ZA Financialinstitutionservices SimplySecuritisation 090107(1)

7/27/2019 ZA Financialinstitutionservices SimplySecuritisation 090107(1)

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Financial Services

Simply Securitisation

Connectingthe process

Series 1/2006


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While all reasonable care has been taken in the preparation of this publication, it should not be considered as a substitute for professional

advice. The issues contained herein have been described in general terms and it is recommended that readers seek professional advice

regarding their specific circumstances.

Table of Contents

1. Introduction ........................................................................ 1

2. The securitisation process ................................................. 2

3. The securitisation components .......................................... 3

3.1. Asset classes .................................................................. 3

3.2. Credit enhancement ...................................................... 3

3.3. Liquidity facilities ........................................................... 5

3.4. Owner trust ................................................................... 5

3.5. Rating ............................................................................ 5

4. The effects of accounting treatment,

taxation and regulation on securitisation ....................... 6

4.1. Accounting .................................................................... 6

4.2. Taxation ......................................................................... 6

4.3. Regulation ..................................................................... 7

Key Contacts ............................................................................ 8

Glossary ................................................................................... 9


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Series 1/2006Simply Securitisation

1

Securitisation provides local institutions with additional

flexibility in managing credit, liquidity and other risks

involved in originating and funding assets. Depending on

the particular structures utilised, these risks can be eitherretained by an originating institution or passed on to

investors and others involved in the schemes.

The securitisation market in South Africa continues

to grow in both size and innovation. This publication

therefore does not attempt to cover each possibility arising

from any individual securitisation transaction, but to

provide readers with a basic explanation of securitisation

and the benefits thereof.

It has been widely observed that securitisation offers

tremendous opportunities and potential benefits to issuers

and investors. Securitisation also provides companies with

access to an alternative funding source compared to the

traditional funding mechanisms available in South Africa.

For issuers, securitisation provides a vehicle that can

be used to transform non-liquid financial assets into

tradable capital markets instruments. It offers an efficient,

diversified source of financing, often at lower execution

cost than is available through traditional bank loans, debt

or equity financing.

Securitisation can potentially also facilitate the removal of

assets from company balance sheets. The proceeds from

the transfer of the assets can be invested in other assets

with a better return.

This process also transfers the risk of exposure to one asset

type to investors and the capital markets in general.

For investors, securities issued by a securitisation

vehicle generally offer an attractive return compared

to a government security with similar credit quality and

maturity. The securitisation sector permits investors to

diversify their investment portfolios and corresponding

risks, while offering a significant variety and flexibility

of credit, maturity and payment structures and terms,

attributes that may be tailored to meet specific investor

needs.

In its simplest form, securitisation is a method of funding receivables (assets), such as mortgage debts,

leases, loans or credit card balances, through creating freely tradable securities backed by these assets.

1. Introduction


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2

A company may have assets on its balance sheet that

are producing a return, normally in the form of interest.

These assets usually also have a funding cost attached

to them, even if it is the cost of internal cash resourcesof the company that may be more profitably employed

elsewhere. The assets are grouped into a homogenous

set (e.g. all mortgage loans where the customer meets a

specified list of criteria such as loan to value ratio, credit

rating, geographic location, etc).

This set of pooled assets is then sold to a special purpose

vehicle (SPV) set up specifically for the securitisation

transaction i.e. the SPV does not own any other assets.

The SPV then issues securities (e.g. bonds or commercial

paper) to investors. The balance sheet of the SPV reflects

assets (a pool of mortgage loans) and liabilities (bonds or

commercial paper). The cash received from the investors

is used to pay off the liability the SPV has for the purchase

price of the asset pool it acquired.

The income statement of the SPV reflects interest income

on the mortgage bonds and interest expense on the bonds

or commercial paper issued. As cash is received from

bondholders in the form of their monthly instalments,comprising interest and capital, this cash is used to settle

the interest obligation to the investors and to either

redeem the notes issued, or to acquire further mortgage

assets.

The investors, for the most part, decide whether to invest

in the securities based on the quality of the underlying

assets in the SPV. This is where the term Asset-Backed

Securities (ABS) comes from.

The company that sold the pool of assets primarily decides

whether to participate based on the amount and cost of

funding it can generate from the securitisation transaction.

The end result is that the assets are converted into

securities that can be traded in the capital markets.

