SECURITISATION NEWS AND DEVELOPMENTS – Nov. – Dec., 2000

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

 

US asset-backed market likely to end 2000 with marginal growth

It has not been a very good year for US abs markets. While the first half showed a negative growth rate after a long time, the volumes picked up in the second half. With just two weeks to go, it now seems the volume for the calendar year will only be marginally up from the last year's, nowhere near the impressive double digit growth rate it was maintaining for a long time in the past.

As of end of the last week, volumes for year 2000 output stood at USD 263 billion, about 2% behind the 1999 volume of USD 269 billion. Taking expected deals during the holiday season into account, market analysts do not expect the aggregate year 2000 volume to be very better than that last year. The decline in volumes is attributed to lesser of 144A deals coming to the market, while public offers showed an impressive performance.

Market analysts are also busy making yearly tallies of lead investment bankers. It is likely that Salomon Smith Barney will end up as the top underwriter with Lehman Brothers at number 2 position.The two together will hold more than a quarter of the market.

Links For data of the volumes in the ABS and MBS market upto 30th June, 2000, click here.

Guy Hands continues to make news

With the focus on financing potential of securitisation for infrastructure projects in London, Guy Hands of Nomura continued to be in the news.

The Independent of 16th December carried the following comment:

"IF GUY Hands at Nomura can do it, then so can the fusty old managements who run the utility businesses that he seems so keen to get his hands on. PowerGen has became the first UK utility to mortgage some of its future revenues to pay down a chunk of its present debts [see news item below]. Peter Hickson, PowerGen's finance director, has parceled up about one year's worth of gas and electricity bills and sold them to Bank of America for pounds 300m. The resulting cash inflow will both help to reduce PowerGen's debts and cut around half a per cent from its interest payments.

xx

Will other utilities follow where PowerGen has led? The most obvious candidate is Railtrack. Like electricity and gas bills, its track access revenues are secure and reliable. And if electricity and rail companies can do it, then why not water companies? Securitisation is one of the mechanisms Nomura would have used to make its takeover of Welsh Water stack up financially. This is just the kind of instrument water companies may now have to look at if, as looks likely, their exotic restructuring plans are blocked by the regulator. "

Who is Guy Hands

Head of the Principal Finance division of Nomura Securities at London is one of the most talked-about financiers in the City and in the securitisation world, he has the reputation of being the one who pulled securitisation out of its mainstream applications and intermixed venture capital approach into it to introduce to the world a wholly new range of asset classes such as pubs, real estate, plant and infrastructure assets.

 

French bank in mega CLO deal

French banking group Natexis Banques Populaires has announced that it has securitized a portfolio of loans to a number of companies under French control, for a total value of Euro 2 billion, as per a report in La Tribune of 20th December.

Following the launch of Natix in June 2000, this operation, which has been named Igloo, is the second securitization operation concerning a portfolio of loans to French companies by the Bank. The operation was jointly managed by Natexis Banques Populaires and Merrill Lynch International.

World Football body to securitise receivables

Federation Internationale de Football Authority [FIFA] wants to securitise future receivables to raise as much as USD 1 billion by way of securitisation, thus catapulting securitisation from the limited mainstream of banks and financial intermediaries to the sports arena. FIFA would be the first international sports body to use securitisation to raise resources. According to a report in The Times London, FIFA will cover its costs in the run-up to the next two World Cup tournaments. The organisation is working with Credit Suisse First Boston to prepare the securitisation for subscription by the middle of next year.

This would be the second notable instance of securitisation in the sports field, and the first of its own kind. Before this, Formula 1, the TV-based car sports organisation, has used securitisation to raise resources.

The securitisation deal banks o potential marketing contracts and television revenues surrounding the 2002 World Cup.

UK electricity company to securitise receivables

Powergen, the third largest electricity company in the UK, has decided to raise resources by securitising its future receivables. Reports suggested that Powergen will raise £300 milion against its customers' future payments of gas, electricity and telecoms bills.

Securitisation is seen as the right funding device to reduce the huge funding the company currently holds from banks. The company justified securitisation saying it would entail lesser funding costs as compared to straight bonds.

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

Securitisation makes headlines in London: The Tube mulls it for revitalisation funding

For a last few days, securitisation as an infrastructure funding option has been making headlines in London newspapers as it has been suggested as a mode of funding the essential revitalisatin of London's underground train system.

An agency called Transport for London has suggested securitisation as the device, whereby the Tube can raise Euro 3.8 billion to part-finance its requirements. The Times on 16th Dec. carried a commentary titled Securitisation is the right route by Patience Wheatcroft which projects securitisation among other options as a straightforward and cleaner option. The commentary cites the various ventures where Guy Hands of Nomura has used securitisation as a funding device: "Guy Hands has made Nomura a major player in such diverse sectors as train leasing companies, housing and pubs. There is no magic involved. Those who are prepared to put up the cash need to be assured that the income will be there to service the bonds and the coupon they demand is determined by the level of security they feel on that front. Pubs proved an easy deal for Hands, for instance, since he had no difficulty in persuading investors that the drinking public would continue to take refreshment in his establishments".

IFC promoting securitisation in emerging markets

International Finance Corporation, Washington (IFC) is promoting securitisation in emerging markets. IFC has the task and reputation of spreading new financial instruments in emerging markets.

Currently, IFC is on various projects involving mortgage-backed securitisation in several emerging markets. In the past two years the IFC has helped set up new financial institutions in Argentina, South Korea and Colombia that are designed to buy up mortgages in the secondary market. The model adopted is similar to US Fannie Mae.

One of the institutions where IFC has participated as a promoter is KoMoCo, Korea. KoMoCo has already come out with three issues of mortgage-backed bonds. Click here for more about KoMoCo. In Argentina, IFC has helped in the promotion of a body called Banco de Credito & Securitizacion.

IFC's forthcoming projects could be Mexico, Russia and the Middle East.

First Islamic securitisation to hit the market

The first Islamic securitisation is likely to hit the market soon. The transaction will emanate from Saudi Arabia and is backed by leases on military property. The transaction will be lead-managed by Credit Suisse First Boston. We reported on this site recently that CSFB has opened an office in UAE to promote securitisation in the Middle East. Soon, another commercial mortgage backed securitisation may be launched from Bahrain.

The transaction is aimed at attracting Islamic funds into investing in a deal which is compliant with Islamic principles. Islam debars charging or paying of interest: but risk-participation is permitted.

A report in Investment Dealers Digest said that the upcoming Saudi Arabian transaction will likely not resemble what Western investors consider a typical asset-backed security. The issuer would have to sell the assets to a third-party, special- purpose vehicle, which in turn would have to hold on to at least 51% of the assets securitized.

Links There is an article on Islamic securitisation in our articles section – click here.

Securitisation workshop in Bahrain Vinod Kothari Consultants along with Bahrain Institute of Banking and Finance will be offering a course on Securitisation and Credit Derivatives in Bahrain in March, 2001. For details, click here.

ABN Amro to hit the market with largest ever synthetic CLO

ABN Amro is reportedly preparing what would be the largest-ever CLO in history – a USD 15 billion deal. A report in Euroweek of Dec. 1 says that this would be a synthetic transaction, partly funded. As is the case with synthetic CLOs, the deal might aim to raise a part funding to provide credit risk swap to the USD 15 billion worth portfolio. The portfolio would comprise of North American corporate loans.

In the meantime, ABN Amro is already in market with Euro 8.5 billion synthetic securitisation of European corporate loans. Named Amstel CLO 2000-1, the offer consists of 4 tranches.

Vinod Kothari comments: Taking into account the above with Deutsche Bank's synthetic CLO named CAST 2000-2, European synthetic CLO activity seems to be at its peek.

Links For more on synthetic CLOs and CLOs in general, refer to our page on bank loan securitisation here.

Alternative risk transfer forum notes increasing convergence between insurance and financial products:
Insurance seen as a source of capital

Speakers at the the 10th annual World Captive and Alternative Risk Financing Forum held in Palm Beach Gardens, Fla., USA noted increasing trend towards convergence of financial and insurance products.

Erwin Zimmermann, divisional chief executive of Swiss Re New Markets saw insurance as an essential tool of risk management. It has become increasingly important for corporates to manage their volatility. The role that insurance solutions can play, therefore, is by helping to minimize that volatility and providing a source of contingent capital, which unlike debt or equity, is not reflected on a client company's balance sheet. However, unfortunately, the traditional financial markets do not see insurance as a financial product. "Rather than seeing it as a financial product that can provide a value, it instead is seen as a cost. A key attraction of using insurance as a source of contingent capital is that it can lower a company's cost of capital". The present-day corporate ought to see insurance as an essential building block of the company's capital structure, just like equity and debt. . "This shift in view means the risk manager is no longer the ruler of sprinklers and loss control, but also the owner of this financial area," said Zimmermann.

Zimmermann proposed insurance as a source of contingent capital.

Within the insurance product, according to Zimmermann, one has either the choice of speaking in terms of a traditional vs. alternative risk transfer, or one can talk in a more pragmatic sense: an optimally structured convergent financial instrument, where insurance is an element in a financial instrument. The financial instrument approach would require insurers to provide more modeling, a more complex structure and capital markets innovation.

Links For more on alternative risk transfer, see our insurance risk securitisation page here. A very good site on alternative risk transfer is here.

Why do investors flock to securitisation products: S&P highlights investor perspective

International rating agency Standard and Poor's (S&P) has highlighted the advantages of securitisation from investors's perspective. A commentary titled The Investor Perspective: The Benefits of Buying Securitized Bonds appeared on Ratingsdirect on 28th Nov.

Securitization is being embraced the world over by pension funds, life insurers, and other types of investors because of key highlights of securitised instruments : their comparatively high quality and low volatility, their relative value, their ability to cope with unexpected events, and the opportunities they offer for portfolio diversification.

As regards low volatility of structured instruments, studies by the rating agencies show that the migration of the ratings, that is, downgrades or upgrades to the initial rating, are less frequent in case of securitised instruments than for other instruments. On this site, we carried a report on this study – click here. Over 1978 to 1999, S&P has rated 3269 ABS transactions with 4685 classes, of which only 2 have defaulted and only 2% have been downgraded. This is a remarkable evidence of stability and quality of ABS transactions.

Securitisation structures are designed to mitigage event risk, that is, impact of adverse economic scenarios on the performance of the transaction. S&P cautions investors against investing in transactions that look like securitisations, but truly speaking are not – "A lot of transactions look like securitizations on the surface but they ultimately depend on the ability of the underlying originator to generate more assets, in contrast to a true securitization".

Another strong investor incentive in investing in securitised products is portfolio diversification.

Lack of liquidity might be an adverse factor on a number of securitised instruments.

Economic stability brightens securitisation prospects in Russia

As the once-trouble-torn Russian economy is gradually recuperating, securitisation deals are being noted around, particularly future flows deals. Future flows deals have proved particularly handy for bringing down funding costs in emerging markets with low sovereign credit ratings.

Report in Euroweek 24th Nov. suggest that the EBRD and Standard Bank are finalising the underwriting of an asset backed loan that will provide financing for some half dozen Russian goldmines. More such deals are in the pipeline, says the report. A similar deal was struck last year – not exactly securitisation but a loan paid off by the sale proceeds of gold exported from the country. In view of the lower credit rating of the country, these deals are essentially bullet payment small tenure loans.

Links For more on securitisation of future flows, click on our page here.

Munich Re might enter the market with a catastrophe bond

Reinsurance company Munich Re might come to the market with a USD 500 cat bond against US hurricane and earthquake risk and European windstorm risk. The deal is expected to be arranged by Lehman and Goldman Sachs Munich’s subsidiary American Re will also play as a third manager on the deal.

The issue is expected to be tranched into two classes: a USD 250 million, three-year tranch dedicated to hurricane risk expected to be priced at 600-675 basis points over LIBOR and the other tranche for earthquake and windstorm risk expected to be priced at 675-750 basis points over LIBOR. The deal will be linked to a parametric measure, unlike an index-based or indemnity-based deal.

Links To learn more about cat bonds, click on our page here.

Swiss Re's insurance credit-enhances franchise royalty securitisation

Swiss Re has provided first loss reinsurance on a securitization of intellectual property for Arby's(R), the fast-food chain best known for roast beef sandwiches. It was a private placement by a newly-formed special purpose vehicle of $290 million of non-recourse fixed rate insured notes.

The transaction is backed by rights to collect franchise royalties and fees from current and future Arby's(R) branded franchise owners throughout the U.S. and Canada, and is believed to be a cutting-edge transaction. — The execution hinges on an innovative insurance and reinsurance platform in which a Swiss Re Group company takes the first loss position, and Ambac Assurance Corporation takes the excess risk position and provides a AAA financial guaranty policy for the $290 million issue of asset-backed securities.

Swiss Re feels that the transaction will lead to a further convergence of insurance and securitisation markets.

ABN Amro bank launches first Asian synthetic securitisation deal

ABN Amro bank took the laurels to become the first originator of a synthetic securitisation in Asia. The transaction, called HK Synthetic MBS Co. Ltd, seeks to transfer the credit risk inherent in mortgages originated by ABN Hong Kong.

The HK Synthetic MBS, a Cayman Island companuy, is the SPV used for the purpose, will write a credit default swap with ABN. The proceeds of the notes will be put up in deposits to be held by the SPV. The amount so deposited will be used in case of losses suffered by ABN which need to be compensated by the SPV in terms of the default swap.

Rating agency Standard and Poor's expects to give a AA rating to the class A notes to be issued. The transaction has as many as 5 classes running from A to E. A class forms the largest part , HK$ 1124 out of a total issuance of HK$ 1261. Class A notes get a subordination of approximately 10.8% due to the combined impact of classes B through E.

The reference portfolio consists of a pool of 1168 mortgages originated by ABN Amro. The principal outstanding under the mortgages equals the amount of notes issued by the SPV.

Links To know more about synthetic securitisation, click here.

Greece securitises dividend income

Aptly naming it as Hellenic Securitisation, a Greek government body on 17th Nov securitised government receivables in a novel deal. The receivables in question are the dividends being paid to the Government every year by the state-owned Consignment and Deposit Loan Fund. The government has thus raised upfront cash to the tune of USD 633 million. Market reports say that this is the first public issuance of asset-backed securities in Greece, but two deals are closely following – one, that of lottery ticket receivables, and the next will be the Italian-type social security receivables.

The Hellenic Securitisation deal carried two tranches. The first tranche, having a maturity of 4.3 years, was priced at 18 basic points over Euribor, and the second tranche, with expected maturity of 10.3 years, was priced 24 basis points over Euribor. Investment managers have claimed that the issue was oversubscribed twice.

Your comments Securitisation of government revenues is becoming quite a cult in Europe, with Italy doing as many as 3 transactions over last year or so, and Greece doing or proposing three. Where do you think this is leading to? Do you have any views on this tendency? Do write back and we will be glad to publish your views on this site.

Links For more on securitisation in Greece, refer to our country site here. For news relating to the social security revenues, click here.

FDIC staff issues draft memorandum on securitisation of predatory loans

The issue of banks investing in predatory loans either directly or through the securitisation route has been causing concern of bank regulators in the USA, as covered earlier on this site. There have even been court cases against banks that bought

What are predatory loans:

Predatory loans are not just subprime loans. The FDIC draft guide lists the following features of predatory loans:

  • Misleading or fraudulent marketing
  • Loan fees and interest rates higher than necessary to cover profit and risk
  • Excessively priced products, such as single premium credit life insurance
  • Large prepayment penalties that make it difficult to refinance affordably.
  • Balloon payments likely to result in default and foreclosure
  • Abusive collection and aggressive foreclosure practices
  • Mandatory arbitration provisions
  • Underwriting based on the value of collateral rather than a borrower’s ability to repay

or underwrote such mortgages –see report here. The FDIC staff has now proposed a memorandum to guide banks into staying clear of buying or investing in predatory loans. The draft memorandum was issued on 17th Nov., and the FDIC has sought public comments on it. The memorandum provides suggestions on how to avoid purchasing or funding predatory mortgage loans and investing in securities backed by such loans. These activities may be the most common means by which financial institutions and other investors unknowingly help to fund predatory loans, incurring several risks.

Apart from buying subprime loans, the draft guides includes a section on how to refrain from investing in MBS secured by subprime loans.

The FDIC draft document is available at:
http://www.fdic.gov/

The site also allows electronic comments to be filed with the FDIC.

 

Philippines president passes order for securitisation regulations

Philippines president Joseph Estrada has ordered the goveernment agencies concerned to develop a legal and regulatory framework. The President passed an order to this effect on November 17 [E.O. No. 318]. The order is effective immediately.

Earlier on this site, we carried news about trade and industry in the country pleading for facilitative regulatory framework for securitisation. Responding quickly, the Presidential order instructs the Department of Finance, the Bureau of Internal Revenue, and the Securities and Exchange Commission, as well as the Housing and Urban Development Coordinating Council (HUDCC), to form top-level teams which will develop the administrative and regulatory framework in their respective departments for the development of a market for assetbacked securities, in consultation with the private sector.

Besides clarifying the regulatory, tax and securities regime relating to securitisation, it is expected that the Order will also achieve the following:

Other provisions of the E.O, include the following:

1. The SEC shall issue the revised rules on securitization and shall recognize the creation of Special Purpose Vehicles as the recipient of assets and issuer of asset-backed securities and securitization transactions, if determined to be within the current legal and regulatory framework.

2. The Insurance Commission shall study and, if possible, implement the expansion of the coverage of admitted assets for insurance companies to include investments in assetbacked securities.

3. The above listed agencies shall coordinate and seek the assistance of the BSP regarding policy, administrative and regulatory issues in securitization where coordination with BSP is necessary.

4. The HUDCC, in coordination with the SEC and DOF, shall initiate the formation of a private sector Secondary Institution (SMI) for assetbacked securities with priority to the housing industry.

5. The Board of Investments shall consider the inclusion of SMIs for asset-backed securities in the Investment Priorities Plan as among those eligible for tax and other incentives under the 1987 Investments Code.

Mexican government wants securitisation push

President-elect Vicente Fox who broke the 71-year old single-party reign in Mexico and will assume the presidency from Dec 1 wants to give a big push to securitisation. To carry the idea to reality is Mr. Jose Luis Romero Hicks, who is overseeing housing policy as a part of the President's team.

To begin with, Hicks wants to set up a body similar to the Fannie Mae for securitisation of mortgages. Hicks plans to undertake a series of steps to make this possible. Although twenty-three of the country's 32 states have adopted laws making it easier for mortgage lenders to foreclose on the homes of delinquent borrowers, the country does not have a secondary mortgage corporation. Title insurance does not exist.

Hicks' plan is to securitise mortgages worth USD 2.5 billion out of Mexico every year. Towards this, he has discussed his plans with Wall Street investors at firms such as Citibank and Merrill Lynch. [based on the Dallas Morning News 19th Nov.]

Korean mortgage body to get technical and equity support from global majors

Internationally-known mortgage-market-maker Fannie Mae, mortgage lender Countrywide International Holding, and global investment banking firm Merrill Lynch have tied up with Korea Mortgage Corporation (KoMoCo) as foreign technical partners to assist KoMoCo in various aspects of its mortgage securitisation business.

KoMoCo is the Fannie-Mae-type body to securitise mortgages in Korea. KoMoCo's website is here.

Under the contract signed on 31st Oct., IFC takes over equity stake in KoMoCo equal to KRW 15 billion. Besides, Merril Lynch will provide assistance in capital market development, Countrywide in business development & operations, and Fannie Mae in IT Development & Treasury Functions.

KoMoCo has already begun issuance of mortgage backed securities. In September this year, KoMoCo issued 500 billion won worth of mortgage-backed securities which was its second issuance.

Links For more on securitisation in Korea, click on our country profile. For KoMoCo's website, click here.

Dutch tax reforms set markets worrying:
Eurotunnel revises SPV structure

The recent proposed tax reforms in Holland which seek to treat the junior tranches of securitisation paper as equity for tax purposes has set the markets aflutter. While this website has been getting several mails of concerned market players, there are even news reports of several recent securitisation structures trying to protect themselves from being adversely affected by the proposed changes.

For example, the recent securitisation deal of Eurotunnel had an SPV set up in Netherlands. The transaction will now also be using an SPV in Luxembourg. The transaction can use either of the two SPVs to issue the notes. The obvious plan of action is to shift the jurisdiction avoiding Netherlands.

What do you think of the Dutch tax reforms? We have initiated a discussion on the Dutch tax reforms – have a look at it and post your views – click here.

S&P cautions of risks inherent in Japanese finance company securitisation

Securitisation by finance companies forms a predominant part of Japanese securitisation, and Standard and Poor's expects this to grow particularly among small to midsize players, given the potential for securitization to help finance companies' assets become self- funding. To date, finance companies in Japan have securitized a wide array of asset types, including lease receivables, installment sales receivables, unsecured loan receivables, and other types of trade receivables.

While appreciating the motivations for finance companies to securitise, S&P is cautious of the risks securitisation carries. In a report on Ratingsdirect, S&P discusses the following risks inherent in finance companies' use of securitisation:

  • Credit risk, retained by the originator, in form of a reserve account funded by the originator, and/or the purchase of subordinated tranches of notes.
  • Liquidity risk stemming from early amortization triggers in revolving structures. Early amortization events in asset-backed issuance are often tied to the performance of the securitized asset pool. As such, if the asset pool performs significantly below expectations, the transaction might not be able to fund the purchase of new assets, and/or a wind-down of the transaction might be triggered prior to expected maturity. Usually the originator has incentive to avoid triggering early amortization events, and in some cases can do so by adding better-performing assets to the securitized portfolio, although this practice varies depending on the individual structure of the deal and the incentive for the originator to do so.
  • Variability of cash flow. In many structured transactions, originators receive cash from the receivables only after certain obligations under the notes have been paid, such as interest on the senior notes, various fees, and the establishment of required cash reserves. In essence, the remaining excess servicing income from the securitized assets amounts to a variable income stream, which has to be incorporated into the company's asset liability management strategy as if the assets remained on balance sheet.
  • Accounting risk. Under new accounting rules adopted in April of this year in Japan, originators will record up-front gains from the sale of receivables in securitizations. These gains are essentially the present value of future cash flows expected from the excess spread generated by the assets and servicing fees. If assumptions regarding gains prove to be unrealistic, companies may be required to write down recorded gains. Moreover, because future income streams are being recognized up-front, any slowdown in up-front gains through securitization activity could lead to a precipitous drop in income, as occurred in the U.S. in 1998.

