Securitization markets in South Africa
This page updated regularly deals with securitization developments in South Africa. If you have any news or development to contribute to this, please write to me.
This page has been helped by detailed information on South African market by South Africa's leading securitisation expert Eugene van den Berg
Other useful links on securitization in South Africa:
Workshops on Securitisation
South African Reserve Bank proposes new regulations on Securitisation:
Important links: For full text of the new regulations [including regulations of Dec 13, 2001], as well as the existing regulations, click here.
For an article by Eugene Van den Berg on the new regulations, click here
For news report on the new regulations, click here
Market updates: 16th Oct., 2001
According to an article in Financial Mail, South Africa Oct 12, 2001, the current size of the South African securitization market is estimated at around Rand 4 billion now.
Vinod Kothari's comments on the new regulations are here:
In early May 2001, the South African Reserve Bank issued a proposed form of new regulations to apply to securitisation transactions. Comments are due on the new regulations by June 15, 2001.
My general observations are as follows: the proposed regulations will not promote securitisation in South Africa. On the other hand, the strict wording at several places might hinder development of a product that has, in absence of these regulations, captured lot of interest. The Reserve Bank has failed to realise that unlike FSA, UK or FRB, USA, it is not issuing a guideline which is related to capital relief. It is drafting a mandatory guideline, non-compliance of which does not lead to loss of a benefit but is simply ruled out in law.
Scope of application:
The new regulations have been issued under the Banks Act as a exception to banking business. The correlation of the regulations with banking business is that if a securitisation transaction does not comply with the regulations, it does not enjoy the exception under the Banks Act with the consequence that it may be treated as "business of banking", which is regulated by the Reserve Bank. One would have understood, therefore, that the new regulations will apply to both banks and non-banks. The applicability of the regulations to non-banking companies is specific and limited: only paras 3, 12 and 13 apply to non-banks while the whole of the regulations apply to banks and institutions belonging to a banking group..
A scope for doubt remains as far as definition of commercial paper is concerned. It is clear that this definition does not cover pass through certificates which are not an acknowledgement of debt. As the definitions define securitisation as a scheme in which commercial paper is issued, it may be contended that issuance of pass through certificates in a securitisation scheme is not hit by the regulations, because there is no issuance of commercial paper involved in such scheme.
Another issue which is also signficant is that the regulations apply to issuance of commercial paper to public. Does this imply that is ABS are offered privately, as they mostly are, the offer does not have to comply with the Regulations?
Special purpose companies
The regulations define securitisation SPVs as either companies or trusts. Such SPV shall not be engaged in any business other than a transaction "directly related to securitisation". The scope of such activities has not been discussed any further, which is amply laid down by US accounting standard FAS 140 and interpretations thereunder.
The originator cannot hold any shares in the SPV. If the SPV is a trust, the originator cannot hold any beneficial interest in the trust. These regulations are understandable from bank regulatory point of view, but not as a generic prohibition. In my view, it will be possible to adopt a two-tier structure as common in the US market, with the second SPV issuing the paper, and the second SPV need not be owned by the originator. As far as first SPV is concerned, it will have to be capitalised by the originator to provide credit enhancements.
Not more than one director can be nominated by the originator. The name of the SPV should not reflect the name of the originator. Similar requirements are found in bank regulations in number of other countries.
Isolation condition under Para 3
Far reaching requirements are laid down by Para 3, which may be given the name of "isolation requirements". The primary and most significant requirement [Para 3 (i)] is that the transfer of assets will divest the transferor of "all the risks and rewards" of such assets. "All the risks and rewards", is as difficult to define, as it is impossible to avoid. Continuing association of the originator even as a servicer may spell a risk or reward, because for most banking assets, it is impossible to compute the market rate for servicing fees, and whatever fees the originator charges for the transaction might mean either a risk or reward. This para, as currently worded, will scuttle securitisation transactions.
Right of recourse is completely barred by Para 3 (ii). This again is a problem: recourse can arise on account of breach of warranties and warranties are at times quite broadly worded. The regulation should permit recourse on account of breach of warranties in the assignment agreement.