In a securitisation transaction, the securitised assets are transferred to a special purpose vehicle created for

the limited purpose of entering into the securitisation transaction.

2. The securitisation process

Figure 2.1: An illustration of a typical securitisation transaction


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3

3.1. Asset classes

A wide range of assets could be securitised,

including the following:

3.1.1. Asset-Backed Securities (ABS)

A pool of assets consisting of credit card

receivables, vehicle loans or leases, other types

of consumer loans, equipment leases, trade

receivables, etc.

3.1.2. Residential mortgage-backed securities

(RMBS)

A pool of assets consisting of residential

mortgage loans.

3.1.3. Commercial mortgage-backed securities

(CMBS)

A pool of assets consisting of commercial

mortgages that may consist of a single property or

a group of properties financed by a single borrower,

or a pool of assets that combines numerous

loans from different borrowers secured by diverse

commercial properties.

3.1.4. Collateralised debt obligations (CDOs)

A pool of assets such as commercial loans to

corporates or small and medium-sized enterprises

(SMEs).

3.1.5. Future flow securitisationsThe future cash flows from a pool of physical assets

such as export receivables and airline receivables

or flows from financial assets such as credit card

voucher processing receivables, trade payments

rights or worker remittances.

A variety of assets, including those discussed above,

can also be funded by securitisation programmes

that issue short-term paper through Asset-Backed

Commercial Paper (ABCP) conduits.

There has also been an increase in the use of

synthetic securitisation structures that rely on the

credit derivative market to allow for risk-based, as

opposed to asset-based, structures.

3.2. Credit enhancement

Securitisation transactions rely on the credit quality

of the pool of assets in the SPV as opposed to the

credit quality of the company that originated the

assets. Despite the fact that the credit quality of

a portfolio of diverse assets can be very high, it is

unusual that the credit quality of those assets is

sufficient on its own to support the credit quality

of the highly rated securities (bonds or commercial

paper) issued by the SPV.

Therefore, in most securitisation transactions, it is

essential to design the legal and financial structure

of the SPV to accommodate additional financial

support to the transaction. This financial support

is usually referred to as credit enhancement.

Credit enhancement can be provided in many

different ways but always with the same goal. It is

not uncommon for a securitisation transaction to

have more than one form of credit enhancement

in order to secure the required rating of the senior

securities. Some examples of the types of credit

enhancement are as follows:

3.2.1. Over collateralisationThis is similar to calculating the loan to value ratio

in a mortgage loan i.e. more assets are included in

the pool than are required to back the securities

issued by the SPV. The effect of this method is that,

if there are some assets that default against the

cash they are intended to generate, then there are

surplus assets in the pool to make up for the

asset that have defaulted.

In South Africa, a typical securitisation transaction involves several components, each with their own

specific purpose. These components can be structured in various ways to suit the individual transaction.

3. The securitisation components


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3.2.2. Reserve funds

This method simply means that the SPV

accumulates and maintains additional cash on its

balance sheet to cater for instances when one ofthe assets in the pool goes into default. This cash is

accumulated by paying out less cash than it collects

in the early part of the transaction. In South Africa

the reserve fund is often provided by means of a

subordinated loan from the originator at inception

of the transaction (please also refer to 3.2.3 dealing

with excess spread).

3.2.3. Excess spread

Spread refers to the difference between the

amount of interest received on the assets and the

amount of interest to be paid on the securities

that have been issued by the SPV. If there is

excess spread, i.e. more net interest income than

is required to meet expenses of the SPV, then an

element of reserve funds begins to accumulate.

These reserve funds can be used in the event of

default by one of the assets in the pool.

3.2.4. Guarantees or standby letters of credit

Similar to the concept of reserve funds,

guarantees or letters of credit can be obtained by

the SPV from a suitable institution that ensures cash

will become available if one of the assets in the

pool goes into default i.e. no cash is maintained on

the balance sheet. Should the SPV need to call on

the guarantee or letter of credit then the companyissuing the guarantee will provide the necessary

amount of cash. Using a guarantee or letter of

credit does not provide the same level of credit

enhancement as cash collateral because there is

the potential risk that the institution issuing the

guarantee or letter of credit could default if called

on to provide the necessary cash.