Currently, the risks associated with securitization are insignificant for Japanese finance companies rated by Standard & Poor's, because the practice of recording up-front gains from securitized assets is relatively limited, as is the extent to which these companies rely on securitization as a funding technique. Nonetheless, because of the growing popularity of structured issuance, Standard & Poor's will continue to monitor the impact of asset securitizations on the overall credit quality of finance companies in Japan.

Mortgage securitisation in Portugal likely to grow, says S&P

Rating agency Standard and Poor's is of the view that mortgage securitisation in Portugal is likely to grow, enabled by a growing market for mortgage funding, facilitative law and low interest rate environment.

Securitisation law was passed in Portugal in November last year. On the securitisation laws section of this site, we have the full text of the Portugese securitisation law – click here. The law has established and simplified procedures for the transfer of mortgages and substantially reduced the associated costs, opening up the door to the development of an RMBS market in Portugal. Under the new law, a transfer of mortgages for the purpose of securitization does not require a public deed, making the process virtually free of charges or costs. A transfer agreement contracted under private law between the assignor and the assignee is sufficient to make the transfer valid and enforceable.

S&P officials also feel that the low interest rate regime is conducive to securitisation. The steady decrease in interest rates, which fell to 3% at year-end 1999 from 13% in 1990 and strong economic growth (on average 1% above the E.U. 15-year average between 1996 and 1998) augment the new Law to stimulate the Portuguese mortgage market further and assist in the growth of securitization.

Links See our country page on Portugal – click here. See the full text of Portugese securitisation law here.

Synthetic securitisation spurts in Europe

A Reuters report quotes Merril Lynch as saying that synthetic securitisations have shown an amazing growth from almost nowhere in 1999 to constitute about 1/4 of all securitization in the current year.

Merril Lynch estimates the year-to-date volume of synthetic securitisation at around USD 19 billion, as compared to USD 65 billion for funded securitisation. Synthetic securities had a negligible presence last year.

Synthetic deals are popular because they enable institutions to get assets off their books for regulatory purposes, thus freeing up capital, without selling them to vehicles that issue asset-backed bonds.

Links Our page on CBOs/ CLOs provides an interesting reading, and further links on synthetic securitisation. Click here.

Credit Suisse First Boston puts up securitisation unit in UAE

Credit Suisse First Boston (CSFB) has allied with Strategic Capital, a UAE based company to set up a commercial real estate finance and securitisation operation in the Gulf. This is the first dedicated attempt to initiate securitization in the Gulf region. The securitisation unit was inaugurated on 5th Nov.

Speaking at the inaugural function, Jonathan Davie, vice-chairman of Credit Suisse First Boston said that while the UAE has rapidly grown and diversified from an oil-dominated to a modern, service-oriented economy, the next natural step in its progress is the integration of its financial system to the global capital markets, so that its private sector may benefit from long-term international investment. Real estate securitisation will benefit the UAE since it will introduce international institutional investors to the country and provide it with a benchmark credit framework, which in turn facilitates the issuance of corporate bonds or equity.

China to get into mortgage securitisation

According to a report in Reuters of Nov. 7, China is studying the introduction of securities backed by housing mortgages. The Reuters report is based on the official China Securities newspaper. Dai Genyou, director of the monetary policy department of the central People's Bank of China, was quoted as saying the government had been studying the instrument since last year. No definitive time table for the mortgage securitisation was given. Dai said the central bank had identified two possibilities, setting up a specialised institution for securitising mortgages, or selling mortgages directly.

News reports about the Australian bank Macquarie Bank Ltd tying up with China Construction Bank for mortgage securitization has been around for quite some time. Click here for a news on this site.

Links Do visit our country page on China here.

Bank of Italy requires banks to ensure independent handling of securitisation funds

The Bank of Italy has recently issued rules that require banks getting into securitisation to ensure that the funds on account of securitised accounts are not comingled with those of the bank, and there is greater transparency is administration of securitised portfolios.

According to a write up in Corporate Finance October, 2000, these rules require the securitising bank to (i) ensure the constant separation of the portfolios of different securitization transactions with their own assets, (ii) ensure the transparency of each transaction to investors and the market, (iii) ensure entering into exclusively transactions which pertain to the administration of each securitization transaction on a mutually exclusive basis.

The central bank has also required that the sums relating to each transaction must be deposited in specific bank accounts, expressly identified or separated for each transaction. The special purpose vehicles will also have to keep accurate accounting notations separate for each transaction. The notations will have to be continuously updated and would need to permit to (i) reconstruct at any time the aggregate of the transactions entered into in connection with each securitization, (ii) give concrete application as to the provisions on the segregations of the portfolios, assuring the separations of the assets of the vehicle from those of other transactions. In this respect, Bank of Italy requires that it receives the offering circulars, periodical information and statistical updates on the basis of forms to be subsequently distributed by Bank of Italy for each transaction.

Links For securitisation in Italy in general, please do see our country link here.

Dutch tax reforms to adversely hit securitisation

Tax law amendments proposed in Holland called the Dutch Tax Reform 2001 would adversely hit securitisation business. The new tax proposals will have the following serious implications: (a) tax deduction to the issuer will not be available on subordinate tranches of Dutch ABS ; (b) at the same time, investors could become liable for withholding tax. It seems that the tax laws would treat the subordinate tranches at par with payments to equity, having both the above consequences.

The tax measures above are not targeted at securitisation per se, but for hybrid debt instruments which conceal features of equity in debt instruments. What adds to the injury is that these proposals are to be given retrospective effect from January, 2000.

As per the proposed amendment, a debt instrument will be treated as a quasi-equity if two of the following three conditions are satisfied: (a) if the coupon or compensation is contingent on profits or can be postponed; (b) if the loan is perpetual or has a maturity over 30 years; or (c) if the loan is subordinated to one or more non-preferential loans. Condition (a) and (c) could easily be satisfied by subordinate securitisation tranches.

Vinod Kothari comments: With increasingly complicated financial instruments being designed, it is always a dilemma to distinguish between payments on equity and payments on debt for tax purposes. The former are appropriation of income; the latter are a charge against income. The Dutch tax reforms only are a pointer to what might be a larger concern over time in other countries too.

Malaysia scraps stamp duty on securitisation

While presenting his Budget 2001 before the Parliament recently, Finance minister Tun Daim Zainuddin proposed to scrap stamp duty on securitisation transactions completely.

He also proposed to scrap the real property gains tax on securitisation.

This may be a major incentive for securitisation transactions to take place in Malaysia. In the past, Malaysia has been depending on notifications exempting stamp duty having a limited effective period. The Budget proposal will change the law and abolish stamp duty on securitisations completely. The property gains tax is also on issue on mortgage securitisations, as it may be contended that transferring a mortgage is akin to transferring real estate.

Securitisation market has still been been in its infancy in Malaysia, with very little activity on the domestic front apart from the purchase of mortgage loans by Cagamas.

Links For more on securitisation in Malaysia, check here.

Greece follows Italy's footsteps: to securitise social security receipts and others

Following the landmark securitisation of government's social security dues in Italy, Greece will be shortly coming out with securitisation of delinquent social security contributions. According to a report inEuroweek, the social security payments to IKA that were to be originally securitised this year will now most likely land in the first quarter of 2001. The issue will raise between Euro 2-3 billion, and is being arranged by BNPP, National Bank of Greece and Salomon.

The government is also likely to securitise future Greek lottery receivables and raise Euro 900 million. That deal is mandated to Morgan Stanley, Schroder Salomon Smith Barney, Warburg and two Greek banks.

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

Italy set to launch securitisation of industrial compensation insurance

After being successful in raising upfront cash against its social security receivables, Italy is all set to lauch another first – securitisation of insurance receivables against mandatory industrial compensation insurance. A report on news portal efinancialnews.com by Piers Townsend says that this deal may be launched next week.

Workmen's compensation insurance payments are mandatory payments required by employers and self-employed to an agency called Istituto Nazionale per l'Assicurazione contro gli Infortuni sul Lavoro (Inail) which compensates the participants for accidents or injuries at workplace. Inail is going to securitise these receivables in a USD 1.14 billion transaction that will rated AAA. Like the government social security contributions securitisation last year, this deal also consists of delayed payments. The notes will have an expected maturity of 2.5 years.

BNP Paribas and JP Morgan are lead managing the deal with Banca di Roma and Finanziaria.

Links: Our country page on Italy consists of comprehensive materials, articles and links – click here.

Philippines: Trade body pleads for securitisation law

Leaders of the Federation of Philippine Industries (FPI) have urged monetary authorities to put securitisation laws in place to revive the economy and spur credit and lending. FPI has also suggested that Bangko Sentral ng Pilipinas, should encourage securitisation by providing its stampon the face of the instruments created by securitisation.

FPI explained that this program can also be used by the banks to liquidate their non-performing assets (NPAs).

The banks may create a "special purpose vehicle" that would pool these non-performing assets and issue securities against these assets to convert their real estate inventories into cash.

FPI leaders presented this program in a meeting with Trade and Industry Secretary Mar Roxas II at the BOI building early this week.

Through this asset backed securities program, the government may be able to enhance the credibility of these instruments by adding their guarantee to these securities with the condition that part of the proceeds of this investment scheme would be allocated to the financially distressed but economically-viable institutions.

It is notable that the country's economy is currently in serious problems and the peso is fast depreciating against dollar.

S&P transition study reveals
European securitisation rating show great resilience

Ratings of securitised instruments in Europe have been very stable, indicating that the risk of an ABS being downgraded, after it is bought, is comparatively much lesser. In respect of the lower end of structured products, rated A or below, the chances of downgrades are very very low, almost nil. This is evident from a listing of ratings transition published by international rating agency Standard and Poor's. [European Asset-Backed Transactions' Transition Study, dated 26th Oct.]

Rating transition is an important tool in risk evaluation of securities. The transition table lists the number of cases that have been downgraded or upgraded, and migrated up or down, over a past number of years. Based on the transition study, analysts compute the probabilities of a certain rating to stay through the life of the security. The S&P study takes into ABS rated by S&P from 1987 till the first half of 2000.

Some of the highlights of the study are:

  • No European asset-backed transactions have defaulted since the market's inception;
  • As of the first half of 2000, all European asset-backed transaction downgrades occurred as a result of supporting party downgrades, that is, downgrades of credit enhancers or guarantors: 73% of these were a direct result of one single factor, the downgrading of a number of major insurance companies in the early 1990s; 21% from downgrades of third parties to the transaction; and 6% were as a result of the introduction of EMU when the ratings on six of the 'AAA' local currencies converged in the 'AA' category affecting asset-backed transactions’ ratings where the respective sovereign was a supporting party;
  • The European asset-backed market has reduced its reliance on third-party credit support through the introduction of a number of new structural features;
  • A remarkable fact brought out by the study is that the lower rated classes -A or below, have proven to have been the most stable to date. For example, in case of A rated paper, out of 145 issues, 4 have been upgraded and only 2 have been downgraded. (S&P however cautions that lower rated paper did not exist in any great number until 1997, and have existed only through very favorable economic conditions and generally are not affected by the rating level of supporting parties);
  • and Since the beginning of 1999, there has been a marked increase in the number of upgrades reflecting the performance of the underlying collateral, testifying to market’s increasing maturity.

Full text of this important study is available on S&P website – under Structured Finance, look for Commentary

Italy going ahead with second securitisation of social security contributions

Last year, Italy stole international limelight when it securitised delinquent social security contributions. The transaction, named INPS, has since been in problems as collections were delayed.

Unfazed by problems in INPS-I, Italy is going ahead with INPS-2. The mandate for INPS 2 has been awarded to the houses that arranged the first tranche. The government is apparently in a hurry and wants to complete the deal before the end of the year to meet is budgetary deficit targets.

INPS 1 ran into trouble three months ago when it became clear that payments had not been collected as expected. The problem stemmed from a lack of communication between the government and the various debt collectors. On this site, we have carried reports about these problems – click here.

Links For more on Italian securitization scene, click here.

European Investors migrate to asset-backed securities

European investors are showing a distinct preference to asset-backed securities. While bond markets in general are in shambles, investors equate asset-backed securities with government bonds and German pfandbriefes in terms of risk perception.

One of the most important factors that has boosted demand for ABS in Europe is the fact that there has not been a single case of default ever since the inception of the market in late 1980s. During year 2000, there has not been a single case of rating downgrade of an AAA-rated European ABS paper, while downgrades abound in other debt securities.

Post August 2000, there has been plenty of issuance in Europe, and issues have met with liberal response from investors. Several market professionals state the most remarkable fact: not only is there strong demand, there is demand from investors who are new to the ABS market.

Vinod Kothari adds: Apart from the resilience of ratings and the fact that there has not been a default, there also seems to be working a usual S-curve phenomenon. The market is on the steep-slope-up part of the S-curve, while the US market has come to flat plateau stage. European investors are still honey-mooning with asset-backed securities. Hope the honey moon lasts long!

THE IMPACT ON SECURITIZATION OF REVISED UCC ARTICLE 9

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Steven L. Schwarcz

Relevant links:

A press release by UCC explaining impact of Article 9 changes

A narrative on Article 9 by UCC

The recent revisions of Article 9 of the Uniform Commercial Code ("UCC") are expected to have a significant impact on securitization-a type of financing that is perhaps the most rapidly growing segment of the U.S. credit markets and increasingly a major part of foreign credit markets. In its current form, Article 9 governs the sale of only certain types of assets that are involved in securitization transactions. Revised Article 9 attempts to broaden its coverage to virtually all securitized assets. I analyze how it does that and what it means for Article 9 to apply to these transactions, addressing issues of perfection and priority of asset transfers, commingling of proceeds, assignability of assets in the face of contractual restrictions, and the effect of negative pledge covenants. Finally, I show that the revisions of Article 9 do much to bring the commercial law setting for securitization into the twenty-first century.

Introduction

Asset securitization is "by far the most rapidly growing segment of the U.S. credit markets" and increasingly is becoming a major part of foreign credit markets. In a typical securitization, a company (usually referred to as the "originator") sells rights in income-producing or financial assets-such as accounts, instruments, lease rentals, franchise and license fees, and other intangible rights to payment-to a special purpose vehicle ("SPV"). The SPV, in turn, issues securities to capital market investors and uses the proceeds of the issuance to pay for the assets. The investors, who are repaid from collections of the assets, buy the securities based on their assessment of the value of the assets. Because the SPV (and no longer the originator) owns the assets, their investment decision often can be made without concern for the originator's financial condition. Thus, viable companies that otherwise cannot obtain financing because of a weakened financial condition now can do so. Even companies that otherwise could obtain financing now will be able to obtain lower-cost capital market financing.

What does Article 9 of the Uniform Commercial Code have to do with securitization? In its current form, Article 9, which generally addresses only secured transactions, nonetheless governs the sale of certain types of financial assets-accounts and chattel paper-that are commonly involved in securitization transactions. The rationale for including sales of these assets in Article 9 was that "[c]ommercial financing on the basis of accounts and chattel paper is often so conducted that the distinction between a security transfer and a sale is blurred, and a sale of such property is therefore covered . . . whether intended for security or not." This same rationale, and the significant minimization of transaction costs that the rule achieves, holds equally true today.

What has changed today, however, is that, increasingly, many other types of financial assets are sold as part of commercial financing transactions. Whereas factoring was the only significant form of commercial financing to involve sales of financial assets (accounts and chattel paper) when the UCC originally was adopted, securitization-which involves the sale of a whole range of financial assets-has now become significant. Yet, Article 9 had not been amended to take securitization into account. Revised Article 9 is a bold and largely successful attempt to remedy that omission and to adapt the law governing secured transactions to the realities of modern commercial and financial transactions. It accomplishes these goals in several ways.

I. Revised Article 9 Brings the Sale of Most Types of Financial Assets Within Its Scope

As a threshold matter, Revised Article 9 brings within its scope the sale not only of accounts and chattel paper, as under current law, but also of "payment intangibles" and "promissory notes." Significantly for securitization, the definition of an account is expanded from current law to include not only credit card receivables and health-care-insurance receivables but also any "right to payment . . . for property that has been or is to be . . . licensed, assigned, or otherwise disposed of," thereby covering license and franchise fee receivables. Moreover, the term payment intangible is broadly defined as "a general intangible under which the account debtor's principal obligation is a monetary obligation." This definition appears intended to cover financial assets that are not already covered by the terms account, chattel paper, and promissory notes. For example, loan participations and commercial loans not evidenced by instruments would be payment intangibles.

Accordingly, Revised Article 9 will apply to securitization transactions so long as the financial assets being sold consist of accounts (including credit card, health-care-insurance, license, and franchise fee receivables), chattel paper, promissory notes, or payment intangibles. I will refer to these types of financial assets as "covered financial assets." The reader should note, however, that in some securitization transactions, financial assets are not sold but are merely transferred as security. Revised Article 9 then will apply, as does current Article 9, to virtually any financial asset so transferred.

The remainder of this article discusses what it means for Article 9 to apply to the securitization of financial assets. Most significantly, all sales of covered financial assets will be perfected, and the priority of the SPV as against creditors or a trustee in bankruptcy of the originator will be governed, by the rules of Article 9. Establishing clear and pragmatic rules for perfection and priority of the transfer of covered financial assets will minimize transaction costs for the reasons previously explained in the context of transferring accounts and chattel paper: parties to the securitization transaction will not have to make the difficult determination of whether each transfer of a covered financial asset is a secured transaction or a sale; filing for both types of transfers will forestall litigation attempting to second-guess that determination if the originator in the securitization transaction eventually goes bankrupt; and sales of covered financial assets no longer will have to be perfected under state common law procedures that often are costly and impractical.

But Revised Article 9 will apply to securitization in a myriad of other ways. In this article, I focus on the more significant impacts most likely to be encountered in a typical securitization transaction, such as mitigating the effect of commingling proceeds of financial assets and promoting assignability of financial assets, notwithstanding contractual restrictions to the contrary. The reader must recognize, however, that Revised Article 9 will have other impacts on securitization, some less significant, some that will be significant in only certain transactions, and some whose significance might not become obvious until transactions are actually done under the revised statute.

Of course, the fact that Revised Article 9 will apply to the sale of covered financial assets does not mean that Article 9 applies to those sales for all purposes. In interpreting Oklahoma's enactment of current Article 9, the Tenth Circuit Court of Appeals previously had concluded that Article 9's application to the sale of accounts-characterizing the buyer of accounts as a "secured party," the seller as a "debtor," and the sold accounts as "collateral"-means that accounts cannot be sold under Oklahoma law. Although that decision was much criticized, and the Permanent Editorial Board of the UCC issued a commentary stating that the case was incorrect and also amended comment 2 to current section 9-102 to clarify interpretation, those actions have not generally been approved by legislatures or courts and do not necessarily have the force of law. Revised Article 9, once approved by legislatures, is intended to drive the final nail into the Octagon coffin by providing not only that the question "whether a debtor's rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article [9]," but also that a "debtor that has sold an account, chattel paper, payment intangible, or promissory note does not retain a legal or equitable interest in the collateral sold." The latter point attempts to address the "rarified" argument that Octagon was correctly decided because certain limited property interests may remain with the originator after the sale of financial assets.

II. Revised Article 9 Establishes Clear and Pragmatic Rules for Perfection and Priority

Two of the essential goals of a commercial law statute are clarity and simplicity of implementation. In the context of the commercial law rules for perfection and priority, Revised Article 9 furthers both of these goals.

A. Perfection

Perfection refers to the protection of a transferee's interest in transferred assets from creditors of the transferor and from the transferor's trustee in bankruptcy. Under current Article 9, perfection is generally achieved by filing financing statements in jurisdictions where the debtor (originator) or the collateral is located. The problem, however, is that it is often unclear where the debtor and the collateral are located and, in the latter case, the location may well change.

Revised Article 9 addresses this problem in two ways: by making the location of the debtor-as opposed to the location of the collateral-determine the jurisdiction whose law governs perfection in most cases; and by clarifying where a debtor is deemed to be located. The former point is less critical to securitization, which involves intangibles, than to other forms of secured financing where the assets are tangible items that can be moved around. But the latter point is quite significant to securitization. Section 9-307 of Revised Article 9 changes the rule of current section 9-103(3) to provide that registered organizations, such as corporations, organized under the law of a particular state are deemed to be located in that state. Thus, one would file financing statements against an originator incorporated under the laws of Delaware in Delaware, irrespective of where the originator's assets or business are located. Furthermore, where the originator is a foreign company not incorporated under state law, Revised Article 9 provides that its location is in the foreign jurisdiction where the originator has its chief executive office (or, if the originator has only one place of business, in the jurisdiction where that place is located), but only if that jurisdiction itself has a public filing system for perfection. If that jurisdiction does not have a public filing system, the originator is deemed to be located in the District of Columbia. Of course, whether filing in the District of Columbia will achieve perfection under the law of the foreign jurisdiction is also a question of that jurisdiction's law.

Revised Article 9 also brings a measure of pragmatism to the securitization of payment obligations evidenced by instruments. Under current law, a security interest in instruments can only be perfected by taking possession of the instrument. That may be impractical, however, where (as is common) a securitization transaction involves the transfer of large pools of instruments. The revision solves that problem by allowing a security interest in instruments to be perfected by filing. Nonetheless, holders in due course and certain other purchasers for value of instruments would have priority on the rationale that requiring them to check the filing system in connection with each purchase would impede those transactions, whereas there is only "a remote possibility that is not of serious concern" that an originator will voluntarily transfer instruments to third parties in breach of contractual restrictions.

