Securitisation%20:%20Implications%20on%20Financial%20Markets

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Securitisation Implications on Financial Markets

• Impacts, Consideration Recent Development
• 11 September 2007

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Discussion Plan

• Part I Global Perspective
• Development of US Sub-prime Mortgage Crisis
• Market Trend International Experience
• Part II Regional Perspective
• Recent Development in Asian Securitisation Market
• Institutional Setting Credit Enhancement in
  Securitsation
• Managing SMEs Credit Risk Experience of Korea
• Part III Thailands Perspective
• Capital Market Development
• Recommendation and Conclusion

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Part IGlobal Perspective
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a) Development of U.S. Sub-prime Mortgage
CrisisCausation and Consequences
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Sub-prime Crisis An Initial Underestimation

• Expected Loss
• Size USD 1 trillion while total mortgage size
  is USD 10 13 trillion
• Assuming that default rate 25
• Assuming that sales of NPLs realise loss of 50
  of the amount
• If true, the adverse effect of sub-prime crisis
  is limited.
• Such estimation proves understated.

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Causation A Backward Looking

• Causes
• In 2001, low interest rate environment in US
• Asset price bubble in property market, US housing
  price had been rising at rapid speed
• Wealth effect led to higher leverage
• Low risk awareness Higher risk appetite
• Implication Investors were less sensitive to
  credit risk
• US tightening cycle commenced, fed funds rate has
  been standing at 5.25.
• Debt servicing ability of homeowners started
  deteriorating higher.

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Crisis Development

• Consequences
• As low interest rate lending boom to borrowers
  with weak credit, banks looked for new ways to
  package those loans.
• A central building block to offset the risk is
  asset-backed securities (ABS).
• Banks and other FIs pooled those ABS into new
  units, by dividing them up and issuing securities
  against them, creating Collateralised Debt
  Obligations (CDOs).
• New creation CDOs of CDOs, CDO-squared and
  CDO-cubed.
• Risk in sub-prime ABS was embedded and amplified
  in CDOs.
• When sub-prime mortgage went bust, it revealed
  dangerous amounts of leverage in securities.

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Analysis

• Problems
• Market participants including investors could
  hardly value or quantify embedded risk
• Weakness in the system were left unprotected
• Ratings did not accurately reflect risk
• Faulty assumptions on diversified pools with
  multiple layers of leverage.
• Arising of Risk Aversion
• Investors started selling securities that they
  thought might be risky from stock to loans.
• Volatility in global financial markets took
  place, from US to other economies including
  emerging markets.
• In the present, damage on subprime is still
  open-ended.

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Lesson Learned

• Dilemma
• Securitisation helps enhancing liquidity of
  certain assets but it also redistribute risk
  among market participants.
• Quote of the Day
• Regarding the use of derivatives to power
  financial tools, if you know how to use them
  (derivatives), they are exponentially better and
  faster for building a houses, compared with using
  hammers, screwdrivers and handsaws.
• If you dont, you could drill a hole in your
  head,
• Peter Douglas
• Founder of GFIA, a hedge fund research firm
  in Singapore

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b) Market TrendSecuritisation and Impacts on
Financial Markets
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Trend 1 Increasing Demand for Securitised Papers

• 1. Increasing Demand from Investors
• Demand for MBS/ABS has been increasing
• Rising demand is reflected on narrowing spread
• It is perceived that investing in MBS/ABS allow
  investors to yield higher returns in comparison
  to holding debentures.

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Trend 2 More Risk Appetite on Securitised Papers

• 2. Demand for Lower-Rated ABS/MBS Papers
• Investors demand ABS/MBS that bear lower credit
  rating
• Due to ABS/MBS themselves are secured bond in
  nature
• According to historical data, ABS/MBS (in
  exception of sub-prime mortgage), have never been
  default.
• Investors, thus, incline to make a downward shift
  in credit curve and enjoy higher return.

