SECURITISATION NEWS AND DEVELOPMENTS – September, 2001

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Terror on the Street: securitization markets might see some lasting impact

Even though rating agencies are constantly re-assuring that the WTC-related CMBS transactions that closed just about a month before the terrorists attack are covered by insurance and that there is no reason for instant worries, investors are still unnerved.

CMBS transactions have a substantial exposure on New York property. The total exposure of CMBS universe on downtown NY properties is close to some USD 20 billion, which includes the two single-property deals on the WTC by GMAC and Bank of America [see below]. Rating agency Standard and Poor's admits that it is keeping a close watch on CMBS transactions which are passing through "an unprecedented situation – one that will surely test the structures and criteria upon which the industry was built and investors have come to rely".

The other casualty of the sordid episode is that insurance companies are likely to suffer heavy damage. A report in The Independent 21 Sept said Munich Re and Swiss Re, the largest reinsurers in the world, are likely to suffer losses of USD 3.25bn. This might usher in changes in the view the insurance industry is organised. Currently, even though catastrophe reinsurance securitization has been around for quite some time, it has not been able to find a strong base and the technlogy has been exported away to other markets such as credit risks and weather risks. The current magnitude of losses will surely push up substantially the cost of reinsurance, which will create new interest in insurance risk securitization. The Indepedent article talks of the possibility that "the use of the increasingly global reinsurance companies may decline and insurers may instead try to offload their liabilities by securitising them via catastrophe bonds in the capital markets".

In fact, the securitization industry, as the rest of the capital market, is likely to get into a re-examination and introspection mode in the coming few months.

WTC damage may percolate down to several securitisation deals

Thanks to the ever-increasing role of capital markets in distributed funding and risk sharing, every major loss is a shared loss. In the bygone era, a natural or manmade calamity would affect those directly under its influence, and a handful of banks and insurance companies. In today's complex world, both funding and risk transfer operate through a variety of capital market instruments where the funding as well as the risk protection comes from capital market investors. So all losses leave a long trail.

The unfortunate terrorist attacks on what used to be the World Trade Centre on September 11 is likely to affect several securitisation investors. The World Trade Center's office area was only recently taken on lease by Lloyd Goldman and Silverstein Properties from the Port Authority. Silverstein took a loan of USD 563 million from GMAC, and the latter issued CMBS backed by the loan and the lease to a select group of institutional investors, in an issue that closed only in August, 2001.

Though the lease is covered against an insurance policy, there are doubts floating around that as President Bush has repeatedly referred to the terrorist attacks as an act of war against the United States, insurance policies have an exception against an act of war. There is no exception against an act of terrorism, and therefore, rating agency Fitch issued a press release on 18th Sept hoping that the insurance cover will be available. Unnerved investors, however, still have fears which are not entirely unfounded.

Bank of America had given yet another loan to Blackstone Real Estate Advisors against Seven World Trade Center, which was also securitised into a USD 383 million CMBS.

So in all, the securitization market has more than a USD 1 billion at stake.

 

Prepayment rates rise in US mortgage markets: 
IO strips and subordinate tranches suffer

The several consecutive rate cuts by the Fed have brought the inevitable impact on US mortgage markets: increasing prepayment rates. The terrorists struck on 11th September, and to maintain the stability of the financial markets, the Fed further cut interest rates by 1/2 per cent on 17th September. These events together are likely to further worsen the prepayment scenario, spelling surest trouble for the IO and other CMO investors.

The US mortgage market is estimated at some USD 2.6 trillion. These investments are sensitive to interest rates: if prepayment speed increases due to declining interest rates, mortgage investors whose yield assessment was based on a particular prepayment speed will get lesser of interest in future, and hence, their values suffer. Particularly sensitive to interest rates are the IOs and subordinate tranches of CMOs.

The prepayment speed in August climbed up by some 1 to 6 percentage points, on a CPR basis. A recent S&P report, issued before the terrorist attacks, quoted mortgage analysts who "predicted that prepayment rates will continue their ascent into October, as herds of homeowners are expected to refinance their existing mortgages at lower interest rates to cut their monthly payments or tap into the equities of their homes, which have appreciated as a result of a robust real estate market."

This scenario can only worsen in the wake of the terrorist attacks, and consequent global financial uncertaintly, followed by a further rate cut by the Fed.

