With the increasing sophistication of the Asian markets and the promotion of new financial instruments in the region, Stephen Mulrenan examines the prospects for securitizations.Korea has embraced securitizations in a big way.
First there was the Samsung Capital deal, which provided for the acquisition of auto loan receivables on a revolving basis and which single-handedly paved the way for other cross-border deals.
Then there was the Korea Depository Insurance Corporation / Hanareum deal, Asia's first cross-border securitization of non-performing loans and the country's largest international securitization.
This was followed by the Samsung Card deal, at the time Asia's largest cross-border securitization, outside of Japan.
And who could forget the LG Card deal, the country's first cross-border securitization to adopt a trust structure.
And that was just last year.
It's been more of the same in the first half of 2002, with asset-backed securities (ABS) growing by about 3.6 times the W88.9bn recorded in the same period last year.
Korea's thirst for cross-border issuance in order to tap the international markets remains unquenched.
In addition to some of the more experienced issuers, there have been a number of new market entrants to the international markets in 2002.
These include Hyundai Capital Services, which successfully closed a US$160m securitization of performing auto loan receivables. Proceeds from the notes were used to buy a static portfolio of auto loans generated by Hyundai. The portfolio consisted of Korean instalment financial loans for purchases of new and used vehicles manufactured by Hyundai Motor Co Ltd and Kia Motors Corporation.
Another to dip their toes in the securitization pool was the Korea Exchange Bank Credit Service Co (KEB Card), which completed a US$500m securitization backed by credit card receivables. This was the company's first international securitization.
So what is making Korea such an active market?
"Most of the deals are consumer credit deals," says Neil Campbell, partner at
Sidley Austin Brown & Wood. "Most of the major originators of that sort of receivable view securitization as an efficient means of financing. They do a lot of domestic deals but also want to do cross-border deals for all sorts of reasons such as pricing, as well as targeting international investors."
Sidley has just completed a similar deal for Woori Credit Card Co. Ltd, part of one of Korea's largest banking and financial groups. It acted for
UBS Warburg as lead manager and The Bank of New York as note trustee and principal agent, in relation to a US$500m asset-backed securitization.
Completed on October 9, the transaction, backed by credit card receivables, was Woori Card's first offshore securitization.
Campbell says: "One thing is the originators being comfortable with securitizations and financing products. But there are also the legal issues. Most jurisdictions in Asia are not as clear in the way they treat bankruptcies for example, as you may find in the UK or the US. So, in a lot of cases, legislation has been needed before securitizations could really happen at all. This all requires government and parliament involvement, so there's a lead-time before that can be done."
In 1998, Korea enacted its Asset Backed Securitization Act (ABS Act) that was later amended in 2001. And it has Japan to thank for being able to avoid the hiccups experienced there.
Paul Kruger of
Clifford Chance says: "If you look at Korea, say, versus Thailand versus Indonesia versus the Philippines, you can only conclude that the Korean authorities got it spot on. The securitization law really provides a platform for getting deals done. It has ironed out a number of significant legal problems that existed and it is an incredibly efficient piece of legislation."
The significant number of cross-border deals now being witnessed flows off the back of US$40-50bn of domestic issuance. "And it doesn't surprise anyone that when you've got that level of domestic activity," says Kruger, "you move on to cross-border deals fairly quickly, because you run out of capacity internally, companies get familiar with how these deals work and decide to go offshore and tap a different market."
He adds: "Generally speaking it has to be done in that order. The domestic deals tend to be a lot simpler in their structure. So you get the regulators familiar with how these deals work and then move offshore."
History
Securitization is a technique that has only really begun to be used in Asia since 1994.
Lovells partner John Hartley explains: "There has been a ready availability of bank debt that banks were prepared to lend unsecured. Securitization is normally referred to as a financing of last resort - you've got to give up your assets in return for raising some upfront money. So, on the corporate side, there really hasn't been the need to look at it that much. And on the banking side, banks have been very liquid, so freeing up your balance sheet to do more business hasn't been an issue either."
Hartley adds: "So the underlying factors that drive securitizations, to an extent, haven't really existed in Asia. And the banks haven't had the depth of expertise here."
Then came the financial crisis of 1997 and for the next two years very little happened. The surge in securitization work has only really occurred over the last two years - first in Japan and now Korea.