3.2.5. Hierarchy of securities based on the

securitisation structure adopted

A securitisation transaction can be structured to

provide credit enhancement based purely on thestructure adopted. This type of structure requires

that at least two classes of securities are created

based on the priority of payment to each class. In

South Africa it is common for the number of classes

to be limited to three or four.

The first class will be the senior class, which is

generally highly rated (AAA or AA) and has

the priority of payment for interest and principal

over the second or subordinate class. This means

that different classes of securities can be issued

all the way down the credit curve in a single

securitisation transaction. The subordinate class

is also referred to as the first-loss piece because

any losses arising from defaults are first allocated

to the subordinate class. Because of the priority

of distributions over the subordinate class and the

loss protection provided by the subordinate class,

the senior class receives a high credit rating. The

subordinate class is typically purchased by the

originator of the assets.

In South Africa, the originator is usually also the

servicer and therefore they also carry the credit risk

through the subordinate class. This provides the

originator with an added incentive to service the

book properly and ensure that the losses are keptto a minimum, thus providing further protection

to the senior class. The quality of the underlying

assets sets the precedence for a credit rating. The

subordination provides protection in addition to the

natural protection against losses provided by the

good quality of the assets in the pool.


(continued)


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3.3. Liquidity facilities

A liquidity facility, as distinct from a credit

enhancement facility, is provided to the SPV by abank to cover the potential mismatch arising from

delays in payment from the assets in the pool. A

liquidity facility refers to delay and not default.

Therefore, the liquidity facility is provided to ensure

payments are maintained to the investors in the

SPV, despite differences in timing between when

cash is received from the assets and when cash is

due to be paid to investors.

Detailed rules exist in most regulatory regimes

regarding the extent of capital required to be

maintained by a bank that issues a liquidity facility

to a securitisation transaction. In most cases, the

regulatory treatment is attractive to the bank,

provided that it can be proven that the liquidity

facility is structured so that it does not cover losses

arising from the potential default of the assets

in the pool. If the liquidity facility is structured

incorrectly, it potentially could be seen as a credit

enhancement facility because it absorbs losses

from the underlying assets. In general, a credit

enhancement facility attracts a higher regulatory

capital charge than a liquidity facility.

3.4. Owner trust

An inter vivos trust established in terms of a trust

deed with the purpose of owning all the issuedequity shares of the SPV. The beneficiary of the

trust is normally a charitable organisation. A

fundamental element of a securitisation transaction

is to have the assets isolated from the originator

so that the cash flow associated with the assets is

available to make principal and interest payments

to investors. The inclusion of the owner trust in

the securitisation structure ensures that the SPV is

insolvency remote. The effect of this is that the SPV

is not owned by the originator and therefore, the

assets of the originator could not be attached in

the event of an insolvency proceeding. The owner

trust does not own any assets other than the equity

shares of the SPV.

3.5. Rating

Securitisation transactions are usually rated by a

recognised rating agency. The purpose for rating

the transaction is to increase the ability to attract

investors. A rating for the transaction also assists

in determining the interest rate to be paid on

the notes issued to investors i.e. a highly rated

deal will close at a lower interest rate because

the assumption is that the risk is lower. A rating

is not a guarantee by the rating agency butrather a grading system that is intended to reflect

the likelihood of being paid the full amount of

principal.


(continued)


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4.1. Accounting

The accounting treatment for a securitisation

transaction can be a challenging process but theaim remains to provide the users with information

that is understandable, relevant and reliable.

There are two main considerations regarding the

accounting treatment:

4.1.1. Derecognition

The first is the ability to derecognise the assets

from the balance sheet of the originator i.e.

meeting the requirements of IAS 39 (AC 133) for

transfer of risk and rewards as well as the extent of

control of the asset.

4.1.2. Consolidation

The second consideration is whether the asset

would have to be recognised on consolidation,

even if the requirements for derecognition from

the balance sheet of the originator have been

met i.e. SIC 12 (AC 412) requires an SPV to

be consolidated by the originator when the

substance of the transaction indicates that the

SPV is controlled by the originator. The extent

of equity invested by the originator in the SPV is

not conclusive in terms of deciding the extent of

control.

4.2. Taxation

Taxation is a key component in any financial

transaction, including both direct and indirecttaxation. The issue of taxation is a significant

consideration in structuring a securitisation

transaction. The types of taxes that come into

play include; income tax, value added tax and

capital gains tax.

