2002 was a boom year for Asian securitisation. And while 2003 was less impressive, the experts expect work to pick up in 2004. In ALB's annual securitisation focus, Fiona Larsen takes a look at the future potential of the financing technique throughout Asia's markets
In 2002 it was Korea that provided a major securitisation highlight and hopes were high for repeat issuances. Geographically, securitisation's appeal appeared to be spreading, with the year seeing the first deals in Malaysia and Thailand. Securitisation volume in 2002 was estimated at US$3.8bn, and predictions abounded for greater volume in 2003. However, this year has fallen short of expectations.
A recent report by Fitch Ratings, which provided an overview of the Asian structured finance market, said that by the end of the third quarter "it would appear that 2002 was a false dawn, with a flurry of unexpected events prompting a dearth of Asia-originated issuance, both domestic and cross-border".
SARS, too, had its impact. Fitch lists SARS-related consequences as having the strongest adverse impact on the Asian securitisation market. "The problem with SARS was that apart from the fact that people didn't want to see you, transactions were held up as key decision makers on the investor side had left town. Hopefully there won't be a recurrence of SARS," says Paul Hastings' Neil Campbell.
The region's major markets
The reasons for market shortcomings differ from country to country throughout the region. Simply stated, the two main reasons for continued restricted activity in the securitisation market are regulatory inaction and excessive liquidity. A lack of regulatory clarity in Thailand and Taiwan has stifled securitisation's growth there; and Hong Kong banks continue to be flush with funds.
Over the last year, recessionary trends have prevailed in Korea, Taiwan, Hong Kong and Singapore. Major volumes in ex-Japan Asia had been coming from these centres but activity levels of late have been soberingly low, due to slower generation of consumer financial assets. Other markets such as Malaysia and India have so far only met with domestic issuances.
Korea's consumer credit crisis
The credit and liquidity crisis that has been faced by sectors of the consumer finance market in Korea has resulted in a decrease in the number of cross-border consumer finance securitisation transactions. "The most significant development is that the cross-border market in Korea has almost dried up completely," says Clifford Chance's Paul Kruger of the last year in securitisation. And Mallesons Stephen Jaques' Adrienne Showering agrees. "Most of the activity has gone - there are still deals happening in Korea but if you speak to the investment bankers they'll say that it's not as active a market as it was."
Kruger explains that this is simply a case of the consumer finance companies having a very tight credit time, with a significant percentage of Koreans above the legal age currently delinquent or in default.
"It's a significant problem and that's flowing through into the credit of the underlying assets. There's been some concern expressed about the deals that are outstanding and there would appear to be little prospect of a consumer finance deal going to market at the moment, until delinquency and default rates have stabilised."
The demise has been rapid given that up until the final quarter of last year the virtues of the Korean market were being universally extolled. Only then did the bad debts start coming through. So are those in the know surprised?
Campbell explains that by the end of the year people were beginning to see the delinquency numbers go up and that the credit-card companies were starting to say it would probably peak in the summer of 2003. "I think most people would say that now it's going to be the first half of next year before we see further issuance but that really depends on an upturn in the Korean economy. One of the problems that the existing deals have is a lack of eligible receivables because people are not using the cards."
Adds Kruger: "Hindsight is a great thing. However, the dramatic increase in credit cards being issued and the general ease with which people were able to obtain unsecured credit lines necessarily was going to lead to a credit crunch. I have heard stories of some finance companies effectively handing out pre-approved credit cards in the Seoul subway."
However, within Korea other asset classes are still performing well. Securitisation of residential mortgages - a number of which Clifford Chance is currently working on - seem to be less affected by the delinquencies and defaults in other parts of the consumer finance sector.
Taiwan's slow start
Securitisation in Taiwan has not taken off as many had hoped. As Standard & Poors' Diane Lam pointed out in the September issue of ALB, securitisation legislation has been enacted in Taiwan only recently, but already there is a need for improvement and redrafting.
Kruger contrasts the Taiwanese market with Korea. "From talking to the investment banks in Korea, and based on our experience, the most difficult part is getting the mandate. Executing the deal is comparatively easy because once a decision has been made by senior management to award a mandate, the focus of middle management is to get a deal done within the time frame specified by senior management. In Taiwan, on the other hand, executing the deal is proving to be more difficult than getting the mandate."
