There have still only been a small number of securitization issues in Asian markets outside Japan, but the trend has changed since the Asian currency crisis in 1997. Securitization is now regarded as an effective tool as banks and companies are increasingly required to strengthen their balance sheets, to boost their capital ratios or lower their gearing ratios.
From a long-term point of view, R&I believes the development of a securitization market will have a positive impact on sovereign, corporate and bank ratings in Asia. Through securitization, banks and companies will more easily be able to adjust their balance sheets by lowering their gearing and will also be able to achieve more efficient management, as seen in South Korea and Hong Kong recently.
Also, securitization may contribute to the development of local bond markets, which is essential for the reform of the traditional fund raising regime. It is believed that too much concentration on bank loans and the stock market increased the financial risk for Asian countries before the currency crisis, which arose from the mismatch of funding structure, i.e., short-term funding and long-term investing.
The number of international securitization issues by Asian entities will also increase this year. These issues may include collateralized loan obligations backed by overseas loan assets, asset backed securities on lease assets of Korean banks, or Hong Kong's mortgage-backed securities and ABS collateralized by export receivables in Asean countries.
However, the development of a securitization market
will require comprehensive reforms of the legal, tax, and accounting systems, and the speed of development may vary according to the country. R&I believes South Korea and Hong Kong are in a comparatively strong position, while the rest of the region may take some time to build up an
adequate market infrastructure.
The first question is whether securitization is cost effective. As the Asian securitization market is still in its early stages, arranging the necessary tailor-made deals is time consuming. This means costs tend to rise and this may be a hurdle for market development in Asia.
Also, the narrowing spread on bank loans in Asia, aided by the economic recovery, may reduce the relative advantage of securitization issues. Therefore, for the time being, it will be necessary to reduce costs, to build up the market infrastructure by fine-tuning the legal and taxation systems and to modernize the accounting system for transparent asset evaluation.
Moreover, finding investors for the subordinated part of securitization issues is difficult in Asia, even in Japan. So far, only a small group of investors such as "distress funds" in the U.S. have made such investments. Therefore, in most cases, originators or arrangers have to play that part, increasing the cost of securitization.
Time may be needed before Asia has its own risk takers, but if credit rating and other risk evaluation systems spread in the region, it may happen. Some stock investors may shift their investment partly into the subordinated paper in the form of high-yield bond trusts.
Before the currency crisis, Japanese banks were the largest group that took Asian risk. However, they cannot play the same role for the time being, although they may act as major originators of Asian securitization using their own loan assets.
In this sense, the future development of the Japanese capital market may also have significance for securitization in the rest of the Asia. If a high yield bond market develops in Japan, there will be a broad layer of risk taking investors and they can absorb the subordinated part of Japanese and other regional securitization issues.
South Korea - Big Demand for NPL Deals
South Korea is relatively well prepared for the future expansion of the securitization market. There is a big demand for origination from banks and conglomerates. Banks are seeking to separate their bad assets while conglomerates are required to reduce their huge debt. Also, the government has been quick to respond to securitization demand. Various laws and regulations were enacted in October 1998, providing the legal framework for the development of the market.
CLO issues are expected to be the most active area for this year and next. The government has set up Korea Asset Management Corp. (Kamco) to procure non-performing loans from banks in order to stabilize the financial system. Kamco is planning to issue CLOs and MBS using the assets bought from banks and properties obtained through exercising collateral rights. It has already issued three CLOs so far.
Kamco plans to sell W17 trillion ($15 billion) worth of non-performing loans through international tender and nine issues of CLOs denominated in Korean won and foreign currency. However, these CLOs are guaranteed by Kamco and carry a put option that allows Kamco to sell the loan assets back to the banks when the loan falls into default, and are far from pure securitization.
It is expected that cases where banks form their CLOs directly, not through Kamco, will increase, as they are subject to a big discount when they sell NPLs to Kamco. Also, if Kamco starts buying NPLs for the Daewoo group, it is estimated that the Kamco scheme will not be enough to clear all the bad assets in the financial system.
Benefiting from the economic recovery, many Korean banks are regaining profitability and are prepared to allocate provisions and write off bad assets. Also, banks are now more willing to separate bad assets as the restructuring of the banking sector has almost been completed. During the merger and reorganization process, banks had to stop selling their assets. These factors are providing a background for NPL securitization and major banks are planning CLO issues this year.
