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

• Nomura article says FAS 140 gives misleading picture of real risks
  Added April 24
  Nomura Research's Mark Adelson has joined in criticising securitisation accounting standards in a recent article.
• India's maiden CDO flops
  Added April 24
  India's financial institution ICICI's first Indian CDO is reported to have flopped and is being dropped.
• First toll road securitisation in Japan
  Added April 24
  In what is seen as a template for forthcoming transactions, a road developer securitised a toll road in Japan..
• Indian accounting body mulls guidance note on securitisation
  Added April 24
  The Research Committee of the Institute of Chartered Accountants of India has come out with a draft guidance note on securitisation accounting.
• Malaysian consumer financier to hit market with mega securitization
  Added April 24
  European securitization volumes grew almost 78% in the first quarter of 2002, co
• European securitisation registers major growth
  Added April 24
  European securitization volumes grew almost 78% in the first quarter of 2002, compared to same period last year. But larger part of that is synthetic issuance.
• Securitization biggies have a big chunk off the books
  Added April 12
  The data revealed in a recent S&P article shows that the top 30 securitisers have a sizeable chunk off their books, over 100% for some of them.
• Chinese banks may securitise soon
  Added April 12
  According to reports, the Chinese government is likely to permit 4 banks to securitise in few weeks hence.
• Current accounting rules do not truly reflect securitization risks, says S&P
  Added April 12
  S&P deliberated at length with risk transfer and substance of securitisation transactions and the move by regulators to put several securitisation transactions back on the balance sheet.
• WSJ article lambastes use of SPEs and securitisation accounting standards
  Added April 10
  An article in Wall Street Journal of the 10th April comes sharply against securitisation, Wall Street lawyers, and securitisation accounting practices.
• 1st quarter downgrades dwarf upgrades:
  CDOs, Argentina, Enron take heavy toll of the ABS market
  Added April 10
  As per a rating migration report from Standard and Poor's, the first quarter 2002 downgrades were 26 times the upgrades during the same period.

Nomura paper says FAS 140 approach not appropriate to reality

Of the so many who have recently been venting out their opprobrium to securitisation accounting standards, there are quite a few from the securitisation industry. But a recent Nomura research paper candidly finds flaw with FAS 140 and says accounting under the Standard does not properly reflect risks and rewards. [We have covered several such write ups recently - see, for example, S&P paper below, and a WSJ article here.]

The Nomura Research paper by Mark Adelson says the present approach of US accounting standards (also echoed in International Accounting standards) presents a conflicting picture of retained risks and rewards, and assets on the balance sheet. The current accounting standards are not based on the risk/rewards approach but on the components approach. "Accounting for securitizations sometimes requires the seeming contradiction of removing the subject assets from a company's financial statements while the company continues holding the risks and benefits of owning them. Users of the company's financial statements may suffer confusion over the company's true leverage and the source of its earnings. During the late 1990s, certain home equity lenders were vivid examples of how such confusion can arise", says Adelson.

In terms of retained risks/rewards, most securitizations may be scarcely different from traditional modes of funding, but they give markedly different accounting picture. "It strains common sense that a company's choice of financing method can so drastically change the appearance of its financial statements. Nonetheless, generally accepted accounting principles mandate this result", says the report.

Another source of misleading picture is giving the same treatment to exported sections of a bank's balance sheet by running ABCP conduits, which to Mark Adelson are nothing but "proxy lending". The conduits are not consolidated on the bank's balance sheet, giving a highly misleading picture as compared to a bank which has the lending on its own balance sheet, but with almost similar risks and liquidity support.

India's maiden CDO flops

It was the first-ever attempt to market a CDO to Indian markets, but the effort ended abortively as ICICI's CDO is reported to have failed to attract investor interest at acceptable prices. India's leading financial daily Economic Times reported 24th April that ICICI decided to scrap the deal.

Poor investor response was cited as the reason. It was reported that investors were demanding substantially higher yields than prevalent for AAA bonds. ICICI is reported to have offered coupon of 9.25% which is more than 125 bps higher than AAA corporate bonds, but investors were not forthcoming even at that coupon. Some investors even cited lack of clarity from the country's central bank as a reason.

The deal was being marketed at the end of the fiscal year: ICICI had its own compulsions for doing it at this time, but this is particularly a bad time for Indian banks as they are closing their accounts for capital adequacy purposes, at which many of them are precariously perched.

Vinod Kothari comments: It is a pity that the exercise failed. Few others in India would have spent the amount of effort and money to launch a new product as ICICI could. From my interactions, I know that a phenomenal homework had gone into the deal with contributions from the World's top law firm, funding agencies and ICICI's own structured finance team.

It may be very interested to analyse the reasons: if the reason was merely bad timing, then it was not a wasted effort. But if it was having to do with investor awareness, the Indian market could deadlocked by this failure for quite some time.

