolidation norms are being made in the wake of Enron which used several SPVs to hive off assets and liabilities and thereby made the balance sheet illusory.

Under the new norms under making, a primary beneficiary will consolidate an SPV unless it can establish itself to be "sufficiently independent". The sufficient independence criteria will be satisfied if the SPV has the ability to fund or finance its operations without reliance on the Primary Beneficiary or a related party for guarantees or other forms of support. Besides, at least 10% of the total funding of the SPV, meaning debt and equity, should be form of legal equity which is subordinated to all other funding. Such substantive equity must not be guaranteed or protected and must carry uncapped risks and rewards.

Update on March 1 One of the conditions for an SPV to be a qualifying SPV is business restrictions. SPVs should be completely brain-dead and should not have a power to decide.

CDO conduits, which are managed by conduit managers, often have a power to add to the collateral, replace collateral etc. Many of actively managed vehicles which are run like hedge funds based on certain triggers. Certainly, CDO vehicles will not be QSPEs under FAS 140 and therefore, they might be affected by the new accounting rules. However, the most difficult thing would be to identify the "primary beneficiary" for a typical arbitrage vehicle as the equity ownership of a CDO is likely to be dispersed. So, even if it is hit by the new consolidation norms, it will not be easy to identify the entity with whom it should be consolidated.

Links For more on accounting, see our page here. See related, earlier story below.

Indian Budget proposes securitisation legislation

Indian Finance Minister Yashwant Sinha presented his Budget 2002-3 today before the Parliament, and among other banking sector reforms, hinted at a forthcoming legislation that would enable banks to securitise their loans.

Sinha talked about a banking reform legislation which will allow banks to securitise their loans, as also provide for foreclosure of private property security interests. There was no time specified for introduction of the Bill. However, a related proposal for which he fixed 30th June 2002 as the time limit was the setting up an asset reconstruction company which will buy NPLs from Indian banks and securitise the same. Assuming that the proposed securitisation legislation will also be needed for the NPL securitisation, it may be likely that the proposed bill may be moved in the current sesssion itself.

Besides, though Sinha talked about the foreclosure law and the securitisation law, the impact of both is not limited to banks only.

A draft securitisation law has been around for quite some time -see the text on my site here.

The foreclosure of private security interest law refers to a special legislation whereby enforcement of security claims on movable property will be allowed through recovery officers rather than through Courts – we have commented on this draft law on this site.

Asset reconstruction companies are specialised bodies that buy bad loans from banks with the sole brief of resolving the same. There are similar bodies in Korea (Kamco), Malaysia (Danaharta), China (Huarong) etc.

Links For more on securitisation in India, click here.

Workshops For a 2-day securitisation training on legal, regulatory and acccounting issues in New Delhi, click here.

FASB meets today for consolidation of SPVs

The FASB is meeting today to revise its interpretation on consolidation of SPVs. It is expected that the Board will finalise a draft interpretation on consolidation of SPVs that will cover the scope of the interpretation, the meaning of SPVs and the tests to identify an SPV as different from an operating company, tests for identification of the primary beneficiary (sponsor) of an SPV, laying down the test of sufficient independent economic substance, substantive equity investment at risk and substantive risks and rewards of ownership of an SPV.

The interpretation is expected to increase the present required minimum of 3% independent at-risk investment in the SPV to 10%.

We will post you more news on this issue we get to know developments.

Links For meaning of an SPV in the context of securitization and other deals, as also for brief of the existing accounting rule, click here.

Superior Bank's residual interests fetch far less than their book value

Superior Bank's failure was blamed partly on wrong accounting for residual values in form of servicing and end-period interests in securitised mortgage portfolios – see story on our site here for details. Now inspite of several forced write downs, the servicing rights recognised in books at a value of USD 800 million have actually fetched only USD 471 million, leave aside an earning of USD 46 million received during the intervening servicing period.

Superior Bank, a thrift, went bust last year and the FDIC took over its assets. Out of a securitized subprime mortgage portfolio of USD 3.7 billion, the bank had recognised residual interests of USD 800 million, after a series of regulator-forced write downs. Subprime residual interests are obviously more credit risk sensitive and therefore, their valuation has to be very cautious, but the Superior Bank's track record proves that when it comes to securitization accounting, accountants have long forgottten the age-old rule of conservatism.

Links Securitisation accounting has been a hotly debated issue, particularly after Enron. See discussion, several links and articles on our page here.

 

If you had champagne bonds before, high time to buy some scotch bonds as well!

Let us say three cheers to the innovative pace at which securitisation markets are growing. The other day, a US inventor wanted to use a mix of the Bowie Bonds method and the cat bonds device to securitising lottery jackpots.

With Marne et Champagne deal, where you buy bonds backed by champagne stocks, it is only but natural that you will like to add scotch, and may, over time, wine, vodka and tequila as well.

Evening Standard UK reported that Glasgow-based Kyndal International, maker of Whyte and Mackay, is preparing to raise GBP 188 million by securitising inventory of scotch maturing in its cellars. The issue might be in the market by mid-April or so.

The funding is being raised to repay a loan of an equal amount taken from WestLB for taking over the distilleries from a US company. Thus, you have leveraged buyout in a different form.

The methodology of the deal is apparently sounding similar to the Marne et Champagne deal. Stocks of scotch at various stages of making will be pledged to a security trustee who would realease the same against sale proceeds. The sale proceeds will be used partly to pay off investors in the bonds and the balance to buy fresh stocks from the company.

 

Bankruptcy professionals do not want securitization safe harbor

If a poll running on the website of the American Bankruptcy Institute (abiworld.org) is an indication, the Congress may be forced to scrap the safe harbor protection it intends to provide against true sale question in bankruptcy proceedings to securitization transactions.

At the time of visit early today, 48% of the visitors were opposed to any such safe harborm while only 25.6% favored it.

The question for the poll was: Section 912 of the pending legislation creates a safe harbor from bankruptcy for certain borrowing transactions that are recast as sales and structured in a securitized SPV. In your opinion, this provision would:

 

  • appropriately increase legal certainty in the event of a bankruptcy for legitimate asset securitizations, got 125 or 25.61% clicks.
  • lead to sham and/or secret transactions that inappropriately shield assets from other creditors, got 236 or 48.36% clicks; and
  • don't know/no opinion got 127 clicks.

The poll is still on.

While the size of the polling visitors is not large enough to be reflection of a popular mood, it needs to be realised that the subject is extremely specialised and not too many people could be visiting ABI's site, or voting on the technical issue. Besides, it is also natural that the visitors to the site are mostly bankruptcy professionals, lawyers or legal professionals, whose views are anyway known in the matter.

Links: See below for a related item with background material. See also our page on bankruptcy reform on securitization.

Cast your vote The ABI website is understandably visited mostly by bankruptcy professionals. Let us take the views of the securitization industry – go to the Index page and cast your vote on this very important issue concerning securitization.

 

World Bank opposes gas revenue securitisation by Philippines

According to news reports in BusinessWorld (Philippines), the World Bank (WB) is opposing government's plan to use earnings of the Malampaya Gas Project which has been talked about for quite some time now. According to the WB, such a plan will relegate the WB to the status of a less preferred creditor while the country has promised a preferred creditor status to the WB.

According to the WB, WB's general loan conditions bar member countries from supporting state borrowings with collateral since the bank itself extends loans without security. The securitization scheme aims to convert the Malampaya Gas Project's revenues into collateral. This will violate the WB's 'negative pledge' clause which is a part of general lending documents, under which no other creditor could be put at a better status by charge over the public property..

The Philippine government was planning to raise something like USD 500 million by securitisation of the gas revenues from the Malampaya project. The project itself is a USD 5 billion investment.

 

Securitization accounting can be tricky: analysts

There were such voices all the time, but Enronitis has only brought it to fore: the possibility of imaginary gains on sale sitting on the balance sheets of frequent securitizers.

For example, a recent article in Forbes March 4 titled Is Accounting Dead lists 4 stocks to avoid, which includes Washington Mutual: the largest thrift (Savings and Loans Assocation) in the USA. It has a market capitalisation of USD 31 billion. and asses of USD 243 billion. As for many other mortgage players, the company adopts the gain-on-sale approach to accounting its securitization profits, which in a layman sense means somewhat as follows: the company writes mortgages that it would service for up to 30 years, and yet books some of the profit up front when it sells the future income stream by way of securitization. While this sounds perfectly normal and legitimate for any securitizatio professionals, the analysts smell a rat in this. In the case of Washington Mutual, these upfronted gains more than tripled last year to just shy of USD 1 billion, or 22% of pretax earnings before extraordinary items. .

As the yearly gains on sale went up, so also did the value of retained servicing and residual interests, an asset under FAS 140. In this case, the cmmpany has booked a USD 6.2 billion in such assets, which is up more than sixfold in a year and equal to 44% of shareholder equity.

The analyst compares this with a patent company booking its future stream of income on the patent the day it is issued. There is no question of the legimacy of the gain-on-sale practice under the current GAAPs: but it the GAAPs itself which are under fire right now.

"Calling future profits an asset is a tricky business", says the analyst. To reflect the volatility of these pre-supposed earnings, the analyst points to the revaluation of the retained interests which in the current scenario almosts invariably leads to write down there was USD 1.7 billion by the company last year.

Links There is quite a lot of material on this site on gain on sale accounting and accounting rule EITF 99-20 under which firms like Washington Mutual might have had to write down retained interests.See our page on accounting issues.

"Securitisation can obfuscate and cheat"

The biggest casualty of the Enron debacle is that analysts, journalists and social thinkers have pointed their guns at complex financial instruments. On our credit derivatives site, we have carried news of the opprobrium building against derivatives in general and credit derivatives in particular. Securitization is no better – as the following shall reveal.

Martin Hutchinson, Business and Economics Editor of the United Press International wrote last Friday that securitization has a very wholesome purpose, but it can be used to obfuscate and cheat, and in the 1990s, it was too often employed for that purpose. Martin's peace ends with the bottomline: "reforms are urgently needed".

Martin goes into the history of securitization into the 1970s where it was invented as a device for affording tradability to government-guaranteed mortgages, that is, prime mortgage loans. The device was later used for selling down prime credit cards, and further down, subprime mortgage loans, and then subprime credit cards. Evidence is clear that more and more originators have used securitisation to create and sell the assets that they would not like on their balance sheets. "The two principles of sound securitization, of diversification of securitized assets and of first class securitized asset quality, have been violated time and again in the last 10 years, for transactions involving hundreds of billions of dollars. Consequently, the balance sheets of many of the largest banks, and of heavy participants in the securitization market such as GECC, have hidden deposits of financial "toxic waste" — risk exposures that, in a deep recession, are far more concentrated and more intense than might be expected from a casual reading of the balance sheet and knowledge of the institution's overall loan portfolio", says the author.

According to the author, there must be stringent regulatory checks before securitised portfolios are allowed to go off the books. First, the quality of the portfolio, clear of any credit enhancements, must be good to stand on its footing. Two, if the portfolio is undiversified, it must be sold as in bilateral deals with no participation of the seller.

The author is also in favour of restricting off balance sheet treatment and adopting something similar to the UK's linked presentation approach.

 

European ABS undergo high downgrades but resilient, says S&P

Rating agency Standard and Poor's came out with a rating transition history for European asset-backed issuance covering period from 1987 to 2001. While there have been several downgrades in year 2001, the overall scene is still one of resilience, and the rating agency expects the trend to continue through 2002.

The major highlights of the study are:

 

  • The market expanded substantially in 2001. At the end of the year, there were 1,299 rated classes and 702 transactions remained outstanding.
  • Though Europe has traditionally been an RMBS-dominated market, for the first time in 2001, CDOs took over RMBS on year-to-year basis. CDOs took 32%of the total classes rated. See more on our page on Europe here.
  • No European ABS transaction rated by S&P has defaulted since the market's inception. Market information is that no other Euoprean ABS has defaulted.
  • There were several downgrades during the previous year and some of them were related to collateral deterioration.The number of ABS classes downgraded in 2001 was the highest since 1992, a period when the majority were caused by the downgrade of U.K. insurers providing credit enhancement to U.K. RMBS issuances.
  • The majority of ABS downgrades affected CBO/CLOs and the majority of upgrades were of RMBS transactions. The CBO downgrades took 72% of the total downgrades, affecting 8 out of 13 classes.

As regards the CDO market in Europe, S&P reports that a number of features are beginning to emerge although the market both in numbers and maturity is too small to give definitive signals:

 

  • CBO/CLO tranches backed by portfolios containing a small number of assets are likely to exhibit higher ratings volatility than those backed by large, well-diversified assets.
  • Active management of portfolios–-recently introduced in some CBOs–-gives the CBO asset manager the ability to reduce this potential volatility, but it remains to be seen how successful managers will be in achieving this.
  • On the evidence of the small number of downgrades to date, CLOs have remained almost entirely unaffected, although one revolving pool CLO transaction was subject to downward rating action in 2001. This is a direct result of most CLOs being backed by large, well-diversified pools of corporate loans.

 

 

As for outlook for 2002, S&P expects that the themes apparent in 2001 will continue in 2002. It is likely that there will be further downgrades of CBO/CLOs as they are affected by negative rating movements in their underlying assets. With the increase in managed transactions, the effectiveness of collateral managers in maintaining the quality of their portfolios may be a developing theme

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

 

India's first CDO to take mutual fund route

India's leading financial institution ICICI has lined up a Rs 5.02 billion [approx USD 105 million] CDO that will be structured as a mutual fund scheme. To called Indian Corporate Collateralised Debt Obligation Fund , the mutual fund would be regulated just like any other mutual fund by the securities regulator.

According to the proposal, a pool of debentures and loans of ICICI and ICICI Bank originating from 24 accounts would be sold to the mutual fund. The fund, would in turn issue units with a face value of Rs 5 million each to qualified institutional investors.

The securities will have a tenure of two years and will be available in two options the growth and dividend option.

Though structured as a mutual fund, the scheme will have a tranching similar to a usual CDO. In a usual CDO fund, debt securities are collateralised based on a pool of bonds, supported by an equity tranche. The debt is itself classed into multiple tranches with the senior tranches getting a higher rating on the enhancement provided by the subordinated tranches. The very basic economics of a CDO lies in the cost advantage given by a structured funding.

The CDO will be tranched in 3 tranches. The first tranche of Rs 3.74 billion (AAA) would be sold to institutional investors. The mezzanine tranche of Rs 0.59 billion would be sold to the International Finance Corporation. The third tranche of Rs 0.70 billion would retained by ICICI.

The issue is expected to be in the market in March.

Links For more on Indian securitization market, see our country page here. For more on CDOs, see our page here.

Consolidation accounting standard likely soon

The use of special purpose entities (SPEs or SPVs) by financial institutions and others, for hiving off assets or operations into a separate vehicle so designed as not to be consolidated with the parent has been a core issue raised by the Enron debacle. The accounting standard body FASB in the USA is at present in the process of finalising a new accounting standard on consolidation of SPEs. 13th Feb, the FASB met and discussed issues relating to identifying and consolidating SPEs.

As an offshoot of the SPE discussion, the Board is likely to meet again on 20th Feb to discuss measurement and disclosure of guarantees. Financial guarantees are not treated as derivatives under current accounting standards and are not measured and disclosed as assets/liabilities. The guarantee project is a separate project, unrelated to SPE consolidation.

It is likely that the consolidation accounting rule (interpretation) would be ready in draft form by 27th Feb. The rule is likely to provide for consolidation with the "primary beneficiary" of entities that lack sufficient independent economic substance.

SPEs accounting rule is not limited to securitization SPEs – there are SPEs for synthetic lease transactions [see more on Vinod Kothari's leasing website], reinsurance, derivatives, etc.

 

More on bankruptcy reform on securitizatio true sale

Apropos the raging controversy regarding the proposed Bankruptcy Reform legislation that seeks to give a safe harbour to securitization transactions [see our item below], we give you more materials.

Prof. Steven Schwarcz recently spoke on Enron and the off-balance sheet controversy. A webcast of his lecture is here and text of his talk is here.

Our page on the Bankruptcy Reform Act of 2001 gives details of what is the proposed reform all about. After the collapse of Enron, the legal academia consisting of 35 law professors and deans wrote a letter of Jan 23 to the Senate group opposing the proposed reform which seeks to give a safe harbour to securitization transactions. The text of the letter is here. Yet another letter was sent by some more, on Jan 28 – it is here.

The Bond Market Association, representing the fixed income industry, opposed the letter and supported the intended reform of bankruptcy laws, claiming that such safe harbour would be in the interest of securitization transactions, which are premised on bankruptcy remoteness, and securitization is essential to capital markets. The BMA letter is here.

On Feb 1, the professors gave a rejoinder, replying to the contentions of the BMA. Here is this letter. This letter pleads that sec. 912 of the Bankruptcy Reform Act would insulate any nominal securitization from a substantive judicial review. On Feb 5, yet another letter was shot by another professor, supporting the views of the 35. Here is this letter, contending that sec 912 results into an unlevel field between different modes of capital raising. This letter, among others, also contends that the lower cost advantage in case of securitisation is merely shifting of costs and not reduction.

More European telecom operators eye securitization for flexible funding

The success of Telecom Italia's Euros 700 million securitization last year is not the only reason which makes European telecom operators bullish on securitization: it has to do with the volatile and difficult corporate debt markets across Europe. Rating agency Standard and Poor's recently released a report according to which telecom operators will continue to look at the ABS market for financial flexibility. Investors in telecom ABS appreciate the well-established, long-term operating assets of telcos, such as fixed-line networks of the incumbent (former state-owned) telecoms operators, in particular, which continue to generate very strong, relatively stable, and predictable cashflows.

Among the telcos looking at securitization funding are: France Telecom which is planning to securitise cashflows from its fixed-line business, and has appointed SG and Deutsche Bank as arrangers, and Deutsche Telekom, which is working on a deal with ABN Amro and Dresdner Kleinwort Wasserstein.

 

Philippine railway build-lease-transfer payments to be securitised

Rob Davies writing for Financeasia.com reports [7 Feb] that a Philippine deal to fund the development of a railway track on build-lease-transfer basis will be the first securitisation deal to emerge from Philippines after nearly 5 years. HypoVereinsbank is going to raise the funding of approximately USD 170 million.

The structure of the deal is likely to be as follows: MRTC is a consortium comprising Anglo-Philippine Holdings Corp, Allante Realty and Development, DBH, Fil-Estate and Ramcar which is building a 16.8 kilometer railway that runs over the EDSA highway in Metro Manila. MRTC has a 25 year build-lease-transfer contract with Department of Transportation and Communication (DOTC).

The rental payments under the build-lease-transfer contract are being assigned to HypoVereinsbank which in turn is taking the securities to the capital market. Payments by DOTC are equivalent of a sovereign guarantee, which will act as a strength factor for the deal.

The deal is likely to be broken into a 5-year tranche paying a nominal coupon with a bullet repayment, and two zero coupon tranches, one of which will mature between 2008 and 2014, and the other in 2025, with amortization from 2015.

Philippine ABS law is still in the making but the present deal is not likely to have to wait for the new law.

Links: See related links here.

