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Securitisation and Banks

ASEAN+3 Workshop The Rise of Asset Securitisation in East Asia. Securitisation and Banks. James H. Lau Jr. Chief Executive Officer The Hong Kong Mortgage Corporation Limited 8 November 2005. Contents. Introduction Major securitisation issues for banks International accounting standards

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Securitisation and Banks

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  1. ASEAN+3 Workshop The Rise of Asset Securitisation in East Asia Securitisation and Banks James H. Lau Jr.Chief Executive OfficerThe Hong Kong Mortgage Corporation Limited8 November 2005

  2. Contents • Introduction • Major securitisation issues for banks • International accounting standards • Basel II regulatory framework • Issues and implications

  3. INTRODUCTION: Why securitise? • To improve asset-liability management • To enhance credit risk management • To improve balance sheet, CAR and financial ratios • To expand funding sources and broaden investor base

  4. What assets to securitise? • Mortgages • Credit card receivables • Auto loans • Corporate loans • Any other assets with cashflow

  5. Hong Kong Securitisation Market (1994-2004) 14,000 12,000 10,000 8,000 Issuance Volume (HK$ mn) 6,000 4,000 2,000 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 HKMC RMBS Other RMBS CMBS ABS Who are the major originators of securitisation products in Hong Kong? • The Government, the HKMC, banks, finance companies, property developers, etc. • Hong Kong Mortgage Corporation (HKMC) is an active and a regular originator of MBS in the Hong Kong market Source: HKMC

  6. Major investors in securitisation products in Hong Kong • Retirement funds, investment funds, insurance companies, banks, etc. • Growing in retirement funds demands more long-term HKD debts and securitised products Source: MPFA

  7. Regulatory framework for banks in Hong Kong • Hong Kong is a forerunner in securitisation in Asia. The Hong Kong Monetary Authority (HKMA) issued a set of guidelines titled “Supervisory treatment on asset securitisation and mortgage backed securities” on 30 August 1997, which set out: • Supervisory tests (“true sale” tests) applied to asset securitisation for deciding whether the assets concerned can be excluded from the seller’s balance sheet for capital adequacy purposes • Criteria for MBS to qualify for 50% risk weight • The guidelines will be replaced upon the implementation of the Basel II framework on securitisation on 1 January 2007.

  8. MAJOR SECURITISATION ISSUES FOR BANKS • Implementation of the new International Accounting Standards (i.e. IAS27, SIC12 and IAS39) • More complicated treatment of account consolidation for subsidiaries/SPEs and asset derecognition from balance sheet • Implementation of Basel II in 2007 • More complicated structure in achieving economic capital allocation and credit risk transfer

  9. IAS 27 Applicable to securitisation SPE’s • Concept of control to determine consolidation of SPE’s or subsidiaries • Evidence of control – more than 50% voting rights; governing financial and operating policies;appointment of majority of board of directors • Indicators of control by an entity over an SPE – auto pilot mode; decision making power over board/management; right to enjoy majority benefits; retention of majority of residual risks related to the SPE

  10. IAS 39 Derecognition of securitisation transaction

  11. Basel II: Objectives Compared with Basel Accord established in July 1988, Basel II can: • Better align regulatory capital to underlying risk • Improve risk management capabilities of banks • Provide a comprehensive coverage of risks

  12. Two approaches for determining capital requirements of securitisation exposure Standardised Approach Internal Ratings-based Approach Ratings-based Approach (RBA) Supervisory Formula Approach (SFA) Internal Assessment Approach (IAA) Basel II: Framework on Securitisation • Choice of approach depends on: • Business focus • Bank size and complexity • Capability in setting up systems, modelling and IT

  13. Standardised Approach • Amount of capital allocation for securitisation exposure depends on credit ratings • Unrated securitisation exposures to be deducted from regulatory capital Exceptions: (i) The most senior exposure in a securitisation (ii) Exposure in a second-loss position or better in ABCP programme (iii) Eligible liquidity facilities • Standardised Approach preferred by small- to medium-sized banks

  14. Standardised Approach – Risk Weight Note: * 350% for Investing Banks, deduction for Originating Banks

  15. Internal Ratings-based (IRB) Approach • More sophisticated and risk sensitive than the standardised approach • Three-tier IRB approach to risk assessment:

  16. Internal Ratings-based Approach:Rating-based Approach - Risk Weights Note: Banks may apply the risk weights for senior positions if the effective number of underlying exposures (N) is 6 or more and the position is senior. If N is less than 6, the risk weights under Column 4 of the above table apply. In all other cases, the risk weights in Column 3 of the above tables apply.

  17. Internal Ratings-based approach:Supervisory Formula Approach • Under Supervisory Formula Approach, capital charge for a securitisation tranche depends on five factors: • The exposure’s thickness (T) • Ratio of nominal size of the tranche in question to the notional amount exposures in the pool • Credit enhancement level (L) • Ratio of the amount of all securitisation exposures subordinate to the tranche in question to the amount of exposures in the pool • The pool’s reference capital charge (KIRB) • Ratio of IRB capital requirement including expected loss portion for the underlying exposures in the pool to the exposure amount of the pool • The pool’s exposure-weighted average loss-given-default (LGD) • The pool’s effective number of exposure (N)

  18. Internal Ratings-based approach:Internal Assessment Approach • Only for unrated liquidity facilities and credit enhancements related to ABCP programmes • A bank may use its IAA model to evaluate the credit quality of the securitisation exposure it extends to ABCP programme if the assessment process meets the operational requirements • Internal assessments of exposure provided to ABCP programmes must be mapped to equivalent external ratings • Those rating equivalents are used to determine the appropriate risk weights under the RBA

  19. Internal Ratings-based approach:Internal Assessment Approach • Major operational requirements for internal assessment process: • ABCP must be externally rated • The credit quality of the exposures must at least be investment grade at the beginning of the transaction • The internal assessment process must be based on the rating agencies’ methodologies • The internal assessment process must identify gradation of risk • Banks must perform regular reviews of the internal assessment process and assess the validity of those internal assessments • The bank must track the performance of its internal assessments over time to evaluate the performance of the process and make adjustment, if necessary

  20. Internal Ratings-based approach:Internal Assessment Approach • Major operational requirements (Continued): • ABCP must have credit and investment guidelines, i.e. underwriting standards • Credit analysis of the asset seller’s risk profile must be preformed • Underwriting policy of ABCP programme must establish minimum asset eligibility criteria • The ABCP programme should have processes established to consider the operational capability and credit quality of the servicer • The ABCP programme must consider all sources of potential risk in estimating of loss on an asset pool • ABCP programme must incorporate structural features into the purchase of assets in order to mitigate potential credit deterioration of the underlying portfolio

  21. ISSUES AND IMPLICATIONS • Accounting standards constraining securitisation possibilities • Regulatory authority for banks: treatment of IAS-induced changes • Basel II – for better or for worse • More incentive for elaborate securitisation structure to optimise use of risk capital • Maximise the size of investment grade tranches and minimise the size of sub-investment grade tranches, particularly equity positions, to reduce the utilisation of risk capital

  22. More issues • Need clear guidelines on whether “significant” risk transfer takes places • Need articulation of “implicit support” • Selection of appropriate elements of IRB approach • Banks may be pressured to sell sub-investment grade tranches to market participants not bound by Basel II

  23. END OF PRESENTATION THANK YOU James_H_Lau@HKMC.COM.HK

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