Others see the situation as more straightforward. "The problem in Taiwan is that the companies don't really need to do it," says Campbell.
Cross-border activity is almost non-existent and the level of domestic deals is low. This reflects the lack of incentive for originators to adopt securitisation as a financing technique. Says Showering, "The economic drivers needed to sustain the market don't really seem to be there. People want to do this to introduce the technology but, as I understand it, a lot of deals are local deals - put together locally and sold locally. But it will be interesting to see if Taiwan takes off and becomes the next Korea.
"Securitisation really fits into a suite of financing products that corporates should be looking at as an alternative to other, more traditional forms of lending," she adds.
For Kruger, on the other hand, it really boils down to how keen Taiwanese companies are to use securitisation as a funding technique. "So far we have seen Korean companies saying, 'yes, securitisation forms a key part of our funding strategy.' In Taiwan, however, companies seem to be taking the view that securitisation represents an interesting funding alternative, but that the jury is still out as to whether it will prove in the long run to be a core part of a company's funding strategy. There doesn't seem to be the same level of energy coming through from the originators."
Clearly, Taiwan and Korea are two quite different markets and whilst some find hope in the fact that Taiwanese activity might pick up where Korean deals dropped off, Campbell for one does not concur. "I'm one of the people who doesn't think Taiwan is the next Korea. I think perhaps that was just people looking for a way out of Korea and trying to broaden the market, which is fine, but I just don't see Taiwan right now as being that. Maybe in another couple of years &"
Further adding to the collection of legislation, Taiwan recently passed a real estate securitisation law to promote REIT-type bodies in the country. S&P's Lam, optimistic about this law, said its impact would be important for Taiwan's financial markets, since "many of the non-performing loans are backed by real estate and the financial industry is overweight with real estate".
For the time being, however, securitised forms of funding and activity seem stuck at a domestic level, and for the lawyer the flow of deals and of fees will reflect this.
Hong Kong government boosts appeal
Hong Kong is one of the traditional mainstays of Asian securitisation. However, economic worries continue to weaken securitisation prospects. As property prices fall, unemployment continues to rise and recent political unrest has begun to affect investor confidence. Add to this the fact that an increased percentage of mortgage loans are in negative equity, and the noticeable slowdown in securitisation surprises no one.
"Property prices in Hong Kong have dropped dramatically since '96 - by about 40-50%. One of the consequences is that almost every mortgage written since '97 is in negative equity," explains Kruger.
The main theme in Hong Kong is that of excessive liquidity hamstringing the market, with most of the CMBS deals having been refinanced with bank loans. In a market flush with liquidity it is easier, quicker and probably cheaper to go to the bank for financing. "There is always talk about deals happening but no one needs the liquidity. So if you take any major property developer, if they do want to finance one of their buildings or refinance it they do a syndicated loan - there is no need to do CMBS, for example," says Campbell.
One major highlight to the year in Hong Kong securitisation came out of the Budget announcement that the government would sell or securitise HK$112bn of its assets over the next five years.
"We hear some mixed signals on that. Some say they don't think [the securitisation] is going to happen, others say they think it is highly likely. Obviously, we hope that it will," comments Campbell.
Of particular interest is securitisation of Hong Kong's tunnels and bridges. Showering says the potential to raise funds through such initiatives is enormous; "You'd hope that would kick start the market," she says.
As part of the government's stated initiatives, study groups have been established to examine the creation of new securitised debt instruments and of other related measures, including issuance of debt by international financial institutions, regional credit guarantees and enhancement facilities, and both local and regional credit-rating agencies.
Japan surges ahead
Japan has made significant strides throughout its short securitisation history. In the late '90s the rate of growth was phenomenal and from '98 to '99 growth neared 100%. "My observation is that Japan has had a much deeper and sustainable securitisation market than many other markets," comments Showering. "It's had a steady stream of deals and a range of assets over a number of years. They've done a lot of property-related securitisation transactions."
Adds Kruger, who will now be splitting time between Hong Kong and Japan: "There's been a constant stream of deals from Japan. I think Japan is probably the most sophisticated market in Asia and that is largely a consequence of being volume-driven.