 

ABS market prepares for rough ride

An article in Investment Dealers' Digest [4th Feb.] by Adam Tempkin beautifully sums up the present scene of the ABS market in the USA. "As consumer credit continues to deteriorate and unemployment spikes to alarming levels in the midst of recession and the events of September, the 16-year-old asset-backed sector-for the first time as a mature, diverse and large capital market, reaching a record- breaking supply of $350 billion in 2001-has been swiftly kicked out of its comfort zone", says Tempkin.

It is everyone's knowledge that ABS market has been responsible for much of the riskier part of originated funding such as subprime credit cards, manufactured housing loans, high-yield bonds, etc. Where bankers were wary of putting assets on their balance sheets, they chose to do it through the ABS markets. Now when unemployment rates are scaling new heights, delinquencies in these riskier asset classes are unavoidable, as already reflected in the downgrades history in 2001 [see our report here] As a matter of fact, there have been more defaults in 2001 than in 16 years of ABS history together. Of course, Enron has been responsible for many of these, but exactly that name might also lead to some adverse regulatory developments in the current politically charged scenario against off-balance sheet funding. That the legal academy has used Enron as the alibi to plead against securitisation safe harbour is clear from the reports below; adverse accounting and regulatory developments therefore cannot be ruled out.

ABS analysts compare the current scene with what prevailed in 1991 – securitization fared through the recessionery pressues in 1991. But clearly investors are not willing to take that risk. This has led to steep yield differentiations in ABS tranches.

The lull in activity is visible from Jan 2002 issuance: it ended with only USD 19 billion compared to USD 31 billion for the same period last year.

Links For more on US ABS market, see our page here.

Operating revenues securitisation to make its advent in USA

These would be among the very few, if not the first, whole business securitisations to be tried under the US laws. Bondweek of 5th Feb reports that two US companies are preparing to raise a total of USD 550 million via securities backed by projected future cash flows of their respective operating businesses.

The whole business cashflows or operating revenues securitization is a device mostly limited to UK or countries with similar bankruptcy laws. The bankruptcy laws in these countries uses the secured loan structure that allows for appointment of an administrative receiver by the lending SPV in case of certain trigger events. US securitizations, based on true sales, have not used the future flows device, except for some rare instances such as Arby's deal closed last year.

The reference deals are being underwritten by SG Cowen, a subsidiary of Société Générale. One of the two companies is a communications service provider, which will securitize its future flows from voice mail and such other services. The other is a construction company which will securitise its revenues from building toll plazas, power plants and pollution control equipment.

The report says that the underwriting fees here are 10 to 20 times the usual fees.

Links For more stuff on whole business securitizations, please see our page here.

More comments on bankruptcy law reform on securitisations

In response to our news story below, we got the comments from Prof Steven L. Schwarcz, Professor of Law, Duke Law School & Prof. (Adj.) of Business Administration, The Fuqua School of Business; Founding Director, Global Capital Markets Center. Prof Schwarcz is one the World's most respected academics on securitization and structured finance and has several books and articles to his credit. See more on our site here.

Prof. Schwarcz favours the safe harbour proposed in the Bankruptcy Reform Act of 2001. As a matter of fact, Prof Schwarcz has written a letter to the senate judiciary committee saying he is troubled by the January 23 letter by the law professors. "The suggestion that section 912 would encourage the types of off-balance sheet financings that Enron abused is misleading for two reasons. First, section 912 addresses only securitization transactions, which are not the types of off-balance sheet financings that caused the problems in Enron. Second, the problems in Enron do not appear to have been caused by the creation and use of special purpose entities, per se, but rather by the off-balance sheet accounting treatment of such entities and their specially lobbied exemptions from the investment company act. Accounting treatment is governed exclusively by generally accepted accounting principles, promulgated by the Financial Accounting Standards Board and having nothing whatsoever to do with section 912."

While using Enron as the alibi for opposing sec. 912 is clearly wrong, what about the idealogical basis behind section 912 itself? Does he favour the idea of safe harbour which is essentially in a way scuttling the scope for judicial review by mutual agreement between parties to a contract, to the exclusion of the rest of the interested or concerned parties? Prof. Schwarcz says – he supports the safe harbour.

Detailed article on Bankruptcy Reform on securitization by Prof Schwarcz is here [word file].

Links See our page devoted to the Bankruptcy Reform on securitization transctions. This page gives you all that you would need to know about the proposed reform.

Enron issue brings securitisation true sale to the fore: law professors press for bankruptcy law amendments

In our last piece on the previous newsletter, we had carried the apprehension that the Enron debacle will rake up the true sale issue in securitisation transactions, as was done in LTV Steel. In fact it is turning out to be worse, as several law professors have jointly pleaded with the Congress to relook at the true sale involved in securitisations generically.

On Jan 23, several law professors wrote letter to the congress representatives pleading the Congress to reject a proposed amendment in US Bankruptcy law under which an asset transfer in a securitization transaction could not be challenged in bankruptcy proceedings. This amendment is sought to be made by sec. 912 of proposed bankruptcy law amendment.The purpose of the amendment is to give a safe harbour to securitization transactions.

The law professors allege that in number of securitization transactions, lenders are seeking to reclassify themselves as buyers, so as to stay out of the bankruptcy court's jurisdiction. "Not every asset securitization is a disguised loan transaction, and asset securitization is a valuable financial tool. Yet it is essential that the Bankruptcy Code not be amended to open a massive loophole so that parties interested in dealing with certain assets who simply rename a “loan” a “sale” will be exempt from bankruptcy because the property was no longer part of the debtor’s estate", claim the professors.

The professors claim that if working assets of corporations are securitised and hence moved out of the bankruptcy court's regime, any possibility of reorganisation of the corporation will be ruled out, as was the case with LTV Steel. A number of airlines have securitised their receivables, and if the cashflows into their business belongs to securitization investors, "we could face the spectacle of the government giving the airlines billions in tax dollars, only to have substantial assets of the business removed from the company in “off-book” transactions for which no one would be held accountable."

Enron itself has some USD 4.2 billion worth assets which are off the balance sheet. If the proposed regulatory regime were in place, these assets will be out of the purview of the bankruptcy judge.

As could be expected the Bond Market Association has reacted to the professors' letter. In a letter of 31st Jan, the Bond Market Association claims that the amendment would define circumstances in which assets conveyed for purposes of certain securitizations are removed from the transferor's bankruptcy estate. These amendments have been debated in Congress for a number of years. The BMA harps on the need to give predictability to properly structured securitization transactions. It builds upon the benefits of securitization for the global economy as a whole: "The multi-trillion dollar securitization market has played a significant role in the growth of the American economy. Companies that use securitization have been able to significantly reduce their cost of funds, increase liquidity, and obtain greater and more diversified access to the capital markets. The market efficiencies created through securitization are passed on to both consumers and businesses, in the form of lower interest rates for home mortgage loans, automobile, student and home equity loans, credit card debt, and other extensions of credit. Absent an efficient securitization market, the cost of obtaining this credit would likely increase, as would be more costly for lenders to finance their activities."

What do you think? Do you agree with the law professors that the right to question a purported sale as a true sale should be vested in Courts and we should trust them for coming out with a just answer?Write your views.

Links: The full text of the law professors's letter is here. Here is yet another link. On this site, see our true sale page.

 

SECURITISATION NEWS AND DEVELOPMENTS – March 2002

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[This page lists news and developments in

global securitisation markets – please do visit

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

Previous newsletters

April 02 .…Feb 02 .…Jan 02 .…Dec., 01.…Nov, 01 .… Oct.,2001., Sep.,2001., Aug 2001… July, 2001, .June, 2001, May, 2001,… April 2001…  March 2001 ..Jan. and Feb.2001 Nov. and Dec.2000  Sept. and Oct. 2000  July and August 2000 May and June 2000  April 2000   Feb and March 2000   
For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

 

 

Yet another fund of funds hits market

CDOs that invest into hedge funds, private equity funds and such investments are seemingly in full gear. There are several takers, so it seems, for the Prime Edge type of investment vehicles. Call them CDOs, or CIOs (collateralized investment obligations) or CFOs (collateralized fund obligations), it seems the device is here to stay.

Investcorp has announced a securitisation of up to USD 500 million of a fund of hedge funds. The issue is claimed to be the first market value CFO issued in the European market, and one of the first public issues of this type anywhere.

Credit Suisse First Boston is acting as sole lead manager and bookrunner on the transaction. Managed by Investcorp, the Diversified Strategies CFO will invest in a broadly diversified fund of hedge funds, tracking the performance of Investcorp's established Diversified Strategies Fund. Investments will be heavily tilted towards relative value strategies, but will also include some more directional strategies. Road shows are now beginning. It is anticipated that the bulk of the equity (class D) will be placed by Investcorp with its Gulf investor base.

UK proposes to scrap administrative receivership but saves securitisations

The Enterprise Bill, acomprehensive Bill to revise the competition, insolvency and several other laws of UK was placed before the Parliament on 26th March. Among other things, the Bills seeks to scrap the procedure of administrative receivership which was the basis of several UK secured loan securtisations. However, there are exceptions for several capital and financial market transactions which includes, subject to conditions, securitisation transactions as well. In other words, UK can continue to use secured loan structure for securitizations.

As is common knowledge, UK originators can achieve ring fencing without making a true sale. This was based on the provisions in debenture issues in UK for appointment of administrative receivers which were legal under UK insolvency laws and which could pre-empt the Court getting administration of the assets charged to a trustee. UK had proposed a bankruptcy law reform under which this process was to be scrapped in favour of a US-like Court-assisted administration.

The Bill to give effect to these changes has now been presented. The Enterprise Bill is to insert sec. 72A in the Insolvency Act whereby administrative receiverships will not be applicable despite the provisions in the agreement or debenture. There are several exceptions to this bar: capital market transactions, public private partnerships, utilities, project finance, and financial transactions.

Securitization transactions will most likely get excluded under the capital market category. Transactions involving debt of GBP 50 million or above, involving a rated, listed or traded debt security, and involving grant of a security will be covered as a capital market transaction. Evidently, the exception is very widely worded, and securitisation transactions based on secured loan structure will get exempted. A possible issue that the debt is raised by one person while the security is issued by another (SPV) is also resolved by a permissive definition of "party".

Links Full text of the Enterpise Bill is available here. For our page on whole business securitisations, click here.

 

Securitisation SPVs are a feared lot, thanks to Enron

Even though the FASB is not directly gunning for securitisation SPVs, an inevitable fallout of the Enron debacle is that more and more corporates are shunning complex financial instruments involving use of off balance sheet funding devices. While investment bankers used to rave in their transaction flow charts with huge lot of boxes and arrrows, an article in Financial Times of 26th March reports that corporates are now clearly shunning use of SPVs.

One structuring specialist is quoted as having narrated his experience: "Company directors panic when we present them with funding options involving complex financing schemes which use SPVs, such as the sale of asset-backed securities".

Apart from asset-backed funding devices, asset backed commercial paper has gained tremendously in popularity in Europe. Regulatory attention is focused on the off balance sheet risks banks carry in supporting these conduits.

In the meantime, the FASB is presently drafting its interpretation on SPE accounting. From the discussions so far, it is apparent that the interpretation will provide guidance on indentifying the "primary beneficiary" of an SPE, and if the SPE lacks economic substance or does not have supporting risk capital, it will be consolidated with such beneficiary. While the rules are expected to exclude securitization QSOEs, it is feared that CDO vehicles may be put to a problem as they are not qualifyng SPEs in accounting definition.

Links There are more links on our page on SPVs – click here.

Malaysian loan reconstruction company to securitise again

Danaharta, the Malaysian loan reconstruction company, is planning to securitise once again, according to reports in Business Times, Malaysia.

Earlier on, Danaharta had launched its first ABS issue totalling RM593.964 million to repackage performing loans out of a portfolio of RM3.2 billion performing loans it holds. The deal, through an SPV named Securita ABS One, was jointly managed by Deutsche Bank (Malaysia) Bhd and Alliance Merchant Bank Bhd.

There were two classes: senior and junior. The senior class, rated AAA by RAM, amounted to RM 310 million and was sold to investors at a coupon rate of 4%. These notes mature in December 2005. The junior notes were retained by Danaharta.

Malaysian market takes a deep interest in securitisation, but it still an emerging market. There have been three securitisation deals so far, adding up to RM1.23 billion. The originators were Arab Malaysian Merchant Bank Bhd, Commerce International Merchant Bankers Bhd and Danaharta.

Links For more on securitisation in Malaysia, see our country page here. Also find links to the legal material relating to Malaysia.

Vinod Kothari has been regularly holding training workshops in Malaysia – see our training page for current schedule.

Macquarie floats JV for securitisation in China

Australian investment banking group Macquarie in a joint venture will Paul Keating, former Prime Minister of Australia, has announced the formation of a securitisation company in China called Macquarie Securitisation Shanghai. To begin with, the JV will take up advisory work for China Construction Bank, the largest provider of private housing loans on the mainland, on residential mortgage securitization.

In the meantime, China is supposed to get legislatively ready for securitization in course of this year. As it stands, Chinese commercial law has several shortcomings which will come in the way of securitization.

There has been a boom of private housing in Shanghai region. This is evident from the bulgeoning portfolio of China Construction Bank which has grown to USD 23 billion over a period of 6 years.

Link For more on securitization in China, see our page here.

Securitization is good, says Nomura

Suddenly, so many people have gone into the assertion mode. We have reported Banc One elsewhere. Moody's below. And here is Nomura. Never in the 30 years history of securitization so many people have needed to assert it.

Nomura Research has gone into the basics of securitization and recounts its benefits. Mark Adelson says that securitization is a good thing. On balance, it has produced far more benefit than harm. Unfortunately, in the wake of the Enron debacle, well-intentioned reforms could impair or discourage the use of securitization as a financing tool. To avoid unintended damage to a beneficial financing tool, policymakers must have complete and balanced information about securitization's role in the American financial system.

Full text of Nomura's write up is here on this site. We thank Mark Adelson for providing us the benefit of his very articulate writings.

 

Securitization is still good, says Moody's

Securitization is still good, and it has more gain than harm, and the vicarious bad name it has got due to Enron's SPEs is not warranted. This is the essence of a Moody's publication going into some 114 pages titled Moody's Perspective 1987 – 2002: Securitization and its Effect on the Credit Strength of Companies, released on 18th March.

Moody's emphasizes that there is an important distinction between the special-purpose vehicles (SPVs) used in the $305 billion asset-backed and mortgage-backed market and those used by Enron or by Boeing for off-balance sheet leases. Moody's is concerned that securtization is receiving undeserved negative attention. Indeed, more than 90% of structured finance ratings are unchanged over the course of one year and, moreover, the default rate of these types of transactions is miniscule.

Most structured transactions are highly creditworthy, primarily because of their three main requirements, according to the report: a pool of assets sold through a true sale to a bankruptcy-remote SPV; debt issued by the SPV, which is backed by the asset itself and the payment streams associated with it; and repayment of the debt, which comes strictly from the cash flow generated by the asset pool, not from the original company's cash flows. Moody's goes into the oft-repeated advantages of securitization.

Commenting on the market events over the last several months which have led to a closer examination of balance sheets and accounting practices of US corporations, Moody's says that their message to the market is that securitization continues to be a valid and viable financing method.

Links For more on SPVs and the current controversy, see our page here.

 

American Securitization Forum's leadership elected

The industry forum of the World's largest securitization market the American Securitization Forum (ASF) got on with the election of its executive leadership. A sponsorship group of nearly 40 industry repressentatives elected the leaders. Vernon Wright, senior vice chairman and chief corporate finance officer, MBNA America Bank, was elected as chairman. Greg Medcraft, global head of Securitisation at Societe Generale, will serve as deputy chairman; Jason Kravitt, senior partner, Mayer, Brown, Rowe & Maw, as secretary; and Joseph Donovan, managing director, Credit Suisse First Boston, will serve as the group's treasurer.

Besides the leadership above, the Forum will also have Management Com-mittee to oversee the day-to-day management and operations of the ASF. In addition to Messrs. Wright, Medcraft, Kravitt and Donovan, members of the Management Committee include Cameron Cowan of Orrick, Herrington & Sutcliffe; James Murray of Citigroup; Martin Rosenblatt of Deloitte & Touche, LLP; Daniel Stachel of State Street Global Advisors; Brian Clarkson of Moody's Investors Service; and Dianne Wold of GMAC-RFC.

Various sub-committees have also been formed for specific interest areas.


SECURITISATION NEWS AND DEVELOPMENTS – April 2002

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Securitization news and updates

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China – Now Asia’s biggest securitization market

 

The securitization surge in China has seen a quantum jump in the first eight months of 2015 from $20.8 billion to $26.3 billion in the same period last year[1] making it Asia’s largest securitization market, leaving behind Japan and Korea. The surge in the securitization volumes has been possible owing to the progressive changes in the Chinese regulations pertaining to securitization in the recent past. The recent reforms have led to expansion and quickening of lending and bundling of loans for refinancing purposes.  

China’s economy has had its internal challenges with the economy going into recessionary phase. The securitization market in China has had a pulley effect reviving the Chinese economy from the clutches of non-existent growth.

China started the securitisation pilot project in 2005 but remained conservative through the global financial crisis of 2007. The securitisation program was revived in 2012 in China, however it is only in the last year that the regulatory reforms have led to the upsurge in volumes and enough traction to gauge global attention.

Some of the recent regulatory changes introduced by the Chinese regulators are as follows:

 

a.       Approval system for issuance of securities on deal-by-deal basis has been replaced by a registration system in which the repeat issuers are free to issue Asset Backed Securities (ABS) within approved quota. Though new firm has to take permission from the regulatory authority, nevertheless this relaxation seems to be a major step in enhancing the securitization market.[2]

b.      Latest set of disclosure standard unveiled this year on securitization of non revolving consumer loans.[3] 

c.       Increase in the limit of new securitization for 2015 to Rmb500 billion.[4]

 

 

 

The typical asset classes in vogue in Chinese securitization market are as follows:

a.       Equipment on lease

b.      Real estate loan

c.       Consumer loan

d.      Auto Loan

Since Chinese government reopened the country’s securitization market in 2012, sponsors have  been gradually expanding to auto finance companies and city commercial bank. Issuance of  ABS  has been a game changer in leading the securitization market among the developed countries of the world. Issuance from the financing units of car makers including Ford Motor Co. and Volkswagen AG has led behind the securities backed by the auto loans which now forms a smaller piece of the market. The growth of the infrastructure  has contributed no less in boosting the economy of the country by channelising its capital through the means of various asset class of securitization.

Converging from the process of selling asset backed securities after being approved by deal on deal basis to freely sell the securities after registering with the regulators has made the entire process hassle free. Issuance of ABS in China has shot up dramatically to become the largest securitization market in Asia, and this year issuance had passed RMB269 billion (US$42.14 billion) as of the end of October.[5]

Bankers believe that the domestic investor base in China will make the process of securitization more sustainable unlike other countries in Asia where issuers sell their asset-backed securities to the foreign investors alone. Owing to the impetus that the local investors feel more secured to invest in their home assets with which they are quite familiar, the securitization market in China will be more intensified in the upcoming years.

 

Reported by:  Surbhi Mohata

Dated: 4th  December, 2015

 

 

 

 

 

  

 

 

News on Securitisation: Possible rehabilitation measures for European SME securitisation

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Securitisation>News on Securitisation> Asset Classes> SME Loans

Possible rehabilitation measures for European SME securitisation

Shambo Dey

1 March 2014

The main problem with the recovery of the Small and Medium Enterprises securitisation market in Europe has been the burdensome and inconsistent treatment of securitisation for regulatory capital and liquidity purposes.