One of the major controversies that arose during the Article 9 revision effort was how to perfect the sale of payment intangibles. Bankers were concerned that a perfection requirement of filing financing statements would subject them to costly new procedures when selling loan participations, a form of payment intangible. A somewhat practical solution was reached to mitigate this concern: the sale of payment intangibles would be deemed to be automatically perfected, without the need to file financing statements. This solution, however, is imperfect. Buyers of payment intangibles cannot search filing records to determine whether those intangibles previously have been sold to others. Thus, an SPV in a securitization transaction cannot ascertain the priority (discussed below) of the SPV's ownership rights, other than by relying on representations of the originator. Originators that are insufficiently capitalized to back up their representations therefore may find it difficult to securitize payment intangibles.

B. Priority

Priority refers to the ranking of multiple claims against a transferred asset. In a securitization context, it means that "the SPVs and investors' claims against the transferred financial assets are superior [in ranking] to any third-party claims," including that of the originator's trustee in bankruptcy. Under current Article 9, priority is generally accorded to the first secured creditor to file or perfect, under a rule usually referred to as "first in time, first in right." Revised Article 9 continues that rule.

There is, however, one exception under current Article 9 to first in time, first in right. A holder of a purchase money security interest ("PMSI") generally takes priority over an earlier perfected security interest in the same collateral. That exception, however, would create a significant problem for securitization and other forms of accounts receivable financing: because accounts are the proceeds of inventory, it would mean that a later perfected inventory financier with a PMSI would take priority over an earlier perfected SPV or accounts financier. To ensure that the PMSI exception does not discourage accounts receivable financing, current Article 9 has a special rule that favors accounts receivable financiers, including SPVs that purchase accounts, over purchase money financiers of inventory. Revised Article 9 continues that special rule.

III. Revised Article 9 Mitigates the Effect of Commingling of Proceeds

Commingling refers to the mixing of proceeds of collateral with assets of the originator. Under current Article 9, in an "insolvency proceeding" (such as bankruptcy), the secured party or SPV's interest in cash proceeds will be lost if the cash is commingled with other funds of the originator, except to the extent that an artificial formula preserves the security interest. However, this rule is unfair to secured parties because it can arbitrarily limit the amount of a perfected security interest in commingled cash proceeds and it allows an originator contemplating bankruptcy, in what has become a commonplace legal strategy for debtors, to intentionally commingle proceeds of a perfected security interest in advance of filing a bankruptcy petition in order to use the formula to defeat the perfected interest.

Revised Article 9 will remedy that unfairness. Rejecting the artificial formula, it returns to the common law principles of "tracing," under which a perfected security interest will continue in traceable cash proceeds of the original collateral. This would permit common law tracing rules such as the "lowest intermediate balance rule," in which it is presumed that funds remaining in an account after withdrawal by the debtor include the proceeds of collateral (or, put another way, that withdrawals from a deposit account following the deposit of proceeds are first made from non-proceeds).

Revised Article 9 also expands the definition of proceeds, which currently includes only what "is received upon the sale, exchange, collection or other disposition of collateral or proceeds." This relatively narrow definition had created confusion, for example, as to whether dividends of stock are proceeds. Under the expanded definition, stock dividends clearly would be included.

This expanded definition of proceeds can have major significance for securitization. Increasingly, the financial assets used in securitization transactions represent rights to payment that arise in the future ("future assets"). If, however, the originator goes bankrupt after the securitization transaction is entered into, section 552(a) of the Federal Bankruptcy Code may cut off the SPV's interest in future assets. While section 552(b)(1) generally would preserve the SPV's interest in future assets, that interest is only preserved to the extent that the future assets constitute "proceeds, product, offspring, or profit[]" of the SPV's prepetition assets. In this connection, courts interpret the term "proceeds" by reference to the UCC definition. Thus, Revised Article 9's expanded definition of proceeds will expand the universe of future assets that can be sold to SPVs without the fear of the SPVs' interest in those assets being cut off in the event of the originator's bankruptcy.

IV. Revised Article 9 Promotes Assignability Notwithstanding Contractual Restriction

Parties to contracts sometimes restrict the assignment of rights and obligations thereunder. These restrictions are often referred to as "anti-assignment clauses." In a securitization transaction, the parties to that contract are the originator and a third party obligated on the financial asset. Because the focus is on the originator's transfer of its rights in the financial asset to an SPV, we need only examine the obligor's ability to restrict that transfer.

Current Article 9 nullifies anti-assignment clauses that prohibit "assignment of an account or . . . creation of a security interest in a general intangible for money due or to become due." The rationale given is that the nullification of anti-assignment clauses "is widely recognized in the cases and . . . corresponds to current business practices." An implicit rationale, however, might be that the obligor on the account or general intangible is not prejudiced by its assignment, whereas enforcing the anti-assignment clause would impair the free alienability of property rights.

Revised Article 9 clarifies the rule of current Article 9. First, the revision eliminates any argument that a transfer of financial assets in violation of an invalidated anti-assignment clause nonetheless constitutes a breach as between the obligor and the originator. Second, the revision treats anti-assignment clauses in payment intangibles and promissory notes differently depending on whether the transfer in question is a sale or merely a transfer for security. Anti-assignment clauses would be ineffective in both cases from preventing perfection of the transfer of the right to payment, but they would be upheld to prevent an originator from selling its underlying business relationship. Thus, if the originator is a bank which has made a loan to a borrower, the bank could sell a participation in that loan-a loan participation being a payment intangible-to an SPV or other third party and could perfect that sale notwithstanding an anti-assignment clause in the underlying loan agreement; but the bank could not alter the underlying debtor-creditor relationship with its borrower. The buyer of the loan participation therefore would have no direct collection rights against the borrower.

V. Revised Article 9 Clarifies the Effect of a Negative Pledge Covenant

A negative pledge covenant is an agreement by a debtor in favor of a third party (typically, a creditor) in which the debtor agrees not to grant a security interest in or otherwise encumber its assets. In a securitization context, originators often make negative pledge covenants in favor of SPVs regarding transferred and to-be-transferred financial assets. If, of course, those financial assets already have been sold to the SPV and the originator retains no interest therein, the originator would have no power to grant a security interest and a negative pledge covenant then would be superfluous. But it is sometimes unclear whether the financial assets have been sold; and originators often do retain interests, such as interests in financial assets not yet sold, or undivided interests in financial assets that have been sold, or rights to surplus collections. In those cases, negative pledge covenants may be important.

Current Article 9 is unclear as to the enforceability of a negative pledge covenant. Revised Article 9 offers clarity by providing that while negative pledge covenants cannot restrict alienability, a transfer of financial assets in breach of a negative pledge covenant nonetheless constitutes a default by the originator. That default could entitle the SPV to exercise remedies against the originator and might also allow the SPV to sue the transferee, if it knew or should have known of the breached covenant, for tortious interference with contract.

Conclusion

The revision of Article 9 does much to bring the commercial law setting for securitization into the twenty-first century by embracing a broader range of financial assets, setting clear and pragmatic rules for perfection and priority of their transfer, clarifying inadvertent legal ambiguities, and reducing unnecessary transaction costs.

SECURITISATION NEWS AND DEVELOPMENTS – March, 2001

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IMPORTANT

For all news for April, 2001, please click here 
For all news for Jan. and Feb. 2001, please click here 
For all news for Nov. and Dec., 2000, please click here 
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For all news for May and June, 2000, please click here 
For all news added before May, 2000, please click here 
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For all news added before 9th November, please click here   
For News items added prior 3rd August, 1999, click here.

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

S&P downgrades Hollywood 4, retains 
AAA for Lexington Capital

The Lexington Capital – Hollywood Funding controversy continues. In a press release of 30th March, Standard and Poor's (S&P) downgraded Hollywood Funding 4 from AAA to BB, as Lexington Capital, the insurer, continues to maintain that it had a valid defence on account of failure of warranties.

Lexington's position is that its policy is identical in all material respects to the policy interpreted in the U.K. case known as HIH Casualty and General Insurance Ltd. v. New Hampshire Insurance Company and others, in which the court held that breach of warranty issues, coverage issues, and fraud can properly be raised as defenses to payment. The decision is on appeal before the Court of Appeal.

The rating agency, however, "believes that the policies are absolute and unconditional, that there are no conditions or warranties that need to be satisfied in order to draw on the policies (other than the money in the escrow account being insufficient), that Lexington has waived all of its defenses to payment on the policies, and that the policies meet the standards of the capital market for credit enhancement of financial market instruments."

In another press release of 30th March, S&P affirmed the rating of Lexington as AAA. The affirmation follows "a review prompted by the recent position taken by Lexington on the insurance policies issued in connection with the Hollywood Funding No. 5 and No. 6 film finance transactions rated by Standard & Poor's and the resulting commercial dispute regarding policy coverage. The ratings on these transactions were recently lowered (see press release of Feb. 2, 2001). Should the dispute be resolved in favor of the insured, Standard & Poor's expects that Lexington would honor its obligations under those policies. In view of this, Standard & Poor's believes that AIG's market position is not adversely affected by these coverage disputes. "

Korean company in first cross-border performing asset securitisation

Korean finance company Samsung Capital will securitise auto loan receivables in an interesting transaction credit-enhanced by Financial Security Assurance (FSA). Standard and Poor's has assigned AAA rating to the transaction, which it says "marks the first Korean cross-border securitization of auto loans" to originate from Korea.

The USD 187.5 million transaction follows this structure: the loans are originated by Samsung and sold to Credit Creator, a limited liability SPV formed in Korea. Credit Creator has issued a credit linked note to Credit Creator Ltd., a Cayman Islands company. The Cayman Islands company has been guaranteed by FSA.

Foreign currency exchange and interest rate risks associated with the Korean won-denominated auto loan pool have been hedged through a Korean won/U.S. dollar cross-currency swap provided by ING. This type of swap is difficult to obtain: illiquidity in the swap market has long been an impediment to the successful launch of cross-border transactions originating from Korea.

Non-performing loans have been securitised from Korea on cross-border basis – see Kamco transaction reported on this site.

Links See our country page on Korea.

Real Estate Roundtable seeks time to apply FAS 140

The Real Estate Roundtable, "an organization comprised of the principals of the leading real estate companies as well as the elected leaders of many of the major real estate trade associations", has a written a letter to the Financial Accounting Standards Board seeking deferral of FAS 140 to commercial mortgage-backed securitizations by at least 90 days to clarify ambiguity relating to powers of SPVs.

FAS 140, the new accounting standard on securitizations, is to apply to all transfers made after 31st March, 2001, that is, from Monday next. One of the new conditions inserted in the accounting standard is the limitations on the powers of the SPV. These limitations substantially limit the powers of the SPV on sale of the assets transferred to them. Paras 42/43 and Paras 189/190 of the Accounting Standard deal with these limitations. Importantly, the SPV cannot choose to either sell or retain the assets, if certain trigger events take place, e.g., obligor default.

The CMBS industry is upset by this rule. The industry argues, and apparently understandably, that servicing a pool of commercial mortgage-backed securities or commercial loan obligations could be more complex and involve a higher degree of discretionary activities than in case of other classes. Interestingly, the accounting industry as a whole seems to be caught off guard by this ruling. Because it would require QSPE to dispose of assets in an automatic response to certain events outlined in the FASB rule, the proposed rule would adversely affect the accounting requirements. It would also materially impair the special servicers' discretion in the disposition of assets and could lead to higher loss rates on specially serviced loans.

So, either the CMBS industry re-invents itself in line with the new rules, or it negotiates a way out to live with on-the-balance-sheet accounting.

Links For more on accounting under FAS 140, see our Encyclopaedia page here.

AIG-group insurance company's legal disputes put make securitization investors jittery

First it was LTV, and now it is the refusal of AIG-group insurance company to honour its insurance commitment that covered a film-financed backed securitization deal. They all prove one thing- the securitization market is not immune from defaults, delays and downgrades that rock the rest of the fixed income market. The litigation discussed below could be particularly a problem for emerging market future flow deals.

The background of the American International Group Inc. (AIG) story is like this: Lexington Capital is a part of the AIG Group. A certain SPV called Flashpoint Inc. had securitised future receivables from Hollywood film productions. The deal was credit enhanced by an insurance cover from Lexington Capital, which is a AAA-rated insurer. As is the convention, when a transaction is backed by a AAA guarantor, the asset-backed transaction itself is rated AAA. Most of the money in the transaction was put in by a single investor called Quadrant Capital, a UK-based structured investment vehicle. These films are unlikely to be made, and Lexington Capital has refused to honour its commitment under the insurance contracts.

Lexington, on its part, distinguishes betweeen a guarantee contract and an insurance contract. The credit enhancement in question was an insurance and not a guarantee, and according to Lexington, the money is not payable as the films were never made. As a matter of fact, Lexington claims support of a British court ruling, presently in appeal, in a similar case.

Vinod Kothari comments: An insurance contrat is a contract of indemnity, different from a guarantee, and the distinction between the two is well understood- so Lexington might have a good case in law. The point is: securitization markets, and rating agencies in particular, have to understand out of experience that an insurance policy is not at par with a financial guarantee, and that from a multiline and monoline insurer does not go on the same footing. If the market keeps responding to a go-go call of optimistic investment bankers, such problems are bound to recur, and one cannot blame securitisation structure for such failure.

Future flow deals will particularly be affected by this controversy – as that is where the legal tangle between claiming a damage on account of non-performance of the obligor, and that of the originator, becomes important.

BIS overburdens mortgage loans and MBS

A senior economist attached with the Office of Thrift Supervision in the USA demonstrates in a paper as to how the BIS risk weightages on mortgage lending are more than what they should be, and on commrecial loans, they are less than what they should be. In other words, MBS is safer than the BIS thinks, and commercial loans are riskier than the BIS thinks.

The current regulatory risk weightages of the Bank for International Settlements (BIS) were promulgated way back in 1988 and are based on arbitrary percentages worked out based on observation/experience. They suffer from the "error of the average", and BIS recently proposed a complete rewriting of its regulatory standards moving from the present system to one of risk rating of each individual loan – see our article here.

The present BIS standards attach a 50% risk weightage to mortgage loans. In his conclusions based on data over years, the author finds: "Annual cross-sectional histograms reveal that real estate in general, and 1-4 family mortgages in particular, consistently pose the least credit risk of the six loan categories considered. Commercial and consumer loans typically pose the greatest risk. The Basel risk weights do not appear to price risk consistently across loan types."

Download: Full text of the article here (PDF file)

US ABS celebrates highest volume quarter

If volumes in year 2000 were not as enthusing, Q1 of 2001 shows that the current year has cheers in store. Volume in the first quarter of 2001 have broken all records in history. With a week still to go, the volume upto 23rd March has already reached USD 92.4 billion. The data is available on abalert.com.

The figures show a substantial increase in public issuance and a decline in 144a issuance. Data to date (23rd March) already shows an increase of over 30% over corresponding period last year.

Analysts say that in general, there is a lot of money flowing out of equities and into debt, and ABS is the investors' favourite. The traditional MBS investors are also migrating over to the ABS market as prepayments build up due to consistently declining interest rates.

Links For more about securitization in the USA, click on our country page here.

Telecom Italia ready to securitise receivables

In some of our previous reports, we talked about the increasing interest of European telephone giants in securitization: some have gone ahead and done it and some have on the drawing board. We also referred to the proposal by Telecom Italia to securitise its receivables.

Telecom Italia's proposal to securitise seems to have reached an advanced stage. Italian media Il Sole 24 Ore of 24th March reported that Telecom Italia will raise some euros 750 million by securitisation of phone receivables. This will be the first purely corporate user of securitization under Italian securitisation law which is currently dominated by banks, leasing companies and the like.

The issue will be arranged by BNP Paribas SA, Finanziaria Internazionale and WestLb.

It is set to sell millions of bills, possibly 10 million, to a special issue vehicle named "TI Securitisation Vehicle Srl". The bond will be sub-divided into tranches with different ratings from the maximum possible, "AAA".

Links: For more on securitisation in Italy, refer to our country page. This page was recently updated.

European Securitisation Forum recommends disclosures in offer documents

The European Securitisation Forum, a body of securitisation professionals in Europe and affiliated to the Bond Markets Association, USA, has finalised disclosure requirements in offer documents for securitisation. The new recommendations overwrite on the standards finalised in June 1999.

The recommended disclosures should:

(a) Be clearly identified under a separate heading or subheading within the disclosure document.

(b) Set forth the principal categories, fields and individual items of data, at both the collateral level and security (bond) level, that will be contained in post-issuance reports;

(c) Set forth definitions of key data items to be presented in such reports, to facilitate analysis and comparison;

(d) Specify the timing (e.g., monthly, quarterly or other periodic schedule) that will be observed in the production and dissemination of post-issuance reports;

(e) Identify and provide contact information for the transaction participant(s) (e.g., trustee, administrative agent) that will have principal responsibility for preparing and disseminating post-issuance reports;

(f) Identify specific underlying transaction documents (e.g., indenture, pooling and servicing agreement) that contain more detailed information concerning the content of post-issuance reports, including details concerning how those documents may be accessed or obtained;

(g) Set forth the specific format that will be used in assembling and transmitting reporting data (e.g., text, spreadsheet or other database format); and

(h) Specify the communication and distribution channels that will be used to disseminate post-issuance reports, or from which such reports may be obtained (e.g., internet websites, third-party information vendors, other electronic media outlets).

Links See the website of the Forum here.

Professionals form securitization trust company in South Africa

A lawyer and a chartered accountant joined hands to serve the fledgling securitization market in South Africa, and thus, Steinway Trustees, the first independent trust company for securitization in South Africa, came into existence.

The company was formed by Peter Ditz, a lawyer, and Don Guthrie, chartered accountant. Steinway will provide services of independent trustee for securitizations. An independent SPV is required under South African regulations – see for text here.

Market professionals said the exact volumes of securitization in South Africa were not known but it could reach Rand 20 billion in three years.

The stress for bank funding by way of securitization has increased in South Africa ever since exchange controls were relaxed: more money is now going out of the country.

Related links See our country page on South Africa here. For a forthcoming workshop on accounting for financial instruments, to be conducted by Vinod Kothari in South Africa, click here.

Philippine government plans future flow securitisation to bridge budget gap

According to report on Philstar the Philippine government might be considering a bond scheme securitized by future income from state-controlled agencies and might raise about P56 billion. The amount would help the Government to bridge the country's spanning budget gap. Such a proposal has been sounded long time back and we have carried a news report earlier – click here.

The government was looking at issuing debt instruments backed by future earnings of the Philippine Amusement and Gaming Corp. (PAGCOR), Subic Bay Metropolitan Authority and Clark Development Corp.

The plan to securitize government’s future income from state-run corporations was first hatched by former finance secretary Edgardo Espiritu. His predecessor, Jose Pardo also wanted to implement theh plan but it never pushed through.

Link: For text of securitisation law in Philippines – click here.

The art of ART spans broad field of corporate finance

Alternative risk transfer (ART) devices are becoming the buzzword of high finance and risk management in 2001. ART has lied low over last few years, and as we commented in our write up below, it has been more talked about than practiced. However, with insurance costs rising, there is a distinctive surge of interest in ART. However, more importantly, ART devices are now being seen as a complement to the traditional sources of corporate finance – equity and debt.

First, about the increasing cost of insurance and the rise of interest in ART. A report by the Insurance Information Institute based in New York expects insurance costs to go up by about 10% during 2001. There is more incentive than ever before, therefore, to explore new avenues of risk transfer.

Coming to the use of ART devices as a part of an integrated approach to corporate finance, companies like Swiss Re New Markets are now looking at an integrated approach to corporate finance. The company sometime back proposed risk capital as a building block of corporate capital – click here for a report. An article in a recent issue of journal Risk Management March 2001 quotes John Gantz of Swiss Re New Markets as saying: . "ART isn't just financial solutions or nontraditional solutions to hazard risks. We're not focused so much on hazard risk as we are on the earnings and financial statements of our clients. In effect, we don't have an insurance approach, but an insurance-based corporate finance approach."

Corporate finance is a remarkable word, in the world of insurance. What Gantz is proposing, in essence, is that after all, equity is a source of the ultimate risk capital in a corporate. If external risk support is available in form of a business risk transfer, the need for equity support is reduced, thereby making equity more efficient.

Links Do visit our Risk securitization page for additional materials and links. Several articles on ART are linked on website Artemis – click here. Swiss Re's new markets website is here.

Deutsche Telekom to securitise receivables

A report in Financial Times of 21st March says Deutsche Telekom, the German telephone utility proposes to securitise its telephone revenues to raise resources and restructure its finances. We have earlier carried similar report – see here.

European telephone utilities have been looking at looking at securitisation option to repay the costly debt they incurred while building capability for third generation mobile telephony. Telecom Italia and France Telecom are among the telephone companies who have been making similar noises in the past. The telecom companies hope to reduce their cost of funding due to better ratings normally featured in structured finance deals.

Under the proposal, Deutsche Telekom would transfer future telephone flows into an offshore vehicle, an SPV for the transaction, and raise anywhere between Euros 1.5 billion to Euros 2 billion.

Canadian market grows 8 fold in 5 years

An article in Financial Post of 21st March, quoting a study by Dominion Bond Rating Service, says Canadian asset-backed market has growh 8 fold in just 5 years and the value of securities outstanding as at end 2000 stands at Canada $ 79.4 billion. This volume compares with Canada $ 66.4 billion as at end 1999, and something like $ 10 billion 5 years ago.

As a feature that cannot be missed, Canadian market is predominantly funded by asset backed commercial paper – to the extent of $60.6 billion, and it is only the balance which is backed by term paper in form of bonds or notes.