It is notable that in terms of EITF 99-20, mortgage investors will be required to devalue interest-rate sensitive tranches while preparing their financial reports as at end-September.

Korean lease securitisation gets AAA rating with AMBAC cover

Hanareum International Funding Ltd., a subsidiary of Korean Deposit Insurance Corporation recently got a US$278 million guaranteed floating rate notes issue rated by Standard and Poor's. The isse was rated AAA with a wrap cover from AMBAC. The notes are backed by a portfolio of performing leases and loans originated by 16 failed Korean merchant banks and purchased from Hanareum Mutual Savings and Finance Co.

The transaction represents AMBAC's first involvement in a Korean transaction.

The leases in this transaction owe their origin to 16 failed Korean merchant banks. The portfolio consists of a carefully selected subset of well-seasoned, performing assets that have been sample audited to confirm that they meet specified legal and eligibility criteria. The transaction is also supported by a letter of commitment by KDIC relating to certain asset representations and warranties

The transfer of assets in this transaction is perfected against third-party claims under Korea's ABS act. Note payments ultimately depend on collections from the underlying loans and leases, and on the surety bond provided by AMBAC. The servicing of the underlying receivables will be performed by KDB Capital Corp., with Deutsche Bank AG contracted as back-up servicer.

Links For more on the Korean securitization market, see our country page here. For text of Korean ABS law, click here.

 

Italy plans to liquidate real estate via securitisation

In June 2000, Italy made history by securitisation of non-performing social security contributions in a securitisation transaction known as INPS. With the success of INPS and INPS-II this year, the Italian government wants to go ahead with more securitisation to reduce its budget deficits.

A report in Financial Times of Sept 11 has quoted Giulio Tremonti, the treasury minister, as saying that the government wanted to raise some GBP 3.8 to 4.8 billion equivalent by securitisation of its real estate holdings.

Under proposals, which are still not very clear, the government will set up SPV or SPVs that will acquire billions of euros worth of real estate assets that are directly and indirectly owned by the public sector. The SPVs will then launch a programme of bond issues over forthcoming years that are secured against the value of the property portfolio. This model has been used by Canary Wharf and several others in the UK, and has been on for last several years in the USA. Nevertheless, the Italian government sees in it some highly innovative plan.

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

ABS lives on after death, says S&P

The asset-backed investment is dead, long live the same! There are defaults galore in the bond market in the USA, and many CDOs tranches of 1997 and 1998 vintage are badly affected, but then, defaulted bonds do not necessarily mean a loss as far as asset-backed investors are concerned. Even after rating agencies give a D rating to a structured finance investment, it might still continue to pay both principal and interest.

The findings of this study are very important for the ABS market. S&P says that as of the second quarter of 2001, there were 116 defaults among structured finance securities, which means the relevant security has received a rating of D. S&P is obviously talking of the US market, as in Europe, there is no default to date.

Residential mortgage-backed securities (RMBS) accounted for 83 of those defaults; commercial mortgage-backed securities (CMBS), 14; and asset-backed securities (ABS), 19. Their recoveries averaged 61%, 66%, and 29%, respectively. The fact that there are higher number of defaults in RMBS does not mean there is higher probability of default – in fact, there have simply been higher RMBS issuance. Since 1978, there have been 6361 RMBS classes rated by S&P.

But a 61% recovery rate is simply remarkable. The recovery rate simply means the total amount the investor receives, as a percent of the original principal, cumulatively. The percentage is the reciprocal of cumulative loss percentage.

There have been lesser defaults in ABS, but the loss experience is not consistent. For example, there are 12 classes of credit card issuance by a single issuer which were found fraudulent and are therefore subject to bankruptcy court.

 

Taiwan proposes new law on securitization

As per reports in Financial Times of 5th Sept., Taiwanese Finance Ministry has proposed a new law on securitization. The prime purpose of securitization laws in the erstwhile Asian tigers such as Korea and Taiwan is to put the larger chunks of bad bank loans back into circulation through the device of securitization of non-performing loans. Korea has done it and Taiwan is obviously impressed.

The new legislation is proposed to put in place by December. Taiwanese finance minister described the effort as one occupying the top priority for his government. Bank overdues have reached over 7% of the assets of Taiwanese banks.

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