The transaction was structured through a mutual fund, which, at the time it was drafted, envisaged a tax immunity for the investors. This was a major tax shelter (see Vinod Kothari's comments on the case study here). Even before the marketing could begin, the Budget 2002 proposed a withdrawal of the tax exemption (still being debated though). Even without the tax benefit, there was no reason for the investors to expect a higher coupon than for corporate credits as the transaction was highly credit enhanced.

Toll road securitisation takes off in Japan

Japanese financial press reported that Mitsui Kanko Development is to securitise a toll road, to raise about USD 100million.

Obviously this is a small transaction by international standards but its significance lies in the fact that this deal may well be a precedent for a number of similarly structured financings whereby governments raise funding from the capital markets. This is the first toll road securitisation in Japan.

It is reported that Japan Highway Public Corporation, the country's largest road developer is also exploring similar options.

Links For our country page on Japan, click here.

Indian accounting body mulls guiance note on securitisation accounting

The Research Committee of the Institute of Chartered Accountants of India (ICAI) has come up with a draft guidance note which will be discussed among interested groups and the members of the Committee, leading to a Guidance Note. A Guidance Note is one step short of an accounting standard: it is not mandatory, but recommendatory and members have to see a good reason for not following it.

Vinod Kothari comments: The present text of the Guidance Note adopts a risks-rewards approach to off balance sheet treatment permtting only such assets to get a de-recognition where the originator has sacked all or substantially all risks and rewards. This is certainly not in line with reality, as there is no such securitisation where an originator does not provide support to a transaction either in form of subordination, or recourse, retained profits, reserves etc. Comments are being sent to the Institute suggsting a major overhaul of the present Note and revert to the components test universally followed; alternatively the linked presentation approach of the UK FRS 5.

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

Malaysian consumer credit company Moccis to hit market with big deal

Malaysian consumer finance company Moccis has announced intent to hit the market with a Ringgit 1 billion securitisation which will be the largest to date in Malaysia. This is planned over next 2 months or so. An SPV by name Dominant Capital has been incorporated. The notes are likely to have a 7 year term and have got an indicative AA3 rating from RAM.

Vinod Kothari comments: Malaysian market is hot with interest in securitization. There have been 3 CDOs to date and the current interest mostly looks at CMBS, auto loans and other ABS collateral. Malaysian SC currently does not permit future flow or whole business securitisations, which could be another growth area.

Accounting standards remain an area of confusion. The Malaysian accounting standard setter is apparently coming out with a technical release on securitisation.

Links See our page on Malaysia here.

Workshops We regularly do a number of events in Malaysia. See our page for details.

European volume in Q1 grows

All the gobbledygook about accountnig, Enron and risks have not affected the east of the Atlantic where securitisation seems to be growing very fast. At least the synthetic business is growing fast enough. Eurpean data proves the point. The volume for the first quarter of 2002 has grown 78%, looking at the aggregate of funded and unfunded business.

S&P has reported volume of USD 34.6bn during the first three months of the year against USD 19.5bn in the first quarter of 2001. However, if one looks at the funded business alone, it is only USD 18.2 billion compared to USD 18.3 billion. The major growth in the first quarter has come from German synthetic deals (Promise?). As for the Q1 of 2002, it is apparent that synthetic issuance has almost equalled the funded one.

Europe continues to take the synthetic route to regulatory risk capital relief. European issuers still do not have the clarity that their US counterparts have on the regulatory treatment to uncovered senior risk positions.

Links For more on Europe, see our page here.

Workshops We do several workshops in Europe focused on synthetic transactions. For current workshop schedule, see our page here.

Securitisation biggies have sizeable chunk off their books

In the current raging debate on off-balance sheet funding, it is interesting to see exactly how much has been put off the books by the major securitisers in the United States. S&P's recent article on substance of securitization (see report and link below) gives data of the amount of assets put off the books by top 30 securitisers in the USA.

Here is the summarised table:

As could be seen, securitizers like MBNA have more than 170% of their assets off their books. In case of the largest securitiser, Citibank, it is USD 130 billion, but forming little over 12% of assets on the books.

Chinese banks may securitise soon

The Chinese government is likely to give nod to mainland commercial banks to launch a pilot scheme for mortgage-backed securitization in China in the coming weeks. The Big Four state-owned commercial banks: China Construction Bank, Bank of China, Agricultural Bank of China, and the Industrial and Commercial Bank of China are likely to join the pilot program, according to reports in Hong Kong press.

The reports suggest that currently, Chinese regulators are foxed by accounting issues as to whether securitised assets should go off the books. Chinese banks want to securitise, but do not want assets to disappear as they think mortgage loans are their best assets. The default rate on mortgages is the lowest for mass-loan products by mainland banks : less than 0.5 per cent last year compared with the 30 per cent of non-performing loans overall.

Earlier on, we have reported Macquarie Bank's joint venture for securitization in China. It seems the Chinese are bracing up for big time in securitization.