The asset classes are also becoming more diversified, says the report. Commercial mortgages and credit card receivables, apart from banking assets, are now being securitised. Recently, we carried a report about CMBS market gaining momentum – click here.

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

Sidley and Austin awarded top law firm for CMBS market

In the latest annual rankings of CMBS law firms released by Commercial Mortgage Alert, Sidley placed Number 1 in 2000 among law firms used by underwriters, and tied for first among those used by issuers of registered and Fannie Mae guaranteed commercial mortgage-backed securities.

Of the nearly $29.5 billion in public commercial mortgage-backed securities issued last year, Sidley accounted for around 28% of the underwriting market, representing underwriters in nine of the 35 public and Fannie Mae offerings in 2000.

The CMBS market covers a broad spectrum of commercial real estate financings, everything from multi-family housing to industrial, retail, hospitality, health care and other forms of commercial real estate. Mortgage-backed securities play a significant role in the financing of large commercial real estate in the U.S., from shopping malls to office parks.

In 1999 Sidley was at the second position, preceded by Cadwalader Wickersham which has slipped to the 4th position this yeare.

Tokyo government helps securitise small business loans

This is a remarkable example of a government authority using securitisation to further its developmental objective. According to a report on Dow Jones, last week, the Metropolitan government of Tokyo arranged to issue to investors some Y32 billion in collateralized loan obligations, securitizing loans extended by most of the nation's big banks to 952 Tokyo-based small and midsize companies. This comes at a time when Japan's small business is starved for cash and banks, scared of losses and failures of large Japanese banks, have put brakes on lending.

Under the specially-designed scheme, small firms get access to capital, borrowing up to Y500 million each without putting up collateral. The loans are guaranteed by the Credit Guarantee Corp. of Tokyo. The loans are thereafter pooled and securitised. The three-year bonds are being issued through Tokyo Kirari Corp., a Cayman Island-based special purpose vehicle, and are being launched via joint lead managers Sanwa Securities and Tokai International Securities.

The bonds are broken into 4 tranches and it is only the two subordinate tranches which have the benefit of the guarantee of Tokyo government. Tranche C and D, thus enhanced by the guarantee, are targeted at retail investors.

Other governments may take a leaf from out of the book of Tokyo experiment.

Strong interest in securitization in Spain, says Standard and Poor's

Rating agency Standard and Poor's in a Release dated 13th March says it has noted a very strong interest by financial institutions to use securitization as a mechanism to transfer risk, and thereby manage their balance sheets more efficiently. In addition, Spanish corporates have started looking at securitization as a new source of financing. For the remainder of this year, Standard & Poor's expects to see increased growth in the use of fondos de titulización de activos (securitization funds) to securitize corporate loans and small to midsize loans, as well as the expansion of the securitization of consumer loans, future flows, and trade receivables.

The securitization of trade receivables, using either a foreign asset-backed CP conduit or a fondo de titulización de activos, may prove an attractive source of funding for Spanish corporations.

Securitization is becoming a relatively common financial product in the Spanish debt market. It has been used as an alternative source of financing in Spain since the early 1990s. Since then, the market has been relatively active, with a peak of 14 and 13 transactions in 1999 and 2000, respectively. Of the 13 securitizations seen in Spain during last year, three were FTPYME (fondo de titulización pequeñas y medianas empresas) transactions, six involved residential mortgages, and four involved asset-backed securities, which, by volume, account for 21%, 36%, and 43%, respectively, of the total market.

Although mortgage-backed securities remain a very strong asset in this market, in contrast to previous years collateralized loan obligations (CLOs) have been the main contributor to the recent growth of the Spanish market. The loans used in Spanish CLOs have typically consisted of loans to big corporates, loans to municipalities, and loans to small and midsized enterprises (SMEs). It is not surprising that this type of asset was new to the market in 2000.

In 1999, the Spanish government implemented a program through which the Spanish Treasury gives partial guarantees for qualifying securitizations of SME loans (see the May 28, 1999 Ministerial Order to facilitate the access to finance SMEs). The portfolios that qualify for this type of guarantee must meet the following conditions: At least 40% of the loans in the portfolio must meet the European Commission's definition of SMEs; The maturity of the loans must be greater than one year; The transferor of the loans to a fondo de titulización de activos must reinvest at least 40% of the proceeds of the sale to grant new loans to SMEs; The transferor must sign an agreement with the Ministry of Finance; The SME cannot be a financial institution; and The SME must be domiciled in Spain. For these types of transactions the treasury will irrevocably and unconditionally guarantee 80% of the 'AA' rated securities, 50% of the 'A' rated securities, and 15% of the 'BBB' rated securities.

Although the Spanish legal securitization framework creates two types of fondos–fondos de titulización hipotecaria (mortgage securitization fondos, under law 92/1992) and fondos de titulización de activos (assets securitization fondos, under royal decree 926/1998)–that can be used for the purpose of securitization in Spain, originators will likely also look at new types of offshore structures, for example, for credit default swaps and Pan-European transactions.

Links See our country page on Spain here.

Risk securitisation volume may grow in 2001

Risk securitization or alternative risk transfer looked a beautiful idea, but over last 2-3 years, it was more talked about than practiced. An article in Business Insurance March 12 says that the volume of risk securitization might pick up in 2001.

The volume of risk securitization over last three years has been almost flat at USD 1. 2 billion but it might double this year, says the article. The reasons are increasing reinsurance costs and the growing investor interest in insurance-linked securities.

There have been two significant deals so far during this year – Munich Re's USD 300 million notes, and USD 100 million issuance for California Earthquake Authority structured by Swiss Re. These deals evidence the increasing flow of business, according to market practitioners. The reasons for the flurry of activity are increasing reinsurance cost and reducing scope for retrocessional cover.

Practitioners say that the market for risk securitisation is seeing increasing issuer interest to hedge risks for which traditional insurance covers are not available such as credit risk and commodity risk. Swiss Re pioneered talking about risk capital as a source of managing the liability side of the balance sheet.

Another path-breaking deal of year 2000 was Arby's securitisation of franchise fees. While franchise fees have been securitised in the past as well, the unique thing about this deal was its insurance link, involving a financial guarantee insurance policy from Ambac Assurance Corp., reinsured on a first-loss basis by Swiss Re Group subsidiary European Reinsurance Co. of Zurich, Bermuda Branch, with Ambac taking an excess-risk position. Notes worth USD 290 million were finally issued by the SPV.

Not only in the USA, even Europe seems enthusiasticly growing in alternative risk transfers. One insurance broker reported a fee of as much as USD 37.3 million, an increase of 65% over 1999 earnings.

European tax haven Guernsey has already enacted enabling legislation for incorporation of protected cell companies. For more on protected cell companies, see our report here.

Link See our page on risk securitisation here.

Canadian CMBS market gets a boost

According to reports in Financial Post of 12th March, the Canadian commercial mortgage-backed securities market is set to receive a major boost with the news that at least three deals are in the making.

Caisse de depot, through N-45 Degree First CMBS Issuer Corp., is set to securitise some of its commercial mortgage assets. That deal is expected to come to the market near month-end, and is likely to touch about $350-million. CIBC World Markets is the lead agent.

Merrill Lynch Mortgage Loans will act as a conduit for yet another mortgage securitisation for a transaction approximated at $ 300 million. Merrill will be acting merely as a conduit for mortgages originated by others.

The third deal, expected to be scheduled in early May, is a $275-million offering by Solar Trust, an entity associated with TD Bank.

Links For more on securitisation in Canada, refer to our Country page here.

Shipping pool receivables securitised in India

In line with the spate of securitisations hitting the market in India, newspapers on 13th March carried a tombstone advertisement of a securitisation of shipping pool receivables, for an amount of Rs. 280 million [approx. USD 6.2 million].

The originator is Varun Shipping and the deal has been structured and financed by Infrastructure Leasing and Financial Services Limited.

Do you know more about this transaction – if so, please do write.

Links For more on securitisation market in India, click on our country page.

European CDO activity surges

The European collateralized debt obligations (CDO) market, which includes collateralized bond/loan obligations (CBO/CLO), ended February 2001 a massive 76.5% higher at $3.0 billion, compared with $1.7 billion in the same period a year earlier, says a release by rating agency Standard and Poor's.

According to analysts from S&P, the upsurge has been prompted by European banks' and fund managers' increased use of CDO technology as a balance-sheet management tool and for arbitrage purposes. Besides the traditional centres as UK, a lot of activity is coming from Germany, The Netherlands, France, and Spain.

A report in Deutsche Bank's Securitisation Monthly says that the unusual increase in CBO/CLO sector is accounted for largely by Melrose Financing, a UK CLO. Having a size of Euro 2.4 billion, this is regarded as the largest ABS transaction in Europe to date. Melrose securitised a portfolio of 559 U.K. mid-market corporate loans (250 borrowers) originated by Bank of Scotland. This was the second CLO (after Clover Funding, issued April 2000) using a master trust structure, which also became popular for MBS transactions last year.

February issuance also included three operating assets deals. sector, including Euro 1.5 billion deal from debt for Eurotunnel, the Euro 1 billion RHM issue that securitises the whole business of Ranks Hovis McDougall, a U.K. flour, bread and groceries producer. The RHM transaction by intangible assets being trade marks and business rights.

Electrification finance compay in India securitises receivables

Of late, there is quite a lot of activity in securitization market in India, and the activity got a further boost when Rural Electrification Corporation (REC) reported having securitised its receivables. On March 7th, REC reported having successfully securitised receivables worth Rs 2060 million [USD 46 million approx.] from Aptransco, the distribution utility in the state of Andhra Pradesh. REC provides financial assistance by way of loans to power infrastructure projects in rural areas.

ICICI was the advisor to the issue with ICICI Securities, SBI Capital Markets, Allianz Securities, and ABN Amro Securities acting as lead arrangers to the deal.

This is the first securitization in the power sector in India. The receivables are to accrue over 61 months time. The coupon rate for the deal has been pegged at 11 per cent on an annualised rate. The amount will be payable in equated monthly instalments. Most of the buyers are nationalised banks. The largest investor in this securitisation issue is Punjab National Bank, which has bought Rs 1000 million, UTI, Rs 400 million Central Bank of India, Rs 250 million; Corporation Bank, Rs 150 million; Union Bank, Rs 100 million; etc.

The issue has been rated `AAA(SO)' by Crisil.

The transaction is with full recourse as it is based on an irrevocable and unconditional undertaking executed by REC, assuring full and timely payment on the pass through certificates (PTCs). The payment security mechanism includes a default mechanism wherein, if there is any default by Aptransco, all other payments from the accounts of the transmission utility in the State Bank of Hyderabad will be stopped until REC installments are paid-off.

Vinod Kothari comments: The structure is closer to collateralised lending than securitisation. It is structurally wrong to call the instrument a "pass through" when it hinges on the credit of the originator. However, with this and similar deals coming up, there would be a lot of supply of securitisation paper in India and market activity will pick up, leading to more refinement in practices.

Links For more on securitisation market in India, click here.

Chrysalis raised GBP 60m by securitising future royalty income

Reuters reported on March 1 that London-based media firm Chrysalis Group Plc was reaping GBP 60 million pounds from the future income of its global music catalogue, which includes songs by the Beatles and David Bowie. Funded by U.S.-based MUSIC Finance Corp. and arranged by Royal Bank of Scotland, the Chrysalis deal represents about 40 percent of the estimated current value of the firm's music publishing catalogue over next 15 years.

The earliest known example of music royalty securitization is David Bowie in 1997, but there have been a number of other deals thereafter.See our page on intellectual property securitisation for details.

Argentinan mortgage securitisation agency issues political-risk-insured paper

Argentinan mortgage securitization agency Banco de Credito y Securitizacion (BACS) recently issued USD 95 million worth mortgage securitisation paper that was insured for politcal risk by Sovereign Risk Insurance Ltd. BACS is the Fannie-Mae-type mortgage securitization agency created in Argentina with the support of IFC – see our news report on this site here.

This issue is the first securitization by BACS.

The issue was tranched in senior bonds of USD 95 million, forming part of USD 115.8 million mortgage bonds.

The political risk insurance provided by Sovereign helped the transaction to achieve significantly higher ratings. Moody's assigned an "A1" rating to the senior bonds, which is the highest rating that can be assigned to a cross border bond supported by Argentine assets, while Fitch Inc. rated the transaction "A+". These ratings are 9 notches above Argentina's sovereign ceiling for Moody's and 7 notches for Fitch Inc.

The 12-year political risk insurance policy covers up to 15 months of interest payments on the notes against the risks of currency inconvertibility and currency nontransfer. Bear, Stearns & Co. Inc. served as sole placement agent for the senior bonds pursuant to a Rule 144A /Regulation S private placement.

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

LTV case gets new twist with DIP petition

Important: See also Editorial on this issue.

The truth shall prevail, if the petition by LTV filed on 5th March is admitted. The truth of the securitization transactions, we mean.

The LTV case involves determination of a very significant question by the US Bankruptcy Court of the Northern District of Ohio: whether the accounts receivables securitization facility used by LTV, now under Chapter 11 protection, was a true sale or disguised funding. The case caused strong ripples in the securitization markets, seeing several industry representatives filing an amicus curae motion which was admitted by the Court.

However, even as the case was scheduled for hearing on 7th March, LTV filed, on March 5, motions seeking to replace the securtisation facilities by two alternative Debtor-in-possession (DIP) facilities. The precondition, however, for both the DIP facilities is that the bankruptcy Court gives a verdict approving the securitization transactions as true sales and not disguised funding transactions. The DIP facilities proposed by LTV seek to replace the existing securitization transactions. The participants in the erstwhile securitization transaction will enter into a DIP facility with LTV with which the participants will buy out the receivables held by the SPV.

If the Court approves the DIP option, it would have expressly resolved that the transfer of receivables and stocks by LTV to the SPV was a true sale and such resolution would save the multi-trillion dollar securitization industry from a crucial legal controversy.

With the new motion by filed by LTV, the true-sale question has been adjourned to March 14. Mayer Brown and Platt, who are representing the amici curae in the case expect the hearing to further adjourned.

Contentions of the amici curae

Mayer Brown and Platt's Securitization.net gives the full text of the motion and the background memorandum filed on behalf of the amici. The 41 page backrounder is an excellent document on the significance of securitization industry in US economy and how it is benefiting all connected parties, as also a crisp account of the legal strength of securitization transactions.

The memorandum says that US securitization industry is USD 5.9 trillion strong (the value of securities outstanding, including mortgage-backed paper and asset-backed commercial paper). Approx. USD 1 trillion worth securities were issued in 2000 alone. It says that issuers have increasingly been resorting to securitization to reduce cost of funds, attain liquidity and greater access to funds and resources.

The memorandum contends that the economic and legal rationale of securitization, in isolating the assets of the originator and thereby protecting investors from the generic business risks of the originator, are well founded. The investors who see greater security in such investments are willing to subscribe at lower rates, thereby bringing down the cost of funds for the originator, which benefits everyone including consumers. It is customary to use a subsidiary as an SPV in securitizations, as was done by LTV, but US Courts have consistently approved commercial transactions with subsidiaries. [Comstock v. Group of Investors 335 US 211]. There cannot be any doubt as to the "good faith" nature of a securitization, in that it does not amount to assets being stripped off the originator, as the originator retains equity control on the subsidiary or gets paid in cash for what he transfers.

There is no doubt that LTV benefited from the transfer of accounts made by it, which is what it now challenges as being not a true sale. The amici are concerned about the generic and frontal attack LTV makes against securitization structures in general, and the ripple impact the case will have on the securitization industry. LTV has cited several reasons for consolidation of the SPV with by lifting the corporate veil, such as no separate office space for the SPV, no separate employees, sweeping of cash balances back to LTV, settling of interparty transactions by accounting entry rather than cash transfers, etc. The amici contend that these are usual facts in intra-group transactions and using such grounds as the basis for consolidation would completely demolish the separation of corporate entities.

Amici also cite several rulings of bankruptcy courts in the past where securitizations have been respected by Courts. Amici refer to Allied/Department Stores and Carter Hawley Hale to their benefit.

Amici refer to the history of the Octagon Gas Systems in which case a securitization transfer was recharacterised which met with the disapproval of the UCC Permanent Editorial Board and subsequently led to the law of Art.9 of Oklahama commercial code. [For the amendment to UCC art. 9 and more about the Octagon ruling, this article by Prof. Steven Schwarcz on this site here. ] Amici also remind the Court of the disruption the Octagon ruling had, and that the high profile case of LTV is likely to cause a similar disruption.

More updates and comments We will be bringing more updates and comments on this case soon – stay tuned. Also see the editorial on the issue. For more on the true sale question, see our page here.

UK's first reverse mortgage securitization rated by S&P

UK's first ever reverse mortgage securitization was recently rated by rating agency Standard and Poor's (S&P). A S&P release said the agency assigned its preliminary ratings to the GBP 222.5 million fixed- and floating-rate mortgage-backed notes to be issued by special-purpose entity Equity Release Funding (No.1) PLC. The originator for the mortgages is Norwich Union Equity Release Ltd.

Reverse mortgages are peculiar mortgages designed for old-age people, who essentially want to encash upon the equity in a house owned by them, and supplement their income during their old age, and finally aim at giving up their house when they die. For more details on reverse mortgages, see our section here.

Reverse mortgages have so far been popular only in the USA. This is the first case of a reverse mortgage securitisation in the UK. The mortgages being securitised were created by the originator between December 1998 and November 2000. The average age of the borrowers under these mortgages is 70 -74.

The offer has been given a preliminary rating of AAA by S&P.

Links For more on reverse mortgages, click here. For more on RMBS, click here. For securitization in UK, click here.

Second rated RMBS offer in India

Even as the Finance Minister promised a comprehensive securitization legislation [see below], India's RMBS market got a fresh supply – the second such offering – in form of pass through certificates (PTCs) from National Housing Bank. The PTCs are backed by portfolios of loans acquired by NHB from two originators – Canfin Homes and LIC Housing Finance. The size of LIC Housing Finance's offering is Rs. 468 million of Class A notes, and that of Canfin Homes is Rs. 448 million Class A.

The substantial amount of credit enhancement comes in form of subordinated PTCs retained by the originators, which, in case of LIC Housing Finance, was almost Rs. 274 million.

Both the offerings got a AAA rating.

Vinod Kothari comments: In this year's budget, National Housing Bank, the apex housing finance institution, will lose its tax free status. NHB is acting as SPV for this and other transactions. The way these deals have been structured, the loose PTC structure might not be regarded as a clean pass through, exposing NHB to tax in a representative capacity.

Links See our country page on India – click here.

Swiss Re structures insurance-linked bond for Californian authority

The California Earthquake Authority (CEA) and two leading financial service companies have used a combination of reinsurance and investment capital to arrange $100 million that will be available to CEA policyholders in the event of one or more major earthquakes over the next 23 months. As part of the transaction, the CEA signed a $100 million reinsurance contract with Swiss Reinsurance Company. Subsequently, Swiss Re Capital Markets Corporation (SRCM) and Goldman, Sachs & Co. co-led a private offering and jointly placed $97 million of floating rate notes and $3 million of preference shares that, in effect, will replenish Swiss Re's capital should such an earthquake occur.

The transaction is similar, though not exactly the same as the cat bond device prevailing for past few years.

The floating rate notes were rated BB+ by Standard & Poor's and Ba2 by Moody's. The issuer, Western Capital Limited, is a Bermuda special purpose company whose common shares are held in trust. Payout of the floating-rate notes is linked to an index of California earthquakes as determined by the Property Claim Services (PCS). Earthquake risk analysis was provided by Oakland, CA-based EQECAT Inc. A unit of Swiss Re New Markets, SRCM structured and placed the first California earthquake bond and the first insurance industry loss indexed bond (SR Earthquake Fund) in 1997.

Thanks This news item was contributed by Adrian Leonard, an specialised financial freelance writer risk related issues.

Links Please do see our risk securitization page – click here.

Truth-in-sale question question in LTV bankruptcy worries industry

In good times in securitization industry, a "true sale" opinion from the lawyers might only mean days spent on lengthy legal conferences, a one-inch thick securitization document, and finally, a big hole in the pocket on account of legal fees. But once in a while, bankruptcy of the originator could expose a seldom thought-of question : was the sale of cashflows from the originator to the SPV a sale in fact?

While a US bankruptcy court is currently seized of this issue, the entire securitisation industry is watching the proceedingly anxiously. The case in point is the bankruptcy of LTV Corporation. LTV, a Ohio-based steel company, filed for protection under Chapter 11 on 29th December last year. The bankruptcy court allowed LTV to use its receivables to maintain its staff payments, etc. However, this is where Abbey National stepped in – contending that LTV had no right to the cashflows, as the same had already been securitised. Way back in 1994, LTV had transferred, on a revolving basis, receivables to its SPV called LTV Sales Finance Co., and Abby had bought interest in such receivables.

LTV's lawyers contended that the sale of receivables by LTV is nothing but a disguised financing.

Even as the hearings go, the securitisation industry is worried. Revealing the worry is the fact that several concerned parties, including Bond Market Association, MBNA Corp., GE Capital Corp., Residential Funding Corp. and the Consumer Mortgage Coalition have prayed before the Court to be included as amicus curae and have pleaded that the true sale character of the receivables should not be disturbed. The list of those pleading to be included as amicus curae runs to 23 top names in the securitization industry, represented by Mayer Brown and Platt. Mayer Brown and Platt emphasize that securitization is based on century-old concepts of absolute transfers among affiliated entities and corporate separateness that have been long recognized under federal bankruptcy law, that securitization has become a $5.9 trillion market, benefitting all segments of the U.S. economy (including locally important segments such as the auto industry), that securitization transactions have been routinely respected in other bankruptcy cases, and that accepting LTV's frontal attack on securitization could cause a seismic disruption of the financial markets.