Like Korea, Japan is not a common law jurisdiction - as opposed to the UK and others where securitization issues are adequately met by appropriate legislation - and has had to enact its own securitization laws in order to embrace this area of work.
However, being the first jurisdiction in Asia to amend its laws to facilitate securitizations meant that it became something of a guinea pig in the process, as structures were developed and tested.
The Korean ABS Act was heavily influenced by Japanese legislation and the recent surge in issuances has shown similarities to the way the Japanese market evolved, in terms of the asset classes and structures used.
Says Campbell: "What the legislation tends to do is make it easy to set up a mechanism for having bankruptcy special purpose vehicles, for example. The legislation can also simplify some of the legal mechanics that you have to go through in perfecting the assignment of the deal."
Hartley says the deals seen emanating from Korea and Japan are driven more by the need to sort out non-performing loans and non-performing assets.
He says: "The Philippines is going through that process, Indonesia is looking at it, and Taiwan has amended its laws. But to date, the legal framework hasn't been there to facilitate these types of deals. Now they're realising they want to look at these types of structures - for non-performing assets - so they want to create an environment for it locally."
Taiwan did indeed amend its laws on June 21 this year with a view to resolving its banks' deteriorating non-performing loan problem. It too sought to learn and benefit from Japan's experience and with its Financial Asset Securitization Law (FAS Law) now in place, the Taiwanese Ministry of Finance is eagerly predicting a boom in work. There have been suggestions in the media that its market may soon be worth NT$1.4tn (US$40m).
Says Kruger: "Taiwan is almost a half way house at the moment. They've got this fantastic securitization law in place, but the implementing regulations have yet to be passed by the Taiwanese Government. So a lot of the procedural stuff that you absolutely must have is not there. They're relying on the first couple of deals to get that sorted out to make sure that the structures and the deals work."
Campbell agrees: "Taiwan is probably the area that people are focusing most on after Korea."
And that includes the originators.
"There are a lot of mandates flying around," adds Campbell, "but as with any new legislation, people are feeling their way. There was no history of doing this before so the first deals will take a little time to come.
"We're also hoping there'll be some cross-border activity," he says, "because the legislation does contemplate international issues. So, some pretty encouraging signs there and we're looking to Taiwan, over time, to be another major force for securitizations like Korea."
While Japan, Korea and Taiwan remain active and where most of the business is expected from next year, sporadic deals are hoped for in jurisdictions like Singapore and Malaysia. Indonesia, on the other hand, is unlikely to generate anything anytime soon.
There is not much impetus in Thailand either after a number of auto loan securitizations ran into trouble. Despite having legislation on its books now since 1997, lawyers speak of the many holes that do not address basic tax problems. While the authorities continue to try to resolve the problems, there remain a number of impediments to completing deals.
"It was not as well thought out as the Korean law," says Kruger.
Hong Kong and the PRC
And what of Hong Kong?
Having first been introduced to the financing technique some 10 years ago, the SAR has been waning of late. The economic climate has hardly nurtured the use of securitizations, while lawyers complain that local companies are not all that sophisticated in terms of their fundraising options and what they're prepared to look at.
Hartley and
Lovells have just acted for AEON Credit Service (Asia) and Tokyo-Mitsubishi International (HK) as transaction counsel on the HK$600m credit card receivables securitization, the first of its kind to successfully close in Hong Kong in the last three years.
Hartley says: "Nobody has really been doing that much securitization in Hong Kong. I came here in 1990, when the market was awash with bank debt that was generally lent unsecured on a corporate basis. So companies would have a choice between issuing a bond or a syndicated loan.
"In the mid-90s, the US investment banks sold securitization structures principally to large Hong Kong property companies as fundraising alternatives," he adds. "But it didn't make a lot of sense for them to do that as they had easy access to bank debt. So some of these deals were pulled or refinanced using bank debt."
The failure of the residential mortgage-backed securitization (RMBS) market has been a cause for concern for some time. The only issuer of mortgage deals, for example, for the past three or four years has been the Hong Kong Mortgage Corporation (HKMC) itself.
Freshfields Bruckhaus Deringer was recently granted its first mandate for Hong Kong's MBS programme.
