Securitisation and Banks

1The Hong Kong Mortgage Corporation Limited

Securitisation and Banks

James H. Lau Jr.Chief Executive Officer

The Hong Kong Mortgage Corporation Limited

8 November 2005

ASEAN+3 WorkshopASEAN+3 WorkshopThe Rise of Asset Securitisation in East AsiaThe Rise of Asset Securitisation in East Asia


Contents

Introduction

Major securitisation issues for banks

International accounting standardsBasel II regulatory framework

Issues and implications


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


What assets to securitise?

Mortgages

Credit card receivables

Auto loans

Corporate loans

Any other assets with cashflow


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

Hong Kong Securitisation Market (1994-2004)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Issu

ance

Vo

lum

e (H

K$

mn

)

HKMC RMBS Other RMBS CMBS ABSSource: HKMC


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

MPF and ORSO Asset Size

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Dec-01 Dec-02 Dec-03 Dec-04 Jun-05

Ass

et S

ize

(HK

$ m

illi

on

)

MPF ORSO

Source: MPFA


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.


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


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


IAS 39 Derecognition of securitisation transaction


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


Basel II: Framework on Securitisation

Standardised Approach

Internal Ratings-based Approach

Ratings-based Approach (RBA)

Supervisory Formula Approach (SFA)

Internal Assessment Approach (IAA)

Two approaches for determining capital requirements of securitisation exposure

Choice of approach depends on:

• Business focus

• Bank size and complexity

• Capability in setting up systems, modelling and IT

Choice of approach depends on:

• Business focus

• Bank size and complexity

• Capability in setting up systems, modelling and IT


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


Standardised Approach – Risk Weight

External Credit Assessment

(long-term rating)

Risk Weight

AAA to AA- 20%

A+ to A- 50%

BBB+ to BBB- 100%

BB+ to BB- 350% / Deduction*

B+ and below or unrated Deduction

Note: * 350% for Investing Banks, deduction for Originating Banks


Internal Ratings-based (IRB) Approach

More sophisticated and risk sensitive than the standardised approach

Three-tier IRB approach to risk assessment:• Rating-based

Approach (RBA)• For rated securitisation exposure• External ratings• Inferred ratings

• Supervisory Formula Approach (SFA)

• For unrated exposure• KIRB and “Supervisory Formula”

• Internal Assessment Approach (IAA)

• For unrated liquidity facilities and credit enhancements related to ABCP programmes

• Exposures at least be investment grade at the beginning of the transaction

• Based on Rating Agencies’ methodologies• Internal assessment is mapped to an

equivalent external credit rating


Internal Ratings-based Approach:Rating-based Approach - Risk Weights

External Rating(Long-term rating)

Risk weights for senior positions and eligible senior IAA exposures

Base risk weight Risk weight for tranches backed by non-granular

pools

AAA 7% 12% 20%

AA 8% 15% 25%

A+ 10% 18% 35%

A 12% 20% 35%

A- 20% 35% 35%

BBB+ 35% 50% 50%

BBB 60% 75% 75%

BBB- 100% 100% 100%

BB+ 250% 250% 250%

BB 425% 425% 425%

BB- 650% 650% 650%

Below BB- and unrated Deduction Deduction Deduction

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.


Internal Ratings-based approach:Supervisory Formula Approach

Under Supervisory Formula Approach, capital charge for a securitisation tranche depends on five factors:

1. The exposure’s thickness (T)• Ratio of nominal size of the tranche in question to the notional amount

exposures in the pool

2. 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

3. 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

4. The pool’s exposure-weighted average loss-given-default (LGD)

5. The pool’s effective number of exposure (N)


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


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



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



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


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


END OF PRESENTATION

THANK YOU

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Securitisation and Banks