But rehabilitation may be on the cards for the European securitisation market. The European Commission recently announced it could allow banks to use more securitisations in their liquidity buffers. The Commission's desire to revive Small and Medium Enterprises lending through securitisation seems to be very strong at the moment, unlike in December 2013 when the EBA reviewed liquid assets for the Commission and reported that some RMBS were liquid but put most securitisations in the lowest possible liquidity category.

The Commission is in the process of setting the standards for high quality assets in the LCR ratio and to ensure differentiation of "high" quality securitisation products. If included in the LCR, banks could be encouraged to buy RMBS and ABS, since they will then serve a regulatory, as well as economic purpose, and this could be crucial in reviving the market. To encourage investor involvement in the asset class, it was important to ensure that broader regulatory treatment was practical and consistent. Including a wider range of real-economy assets will also help securitisation to play its role in funding Europe's economic recovery.

Further, the ECB made public its willingness to start reviving plain vanilla securitisation, stating that it is critical that the regulatory treatment of asset-backed securities is based on real data and not the legacy of the US sub-prime disaster. Between mid-2007 and the first quarter of 2013 the default rate on ABS in the EU was only around 1.4%, whereas it was 17.4% in the United States. The ECB, the European Investment Bank and the Commission, have been exploring options that do not change the regulatory environment, but simply channel more funds to securitisation in the hope of boosting bank lending to Small and Medium Enterprises. The Commission published a paper called "Increasing lending to the economy: implementing the EIB capital increase and joint Commission-EIB initiatives" in June 2013, which explored earmarking EU structural funds to invest in ABS, using the European Investment Bank as the conduit for the funding. This would complement existing official support offered by the European Investment Fund, which guarantees securitisation tranches and offers credit enhancement to encourage Small and Medium Enterprise lending.

 

For more news on Securitisation, click here. 

SECURITISATION NEWS AND DEVELOPMENTS

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April 2007 onwards

[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 fed direct into your mailbox]

 

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ASF's subprime relief plan

The much awaited relief plan that seeks to save subprime mortgages from getting into inevitable foreclosure was unveiled by American Secuiritization Forum, having been endorsed by the Bush Administration.

The plan applies to mortgages that are ARMs, are subprime, were originated between Jan 1, 2005 to 31st July 2007, and have interest rate forthcoming between Jan 1 2008 to 31st July 2010.

Essentially, the plan classifies mortgages into 3 segments – (1) those that may qualify for refinancing under available mortgage lending plans, (2) those that are current, that is, not delinquent, and (3) those that are not current. In the first case, the servicer should educate the borrower and advise him to have the mortgage refinanced.

The second case is one of loan modification. Here, if on the reset date, the mortgage instalments would go up by 10% or more, and the borrower meets the FICO score test, the loan will be eligible for a fast track modification, under which the existing interest rate will be kept frozen over the next 5 years.

The third case is one where the loan is already delinquent. Here, the approach is one of loss mitigation. The servicer should take measures that would maximise the present value of the loan recovery. These include loan modification, forbearance, short sale, short payoff and foreclosure.

The complete ASF document is here.

Old habits of securitization world come to question 

Public charities, SPV ownership structures, etc. raise curious concerns

These may be absolutely normal for any securitization practitioner – so normal that one would not even have ever pondered for a second as to how unrealistic the whole setting of facts is, and these practices are now coming into sharp scrutiny.

In a typical securitization transaction, the almost-universal practice is to have a special purpose vehicle owned by a public charity. The legal domicile of the SPV is a tax haven, typically Cayman Islands. The public charity owns the nominal equity of the SPV – typically something like 1 dollar or 10 dollars. So, with a few dollars of capital, the SPV acquires assets of millions, and intends to do the good of mankind with the residual returns on equity that it would never get, since there is a residual income class that sweeps the entire profits of the SPV left after payment of coupons to the noteholders.

The superstition in the legal world is that with legal ownership of the SPV in the hands of a so-called public charity, that has done no charity ever, the SPV would be legally an orphan, that is, would not have any clear owner at all. While accounting standards have demolished this myth and are now looking at residual interest for consolidation purposes (Fin 46R and SIC 12), but for consolidation for bankruptcy purposes, it is still believed that the legal ownership in the hands of a charitable trust would be respected.

Guardian started a wave of investigations in Northern Rock's granite securitisation program. It carried an article titled A twisty trail: from Northern Rock to Jersey to a tiny charity. The article also says that the Charity Commission has started an investigation against Northern Rock.

While Guardian might have led to enthused investigations against Northern Rock, within the securitisation world, it is common knowledge that this structure is used by just everyone.

Bad news galore as securitization markets almost liquidate

Bad news continued to pour in during the week, with JP Morgan, Bank of America etc continued to post gloomy pictures of their Q3 losses and impending Q4 problems. Wall Street Journal is giving a quick summary of Q3 financials.

CDO rating downgrades continued. In almost a rare example, State Street Capital-managed CDO called Carina CDO Ltd fell from the roof and was downgraded from AAA to CCC. S&P justified the stern rating action on the ground that the senior investors had decided to liquidate the collateral at a time when the market was already bad, and therefore, the collateral might realise more losses than otherwise.

New issuance activity has come to a grinding halt. As per data on abalert.com, the new issuance in the whole of October was just about $ 34 billion whereas the same period last year saw a new issuance of $ 130 billion. The liquidity in the ABCP market is also completely dried up as the curve of outstanding ABCP continues to slide down steeply.

The barometer of credit default swaps on asset backed securities, ABX.HE, gives gloomiest picture ever. The AAA tranche of ABX.HE has reached a new low of 69.93, and in just a week's time, has fallen from 80.17. The poorer siblings – BBB and BBB- tranches, seem to be falling from a cliff, with prices of 20.79 and 19.36 respectively.

In a bad time such as this, the pains of the banking community are exacerbated by FAS 157 which becomes applicable from Nov 15, 2007 and would therefore apply to the next quarter. Under this standard, for computing fair value of assets, an entity must distinguish between assets where it applies market values (Level 1), model values based on observable facts (Level 2) and best estimates (Level 3). The new standard requires valuations to consider all risks in case of Level 3 assets.

UNCTAD paper takes stock of securitization risks

While there is no dearth of recent articles and write ups fuming and fretting against securitization, the UNCTAD recently put together a note on the risks facing the global financial economy, and spent a good part on the subprime crisis, and the risks inherent in securitization in general.

On the larger global economy risks, UNCTAD, like IMF and several others, paints a rather gloomy picture of the US economy and predicts three different scenarios – a benchmark scenario, benign scenario and a crisis scenario. In the benchmark case, a bleeding US economy will eventually cause losses to the emerging markets too.

As for securitization risks, the UNCTAD note takes the same line as BIS and FSA recently took – that the originate-and-distribute model on which banks work currently undermines credit underwriting discipline and hence affects the quality of assets. As one of the recommendations, UNCTAD even recommends a legislation that would require banks to keep some part of the assets they originate.

Rating agencies have a substantial role in the CDO market, and rating agencies' rebuttal that their ratings should not be used as the basis of investment decisions is completely unacceptable. The UN trade body recommends a relook at this scenario, including may be an oversight authority on the rating agencies.

The article, containing a complete dossier on the important events in the subprime crisis, also provides a quick view of important risks facing the financial system. The text of the article is here.

Securitisation: Article in The Economist sees it as a turning point

There is absolutely no dearth of harsh words and harsher voices against securitisation these days – you don't even have to dig the surface as it is all up there, all over the financial and general press. There are people who have called it a swindling game, conning game, outsmarting device, etc.However, The Economist has built its own gravity over the years of its readership.

The 20th Sept issue of The Economist carries an article titled When it goes wrong. It says a complete generation has prospered from the wholesale transfer of risk by way of securitisation. Now, it is paying the price.

See the text of the article here.

In the meantime, hearings before lawmakers are taking place on both sides of the Atlantic. The Senate Banking Subcommittee is continuing its hearings in Washington. In London too, the Financial Services Authority is continuing its investigations.

Special purpose vehicles to be put to acid test

As securitization is passing through the worst time over the 30 years or so of its practical history, the ubiquitous tool that enables securitizations – special purpose entities – will be passing through an acid test. If in the coming few months, courts or lawmakers do not make things extremely adverse for SPEs, they would be a part of the business world's toolbox for all time to come.

Special purpose vehicles are special in many ways – they have a legal existence but a substative void, There are no assets, risks or liabiliteis other than those involved in the given transaction. They have a management that is supposed to be independent, but they have nothing really to manage. They are independent, while the only reason why they exist is to enable a particular transaction. The most curious part of SPVs is their ownership by public charities which is virtually a shame on the grand name of charity. The device has been used to simply hive off an asset, transaction or relation and give it an incorporeal status.

The current crisis will put SPEs under very sharp eyes – public, legislative, judicial. The public is already outcrying and investigating the ownership structure of entities like Northern Rock's Granite securitizations.

However, here comes another very curious test – as hedge funds are filing for bankruptcy protection, the enigma is – should they file for protection under Chapter 15 of the US bankruptcy code as a case for cross border insolvency, or Chapter 9 or 11 as a case of US insolvency. In preliminary proceedings relating to Bear Stearns' hedge funds, a Manhattan bankruptcy court seems to have taken the view that while the hedge funds are registered in the Cayman, the Cayman office is nothing but a "letter box". As almost all the liquid assets of the hedge funds are in the US, they must come under Chapter 9 or 11 as US entities,

If this view prevails, the registered office of the hedge funds will be taken as irrelevant. The ruling may form the basis of tax, and on exttension, even regulation. Similar views were taken by the UK Court of Appeal in the case of Indofoods last year.

Links For more on SPVs, see our page here.

Moody's talks of new securitization risks

While lot of heat is turned on the rating agencies themselves, as to how is it that they are getting all this wisdom only now, here is some brilliant piece of wisdom from Moody's – it says it is for the first time since LTCM that the disintermediated financial markets have got their first stress test.

The originate-to-distribute model became particularly very strong over the last few years when banks stepped their originations that would not stay on their balance sheet – something that every underwriter in the bank would know.

Moody's wisdom is that the present crisis teaches us the same lessons that LTCM did – "The lessons to be learned are for a good part lessons to be learned again. Most of the deficiencies exposed by the current episode were identified in the aftermath of the Long-Term Capital Management (LTCM) crisis in 1998: the modern financial system over-relies on the presumption of li quidity; risk is increasingly difficult to localize; asset correlations increase in times of stress; and leverage changes the scale of market dynamics, on 
the upside as well as on the downside", says the article titled Stress-testing the Modern Financial System.

Moody's also blames the mark-to-market accounting system – "The world would be a much safer place if all securi ties were held by ?real money? buy-and-hold inves tors who did not have to mark to market, and who therefore did not have to make forced sales into panicked markets. Unfortunately, literally trillions of dollars of securities are now held by leveraged mark-to-market institutions relying on other peo ple?s money to finance sometimes opaque, complex and risky investments."

The article talks about several securitization risks that the current crisis has thrown up:

  • "Securitization relies upon historical relationships (e.g., subprime default and loss levels) that can change unexpectedly and by orders of magnitude. The proliferation of non-standard products has impeded the development of a liquid secondary market for many types of securitizations. As we are observing, there is no observable market price for a unique security.
  • Securitization creates an agency problem by separating the originator from the ultimate holder. While this is one of securitization's car dinal virtues, it is also a problem in that origina tors may be incentivized to maximize origina tion volume, instead of quality. And, as we see in subprime, some originators may be tempted to misrepresent the quality of loans being sold or, less sinisterly, originators are not motivated to care about the quality of loans because they 
    aren't owners of the assets for very long.
  • The opacity and/or complexity of some securiti zation products have led some investors to over-rely upon third-party credit analysis (i.e., ratings) without fully understanding what they are buying (and now what they own). And many 
    market participants have over-relied on ratings in determining appropriate price levels for such securities.
  • Some companies' business models were built on the presumption of securitization as a viable funding source. When certain asset classes fall out of favor, these actors may find themselves out of business.
  • Idiosyncratic risk is different for structured se curities than for corporate instruments. Idiosyn cratic risk in RMBS appears most visibly at the originator and vintage levels. Originator risk may be analogous to individual company risk, 
    but vintage risk is an overlay that has no corpo rate analog. And even with twin forms of idio syncratic risk, structured securities may exhibit fewer significant idiosyncratic attributes – causing more herd-like changes in creditworthiness –
    due to more limited operating characteristics and more homogenous assets.

Northern Rock's Granite RMBS still safe: rating agencies

While Northern Rock's ship is rocking, its RMBS transactions are not affected, say the rating agencies. While that may be good news for the securitisation investors as opposed to the depositors in the troubled UK mortgage originator, there are questions on the servicing risk, liquidity risk, etc which might affect the securitisation transactions as well.

Northern Rock, 4th largest UK mortgage originator, has been one of the leaders in UK RMBS supply. Under its Granite template, Northern Rock has some GBP 40 billion odd funding by way of RMBS. It has several covered bonds issuances too.

S&P issued a press release on 19th Sept affirming the ratings on the securitisation transactions despite the rating downgrade of Northern Rock. There are sufficient credit enhancements in the securitisation pools, and the pool is a prime RMBS pool. However, the as the originator faces severe liquidity problems, its servicing capabilities are unlikely to remain unaffected. In addition, people ha ve already started probing into the SPVs that have funded the securitisation transactions. In the present environment where SPVs are only again looking suspect, there might be probes into Northern Rock that might bring up some fundamental questions on securitisation structures.

If at all there is a servicer change, this might be one of few instances of servicer migration in the UK.

Today (20th Sept), BoE's Governor equated the current crisis in UK banking as the worst since 1973.

 

The bird in the Bush will now come out –
Prez to announce measures on subprime crisis

Today morning, US time, President Bush is expected to announce measures to contain the subprime crisis that actually continued to build like a toxic tank right under the nose of the Federal regulators ever since 2005, and finally burst and spread all over the World.

US press said Bush plans to announce a variety of measures in the Rose Garden on Friday morning that are designed to help struggling homeowners with subprime mortgages avoid foreclosure and will declare that lending practices need to be tightened. Presumably, bankers were all this while waiting for the Prez to ask them to tighten their lending practices.

The measures might include some tax relief to troubled borrowers to rework their loans. The measures are also affected to deal, at least in part, with securitization transactions, and perhaps will have some impact on the servicing industry and the rights of the servicers to modify terms of loans before they are in default.

While the Prez may not go into finer details at this time, gain-on-sale accounting practice may also come for question. The FASB is already considering proposals to replace the present accounting practice by one based on "linked presentation" that UK FRS 5 had several years ago.

Keep watching this site – we will bring further updates.

Bad news pours in – ABCP, student loans, aircraft leases 
– all seem to be going wrong at the same time

Suddenly, all seems to be going wrong. The institutions of structured finance that we nurtured over all these years, on which Wall Street investment bankers bagged fat bonuses every year, all seem to be looking suspicious. In India, they say – having burnt your lips with hot milk, you would even blow into buttermilk before taking a sip.

The supply in the asset backed commercial paper (ABCP) market is seemingly badly affected. ABCP conduits issue short term paper and were originally created to acquire trade receivables of their clinets, but over years, they have grown into mini off-balance sheet banks and acquire variety of credit assets including RMBS,CMBS, CDOs, trade paper, etc. The size of the ABCP market is nearly USD 1.2 trillion. While most of the paper that ABCP conduits buy has already been credit-enhanced to AAA levels, the issue of commercial paper is done expecting a roll-over funding. The sponsoring banks provide a stand-by liquidity support. As the investors have broadly retreated, liquidity lines of the conduits have been drawn up in some cases, and this has created another source of jitters in the market. Rating agency Fitch held a conference call last week highlighting the liquidity concerns, and resulting capital consequences and mark-to-market pressures.

Increasing consumer bankruptcy fears have also put questions on credit card ABS, one of the very safe collateral classes. According to Moody's Investors service, the bankruptcy filings this year are 30% higher than a comparable number last year.

Liquidity has dried up for student loan ABS also.Even as diverse an asset class as aircraft leases has been affected.

Needless to say, CDO issuance is almost completed dried up. The volumes for August 2007 reported on abalert.com add up to $ 7.8 billion whereas usual issuance in this month would have been nearly 5 times. The total US ABS issuance for August shows as a mere $ 4.5 billion, as opposed to $ 70 billion in the same month last year.

Will the Fed interfere to bail out mortgage markets?

Historically, when financial markets hit rocks, the US government has deployed the Federal agencies to bail them out. This happened in the case of LTCM, and Savings and Loans crisis. As the mortgage market troubles continue to jolt the global financial system, a key question is – will the Fed interfere? If so, will it be a day too late, or just in time?

Noises are doing rounds that the GSEs may be called upon to buy junked loans. If that is to happen, it must happen before it is too late, because it is clear that it would take days, not weeks or months, before the financial system would be in a deep mess.

The portents of the impending crisis are all but unclear. Lots and lots of funds world over are invested in the US mortgage market. Liquidity in the securitization market has dropped down drastically, even for asset classes traditionally regarded very very safe. The cost of borrowing via asset backed commercial paper has gone up by something like 50 bps. As investment funds face liquidity crisis, many of them have already blocked redemptions – the latest to do so was BNP.

The impact of the US meltdown is seemingly spoiling the party of global growth. The financial press is using words like "US exports poison" (BBC News), "Ugly American hits Europe" (BusinessWeek), etc.

Australian mortgage markets also catch cold: 
mortgage insurance claims rise 329%

The frenzied pace at which mortgages were created by banks was not limited to the US banks. Australia is another very well developed mortgage securitization market, and Australian banks were going high on mortgage origination too. Hence, it is not surprising that the spectre of increasing mortgage defaults has affected the Australian market too.

Australian Prudential Regulation Authority (APRA) reported that claims on mortgage insurance companies in 2006 were 329% higher, that is, more than 4 times the claims in 2005. It is a common practice among mortgage originators in Australia to buy pool mortgage insurance covers, and if the defaults happen on a pool, the insurance company faces claims.

The reports also indicated that the rate of increase on account of mortgage defaults was higher than any other insurance sector claims..

Australian stocks have been badly affected by the mortgage crisis, both local and global. Most of Australian banks have exposure in US markets too. Australian banks both originate and invest in CDOs. In fact, CDOs have even been sold to retail investors in Australia. Macquarie's mutual fund is supposed to have lost nearly 25% due to the mortgage meltdown.

Wall Street is now firing:
Securitisation and credit derivatives jobs are being cut

After several years of high-pay and high-stress jobs, investment bankers are now in a mood to fire. Wall Street is facing a lot of fire here, there and everywhere anyway.

Troubled Bear Stearns' president resigned; reports indicated that he was responsible for mortgage-related investments in the investment bank. Bear Stearns has said that it is facing the worst financial crisis over the past 20 years.

Nomura Securities' structured finance research team has been reduced substantially. Notable securitization expert Mark Adelson has left the firm, along with several of his team members.

In the mortgage sector, some 50000 jobs have been laid off in all, as per data on www.mortgagedaily.com.

