the hong kong mortgage corporation limited 1 securitisation and banks james h. lau jr. chief...
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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
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Contents
Introduction
Major securitisation issues for banks
International accounting standardsBasel II regulatory framework
Issues and implications
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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
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What assets to securitise?
Mortgages
Credit card receivables
Auto loans
Corporate loans
Any other assets with cashflow
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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
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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
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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.
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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
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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
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IAS 39 Derecognition of securitisation transaction
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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
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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
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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
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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
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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
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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.
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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)
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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
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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
Internal Ratings-based approach:Internal Assessment Approach
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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
Internal Ratings-based approach:Internal Assessment Approach
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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
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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