"Nobody else is doing them because banks want to hang on to their mortgages," says Hartley.
But Kruger tells a different story. "We've been incredibly busy in Hong Kong working on negative equity mortgage programmes for a company called Pan Asian. HKMC effectively had a monopoly on purchasing mortgages until Pan Asian came along but Pan Asian is now building up assets at a swift pace with a view to securitizing them in the future."
China, meanwhile, continues to be receptive to the idea of securitizations but, like Japan, Korea and Taiwan, legislation is almost certainly needed before the international community is comfortable with the idea. People are looking very closely at what the asset management companies are going to do and whether they will try and copy the Korean model.
In any event, development is likely to occur in the short to medium term through the NPL (non-performing loan) resolution.
"If you take the longer view," says Campbell, "you have to believe that given the wealth of industry there, the export business and so on, securitizations have a huge future in China."
Growth opportunities
Practitioners also have high hopes that the Korean market will evolve and expand into different sets of receivables.
"At the moment, it's been primarily credit cards and auto loans," says Campbell, "but we'd all like to see that market expand a bit further."
He adds: "One of the things we're all hoping for is the use of some kind of master trust structure to be approved in Korea. The current legislation doesn't prevent it but the authorities are a little reluctant to give the go-ahead to master trusts until they have a little bit more experience of how the existing structures work."
Master trusts have quite a lot of efficiencies for the originators in terms of doing further issues of securities out of the same pool.
Says Kruger: "The great thing about master trust arrangements is that you set up a whole load of programme documents and then, as and when you come to do another issue under that programme, all you effectively need to do is a supplement rather than negotiate and execute a whole pile of new documents."
Early on in the development of the Korean credit card market, originators made representations to the authorities asking to use master trusts because of the efficiencies. Although it was hoped that this might materialize by the end of this year, it now seems that the first quarter of next year is more likely.
"We'll be hoping that one of the first deals next year to be mandated will be a master trust," says Campbell, "but it's difficult to predict. That will probably also spur the originators to do some further deals because then they can set up a master programme."
If it is introduced, it will be following the trend set in the US and Europe. While the US remains the home of the master trust, it subsequently drifted into the UK and Europe after that.
Kruger says: "For any jurisdiction using securitization as a serious funding technique, master trusts are always going to be considered the logical way to go."
Other opportunities may also exist in the intellectual property area, although it is difficult to see this happening in many Asian jurisdictions.
Japan is starting to embrace this area, although until recently, had really only completed domestic structures that did not follow typical securitization structures. In September, however, Pin Change, a subsidiary of Matsushita Electric, announced it would raise several hundred million yen through a private placement of securities backed by voice synthesizing patent revenues.
Outside of Japan, many Asian jurisdictions still do not have credible IP laws so there are more concerns with enforcement and protection rather than selling on the revenues and raising cash.
What all practitioners agree on is that for the next 12 months at least, there is likely to be a fairly consistent flow of credit card and auto loan deals. Says Campbell: "Apart from trade receivables of one kind or another, it is consumer-related assets that really fuel the business. And that is how the US and UK businesses started.
"While I would love to see the asset classes expand to more types of commercial generated receivables rather than just consumer receivables," he adds, "we'll continue to see those be the main bulk of the business."
And the contenders are...
With a growing number of opportunities in the region, many firms are now targeting this area of work. Earlier in the year, firms such as
Simmons & Simmons,
Linklaters and
Allen & Overy beefed up their level of expertise on the ground in Japan to exploit opportunities in the active real estate structured finance market, for example.
Sidley Austin Brown & Wood,
Clifford Chance and
Freshfields are frequently cited as housing the leading practices and are the only firms chasing regional work out of their Hong Kong offices. These firms tend to swap roles on each of the high profile transactions with clients gravitating towards those individuals that are familiar with the product (assets being securitized).
But even these leading practices are comparatively small, as the number of deals cannot support a large team.
Hartley says: "Even if you look at the total volume of regional deals that have closed, they are very, very few. They just don't justify from a monetary point of view a lot of people. So, you have three law firms chasing a very slim market."
Hartley says
Lovells operates a small practice in Hong Kong (2 partners and 6 associates) and has tended to be more opportunistic on picking up securitization work rather than having a dedicated team focused on it.