Strict restrictions have been put on the right of the originator to repurchase. True, repurchase options nullify intention of securitisation. But the proposed regulations also prohibit a put option of the investors, as the originator cannot have an obligation to buy back [Para 3 (f) (ii)]. In accounting standards, an obligation to buy back transferred assets does not disqualify off-balance sheet treatment. Even in legal concept of true sale, option to buy back and obligation to buy back are distinct and the latter does not lead to recharacterisation risk. Repurchase option upto 10% of the transferred value is permitted - this seems to be a clean up call option even though the regulations do not specify it as such.
Capital impact of credit enhancements
There is an obvious contradiction in saying that the transferring bank may provide credit enhancement, but may not take any risk in the transaction. Provision of credit enhancement by the originator could take one out of many forms: recourse, overcollateralisation, cash retention, replacement, subordinated participation, etc. In either case, there is a risk retained by the originator.
Para 4 provides, however, something further. It says that first loss protection provided by a bank will lead to a reduction of capital of the bank to the extent of such protection, capped, however, at 8%. Second loss protection will be treated as a direct credit substitute and will call for capital maintenance at par with the underlying asset. This is a direct offshoot of BIS's proposed standards on capital adequacy [see my article here], which have not been implemented, and probably may not be implemented without substantial amendments.
This is a straight invitation to regulatory arbitrage. There is a punishment for subordinated tranches, while Para 7 permits and assigns rating-related risk weightage to banks buying bank securities created as a result of their own securitisation, or those of others. BIS has made simialar proposals, but these proposals relate to a total change of framework where every asset, not just securitised products, will be risk-weighted based on their rating. The proposed regulations, shaped by FRB, USA's recent regulatory guidelines, will encourage banks buying back senior tranches of their securitised portfolio which qualifies for lower risk weightage based on the rating of the portfolio. The risk weightage ranges from 20% to 150%, exactly as proposed by the BIS.
Repackaging and ABCP conduits
The South African market may soon see repackaging and ABCP transactions as the regulations lay down clear guidelines on provision of liquidity facility by banks doing repackaging.
Eugene Van den Berg 's remarks on South African securitisation scenario: added 3rd Nov., 2000:
In response to news report on this site regarding Gateway's inability to securitise loans due to non-cooperation by banks, and generally about the securitisation scenario, Eugene van den Berg, a distinctive and devoted expert on South African securitisation, offers the following comments:
- The research I recently conducted [Is South Africa shaping up to securitization?] proves that a suitable environment exists for securitization to further develop in South Africa. The framework at work in protecting investor's interests is adequate.
- Within Mortgage Securitization, obviously, the large banks do not see the benefits attached to use securitization in effectively making their assets liquid, thereby through securitization into Gateway, the banks divest itself from the perceived geographical risks.
- The South African Title transfer system is adequate in keeping adequate record of ownership, transfers and mortgage information. [The recent developments within the micro loan industry (repayment deductions from payrolls are no longer allowed) obviously contributed to the problem.
- The biggest problem, which is not lending risk and exposure related, comes from the stamp duty act. There is no cost ceiling, as is the case with other types of asset classes, when transferring mortgage title from a bank to an SPV. This contributes to high securitization costs compared to the securitization of other securitizable asset classes. For this reason, large transaction sizes addresses the problem (i.e. SA Homeloans that is planning to securitize by way of substantial packages - latest indication is that the first parcel will come to market early in 2001 - also JP Morgan recently obtained a stake in SA Homeloans)
- The problem should be looked at mortgage origination level. Not the quality of the loan, the risk of default nor the geographic exposure etc. The solution lies in optimized credit enhancement procedures and techniques that should be developed at origination level combined with the establishment of a Code Transferor type SPV. When the banks sell the mortgages to Gateway, the Code Transferor SPV is also transferred into the securitization (Issuing SPV's) structure. For one this will certainly reduce the costs attached to mortgage securitization since the mortgage title is placed within the Code Transferor at the time of origination.