Tokyo has seen a significant move towards synthetic deals, and leads the region in this area. Its position at the vanguard is symptomatic of Tokyo's greater volumes and willingness to take on more sophisticated transactions.
PRC deals not in near future
"Maybe one day," is the common reply to whether securitisation will catch on in China - with a "not in the near future" implied. Even though there have been some deals, shortcomings in the legal, regulatory and taxation regimes coupled with an absence of organised mortgage lenders or credit-card issuers work to stifle development.
"You need a set of laws and regimes, particularly insolvency regimes, so if things go wrong you've got direct access to the assets. If you don't have that certainty then you need someone to take the risk. So you need someone like a third-party monoline insurer to come in and take that risk and I'm not sure that we're at that stage in China yet," explains Showering.
Some leading commentators have wondered whether non-performing loans (NPLs) could be used to rekindle the growth of the securitisation market. Undoubtedly the PRC has a huge NPL problem, so can securitisation lend a helping hand in the clean up?
"I think securitisation of NPLs in the PRC is not going to happen soon," says Campbell. "Obviously people who buy the NPLs have evaluated the system and worked out what they can get out of it and that is reflected in their bid price. The price reflects the bidder's perception of the risks involved in getting something back. So to securitise that is very difficult." Campbell also cites the difficulty in setting up any kind of bankruptcy remote vehicle onshore in the PRC as a major stumbling block.
New innovations and areas to watch
Whilst it might have been hard to find optimism over the past year, perhaps one bright spot on the horizon is the developing CDO (collateralised debt obligations) market.
Said Fitch's report: "While the first half was fairly quiet in Asia's securitisation/ structured finance markets in general, the one exception was the CDO market, which saw the completion of five publicly announced (although not public in the true sense of the word) transactions and an increasing interest in synthetic CDOs."
Under a synthetic CDO, the originating bank retains the loans on its balance sheet whilst simply securitising the inherent credit risk. Synthetic CDOs repackage the underlying loans into cash flows that suit the needs of the investors and are not dependant on the repayment structure of the underlying debt obligations.
"Synthetics is an area to watch," says Kruger. "In relation to securitisation generally, entities such as ADB (Asian Development Bank) have always viewed securitisation as a way of making the international debt markets more accessible to Asian corporates and banks and to generally develop the debt capital markets."
Adds Campbell: "I think we are going to see another synthetic securitisation in Hong Kong in one form or another."
Another emerging feature of the markets is the development of conduits - entities formed to hold receivables transferred by the originator on behalf of the investors, which bring with them significant advantages.
Although there aren't a lot of conduits operating in Asia, earlier this year Showering acted for ABN AMRO in developing the 'Orchid' conduit, which is set up in the tax-friendly Cayman Islands and is focused on Asia-Pacific assets.
Orchid is a series-segregated vehicle, and, unlike most current CP vehicles, offers the ability to provide different debt structure side-by-side under consistent security and standard documentation. "This has both reduced issuance cost and improved the time for execution," explains Gary Watmore, head of Asia asset securitisation ABN AMRO.
"As each asset acquired is individually rated, there is greater transparency and less structural risk for end investors. By having a full segregation of assets we have been able to successfully utilize our product in countries and for assets which conventional ABCP vehicles would have been prohibited from considering."
Also of note is the initiative to push Korean Authorities to permit master trusts.
With these in place, if a credit-card company wants to do four deals they just have one structure and can do four issuances out of that. This would improve the efficiency, the timeliness and the costs - and at the moment these are issues.
The outlook: putting 2003 to bed
"For a lot of bankers particularly, the year can't be over quickly enough," says Campbell. "One consolation from the lawyer's perspective is that the level of activity has discouraged other firms from participating in the business!"
Another consolation is that the perils of the last year have raised securitisation's general profile. Throughout a relatively short history in Asia - less than a decade - it has moved away from being a little understood concept to something people talk about. Hence many are bullish. "Most people that I've spoken to have been positive. There's good activity to come," comments Showering.