And, he says, they've been enjoying some success.
"For example, we were bidding against
Clifford Chance for the AEON deal [see Deals on p6] and took the deal off them."
Clifford Chance had worked on the previous AEON deal with
Citicorp.
But, argues Hartley, it is not simply a question of lowering fees.
"People recognize that there's a real value add in getting the right firm and getting the structure right," he says. "You need to have a reputation for structured finance work and there is a certain benchmark entry level for this stuff."
Hartley says the way
Lovells differentiated itself on the AEON deal was to make a significant number of simplifications to the structure of its last deal, all of which meant that the ongoing transaction costs for AEON was much lower than the previous deal.
"The more people learn about the way it was done and the structure," he says "then they may be interested in it.
"Commercial property securitizations take an awful lot of management time for the originator to understand the structure and then they've got to change their procedures to come in line so that they can get the rating agency comfortable. I'm not sure whether when they've got into these things, people really realized how complicated they'd be to do.
"From Hong Kong's point of view, the simpler you can keep things while still achieving the objective, the more people you'll be able to get interested in it."
It is a philosophy shared by both Kruger and Campbell.
Kruger says: "Certainly the new nature of transactions is something that needs to be overcome. But it really boils down to a numbers game for most originators in terms of a cost-benefit analysis. Securitization is really there for un-rated or low rated originators, because they can access the major debt markets by using their receivables and their assets. But I think it is just getting people over the hurdle of the complexity of the deals."
Campbell adds: "As Asia continues to turn around, economies improve, countries are upgraded, we'll see increased opportunities across Asia."
What is securitization?
Securitization is a means of raising finance secured on identifiable and predictable cash flows derived from a particular class of assets (for example mortgage portfolios, aircraft leases and credit card receivables).
In essence the cash flows generated by a portfolio of assets are packaged together and refinanced by newly raised debt. Consequently, any asset that generates a predictable and regular future stream of revenue may be securitized.
Typically, the owner of the assets (the originator) sells the assets that are to be securitized to a special purpose vehicle (SPV). The assets are sold to the SPV at their market value or slightly below and the SPV pays for them by issuing debt securities to investors on a fixed or floating rate basis, the latter being more common in European jurisdictions.
The cash flows from the assets are used to support the repayment obligations of the SPV to the investors under the bonds. Security will be taken over these assets which will be granted in favour of a trustee for the benefit of the bondholders.
There are a number of asset classes that have been commonly securitized in recent years. Such asset classes include:
• consumer loans
• credit card balances
• lease or trade receivables
• non-performing loans
• operating asset receivables
• project finance loans
• real estate; and
• residential and commercial mortgage loans.
Source:
Lovells
Taiwan's Financial Asset Securitization Law
In late 2001, the ROC Ministry of Finance (MOF) issued its first draft of the ROC Financial Asset Securitization Law (FASL), which was based on the Japanese ABS law, to the Legislative Yuan (LY). This underwent a redraft, was resubmitted to the LY, and became law on June 21 this year.
The most prominent features of the new FASL are:
· it permits the securitization of financial assets through use of either a special purpose trust (SPT) or a special purpose company (SPC);
· it provides several tax and fee breaks in connection with the sale of financial assets by an originator to a special purpose vehicle. 'Financial assets', as defined by the FASL, include specified assets such as credit card receivables, chattel mortgages and real estate mortgages, as well as any others approved by the MOF (which is able to be flexible with this definition);
· it provides that a special purpose vehicle can issue any type of security that has previously been approved by the ROC Securities and Futures Commission, with issuances being either privately placed or publicly listed.
Product structure
A vast majority of card securitizations have been completed using two different vehicles — the stand-alone trust and the master trust. The stand-alone structure is a single pool of receivables sold to a trust and used as collateral for a single security. When the issuer intends to issue another security, it must designate a new pool of card accounts and sell the receivables in those accounts to a separate trust. This structure was used from the first credit card securitization in 1987 until 1991, when the master trust became the preferred vehicle.
The master trust structure allows the issuer to create various securities from the same pool of receivables. The master trust serves as a reservoir of receivables to which receivables are added from time to time to issue more securities. The structure allows the issuer increased flexibility.