Prior to the currency crisis, Korean banks had accumulated huge exposure to Southeast Asia, Eastern Europe and Russia, most of which became non-performing after the crisis. It is expected that CLOs and collateralized bond obligations backed by such assets will be issued in the international market in the near future.
MBS collateralized by mortgage loan assets may emerge in the future. The government will soon establish the Korea Mortgage Corp. (Komoco) as a joint venture with International Financial Corp. (IFC) and some domestic banks. Komoco is expected to issue MBS collateralized by mortgage loans acquired from National Housing Fund in the first half of this year.
Also, securitization issues of credit card-related assets and lease assets are in the pipeline as many banks have credit card and lease companies in their groups. Some of these securities backed by foreign currency assets may be placed in overseas market.
So far, securitization issues originated by corporations have been limited in number, but these may grow if the market expands. Korean companies have maintained a high gearing, which is regarded as a factor behind the currency crisis. The government required conglomerates to decrease gearing ratios to 200% on the consolidated basis by the end of 1999.
Top-notch groups such as Samsung have already achieved this requirement, but the medium to small groups have not, and their prospects of achieving it is still bleak. For these conglomerates, securitization would be an effective tool to solve the debt problem.
Hong Kong to Lead with MBS
In the area of MBS, Hong Kong leads other Asian countries as property assets are abundant and the efficient legal and tax systems needed for securitization issues are already in place.
Hong Kong Mortgage Corp. (HKMC), established by the government in 1997, has already issued MBS with mortgage loan assets it has bought from banks as collateral. In October 1999, HKMC listed seven already issued MBS and a new bond-issuing program of HK$20 billion (U.S.$2.57 billion) on the Hong Kong Stock Exchange to enhance the liquidity of MBS.
The MBS market will grow in Hong Kong as Hong Kong banks' mortgage loans stand at about 30% of total exposure on average. Through securitization, banks can limit their asset expansion and turn their mortgage loan lending into a fee-based business.
MBS issues other than those from HKMC are also increasing. Although some big property companies maintain low gearing and their loan spreads are narrowing - meaning that their demand for securitization is limited - the advantage of raising funds through securitization for medium- to small-sized companies will grow.
Securitization of consumer loans, including credit card loans, is also on the increase. The market is rapidly expanding with declining interest rates for customers due to the intense competition among consumer credit companies and banks.
The securitization moves will have a certain impact on the development of Hong Kong's debt market. With the start of the Mandatory Provident Fund scheme, huge investment demand will arise seeking long-term and relatively stable investment opportunities. Hong Kong's debt market, however, is still small and the supply of low-risk fixed income products falls short of the demand.
Obstacles Remain for Other Countries
The expansion of the securitization market may take longer elsewhere in Asia. Many countries wish to use securitization as a tool for clearing the NPLs of their banking sectors, but obstacles remain in terms of market infrastructure and macro economic conditions.
In Thailand, the Financial Sector Restructuring Authority (FRA) has initiated bids for NPLs it bought from banks. The country's first MBS issue was arranged by the Lehman Brothers in May 1998 backed by mortgage loans bought from FRA. But good quality assets such as mortgage loans are limited in Thailand. Also, asset valuation is difficult as the collection rate of bank loans is still low and the property market is stagnant.
The situation is similar in Indonesia and Malaysia. In these countries problems remain in the area of the legal system and taxation in terms of establishing a SPV as a bond issuer and "true sale" of assets from originator to SPV. Other problems include tax exemption on the sale of assets to SPVs and placing a "servicer," which acts as the administrator, collector and provider of other services with respect to the financial assets. These obstacles reduce the advantage of securitization.
In Singapore, the market environment is more advanced. Some CMBS have been issued after the Monetary Authority of Singapore published guidelines on the securitization of real estate assets in January 1999, allowing banks to off-balance their properties through securitization. Development Bank of Singapore launched a landmark CMBS issue and others have followed suit.
However, even in Singapore, there are still legal and tax problems and the market infrastructure may need to be developed further. The government may be required to adopt more comprehensive policies and, if not, the development of other types of securitization market such as deals backed by mortgage loans, consumer credit, plus CLOs and CBOs, may be limited.
The securitization market in China cannot be ignored in the long run. The big four banks in China have started to separate their NPLs to asset management companies, but, eventually, the government plans to introduce securitization as a tool of asset collection.
R&I estimates that the big four commercial banks hold RMB1.8 trillion ($217 billion) of NPLs, as at end 1998. Hence the market would be enormous. But China may have a long way to go, as it may have to start by modernizing the accounting system, something indispensable for accurate asset valuation.