There have been cases in the past where purported securitization or receivables transfer agreements have been characterized as loans: the issue depends almost entirely on the facts and the strength of documentation. The case is scheduled for hearing on 7th March. On this site, we will be covering further developments in this case.

In yet another unrelated development, US airline company TWA filed for Chapter 11 protection in Jan. this year. TWA has originated several securitizations in the past, and is the obligor for several other aviation related securitisations. There are as many as 7 operating leases to TWA that have been securitised by the respective lessors. Rating agencies do not expect much problem for operating lease securitizations, as the leases, if cancelled, can only result into release of the aircraft to the lessor which can be redeployed.

But the bigger problem is for future ticket sales deals securitised by TWA. This is a ticket sale securitisation through Constellation Finance LLC Series 1997-1. This deal, worth around $100m, was rated BB and sold in December 1997 and is collateralised by ticket sales being paid by specified credit cards. The deal does have a cash reserve, and fast amoritisation trigger, but quite possibly, will be affected by the bankruptcy.

No airline originated deal has defaulted in the past.

Links Our article on true sale in securitization covers the true sale question as also major cases in the past – click it here. See the comment on Mayer Brown and Platt-sponsored website on the LTV case – click here.

Indian Finance Minister promises securitisation law

Finance Minister Yashwant Sinha presented a reforms and growth-oriented Budget for 2001-2. The Budget has been hailed as bold and beautiful, though it contains some fine prints which might hit the financial services sector. [See Vinod Kothari's financial services website for a detailed commentary]

Proposing several measures to invigorate the debt market, Yashwant Sinha listed a proposed comprehensive securitization legislation too. Though no time frame has been laid, it is expected that the Bill may be placed in the next session of the Parliament.

Draft of the securitization legislation proposed by the Andhyarujina panel is already on this site – click here. The draft law is almost like the wish-list of the securitization industry – it is just too good.

Link For more on securitization in India, click on our country page.

Malaysian securities regulator places capital market masterplan

Malaysia's securities regulator, Securities Commission (SC) recently prepared a Capital Market Masterplan (CMM) whichi aims to turn Malaysia into an international Islamic capital market centre by introducing more Islamic capital products and services.

The CMM also includes proposal to create a new securitization instrument – new class of debt securities can be created through the securitisation of real estate held by Wakaf, Baitul Mal and other Islamic institutions. Wakafs are Islamic endowments.

Currently, Cagamas, a mortgage securitization body in Malaysia, buys and securitises the mortgage loans of Malaysian banks and financial institutions, but with recourse to the originators. Other than securitisation by Cagamas, there is not much of activity in the field of securitisation, either by banks or by others.

The Securities Commission is also vested with the task of preparing Guidelines on securitization, which as per last available information are still in the process of being drafted.

Links See our country page on Malaysia here.

US insurance regulators agree on model SPV law

Ina meeting in Atlanta on Feb. 6, the National Association of Insurance Commissioners' Securitization Working Group has agreed in principle to a model act that would allow insurers to use onshore special purpose reinsurance vehicles to securitize risk. The meeting was attended by regulators from 11 states.

The law will facilitate setting up securitization SPVs for insurance securitization in the US. Presently, securitization SPVs are being exported to off-shore jurisdictions primarily because of lack of an enabling legislation. Consequently, insurance risk securitization has not gathered the pace otherwise thought of.

Due to this, most of the insurance risk securitization activity is carried in tax haven jurisdictions. Analysts estimate that so far, over last 7-8 years of the history of risk securitization, there have been almost 56 offshore special purpose vehicle deals, as compared to only 2 that were domiciled in the United States.

After incorporating the SPV law in the country, the next task will be to seek IRS clarifications on the tax treatment of the vehicles. The market expects that the pass-through principles applicable to other securitisation SPVs will apply here too.

Links For our page on insurance securitisation, click here.

South African furniture vendor to securitise debts

A report in Business Day, South Africa, of 27th Feb says that Profurn, a furniture and electronics vendor might be raising something like Rands 800 million by securitising its debts. The debts are essentially the credit sales made by the vendor.

The report says that financial institutions and investment bankers were keenly interested in structuring the deal for Profurn. They expect a good appetite among investors too, as there is a dearth of properly rated debt securities in the South African market.

Securitisation had been hindered in the SA market to date partly because of restrictions on the practice contained in the regulations section of the Banks Act, analysts explained. Although private placements are permitted, any public issues by nonbanks must adhere to a series of restrictions that makes them more difficult, although not impossible, to structure. The Reserve Bank is drafting revised regulations that will make securitisations easier to complete and more accessible for all lenders. Some analysts expect these to be completed within three to four months.

Links For more on securitization in South Africa, see our country page here. We have also handled several securitization-related workshops in South Africa. For details of forthcoming and past events, see our page here.

Fannie and Freddie should grow up

An article by AMITY SHLAES in Financial Times UK reiterates the case so very often made by others that the US Government should withdraw its support to mortgage securitization agencies Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are two of the three agencies used by the US government to securitise mortgages [ see for details on our country page here and our page on RMBS here]. Of these, Ginnie Mae continues to be government-owned, but Fannie Mae and Freddie Mac have been privatised over time.

Though privatised, the agencies continue to carry government support. Examples include: The president appoints members to their boards. The Treasury secretary may invest up to Dollars 2.25bn in their securities. Both companies are exempt from state and local taxes. And, most significantly, there is the general feeling that because of their social value and their size, the pair must not be allowed to fail. [Citing Peter Wallison and Bert Ely in Nationalizing Market Risk; American Enterprise Institute].

On this site, we have earlier carried glimpses of this debate – see our news report here, and a further news link on this link.

The article talks of the possible distortions that this implicit government support to the agencies creates – "For one thing, the pair may already be distorting markets – luring Americans into homebuying when they might better invest elsewhere. For another, the pair are growing so fast that they now threaten to consume the entire mortgage market, doing the damage of classic monopolies". Alan Greenspan has also expressed concern that the agencies might be "diverting real resources from other market-determined uses".

Links The debate continues. This website is dedicated to the Fannie Mae debate – fmwatch.com.

SECURITISATION NEWS AND DEVELOPMENTS – Jan.-Feb., 2001

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

 

Eurotunnel raises GBP 892 million by securitisation

According to a report in Les Eschos France of 23 Feb., 2001, Eurotunnel has securitised receivables to raise GBP 892 million from the capital markets. The issue was lead managed by Merrill Lynch and Dresdner Kleinwort Wasserstein to refinance part of Franco-British channel tunnel operator Eurotunnel's junior debt, and has attracted numerous investors.

A notable feature of the offering is that not only the senior tranches totaling GBP232 million and 365 million euros were well received, but even the junior tranches worth GBP230 million were easily placed. The senior tranche was rated AAA and the junior tranches were rated A-, BBB and BB-.

Indonesia to securitise future flows on gas sales

According to a report in Business Times of Singapore of 26th Feb., Indonesia has invited global financial institutions to handle a proposed securitisation of bonds collateralised by natural gas sales from its West Natuna field to Singapore. A couple of Singapore banks, including DBS Bank, are expected to have joined global institutions like Goldman Sachs, Merrill Lynch, Warburg and Morgan Stanley in submitting their proposals.

In what the Indonesian government called "structured export notes", the notes will be backed by future export sales. The amount could go upto USD 500 million.

The Indonesian government also did not state what the money would be used for, but it is understood that it would be used to settle part of its massive foreign debts totalling US$134 billion. Jakarta is also likely to securitise its proposed natural gas sales to Singapore Power from the Asamera gas fields in South Sumatra. Indonesia will generate over US$7 billion over 20 years starting from the year 2003 from this contract.

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

Grateful thanks This and the following newsfeed was provided by Mr G N Setty from Sydney. We appreciate this, and similar contributions by visitors from all over.

Indian aviation company uses securitisation to raise USD 355 million

According to a news report appearing in Business Line of 24th Feb., India's private aviation company Jet Airways has raised USD 355 million (Rs. 1600 crores) from domestic investors.

The report says that Standard Chartered Bank has, along with UTI Bank, as lead arrangers, placed credit-enhanced pass through certificates (PTCs) of Rs 1,600 crore with UTI, LIC, Bank of Maharashtra and HDFC Bank. State Bank of India has credit-enhanced the PTC by guaranteeing the principal and interest on the PTCs.

It appears from the Press Reports that Jet Airways will be using an SPV to give these aircraft on hire purchase to Jet Airways, and the hire purchase rentals will be securitised by the SPV, thus raising the funds needed to buy the aircraft. Hire purchase is an type of financial lease. With the proceeds of the rentals, the SPV will provide to Jet Airways on hire purchase 10 new Boeing 737 aircraft.

The transaction is guaranteed by US Exim Bank and the rupee part is the single-largest securitisation deal in the domestic market. It was also the first US Exim-backed transaction which raises rupees, the release said. The door-to-door tenor of the PTCs is 12 years (seven year average) and a draw-down period of 30 months. Interest rates will float in a band of 60 basis points until the time of draw- down of each of the 10 tranches. They would be fixed at a margin over the 7-year Government security. Jet Airways had struck a deal with Boeing to buy 10 new 737s at a total cost of $420 million. US Exim agreed to guarantee 85 per cent of the funding. The US Exim guarantee was used to raise dollar funds and placed with SBI as collateral against which SBI issued a guarantee to investors in PTCs. The aircraft will be acquired by an overseas special purpose vehicle and given to Jet on hire purchase. The future hire purchase rentals of the airline denominated in rupees were securitised to issue PTCs for raising rupee funds. The deal allowed Jet to have only rupee obligations avoiding dollar risk and US Exim to avoid rupee risk.

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

Canadian mortgage securitization agency to use bonds to buy mortgages

The Canadian mortgage securitisation agency, Canadian Mortgage and Housing Corporation (CMHC) will soon use bonds to buy mortgages. The bonds are designed to convert the monthly cash inflows from mortgages into non-amortising bonds that will provide attractive investment opportunity to investors. The principal on the bonds will be paid only on maturity, while pass through certificates amortise every month.

Canada Mortgage Bonds represent the latest evolution for mortgage funding in Canada. They provide an attractive fixed income investment opportunity featuring semi annual interest payments, repayment of principal at maturity, and a CMHC timely payment guarantee, backed by the Government of Canada. The bonds will be issued through a newly created special purpose trust known as the Canada Housing Trust. The Trust sells bonds to investors and uses the proceeds to purchase mortgages. Under the CMB program, the Trust transforms monthly cash flows from NHA MBS pools into non-amortizing bond cash flows. CMHC guarantees the mortgages to the SPV.

It is expected that the bonds will allow for more retail and institutional investment in Canadian residential mortgages, while providing investors with high quality, easily tradable guaranteed investments.

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

Securitisation, with IFC backing, to fund IT education in India

It is a potent case of securitisation being used to fund one of the most important capital asset of our times – knowledge. Citibank has tied up with software education company NIIT to fund IT education in India. The deal is the first case of use of securitisation for education funding in India, and also the first major organised attempt to fund IT education in a country that commands global edge in the field.

Under the proposed deal, Citibank will provide funds of USD 90 million to students fo NIIT under NIIT's flagship three-year IT training program, christened iGNIIT. NIIT is one of the IT education majors in the country.

The program uses a structured risk sharing pattern with the first loss risk of 11% being absorbed by NIIT as the originator. IFC will absorb mezzanine risk to the extent of next 10%. The balance of the funding to come from capital markets is virtually risk free, with 21% of the risk having been hived off already.

Gain-on-sale accounting, or how to make unhatched chickens fly

A recent article in Forbes (Feb. 19, 2001 issue) gives an example of the arbitrary gain-on-sale accounting for securitisations. Earlier, on this site, we have carried several reports and comments on gain-on-sale accounting.

Essentially, US securitization accounting standard FASB 140, which is the most detailed set of accounting principles for securitization and has coloured the approach of IAS 32/39 as well, provides for a securitization originator to account for on books retained interests in securitizations. These retained interests would primarily be the value of (a) any liabilities on account of recourse; and (b) retained interests in form of subordinate or interest-only or any other fraction of the transaction, not sold off to investors. Generally, the originator is also the first-loss protection provider, and therefore, would have the right to share the residuary cashflows after all fixed-income investors are fully serviced. The accounting standard permits the value of such retained interests to be captured on the books of the originator. Since the value of the retained interests, and the resulting gain-on-sale of receivables, is subject to the actual portfolio performance, losses, defaults and prepayments, there is a great degree of subjectivity in the valuation of retained interests.

The Forbes article gives an example of this arbitrary profit-booking. It talks of an Atlanta-based company called CompuCredit which issues Aspire Visa cards to consumers with marginal credit histories. The interest rate on these cards is 28%. Despite the rate, the company has had no trouble finding customers who want the cards. It has 1.9 million accounts with a collective $1.3 billion balance.

The article says that in CompuCredit's case, 10% of its pretax profits comes from gain-on-sale accounting and nearly 90% comes from the interest-only strips, the value of which is also based on securitization accounting standards. "To calculate profits that are still to come, the card issuer makes guesses about future losses from bad loans and about how long the average account will stay on the books throwing off interest. The resulting hypothetical earnings are discounted back into today's dollars and called profit", says the article. "How do you foretell the future when you don't know when or if a recession will hit? Let's just say this kind of profit-and-loss statement is more art than science. "

In the meantime, the Financial Accounting Standards Board is seeming undeterred by such critique. While it recently replaced the securitization accounting standard by a new-look FASB 140, it did not re-examine its gain-on-sale policy. Recently [on Jan 30, 2001], the FASB staff has put on its website a worksheet that shows how securitization accountants are expected to compute fair value of gain on sale. The spreadsheet advises accountants to assign probability values to bad, unfavourable, most likely and favourable scenarios and compute present values of cash flows under either case, and thus work out a probability-weighted value of the retained interest.

However, analysts feel that since the entire work is still based on future-gazing, it is violative of one basic principle that accountants have learnt over years: conservatism, which advises accountants not to book a profit based on guesswork, though losses are to be provided for based on anticipation.

Links See articles on gain-on-sale accounting by Martin Rosenblatt and others in our articles section. Also there are several news reports on news pages about arbitrary profit booking by gain-on-sale including failure/closure of some banks on such grounds.

Ernst and Young is optimistic about CMBS markets

Ernst and Young (EY), international accounting firm, recently put up a report which expresses optimism about the growth of international CMBS markets. According to EY, "the overriding goal behind the creation of the commercial mortgage backed securities (CMBS) market – to provide a stable source of liquidity to the commercial real estate industry in the United States in all economic cycles – has been achieved".

EY is optimistic about the growth of CMBS outside of the United States. In year 2000, CMBS issuance outside the U.S. reached USD 12 billion, up from USD 9.8 billion in 1999 and only USD 600 million in 1998. On the other hand, issuance within the United States has leveled off at about USD 50 billion.

Here are the key highlights of the CMBS market's activity in 2000:

  • Issuance of new mortgage backed bonds in the U.S. fell for the second straight year, from a high of $77.7 billion in 1998 to $58.5 billion in 1999 and $48.9 billion in 2000.
  • However, the rate of the decline in 2000 was less than in 1999 and was in line with market expectations.
  • About 20% of all outstanding commercial and multifamily mortgages in the U.S. have now been securitized.

Links For more on commercial mortgage backed securities, please do see our page here.

Munich Re issues cat bonds

Munich Re has issued USD 300 million worth cat bonds that protect it against super-catastrophes such as exposure to hurricanes in Florida and New York, earthquakes in California and windstorms in Europe.

The deal is based on parametric triggers: that is triggers which are based on objective parameters and not the actual loss suffered by the insurance company. For example, in greater Miami and greater New York, triggers are based on the central pressure of hurricanes making landfall along specified sections of coastline. For the San Francisco Bay and greater Los Angeles areas, triggers are based on earthquake magnitudes within several areas surrounding sources of major tectonic activity. The European windstorm trigger is a weighted index calculated from wind speeds measured at 600 stations across five countries in Western Europe.

Risk modeling company Risk Management Solutions provided the risk analysis, and Goldman Sachs, Lehman Brothers and American Re Securities Corp. placed the bonds.

Links: For more on cat bonds, click on our page on risk securitisation here.

German tax law proposals may spell problems for SPV taxation

One of the prime reasons for locating an SPV in an offshore jurisdiction, normally a tax haven, is to avoid double tax on the residuary income, that is, the income that remains after paying off interest on the notes. However, to escape the tax, the SPV should be treated as a non-resident for tax purposes. To be treated as non-resident, tax rules normally require that the SPV should not have a business in the host country.

Certain German states are now proposing that since securitization SPVs carry servicing functions in the host country, they should be treated as residents in Germany, and hence, subject to German taxation.

A recent report by Standard and Poor's analysed this eventuality and felt that the proposed change may not affect synthetic securitisations, which are incidentally quite popular with German banks, but may affect several deals.

US law firms to securitise tobacco settlement legal fees

Last year, when we commented on this: we said – why wait for years, if you can have it today. In our age of impatience, waiting is the biggest sin. Realising this, US law firms have decided to securitise their legal fees in the multi-billion tobacco settlement and raise cash upfront from Wall Street.

The first offering, of USD 295 million, might be hitting the market in February. The SPV is called called "Litigation Settlement Monetized Fee Trust" (LSMFT). The offering will be a 144a offer: and will consist of two classes of notes — a $250 million five-year tranche and a $45 million 10-year tranche. Deutsche Bank Securities will be the underwriter. Investor roadshows have already begun. The offering's five-year tranche will likely be rated Aa3 by Moody's Investors Service and single-A by Fitch and Standard & Poor's. The 10-year tranche will likely be rated A2 by Moody's and single-A by Fitch and S&P.

Market practitioners agree that this is the first time that legal fees are being securitised. Before this, David Pullman has introduced bonds backed by revenues of musicians and the like.

Links: There are several news items on our previous news pages about the tobacco bonds in the US – click here, here and here.

European telecom utilities increasingly look at securitisation

A report in Financial Times 1 Feb. 2001 says that European telecom utilities, seeking to fund billions of Euros, are all set to make the most of securitization markets. Telecom Italia will be the first to test this market, with marketing due to start in the coming weeks for Euros 1bn worth of debt backed by telephone bill receipts.

A similar proposal is at advanced stage of consideration by France Telecom.

Deutsche Telekom has set up a joint venture with Morgan Stanley Dean Witter and Corpus, a real estate company that aims to release cash from the telecoms group's real estate portfolio. This will be achieved through the sale of properties, the creation of real estate funds and asset-backed securitisation.

Links For news items on similar deals from electricity and railway companies, click here.

Europe set for strong securitisation growth

A report in Financial Times, London, 26th Jan., 2001 predicts a strong growth in securitisation volumes in Europe. Investors have growth nervous with increasing number of defaults in straight coporate debt, and are looking for a shelter in securitisation markets where there have been no defaults till date.

In the meantime, rating agency Standard and Poor's reports an 86% surge in ABS volumes in Europe, recorded at USD143 billion. With growing supply of ABS paper, the demand has also been growing correspondingly. One of the interesting features is the bouyant demand for low-rated paper, where spreads are good and there have been no defaults as yet.

The use of credit derivatives emerged as even a stronger feature of European securitisation growth in 2000. The S&P report records a 32% of the total issuance to be based on use of credit derivatives. European securitisation practice makes use of synthetic securitisation [for details see our page here] where the reference portfolio for which the risks are transferred is several times the amount of actual funding raised. These unfunded transfers are not included in the volume of securitisation reported.

Which are the main growth pockets for securitisation in Europe? The S&P report says that while the U.K. remains the principal engine room of the European securitization market, 2000 saw a significant leap in volumes from the continent–Germany and Italy being particularly active. The continental European securitization market has expanded significantly, supported by improving legislation, the single currency environment, and the drive for opportunities provided by credit derivative technology.

Deloitte Touche sweeps accounting firm awards

International Securitization Report's best accounting firm for securitization awards have been swept by Deloitte Touche Tohmatsu (DTT). DTT swept all three First Place categories for Best Securitisation Accounting Firm in Europe, North America and Asia-Pacific.

Deloitte Touche Tohmatsu is a provider of global securitization services such as: due diligence, cash flow modeling, collateral stratification analysis, accounting and tax advice, surveillance, technology support, and financial statement audits. The group's practitioners have worked on over 7,000 securitization transactions in over 20 countries. In anticipation of increased securitization activity throughout the world, Deloitte has established a network of seasoned professionals in 41 countries to meet the specific needs and expectations of its clients.

International Securitization Report (ISR) annually gives awards in several categories to agencies involved in securitisation practice. This year, ISR polled over 11,000 securitization professionals including: subscribers, issuers, investors and other securitization service providers.

The award relating to accounting firm in Asia Pacific is a new feather in DTT's cap as this is the first year that DTT has won this award. As far as Europe is concerned, it is the third consecutive year, and the second consecutive year for North America.

Vinod Kothari adds: Congratulations, DTT! DTT's contribution to the news and articles on this site, particularly from Marty Rosenblatt, has been very helpful. We wish DTT all the best.

Reverse mortgages in forward gear

Reverse mortgages are growing fast in the US and many market players expect this market to have a sustained growth as senior citizens use it as a decent way of adding to their social security payments. A reverse mortgage is one where a borrower, typically a citizen over 60, receives payments every month from the mortgage lender against the value of the house he or she owns, and when he or she dies or moves from the house, the house is taken over by the lender. It is called a reverse mortgage, because unlike in a normal mortgage loan where the borrower makes monthly payments to the lender, here the lender makes monthly payments to the borrower. The concept of reverse mortgage is explained in our page here.

A recent article in Barron's Jan 8, 2001 kicks off with the story of a US lady who took a reverse mortgage loan 3 years ago at the age of 71 against her house valued USD 88000. She has been receiving payment of USD 283 from the lender. Mother of 12 and grandmother of many more, she is keeping herself perfectly fit and active, and hopes she will live to be 95. That is exactly what her bankers hate about it, because in a reverse mortgage, the longer the borrower lives, the bank loses.