Every year, leading investment banks hire finance, quant and trading experts from business schools world over. Investment banks are typically manned by young blood, who believe more in passion than in caution. This year, it seems recruitments in derivatives, investment banking and structured finance desks, particularly hedge funds and private equity, will be substantially reduced.

Crisis raises basic questions on securitisation; many funding plans disrupted
BAA's whole business securitisation may not fly

As is quite common behaviour, the subprime crisis has put some very basic questions on securitisation. In some of the blog sites [for example, cfo.com’s blog site], people are arguing about securitisation per se. As investors get securitisation-scary, funding plans of many are being disrupted.

Global issuance data on abalert.com shows a world-wide decline in the month of July – a rare occurrence after several years. As the after-effects begin to jell, there might be sharper decline in the current month. Spreads on ABS are also showing at 52 weeks' highest, with AAA home equity quoting at a whopping 170bps.

In the USA, alt-A mortgage securitization has completely stopped, says a report at marketwatch.com

Reuters came out with a big listof hedge funds who are reportedly or admittedly in trouble. Here is the list:

  • Bear Stearns Two Bear Stearns funds have filed for bankruptcy already. A third one has stopped redemptions.
  • Absolute Capital (Australia) – Half-owned by ABN AMRO. Temporarily closes two funds in late July with a combined A$200 million in assets amid problems with collateralized debt obligations.
  • Macquarie Bank (Australia) – The bank warns in early August that retail investors in two of its debt funds face losses of up to 25 percent. Note that this is a mutual fund and not a hedge fund.
  • Basis Capital (Australia) – Suspends redemptions on two of its funds in July. Presently conducting a fire sale of assets.
  • Oddo Asset Management (France) – in late July closes its Oddo Cash Titrisation, Oddo Cash Arbitrages and Oddo Court Terme Dynamique funds, which manage total assets of around 1 billion euros.
  • Sowood Capital Management (United States) – The hedge fund which managed money for Harvard University tells investors on July 30 that it will wind down after suffering losses of more than 50 percent which wiped roughly $1.5 billion in capital.

Among the casualities are the huge whole business securitisation announced by BAA earlier this year [see news on our site here]. Reports indicate that BAA may not be able to refinance its properties by arising GBP 4.5 billion, as proposed earlier, as liquidity in the market is quite tight and leveraged finance may drop down sharply.

Lot of fire, and lot of smoke all over: crisis spreads wider and deeper

The inevitable crisis in the subprime mortgage securitization segment is now spreading like wild fire. And it is difficult to say if the fire is more or the smoke, as crisis alarms have gone off everywhere.

Geographically, the crisis has already affected some European banks; some Australian hedge funds have also suspended redemptions, though they claim to be unaffected by the subprime crisis. Some more US hedge funds closed redemptions.

A third Bear Stearns hedge fund, Asset-backed Securities Fund, was reported by Wall Street Journal to be in trouble; has stopped redemptions. C-BASS, a mortgage investor, seems to have heavily lost money, and consequentially, MGIC and Radian have suffered losses of impairment. There are other subprime lenders who have suffered huge casualties, as reports indicated that subprime mortgage losses were not stopping. Mortgage insurers might have substantial liabilities.

Australian bank Macquarie's Fortress Funds might lose value upto 25%, though it is not reportedly connected with subprime losses.

German bank IKB was also reported to have suffered huge losses out of US mortgage market – its rating has already been downgraded by Fitch. In Paris too, Oddo and Cie, a fund manager, is reportedly shutting down two of its funds.

In the midst of the heightening worries in the subprime market, trades in credit derivatives on subprime securitizations found that the subordinated tranche of the ABX.HE index still meant some value – BBB- tranche of ABX.HE's 2007-2 run went up in value from its lowest point of 39.97 on 27th July to 41.22 on 31st. However, the senior-most tranche still lies at 94.5, its lowest since inception.

Updated August 2, 2007: The impact of the US securitization crisis is widening. Equity markets world-over reacted sharply with most indices taking a beating. Losses in market cap add up to billions of dollars. In the meantime, Bear Stearns hedge funds filed for bankruptcy, and investors have joined together to file litigation. Reports keep pouring about several European banks that would lose heavily in the subprime market.

Notably, the Macquarie Ban's fund reported to have lost nearly 1/4th of its capitalisation is a retail mutual fund.

Most other hedge funds have got margin calls from their banks, bringing liquidity to an all time low.

It is not a ripple effect; it is web effect

It would be wrong to call it a ripple effect: ripples get lighter as they spread. This one is a web effect, as the world of finance today is a complex web of one instrument heavily depending on the other. The crisis that originated in the subprime mortgage market brought CDOs to a complete halt (see report below and updates in this item). At the same time, hedge funds were hit as they continue to face losses either as purchasers of the ABX indices or as equity holders in CDOs. The CDO/CLO market was a big supplier of liquidity to the leveraged loan market – so, with the CDO machine halting, there is a sudden crisis of liquidity in the leveraged loans market. And it would continue to spread – to conduits, to private equity lenders, even to seemingly unconnected participants as insurance and reinsurance companies.

Market is abuzz with news of failed syndicated loan deals – be it refinancing of Cerberus' purchase of Chrysler,or Kolberg Kravis Roberts & Co.'s purchase of Alliance Boots.

Lots of investors have started doubting the veracity of the ratings – AAA ratings have fallen by several notches in the recent weeks, and the downgrades are not stopping. Investors are questioning as to whether the rating agencies could not have seen this when they rated the transactions in 2006 – credit enhancements levels were much lesser in those deals than the transactions structured in 2001 and 2002.

In the meantime, a new roll of ABX.HE, 2007-2, continues to slide. The safest tranche fell from 99.3 to 95.39 in matter of days, a decline of nearly 5%. The BBB- piece fell to as low as 40.39 from its inception price of over 50.

On the other side of the Atlantic, the iTraxx crossover index, an index of credit default swaps on entities that crossed over recently from investment-grade to below, has been crashing, taking along the confidence of the community that saw credit derivatives as a hedge against volatility. Today's Financial Times quotes Jim Reid of Deutsche Bank as saying this: "We should now be in little doubt over the power and influence of leverage, derivatives and structured products. They are not volatility dampeners, but volatility magnifiers".

CDS spreads on most of the leading Wall Street investment banks have risen sharply, which means their cost of capital will increase. As mortgage delinquencies continue to raise, and housing sales have been dropping, the portents are surely not good.

Links See Vinod Kothari's piece on two old risks of structured finance here.

CDO market comes to a grinding halt, says report

If, as 2006 volume statistics clearly show, 70% of CDO issuance was what is called structured finance CDOs, it is hardly surprising that with never-before concerns about the structured finance market, CDO issuance should have halted. International Herald Tribunequoted a JP Morgan report that the volume in July had come down to a mere $3.7 billion from $42 billion in June. The global CDO issuance data on abalert.com bears this out – the number for June 2007 is shown as USD 50.1 billion, whereas that for July to date (as seen on 24th July) is merely USD 1.9 billion.

CDO structurers were going gung-ho on structured finance transactions. A CDO would pick up BBB to BBB- pieces of asset backed transactions, mostly subprime and the likes. That is where the arbitrage lay. Till 2005, CDO structurers were making merry on CDO^2, which became unpopular thereafter.

The sqeeze of liquidity in the CDO market is also likely to be accompanied by similar shortage of funds in the private equity market.

On the other side, a new 2007-02 run of the ABX.HE index was launched. The BBB- tranche that started with a price of 50.33 slided to 47.86 in a matter of days. Even the AAA tranche fell from 99.33 to 98.03.

India's securities regulator puts up draft regulations on securitised instruments public offer and trading

There may not be much of securitisation happening in India these days, but that has not stopped regulators from coming up with elaborate rules, complete with licensing, eligibility conditions, rejection of application for registration, appeals, and so on.

The Parliament recently amended the law that deals with trades in securities – Securities Contracts Regulation Act – and made "securities" inclusive of securitised instruments. This was made out to be a boon for securitisation as it would permit public offers and exchange trading for securitised instruments. It was noone's case that lack of such listing or public trading was hindering the market in any substantial way.

That amendment having been through, the Securities Exchange Board of India [SEBI] which was empowered to write regulations for public offers and listing has now come up with draft regulations that have been put up on its site today.

Instead of falling in line with similar public offer rules for asset backed securities in other countries, for example, Regulation AB, SEBI has drawn heavily on its own template in context of mutual funds and similar market intermediaries. Thus, for a securitised instrument to be offered to public, there has to be a special puropse distinct entity (read SPV). While the normal concept of SPVs is a discrete body for each transaction, SEBI's idea seems to be some kind of a continuing umbrella entity that would serve several transactions in a sequence. Hence, there is a need for registration of such entity, and such registration must be maintained on a continuous basis. A single SPV can come up with several transactions of securitisation, called "schemes", again in line with mutual fund parlance. Hence, the SPV becomes a kind of protected cell or multi-segmented entity, though the law in India currently does not have any cell protection rules.

Once the SPV is registered, it can, over time, bring public offers by having an offer document which would also need to be registered with SEBI. There are scanty disclosure requirements in the offer document, which obviously indicates that SEBI did not have the benefit of similar disclosure requirements either from SEC USA or from industry bodies.

The draft rules are placed for public comments on SEBI site.

Subprime sorrows deepen with downgrades, 
defaults and hedge fund collapse

Financial press is full of stories about the sorrows of subprime lending. The news is coming from different quarters, and is constantly causing loss of nerve in the CDOs, ABX trades and the financial services industry in general. The news of the mounting delinquency rates in the US mortgage market (see news immediately below) was quickly followed by Moody's releasing its latest reseach report on the "challenged" market. Moody's downgraded 131 securities of the 2006 vintage and placed a good 136 on rating watch negative. While most of the downgraded securities had a rating of A or lesser, a small percentage had a Aa and Aaa rating also.

In the meantime, the market got further disturbing news about a 10-month old Bear Stearns hedge fund High-Grade Structured Credit Strategies Enhanced Leverage Fund was nearing collapse as investors were breaking gates for redemptions and the fund did not have liquidity to do so. The fund was focused on subprime market. The highly geared fund had a capital of about USD 640 mil, but borrowings of about USD 6 billion. There were reports about a bail out effort with additional capitalization from Bear Stearns or others.

In the meantime, the ABX.HE index continued to slide down. The BBB- piece reached an alltime low of 60.39 and the slide does not appear to have stopped.

The liquidation of the subprime MBS portfolio held by the BS hedge fund and others might soon exacerbate into a liquidity crisis in the market as most of the players are driven by mark to market practices and will have to report losses. The reported losses may reach deleverage triggers. In fact, most of the leveraged investment vehicles in the market has deleverage triggers that are ruthless and automatic. They require the fund to liquidate its assets when the times are bad, which sounds like counterintuitive.

While subprime servicers are exploring ways to resolve foreclosures by restructuring loans, one of the technical issues that have comes up is – does FAS 140 laying down conditions for QSPEs allow that discretion? Some democrats seems to have sought SEC clarification on this.

Updated 21st June 2007

Merrill Lynch, a lender to two of the Bear Stearns hedge funds that are nearing collapse, has reported seized USD 850 million of the assets of the hedge funds held as collateral by the former. Merrill has begun selling these assets, most comprised of CDOs and CDO^2.

In the meantime, ABX.HE fell below the 60 mark and the last quote went to 59.79. The expectations are that there will be further decline before the trading closes for the week.

In the meantime, SEC and FASB are meeting today to discuss whether a servicer can have the right to alter the features of a mortgage before it goes into a default. The critical question comes in context of the 2/28 ARMs that would start posting increased instalments from the end of the second year, fast approaching in case of mortgages written in 2005 and 2006. In the already weakened market, the increase of mortgage payments would be a hard blow

We will continue to provide more coverage on this very serious crisis facing the securitization market.

Mortgage woes hurt leading originators; 
foreclosure rates highest in last 50 years; ABX.HE starts sinking again

Several related things happened this week to hurt the sore spot of US banking – the mortgage market. Piggybacking on historically low interest rates, most US originators marketed mortgages aggressively enough, mostly with features that would look attractive enough upfront, but would be painful in the long run.

The US mortgage bankers body Mortgage Bankers Association of America reported that foreclosure rates in the 1st quarter of 2007 reached 1.28 percent of all loans outstanding at the end of the first quarter, an increase of nine basis points from the fourth quarter of 2006 and 30 basis points from one year ago. The Washington Post added that this was the highest in last 50 years.

The rate of foreclosures started on subprime ARMs jumped from 2.7 percent to 3.23 percent. The states mainly responsible for that increase were California, Florida, Nevada and Arizona. The reasons cited for the increase were decline in home prices and increase in unemployment rates.

In the meantime, the Goldman Sachs reported performance for the last quarter and its shares dropped 3%. Bear Stearns' earnings at Bear Stearns in the second quarter fell 10 per cent to $486m, with lower mortgage lending and securitisation volumes offsetting strong growth in other businesses, particularly investment banking, prime brokerage and wealth management.

The index of representative subprime securitization transactions, ABX.HE has started sliding again. The BBB- tranche fell to a price of 61.91, lower than the previous low reached in the 1st week of Feb this year.

More reports There are more related stories below.

UK FSA report exposes securitisation risks, loud and clear

There is a saying in rural India – If there is a theft at the village launderer's shop, everyone loses, except the launderer. Present day banking system relies heavily on the originate-and-distribute model for credit assets. The assets are distribute either by cash securitisation, or synthetically by structured credit trading. In either cases, the risks are dispersed in the capital market, with the banks merely making their originator profits. To Alan Greenspan, this was responsible for holding the entire banking system in good stead, but the UK FSA clearly warns that the systems has far thrived in benign credit markets; it has not faced the test of stressful times.

A phenomenal part of the latest Financial Stability Report of the the UK Financial Services Authority is dedicated to the risks of securitisation and credit derivatives market.

Taking a leaf from the troubled UK subprime mortgage market, the FSA argues that similar risks might be growing underneath the calm of the UK financial system too. It makes what seems like a very bold critique of the securitisation system:

  • Strong investor demand for securitised assets, combined with benign market conditions, has sustained a heavy
    issuance of both RMBS and CMBS. In turn, this seems to have led to an easing in underwriting standards, such as increasing ‘covenant-lite’ deals in the leveraged lending arena and weaker documentation requirements for CRE lending.
  • Given that risk is transferred to other market participants, there are concerns that the originate and distribute’ model might dilute incentives for the effective screening and monitoring of loans in the corporate market, as appears to have occurred in the sub-prime market.
  • Since lower tranches of securitisations are mostly taken to CDOs, the embedded leverage in CDOs is common across sub-prime, CRE and corporate credit markets and could magnify the market response if there was a particularly sharp deterioration in the performance of underlying assets.
  • The separation of the origination of risk from its ultimate incidence may mean that less information on underlying credit quality is available to the bearers of risk. In US sub-prime markets, end investors appeared not to be able to determine the credit quality of lending being securitised very accurately. Originators with incentives to sustain lending volumes originated poorer quality lending. While market mechanisms
    exist to maintain credit quality by ensuring that originators remained exposed to some of the potential credit loss, the high levels of arrears in recent vintages of US sub-prime mortgage lending raise questions about the effectiveness of those mechanisms.
  • Where risk transfer leads to a greater dispersion of individual credit risks across investors, the fixed costs of monitoring credit risk may mean that the standards of individual investors’ own credit risk assessments are lowered as they hold smaller exposures. In such circumstances, credit risk assessment is often partly delegated to third parties, including rating agencies, lead arrangers and managers of structured credit vehicles, such as CDOs. But there are risks that investors could become overly reliant on the assessment of others.
  • Recent events have also highlighted risks from excessive reliance on, or confidence in, historical credit-risk scoring models for credit assessment. Models can break down when the attitudes of borrowers towards default are shifting, as may have been the case recently in the UK unsecured lending market. And modelling risks will be heightened when these models are applied to new forms of lending

Links For full text of the FSR, see here.

Subprime debacle hardly surprising, says paper

Nomura Fixed Income Research's Mark Adelson and team came out with a very timely paper on the subprime debacle. As may be common intuiation, the subprime lending spree of 2005 and 2006 ignored some very basic principles of money lending and therefore, foreclosures were bound to rise with house values declining. The brilliant is just brilliant, and we bring below the key conclusions of the paper:

There is no sub-prime surprise. High delinquencies and defaults are an inevitable result of the kinds of loans made in 2005 and 2006. Ignoring the Three C's of lending could produce no other result. Moreover, the warnings were loud and clear. The warnings also were numerous and frequent. And they came from many diverse sources, including the general media.

The current flurry of activity to "do something" about the sub-prime mortgage situation is a day late and a dollar short. Policymakers and market participants who don't like the current situation should 
have acted sooner by taking obvious preventive measures. Both policymakers and market participants share responsibility for the current situation by having ignored the warnings and having failed to act sooner.

Unfortunately, some policymakers are trying to exploit the current situation by pandering to defaulted
borrowers. That conduct is counter-productive. Policymakers and market participants need to come to grips with reality. There likely will be an uncomfortably high level of foreclosures. Despite the best of intentions, rescue attempts on many loans probably will fail. And, lastly and most importantly, policymakers should refrain from taking drastic, ill-conceived actions that ultimately do more harm
than good by unduly reducing the availability of mortgage credit to American families.

 

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

While US congressmen continue to examine if things had indeed gone wrong in the way subprime mortgages were packaged and sold, trade bodies got into the act and released draft of self-regulatory non-mandatory guidelines for retail structured products.

The guidelines were released jointly by the Securities Industry and Financial Markets Association, European Securitisation Forum (ESF), the International Capital Market Association (ICMA), the International Swaps and Derivatives Association (ISDA), and the London Investment Bankers Association (LIBA).

The guidelines are applicable when structured products are delivered to retail investors. Retail structured products should always be distributed through distributors. The distributor should understand what he/she is distributing and should take responsibility for the contents of the term sheets. Product providers should likewise understand who the distributors are. Even the distributors should know who the product providers are. The essence is the same as in case of the general "know your counterparty" principles such that people do not hide behind their ignorance about the counterparty.

The guidelines are very general and do not say much that is not sheer commonsense. Like industry codes, they are perhaps overpowered by the desire not to restrictive at all. Like most self regulatory codes, they remain like holy principles of benign conduct which but for the code would be found in religious texts.

Links Full text of the guidelines in draft is here.

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

With all the turbulence in the home equity market and the resulting impact on several CDOs, the volumes of ABS issued in 1st quarter 2007 is not much lower than the same quarter last year. Data on abalert.com, which compiles global data, shows that the volume for the 1st quarter was Usd 267.6 billion , compared to last year's 281.8 billion, roughly a decline of 5%. Given the fact that last year was an exceptionally good year, this decline is not very dampening. On the contrary, if one looks at the volume of CDO issuance for the 1st 3 months of 2007, it is USD 132.1 billion, as against only 69.9 billion last year.

A report on Bloomberg citing a Citibank source said the volume of home equity securitization was down sharply -with a decline of over 37%. This is clearly understandable, since, home was at no 1 position in asset backed segment last year, and this year seems to be the year of CDOs.

