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For all news for April, 2001, please click here
Read on for chronological listing of events, most recent on top:
INPS-II is most likely oversubscribed, as European ABS goes strong
Added on May 30, 2001
The second issuance of defaulted social security contributions from Italian social security collection agency INPS was brought to the market on 29th May, and newspaper reports today indicate that it is mostly likely to be oversubscribed.
Consumer spending bolstered by asset-backed market
Added on May 30, 2001
Amidst Greenspan's warnings, more layoffs and more charge offs, Americans can still continue to spend as asset-backed products support consumer credit.
Investors flocking to ABCP as corporate credits deteriorate
Added on May 30, 2001
While corporate credits remain fragile, money market investors prefer investments in asset-backed commercial paper, as affirmed by a recent Moody's report.
CDO ratings historically stable, but 2001 may see volatility, cautions Moody's
Added on May 30, 2001
Rating trasition studies indicate the CDO ratings have historically been more stable than corporate bonds, but 2001 may see a few reverses..
FASB issues draft technical bulletin to clear problems in single step securitizations
Added on May 28, 2001
On 17th May, the FASB issued a draft technical bulletin for comments that seeks to clear problems recently created by a staff interpretation that virtually ruled out off balance sheet treatment to single-step securitizations.
Clementi opposes Basle proposals
Added on May 28, 2001
Bank of England Deputy Governor Clementi opposed risk-based capital standards proposed by BIS; other banks have also expressed concerns. It is an open question as to whether the revised proposals will be deferred.
Japanese restructuring body to securitise bad loans
Added on May 28, 2001
It seems the Asian laundry machine is on its full speed – with Korea, Malaysia and China, now it it is Japan's bank restructuring body announcing a plan to securitise illiquid assets of sunk Japanese banks.
Italian INPS-II comes to market
Added on May 10, 2001
The landmark social security contribution securitization from Italy, INPS, is coming to the market for its second tranche.
First non-agency securitization in Malaysia soon
Added on May 10, 2001
Soon after the Securities Commission notified securitization guidelines, several companies are planning securitization offers, including a leading consumer durables supplier.
Guy Hands leaving Nomura
Added on May 9, 2001
One of the most illustrious personalities in securitization, and one of the best known investment bankers in London, Guy Hands is leaving Nomura.
Moody's: Why need an SPV, if you can walk your way without it
Added on May 9, 2001, updated 10th May
In a recent report, rating agency Moody's mooted the interesting idea of doing away with SPVs in several securitization transactions. Vinod Kothari does not quite agree.
Chinese asset management company plans to securitise
Added on May 9, 2001
China Huarong Asset Management Corporation wants to do for China what Kamco did for Korea – securitise non-performing assets.
Primary CBOs: a new trend in Korea
Added on May 7, 2001
This may well be a lesson for emerging markets with banking credit constraints. Korea is seeing a new kind of securitization vehicle: primary market CBOs that allow companies with lower credit ratings to raise bonds from capital markets.
CDO market triples in Q1, 2001, non-US growth outstanding
Added on May 7, 2001
A recent report by Moody's says that the first quarter of 2001 has seen a 200% growth in CDO market, with growth outside the US being particularly impressive.
LTV controversy is over: but is true sale a safe harbour?
Added on May 7, 2001
The controversy about true sale in securitization transaction occasioned by LTV bankruptcy is over by an escape route, but true sale will remain a significant issue, feels Vinod Kothari.
FASB defines "isolation" criteria, ruling out single step securitization for banks
Added on May 4, 2001
The Financial Accounting Standards Board recently issued answers to some questions regarding the isolation criteria for securitization, and by virtue of their answers, made single step securitizations disqualified for off-balance sheet treatment.
Synthetic structure transfers residual risk in securitizations
Added on May 1, 2001
In what is claimed as a new application of synthetic securitization technology, Lehman has recently used securitization to lay off residual risk in previous securitizations of home equity loans by a US bank.
Risk-linked securities conferences exhibits optimism
Added on May 1, 2001
A recent meeting of the Bond Markets Association on risk-linked securities evinced optimism for a strong market in 2001.
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.
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?
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.