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Trend 3 Improvement in Liquidity Condition

• 3. Liquidity in Secondary Market is Improving
• In advanced financial markets, ABS/MBS has good
  liquidity in secondary market
• In the US, liquidity has been improving since 90s
  and in Europe, secondary market condition is
  getting better during the past 3-5 years.

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Trend 4 Impact from Financial Institutions

• 4. Capital Efficiency Improvement
• Financial institutions tend to securitise assets
  that have high risk- weight out of their balance
  sheet
• Higher risk-weighted assets cause banks need to
  maintain higher capital
• Thus, securitisation is regarded as a tool to
  improve FIs capital efficiency.

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Part IIRegional Perspective
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c) Recent Development inAsian Securitisation
MarketSpectrum of Structured Finance
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Structured Finance Market in South East Asia

• Moodys Investors Service announced
  (Reuters 6 September 2007)
• Asias structured finance market during 1H07,
  activities was prominent in Singapore and
  Malaysia.
• Property-related securitisation (REIT) expanding
  more than double in Singapore. (Issuance size
  USD 1.2 billion in 1H07 compared to USD 600
  billion in 1H06)
• Malaysias Cagamas issued second Islamic RMBS (
  USD 700 million)
• Thai securitisation market, regular issuers
  including SICCO (3rd), AEON (3rd), GHB ( USD
  1.22 billion, expected within H108)
• Indonesia last securitisation deal took place
  in 2005. Forthcoming deal is state-owned mortgage
  provider ( USD 53 million, H207)

Source Structured Finance in South Asia
Singapore and Malaysia on Growth Track RMBS
Potential in Thailand and
Indonesia in www.moodys.com
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Major Players

• Classified by Economies
• Korea is the largest market, providing ABS and
  RMBS activities.
• Singapore is also an active market with majority
  of the activities are property related.
• Taiwan has been active since it passes two
  securitisation laws in 2002 and 2003. Asset
  classes include RMBS, ABS and real estate-related
  transactions.
• Hong Kong has liquidity and issuance has been
  sporadic.

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Types of Major ABS Assets in Asia

• Underlying Assets
• Credit Cards
• Auto Loans
• Consumer Loans
• Students Loans
• Trade Receivables
• Commercial Mortgage
• Residential Mortage

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Contributing Factors

• Established legal and regulatory framework - ie.,
  the enactment of securitisation laws in Korea and
  Taiwan.
• Large potiential supply of assets ie., credit
  card receivables in Korea.
• Genuine need from originators ie., funding
  requirements for monoline credit card issuers in
  Korea, .
• Interest Confidence of investors.

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Model Country Korea

• The Largest ABS Market in Asia (ex-Japan)
• Enactment of ABS law in September 1998.
• Regulators have been supportive in the
  development of the securitisation market.
• Active cross-boarder market since 2000.
• Typical ABS asset types residential mortgage,
  credit cards, auto-loans, consumer loans, student
  loans and etc.
• Funding requirement from originators.
  

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Other Markets

• Selected Countries
• Thailand several domestic ABS and MBS
  transactions.
• China large pool of potential assets.
• Other Asian countries potiential and interest
  including Malaysia, Indonesia and India.

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Challenges Ahead (1)

• Aspects of Credit Risk
• Externality Negative spillovers from advanced
  financial markets.
• - Sub-prime market in US
• Unstable credit environment in emerging markets.
• - Consumer credit crisis in Korea in 2003
  2004
• - Taiwan card crisis since in late 2005.
• Credit risks across different emerging markets
  may be highly correlated.

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Challenges Ahead (2)

• Aspects of Data Requirement
• Availability and integrity of historical
  performance data.
• Discretionary practices in data collection /
  definition.
• Data integrity
• - Discrepancies
• - Unable to obtain certain performance data

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Challenges Ahead (3)

• Other Aspects
• Aggressive bank lending market provides lots of
  liquidity.
• Increasing interest in Asian papers.
• Risk assessment and management capability.