New Century files for bankruptcy

Even as New Century, one of the one-time leading lenders in the subprime mortgage market filed for bankruptcy protection, the key question in everyone's mind is – is that the worst? While S&P ran a comparison between subprime deals of 2000 and 2006 vintage, and estimated expected losses of about 7.5%, the worry is if with the lowering house prices, will the defaults increase beyond that level?

New Century, which has been in the news below for almost 2 months now, finally succumbed and filed for Chapter 11. It has set up a new sitehttp://www.ncenrestructuring.com/ where it intends to put further information on the restructuring plan. The company's press release says it has entered into an agreement to sell its servicing assets and servicing platform to Carrington Capital Management, LLC and its affiliate, subject to the approval of the Bankruptcy Court. The purchase price for the assets is approximately $139 million. In addition, New Century has agreed to sell to Greenwich Capital Financial Products, Inc. certain loans originated by the company, as well as residual interests in certain securitization trusts owned by the company, for an aggregate price of $50 million.

The subprime market has seen several sad spots over the last couple of months or so – see our comments below.

In the meantime, the subprime credit derivatives index ABX.HE BBB- was quoting at 66.59. It is not the least that it has recorded – there was a bit of revival from the trough of 62.25 quoted earlier.

See more of our notes and coverage below.

SECURITISATION NEWS AND DEVELOPMENTS

/in /by

Jan 2008 onwards

[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 fed direct into your mailbox]

 

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

See the latest news for 2009 here

Previous news pages

April 07 onwards…April 05-March 07.…Aug 04-March 05.…Dec 03-July 04.…July 03 – Nov 03.…Mar 03 – June 03.…Nov02- Feb 03.…Sept-Oct 02 ...June-Aug 02 ...May 02 ...Apr 02 ...Mar 02 .…Feb 02 .…Jan 02 .…Dec., 01.…Nov, 01 .…  Oct.,2001., Sep.,2001., Aug 2001… July, 2001, .June, 2001, May, 2001,… April 2001… March 2001 ..Jan. and Feb.2001  Nov. and Dec.2000 Sept. and Oct. 2000 July and August 2000 May and June 2000 April 2000  Feb and March 2000   
For all news added before 21 January, 2000, please click here   
For all news added before 9th November, please click here  
For News items added prior 3rd August, 1999, click here.

 

Mega US financial restructuring Bill mandates risk retention in securitizations

This is how lawmakers commonly react – to make up for lapses in shutting the door, they install a new door. In this case, they have put up several doors. In a massive exercise of lawmaking, the US draftsmen have presented a 1279 page bill that seeks to enact provisions in several of the sensitive areas of the recent crisis. It proposes a Financial Services Oversight Council, Office of Thrift Supervision be abolished and its functions be merged with those of Office of Comptroller of Currency, OTC derivatives to go through clearing houses and be traded on exchanges where possible, ‘stress tests’ and ‘living wills’ for risk firms and more. 

Specific to securitization, the Bill proposes a new Credit Risk Retention Act that primarily, as the name suggests, mandates retention of credit risk in securitization transactions. The 5% minimum risk retention that has been the central theme of regulatory discussions all over the world of last finds a place in the Bill as well, but with flexibility that permits appropriate regulatory authority to either reduce the minimum risk retention requirements in case of fully amortising loans, or in cases where the purchaser of the loans specifically negotiates for a first loss position. Such purchaser of first loss position must, however, provide due diligence on all individual loans covered in the pool. 

The standards subject to which the rules of risk retention will be framed would aim at improving underwriting standards, and encourage appropriate risk management by creditors. 

The above requirements apply in case of “asset backed securities”. The definition of the term “asset backed securities” has been imported from Regulation AB. As it stands today, the term “asset backed securities” includes only those securities that are serviced primarily from cashflows of defined assets. Hence, the term will not include any covered bonds, and will not include any synthetic securities as well. 

A new provision empowers the SEC to enact provisions pertaining to representations and warranties in case of securitization transactions.  

There are studies proposed about risk retention, and macro-economic impact of securitization transactions. 

Links: See the Text of the Bill here; Read our news on the similar provisions by EU here 

[Reported by: Vinod Kothari]

UK financial regulators propose amendments to capital regulations

12 December, 2009:  UK’s Financial Services Authority has issued a Consultation Paper on several far reaching amendments to Capital Requirements Directives (CRD). Consultation on the Paper will end on 10th March 2010, and the amendments will finally become effective 2011. 

The 360-page document contains proposed amendments relating to several areas – qualifying conditions for being part of hybrid capital, large exposures, risk management in case of securitisation, idea of a “college of supervisors” for cross-country exposures, higher capital requirements for resecuritisation, upgrading disclosure standards in case of securitisation, etc. 

The major amendments pertaining to securitisation are as follows: 

  • Firms investing in securitized products must do comprehensive due diligence. Those failing to do so with be penalized with heavy capital penalties. There is also a mandate not to invest in transactions where originator risk retention is not at least 5%. This is tune with changes proposed by the EU (see our news here) and similar changes proposed by US regulators (see our news here link).
  • In respect of resecuritisation, the FSA seeks to implement changes proposed in Basel II vide the amendments made in July 2009. This is higher risk weight, and greater chances of impairment losses.
  • Securitisation capital relief will be restricted to cases where firms can demonstrate that there is a “significant risk transfer” (SRT). Criteria are laid down in defining what is SRT. Illustratively, the originator does not hold more than 50% of mezzanine positions, or where there is no mezzanine position; originator does not hold more than 20% of senior positions, and so on. It is not clear how the requirement of SRT marry with the other requirement of originators maintaining a minimum 5% exposure, commonly understood to be 5% horizontal piece. 

Vinod Kothari comments – The securitisation market continues to remain very weak, and regulators’ approach of tackling the instrument, not the malaise, will only contribute to it. Investors will develop apprehensions of regulatory intensity in case of investments in securitized products – thereby deterring investments.

[Reported by: Vinod Kothari]

Consensus on OTC derivatives regulations

7 December, 2009: Several authorities over the past few months have been framing regulations to tame the OTC derivatives market.  The House of Agriculture Committee, the House Financial Service Committee had presented bills for regulating the OTC derivatives market and the Banking Subcommittee on Securities, Insurance and Investment, introduced the Comprehensive Derivatives Regulation Act of 2009 (See our report here). Now the House of Agriculture Committee and the House Financial Service Committee have reached an agreement on a bill to impose federal regulation for the first time on the over-the-counter derivatives market.  The OTC derivatives helps corporations, hedge against operational risks but post financial crisis the lawmakers have been wanting to tighten the regulatory noose to curb the speculative activities.

However there are two issues that are yet to be decided whether to limit ownership in swaps clearinghouses, and whether regulators would have the power to set margin and capital requirements on swaps traded by non-financial end users. The compromise bill includes that the standardized swaps will be traded on the exchange whereas there would be higher margin and capital requirement for customized swaps but registration of dealers and major market participants would be required to ensure transparency and record keeping in trading.

The bill is expected to come up for a vote on the House floor next week as part of financial regulation reform proposals. See the press release here.

[Reported by: Nidhi Bothra]

ASF official suggests Securitization regulatory reforms

American Securitization Forum’s (ASF) Executive Director, George P. Miller, delivered testimony on 7th October, 2009 at a hearing of the Senate Banking, Housing and Urban Affairs Subcommittee on Securities, Insurance and Investment on “Securitization of Assets: Problems and Solutions.” 

Miller’s testimony sung paeans about the relevance of securitization, and lamented that since the mayhem in the financial markets, securitization has remained dormant. Lots of people have held securitization responsible for the subprime debacle, but according to Miller, the deficiencies are not inbuilt in securitization but the manner in which securitization was used by the market participants that led to the rigmarole. High leveraging caused significant increase in the demand much of which was artificial and not guided by the financing needs of the lenders and the borrowing needs of the consumer.

Miller also suggests that the policy reforms coupled with industry initiatives may help in reviving the securitization market, for a more stable environment these reforms should be coupled with integrity and reliability of securitization data and transaction structures coupled with enhanced operational risk. The reforms that Miller suggested are as below:

  • Increased Data Transparency, Disclosure and Standardization, and Improvements to the Securitization Infrastructure – ASF’s project on Residential Securitization Transparency and Reporting (“Project RESTART”) focuses on addressing the transparency and standardization deficiencies in the RMBS markets initially.
  • Required Risk Retention and Other Incentive Alignment Mechanisms – ASF supports the idea of risk retention as a means of aligning of the economic incentives of the transaction participants. However he does not rule out the possibility of having other forms of achieving effective means of alignment of interest of the transacting parties.
  • Increased Regulatory Capital Requirements and Limitations on Off-Balance Sheet Accounting – ASF believes that increase in the regulatory capital requirements should be introduced for certain securitization. Overall increase in the regulatory capital requirement may have a negative effect on the economic viability of securitization itself.
  • Credit Rating Agency Reforms – Credit rating agencies play a very important role in the securitization market and the reforms suggested to increase the quality, accuracy and integrity of credit ratings and the transparency of the ratings process are all welcomed. ASF supports the reforms for full and transparent disclosure on the basis for structure finance ratings so that the risk of securitization can be understood and differentiated from the risk presented by other types of credit instruments.

[Reported by: Nidhi Bothra]

 IMF recommends restarting securitization

IMF issued the Global Financial Stability Report on 21st September, 2009, which would give the securitization market and the industry analysts a reason to cheer. The chapter 2 of the report on ‘Restarting Securitization Markets: Policy Proposals and Pitfalls’ summarizes the rise and fall in the securitization market, analyses the recommendations made so far for the revival of the securitization market and lays emphasis that restarting of the securitization markets would be important for financial stability globally.

The Chapter brings out the flaws of the market before crisis that ultimately led to the debacle. Banks started holding the least risky tranches, originated by other banks including the sub prime exposure which reduced the risk dispersion that led to the market fallout. The report also talks about the ‘alphabet soup’ where demand for various structured products was instigated by the rating agencies willingness to give away their highest ratings coupled with the investors dependence on the ratings provided to these securities and inadequate information to assess or adjudge the ratings. The numbers prove the flaw where the report says that of all the ABS CDO tranches issued from 2005 to 2007 that were originally rated AAA, only 10 percent are still rated AAA by Standard & Poor’s, and almost 60 percent are rated single-B or less, well below the BBB-investment-grade threshold.

The report also recognizes that though most people were talking about what went wrong it was imperative to revive ‘sound securitization.’ The report stresses that the restarting private label securitization is vital to end the financial crisis. The report welcomes the changes brought with regard to securitization and presents its recommendations on implementation of the suggestive changes. Some of the recommendations are as below:

  • Credit Rating Agencies: Chapter 2 says that so far the investors had placed too much of reliance on the credit rating provided to the securitized products and under the issuer pay model, interest of the investors were ignored. The report recommends that as credit rating agencies have a vital role in the securitization process, elimination of the issuer-pay models, disclosing preliminary ratings to reduce ‘rating shopping,’ publishing performance data to enhance due diligence and competition among credit rating agencies be increased
  • Retention of risk by the originators: The report says that these requirements adopted by both US and European authorities should not be standardized. For diligent loan underwriting and monitoring, the report welcomes that there should be more “skin in the game” but the report says that the requirement should not be standardized and both size and the form of retention should be more flexible to achieve the broad based incentive alignment. The flexibility could be brought about by basing the retention policy on type and quality of the underlying assets, the structure of the securities, and expected economic conditions
  • Changes in the accounting standards and regulatory requirements: The report recommends that disclosure and transparency standards should be improved. Accounting standard changes brought in by FASB on elimination of gain on sale accounting treatment was welcomed by the report as it meant disclosure of income as and when received and not upfront, but the report also cautioned that the changes in the disclosure requirements should not be such that would burden the securitizers and investors. Loopholes of the Basel II regulatory capital requirement should be plugged too.
  • Standardization of the securitized products: To avoid problems relating to valuation and risk analysis the securitized products should be simplified and standardised. The report also mentions that some of the complex products like CDO2 should not re-emerge.
  • Covered Bonds: Covered Bonds are viewed as an alternative to risk retention policy adopted by both EU and US, but the report views covered bonds as a complementary form of capital market based funding and not as an alternative to securitization.

While the report is appreciative of the recent changes brought about but also state that if new rules are not implemented well it could have its side effects on the market and would slow down the market rather than reviving it, thereby defeating the purpose. The new regulations should not throttle the markets but should facilitate maintaining a firm ground and sustainable growth.

In times where securitization is looked upon as a taboo or a jinx of sorts, the report gives securitization its due.

[Reported by: Nidhi Bothra]

Yet another credit crisis ruling: Morgan Stanley, Rating agencies defence in SIV Cheyne compensation claim dismissed

It is the same story everywhere – when the Stamford court was ordering UBS (see the news item here) to set aside money for damages to Pursuit for selling CDO notes, SDNY judge Shira A. Scheindlin was writing order denying rating agencies’ and Morgan Stanley’s motion to dismiss investors’ claims for losses in structured investment vehicle (SIV).  

The suit, brought by Abu Dhabi Commercial Bank, charged the defendants for misrepresentation, fraud, breach of fiduciary duty, negligence, etc. Morgan Stanley and the rating agencies had filed a motion for dismissal on various grounds.  

Cheyne Finance Plc was a structured investment vehicle that is now in bankruptcy. Cheyne issued 3 types of notes – commercial paper, medium term notes, and mezzanine capital notes, all of which were rated by the rating agencies. This is the common structure of SIVs.  

The case brings to public light the role of rating agencies in structured vehicles such as SIVs. The rating agencies charged upwards of 10 basis points of the capital of the SIVs as their initial fees, and charged $ 1.2 million + 0.055% of the market value of the SIV’s assets. This means the rating agencies continued to gain as the SIVs continued to build more assets. Also, there is a startling fact that the rating agencies in case of SIVs get their fees only if the notes get the AAA ratings. The rating agencies claimed that their opinions are non-actionable – this argument was rejected by the court. “Rating agencies’ opinions are not mere opinions but actionable misrepresentations”, held the Judge. 

In summer of 2007, Cheyne SIV collapsed. In August 2007, it declared bankruptcy.  

The factual analysis reveals that while the SIV was required to limit its exposure to RMBS to 55%, Morgan Stanley and rating agencies were well aware that the actual investment was well above 55%. The SIV held New Century’s debt, and Morgan Stanley, as New Century’s 4th largest creditor, was aware of facts about New Century that were not in public domain.  The structure of the fees for the rating agencies created a conflict of interest as they were directly connected with the success of the vehicle and its size of assets. “Where both the Rating Agencies and Morgan Stanley knew the ratings were flawed, knew that the portfolio was not safe, stable investment, and knew that the Rating Agencies could not issue an objective rating because of the effect it would have on their compensation, it may be plausibly inferred that Morgan Stanley and Rating Agencies were disseminating false and misleading ratings.” 

[Reported by: Vinod Kothari]

Links: Text of the SDNY ruling is here:

For more on SIVs, see Vinod Kothari’s presentation here:

CDO investors continue to crowd courts: UBS charged for selling "crap" to Connecticut Hedge Funds

This is only one of the several rulings either already out of the legal press, or under publication. Law courts all over the US and some even in Europe are currently considering CDO/ MBS/ ABS investors’ claims as to fraud, mis-selling, misrepresentations and so on. In a ruling dated 8th Sept 2009, Justice Blawie of the Stamford’s  Superior Court ordered UBS to set aside money for pre-judgment damages, or face garnishee orders for recovery. 

In this case  brought by Pursuit Partners, a Connecticut-based hedge fund, UBS was charged for selling CDO tranches that were described in internal emails as “crap” and “vomit”, and were sold shortly before Moody’s downgraded the securities. All the CDOs were so-called bespoke CDOs structured to meet Pursuit’s needs of a triggerless, investment-grade piece that could be available at significant discount on face value. 

Moody’s and S&P have also been charged in the case, as there were allegations that UBS was privy to forthcoming changes in the rating methodology of Moody’s whereby the notes that were sold to Pursuit would cease to be investment grade. The change in methodology was the correlation assumption in CDO pools. 

The offer document, as is quite usual with transactions, said the transaction will be governed by New York law. However, the Connecticut court still assumed jurisdiction, ignoring the choice of law clause, on the ground that a choice of law by parties can  be ignored on ground of public policy. The Judge said: “To allow securities to be marketed, offered and sold in any or all of the 49 states outside of New York, and hold that no other jurisdiction’s laws can be enforced or invoked, or that Connecticut law must be ignored, even if a plaintiff can establish, as it has here, probable cause to support a cause of action under Connecticut law, the state where the solicitation was made, simply because of this choice of law provision, is not a proposition this court will or may accept, both as a matter of statute and public policy”. If this ruling is finally accepted at higher forums, then CDO marketers would have a real tough time defending suits all over the country. 

The notes were sold to Pursuit between 26th July 2007 and Oct 1, 2007. This was the beginning of the avalanche of CDO downgrades. Obvious enough, UBS would have sensed the impending downgrades, and therefore, internal emails of UBS indicated the need to clear the inventory of CDO tranches that UBS was carrying. This evidence led the court to find “probable cause to sustain the claim that UBS sold the Notes to Pursuit without disclosing the following material non-public information: (1) that the Notes would soon no longer carry an investment grade rating, as the ratings agencies intended to withdraw these ratings as a result of a change in methodology; and (2) that once the investment grade rating was withdrawn, the CDO Notes sold by UBS to Pursuit, being valued in the tens of millions of dollars, would thereby become worthless”. 

The court on analysis of facts, primarily emails of the CDO marketing team of UBS, that UBS was in superior knowledge of the facts, which were concealed from the buyer, which the buyer relied upon and was thus unduly affected by the representations of the seller.  Internal emails of UBS said they had sold more “crap” to Pursuit, etc., which led the court to apply the “superior knowledge” doctrine. The court noted that risk is something that attaches to all such investments. However, (t)hat is the difference between a risk that something might happen to change the value of an investment, which is both a fact of life and a risk shared by all parties to any securities transaction, and the undisclosed knowledge that something will happen. That type of nondisclosure, whether it is on the part of a seller or a buyer, can cross the line into actionable securities fraud, and the court finds probable cause to sustain a finding that it this instance, it did”. 

Vinod Kothari comments: The ruling above is a flavor of the times. Judges, like the financial press, common people and others, have been affected by the wave of sentiment that goes against people who marketed and sold CDOs. On objective analysis of the ruling above, the question to be asked is – if UBS sold crap to Pursuit, what else do you sell to someone who comes to buy crap? Pursuit wanted to buy investment grade, being sold at steep discount on face value. Which investment grade notes would sell at steep discount on face value, given the high return on face value itself that they carry? The notes in question were bought between July and October, 2007 when the subprime crisis had already started surfacing. Bear Stearns’ hedge funds had already imploded by then. Rating agencies had also started downgrading several CDOs. On our website here, on June 20, 2007, we had reported that securitisation market was looking like a sinking ship, and there was fire everywhere. The purchases were made by Pursuit in tranches upto 1 October, 2007, by which time the subprime story, and the impact of that on CDOs was spread all over the financial press. So, can Pursuit really contend that there was a “superior knowledge” that UBS had, which Pursuit could have had? Pursuit, as a matter of investment strategy, might have projected that that was the right time to buy CDOs at deep discount, as its investment team might have projected that the crsis will not last long. 