People now understand what securitisation is and whether it's worth using - and all agree that it is an option that is here to stay. However regulatory and accounting discords do still persist and one thing being closely watched is what is happening with BIS II and balance sheet treatment. "Whether there is going to be a continuation of the ability to get these assets off balance sheet could have a major impact on the attractiveness of the technique," says Showering.
Furthermore, across the region there is a multitude of diverse pieces of legislation and hopes are high for the creation of a homogeneous legal and regulatory framework, the lack of which is a major impediment to cross-border activity.
Repeat issuance is also high on the securitisation industry wish list. Whilst most deals are firsts, and this makes things interesting especially for the lawyers involved, resulting inefficiencies do nothing to further development.
Clearly, another key issue is the role of the public sector and its willingness to utilise securitisation as an effective tool to develop the debt market. Regional schemes will also contribute. The result oriented APEC Initiative on the Development of Securitisation and Credit Guarantee Markets, which aims to promote the understanding and awareness of the importance of securitisation and credit guarantees to the bond market development in the region, is just one example.
Advantages of securitisation
The securitisation structure is intended to provide significant advantages to originators, including:
Off balance sheet treatment - receivables are moved off balance sheet and replaced by a cash equivalent
More expedient access to funds - the originator does not have to wait until it receives payment of the receivables to obtain funds to continue its business and generate new receivables. This is more significant in relation to long-term receivables such as real property mortgages or auto loans.
Improved ratings - the securities issued in a securitisation transaction are more highly rated by participating ratings agencies. This reduces the originator's cost of funds compared to traditional forms of financing.
No need for hedges - in non-revolving structures, and those with fixed interest rate receivables, assets and related liabilities can be matched, eliminating the need for hedges.
Transparency - because the originator acts as a servicer and there is normally no need to give notice to the obligors under the receivables, the transaction is transparent to the originator's customers and other persons with whom it does business.
Note, however, that the securitisation structure results in higher costs than with traditional forms of financing.
FIRM PROFILE
The Korea securitisation market
By Jeffrey H Chen, partner, Jones Day
Overview
Korea remains the most significant market for securitisation in Asia ex-Japan. Since enactment of the Asset-Backed Securitisation Act of 1998 (ABS Act), several hundred securitisation transactions have been concluded by Korean originators, in aggregate representing over US$100bn worth of offerings, including at least 26 rated cross-border deals. Although 2003 has seen increased pressure on asset performance, participants view the Korean ABS market as fundamentally robust. The current expectation is that new issuances in consumer credit will begin recovering around mid-2004, while other asset classes, particularly RMBS, will pick up in the near term.
Although some Korean deals are being restructured, it is significant that to date no rated ABS deal out of Korea has yet defaulted. The Plus One deal (which was unwrapped) has undergone early amortisation, but full repayment is expected. Most cross-border deals are still being wrapped by monolines or purchased by single-investor ABCP conduits.
Structures
Historically, the two most commonly-used structures for Korean cross-border securitisation have been (i) dual domestic/offshore SPCs; and (ii) onshore trust/offshore SPC.
Under the dual SPC structure, the domestic SPC purchases assets from the originator and finances the purchase by issuing a senior note to the offshore SPC and a junior note to the originator, comprising the required subordination for the deal. The offshore SPC issues the asset-backed securities to investors.
Under the trust/SPC structure, the originator entrusts all of its rights, title and interest in the asset pool to the trust for the benefit of holders of the trust interests. The offshore SPC acquires the investor interest and issues the asset-backed securities to investors, while the originator acquires the seller and subordinated seller interests, the latter comprising the required subordination. Given the increasing number of repeat issuers, there is growing interest in master trust structures. However, the ABS Act currently allows for only one plan to be registered by an SPC thus restricting each SPC to a single transaction.
Selected Legal Issues
Servicer Insolvency. One of the most difficult issues to deal with is how to terminate the servicer in an insolvency situation. Typically, once formal insolvency proceedings have commenced, the termination of the servicer will be subject to various restrictions imposed by law or by court order. For example, the receiver in a bankruptcy proceeding may have power to affirm an executory contract such as the servicing agreement. From the deal's perspective, this is highly undesirable, as the deal parties would wish for the backup servicer to replace the servicer in a servicer insolvency. Various mechanisms have been explored to address this situation, such as revolving three-month terms and automatic termination upon insolvency.