- The government should develop criteria in conjunction with the rating agencies that pave the way for them in absorbing some of the potential default risk in a ring-fenced structured fashion.
- The accusations being thrown around and between the banks and government is not going to solve the problem. This obviously supports your commentary (refers to Vinod Kothari's comments) in that the lower income citizens are suffering as a result thereof. There are also the possibility where banks could establish specific origination funds. Together with government specific developed guarantee criteria the Bond Exchange of South Africa could be drawn into the equation by making them part of some of the indirect credit enhancement. An issuer apart from paying listing fees could also contribute to a separate fund being administered by BESA in conjunction with one of the international re-insurance companies. The logic is drawn form the fact that potential default are properly dealt with at all levels. [default by a pool or pool constituents could lead to default by the issuer (SPV), hence this BESA type fund further protects the interests of investors investing in the ABS.
- Where a securitization is assembled strictly according to securitization regulation, commercial paper regulation, rules of BESA, including rules of some of the international exchanges, the problems currently being faced in taking GATEWAY into its next level can be solved.
Your comments - Do you have any comments to post on the South African securitisation market? If so, write them and we will be too happy to post them here.
Added on 13 June 2000:
Our news page contains lot of news reports on South African developments, for example, future flow securitization by Firstrand Bank- click here for the news report.
Added on 11th March, 2000:
Mettle, a specialised finance house has assisted Unibank to securitize micro loans - click here for the news report.
Added on 16th Feb., 2000:
Mettle, a specialised finance house (website link in the Box above), is engaged in securitisation in South Africa and has reported good activity in year 1999 - see a news report on our News page.
Added on 17th Dec., 2000
Full text of Securitization schemes, promulgated by the Govt. has been placed on our Securitisation laws section - I am grateful to Mr Eugene van den Berg of Scotta Securitisation for kindly contributing this material.
Added 29th Sept., 1999: Securitisation is being viewed in South Africa as the means to provide low cost housing to the lower income segment. Formal credit for low cost homes is difficult to come by - hence securitisation is fast emerging as the alternative. SA Home Loans, one of the premier institutions in mortgage securitisation market, based in Durban, thinks securitisation would enable it to provide cheaper funds for housing. Capitalised at R30m, SA Home Loans is a pass-through management company - a company that takes a fee for managing an account, but does not take deposits or hold the actual money.
State of the Market:
The history of securitisation in South Africa dates back to 1989 when the first securitisation issue there was a R250 million mortgage-backed issue by the then Allied Building Society (United Bank of South Africa Limited).
In South Africa, the concept of securitisation is not widely accepted yet despite the two issues, worth around R335bn, placed on the market in the late 1980s and early 1990s. The issues were made by Allied Building Society in 1989 and SASFIN in 1991. The SASFIN transaction was a securitisation of rentals from leasing of machinery and equipment.
It is only recently that the topic has been brought up again locally, and attracting increasing interest. Recent developments in the field is the listing of the first securitisation company (Sotta Securitisation International) on the Johannesburg Stock Exchange on November 26, 1998. The company has obtained its biggest deal, worth R120m, in March this year with Lyons Property Company, when it has been mandated to securitise the latter's lease agreements over five properties (Business Day, March 18, 1999).
Toward the end of 1997 The National Housing Finance Corporation decided to employ securitisation to provide liquidity to the mortgage market. The idea was to use a Fannie Mae kind of structure. The securitization will be housed in Gateway (Pty) Ltd a subsidiary of NHFC. Arrangements were put in place with traditional mortgage financiers, against pro-active predefined securitization parameters, who will then securitize these mortgages in packages into Gateway. Gateway will obtain funding directly from the capital market. Loans being originated are standardized with regard to the duration, the rate and re-developed documentation that standardizes the legalities attached to risk associated with securitization. It is expected that the first securitized packages will be placed during the course of 1999.
SA Home Loans promised home owners to offer them interest rate discounts of up to 4% on conventional mortgage rates by securitising their home loans (Financial Mail, March 19, 1999).