Offer documents contained a detailed description of what were the assets of the pools, and what risks they carried. The impending change in rating methodology of Moody’s was  in public domain as rating agencies had come up with public statements on the same. Pursuit has affirmed before the court that it had read the offer documents and understood the same. A hedge fund is not a lay investor – its sole USP lies in being able to make money by taking risks that lay investors do not or cannot take.  

If this ruling leads UBS to pay damages for the losses that Pursuit faced, almost every seller who sold bonds that went bad would, sooner or later.

[Reported by: Vinod Kothari]

 Insurance Securitisation important and growing: IAIS Report

International Association of Insurance Supervisors (IAIS) published its report on ‘Developments in (Re)Insurance Securitization’ on 26th August, 2009. The report recognizes insurance securitisation as a significant complement to traditional reinsurance: the market, though small, is growing at a discernible pace.

Insurance securitisation is used by property and casualty companies for seeking reinsurance capacity, and life insurance companies for seeking regulatory capital by embedded value encashment, or extreme mortality risk transfer.

The aggregate market for insurance linked securities (ILS) peaked up in 2007 with an issuance of $ 15.5 billion, including $ 7.6 billion of life, and 7.9 billion of non-life issuance. The market in 2008 was quite slow – due to a global retraction of investors from anything that was new or complex. 2009 so far has seen only some extent of activity. Volume is not the only indicator of the maturity of the market – there are several other parameters noted in the Report – including width of sponsors, nature of perils covered, maturity of transactions, and so on.

The Report notes the regulatory developments in various jurisdictions too – including laws related to special purpose reinsurance vehicles, subordination of investors’ claims to the cedants, and so on.

The Report notes examples of ILS that have gone under stress over time. The first bond that suffered losses was Georgetown Re in 1996 and the report studies the performance of various other bonds like Kamp Re and Avalon Re affected by 2005 USA hurricane season, Newton Re, Orkney Re and others affected by the current financial crisis. There are 4 transactions that were stressed due to the bankruptcy of Lehman as a counterparty.

The IAIS Standards and Guidance paper on reinsurance is to include the guidance on insurance securitization as well and is expected to be finalized in 2011.

Report says that the insurance securitization market remains largely untested but shall grow in the times to come, taking cues from the report the market is all geared up to tap the resources that went undermined so far.

[Reported by: Vinod Kothari]

Link: See the full text of the report here

Link: See our risksec page

Workshops: Vinod Kothari offers workshops on insurance securitization. For sample course outline of a workshop offered in Milan recently, see here 

IOSCO recommends securitisation and CDS regulations

The International Organisation of Securities Commissions’ (IOSCO) has published the ‘Unregulated Financial Markets and Products – Final Report’ prepared by the Task Force on Unregulated Financial Markets and Products  on the 4th of September, 2009. The Task Force had earlier, in May published its consultative report on the issue (see our news here) 

The Final Report recommends the regulatory actions to improve the transparency and oversight of the securitization and credit default swaps (CDS) markets.  

As regards securitisation, IOSCO’s recommendations are not lot different from what regulations in the EU and US have proposed – alignment of incentive in the securitization value chain, essentially implying retention of originator stakes in securitized pools. CDS issues relate to counterparty risk, operational risk and market transparency.  

The main securitisation-related recommendations are: 

  1. Consider requiring originators and/or sponsors to retain a long-term economic exposure to the securitisation in order to appropriately align interests in the securitisation value chain;
  2. Require enhanced transparency through disclosure by issuers to investors of all verification and risk assurance practices that have been performed or undertaken by the underwriter, sponsor, and/or originator;
  3. Require independence of service providers engaged by, or on behalf of, an issuer, where an opinion or service provided by a service provider may influence an investor's decision to acquire a securitised product; and
  4. Require service providers and/or issuers to maintain the currency of reports, where appropriate, over the life of the securitised product.  

The main CDS recommendations are: 

  1. Provide sufficient regulatory structure, where relevant, for the establishment of CCPs to clear standardised CDS, including requirements to ensure:

a.       appropriate financial resources and risk management practices to minimise risk of CCP failure;

b.      CCPs make available transaction and market information that would inform the market and regulators; and

c.       cooperation with regulators;

  1. Encourage financial institutions and market participants to work on standardising CDS contracts to facilitate CCP clearing;
  2. The CPSS-IOSCO Recommendations for Central Counterparties should be updated and take into account issues arising from the central clearing of CDS;
  3. Facilitate appropriate and timely disclosure of CDS data relating to price, volume and open-interest by market participants, electronic trading platforms, data providers and data warehouses;
  4. Support efforts to facilitate information sharing and regulatory cooperation between IOSCO members and other supervisory bodies in relation to CDS market information and regulation; and
  5. Encourage market participants' engagement in industry initiatives for operational efficiencies.  

[Reported by: Nidhi Bothra]

Links – for text of the IOSCO report, see here

Yet another shock to bankruptcy remoteness

UK Chancery Court temporarily defends attack by Lehman’s counsels

Vinod Kothari

We have always contended that the concept of bankruptcy remoteness is a product of good times, and has not been tested in bad times such as these.

The latest in the series of shocks to bankruptcy remote vehicles is the contention of the counsels for Lehman before the UK Chancery Court in Perpetual Trustee Co. Ltd  v. BNY Corporate Trustee Services Ltd [2009] EWHC 1912 (Ch).

Transaction structure

The case pertains to a multi-issuer synthetic CDO program called Dante Program. The structure is the familiar synthetic CDO structure, wherein several Irish SPVs, in this case, Saphir Finance Public Limited Company, Zircon Finance Ltd and Beryl Finance Ltd, would issue notes to the investors and raise funding. The funding would be in government bonds or other secured investments (Collateral). The SPVs would enter into a swap (perhaps a credit default swap, or total rate of return swap) under which Lehman Brothers Special Financing (LBSF) would make periodic payments to the issuing SPV, which, in turn, would pay the coupon to investors in the notes.  The Collateral would be charged, first, in favour of LBSF as the swap counterparty, and thereafter, in favour of the investors of various classes in descending order of priority. The collateral trustee in the present case is BNY Corporate Trustee Services, and Perpetual and Belmont (Note Trustees) were the trustee for the noteholders based out of Australia, New Zealand and Papua New Guinea.

As Lehman filed for bankruptcy, the payments under the swap were not made. Hence, the swap payments were defaulted post 15th Sept 2008. Pursuant to this, the Note Trustees filed a claim against the Trustee, for realization of the collateral, as an event of default under the swap agreement had taken place. The terms of issue provided that the noteholders would have a priority over the swap counterparty, if an event of default on the part of the swap counterparty had occurred.

Contentions of LBSF counsel

LBSF denied the claim of the noteholders, taking shelter under sections 362(a)(3), 365(e)(1) and 541(c)(1)(B) of the US Bankruptcy Code. They also contended that the action of the Note Trustees be stayed until resolution of the matter by the Bankruptcy Court in the Southern District of New York (SDNY) where Lehman’s bankruptcy proceedings are going on. Section 362 of the US Bankruptcy Court provides for automatic stay on proceedings against the property of an entity after a bankruptcy petition has been filed. The section marks a significant difference between US and UK insolvency laws – the latter do not have a provision for automatic stay against creditors or security interest holders. Section 365 allows a bankruptcy trustee to disown onerous clauses in contracts of the bankrupt.

In essence, the Note Trustee pleaded that as an event of default had occurred, the interest of the noteholders overtook priority over that of LBSF, while on behalf of LBSF, it was pleaded that LBSF could take shelter under benevolent provisions of the US Bankruptcy code and prevent the subordination of LBSF.

LBSF has filed a motion in the SDNY Bankruptcy court which was due to come for hearing on 5th August 2009. Text of the motion is available here.

Contracting out of bankruptcy law?

The arguments in this case tread over a very significant topic in bankruptcy laws – is it possible for contractual clauses to override bankruptcy laws? In other words, can parties contract out of bankruptcy laws? For instance, bankruptcy laws provide for a particular manner of priority in distribution of the estate of a bankrupt. Could parties have provided by contract for a different order? The most logical answer would have been no, because if that was the case, bankruptcy laws would lose their meaning. But then bankruptcy proofing that structured finance transactions seek to attain, is actually, in a manner of speaking, contracting out of  bankruptcy laws.

Counsel for LBSF pleaded that a clause in the swap documents was void under English law. The clause (Clause 5.5 of the Supplemental Trust Deed) provided that the Collateral would be held by the trustee with first priority to the swap counterparty, unless the swap counterparty had committed an event of default.  Note that this clause is most usual clause in any synthetic CDO issuance, and is most logical and easily understandable. The CDO issuing SPV has obligations on account of the protection it sells to the swap counterparty, and obligation to pay interest and principal to the noteholders. The idea of holding the collateral with the SPV is that any protection sold by an SPV has no meaning unless it is backed by assets – therefore, the SPV backs the protection it sells to the swap counterparty with the collateral. The collateral will continue to enure  for the benefit of the swap counterparty, but if the swap counterparty has defaulted under the terms of the swap, the swap gets cancelled, and the collateral flows back to the investors. If this was not the case, the investors have no support of the collateral at all, and the investors have taken the risk of bankruptcy of the swap counterparty, whereas the very idea of interposing an SPV between the swap counterparty and the investors is that the investors remain immune from the bankruptcy risk of the swap counterparty.

In essence, what the counsels for LBSF were pleading was both against concept of bankruptcy remoteness and against common intuition. The counsels relied upon a ruling in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd [2002] 1 WLR 1150. wherein a UK court had held that if a clause in a contract provides for deprivation of the property of someone upon bankruptcy, such a clause is invalid. In that case, the court had held: “There cannot be a valid contract that a man's property shall remain his until bankruptcy, and on the happening of that event go over to someone else, and be taken from his creditors.”

The ruling, for most part, has dwelt upon the breadth of the above principle in Money Markets International Stockbrokers Ltd v London Stock Exchange Ltd. The counsel for the Note Trustees contended that if this principle was to be applied widely, it would frustrate myriad contracts in the commercial world, many of which contain re-alignment of priorities in the event of default of a party to the contract.

LBSF counsel relied upon an old English ruling in Ex parte Mackay (1873) LR 8 Ch App 643, wherein it had been held that “in my opinion a man is not allowed … to provide for a different distribution of his effects in the event of bankruptcy from that which the law provides. It appears to me that this is a clear attempt to evade the operation of the bankruptcy laws”.

LBSF counsel also cited from other English rulings. For instance,  Ex parte Jay (1880) 14 Ch D 19, holding as follows: “"a simple stipulation that, upon a man's becoming bankrupt, that which was his property up to the date of the bankruptcy should go over to someone else and be taken away from his creditors, is void as being a violation of the policy of the bankrupt law.”

The Chancery court, however, dismissed the arguments. The Chancellor held:

“In my view clause 5.5 of the Supplemental Trust Deeds is not contrary to public policy on the grounds relied on or at all. I reach that conclusion for a number of reasons. First it is necessary to consider the structure of the transaction as a whole, not the terms of clause 5.5 of the Supplemental Trust Deed in isolation. The security conferred by that clause is in respect of the collateral. The collateral was bought by the issuer with the money subscribed by the investors for the notes. In no sense was it derived directly or indirectly from Lehman BSF as the swap counterparty. Second, on general principles the court should not be astute to interpret commercial transactions so as to invalidate them, particularly when, as counsel for Belmont suggested, consequential doubt might be cast on other long-standing commercial arrangements. Third, the involvement of Lehman BSF is the consequence of the swap agreement under which it sought and obtained, in effect, credit insurance in respect of the Reference Entities. As long as that agreement was being performed it was appropriate for Lehman BSF to have security for the obligations of the issuer as the other party to the swap agreement in priority to security in respect of the issuer's obligations to the noteholders under the trust deeds and the terms and conditions of the notes. It is plain that the intention of all parties was that the priority afforded to Lehman BSF was conditional on Lehman BSF continuing to perform the swap agreement. Fourth, so regarded, the priority of Lehman BSF never extended to a time after the event of default in respect of which it was the defaulting party had occurred. Fifth, it follows that such beneficial interest by way of security as Lehman BSF had in the collateral was, as to its priority, always limited and conditional. As such it never could have passed to a liquidator or trustee in bankruptcy free from those limitations and conditions as to its priority”.

The reasons cited by the judge are most significant and appreciable. The collateral was sitting in the transaction to provide asset backing to both the investors and the swap counterparty. The swap counterparty was provided seniority during the performance of the payments by the swap counterparty. But obviously, the swap counterparty cannot contend that even if fails to make the swap payments, it must still continue to enjoy the collateral. The shifting of priorities is critical to the very nature of the transaction, which is to provide protection against bankruptcy of the swap counterparty. If the swap counterparty still has superior rights over the collateral despite  bankruptcy, there is no bankruptcy remoteness at all. What the counsels for LBSF were claiming would, if approved by the courts, terminate the whole concept of bankruptcy remoteness.

The present case was adjourned, in view of the pending proceedings in SDNY bankruptcy court. This was done in pursuance of the protocol under UNCITRAL’s model law on cross border insolvency.

Subsequent to the ruling of the Chancery court, the counsels for LBSF have applied to the US bankruptcy court to appoint LBSF as representative of the bankrupt’s estate and to seek the assistance of a foreign court in protecting the property of the bankruptcy.

It would be interesting to watch out for further developments in the case as this case would be one out of many where, post-credit-crisis, the concept of bankruptcy remoteness will face the tough test that it has been escaping all this while.

Important links:

See the Ruling of the Chancery court, Dated August 7, 2009

To know more about Special Purpose Vehicles see our page on SPVs here.

Department of Treasury proposes regulations for securitization and CDS transactions

It is always like this – things go wrong because of natural process of sheer over-exuberance, and we react with more rules and more regulations, as if it was lack of rules that caused the problem. Not unexpected at all, the Department of Treasury issued an 89 page report proposing several new regulations in the financial market. 

As for securitization transactions, it proposes originators to be mandated to keep at least 5% risk in the securitized portfolios – similar to what European counterparts have already imposed (See our news here). Recognition of upfront gain on sale should be eliminated, and off balance sheet treatment should be ruled out (see FASB’s new standards).  Originators should have fees or incentives based on actual performance of the pool. Originators should give representations and warranties as to performance of the pool – something which is today seen as violating the true sale condition. In short, the true sale business is clearly frowned upon in the report.  

SEC should continue its effort to regulate credit rating agencies. Ratings to structured products should be distinguished from other products – something which technically takes away the very comparability of ratings. Surprisingly, the report also says the regulators should reduce dependence on ratings for risk weights, and should think of different risk weights for structured and unstructured products. 

On credit derivatives, the Report has comprehensive regulation on all OTC derivatives, including credit derivatives. Clearing of all standard OTC derivatives should be required through centralized counterparties. [Reported by : Vinod Kothari] 

For full text of report, see here.

Over with off balance sheet securitization – FASB issues new standards on securitization accounting

As expected, last Friday, 12th June 2009, FASB issued new accounting standards (FAS 166 and FAS 167) that bring about very significant changes to the way securitization transactions have been accounted for under the US GAAPs. The IASB had already put up exposure drafts on the issue (see our news here). As (a) the new rules require that where there is continuing involvement of an originator in a securitization transaction, off balance sheet treatment will not be granted; and (b) continuing involvement is a reality with most securitization transactions world-over, it is almost clear that either securitization transactions will not be put off the books at all, or even they are put off the books, they will get consolidated back under the new consolidation regime. In essence, bye-bye off-balance sheet securitization.

The new regime may usher in a completely new thinking on bankruptcy-remoteness and ratings arbitrage. New devices of credit enhancement will be searched. Of course, there always will be asset-backed funding and asset-backed investing, but existing system of achieving isolation by a true sale would possibly get a hard re-look.

The new standards will be effective for accounting periods beginning after 15th Nov 2009. [Reported by : Vinod Kothari]

Links: For details of changes brought about by FAS 166 and FAS 167, see our page here

FASB's proposed changes to bring US GAAP securitization accounting close to IFRS

On 18th May 2008, the FASB concluded its deliberations on several crucial amendments to securitization-related accounting standards. Both FAS 140 and FIN 46R are slated to be amended. 

The proposed amendments to FIN 46R add a qualitative test to the criteria for consolidation of variable interest entities (VIEs). VIEs are special purpose entities – they are normally not controlled by their legal owners but by another entity or entities that hold the risks/returns of the entity (which is referred to as variable interest) either by holding a residual interest in the entity or by being exposed to variability in losses. Existing conditions for consolidation of VIEs are quantitative – holding majority of variable interest. The proposed changes add a subjective, qualitative test of “control” also to the consolidation criteria. That is, if the VIE is controlled by a particular entity, the controlling entity will consolidate the VIE. 

It is not usual for US GAAPs to have subjective tests such as control as the basis for consolidation – as US standard writers have mostly relied upon more specific “rules” than principles.  

The second package of changes will amend securitization accounting standard FAS 140.  

First of all, quite significantly, the existing exemption for qualifying special purpose vehicles (QSPEs) from FIN 46R will go away as the very concept of QSPEs is intended to be done away with. Existing rules provide an exemption to QSPEs from consolidation under FIN 46R, with the result that most RMBS and ABS SPEs that can qualify as QSPEs remain free from consolidation requirements. Now that the exemption will be removed, the position of US GAAPs on SPE consolidation will be similar to that of IFRS, where SIC 12 requires consolidation of most SPEs. Since the basis of consolidation is variable interest, it is almost unlikely that SPEs will not have someone holding majority of variable interest: hence, every SPE will require consolidation with someone or the other. The net result may be that off-balance sheet treatment for securitization may be effective over – a position that we have predicted will apply under IFRS as well.

Another change is to require that de-recognition standard will apply to a fraction of a financial asset only if such fraction is fully proportionate share of a financial asset. This is the position under IAS 39 currently: FAS 140 as it exists does have the possibility of elements of financial assets being taken as assets by themselves. 

Additional disclosures are going to be required for “continuing involvement” in securitization transactions. Notably, proposed changes in IAS 39 seek to deny off balance sheet treatment in case of continuing involvement. [Reported by: Vinod Kothari]

Links: see our page on accounting for securitization here.

General Growth CMBS SPEs file for bankruptcy: One more nail in the coffin of securitization

We have been contending on this site that the myth of special purpose vehicles, as entities with peppercorn capital and isolated from the originators with capital held by charities claiming to do the good of mankind, is all a legal superstition and is a product of good times. The presumption of bankruptcy remoteness is  valid only as long as any of the parties is not in bankruptcy. It is not that there have not been challenges to true sale before, but this one taking 166 SPVs for CMBS transactions into bankruptcy may be quite a big jolt. The worst part is that this may be a temptation for more such attempts by transactions facing rough weather.

In the present case, General Growth Properties Inc., a leading CMBS issuer in the US, filed for Chapter 11 protection last month, and also took 166 of SPVs for various CMBS transactions into bankruptcy. Since a bankruptcy filing would have been based on vote of directors, and SPVs typically do not have substantial originator presence on their boards, legal circles have a feeling that the originator strategically changed the composition of board of directors of each of the SPVs to introduce “convenient” who ultimately voted for the bankruptcy filing.

The bankruptcy filing has obviously rattled the securitization investors, not just in this transactions, but the entire market.

General Growth is the single largest CMBS borrower in the U.S. The CMBS market has grown up over the past two decades and was continuing  growing, until 2008, when securitization markets in general sank.