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

Securitisation accounting does not reflect the retained risks, says S&P

International rating agency S&P has been intimately associated with securitization industry for years now, and their comments at a time when regulators in many countries are pondering over whether off-balance sheet treatment is suitable for many securitisation structures is particularly interesting. The key essence of this elaborate article is that it is necessary for readers of financial statements to appraise the risks retained by a securitiser, and that the current accounting rules either in the USA or elsewhere fail on this front ("Current disclosure rules are not helpful in most cases, either in the U.S. or abroad, so that the analytical legwork required increases many times from what many call "the good old days." ")

A number of securitization transactions achieve a minimal transfer of risk, in which case for computing the bank's leverage, the rating agency does not treat the asset off balance sheet. S&P does not expect that regulatory moves to curb off balance sheet funding will mean a havoc for many banks active in securitization, but it can surely multiply the apparent leverage of the banks. Transfer of risk is not the present feature of many securitizations, but S&P expects that with the increasing maturity of the credit derivatives market, risk transfers will increase.

Another accounting impact of securitization is to accelerate non-cash upfront incomes which are based on estimates of profits to be left in the structure after paying off the investors; and therefore, often arbitrary. "At times, these amounts represent a substantial portion of equity. Earnings should be looked at on a basis that treats the assets as if they had remained on balance sheet or on a cash flow basis, if that is the only option," says S&P. The volatility of the earnings caused by re-valuation of these estimated profits creates a pressure on the securitiser to "increase asset generation more rapidly to be able to print more gains in the next reporting period. This creates a pressure for growth that then leads to greater risk taking."

The S&P write up gives an interesting tabulation of the off-balance sheet vs. on-balance sheet assets of USA's 30 top securitisers. The data, which may sound astonishing, shows MBNA's off balance sheet assets being 171% of their assets on the books; the percentage for Countrywide is little over 100%, and that for larger entities like Citibank is 12%.

The S&P article talks of the hierrarchy in which a securitisation transaction distributes the risks - it does not obviate risks but merely re-allocates risks and the securitiser often takes the first loss risk. While many structures do not, therefore, effectively transfer any risks, a securitisation might create some new risks of its own, such as liquidity risk arising due to dependance on a particular source of funding, early amortisation powers of the trustees, moral risk requiring the securitiser to use his own balance sheet assets to rescue a failing transaction, and accounting volatility.

Link This important article from S&P is a must-read for all securitization pros - read it here.

WSJ article lambasts securitization accounting, SPEs et al

An article by Glenn R Simpson in today's (10th April) WSJ has come sharply against the alleged lobbying by Wall Street lawyers and advocates against several attempts by the accounting standard-setters to reign in off-balance sheet SPEs. "Policy makers have made repeated attempts over the past decade to rein in off-balance-sheet entities, only to back down in the face of an avalanche of criticism from firms that profited from the securitization of assets", says the head note of the article.

The article tracks the history of aborted attempts by FASB and banking regulators to have disclosure norms for securitization SPVs, which have constantly been stone-walled, as per the author, by Wall Street lawyers and investment bankers.

Companies started setting up SPEs in the late 1980s to help with a new way of raising money: creating bonds and other new securities from loans, mortgages and other assets that generate streams of payments. "In 1995, the FASB sought to reverse that trend by proposing that if a company retained control over the assets or had other substantial involvement in an SPE, it would have to disclose the entity in its consolidated statements regardless of how few of the assets the company technically owned. Before long, the FASB was deluged with 806 pages of letters from public companies, including financial, accounting and industrial firms. Only a handful of the 161 letters favored the FASB proposal. Many of the rest came from the Bond Market Association and its members".

The article goes on to track the attempts by accounting standard-setters and the regulators to put in place securitisation disclosure norms, pelted at by the securitisation industry.

Like it or not, it is very important to read this article.

Your comments Do you have any comments that you would like to put on this page? Do write.

Passing turmoil or debacle to come?
Rating downgrades dwarf upgrades in 1st quarter

Rating agency Standard and Poor's released the rating survey for the quarter just ended, and not quite against expectations, the rating migrations have downgrades outnumbering upgrades 26 times over. "Predominately, three asset classes have driven the increase in downgrades: CDOs, manufactured housing, and franchise loans. On a combined basis, these three asset classes accounted for approximately 48% of total downgrades initiated during 2001, and approximately 75% of total downgrades initiated during the first quarter of 2002", says the S&P survey.

The rating activity in CDO sector is attributable to high yield defaults, sectoral problems in telecom and steel industry, general corporate bankruptcies, Enron and Argentina. Manufactured housing and franchise loans always consisted of less-than-bankable assets that were pushed by the originating banks into the capital markets to keep their own balance sheets neat.

Within the CDO segment, the prime reason for downgrades was the arbitrage CDO segment which typically represents a pool of high yield (aka junk) bonds packaged and sold to investors. UK regulator Howard Davies called this segment the "toxic waste" of the securitisation market - probably the numbers S&P has affirms his unkind statement. "Of the 19 domestic U.S. cash flow CDO transactions with one or more ratings lowered since the beginning of this year, 18 were arbitrage CBO transactions collateralized by speculative-grade assets. The other was an arbitrage CLO transaction. The trend looks like it may continue for a while", says S&P.

It is almost the same story in the synthetic CDO segment.

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