Set-Off. The obligors on the underlying assets will seek to set off the risk against the purchaser of those assets the claims which they have against the seller of those assets. Under the ABS Act, registration of the securitisation plan with the Financial Supervisory Commission (FSC) constitutes notice of the asset transfer to all third parties except the asset obligors. In order to effect legal notice of transfer to the asset obligors, which will be effective to cut off all obligor defences including set-off claims, it is necessary to send fixed-date stamped notices to each asset obligor on or after the transfer date.
Commercial reasons can often militate against sending such notices. The parties to an ABS deal are thus obliged to utilise various enhancement and structural features to protect the deal against set-off risk, such as seller buybacks for breach of rep and an overall cap on set-offs triggering early deal termination.
Individual Work-Out Plan. Banks and other financial institutions (FIs) in Korea entered into an agreement on 25 September 2002 (the Plan) that permits qualified individuals and sole proprietorships to avoid bankruptcy through a pre-agreed workout procedure. Under the Plan, a person with total FI debt of KRW300,000,000 or less, income sufficient for basic living expenses and who is deemed 'capable of repaying his/her debt' may make an application for individual workout, which freezes all collection and enforcement actions by the applicant's FI creditors that are party to the Plan. A review committee will then solicit claim information from the relevant FI creditors and resolve upon a workout plan. It will be binding if consented to by 50% of unsecured and two out of three of secured claims. Significantly for RMBS offerings, the Plan does not exempt debt on the individual's principal residence. Applications were negligible in the months immediately following the Plan's effectiveness, however, in recent months the number of applications have exceeded 5000 per month. From the deal's perspective, therefore, it has become necessary going forward to build in enhancements and structural protections to cover this risk where individual debt comprises part of the underlying assets.
Swaps
Due to mismatches on payment obligations on the underlying assets and payment obligations on the ABS securities, it is often necessary to interpose a rate swap (eg, fixed for floating, CP index to LIBOR, etc), and in addition for cross-border transactions, a currency swap. Fortunately, Korea has, by Asian standards, a relatively well-developed and liquid swap market.
There are special swap problems, however, for RMBS transactions. Korean residential mortgages are typically up to 30 years maturity. The legal maturity for RMBS notes can therefore be up to 30 years. This means that the swap provider must enter into a long-dated swap that is non-terminable (rating agencies require backing out of virtually all of the standard ISDA termination events). This also means that the monoline guarantor (typical for cross-border deals) must issue a swap guarantee that is unconditional for this period of time. Swap negotiations on a cross-border RMBS deal can thus be challenging.
Conclusion
Although the issues are challenging, Korea has clearly emerged as the front-runner in ex-Japan Asian securitisation, and the resolutions of those issues in Korea will be useful when dealing with other Asian contexts.
Jones Day
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E-mail: jhchen@jonesday.com
FIRM PROFILE
The Taiwan securitisation market
By William Bryson, partner, and Shirlie Pai, of counsel
Overview
After a slow start, the securitisation market in Taiwan appears to be gaining momentum, with no fewer than four transactions poised to go to market before the end of the year, several of which will be transactions of first instance in this emerging market. The gains made by the market during 2003 have largely been due to the ingenuity and determination of the transaction participants, the flexibility and openness of local regulators, and the legal support for securitisation structures that was created by the promulgation of the Financial Asset Securitisation Law (FASL), Taiwan's organic securitisation legislation, and its associated regulations.
Additional potential in the Taiwan market was created by the promulgation earlier this year of the Real Estate Securitisation Law (RESL). The RESL, modelled after US REIT legislation, provides for the establishment of REITS as vehicles for the securitisation of the receivables generated by existing real estate development projects.
An important milestone in the development of the Taiwan market was reached in late January 2003, with the financial close of Taiwan's first securitisation transaction. Arranged by Societe Generale, this first transaction consisted of the securitisation of a NT$3.5bn portfolio of commercial and industrial loans originated by Industrial Bank of Taiwan, a private bank. Land Bank of Taiwan, a government-owned bank, acted as Trustee for the transaction. The securities issued by the special purpose trust were privately placed and were quickly bought up by investors. This first transaction was an encouraging beginning for Asia's newest securitisation market. Since the closing of the IBT transaction, two other CLOs have been approved in Taiwan, one of which (arranged by Credit Lyonnais) closed in September.