Reported by: Vinod Kothari

Links : see SPV page; true sale page 

European Parliament adopts new capital rules for banks

The Legislative Report amending the capital requirements for banks to improve transparency and supervision of the financial systems and to avoid future financial crisis was adopted in the Parliament with 454 votes in favor and 106 votes against the motion. The European Parliament, Council of Ministers and the European Commission delegations agreed to have the new legislation approved before the end of the current legislative term. The ‘Capital Requirements’ Directives, sought revision of the previous directives to improve crisis and risk management. The few notable points of the new legislation are:

  • Council to establish the colleges of supervisors to facilitate cooperation among national authorities dealing with cross-border financial institutions
  • The banks could not expose more than 25% of its own funds to a client or group of clients. The exception to this threshold limit will be exposure between credit institutions but capped to not more that Euro 150 million. This limit on the exposure will be subject to review by the end of 2011
  • In case of securitization the legislation mentions that a retention of 5% of the total value of the securitized exposure to be retained by the issuing institution, ensuring material interest in the performance of the proposed investments. This again was subject to review by the end of 2009.
  • With respect to Credit Default Swaps as well, there was a need felt for stricter regulations to bring about transparency in trade and to set up a central clearing house to be supervised by the European Union to reduce the risk of these instruments. The legislative proposal in this regard is to be out forth by the Commission by the end of 2009

The European Legislation, Councils of Ministers and the European Commission agreed on the insertion of the review clause and also to increase the retention rate by 31st December, 2009 after consulting the Committee of European Banking Supervisors. These legislations are to be complied with by the end of the year 2010. This is just a step in response to the present financial crisis. EU in the last month had also approved of the new rules for the Credit Rating Agencies (see report below) in a similar effort to improve transparency and to gain investors’ confidence.

Reported by: Nidhi Bothra

IOSCO recommends regulations of securitisation and credit-derivatives

The International Organisation for Securities Commissions’ (IOSCO) Technical Committee published a report on ‘Unregulated Financial Markets and Products – Consultation Report prepared by its task force.

Thankfully, in a period when lot of commentators are spitting venom at securitization as being the source of the present crisis, the Report recognizes the significance of securitization. “The absence of a well-functioning securitisation market will impact consumers, banks, issuers and investors. The price of credit is likely to be higher for the consumer and the availability scarcer. Banks will no longer have a tool to reduce risk and diversify their financing sources”, says the Report.  Credit default swaps, too, can serve as an excellent instrument for risk hedging and price discovery, but also have a potential to proliferate as a tool of speculative trading in credit.

Thus, the interim recommendations are aimed towards restoring transparency and investors’ confidence, promoting fairness and bringing about stability in the international financial markets. The interim recommendations on securitization include:

  • The originators or the sponsors to have longer term economic interest in the securitization transaction
  • Disclosures and the transparency norms to be made stringent to ensure that appropriate checks and assessments are done and the originator, issuer and underwriters have duly performed their duties.
  • Improving disclosure norms for the issuers on initial and continuing basis, giving out data on the underlying asset pool’s performance and so on.
  • Independence of experts used by issuers

In the CDS market, the task force recommended the formation of central counterparties to handle clearing of CDS contracts and for market participants to support the clearing process by developing a standardised CDS contract. The report is open for comments till the 15th June, 2009. See the full text of the report here.

Links: See news updates on credit derivatives here

Reported by: Nidhi Bothra  

Chase's $5 billion swells TALF ABS issuance to $11 billion for May

Since the launch of the TALF program in March the issuers have sold $11.4 billion of securities mostly backed by credit card and auto loans. Now with the Chase Issuance Trust coming up with a $5 billion ABS deal in the third round of TALF program; the supply figures come to a $9.5 billion in May alone. The Federal Reserves says that the investors have requested $10.6 billion worth of loans as against $ 4.7 billion in March and $ 1.7 billion in April round.

The Chase AAA rated securities are of 3 years maturity and are priced at 155 basis points over one month LIBOR rate. The other deals that will qualify for TALF financing in the month of May are a $760 million equipment loan deal from Case-New Holland (CNH), $500 million offering backed by motorcycle loans from Harley-Davidson, a $1.75 billion issue by Volkswagen and a $1.75 billion of auto ABS by Honda Auto, so the number of TALF eligible auto deals has come to a total of four. Apart from Volkswagen and Honda, Mitsubishi, Harley-Davidson also eyeing the market. A $1 billion offering of credit card securities from GE Credit sold at 210 basis points over one month LIBOR rate. So the TALF eligible new issuances stand at $11 billion for the month of May. There are reports of a $3.6 billion Sallie Mae deal materializing as well.

After a positive start and a disappointing dip in the issues in March and April respectively the third round has brought in strong sentiments of confidence as the issues are met with high demand for the securities and are oversubscribed. There are definite signs of revival of the securitization market.

Reported by: Nidhi Bothra

Is Securitization Islamic? IIFA to clear ambiguity

Is securitisation Islamic? There is controversy lingering on securitization where various scholars and schools of thought are diverse on their opinion – whether the act of securitization (tawriq) is permissible from the Islamic perspective or not.

In a securitization transaction there are selected debts that are permissible for securitization. For instance credit cards loans where there is a flat fee charged (rather than it being called interest charges) and the investors are paid dividend on their investments (dividends being the principal plus fees charged from the credit card holders). Presently banks securitize without considering the interpretations of the Holy Qur’an and make offerings to the customers ignoring the text that bans various provisions so incorporated. As a result there a lot of scholars who issue fatwa based on their opinion on the securitization transaction.

The International Islamic Fiqh Academy (IIFA) constitutes eminent scholars from various parts of the world and gives their recommendations on various financial matters. The Fiqh Academy will be taking up the issue of securitization and formulate a stance on the issue from the Islamic perspective. The responsibility dawned on IIFA is to bring all the schools of thoughts closer to the understanding and interpretation of the Ummah and abiding by it while dealing with the ambiguities related to the issue.

Reported by Nidhi Bothra

Vinod Kothari comments: Is securitisation Islamic? This question, and similar questions about lots of other present-day financial instruments, arise naturally because there is nothing like securitisation that would have prevailed during the time the key tenets of Islam were written. But then, the key principles of brotherhood and humanity, and being devoid of attachment to material possessions, were the basis for the riba that a Muslim will not charge interest from other fellow brothers, and that money does not have either intrinsic value or time value. However, the world we live in is quite different – here, greed and selfishness are the very basis of our existence, and money is the form in which we measure and satisfy our greed. Similar question recently arose in Malaysian courts about BBA, a form of deferred sale perceived widely to be an Islamic product, and the court ruled in the negative.

Links: see our page on Islamic Finance; workshops on sukuks – securitisation school 

Korea's Kookmin Bank brings Asia's first covered bonds

Is securitisation rising from its ashes like a phoenix? Though the structured finance markets globally still remain jittery, this deal, and the other story on projected issuance in USA under TALF certainly give reasons for cheers.

South Korea’s largest lender – Kookmin Bank is all set to bring out Asia-Pacific’s first covered bonds issue. These bonds are backed by a pool of residential mortgages and credit card obligations. The bonds are described as covered bonds – however, unlike most European jurisdictions, there is no law governing covered bonds in Asian markets. This might perhaps be a reason why a very complicated transaction structure has been used in this case – almost verging towards the true-sale-type.

No matter the lack of law, S&P has given a AA rating to the bonds, which is good 3 notches above the rating of Kookmin (A-). S&P had recently issued a draft methodology for covered bonds 4th February, 2009

Notably, the pool consists of residential mortgage loans and credit cards – in a normal securitisation transaction, this would have been a queer mix, but in covered bonds, all that matters is the value of the cover, as investors are not necessarily paid from the cover pool. The bonds have a maturity of 3 and 5 years – another distinguishing feature of covered bonds being maturity mismatch between underlying assets and investor cashflows. Credit enhancement comes from a substantial over-collateralisation, as well as obligation of Kookmin to repay the bonds. 

The transaction structure is complicated, and may be understood in following steps:
  1. Kookmin issues the bonds and gets $ equal to the senior interest of the loans.
  2. Kookmin entrusts the loans to a Korean Trust. This includes the overcolllaterlisation also. The Trust sells senior certificate to a Korean SPV, and junior interest back to KB. The Trust still has to pay money to Kookmin for the purchase of the senior interest (see Step 7).
  3. Korean SPV issues notes to Irish SPV equal to the senior interest. Irish SPV provides guarantee to bondholders for repayment of the bonds issued in step 1.
  4. Kookmin lends money under a subordinated loan to Irish SPV, equal to the senior notes. Kookmin has already got this money in Step 1.
  5. With this money, Irish SPV in step 4 pays for the Notes it buys from Korean SPV.
  6. Korean SPV in turn pays to the Trust in step 2 for the senior interest it bought.
  7. Trust pays the money to Kookmin – therefore, the proceeds of the notes issuance do a full round back to Kookmin.
Apparently, this is structured as a true sale – therefore, to the extent of the senior interest in the loans sold, the mortgage loans and credit cards must be replaced by the subordinated loan given to the Irish SPV. However, the transaction would almost inevitably carry a buyback option with Kookmin, thereby denying any true sale/ off balance sheet treatment. 

Reported by: Vinod Kothari

To learn more about covered bonds, see our page here 

Our Workshops: We discuss covered bonds full scale now in our 11th Securitisation and Covered Bonds School – for the forthcoming school in August 2009, click here
 

TALF backed issuances soon to pick up momentum

As the round three of TALF financing is nearing, US asset backed issuers have $3billion offerings for the investors in May, and in addition, there are more issues of indeterminate sizes that may be ramping up soon. This figure compares with funding of $ 2.7 billion under TALF-backed issuance in April.

For May, some of the TALF eligible offerings include Case New Holland, which has come up with $760 million ABS sale of securities backed by equipment loans Other issues like that of $1.125 billion Honda Auto deal and a $1 billion Volkswagen sale are issues backed by auto loans and will also be eligible for the TALF financing.

Among credit card deals JP Morgan is planning a $1 billion offering. Others like GE Capital, Harley Davidson also intend to be in the market. These and several other issuances are in the pipeline and considering the momentum that is picking up, the Fed is soon to come with two new interest rates for loans secured by asset backed securities with maturities of one and two years.

Further the Federal Reserve has also announced that it would extend loans against commercial mortgage backed securities in June for up to five years. TALF loans with maturities of five years will also be available for securities backed by students’ loan and loan from small businesses. An initial limit of $100 billion has been set for the five year loans and the limits are open for re-evaluation.

Reported by: Nidhi Bothra

EU approves new rules for Credit Rating Agencies

European Union approved the new rules on the Credit Rating Agencies (CRAs) that are designed to improve transparency provide information, integrity and impartiality to the investors. The general notion prevalent is that the CRAs have failed to duly warn the investors of the risks underlying the asset backed securities and has significantly affected the investors’ confidence while making investment decisions.

Under the new rules a firm seeking to issue credit ratings will have to get itself registered with the Committee for European Securities Regulators (CESR). Securities regulators grouped together are called a ‘college’ of regulators who shall be monitoring and supervising the activities on a day to day basis. The following are the specifications provided in this regard under the new rules

The key features of the rules are as follows: 

  • Disclosure of models, methodology and assumptions used in rating and instrument
  • Ratings of complex products to be differentiated by adding a specific symbol
  • Create an internal function to review the quality of ratings
  • CRAs are to publish an annual transparency report.
  • CRAs may not provide advisory services
  • CRAs to have two independent directors on their board

    • The remuneration paid to the directors will not be determined on the firm’s performance
    • The Directors can only be dismissed from the office in case of professional misconduct. 
    • The two directors will be elected for a term of 5 years and cannot be re-nominated.
    • One of the two directors needs to be an expert on securitization.

These rules are aimed to ensure that the rating agencies are cautious of the quality of the ratings and the methodology used for the same and that there is high level of transparency involved in their act to ensure that the ratings provided are of valuable use to the investors.

Reported by: Nidhi Bothra

The 2008 Global Securitization issuance down by 79% compared to 2007 – IFSL reports

The Murphy’s Law quite applies to securitization as well. The International Financial Services London came out with the Securitisation 2009 report. The report says that the Gross global securitization issue dropped from $3,817bn in 2007 to $2,777bn in 2008. The net global securitization issuance sold in the market and purchased by the investors dipped by 79% from $2,138bn in 2007 to $441bn in 2008 (Excluding securitization retained with the issuing banks, which are not included in the gross figures).

The sea plunge was visible in the quarterly issuance reports that the volumes fell from $149bn in Q1 to $60bn in Q4 2008. The first quarter of 2009 also indicates that securitization is at low ebb and that there is very little indication of recovery. The report provides a comparative view on the industry performance over the years world over. The report shares concerns by the leading industry groups in the securitization industry and talks about ‘restoring confidence in the securitization market.’ It lists out the multiple effects that lead to the debacle and also lists out few suggestive actions that the industry should consider. See full report here.

Reported by: Nidhi Bothra

FASB issues staff guidance on exceptions from fair value accounting in disrupted market conditions

The much awaited FASB Staff Position (FSP) on fair value accounting (FSB FAS 157-4) has been issued, quickly enough after the last FASB board meeting on 2 April decided to amend the provisions of the draft (FSP FAS 157-e – see our news item below). On 9th April, the FSP was issued, overriding FSB FAS 157-3 and providing guidance on departure from the “market value” rule in situations such as the present, where for many assets, markets have considerably thinned down or otherwise. For a background leading up to the FSP, see news item below.

The revised draft of the FSP, like the exposure draft, provides that where the volume or level of activity for an asset needs to be marked to market has come down as compared to “normal market activity” for the asset, then significant adjustments to the quoted prices may have to be made – indicating that the prevailing market price need not be taken as the basis of fair valuation, and other techniques of valuation may be employed. The other techniques of valuation include consideration of  the “transaction value” where the transaction may be taken to be conducted in “orderly” market situations; and  discounted values using discounting rates appropriate to the riskiness of the asset in question.

There is an illustration included in the FSP of junior tranche of an RMBS transaction involving alt-A mortgages. The examples comes up with a discounting rate of 12% for discounting the expected cashflows, while the quoted rates from reputable dealers implied yields of 15% to 17%. In other words, the value that the entity estimates is substantially higher than what is quoted in the market on the measurement date.

The IASB is also almost waiting to introduce similar guidance – see here.

The FSP introduces more subjectivity and more complexity in the already monumental fair value rules. The question at the end of the day is – what is the user getting out of this all? If the current market situation is not even representative of the exit price of the asset, why apply fair value at all. Standard setters have regrettably lost sight of the basic attribute of accounting statements – objectivity, as that comes from the FSP is a subjective valuation.

Reported by: Vinod Kothari

FASB to issue amended staff position on fair value accounting standard FAS 157

Mark-to-market accounting continues to remain the epicenter of this age of volatility. US standard setter FASB has responded to adverse industry comment on staff position paper FSP 157-e and voted, on 2 April 2009, to amend the proposed staff position.

An FSP is a statement of FASB staff views on an accounting standard. The relevant accounting standard here is FAS 157 dealing with fair value accounting. FAS 157 had required, effective from 15th Nov 2007 classification of assets and liabilities subject to fair value rules into 3 levels based on the transparency of such valuation. FAS 157 was issued in September 2006 when the goings-on were good. By the time of its implementation, markets had plunged into abysmal lows.

The markets that have prevailed over late 2007 to date easily qualify to be called “distressed” markets. The fair value accounting standards (both IFRS and FAS) contained an exception that in distressed (defined as not “orderly”) market conditions, the classification of assets as trading assets (which require daily mark to market) may be changed to assets that do not require mark-to-market.

FSP 157-e as proposed had suggested a two step approach to valuation in distressed markets. Step 1 contained an illustrative list of factors to consider markets as distressed. In step 2, there was a presumption that if the markets are distressed, then the quoted price is not representative of fair value. In that case, the FSP required the entity to use other methods for fair value determination, such as present value of expected cashflows.

The proposed draft of FSP 157-e was put for a 15-day comment period. As widely expected,  hundreds of comment letters were received. In response, the FASB decided to amend the FSP 157-e, to broadly incorporate more examples of situations in which the markets may be taken as distressed, and provide additional guidance on what fair value measures to use in such situations.

The FSP 157-e would  be reissued, and would be applicable for periods ending after 15th June 2009, with early adoption for periods ending after 15th March 2009. As markets for most of the sensitive assets such as derivatives may be taken as currently distorted (abnormal liquidity risk premiums or abnormal yields, abnormally wide bid-ask spreads, etc), this may be a relief for affected entities.

See the summary of the board's decision here

Reported by: Vinod Kothari

Islamic finance industry expected to grow to $1.6 trillion by 2012

With a 20% growth annually over the past several years, Islamic finance is growing at a fast pace with the estimates of the current asset ranging from $700 billion to $1 trillion. By a report from a consultancy firm, Oliver Wyman, the assets of the Islamic industry are further expected to grow to around $1.6 trillion by the year 2012 and that the biggest market for Islamic finance – Islamic wholesale banking will continue its strong growth to reach $1 TR with revenues of more than $60 BN.

The Islamic finance industry is still in its budding stage and there is a need for its banking sector to diversify to include other than generic sectors, like asset management, securitization etc. Islamic finance products are guided by the Sharia and Islamic laws and are open to wide interpretations. The conventional banking products can be dressed as per the Sharia requirements and can also accommodate the complexities of the conventional products, inspite the prohibitions and restrictions imposed by the Islamic laws.

The Islamic finance industry is in its nascent stage and countries with large Muslim population are awaiting development of the Islamic finance market. With the gloomy prospects of the revival of the dominant players in the near future and with countries like UK also tuning in to accept these unconventional products as ‘Alternative Finance Investment Bond’ the Islamic finance market is surely on its way to growth.

Reported by: Nidhi Bothra

Another bad news on the US ABS market

Where is the market heading? Probably this is the question that is playing on everyone’s mind and the unraveling quarter results are leaving people disheartened all the more. The existing credit crunch is acting as a catalyst to further unleashing misery, atleast the numbers tell such a tale.

The first quarter of 2009 reported a tremendous fall in asset backed securities issuances in the US as compared to the same period last year. The asset backed securities issuances stand at $13 billion at the end of the first quarter this year as against $61.9 billion in the same period last year, a 79% fall. The year on year comparisons on the ABS supply presents a gloomy picture as well. The final quarter for 2008 had a $3.6 billion ABS supply as compared to a total of $106.3 billion.

For more statistical information about ABS market click here.

End of off balance sheet for securitisation: IASB proposes changes in securitisation accounting norms

The international accounting standards setter IASB, on March 31, 2009 issued an Exposure Draft of changes in accounting standard IAS 39. The changes are focused on accounting for securitisation transactions. If the changes are carried out as proposed, this is like a clear end to off-balance sheet accounting for securitisation transactions.

The existing scheme of IAS 39 on securitisation accounting is like this: if risks/rewards in a financial asset are entirely retained, the transaction does not lead to off-balance sheet. On the other hand, if risks/rewards are entirely transferred, the asset is put off the books. These two extremes are most uncommon in real-life securitisation transactions. Hence, most cases involve retention of some risks/rewards and transfer of others. In such cases, the approach is one of partial de-recognition, and keeping the asset on books to the extent of “continuing involvement”. Continuing involvement is the stake of the transferor in the transferred asset – for instance, subordinated share, share in residual profits, servicing income, retention of significant options, etc. Most securitisation transactions have so far been qualifying for such partial derecognition, with only the retained components being put on the books, and the rest of the asset being de-recognised.

