1 ASEAN+3 Workshop on the Rise of Asset Securitization in East Asia (S ponsor: Ministry of Finance, P.R.China; Co-organizers: APEC Finance and Development Centre and World Bank) Asset Securitisation in East Asia Ismail Dalla Royalton Hotel, Shanghai, P.R.China November 7-9, 2005 Views expressed in this presentation do not represent official views of the World Bank

2 Financial Sector Profile (Dec 2004)-The rise of bond market /Economy

3 The Size of Debt Securities in 2004

4 East Asian Bond Markets Outstanding Domestic Bonds (in US$ Billion)

5 Fixed Income Securities Market in USA Source: The Bond Market Association

6 Role of Asset-Backed Securities Markets in the Economy Development of domestic bond market Development of residential mortgage market Additional funding source for capital constrained financial institutions and corporations. As a risk management instrument, securitization can reduce risk in the financial market Potential investment opportunities for domestic and regional institutional investors. Potential source for infrastructure projects.

7 Securitizable Assets Residential mortgages Commercial mortgages Hire-purchase receivables Small business loans Credit card receivables Nonperforming loans Worker remittances Bond portfolio Collateralized mortgage-backed or loan backed obligations (CMOs or CLOs) Tax liens Toll road receivables Trade and export receivables Utility (e.g., electricity, telephone, and water receivables) Oil and gas receivables Service contracts Source: Asset-Backed Securities Market in Selected East Asian Countries, Ismail Dalla, World Bank, July 2002.

8 Asset-Backed Securities Terminology Securitization involves the repackaging of generally illiquid assets that generate cash flows. The assets are sold to a special purpose vehicle whose sole function is to buy such assets in order to securitize them. The attractiveness of the transaction is that it separates the assets from the credit profile of the company that originally owned them. By adjusting the tranche amounts and term structure, the assets can be altered to suit the needs of investors. In addition, swaps, guarantees, and reserve funds can be used to enhance the creditworthiness of the newly issued securities, making them desirable for a broader range of investors. Collateralized Debt Obligation. A security backed by a pool of assets. CDOs do not specialize in one type of debt. Those that do include collateralized bond obligations (CBOs) and collateralized loan obligations (CLOs) Monoline insurer. Agencies that provide credit guarantees. They began by offering guarantees on municipal bond defaults, but have branched out.

9 Asset-Backed Securities Terminology Mortgage-backed securities. A bond that represents a securitized interest in a pool of mortgages. The simplest form of MBS is a mortgage pass-through. With that structure, all principal and interest payments (less a processing fee) from the pool of mortgages are passed directly to investors each month. There are residential (RMBS) and commercial varieties (CMBS) of these bonds.securitized Originator. Almost any entity that originates a receivable. Examples include a finance company with a pool of loans, a utility company selling electricity, or a credit card company. Obligor. The entity that pays the receivable, including the guarantor of the payment. Pass-through. Refers to mortgage pass-through securities when one or more mortgages are pooled and sold off. The cash flow of the resultant securities depend on the cash flow of the underlying mortgages. Receivable. The obligation to pay money. This can take many forms, such as payments on a loan, lease, or bond. Almost any cash flow can be securitized, though the receivable must be convertible into cash and the cash flow usually needs to be predictable.

10 Asset-Backed Securities Terminology Seniority. Affording a certain class of securities with a priority in claiming assets. It usually confers a greater creditworthiness, while subordinated issues offer higher yields. Servicer. They collect the payments on the receivables and are usually the originator. This is necessary since special-purpose vehicles typically have no staff or premises. Special-purpose vehicle. The entity that purchases the receivables and issues securities backed by them. It is typically structured to provide bankruptcy remoteness, insulating the issuer from the originator. SPVs are usually located in a tax-neutral location such as the Cayman Islands or Bermuda. SPV activity is typically restricted to the transaction being contemplated. Tranches. Different securities classes, typically with different payment structures and credit profiles.

11 Why invest in ABS? Attractive yields ( a yield pick up of basis points over treasury) High Credit Quality Diversification Predictable cash flows Reduce Event Risks.