Niche merchant bank, Mettle, also announced that Retail Apparel Group's (RAG) R600m securitisation of its debtors book will be conducted after having received an A+ rating from CA Ratings (Standard & Poor's SA partner). According to RAG's partner McCarthy Retail, the securitisation is part of the group's strategy to establish and ensure that all subsidiaries and associates have their own lines of credit (Business day, March 18, 1999).
Despite its benefits and wide use in the rest of the world, securitisation faces some major obstacles in the local market. The first limitation is the fact that investors do not accept the concept yet, and prefer to invest in listed companies with established track records.
Secondly, there are the legislative and accounting problems. The fact that the transaction is off-balance sheet, it is considered more risky than a mortgage. Furthermore since no separate legislation exists for securitisation, a separate entity than the bank is not allowed to issue debt paper to fund its operations. Hence the securitisation process by a special purpose vehicle must be routed through a bank.
Another problem is that debt issued must be denominated at R1million or more, which does not help promote secondary market liquidity.
The absence of securitisation in the local market has also been attributed to other factors like the banks having had sufficient capital on the balance-sheets, and wanting to grow rather than selling off assets (Financial Mail, March 19, 1999).
It is interesting to note that the use of insurance-linked derivative products have been considered by insurance companies in South Africa as well (Financial Mail, February 7, 1997). In the article, Swiss Re purports that despite their drawbacks, these investments offer above-average yield potentials due to the fact that the investor acts as both the lender and insurer, and also because the performance of such investments are not correlated with other financial risks.
Legal and regulatory issues:
The following are the extracts from a Chapter titled Current Issues in Banking Supervision by the central bank of South Africa:
An international trend that cannot be ignored is that of banks entering the growing market for securitised assets and the sale of credit in capital markets. In the United States of America alone, the residential mortgage-loan securitisation market exceeds US$3 trillion per year, a figure that excludes the burgeoning commercial real-estate securitisation market, and banks in the United States are actively exporting this business. Not wishing to sacrifice the possibility of attracting capital to their markets, several countries have gradually started to address their legislative and regulatory structures in order to make better provision for securitisation. Belgium has taken an approach of major reform in one fell swoop and, within a short period, has become one of the more "securitisation-friendly" countries.
The prospect for any emerging country is one of attracting large amounts of capital, which they would otherwise not have been able to attract, from countries such as the United States of America and Japan. Although demand securitised assets from large institutional investors is already immense and growing, many developing countries have deal-stopping features, such as withholding taxes, transfer duties, value-added tax ("VAT") at the special-purpose vehicle level and VAT on custodial and trustee services. All regulators in South Africa are clearly faced with a challenge to review the impediments to legitimate and prudent securitisation within their jurisdiction and to work towards removing such impediments where appropriate.
South African banks will obviously have to make a commercial decision on whether to become involved in this market. There are, however, clear indications that more aggressive institutions in other parts of the world have benefited from positioning themselves as multi-purpose players in the real-estate capital markets, often profiting from additional sources of positive income streams and countering disintermediation by offering their clients new forms of real-estate risks to take on or to shed. Indirectly, such institutions and their clients also benefit from the additional long-term financing, liquidity and flexibility that are breathed into the real-estate market.
As far as regulation of securitisation in South Africa is concerned, Government Gazette No. 13723 dated 3 January 1992 designates securitisation as an activity not falling within the meaning of "the business of a bank", and gives guidelines as regards securitisation schemes.
See also the text of government notification regarding securitisation on our Securitisation laws section - click here to visit.
South Africa imposes corporate business tax @ 35%.
There is a tax on interest earnings of financial institutions. There is also a value-added tax on sale of goods and services - it is not certain whether this tax would be applicable on assignment of receivables, though the English common law definition of "goods" does not include actionable claims.
There is a stamp duty of 0.25% on transfer of marketable securities.
Interest payments to an SPV formed and registered outside the country should normally be exempt from withholding tax