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d) Credit Enhancement in SecuritisationInstitutio
nal Setting
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Credit Analysis A Building Block

• Credit Rating
• Credit Rating Agencies (CRAs) ratings are merely
  credit opinion.
• It provides a simple, (globally) consistent
  framework for comparing the credit quality of
  debt instruments.
• Not a guarantee against losses.
• Not a recommendation to buy or sell.
• Not addressing whether the particular investment
  is appropriate.
• Credit Rating measuring relative ability and
  willingness of an issuer to make
• its debt payment over the life of the instrument.

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Credit Enhancement

• Purposes
• Enable the transactions probable default to be
  less likely than the probable default of the
  originator.
• Higher the credit enhancement, the higher credit
  rating outcome.
• Credit enhancement mitigates credit risk, and
  some other transaction risks.
• Set-off risk yes
• Commingling risks yes
• True sales risk no
• Servicing risk yes

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Internal Credit Enhancement

• How is it determined ?
• Relies on assets of the SPV, on structural
  features such as legal entitlement to priority of
  payment.
• Rating agencies, investors, monolines study data,
  trends (past and future) to determine suitable
  level of credit enhancement.
• - Actuarial analysis (probable default, loss
  given default)
• - Model based analysis

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Types of Credit Enhancement

• Internal Enhancement
• Subordination
• Excess spread
• Over-collateralisation
• Cash Reserve
• External Enhancement
• Standby Letter of Credit / Credit Facility
• Guarantees
• Insurance coverage
• Monoline Insurance Coverage
• Credit Default Swaps

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Is it there, when you need it ?

• Considerations on Credit Enhancement
• Reliance and correlation to asset behaviour
  (internal vs external)
• Coverage
• Conditionality to payment
• Certainty of payment
• Timeliness of payment
• Impact to the rating stability of the rated bond
• Country risk / Systemic risk

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Summary

• Considerations on Credit Enhancement
• Credit enhancement is a fundamental concept of
  asset backed securitisation and types of
  structured debt.
• Choice and form of credit enhancement affects
• - Rating depends on credit enhancement / credit
  enhancement provider
• - Rating stability
• - Mark-to-market volatility
• Monoline insurancers usually provide guarantees /
  guarantee equivalents
• - Backed by very high ratings (AAA)
• - Comprehensive and timely payment cover
• - Uncorrelated with asset and country risk
• Monoline guarantees and CDS will become an
  important risk capital management tool for banks,
  insurances sectors under Basel II.

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e) Managing SME Credit RiskExperience of Korea
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Roles of SMEs in Economy
Difficulties
Impact on Economy High

• Insufficient collateral
• High transaction costs
• Low credit risk assessment ability
• of financial institutions
• Limited access to formal financing

No. of Companies
SME

No. of Employee
SME

Exports
SME
LE
represents large enterprises (LE)
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SME Credit Database

• Korea
• Established Korea Enterprise Data (KED) in
  February 2005 as a spin-off company of KCGRs
  credit information services.
• Credit bureau specialises in credit information
  of SMEs.
• About KED
• - Capital USD 72 million
• - 8 Branches Nationwide
• - Shareholders KCGF (47.8), KOTEC, KDB, IBK
  and etc.
• - 8 Types of credit information services to
  domestic and oversea clients

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Corporate Credit Rating System
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SME Securitisation Program
CBO Program
23 SMEs
Corporate Bonds KRW 72 billion
KRW
Small Business Corporation
Asset sales
SPV
Credit Enhancement By Korea Housing Bank
Senior bonds (2 yr 8.5 billion, 3 yr 36 billion)
Junior bonds (27.5 billion)
Investors
Repurchased by SMC
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Credit Risks Involved in SME Securitisation

• The main problems are SMEs in Korea have high
  default risk
• Cumulative Default Rate