The following three points on Accounting, Taxation and Regulation are the topics of further publications in

this series on securitisation. They are mentioned briefly in this publication as an indication of some of the

technical aspects that are required to be considered in a securitisation transaction.

4. The effects of accountingtreatment, taxation and

regulation on securitisation


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4. The effects of accountingtreatment, taxation and

regulation on securitisation(continued)

4.3. Regulation

The financial regulators, including the Basel

Committee on Banking Supervision, havedeveloped complicated rules to apply to

securitisation structures.

In South Africa, securitisation transactions

are currently regulated by the South African

Government Notice R. 681, Designation of an

activity not falling within the meaning of the

business of a bank (securitisation exemption

notice). This securitisation exemption notice

was issued to both authorise and to regulate

securitisation transactions i.e. an SPV accepting

funds from the general public against the issue of

commercial paper. Ordinarily, the acceptance of

funds from the general public would fall within the

definition of the business of a bank, and therefore

be limited by the Banks Act, 1990 to institutions

with a banking licence. In essence, a securitisation

transaction is exempt from the definition of a

business of a bank provided that it complies with

the conditions of the securitisation exemption

notice, and it therefore does not have to comply

with the requirements of the Banks Act, 1990 and

Regulations thereto. A bank that participates in asecuritisation transaction would have to comply

with both the requirements of the Banks Act, 1990

and the securitisation exemption notice. A corporate

entity that participates in a securitisation transaction

only has to comply with certain defined sections of

the securitisation exemption notice.

The International Convergence of Capital

Measurement and Capital Standards was published

by the Bank for International Settlements (BIS)

in June 2004 and then updated in June 2006.

This document, published by the BIS, is commonly

known as Basel II and supersedes the original 1988

Basel I Accord. Basel II includes a specific section

referred to as the Securitisation Framework that

deals with the various approaches for calculating

the capital requirement as a result of credit risk

to a bank from participating in a securitisation

transaction.


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8

Key Contacts

Andr Pottas

Partner Financial Services Team:Debt Origination and Securitisation

Services Group

Andr is the lead partner responsiblefor the debt origination and assetsecuritisation services group of DeloitteSouth Africa. He is on the ExecutiveCommittee of the South AfricanSecuritisation Forum. He has beenpublished on current trends in thesecuritisation industry in South Africaand on the impact of IAS 39 (AC133) on securitisation structures, andhas consulted and spoken widely onsecuritisation structures and compliancewith the Banks Act Securitisation

Regulations.

Riaan Eksteen

Partner Financial Services Team:Assurance Services

Riaan is responsible for assuranceservices to a large number ofsecuritisation structures and relatedvehicles. In addition to the statutoryaudit of securitisation structures, hisresponsibilities include the assessmentand reporting of compliance in termsof securitisation agreements, whichrepresents an integral part of the overall

securitisation governance process.

Grant Fowlds

Partner Financial Services Team:Advisory Services

Grant has provided specialisedaccounting services to a numberof securitisation structures to date,including advice and technical opinionson the impact of IAS 39 (AC 133) andSIC 12 (AC 412), and valuation offinancial instruments.

Nazrien Kader

Partner Tax:Corporate Tax Services

Nazrien is responsible for the provisionof taxation services to large and mediumsized corporate entities. She hasconsulted on both the direct and indirecttaxation implications to originators andSpecial Purpose Vehicles in securitisationstructures.

Chris Beneke

Director Tax:Specialist Financial Services

Chris is responsible for the provision ofspecialist taxation services to financial

services institutions, including a focus onsecuritisation, and has consulted on awide range of tax issues in the financialservices sector.

Andrew Huntley

Senior Manager Financial Services Team:Advisory Services

Andrew has worked on assuranceengagements relating to varioussecuritisation structures in Australiaand South Africa and completedseveral due diligence reviews specific

to securitisation. He providesadvisory services to financial servicesinstitutions on the impact of the Basel IISecuritisation Framework.

Preparation of this publication was performed by Andr

Pottas and Andrew Huntley. For any queries regardingthis publication, or in respect of the securitisation servicesoffered by Deloitte, please contact:

Andr Pottas [email protected]+27 (0)31 560 7206

Andrew Huntley [email protected]+27 (0)11 806 5732


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Arranger

This is the company that handles all aspects of establishing

a securitisation transaction and takes the deal to market. In

South Africa, this role is normally fulfilled by a bank.