The growing popularity of reverse mortgages is evident from the fact that over last 15 years, about 50000 such loans have been written, of which 40000 were written over last 5 years.

Among many others, Lehman is optimistic about the prospects of reverse mortgages, based on simple data. There are more than 12.6 million households in the age group of 65 plus. There are also 16.7 million homeowners under 65 who have little or no mortgage debt. Ultimately, many of them could become tempted to sign up for a reverse mortgage. This represents a pool of home equity of between $3 trillion and $4 trillion that might be used as collateral for reverse mortgages.

Lehman in August 1999 securitised reverse mortgage loans.

Links See our page on reverse mortgage loans here. See our page generally on RMBS here.

US ABS market ends 2000 with 9% growth

It seemed as if year 2000 will go into red and break the record of sustained positive growth by US securitisation market, but the last quarter of the year came as face-saver, or rather, grace-saver. According to Thomson Financial Securities Data, the year ended with USD 299 billion of new-issue volume, a 9% jump over the USD 275 billion recorded in 1999.

The last quarter showed a very strong performance with USD 78 billion volume.

Earlier, there were apprehensions that year 2000 would not augur too well for securitisation industry – see our report here.

With Citibank's pioneering position, Salomon SB was at the top of the league of securitization arrangers. J.P. Morgan/Chase Manhattan combine was at number two and Credit Suisse First Boston/Donaldson, Lufkin & Jenrette at number three.

Korean airlines securitises future ticket sales

South Korean airline Asiana raied USD 65 million in first securitisation of future flows to emanate from South Korea. The transaction, closed on 29th Dec., was lead managed by Chase Manhattan.

The transaction has only one tranche, and is backed by present and future ticket sales revenues denominated in dollars, arising from the US. The SPV has been domicilined in Ireland to receive payments from American Express, Diners Club and Pacific Union Bank from passengers booking tickets in the US. Pacific Union will make payments on behalf of Visa and MasterCard.

Fitch rated the deal BB, one notch above Asiana's unsecured rating. The notes have a five year maturity and an average life of 2.6 years. The coupon is 8.92% with an issue price of 97.40.

The other ticket sale securitisation to emanate from Asia was Philippine Airlines. Philippine Airlines went for debt restructuring, default of rentals on leased aircraft, etc., but securitisation investors have remained unimpaired.

Links For more on future flow securitisation, click on our page here.

Where are the cats: enthu for cat bonds is dying down

Where are all the cats? A market that seemed promising enough in 1996 and 1997 so that many observers predicted the end of the traditional reinsurance business, now seems to be a non-starter. An article by Perry DeFontaine in Best's Review Jan 2001 says that the cat bonds market is not picking up any further and traditional reinsurance continues to be the standard.

Perry says: "When the first cat bonds were issued, there was tremendous enthusiasm. For insurers, transferring catastrophe risk to the estimated $30 trillion-plus global capital markets could solve capacity and credit-risk concerns, as well as ultimately reduce the overall costs of reinsurance. Investors were attracted by the opportunity for higher yields plus diversification due to the noncorrelated nature of catastrophic risks. Excitement was so high there were even predictions of the end of the catastrophe reinsurance market; these reinsurers were stating that if the cat bond market took off, they would simply transform themselves from premium-based risk takers to fee-based catastrophe risk consultants."

But then, cat bonds no more have the same appeal that they had when they first appeared. Perry sees the reason in the high costs of cat structures, which are a complicated process involving legal costs, SPV costs, etc. On the other hand, traditional reinsurance has ample capacity as of now, having low costs.

The other difficulty is model risk of catastrphes, which was an essential feature in the success of securitisation as the risk was easily defined.

Vinod Kothari adds: Cat bond issuance in year 2000 has been at a very low level as compared to the past, but the cat technology has quickly been grabbed by several other asset classes which continue to use it increasingly. For example, synthetic securitisations involving risk transfers. Securitisation as a device of risk transfer in other fields also continues to hold a promise. A survey by Dentonhall Wilde Saptetitled The ART Survey 2000 concludes based on a survey of market participants: "Credit products – especially where banks are end users – are clearly the fastest growing area of the ART marketplace. According to respondents, they will continue to be the fastest growing area for near future. Risk financing products – in the form of finite products – were a clear second".

Links For more cat bonds and risk securitisation, see our page here.

BIS reconstructs regulatory proposals for securitisation

The Basle-based international bank regulatory body Bank for International Settlements (BIS) on 16th Jan. published revised proposals for securitisation regulation by financial supervisors. These proposals are a part of the revised capital adequacy framework that has been suggested by the BIS.

Earlier, in June last year, the BIS had published proposed capital adequacy framework, to replace the existing standard based on a 1988 concordat. The June 2000 proposals were put for public comment. BIS was expected t to finalise the regulatory proposals in this January, but "reflecting those comments and the results of ongoing dialogue with the industry and supervisors worldwide", BIS decided to frame a more detailed, more concrete set of proposals.

The proposals include a detailed set of regulations for securitisation transactions spanning over 32 pages. While the June 2000 proposals were based on investing banks' perspective, the present set of proposals include regulatory proposals for originating banks, investing banks and sponsoring banks. There is also a set of regulatory proposals for synthetic securitisation.

A write up on the revised regulatory proposals by Vinod Kothari is here on this site.

The revised proposals are now for public comment by end-May. They are expected to be finalised by end of 2001 and implemented by beginning of 2004.

Links For text of the securitisation regulatory proposals, click here. For text of the complete proposals on capital adequacy, click here. For an article by Vinod Kothari on the proposals, see here.

SECURITISATION NEWS AND DEVELOPMENTS – April, 2001

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

 

 

Malaysian bad loans recovery agency considers securitization

Malaysia recently put in place securitization guidelines – see our news report below. Even before the ink could dry on the rules, there are a number of possible candidates, including the bad loans recovery agency Danaharta.

At the recent Malaysian Debt Conference, Danaharta's managing director said he is taking concrete steps to securitize and dispose some of its rehabilitated and performing loans later this year. He said Danaharta believes that asset-backed securitization will not only result in better recovery, but also assist in the widening and deepening of the ringgit bond market.

He went on to clarify that as at 31 December 2000, Danaharta had within its portfolio approximately RM5.45 billion of rehabilitated (and now performing) loans; of which approximately RM3.71 billion had been performing for more than 12 months (thereby indicating the robustness of their restructured cash flows). This (RM3.71 billion) would form the feedstock for the securitization venture as the loans could be offered in tranches.

A comment by a Communications officer of Danaharta dated 25th April 2001 affirms that Danaharta has requested and received proposals from a number of financial institutions – to help formulate the securitization mechanism and structure. There is still a bit of work left, for instance on structure and documentation.

Links See our country page on Malaysia – click here. For text of Malaysian law on securitization, click here.

Government Housing Loan Corp's debutante securitization likely to spur Japanese RMBS market

Japan could well be the securitization giant that it deserves, if this particular deal is a trend setter. Securitization markets in other countries contain a large component of RMBS transactions, which have been unseen in Japanese market due to lack of a Fannie Mae kind of body. But with the Government Housing Loan Corp (GHLC) making a recemt debut, that could well be history.

GHLC stepped into the RMBS market in March with a debut issue that raised USD 406 million. The offer was jointly led by CSFB, Goldman Sachs and Sanwa Securities. GHLC's plans include continuance of its securitization exercise raising some Yen 200 billion every year.

The GHLC series 1 secured passthrough notes will mature in 2036. The securities were priced at par with a coupon of 1.75 % – a spread of 45 basis points over 10-year swaps. They were supported by 2,831 residential mortgage loan contracts dated between April and June 2000.

In the typical structure, there is no true sale of the receivables by GHLC which continues to hold the loans, and has issued bonds directly to investors. The notes represent an undivided interest in the portfolio of loans held by GHLC, which is the legal equivalent of a floating charge. There is, however, an agreement with Mitsubishi trust that allows the transaction to be converted into a true sale, should it be so required.

Why not true sale? There was earlier a tax on transfer of receivables, which has since been removed, but Japanese lenders still have a taboo against transfers. They cite problems such as existing guarantee of a sister bank, which holds a first charge over the loans, etc. Are you aware of the reasons why Japanese home loan banks do not prefer a true sale? Are you aware of how would the transaction be accounted for in absence of a true sale, which is a requirement under FAS 140, or BIS capital standards as proposed? If so, please do write your comments.

Thai SEC finalises amendments to SPV law

It has almost been a couple of years since Thailand put in place the SPV law, but not of much avail as securitization is still a non-starter in the country. The Securities and Exchange Commission has recently approved amendments to the Securitisation Act in a bid to develop the debt market. The amendments are expected to be proposed to the Legal Reform Panel for consideration later.

The amendments are aimed at allowing establishment of SPVs with a multi-tiered structure as prevailing in the United States. Taxation has been a major problem area in Thai securitization – the Revenue Department also sees a possibility of tax incentives for SPVs. Value-added, corporate and special business taxes for SPVs are proposed to be waived for securitization SPVs.

Links: See our country page on Thailand for details

Securitization of timber plantation by Australian company sets good template

This deal is a quite small in international terms, but its structure may well set an example for those who would like to use securitization to promote plantation and farm finance. Timbercorp Finance has raised USD 16.9 million to securitise a portfolio of loans which will be repaid by plantation income.

The structure of the deal is as follows: Timbercorp invests approximately A$ 50 million in developing a certain plantation which includes land and infrastructure. It then provides a loan to individual investors who would buy a portion of this plantation. The purchase of plantation is funded to the extent of average 75% by the plantation company by way of a loan to the investors. In essence, therefore, the investor contributes 25% to the cost of development, and the 75% funding arranged by Timbercorp is what it uses for securitisation. So, the receivables being securitised by Timbercorp are receivables from portfolio of loans extended by it.

It has been extending such loans since 1992. The loans are 3 to 5 years amortising loans given to individual investors. The plantations are managed by a sister company of Timbercorp. The loans are secured by plantation – that is, timber, that has a value after 10 years or so. Because of this attractive backend value, investors are unlikely to default.

Vinod Kothari comments An attractive template for those who would think of funding plantations with involvement of retails investors. Makes a developmental use of securitization device.

Recession and credit card losses not to affect securitisation, says S&P

The U.S. economy is softening and could be headed for recession. The credit card industry, meanwhile, has not seen an economic downturn in a decade and, even with the economy strong, has been suffering high losses. If the economy turns down, will the securitisation investors be affected? Rating agency Standard and Poor's (S&P) says in a commentary dated 5th April that though credit card charge offs are expected to rise in 2001 and 2002, the same may not affect securitisation.

Recession might cause consumers to spend less. A slowdown in consumer spending will mean reduced borrowings and a lower supply of newly originated loans for securitization. Still, ABS new issuance volume is expected to increase in 2001. Relative to the cost of securitization, the cost of unsecured funds for finance companies has been on the rise and the ABS market has become a more attractive source of funding for many. The securitization rate jumped from only 13% a decade ago to 54% at the end of 2000. Large issuers are securitizing as much as 70% of their assets.

On the key question whether the increasing rate of charge offs means potential problems for securitisation investors, the report feels the charge off rate on credit cards to be around 6.1%, higher by 60 bps over the rate last year. However, a 60-basis-point increase in credit card charge-off rates will not have a major impact on the credit card-backed securities market in general.

Asian Pulp bankruptcy not to affect securitisation investors, says insurer

Financial risks insurer Centre Solutions does not expect any problems for the investors in a trade receivables transaction, totalling USD 250 million, originated by Asia Pulp & Paper Co Ltd (APP). Centre Solution is a unit of Zurich Finanical Services, and had provided financial risks insurance cover for the transaction. APP is based in Singapore and listed in NY, and is passing through one of the biggest debt workouts in Asia.

The securitisations were issued in 1999 and 2000 and are maturing only in 2003 and 2005 respectively. Though the rating of APP was CCC at the time of the issuance, the rating was hiked to AA on account of the enhancement provided by the insurer. The transaction represented trade receivables of APP from its forestry projects in Indonesia.

As usual for future flows transactions, there is a trapping mechanism for the cashflows which will be used for early amortisation of the investors' notes. However, recovery of the receivables is likely to be affected by claims of other creditors as also those of Indonesian restructuring agency IBRA. The case could be a crucial test for the legal strength of securitisation of future flows in Asia.

First European port revenue securitisation

According to a report by Rebecca Bream in Financial Times of 10th April, the Port of Tees and Hartlepool has become the first European port to securitise its revenues. The transaction allowed the Port to raise GBP305 million in an asset-backed bond issue.

The bonds are backed by the cash flows generated by Tees and Hartlepool's position in the bulk cargo, petrochemicals, container and oil and gas markets. Proceeds will refinance bank debt incurred when Nikko Securities' principal finance arm bought engineering and ports group Powell Duffryn, the port's owner.

Malaysia issues securitisation guidelines
Issuance to require prior approval of SC

Securities regulator in Malaysia, the Securities Commission, on 10th April issued the much awaited guidelines on offering securitised instruments. The report below captures the essential features of the Guidelines as also contains comments of Vinod Kothari.

A press release of the SC says that the Guidelines serve to set out clear and transparent criteria so that market participants are able to understand the SC's requirements. As a notable feature, prior approval of the SC will be required for any securitisation offer, which will also require the approval under the existing guidelines relating to issue of private debt securities. However, the SC is committed to a speedy clearance of such applications and will not take more than 28 days to clear the applications.

The assets that are eligible to be securitised must generate cash flow. The Originator must also have a valid and enforceable interest in the assets and in the cash flow of the assets prior to any securitisation transaction. Apparently, this seems to apply only to existing assets and future flows may not be securitisable at all.

The Guidelines, in essence, look backwards instead of looking forward. The SC has taken considerable time in issuing these guidelines and it is understood that a task force comprising of market practitioners joined the SC's staff in formulating these. However, the Guidelines have not kept up with the latest developments in the market such as synthetic securitisations and unfunded credit-derivative based transactions. The guidelines require the transfer of assets to the SPV to be fully non-recourse. The Guidelines state that any transfer of assets by an Originator to the special purpose vehicle must, in addition, comply with the "true sale" criteria. This, by itself, takes away the possibility of any credit-linked notes or synthetic securitisation, for which the scope in a country like Malaysia should have been phenomenal.

The Guidelines require the Originator to effectively transfer all rights and obligations in the assets to the special purpose vehicle and not retain any residual beneficial interest in these assets. As a limited credit enhancement by the Originator is almost a rule in securitisations, market practice will perhaps evolve on the style of US securitisations – two tier SPVs with the first transfer to the SPV being without recourse and without any enhancement, but the second transfer to be with required enhancement.

The Guidlines also eliminate the scope for offshore securitisation: in that the SPV is required to be a Malaysia-resident. The Guidelines provide stamp duty and real property gains tax exemption to SPVs, but are silent on income-tax exemption – which again might remain a grey area in case of bond/note structures.

Links For more on securitisation in Malaysia, click here.

More developments We will come back with more analysis of the guidelines soon on this site.

Workshop in Malaysia Vinod Kothari will offer a 3-day workshop in Malaysia to analyse legal, regualatory, tax and accounting issues,including the latest SC Guidelines on May 14-15-16, 2001. See details here.

CDO activity surges 500% in Europe
Overall securitization volume grows 60%

The tremendous surge in CDO activity in Europe was visible as the volume in the first quarter of 2001 increased 500% over corresponding period in 2000. A press release by Standard and Poor's says that the volume in Q1 of 2001 was USD 15.2 billion compared to USD 2.3 billion in the same three months last year.

The volumes were largely propelled by European banks' and fund managers' increased use of CDO technology as a balance-sheet management tool and for arbitrage purposes. Typically, European banks have used CDOs for funded as well as unfunded transactions.

Among other securitization segments, overall rate of growth in 2001 1st quarter was 60% higher than same period last year. The RMBS market sustained its solid growth pattern in the first quarter of 2001, ending a strong 39% higher at $7.9 billion compared with $5.7 billion a year earlier.

In the CMBS segment, volumes ended at USD 179.7 million compared with USD 3.1 billion in the same period last year. However, the rating agency sees the European CMBS market as still pegged as a prominent growth area in 2001.

The total securitization volume in Europe ended massive 60% higher at $29.9 billion compared with $18.7 billion in the same quarter of 2000.

 

SECURITISATION NEWS AND DEVELOPMENTS – May, 2001

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

 

INPS-II is most likely over-subscribed, as Europe goes strong on asset-backeds

The unique securitisation of delinquent social security contributions by the Italian government agency Istituto Nazionale per la Previdenza Sociale [INPS] hit the market once again on 29th May. Today, that is, on 30th May, London-based newspapers already gave signals that the issue is likely to be oversubscribed.

The Euros 1.7 billion offer by SPV called SCCI has an expected maturity of mid-2004. The Triple A rated bonds offer investors a 30 basis point spread over Euribor.

[We have earlier reported extensively on the INPS-II and INPS-I. See story below and more links. INPS-I was mired in controversy till late last year; however, the redemptions due in January this year were duly made. The performance report of INPS is available in Italian and English on INPS website at www.inps.it. The report says that not only have Series 1 notes been redeemed without recourse to the Debt Service Reserve, in fact, the overall balance of the S.C.C.I account (including DSR) increased by over ITL 100 billion.]

The European ABS market had a record month in April when USD 7.5 billion worth issuance was recorded. May is set to achieve a volume of approximately USD 4 billion, says a story in Financial Times of 30th May, quoting a Merril Lynch research.

Canary Wharf is another issuer likely to enter the market next week with GBP 875 million deal. Other prominent stories in British press today were those of British Land which proposes to raise GBP 600 millions by securitising its real estate holdings.

Links For more on securitisation in Italy, see our page here. For more on Europe, see our page here. For more on securitisation of government revenues, see our page here.

Consumer spending bolstered by securitised products

Notwithstanding Greenspan, notwithstanding recession, American consumers can continue to spend in the midst of looming clouds of recession. A report by Gary Silverman in Financial Times of 11 May puts it as follows: "These are trying times for US consumers. Layoffs are rising, investment has stalled and falling stock prices have dramatically reduced personal wealth. But Americans keep spending – so much, so far, to stave off a recession – not least because of the availability of cheap credit. The supply of credit has in turn been boosted by investor demand for bonds backed by payments on consumer borrowings such as credit cards, auto loans and "subprime" second mortgages."

That is to say, even in the face of a weakening economy, asset-backed market constantly feeds substantial amounts in the domestic market for consumer binge. The economy.com's sister site www.dismal.com points to a number of dismal data starting from dumped trucks to vacant hotel rooms to paint the full picture of the recesssion, and yet there is no decline in consumer spending. Consumer debt burdens are at their highest since 1987. Mortage debts, including second mortgages used to pay off other debts, are the highest on record.

Analysts feel that one of the reasons for the growth in asset-backed securities is growth by default – the federal government is issuing lesser bonds and investors need something to invest in.

The worry is that if the Fed's rate cuts fail to spur the economy and asset backed investors have to bite the bullet of increased consumer delinquency, the market will lose its confidence which will hasten the process of a vicious cycle. Any thoughts?

Investors flock to ABCP, as corporate credits deteriorate

With corporate credit scene turning dismal and little chances of any betterment in the short run, investors prefer investment in senior tranches of asset-backed commercial paper (ABCP) to either clean paper or to corporate bonds.

ABCP volumes have grown sharply over the past few years. The latest data on issuance volume may be found at Asset backed Alert . The amount of ABCP outstanding in the US is now at $653 billion, representing 42% of all outstanding commercial paper, up from 27% or $285 billion three years ago. The latest data on the above website shows 23rd May volume as USD 656 – of course, this is only US paper, while other active ABCP markes incluce Canada, Australia and parts of Asia and Europe.

A Moody's report [US money market fund holdings of ABCP skyrocketing, 15th May] confirms the above. It says US money market fund holdings of ABCP have skyrocketed in the past three years, with money market funds now holding more than $307 billion, or over 47% of all outstanding ABCP as of March 31, 2001.

ABCP represents a high-quality alternative to the unsecured commercial paper issued by corporations, and at the same time, ABCP’s favorable spreads over traditional CP, which averaged 7.4 basis points from August 1997 through April 2001, continue to be a prime motivator for investors. Multi-issuer ABCP programs are also more insulated from certain event and credit risks compared to traditional corporate CP. These risks include individual company defaults or event risk in a specific industry or corporation.

ABCP’s performance since its inception in the early 1980s has been exceptional, as evidenced by its 100% no-default record.

For more on ABCP, see our page here.

CDO ratings historically stable, but 2001 may be volatile, warns Moody's

While CDO tranches have historically been safer than corporate bonds, Moody's cautions that year 2001 may see more of volatility. Balance sheet CDOs may see higher volatility than other segments. This is because of higher risk of corporate credits being downgraded.

Historically, of the four segments of the CDO market, the study found market value CDO notes to be the most stable, followed by balance sheet CDOs, and then by arbitrage cash flow CDOs. Emerging market CDOs came in last. During the period 1996-2000, covered by the Moody's transition study, there were no CDO defaults, however, the report expects some defaults during this year.

Moody's CDO rating transition study documents the frequency at which credit ratings for particular CDO instruments change over the course of time. Moody's findings confirm that CDO ratings are historically less volatile than those of corporate bonds, both for upgrades and downgrades.

Links For more on CDOs, see our page here.

FASB issues technical bulletin to clear problems in single step securitisations

The US Financial Accounting Standards Board (FASB) on 17th May issued a draft Technical Bulletin no. 01-a that seeks to clear the problems created by a recent staff interpretation that virtually ruled out off balance sheet treatment to securitisation using the single-step SPV format.

Read more about the staff interpretation given on 19th April that created the problem here. The problem pertains to isolation which is required for off-balance sheet treatment, and isolation is interpreted as the legal impossibility of the liquiditor of the originator from clawing back the assets transferred in a securitisation program. According to FASB staff interpretation, such impossibility did not exist in case of single step securitizations in FDIC-insured banks, due to an inherent power to beneficially re-acquire the assets.