Structures
As noted above, the first transaction in the Taiwan market involved a local SPT and a local issuance. This is also true of the remaining transactions, which are likely to go to market by the end of the year. This is hardly surprising, as these structures are necessarily less complex than cross-border transactions.
As this article is going to press, however, there has been one mandate signed for a cross-border issuance, which is contemplated to be, at least in part, a Reg S/Rule 144A offering. This transaction, and any other similar transactions which follow, will be breaking new ground under the FASL, as the rules for cross-border issuances have not yet been completely clarified. For example, there is still some discussion as to whether a cross-border issuance can be done out of a local SPT, or whether such issuances also require the establishment of a foreign SPT. These principles, which are not directly addressed by the FASL, will be clarified as these deals progress.
Asset classes
Despite its status as a new market, securitisation transactions in Taiwan have shown a remarkable diversity in the types of assets to be securitised. While residential mortgages are the clear favourite among arrangers and originators at present, industrial and commercial loans were the first asset class to be securitised and mandates have been signed for the securitisation of consumer debt and industrial trade receivables.
The securitisation of industrial trade receivables, which has already been approved by the MOF, represents yet another milestone in the Taiwan market. While the FASL specifically refers to specifically-enumerated 'financial assets' originated by specifically-enumerated types of 'financial institutions', it also provides the MOF with discretion to approve other asset classes as 'financial assets' and companies other than financial institutions as originators. Securitisation of industrial receivables represents an important, if intended, expansion of the scope of the FASL.
Legal issues
ABCP Structure. Taiwan has a very active CP market and there is great interest in ABCP products. While the ABCP structure under the FASL is feasible through the issuance of short-term trust certificates, the FASL is drafted to facilitate ABS structures, requiring the instrument to be in a registered form and to be registered with the SPT trustee, which is contrary to local CP market practice. Market participants and legal professional have worked towards removing such obstacles but the creative solutions devised so far are subject to the regulator's approval and acceptance by investors.
Liquidity facility. Another challenge in arranging an ABCP structure is that the FASL provides that any money borrowed by the SPT may be used solely for the purposes of the distribution of 'profits, interest and other income' of the trust. Typically, ABCP liquidity for securitisations with revolving mechanisms must cover any shortfall on maturing CP, as well as the trust's revolving purchase commitment. Thus, a special exemption to the lending limit for ABCP deals is critical.
Mortgage issues in RMBS. For a securitisation project involving RMBS, transfer of the mortgages is complicated by the Civil Code and relevant mortgage registration rules under which, except for certain exemptions, the consent of the mortgagor is required at transfer of the mortgage. The Enforcement Rules of the FASL have partially addressed this by exempting the mortgagor's consent requirement if the originator is willing to 'crystallize' the debt secured under such mortgage (ie to fix the amount of loan secured by such mortgage).
Given such limits, the assets for RMBS deals are necessarily restricted to traditional housing loans (without the re-drawing feature which is commonly found in residential loans in Taiwan). There are proposals to amend the Civil Code to resolve this issue. However, until then home equity loans and other mortgage loans with re-drawing features, which represent a significant percentage of the housing loans in Taiwan, would be excluded from RMBS deals.
Untested issues in credit card securitisation. Taiwan law recognises that an assignment of future debts is a legal and valid contract. However, the transfer of each individual debt does not occur unless and until the occurrence of such debts and such continuing transfer of the debts could be stopped by a court foreclosure order initiated by the creditor of the originator. The FASL and its enforcement rules have been drafted in a manner suggesting this technical legal issue could be overcome. However, given the vagueness of the language in the FASL and enforcement rules, it is not clear that this issue has been resolved.
Conclusion
The legal framework for securitisation in Taiwan has been established, and the market has already started moving forward. While some details remain to be worked out, the market is growing and continues to attract the attention of foreign arrangers and local originators. If current levels of activity continue, it is likely that between three and four more deals will close by the end of 2003, and the number of deals in 2004 will enter double digits.
Jones Day
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