12 Cross Border East Asia Securitization Transaction by location of assets (US$ million)

13 Cross-Border Asset-Backed Securities Transactions in Asia (2000–2004) US$ million

14 Korea is the largest ABS market in East Asia (x Japan)

15 An Example of Securitization-Korea Asset Funding ( US$367 million) The Korean Government established Korean Asset Management Corp. (KAMCO) to deal with the nonperforming loans of the state-owned Korea Development Bank. KAMCO aimed to restore the liquidity and soundness of Korean banks by disposing of their problem loan portfolios. The $367 million floating rate bond issue was underpinned by a portfolio of restructured loans that KAMCO bought from Korean banks. Put options for the loans allowed recourse provisions to each originating bank in the case of default. Due to Korean law, the securitization of these loans was a two-step process. They had to be transferred to a special purpose corporation outside Korea, and then financing was raised through a separate offshore vehicle. A swap was included, as 10% of the portfolio was yen-denominated, and the Korea Development Bank (KDB) provided a credit facility worth 30% of the deal. Subordinated notes of around $53 million were issued back to KAMCO. The deal was 3.5 times oversubscribed and was considered the asset-backed deal of the year.

16 Korea Asset Funding

17 KAL Japan ABS 1 Cayman Ltd KAL Japan ABS 1 Cayman Ltd.(Y27 billion) KAL Japan ABS 1 Cayman Ltd. (the Note Issuer), a limited liability company incorporated in the Cayman islands issued Y27 billion of secured floating rate notes. The transaction is a securitization of yen-denominated future ticket receivables originated by Korean Air Lines Co., Ltd. in Japan for flights including its Japan-Korea routes. The Korea Development Bank (KDB) provided unconditional and irrevocable yen-denominated credit facility and covers full payment of principal, interest, and priority expenses on the notes.

18 KAL Japan ABS 1 Cayman Ltd Trustor/Servicer Korean Air Lines Co., Ltd Bond Issuers, Tokyo Branch KAL Japan ABS 1 Ireland Plc Bond Issuer KAL Japan ABS 1 Ireland Plc Note Issuer KAL Japan ABS 1 Cayman Ltd Investors Japan Trust Liquidity Reserve Credit Facility Provider Korea Development Bank Swap Provider Korea Development Bank Entrustment of BSP Receivables and Bank Account Rights Investor and Seller Certificate Source: Fitch Ratings Invest Certificate Inter-Office Funding Memo Yen BondYen Yen Notes Yen

19 Malaysia-the runner up in local ABS Source: Rating Agency Malaysia

20 Malaysia: ABS by Asset Type (2001-Sep 05) Source: Rating Agency Malaysia

21 Asset Securitisation and Implications on Financial Markets Positive A new financial instrument that facilitate development of bond market which in turn help create a more diversified financial markets. Can also be used for open markets. Improve risk management in the financial system and therefore reduce financial vulnerability. Create a new investment vehicle for investment for institutional and high net worth investors in the region. Increase liquidity for financial institutions. This would enable them to increase lending to corporate and households especially for housing finance.

22 Securitisation of the Government’s Islamic House Financing Debts and the Issuance of Islamic RMBS : Portfolio Pool of RM2,844 million (Collateral/Security) IRMBS Proceeds Issuance of RM2,050 million IRMBS Cash Settlement True Sale of RM2,844 million Portfolio Pool GOVERNMENT’S HOUSING LOANS DIVISION TRUSTEE AND SECURITY AGENT CAGAMAS MBS BERHAD (ISSUER) CAGAMAS BERHAD SUKUK MUSYARAKAH INVESTORS Equity (100% Ownership) Source: Cagamas

23 Asset Securitisation and Implications Challenges Complex administration of capital adequacy under BASEL II. Should AAA rated securitized assets be given preferential treatment for capital adequacy?. Clear regulatory framework for securitization covering the accounting and tax treatment of SPV and other service providers. Increase in securitization reduce the efficacy of monetary policy (Arturo Estrella, FBRNY, Economic Policy Review, May Lack of liquid market can create valuation problem for ABS and the calculation of capital adequacy (marked to market issue).

24 Prospects for ABS markets ( ) Countries Rapid Growth : Malaysia, China Moderate growth: Hong Kong and Singapore Emerging growth: Indonesia, Thailand, Philippines Assets: Infrastructures (Thailand, Malaysia, Singapore, Indonesia). Non-Performing loans: China Credit Cards: Thailand, China, Indonesia. RMBs: China, Indonesia, Thailand, Korea

25 Asset Securitization in East Asia Thank you Ismail Dalla