The draft technical bulletin now issued for public comment by FASB does two things: (a) it defers the applicable date of the new rules to FDIC-insured banks doing single-step securitization to 31st Dec., 2001, such that assets transferred after this date will be affected by the new rules; and (b) it also makes certain relaxations to transfer of assets to master trusts. For full text of the FASB draft, click here.

Links For more on accounting for securitization, see our article here – the article also gives a number of further links.

Clementi opposes new BIS norms

David Clementi, Deputy Governor of Bank of England, recently criticised BIS proposals that seek to link the capital required by banks to the riskiness of assets held by them. According to Clementi, the new rules may precipitate banking crises.

The new BIS rules seek to replace the 1988 concordat. According to the existing regulatory norms, the minimum capital required by banks is linked with the risk-weightages of assets held by them and the weightages are arbitrarily fixed by the nature of the asset – such as a claim on a sovereign, claim on another bank, etc. The new rules, first proposed in June 2000 and later revised in January this year, seek to replace these weightages by those based on the risk, as indicated by the rating, inherent in the assets. Hence, riskier the asset, more the capital required to hold such asset.

The new draft rules have accordingly sought to revise applicable regulatory norms to securitisation transactions as well – see our report here and an article and a graphic here.

Clementi's opposition is that the accord linking the amount of capital to risk could amplify the economic cycle. Downturns would be accentuated if bank credit dried up because the increased risk of loan default required banks to hold more regulatory capital. Clementi says that the evidence of this could be seen during the Asian crisis of 1997.

Clementi suggests that risk-adjusted capital requirements should be based on long-term measures that include the possibility of future economic downturns in assessing credits.

Clementi also criticised the fact that the new rules could lead to arbitrage by simply securitising assets or entering into credit derivatives. [Vinod Kothari adds: Clementi's opposition to credit derivatives and securitisation is no more a secret – see news report on our credit derivatives site here. ]

Not only Clementi, several other leading banks have either criticised the BIS proposals or sought for more time and clarification. A report in Financial Times of 22 May said heads of leading European, Japanese and US banks have wanted more time to understand teh BIS proposals, raising the possibility that final proposals from the Basle committee could be delayed. In a letter to William McDonough, chairman of the Basle committee of international financial regulators, banks asked for more detailed information on seven key areas. The letter was signed by heads of the US, European and Japanese banking associations.

Links For an article on the regulatory proposals of the BIS, click here.

 

Japanese restructuring body to securitise bad loans

Securitisation seems to be launched as the laundry machine to wash the sins of the banking system – in other words, securitise bad loans and convert them into marketable securities. Morgan Stanley has already done it in Japan, and KAMCO has done it in Korea. Malaysian Danaharta has announced intents, and the same with Chinese Huarong.

So, as if it is all a part of life, the latest one to try the laundry machine is the Resolution and Collection Corp of Japan. (RCC), the Japanese bad loans restructuring body. RCC, a subsidiary of the Deposit Insurance Corp intends to sell, as a first step, the former headquarters building of the failed Long-Term Credit Bank of Japan, now relaunched as Shinsei Bank.

With Daiwa Securities SMBC Co as its adviser on the LTCB headquarters securitization dea, the property will be transferred to a special-purpose company, which will issue a total of Yen 40 billion in bonds.

Links For more on securitisation in Japan, see our country page – click here. For more on securitization of non-performing loans, click here.

INPS II from Italy comes to the market

The landmark securitization of delinquent social security contributions from Italian government agency INPS is coming to the market for its second tranche. This is what The Times international business editor (7th May 2001) reacted: "ITALY is coming to the City of London this week to ask investors to fill a 2 billion euro (£1.2 billion) hole in its state pension scheme".

INPS is the Italian government agency's securitization of delinquent receivables that made global headlines in 1999. We have earlier commented on the problems on INPS -I and the proposal for INPS-II. See our news reports here and here.

The second tranche of some Euro 2 billion will be managed by Morgan Stanley, San Paolo-IMI, the Italian bank, and UBS Warburg.

The Times editorial continues: "Italy’s ramshackle state pension is owed 45 billion euros in unpaid contributions, mainly because of a past failure by the Italian Government to organise an efficient scheme to collect the money. Much of it will never be recovered. Faced with a mounting pension burden and the need to cut the country’s borrowing requirement, the Government created a debt collection agency that is expected to realise a large portion of the missing funds. The investment banks realised that these debts could form the basis of a novel securitisation scheme. "

Links For more on securitization in Italy, click here.

First non-agency securitization in Malaysia to hit soon

A report in Malaysian newspaper New Straight Times of 8th May says that the first Malaysian securitization, other than by the agency of Cagamas, is likely to hit the market soon. This offer, of RM 1 billion, has been proposed by Moccis Trading Sdn Bhd and most likely, this would be the first offering since the introduction of the Securities Commission's new guidelines on debt securities.

The issuer's plan is to issue up to RM 1 billion in Islamic Murabahah papers sometime this year, backed by the company's assets, namely consumer receivables which currently total about RM 600 million in its books. The company has appointed Amanah Short Deposits Sdn Bhd, a subsidiary of Amanah Capital Group, as its lead manager.

Links For more securitization news relating to Malaysia, browse through our news page – for example see a news about a proposed NPL securitization by Danaharta here. For more about securitization in Malaysia, see our page here. For text of securitization laws in Malaysia, click here.

A training workshop on securitization in Malaysia will be held on May 14-16 at Kuala Lumpur where Vinod Kothari is the sole facilitator. Click here for details.

Guy Hands leaving Nomura

It is not only financial press in London which is full of stories of Guy Hands leaving Nomura. Guy Hands, so far the Head of the Principal Finance division of Nomura Securities at London is one of the most talked-about financiers in the City and in the securitisation world, he has the reputation of being the one who pulled securitisation out of its mainstream applications and intermixed venture capital approach into it to introduce to the world a wholly new range of asset classes such as pubs, real estate, plant and infrastructure assets. We carried a story about Guy Hands – last year – click here. Guy Hands will set up a GBP 2 billion private equity fund, in which Nomura may invest.

According to a report in the Daily Telegraph 7th May, Nomura is concerned that Mr Hands has invested too heavily in his principal finance group and that his personal profile eclipses the bank's.

Among creditable deals concluded by Hands were the 5,500 British pubs that he acquired and securitised, 64,000 German railway workers' houses. At one time, he also bid for the the Millennium Dome which he ducked because he thought the risks were unquantifiable. And closely before his decision to quit, he was negotiating to bail out the Le Meridien hotel chain.

Why need a vehicle 
if you can walk your way without it, asks Moody's

It is no news to securitization industry that an increasing number of securitizations in Europe, particularly in UK and Germany are turning synthetic, and for many of these securitization transactions, SPVs are not required. Moody's led the thinking process by releasing its report recently titled Non-Bankruptcy-Remote Issuers In Asset Securitisation dated March 22, 2001.

Essentially, the use of SPVs in securitization is for three essential purposes: isolation of assets to the exclusion of the originator or his claimants/liquidatory, for bankruptcy-remoteness by housing the receivables in a vehicle which does nothing except such housing, and for off-balance sheet accounting.

Moody's feels that the legal isolation of assets by actual true sale to an SPV may not be necessary in countries like UK, and those following the Anglo-Saxon legal system, including Cayman Islands, Hong Kong, Singapore, Australia, Malaysia and Bermuda.

The Moody's report is based on bankruptcy laws of UK which enable creation of a fixed charge and a floating charge. A fixed charges attaches to a property, and acts as a bar against transfer of the property by the borrower; even if it is transferred, it will move along with the property. A floating charge over the entire assets of the borrower might permit the chargeholder to appoint an administrator to preempt the Court from appointing one.

Though it is a worthwhile thought to think of ways of expanding securitization markets improving upon existing practices, it is unlikely that the way suggested by Moody's will go a long distance. Secured bonds have been prevalent since times immemorial, and so also fixed and floating charges under English law. The method suggested by Moody's is no categorical improvement over the traditional secured bonds, to give any better rights to investors than secured bonds do. In bankruptcy, even if the bondholders carry a fixed charge, the claims are still subject to preferential debts, and in most bankruptcies, preferential claims eat up a substantial part. The assets securitised will not be out of the purview of bankruptcy estate, and therefore, stays and injunctions on payment to investors will be unavoidable, as bankruptcy courts are unlikely to be much concerned about interests of capital market investors opposed to workers and such claimants.

Isolation by way of fixed charge and isolation by way of transfer are very different in common law, and it is unlikely, either that an operating company securitising assets as Moody's suggests will not go bankrupt, or that the Court will afford the same protection to a fixed charge holder as to the owner of an isolated portfolio.

Most significantly, Moody's suggested method will not qualify for off-balance sheet funding.

If off-balance-sheet treatment is not important, there is yet another possible way of avoiding an SPV -declaration of trust by the originator himself. Bankruptcy laws do not apply to assets held by the originator in trust. However, declaration of trust itself, in many countries might attract stamp duties.

Updated 10th May by Vinod Kothari Having written the above peace yesterday, I read today a write up in Corporate Finance April 2001 and I see some legal experts, disagreeing with Moody's view. The article quotes UK lawyers saying: "We see nothing to suggest that the Moody's report will have any effect on the way in which porfolios of assets are securitized or on deal costs". The lawyers say that the Moody's method could work on something like whole business securitization where the structure is similar to a secured loan, but for discrete assets, capital relief and accounting treatment could be crucial questions.

Tamara Adler of Deutsche even says that by eliminating the SPV, the impact on costs is also not dramatic -hence, not great motivation.

Links: For more on why an SPV is required for securitizations, click here.

Chinese asset management company wants to securitise non-performing loans

The China Huarong Asset Management Corporation (CHAMC) wants to do for China what Kamco has done for Korea, and what Danaharta wants to do for Malaysia – securitise non-performing receivables. In other words, a whole lot of Asian asset recovery companies are waiting in the wings to use the new-found way of converting bad apples into good apples.

CHAMC has invited KAMCO itself to teach the former the latter's first hand experience in parceling a bunch of bad loans. KAMCO might work as its advisor in asset-based securities, according to a report in People's Daily Online of 27th April. KAMCO company will help Huarong select several portfolios from its 407.7-billion-yuan in assets and provide consultation for securities structure design, credit-rating and securities issuance. When all the preparation work is finished, Huarong plans to securitise its non-performing loans.

Links For more on securitization on non-performing loans, click here. For more on securitization in China, click here.

Primary market CBOs: a new trend in Korea

This may well be a lesson for emerging markets with tight banking liquidity. Korean experiment that allows companies with lower credits to raise resources directly from capital markets has succeeded and there have been several issuance of "primary market CBOs". The term "primary CBO" refers to a CBO which will subscribe to primary bond issues of entities, as opposed to common CBOs which pick up bonds from the market. A primary CBO essentially serves as a lending device to the bond issuers.

Earlier this year, Daewoo Securities entered the securitization market with a CBO that packages corporate bonds issued by 52 smaller domestic companies. The Won 160 billion deal (USD 124.8 million) has been jointly promoted by Daewoo with the Small and Medium Industry Promotion Corporation to promote this means of raising funds for smaller corporates. The collateral consists of bonds rated locally between B and BB-plus entities, having maturities of one to two years.

To allow investors to walk in, the transaction was split into a senior class of Won 130 billion a junior class of the balance that will be held by the small industry promotion corporation as credit enhancement. Thus, while the market funds the essential credit creation, the risk is parked with the promotional agency – a true splitting of roles rather than a common model of the State attempting to provide all funding and no risk absorption.

The senior tranche itself was sequenced into one-year bonds two-year paper, for finer pricing.

This is not the only primary CBO in Korea, but is schematically designed as a part of the financial markets stabilisation package by the Govt. Banks face a liquidity sqeeze, which leaves small and medium enterprises high and dry. The primary CBO format allows smaller firms to draw from the CBO vehicle, the vehicle in turn benefits from economies of scale, and investors get both diversification and credit enhancement.

LG Investment and Securities launched the first offering in August 2000 amounting to Won 1.55 trillion for 60 companies via four SPVs. During year 2000, there have been CBOs worth about Won 5 trillion.

Links To read more about CBOs, see our page here. For more on securitization in Korea, see our page here.

CDO market in Q1 2001 grows 200%
Non-US growth outstanding

A recent report by Moody's titled "First Quarter 2001 Global CDO Review: Healthy Pace of Activity Across All CDO Subsectors" says issuance of CDOs in the first quarter of 2001 increased more than 200% over last year.

Issuance outside the US climbed to 45% of the total, up from an average 29% last year. The growth levers in 2001 suggest a record-breaking year in 2001, caused by arbitrage opportunities, introduction of new collateral types, and increased investor appetite for CDO paper. Of particular note, says Moody's, is the continued growth of less traditional collateral types, including CDOs collateralized by investment grade corporate bonds and resecuritizations. Talking of the arbitrage opportunities, Moody's report says that of the 58 transactions completed during the first quarter, 47 were motivated by arbitrage.

The global CDO markets expanded to USD 18.2 billion across 58 transactions — up from USD 6 billion across 14 transactions in the first quarter of 2000.

The Japanese CDO volumes are a remarkable feature of this quarter. Six deals were ated in Japan, the country's highest quarterly total in two years. The synthetic securitization trend has caught up in Japan – almost all the transactions were synthetic and referenced pools of bonds – typically issued by non-Japanese obligors.

Even as volumes grow, rating downgrades were the highlight in the high yield CBO segment. Rating agency Standard and Poor's press release of 3rd May says it placed its ratings on 12 tranches of cash flow CDO transactions on CreditWatch with negative implications, bringing the total number of CDO ratings on CreditWatch negative to 14 by the end of the quarter. In addition, the ratings on 10 tranches of notes issued by CDO transactions were lowered, while none were raised.

Links For more on CDOs, see our page here.

LTV controversy resolved, but true sale trail remains

The LTV controversy that threatened the foundations of the USD 6 trillion securitization industry is over, but the trail remains, even though some securitization practitioners try to shrugg off the case as a non-issue. The LTV controversy ended with the bankruptcy court admitting the DIP funding, and recording, as was a precondition to the DIP funding, that the transfer of collateral from LTV to the SPVs was indeed a true sale.

Moody's, for example, recently came out with a report titled "True Sale Assailed: Implications of In re LTV Steel for Structured Transactions". Alexander Dill and Letitia Hanson writing this report contend that the LTV case does not have much of a precedent value, but surely has quite a few lessons to teach the securitization industry. The authors say that in the banruptcies in the past, DIP financings have come as a succour for beleagured securitization investors as DIP financiers replaced securitizations. The lessons are in terms of evaluating the the seller’s own capitalization and its sources of working capital outside of the structured financing. LTV had securitized virtually all of its liquid working capital assets, thereby making DIP funding a faint possibility.

The authors also contend that usually for an originator, disincentives against assailing true sale in securitizations will prevail. These are: high legal hurdles in ultimately prevailing on the merits; first priority security interests of securitization lenders; higher interest rates on take-out debt; and difficulty in future capital market access.

The authors, however, have not considered the fact that the LTV case left a number of significant questions open, and unresolved questions are dangerous. LTV's motion had challenged true sale based on facts which are not absolutely uncommon. The Court did not go into the merits of these contentions. There was no substantive hearing on the merits of either LTV's motion or those of the opponent or amicus curae. There were several facts stated in LTV's motion, which apparently take the transaction closer to a funding transaction than securitization. So, if the facts in a potential banruptcy in future resemble those of LTV, there will be a temptation to question true sale. Let us not forget that the attack need not necessarily come from the seller: it could be a voluntary decision of the facts on examination of facts.

With the bankruptcy index rising, securitisation transactions must increasingly both be true sales and look like true sales. The LTV case cannot be underplayed.

Links For more on true sale, see our page here.

FASB staff answer questions on isolation, make single-step transfers disqualified

On April 19th, the staff of the Financial Accounting Standards Board recently answered some questions relating to "isolation" criteria. The text of the isolation criteria is here.

The isolation criteria is a key to off-balance sheet treatment for securitisations. The condition requires that a transfer of assets in a securitization must so isolate the assets that such assets are put beyond the originator and the creditors and liquidator of the originator, presuming a bankruptcy or other claim against the originator. The questions and answers deal with the isolation criteria.

In answering these questions, FASB staff has taken a steep technical view of the isolation criteria and has envisaged a theoretical possibility where an FDIC-insured bank goes bankrupt and the FDIC under its statutory powers can re-acquire the assets using what is called "equitable power of redemption". The equitable power is a special power granted under FDIC statute to recall, in its capacity as the receiver/ conservator for FDIC-insured banks, assets including assets securitised by the bank.

The FASB in answer to Q. 3 in the questions and answers says that in case of a single-tier transfer by a bank insured under FDIC, the FDIC's equitable power of redemption goes counter to the isolation criteria, as the FDIC may recover the assets transferred.

The FDIC staff also concedes that this opinion of the FDIC may not have been expected, and has therefore, promised to come out with a technical bulletin on isolation conditions, but pending that issuance, it was not inclined to defer the application of the above opinion, to transfers made after 31st March 2001.

Securitization accounting experts agree that FASB has taken a hypertechnical view of the never-used equitable redemption power. They also contend that the FASB view will cause a disruption in single-tier securitization practices. Deloitte Touche, for example, in their publication Heads Up remark: "The decision will cause a seismic shift in the way future bank securitizations are structured. But equally important, some deals maturing beyond 2001 will have to be structurally reconfigured if they are to remain off-balance sheet."

Links For a general write up on accounting for securitization, see our page here.

Synthetic structure used to lay off residual risk in securitizations

In what is claimed as a new application of the synthetic securitizationtechnique, Lehman has recently laid off residual risk in prevoius securitizations of home equity loans by a US bank.

Provident Bank is the issuer in question, which has used an SPV called Sherpas Ltd for the purpose. Provident Bank has done several home equity loan securitizations in the past, and it has used the residual risk in 9 previous securitizations as the feedstock of the present transaction. The residual risk normally represents the spread account of the originator, which is retained as a collateral to bear the first loss of the securitised portfolio. The modus operandi is as follows: Sherpas Ltd issues credit linked notes, proceeds of whicih are invested in an investment account. Sherpas also does a total rate of return swap with Provident, with the residual risk retained whereby Provident is promised a certain rate of return on the residual portion retained by it. As a result, if a loss is faced by the securitized home equity transactions, Provident's spread account suffers a loss, which is compensated in terms of the swap by Sherpas, in turn claiming a set off against the amount payable to the credit linked note investors.

Effectively, therefore, Provident has been able to displace whatever risk was retained by it in form of residual risk on its earlier securitization. The transaction achieves the purpose of releasing economic capital of Provident, which rating analysts normally reduce by the amount of cash collateral provided by a securitization originator.

Lehman expects that the deal will a groundbreaking innovation and will find many buyers in time to come.

Links For more on synthetic securitization structure, click here.

Conference shows optimism for risk-linked securities

There are any number of instances of optimism relating to volumes of cat bonds and other risk-linked securities, but this one, coming under the auspices of one of the most important fixed-income bodies of America, merits special attention.

In a conference on risk-linked securities organised by the Bond Market Association on March 21-23 in Aventura, Fla., USA, both issuers and investors showed interest in increasing the size of the market. This was the first such conference organised by the Association.

Noting the size and scope of the risk-linked market, speakers said since 1994, there have been 47 transactions by 31 different issuers in the World, representing USD 6 billion in risk transferred to capital markets investors. This is still quite small, compared to other market segments and the size of the reinsurance market itself. At present, about 100 investors are active in the cat bond market, of which about 30 are core investors. The investors include life insurers, pension funds, reinsurers, hedge funds, banks and investment advisers. The motive of these investors is both yield appreciation and reduction of portfolio variability: the latter referring to lack of correlation between capital market securities in general and risk-linked securities. Talking of returns, the average returned earned in cat bonds over past few years have been around 12%.

There are a number of issues facing the cat bonds market. These include the need for investor information; the high cost of risk-linked securities transactions, particularly when the deals are structured on an indemnity rather than an index basis; and tax consideration and the deals' present offshore focus.

Links For more on cat bonds, see our insurance risk securitization page – click here. For recent news items relating to growing cat bonds market, see our newsletter for April 2001 here.

SECURITISATION NEWS AND DEVELOPMENTS – June, 2001

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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.

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

 

European equity analysts don't know what is securitisation

Though a larger majority understands it and would like to recommend it, more than 25% of equity analysts recently surveyed by Price Waterhouse Coopers (PwC) do not know what is securitization. Of those who knew about, 75% confessed not to have a good understanding of the process. The PwC survey is the result of about 300 equity analysts interviewed between 26th March to 19th April 2001. The results of the survey were recently published as a booklet by the intenational accounting major.

The important findings of the survey are:

 

  • Securitisation is viewed very positively by equity analysts with 2 out of 3 claiming that they would recommend this source of funding. Securitisations may well replace traditional bank lending as the preferred funding option for many companies in the future.
  • Securitisation practices were thought to be on the increase. On average it was thought that 32% more companies will be securitising over the next 5 years. It was also felt that more non financial companies would participate in securitisations. Innovative structures will help this trend.
  • Securitisation is perceived to be an important source or funding and not considered to be detrimental to the reputation of a company. Telecom companies in particular might look to securitisations to provide their funding requirements.
  • Over a third of analysts felt securitisation was too complex for most companies and 16% said the impact of securitisation on a company’s reputation would depend on how it was carried out. This highlights the need for good project management within a securitisation process and professionals who can be “user friendly” to the majority of company executives.
  • One in four equity analysts had no awareness of securitisation and, of those that did, 75% felt they did not have a good understanding of the process. There is clearly a need for those companies embarking on a securitisation to educate the analysts covering their sector.

Links For more on securitisation in Europe, click on this page.