(by Korea Ratings, Periods 1998-2004, unit ) (by Korea Ratings, Periods 1998-2004, unit ) (by Korea Ratings, Periods 1998-2004, unit ) (by Korea Ratings, Periods 1998-2004, unit ) (by Korea Ratings, Periods 1998-2004, unit )
Rating 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year
AAA 0.00 0.00 0.00 0.00 0.00 0.00
AA 0.00 0.00 0.00 0.00 0.00 0.00
A 0.00 0.00 0.00 0.00 0.00 0.00
BBB 0.32 0.68 1.11 1.93 3.20 3.20
BB 3.94 6.77 9.12 10.18 11.29 12.48
B 13.73 17.10 9.44 19.44 19.44 19.44
Below B 0.16 0.36 0.60 1.09 1.82 1.82
Speculative 6.5 9.47 11.81 12.59 13.37 1.42
Average 2.22 3.41 4.47 5.07 5.82 6.13
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Small Business Corporation (SBC)

• Program
• CBO program will remain operative in the future.
• Maturity of bonds (issued by SMEs in the CBO
  program) will be extended from 3 to 5 years.
• Mezzanine tranche is sold to investors (since 8th
  tranche).
• Junior tranche can be sold to other investors.

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Part IIIThailands Perspective
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f) Capital Market DevelopmentAn Important
Pre-requisite
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Capital Market Structure

• 1. A Well-Balanced Capital Structure
• Consisting of large investor base
• Mitigating problems of one-way market
• Higher proportion of sophisticated investors

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Transaction Costs

• 2. Cost Efficiency
• Efficient market allowing market participant
  transacts at lower cost
• Tight bid/offer spread encourage more
  transactions
• Need market-makers, bond-dealers and brokers to
  make market

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Related Issues on Capital Market

• 3. Issues to be settled including
• Structuring ABS that response investors need
• Regular issuance is required
• Limited absorption ability in the capital market
• Adjust investment guideline of institutional
  investors
• Information dissemination

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g) RecommendationA Survey from Practitioners
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??????????

1. ????????
2. ??????????????
3. ????????????????????????????????
4. ??????????????????????

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1. ????????

• ???????? Payout-ratio
• - SPV ?????????????????????????????? Pay-out
  ratio ????????????????????????? (Fixed
• Proportion)
• - ????????????????????????????????????
  Securitise ??????????????????????
• ?????????????????? ????? Pay-out ratio
  ????????????????????????????????
• ?????????????????????????????????????????????????
  Pay-out ratio

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2. ??????????

• ????????????????
• ????????????? ????????????
• - ??????????????????????????????????????????????
  ?????????
• - ??????????????????????????????????????????????
  ????????????
• ??????????????????????????????????????????
  (Future Receivables)
• - ???????? ???.???????????????????????
  ?????????????????? Securitise ???
• ??????????????????????
• - ?????????????????? ???? ??????????????
  ???????????????????????????????
• ?????????? ???????????????????????????????????
  ??????????????????

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3. ????????????????????????

• ????????? Credit Bureau ??????????????????????????
  ?????????????
• ??????????????? Credit Bureau ????????????????????
  ??? (Qualitative Status) ????????????? Portfolio
  ??????????????????????????? (Judgment) ????????
• ???????????????????
• ???????? FICO (Fair Isacc Corporation)
  ????????????????? Credit ?????????????????
  ??????? ???????????????? (Quantitative Status)
• ??????????????????????????????????????
  ??????????????????????????????????????????????????
  ??? Credit ?????????????????

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4. ???????????????????????

• ?????????????????????? Securitised products
  ???????
• ???????????????????????
• ???????????
• ?????????????????????????????????????????????????
  Securitised products
• - ???????????????????????????????????????
• - ????? Absorption Capacity
• - ???????????????????????????????? ????
  ????????????????????? Prepayment
• Risk