Securitisation: Benefits for Emerging Markets and Lessons from the Global Financial Crisis SEC Securities Markets Workshop Washington DC May 1, 2009 1
Securitisation: Benefits for Emerging Markets Investors need supply of higher-quality/higher-rated investment instruments Banks / other FIs require access to long-term funding Provides banks with regulatory capital relief / greater operational leverage Provides lower cost funding for corporates, other FIs with weaker balance sheets, e.g. manufacturers/exporters, leasing companies, consumer finance companies, etc 2 Securities Markets
Catalyst for local bond market development Domestic pension and provident funds must invest onshore and in local currency but are reluctant to buy anything other than G-secs or handful of AAA-rated corporate bonds Securitisation broadens supply of local instruments which these investors can hold and also enhances returns they can offer Opens access to local bond markets for key sectors and issuers who might not otherwise be able to source LT funding, eg mortgage lenders, infrastructure sponsors, etc 3 Securities Markets
Catalyst for local bond market development Fosters development of legal and regulatory framework for more diverse and robust securities market, promotes development of required market infrastructure, ie rating agencies, credit bureaus, market makers, fixed-income research, etc Limits vulnerability to foreign capital outflow shocks and can potentially reduce ALM/maturity mismatch in overall economy by enabling borrowers with LT funding needs to tap onshore savings pools, thus fueling domestic growth with own resources Supports growth of other key market segments including derivative markets, hedging instruments, etc. 4 Securities Markets
Illustrative EM Securitisations Blue Orchard (Global) CDO issue backed by local currency term loans to 22 leading Microfinance institutions in markets ranging from Bosnia to Brasil. Accompanying package of currency swaps arranged by Morgan Stanley. Hyundai Card, Shinhan h Card, LG Card, etc (Korea) Numerous repeat credit card receiveable securitisations done in cross-border market mainly for funding purposes by leading Korean card issuers National Housing Bank (India) Numerous RMBS issues in domestic market to fund purchases of mortgage pools from local banks and primary mortgage lenders Extensive use of securitisation i i (across most asset classes) in Latin America: Brazil, Mexico. Argentina, Venezuela, El Salvador, etc. - See table I. 5 Securities Markets
Latin American Securitisations Mexico Brasil Argentina Peru Venezuela Columbia MBS Credit cards Personal loans Auto loans Leases Future flows (Corp) Future flows (FIs) Tax-backed Distressed debt Construction loans Repackaging Ticket receivables Source: PWC / Fitch (2008) 6 Securities Markets
Origins of the Global Financial Crisis Three distinct crises rolled into one: Started as a basic credit shock in the US sub-prime mortgage market resulting from deterioration in lending standards Further amplified by aggressive balance sheet leveraging using asset securitisation markets Transformed into a global liquidity crisis by lenders increasing reliance on short- dated funding 7 Securities Markets
(1) Credit Shock in US mortgage market Credit problems in the US sub-prime lending market can be attributed to: Consistent trend in US housing price appreciation Past decade of very rapidly rising home prices Lower unemployment rates and falling mortgage rates following 2001 recession period Loosening of lending and credit/underwriting standards Declining credit spreads on other competing debt products 8 Securities Markets
(2) Increase in financial system leverage Relaxation of credit standards, higher consumer leverage in US mortgage markets and resulting loan losses were further amplified by steady rise in overall financial system leverage Higher system leverage not driven only by regulated players in mainstream banking sector, or even by hedge funds, but rather by functioning and levered funding of securitised markets Commercial banks subject to strict capital adequacy limits Hedge fund leverage has declined significantly since LTCM crisis 9 Securities Markets
Increase in financial system leverage Increase in overall system leverage depends partly on how loans are securitised but even moreso on how they are funded Banks securitise loan assets in order to gain operational leverage, thus increasing ROA etc If all ABS tranches are bought by pension funds and LT investors like insurance companies, etc then aggregate system leverage shouldn t necessarily rise When risks and cash flows are sliced and diced and CDOs or ABS are themselves securitised and then sold to leveraged buyers (investment bank prop desks or SIVs and similar conduits funded by short-term CP issuance), overall system or balance sheet leverage increases sharply 10 Securities Markets
(3) Funding and liquidity crisis Third aspect of the current crisis can be characterised as a run on securitised credit (ie. analogous to a classis bank run ) Many investors in securitised products were overly dependent on short-dated funding Short-dated funding took two basic forms: (a) SIVs and conduits issuing CP, often on strength of monoline support or liquidity backup lines from banks and (b) repo funding by hedge funds and investment banks investing in structured products Basic ingrediants for a run are: a negative credit shock, illiquid assets, lack of transparency on asset values, maturity transformation/alm mismatch and lack of a lender of last resort 11 Securities Markets
Increasing complexity of securitised credit model Traditional credit model Deposits Loans Securitised model of credit Multiple bank, investment bank, Hedge fund and SIV balance sheets Fund Investors - including mutual funds Carrying out maturity Tansformation Rescuritisations CDOs AAA Loan Originators AAA Credit Insurance (CDS) and CDS proprietary trading CDO 2 Source S Source: u FSA / Turner Report (March 2009) r c e 12 : Securities Markets
Problems to be addressed: in US and EMs Misaligned incentives: banks, non-bank mortgage g originators, investment banks, rating agencies Regulatory gaps: commercial vs investment banks, non-banks, hedge funds, derivative markets and intermediaries Over-reliance on rating agencies, difficulty in valuing highly complex structured/securitised products Relaxation of lending and underwriting standards in US mortgage market (and other consumer credit markets) attributable t bl in part to housing price boom, low interest rate environment and benign economic scenario 13 Securities Markets
Conclusions Significant benefits for EM issuers and investors Catalyst for development of local bond and capital markets Helps drive macro-economic growth and stability ie. by using onshore savings pools to provide LT funding for key growth sectors such as infrastructure, housing, banking and finance, etc Risk transfer, leveraging and liquidity mismatch risks must be monitored across the entire financial system and appropriate regulatory safeguards put in place 14 Securities Markets