Asset

The receivable (obligation from debtor to creditor) to be

securitised (e.g. mortgage loans or vehicle loans) that the

company has on its balance sheet and that will be sold to

the SPV.

Asset-Backed Securities (ABS)

The securities (bonds or commercial paper) that are issued

as part of the securitisation transaction by the SPV.

Investor

The entity that buys the securities (bonds or commercial

paper) issued by the SPV. These investors are normally

entities such as collective investment schemes, life insurers,

pension funds or other companies.

Issuer

The SPV that buys the assets from the originator and issues

securities backed by those assets in order to acquire the

cash to settle the purchase price of the assets acquired.

Multi-seller conduit

An SPV that issues securities backed by numerous different

asset classes or a pool of smaller securitisation transactions

based on assets it has purchased from a variety of

companies over time.

Originator

The company that has the assets on its balance sheet and

sells them to the SPV.

Physical (Traditional or Cash) securitisation

In a physical securitisation, the assets are sold and

physically transferred off the balance sheet of the

originator and the issuer becomes the new legal owner.

Priority of payments

All payments to investors and other creditors are made

in terms of an agreed order of priority i.e. in the event

that there is insufficient cash in the bank account whenpayments are due, then there is a pre-determined order

in which payments will be made. The ranking or order

in which payment will be made is normally detailed in

the securitisation documentation and any party to those

documents agrees to be paid in terms of the priority of

payments listed.

Rating

The grade assigned, by a rating agency (e.g. Moodys,

Standard & Poors or Fitch), to the securities issued by

the issuer. There could be different classes of securities

issued by the issuer for one securitisation transaction

and each class would be assigned its own rating. The

different classes are often called tranches of a securitisation

issue. One of the conditions of a properly structured

securitisation is the isolation of assets from the creditors of

the company. Separation of good quality assets, in terms

of their credit quality, from a companys core risky business

will likely result in an enhanced rating for the securities

issued by the SPV when compared to the rating of the

originating entity.

Single-seller conduit

An SPV that issues securities backed by a single asset class

purchased over time from a s ingle originator. The assets are

usually short-term receivables and the proceeds on receipt

of payments from the obligors are utilised to purchase newreceivables (e.g. In-store credit card receivables from large

retailers).

Synthetic securitisation

In a synthetic securitisation, the underlying credit risk of

owning the asset is transferred from the originator to the

issuer through the use of derivative instruments; the assets

themselves are not physically sold. The economic rights of

ownership embodied in the assets are owned by the issuer

and therefore ultimately by the investors.

The following are some key terms used in this publication:

Glossary


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ABOUT DELOITTE

Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, its member firms, and their respectivesubsidiaries and affiliates. Deloitte Touche Tohmatsu is an organisation of member firms around the world devotedto excellence in providing professional services and advice, focused on client service through a global strategy

executed locally in nearly 140 countries. With access to the deep intellectual capital of approximately 135,000people worldwide, Deloitte delivers services in four professional areas - audit, tax, consulting and financial advisoryservices - and serves more than 80 percent of the worlds largest companies, as well as large national enterprises,public institutions, locally important clients, and successful, fast-growing global growth companies. Services are notprovided by the Deloitte Touche Tohmatsu Verein, and, for regulatory and other reasons, certain member firms donot provide services in all four professional areas.

As a Swiss Verein (association), neither Deloitte Touche Tohmatsu nor any of its member firms has any liability foreach others acts or omissions. Each of the member firms is a separate and independent legal entity operating underthe names Deloitte, Deloitte & Touche, Deloitte Touche Tohmatsu, or other related names.

In Southern Africa, Deloitte & Touche is the member firm of Deloitte Touche Tohmatsu, and services are provided byDeloitte & Touche and its subsidiaries. Deloitte & Touche is among the nations leading professional services firms,providing audit, tax, consulting, and financial advisory services through nearly 3600 partners and staff in more than16 offices in Southern Africa. Known as an employer of choice for innovative human resources programme, it isdedicated to helping its clients and its people excel. For more information, please visit Southern Africas website atwww.deloitte.com/za

2006 Deloitte Touche Tohmatsu. All rights reserved.

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Deloitte Touche Tohmatsu

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ZA Financialinstitutionservices SimplySecuritisation 090107(1)