IASB now proposes to change the de-recognition algorithm, to provide that if there is a continuing involvement, there will be no off-balance sheet. Irony is that in most transactions, there is a continuing involvement. Under the proposed standard, de-recognition will be allowed only in 3 situations – (a) where all risks and rewards are transferred – which is almost never the case; (b) where the transferee has the practical ability to re-sell the asset for its own benefit – unlikely in case of any transfers to SPVs; and (c) where there is no continuing involvement at all. While the standard clarifies that mere retention of servicing by the seller is not a case of continuing involvement, clarificatory guidance on retention of subordinated investment and residual profits leaves no doubt that practically no securitisation transaction will qualify for off-balance sheet treatment.

Earlier, in Sept 2008, US standard setter FASB had likewise issued an exposure draft of changes in FAS 140. FASB has been waiting for IASB’s exposure draft, as the idea is to have convergent accounting principles on securitisation accounting.

It seems that we are heading towards end of off-balance sheet securitisation. To know more about accounting for securitisation click here.

Philippines comes out with its first RMBS transaction

The National Home Mortgage and Finance Corporation (NHMFC) with Standard Chartered Bank came up with the maiden 5 year RMBS issue worth 2.1 billion Pesos with a coupon rate of 8.4337 percent, 200 points above the five year bond benchmark. These bonds are called ‘Bahay Bonds’ and are backed by 12000 residential mortgage loans which originated from 1985 to 1996.

The bonds are exempted from withholding tax payments and are divided into two tranches and were rated by the Philippine Rating Services Corporation (PhilRatings). The AA rated senior notes of Pesos 1.754 billion and the BBB rated subordinated notes of Pesos 309.5 million. The sub notes are to be retained by NHMFC itself. The debt issue has several credit enhancement levels, apart from having a low loan to value ratio, the mortgage loan repayments are guaranteed by state run Home Guarantee Corp.

The first RMBS issue was well received by the investors and was over-subscribed. After the success of the first RMBS issue the government is eyeing more RMBS issues in the year. To know more about the story click here. To know more on the assigned ratings to the classes of securities click here.

Also see news on Indonesia’s first RMBS transaction here.

New reporting requirements for securitization SPVs in eurozone 

The European Central Bank has introduced new reporting requirements ‘financial vehicle corporation’ (FVCs) or SPV’s residing in the euro area. Under the new reporting requirements a FVC will have to notify the National Central Bank of its existence and make certain disclosures quarterly. The new quarterly reporting requirements will be applicable from December, 2009 but the notification requirements will apply from March, 2009 and will apply to all the FVCs incorporated or resident in euro area.

Apart from the disclosure requirements these regulations will also assist in data collection with regard to the securitization transactions. The ECB regulations are aimed at providing data on the financial activities carried out by the FVCs within the participating member states in the euro zone. These regulations also aim at aligning the reporting requirements with that of the Monetary Financial Institutions (MFIs). Integrating the reporting requirements of the two would make the disclosures more meaningful and useful. The ECB regulations define FVCs in article 1 and lays down details on reporting requirements some of the highlights are: 

  • Article 2 lays down that all FVCs residing in the territory of a participating member will form the reference reporting population
  • As per Article 4, the actual reporting population shall provide to the relevant NCB, data on end-of-quarter outstanding amounts, financial transactions and write-offs/write-downs on the assets and liabilities of FVCs on a quarterly basis as prescribed in the regulations
  • As per Article 7, FVCs shall comply with the reporting requirements to which they are subject in accordance with the minimum standards for transmission, accuracy, compliance with concepts and revisions specified in the annexure to the regulation

The European Securitization Forum has come together to actualize the requirements among the FVCs by organizing industry response, roping in interested market participants for their involvement and including common language in the transaction document to ensure that all FVCs comply with the new requirements. To read the more on the story and ECB regulations click here

Top economists suggest ways to 'smarter securitization'

As a part of Wall Street Journal’s, ‘Future of Finance Initiative’ eminent speakers Roger W. Ferguson Jr., President and CEO, TIAA-CREF and Myron S. Scholes, Nobel Laureate and Professor Emeritus of Finance, Stanford University; spoke on ‘The Future of the Credit Markets.’ The speakers discussed the problems confronting securitization and how with small reforms, ‘smarter securitization’ can be achieved.

In an effort to move towards ‘smarter securitization’ and to align the interest of the various parties involved in a securitization process few key areas of reform were addressed and improvisation on the same was suggested. In the discussion the speakers, named five areas where there was scope and need for change.

The speakers said that the disclosure norms needed revision; there was a strong need for the alignment of interest of the parties like the underwriters and the rating agencies. As the underwriters do not hold the resulting securities, the underwriting standards suffer. Similarly, as the investors are unwilling to pay for the ratings of the securities, it is in the interest of the rating agencies to be in the issuers’ camp. To increase transparency levels and do away with these problems it was aired that the interest of the various parties should be aligned. For the rating agencies to be more accurate a revision in the pay structure was suggested whereby instead of a one time payment, fees should be paid over a longer period of time. The next recommendation was on having constrained on the leverage which would mean increasing the capital requirements to match up the risk levels involved. The next recommendation was on amending the accounting standards to have a sensible set of accounting standards that would reflect value for financial reporting and capital purposes. The last recommendation was on reducing the role of the government in providing compensation to the companies in which it has a stake to ensure that the right kind of incentives were trickling down.

These recommendations aimed at reviewing the securitization market, rebuilding the financial systems and dealing with the present financial crisis. To read the full article click here. To read the full article on ‘The Future of Finance Report’ and related articles, click here.

ESF Principles on Transparency & Disclosures

The European Securitisation Forum published Principles for Transparency and Disclosures for Residential Mortgage Backed Securities issuers. These principles have been delivered to increase the transparency, improve reporting standards and formats and to assist the regulators and the speculators who play an active role in the securitization industry. The basic objective of these principles is to provide investors with a mechanism whereby they can independently adjudge the creditability of the transaction so as to reduce complete dependence on Credit Rating Agencies for investment decisions.

These are voluntary principles and are applicable for RMBS structures originating in European Economic Area (EEA). The principles deal with pre-issuance information disclosures in the form of issuance of prospectus and offer documents as well as post issuance information disclosures in the form of investor reporting and ad hoc disclosures. With enhanced levels of comparability disclosures, these principles will enable the investors to make informed decisions. These principles include two data reporting templates for the issuers – ESF Prime RMBS Standardised Reporting Template and a new combined uniform Credit Rating Agency Reporting Template for UK Non-Conforming RMBS.

These principles were released in response to the Ten Industry Initiatives to Increase Transparency in the Securitisation Market as committed to the European Commission and are in response to the challenges posed by the Financial Stability Forum and International Organisation of Securities Commissions’ recommendations to improve transparency and disclosures. These principles have been drafted to improve four aspects of data disclosures: transparency, accessibility, comparability and granularity and have been prepared in consultation with RMBS issuers and market participants.

To know more on the templates and disclosure norms, see here

UK's Asset Protection Scheme

As the losses on asset backed securities bought by banks over the past continued to mount, UK Treasury came up with a scheme that will suck out losses above particular levels, thereby maintaining the capital of UK institutions. The Asset Protection Scheme is about protecting the banks’ assets against losses (second level losses) exceeding levels that are to be fixed for each asset on case by case basis. The UK Treasury would be protecting the participating banks from such second level losses for a fee. The eligible assets would include Mortgage Backed Securities, CDOs and CLOs, certain Asset Backed Securities, corporate or leveraged loans and any closely related hedges, in each case, held by the participating institution or an affiliate as at 31st December 2008 and can be denominated in any currency. The Treasury may include such other assets on appropriate investigation for appropriate fees. The other features of the scheme briefly are as follows:

·        The Treasury will initially extend its protection offer to UK incorporated authorised deposit-takers (including UK subsidiaries of foreign institutions) with more than £25 billion of eligible assets and later extend it to other authorised deposit-takers as well. Other entities may be considered in the light of its assessment of the impact on financial market stability and the overall economy and the most effective possible use of public resources.

  • There will be a verifiable commitment agreed between the participating institution and the Treasury to support lending to creditworthy borrowers in a commercial manner. The commitment demanded from participating banks is to increase their lending to creditworthy homeowners and businesses.

    < > The Treasury expects to provide protection for those assets on an institution’s balance sheet  where there is the greatest degree of uncertainty about the future performance of those assetsThe management and control of the assets will remain with the participating banks subject to such conditions as considered appropriate by the Treasury to take the management and control in its own hands. The assets will remain on the Balance Sheet of the participating institutions but the actions taken in relation to these assets shall be monitored by the Treasury and under its appropriate controlThe duration of the scheme will be consistent with the tenor of the asset and will be not less than 5 years.here.

     

    US Federal Reserve to pump in $200 billion to spurt sagging ABS market

The US Federal Reserve and the treasury launched TALF (Term Asset backed securities Loan Facility) – asset securitized loans in an effort to help consumers avail loans and put the credit market on the roll. The USD 200 billion funding program intends to provide loan to the purchasers of AAA-rated securities of the newly securitized credit card, auto, students and small business loans. The interest rates will range from LIBOR plus 50 basis points for students loan to LIBOR plus 100 basis point for a credit card loan to the likes. The intent of the plan is to induce investors to asset backed securities which in turn generate more lending

The following are the features of TALF:

  • TALF loans will have a term of three years with monthly interest payments. These loans will not be subject to mark-to-market or re-margining requirements
  • Non-recourse to the borrower

·        Eligible Collateral: For ABS to be eligible collateral and the dates of origination for the underlying credit exposure will be as specified in the terms and conditions of the program. ABS used as collateral that has a credit rating in the highest long-term or short-term investment-grade rating category from two or more major nationally recognized statistical rating organizations (NRSROs) and do not have a credit rating below the highest investment-grade rating category from a major NRSRO. Eligible auto loan ABS and credit card ABS must have an average life of no more than five years.

  • The set of permissible underlying credit exposure of eligible ABS includes

    • Auto loans which will include retail loans and leases relating to cars, light trucks, recreational vehicles, or motorcycles, and will include auto dealer floorplan loans
    • Student’s loans will include federally guaranteed student loans (including consolidation loans) and private student loans
    • Credit Card Loans
    • Small business loans fully guaranteed as to principal and interest by the U.S. Small Business Administration
    • The set of permissible underlying credit exposures of eligible ABS may be expanded later to include commercial mortgages, non-Agency residential mortgages and/or other asset classes
  • Eligible borrower: Any US company as specified in the terms & conditions of the program that holds eligible collateral can borrow from TALF

·        For ABS benefiting from a government guarantee with average lives beyond five years, haircuts will increase by one percentage point for every two additional years of average life beyond five years. For all other ABS with average lives beyond five years, haircuts will increase by one percentage point for each additional year of average life beyond five years.

  • TALF loan subscription and settlement dates will be announced monthly

The first fund will be released by March end and TALF will cease making loans by December this year.

The ABS issuance in US has come down from US$ 906.6 billion in 2006 to US$ 151 billion in 2008. The three year low interest loan facility intends to churn credit and restart the securitization machine which has experienced heavy downturn in the recent years as indicated by the figures.

TALF has invited mixed bag reactions, where some are interested and keen on participating, others are of the view that there is a long way for securitization to make a come back. Read more on the Federal Reserve press release and the terms and conditions applicable on TALF here

Indonesia's first RMBS issue

On 11th February, 2009, PT Sarana Multigriya Finansial (Persero) or PT.SMF came out with its first RMBS issue. PT.SMF, a secondary mortgage corporation owned by the government of Indonesia, started operations in first half of 2006 and has been involved in developing the secondary mortgage market in Indonesia. PT.SMF is securitizing pool of mortgage loans receivables worth Rp 500 billion, originated by PT. Bank Tabungan Negara (Persero) ("BTN").

The securities will be issued in two series, the first issue being of Rp 100 billion of Class A EBA Certificates rated Aaa.id by Moody’s Indonesia. Moody’s ratings are based upon several factors including credit enhancement and liquidity available to Class A EBA by issuance of Class B EBA Certificates and a reserve fund, these loans have a low loan-to-value of 48.35% and long seasoning of 4.64 years, external factors like the economic environment and the real estate markets

The second deal which will be four times the debut transaction is expected to close around the third quarter in this year. With a positive beginning, there is a potential of more of these deals in the times to come by.

Links: For more on Securitisation in Indonesia, see our country page and to know more about RMBS transactions, see here.

Crisis spurts securitization litigation

As one would expect, a crisis time is a boom time for litigation lawyers. As pains of the crisis spread, people are exploring ways to lay blame on someone, somewhere else. Those who bought loans are  suing those who sold; those who insured securitizations are suing those who originated; servicers are suing trustees, and so on. As they say, it is trying time – so, lots of securitization questions are facing trial right now.

Insurance company MBIA has sued Residential Funding, a unit of GMAC. MBIA had also sued Countrywide, alleging that the transactions it insured made misrepresentations about quality of loans.

There have  been several cases relating to CDOs. A webpage by Nixon Peabody (here) says there has  been a surge in disputes relating to “waterfall”  clauses,  or between noteholders and swap or liquidity counterparties, regarding subordination and priorities of payment stemming from an event of default (EOD), acceleration of maturity, and liquidation of collateral under such indentures. The page refers to at least two cases: LaSalle Bank Nat’l Ass’n v. UBS AG and Merrill Lynch International, 08 CIV 3692 (S.D.N.Y., filed April 7, 2008), and a UK ruling relating to an SIV, Bank of New York v. Montana Board of Investments [2008] EWHC (Ch.) 1594 (Eng.),

In yet another case, Brooke Capital, a servicer, has sued the trustees for not paying the servicing fees.

There has been a series of cases where foreclosure actions by securitization trustees have been in various controversies.

New Century Bankruptcy examiner points several securitization accounting lapses

The report of the Bankruptcy Court-appointed Examiner in the bankruptcy of New Century, a subprime originator that filed for bankruptcy earlier last year, has pointed out several securitization accounting lapses. Fair value based accounting has become intensely subjective; it is a statement of opinions and not a statement of fact. Any opinion can be questioned, as on every issue, there is a minimum of two opinions.

The 581-page report goes into New Century’s business models, etc. and spends nearly 200 pages on securitization accounting issues – valuation of residuals, valuation of mortgage servicing rights, etc.

On securitization accounting, the Examiner commented that New Century was using antiquated Excel-based models whereas it ought to have used third-party vendor models. One of the key assumptions in valuation of residuals is the discounting rate. A risk-adjusted discounting rate is used which reflects the riskiness of the residual cashflow. New Century, the Examiner says, was using a discounting rate of 12-14% whereas peer firms were using 15-21% discounting rates. In addition, New Century wrongly made an assumption that on clean up of transaction when the pool value falls, the loans may be sold at par value.

There are similar allegations of flawed assumptions on valuation of mortgage servicing rights as well.

Links: See our securitization accounting page. For a US workshop where we focus on securitization accounting, see our workshops page.

 

Paulson Plan proposes Mortgage Origination Commission

US financial regulators presented, on 31st March 2008 a Blueprint for Modernized Financial Regulatory Structure, commonly referred to as the Paulson Plan in response to the ever-bludgeoning problems of the subprime crisis. The study distinguishes between short-term and intermediate term objectives, and presents what it calls an “optimal” objective-based model to regulate financial institutions. It recommends a threesome regulatory structure, splitting between (a) market stability regulation, (b) safety and soundness regulation, and (c) business conduct regulation.

Among the short-term objectives of relevance to the securitization industry, the following recommendations are notable:

There is proposed a Mortgage Origination Commission for licensing and regulation of agencies involved in the mortgage origination process. In addition, Federal laws should ensure consumer protection in mortgage origination.

Links The text of the Blueprint is here.

President's Working Group announces measures about securitization

The inter-agency group of financial regulators, President's Working Group on Financial Markets (PWG) announced some measures yesterday aimed at containing the fire that seems to be blazing the global financial markets, esepecially those in the US.

The PWG has proposed a range of measures to contain the crisis. Those pertaining to securitization can broadly be classed into two: 1.words of advice and some regulatory responsibility for market players, including mortgage brokers, rating agencies, originators and regulators; 2. Introduction of covered bonds and formalization of bankruptcy remoteness. From the second measure, it seems evident that the US will make positive moves towards on-balance sheet securitization in time to come.

Here are some extracts from the PWG report:

"Mortgage Brokers will be held to strong national licensing and enforcement standards. There will be stricter safeguards against fraud, and full and clear disclosure to borrowers about home loan terms, including long-term affordability.

Credit Rating Agencies will clearly differentiate structured product ratings from ratings for corporate and municipal securities. They will also disclose reviews performed on asset originators, and strengthen data integrity, models and assumptions.

Issuers of Mortgage-Backed Securities will disclose the level and scope of due diligence performed on underlying assets, disclose more granular information regarding underlying credits. And, if issuers have shopped for ratings, disclose the what and why of that as well.

Investors will conduct more independent analysis and be less reliant on ratings. They will require, receive and use more information and more clearly differentiate between structured credits and corporate and municipal securities.

xx

Regulators have a role to play in every change. They will issue new rules and seek regulatory authorities as needed, evaluate progress, provide guidance and enforce laws – to ensure that implementation follows recommendation.

Covered Bonds, which allow banks to retain originated mortgage loans while accessing financial market funding, are another alternative worth considering. Covered bonds may address the current lack of liquidity in, and bring more competition to, mortgage securitization. Rule-making, not legislation, is needed to facilitate the issuance of covered bonds. Through clarification of covered bonds' status in the event of a bank-issuer's insolvency, the FDIC can reduce uncertainty and consider appropriate measures that will protect the deposit insurance fund. These steps would encourage a covered bond market in the U.S.; similar changes in Europe have resulted in more covered bond activity".

 

ABS issuance falls 30% in 2007

2007 is, beyond doubt, one of the worst years in recent memory for financial services in general, but for securitization, it will go down in history as the worst, as, for the first time since its inception, issuance volumes took a deep dive of 30%.

Financial press cited Thomson Financial data to report a 30% decline in issuance volumes with the steepest decline, quite obviously, from the home equity segment (nearly 62%). According to Thomson Financial data, issuance in 2007 added up to $ 864 billion, compared to $ 1249 billion in 2006.

The data available on abalert.com shows worldwide ABS issuance added upto $ 996 billion, compared to last year's volume of $ 1322 billion.

The drying up of liquidity is also evident from the spreads on AAA home equity ABS – reported to be about 220 bps for 2 years and 280 bps for 5 years, whereas the average spread for 12 months is just 74 bps.

Financial press is abuzz with news stories about the death of securitization, but clearly, the originate-to-distribute model on which banks work today will continue in some form or the other. Hence, either in cash form or synthetic form, securitization would continue. Securitization is an excellent tool for integration of capital markets with asset markets – hence, its basic economic rationale is beyond question, though there might be rethinking on off balance sheet and special purpose entities. 2007 may prove to be the worst, and that is over.