 

The agencies do lower mortgage costs, finds Federal Reserve study

In a paper titled GSEs, Mortgage Rates, and the Long-Run Effects of Mortgage Securitization by Wayne Passmore, Roger Sparks,, and Jamie Ingpen, it was contended that US mortgage securitisation agencies have in fact resulted into lower costs.

The paper comes in the midst of a controversy raging over whether the tacit US government support to the agencies should be withdrawn. For our earlier story and some important links, click here.

The paper finds that "GSEs [govt-supported entities, such as Fannie Mae, Freddie Mac – Ginnie Mae is a Govt entity itself, not a govt-supported entity] generally–but not always–cause mortgage rates to be lower in the long-run than they would be with private securitization because the GSEs have implicit public backing. When GSEs securitize mortgages, their implicit government-backing allows them to sell securities without holding the capital or purchasing the credit enhancements needed in the private sector."

Links Full text of the paper is available for download here.

Peugeot launches major securitisation of car loans

The French car company Peugeot has launced a major securitization issue totaling to Euro 1 billion. Credit Agricole Indosuez is the lead manager with Deutsche Bank.

The collateral for this mega transaction is 215,868 car loans granted to private individuals in France by two subsidiaries of Banque PSA Finance for 1.097bn euros. The issue is broken in two tranches, a Euro 950 million senior tranche and the balance junior tranche.

Vinod Kothari comments: With this issue, the already bouyant French securitization market gets a further boost. In year 2000, France had recorded a volume of some Euro 15 billion. This year, both synthetic as well as funded securitizations are likely to boost volumes. For more on securitization in France, see our recently updated page here.

Telekom Italia phone revenues securitization is a success

The Euro 700 million securitization of telephone revenues by Telekom Italia has been sold successfully, and Financial Times of 27th June quoted Telekom Italia's finance director as saying that "the asset-backed market is the best way to raise money compared with the other markets we have used".

The three tranche securitization transaction is collateralised by short-term bill receivables from Telecom Italia's domestic fixed-line voice and data customers.

Even though all major telecos in Europe have made noises about using securitisation for their ambitious funding plans, Telekom Italia is one of the very first to do so. Others who have expressed interest are KPN, France Telecom and Deutsche Telekom.

Telekom Italia has affirmed intent of tapping the securitization market once again later this year.

Links For connected stories, click here. There are more links at this story.

Bye bye Basle, see you soon!

The Bank for International Settlements (BIS) on 25th June announced that it had received more than 250 comments on its proposed revision of the capital adequacy framework, and as such, has decided to come out with a revised, "fully specified" version in early 2002 and aim at implementation of the revised framework from beginning of 2005, which delays its implementation by at least one year.

The revised capital adequacy framework has been kept boiling for quite some time. First draft of the revised framework was issued first in June 1999 with 60 odd pages of text, and then, a revised package was released in Jan 2001 with more than 500 pages of text. The third version may only be expected to be more elaborate, and who knows, more complicated.

Bankers over the world had expressed concern about the provisions in BIS-II. David Clementi, Deputy Governor of Bank of England also expressed concern – see our story here.

The BIS proposals has made fairly detailed provisions relating to securitization and credit derivatives. Even while Basle-II was under consideration, some regulators, for example, South Africa, went ahead and incorporated BIS-II norms into its local regulations.

Links For article and further links on the BIS proposals relating to securitization, click here.

Securitisation law in India: Whose baby is it?

It is bureaucracy at play again. India is one of the few remaining Asian countries to have a securitization regulation in place. Malaysia has done it earlier this year. Pakistan did it nearly 2 years ago. And so also Singapore, Hong Kong, Korea, Thailand, Philippines et al.

However, the Indian regulator is still to decide the right father for the securitization baby. The draft securitization law was recommended by the Andhyrujina panel quite some time back and even the RBI's report on securitization is almost one year old now. However, as per a report in Economic Times of 25th June says that the banking division of Finance Ministry was earlier thinking of piloting a separate securitisation bill in the reconvened session of Parliament. But the thinking now is that securitization could be permitted by notifying it under the Securities Contracts law and let the securities regulator SEBI regulate it. The report says that finance secretary Ajit Kumar took this view at a recent meeting on securitisation entrusted the task to J Bhagwati, joint secretary, capital markets division to work out the modalities.

Vinod Kothari comments: If experience with earlier products is of any indication, it would be a mistake to entrust the lawmaking to SEBI, a body which is known for its adhoc style of regulating – 10 uncertain, unclear laws today and 20 clarifications every one month hence. SEBI has a role in public issuance of securitised debt, but SEBI obviously cannot take care of private issuance, which will presumably form a bulk of securitization transactions. SEBI also cannot take care of the Transfer of Property law, Stamp law and income-tax law in which amendments were conceived of in the draft bill.

An umbrella all-pervasive securitization law, as done by Italy, Korea, France, etc. is the best bet.

Links For full text of the draft securitization law, see our legal page here. For country profile of India, click here.

Philippine govt. defers plans to securitise royalty income

The Philippine government has been talking about securitization of royalty income from the Palampaya natural gas fields for quite some time now, but it seems the plan is now deferred until the next year. The published proposal earlier was to set up a power sector SPV called Power Sector Asset and Liabilities Management (PSALM) Corporation, to which the royalty income will be transferred to pay off the debts of the National Power Corporation.

The government expects a royalty income of about USD 9 billion from the gas project which it shares with Shell.

Links Securitization law in Philippines was recently enacted. See full text on our laws section here.

Spanish securitization poised to grow fast, says Moody's

Securitisation, or titulizacion as they would call it, is about to complete a decade of existence in Spain and rating agency Moody's expects it to grow fast. Moody's recently released a report titled A Review of The Spanish Securitisation Market: 1991 – 2001.

Securitization issuance in Spain in 2000 reached Euro 7,320 million, about 9.3% higher than 1999. However, what is more important is the introduction of new asset classes such as CLOs, ABCP, and innovative ABS applications. Moody's expects these developments to enliven the Spanish market in 2001 and stimulate future issuance.

Though the Participación Hipotecaria law was passed in August 1991 to enable true transfers of credit (enforceable in the event of an issuer's bankruptcy), it was really not until the introduction of Spain's Securitisation Market Law and the concepts of Fondos de Titulización Hipotecaria and the Sociedad Gestoras (management company) that the market was able to see marked growth.

Links For more on securitization in Spain, see our page here. This page features a new article link.

Fitch cautions on use of insurance to support securitisations

The use of insurance to provide a cover and enhance the credit of securitization transactions recently came under sharp attacks following the controversy surrounding structured investment vehicle Hollywood Funding. Hollywood Funding enjoyed insurance cover from insurer Lexington Insurance Co., which denied its liability to the insured relying on a ruling of a UK court in a different case : see more of this story here along with more links.

Following this, the use of insurance policies as credit enhancement came under review and market practitioners were divided on whether insurance covers from monoline insurers were more effective or those from multiliners. Rating agency Fitch has recently issued a special report titled Use of Insurance Policies as Credit Enhancement in Structured Finance. Fitch says that it is normally believed that under traditional insurance from multiline insurance companies, insurers generally maintain the right to adjust a claim and, if warranted, litigate the validity of a claim before actual payment is made. Such actions are common and ordinary in the world of the multiline insurers. Even if the policy terms cover the necessary items, this approach does not meet the requirements of structured finance transactions, under which the timeliness of the payment of debt service obligations is of the utmost importance. On the other hand, monoline insurers are closer to financial guarantees and their covenants under the policy normally restrain them from delaying the claims even if they intend litigating the same.

However, as the market place distinction between monoline and multinline insurers has gradually got blurred, it is more important to look at the nature of the insurance cover rather than its source. Fitch says that there are three signficant provisions that are necessary to provide the required enhancement:

 

  • An unconditional obligation to pay the claim, if the premia are paid and there is basic performance by the insured.
  • A clear and straightforward method for the submission and payment of the claim.
  • A clear and unconditional waiver of any and all rights and defenses to payment available to the insurer under law or equity, including: set-off, counterclaim, fraud, etc.

 

Synthetic securitisations continue to dominate as new applications emerge in Europe

Synthetic securitisation is becoming synonymous with European securitisation scenario as these structures continue to dominate. However, new innovative applications of the synthetic securitisation method contine to evolve.

A Fitch newsletter [European Securitisation News, June 2001] talks of the innovative applications of synthetic securitisation. One remarkable deal in April this year was the Leonardo Synthetic Aircraft CDO.

In the sphere of aircraft securitisation, the common devices used in the past have been enhanced equipment trust certificate (EETC) and asset lease portfolio securitisation (ALPS). For more on these methods, see our page here. However, Leonardo was the first case of a synthetic CDO in the aviation segment. The originator was IntesaBCI which used a combination of credit default swap and total return swaps [for details, see our site on credit derivatives here] to transfer the risks in about USD 1 billion of portfolio of aircraft leases and loans. The leases and loans remain on the books of the originator. Fitch says that "Leonardo evidences the growing trend in the use of synthetic structures in securitisation across a range of asset classes."

Links For more on synthetic securitisations, see our page here.

Under-construction houses securitised in Singapore

Indicating the fast pace of developments in securitisation markets in the region, a builder has securitised houses under construction in a deal believed to be first of its kind in Singapore. We have reported earlier about a mortgage securitisation by Raffles – this deal was sold recently.

Close on the heels came yet another deal: Business Times of 12th June reported Capitaland Residential's Sing $ 200 million asset-securitised bond issue which was launched recently and attracted very good response. This is described as the first of their kind in Singapore. Senior bonds of $160 million, or 80 per cent, of the six-year bonds have been given the highest rating of AAA by Fitch.

CapitaLand Residential is a unit of property giant CapitaLand. The bonds are backed by money collected through progress payments – the typical method of payment for uncompleted homes in Singapore – on uncompleted CapitaLand Residential projects. The projects include Sun Haven, Palm Grove and The Loft, each of which are 70 per cent sold.

Links For more on securitisation in Singapore, click here.

Technogy merger to make it happen: origination to securitisation of mortgages automated

Ultraprise Corporation and LoanTrader, Inc., two US based technology companies in the mortgage industry, have merged to form a new company, Ultraprise Loan Technologies, Inc. Consequently they have combined their solutions: Ultraprise and LoanTrader.

With the merger, the new firm will be in a unique position as the only mortgage technology company providing e-commerce infrastructure and application software for processing loans and other related assets from origination to securitization.

The mortgage market looks at technology as a significant source of savings. Linking the primary and secondary markets also holds significant value. The ability to reuse information already gathered during the origination process when creating loan pools for sale or securitization as well as the ability to communicate quickly and accurately the appetites of investors in the secondary market to origination channels brings sizable potential savings.

More info is available on the website of the company at www.ultraprise.com

Swiss Re study sees 10 fold growth in insurance securitisation

A Swiss Re Capital Markets study went into the growth potential of insurance securitisation and came with results which do not sound strartling: given the fact that similar noises have been made time and again: it predicts a 10 fold growth in securitisation of risk by year 2010.

Approximately USD 12.6 billion of these capital market insurance solutions have been issued since 1996. Some of the important findings of the study are:

 

  • To date, the issuance of catastrophe bonds has accounted for nearly half of insurance risk securitisation transactions.
  • Annual issuance of catastrophe bonds, now about USD 1 billion, is expected to reach USD 10 billion by 2010.
  • Capital market insurance solutions linked to non-catastrophic risks have an even greater market potential. Promising areas include life and automobile insurance.

The study examines capital market insurance solutions in the context of the global wave of financial innovation that has occurred since the 1970s. A variety of forces have stimulated this innovation: the need to protect against market risk; technological progress facilitating the innovation process; and a desire to minimise the costs imposed by taxes and regulation.

Links Full text of the Swiss Re study is available here. For a page on insurance risk securitization and lot of links from there, click here.

Islamic securitisation in Singapore

The Islamic Religious Council of Singapore intends to finance 75% of the cost of acquiring a S$32m commercial building in Singapore through a bond issue. Muis will shoulder the remainder of the total cost. The move marks the first time that a bond has been issued in Singapore in accordance with Islamic laws on financing. The planned purchase is part of Muis' restructuring and upgrading of its property portfolio. The Council is a statutory board to advise the government of Singapore on Islamic matters.

The above news item appeared in Business Times Singapore 11 Jun. No details were apparent on the website of the Council. However, the Business Times report compliments the deal as such: "The issue will be a significant breakthrough for the local bond market as it will be the first bond instrument to comply with Islamic laws on financing. This would open the gates for the bond to be marketed to Islamic markets around the world, and for other Islamic institutions to raise funds through such instruments in Singapore."

Islamic securitization is an idea that has not picked up as it should have. Last year, there was an Islamic securitization concluded in Saudi Arabia [report on this site is here], but that is perhaps the only deal still.

Links There is an article on Islamic securitization by Tariqullah Khan on the articles section of our website – click here.

 

IFC makes first investment in KoMoCo securities; intends to play active role in emerging market MBS

International Finance Corporation (IFC) Washington has made its debutante investment in emerging market MBS by USD 41 million worth mortgage backed securities issued by KoMoCo, the Korean MBS agency. AN IFC press release of 7th June says that the move marks the beginning of IFC's stronger participation in emerging mortgage markets and "will stimulate more affordable long-term loans to homebuyers and develop a modern, transparent, and efficient housing finance sector in Korea". Quite some time back on this site, we had reported about the in-principle accord signed by KoMoCo for this issuance – click here for our previous news report.

KoMoCo, Korea's first specialized secondary home mortgage market entity, was established in September 1999 with IFC's assistance. The current MBS offering, christened as MBS 2001-1, consisting of a senior tranche of USD 174.4 million and a subordinated tranche of USD 7.4 million, both denominated in local currency, is backed by Won-denominated mortgage loans and collateralized by residential properties located in Korea. This is the fourth MBS issued by KoMoCo over a twelve month period which saw KoMoCo arranging about USD 1.2 billion equivalent MBS, listed on the Korea Securities Exchange.

Links For more on securitization in Korea, click here.

S&P issues model documents for revised Article 9 of US UCC

The revised Article 9 of the Uniform Commercial Code of the United States will become effective in some 40 states from 1st July 2001. The revised article deals with the creation, perfection, and priority of security interests in personal property including receivables and intangibles. As securitisation transactions are based on transfers of assets or creation of security interests therein, securitisation documents need to comply with the revised article.

As the representations and warranties in the transfer agreements need to comply with the new rules, rating agency Standard and Poor's has put up a set of model representations and warranties for various clauses of collateral. These models are available on the rating agency's websitehere.

The rating agency has also decided that under the revised Art. 9 it will not insist upon a "first priority perfected security interest" opinion that it has been asking so far for securitisation transactions.

Links For more on article 9, click here.

First rated securitisation of a private equity fund to open new funding doors

This sounds as a logical, and simple, extension of the concept of CDOs and structured product funds which have been around for quite some time, but most remarkable innovations that make so far reaching changes are invariably based on so simple ideas. Rating agency Standard and Poor's recently rated the first offer of structured notes by a private equity fund. A release of 4th June by the rating agency says that it rated the first structured notes issued by a leveraged fund and backed by pools of private equity investments. The transaction, Prime Edge Capital PLC, totaled Euros 150 million; the rated senior notes have a stated maturity of 12 years and the unrated junior notes have a maturity of 24 years.

The senior notes have been credit-enhanced by insurance wrap by Allianz Risk Transfer N.V. Prime Edge will use the proceeds it receives from this public transaction to make investments in more than 20 different private equity funds. Prime Edge Management Ltd., as the investment advisor, will be responsible for allocating these funds based on certain established investment parameters and diversification guidelines, monitoring the performances, and reporting the valuations of its investments.

The Wall Street Journal of 5th June described this transaction as "a move expected to have a far-reaching effect on money managers, making venture-capital and buyout funds available to bond investors". Securitisation of private equity funds marks the coming together of debt and equity -reinforcing the dictum that as markets develop, more and more things tend to converge.

European securitisation volume grows 100%

The early growth trend in securitisation volumes in Europe established this year [see our news report here and here] continues to get even stronger. Rating agency Standard and Poor's reports that the new issue volumes in Europe doubled on the same period a year earlier. The new issuance in May totaled USD 14.3 billion, which compares with USD 7.5 billion in May 2000, and USD 7.5 billion in April.

During May, a total of 22 transactions closed, including some mega issues such as INPS II. The European CDOs market continued on its whirlwind growth pattern ending 59% higher on the same period a year earlier at USD 4.6 billion compared with USD 2.8 billion last year.

The rating agency expects the growth rate to be maintained, looking at the pipeline which has some big issues from London, and a number of CBOs from both England and other countries. Arbitrage CBOs are likely to remain a dominant theme as many were delayed from the beginning of 2001. Credit default swaps and credit-linked notes backed by pools of corporate and asset-backed bonds are also expected to maintain their high volume throughout the rest of the year.

The European CMBS market ended at USD 832.42 million after two transactions closed, as compared to no transactions closed in May 2000. The European RMBS market commanded the largest market share, accounting for 30.4% of overall volumes, ending at USD 4.7 billion.

One of the most remarkable features is the rise of Italy as the prime player, which toppled the U.K. from its traditional premier spot with volumes there ending at USD3.6 billion. This is, of course, a transient feature due to INPS II during the month, and two other prominent transactions.

Links For more on Europe, click our page here. For individual country pages, go here.

New securitisation rules proposed 
in South Africa

Last month, the South African Reserve Bank proposed and put up for public comment a new set of rules for securitisation transactions in the country. Comments are due by 15th June.

The new regulations have been shaped by the BIS proposals in the revised capital adequacy framework, which is yet to be implemented, and is already facing lot of criticism all over. The new regulations will evolve a new risk weighting system in case of securitised tranches, with senior securities carrying a far lower risk weightage than junior tranches. Junior tranches, particularly those providing first loss protection, will be a straight reduction from capital of the issuer or the investor.

For detailed comments of Vinod Kothari on the guidelines, see here. Also see the above link for a detailed commentary by Eugene Van den Berg of Decillion, South Africa.

Do you have a comment on the proposed regulations? Please do write.

Links For our page on South Africa, click here. For full text of the existing guidelines as also the proposed regulations, click here. For comments by Vinod Kothari and Eugene Van den Berg, click here.

Singapore company to securitise prime shopping complex

If you have been to Singapore, you might have shopped at Raffles City, but now, if you have deep enough pockets, you can shop Raffles City itself.

As per a report in Financial Times of 5th June, Raffles Holdings, the Singapore-based property company, proposes to raise USDollars 547 million from the securitisation of a 55 per cent stake in its landmark Raffles City shopping complex.

The securitisation transaction will be achived by a bond issue by an SPV named Tincel. Tincel in turn will issue bonds to investors, partly by way of public offer and partly privately.

Proceeds from the deal will be used to cut debt and fund international expansion.

Vinod Kothari adds: With activity levels already high in Korea, lot of noise in Malaysia, signs of interest in Thailand, and meaningful portents from Singapore, it seems the erstwhile Asian tigers are back in business.

Links For more on securitisation in Singapore, click here. For more on Asian securitisation, click here.

Securitisation activity to speed up in Thailand with proposed law changes

Securitisation industry needs clear and practical law: it becomes evident in Thailand. The country has had the SPV law for last 2 years but no signs of any securitisation activity so far. Now, just as the SEC announced legal changes to make the law more industry-friendly [see news report here], the market players have jumped up in action.

Here is an example: Bangkok Post reported on June 1 that Trinity Advisory 2001 Company Limited, a unit of Trinity Securities Group, has teamed up with Devonshire Capital Limited and Allen & Overy to provide securitisation services for small and medium enterprises. Devonshire has experience in securitisation in the Asia-Pacific region and Allen & Overy is a well-known law firm with securitization familiarity.

Although the Securitisation Act in Thailand has been effective for about two years [see text of the law on securitization laws page on this site], securitisation activities have been limited due to some unclear points in the law and high expenses. In the future, the situation will improve with the proposed changes. The proposed amendments include allowing the setting up of multi-tier SPVs express legal provisions for bankruptcy remoteness.

In particular, there is a lot of potential in Thailand for securitisation by SMEs who need funds to expand their businesses.

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

Securitization residual value accounting to blame for debacle of Superior Bank

Change of assumptions can cause significant depletion of asset values under securitization accounting stipulated by FAS 140, and such write downs may even result into severe financial problems. The example below is not the only one – there have been more from the United States in the past – see our reports and further links here.

The recent example is of Superior Bank FSB, a thrift institution based in Oakbrook Terrace, Chicago. Superior Bank faced a substantial write down in its residual interests as well as the value of overcollateralisation account, totalling to some USD 238 million, resulting into the bank being undercapitalised as per regulatory norms.

Superior Bank had to run for a bail out. Alvin Dworman and the Pritzker family subsequently injected a USD 350 million sum into the bank and its holding company, to keep it afoat. This was based on the negotiations with the Office of Thrifts Supervision.

Analysts report that the write down was a result of the discouting rate being hiked up to find the fair value of retained interests in securitisation. It is notable that securitisation accounting requires the carrying value of the asset being securitised to be split in the ratio of the fair values of sold assets and retained assets. While the value of the sold asset is easy to come from what the securitiser gets therefrom, the value of the retained interest is an approximation of future or residual cashflows, which are discounted at an appropriate rate to get their value today. Accounting differences arise due to both the estimation of the residual cashflows, as also the discounting rate.

Chicago Tribune of 25th May said: "At the heart of the bank's troubles this time is an arcane but often used banking practice called securitization, by which banks routinely convert the mortgage loans they make to customers into cash that can be used for more lending". This is how the newspaper described the accounting problem: "Using a different set of accounting methods than the bank, the government concluded that Superior had essentially counted some of the assets twice and also had failed to discount the value of these assets for the fact that it would be several years before they could all be collected. Prepayments of loans and lower interest rates also affected the value of the mortgage-backed assets. "

Links For more on accounting for securitization, more articles, and more links to similar news items, see our page here.