East Asian Finance-Road to Robust Markets

1. East Asian Finance-Road to Robust Markets Asset Securitisation in East Asia Ismail Dalla Hong Kong June 22-23, 06 Views expressed in this presentation do not represent official views of the World Bank

2. Key Economic Indicators East Asia and Pacific (in %)

3. East Asian Savings(% of GDP)

4. Gross Domestic Investment(% of GDP)

5. East Asia Gross International Reserves (in US$ billion)

6. East Asian Financial Markets (2005) (US$ billions) Source: Dalla (2005), “ Deepening Capital Markets in East Asia”, Dec 2005, World Bank background paper for “East Asian Finance-Road to Robust Markets”, World Bank (2006).

7. Financial Sector Profile (Dec. 2005)

8. The Size of Debt Securities in 2005

9. Size of Domestic Bond Markets in Selected Countries Outstanding value as % of GDP, 2004 Source: Dalla(2005), Deepening Capital Markets in East Asia, Background Paper to “ East Asian Finance-road to robust markets”, World Bank (2006)

10. Size and Composition of East Asian Bond Market (Size Sept., 2005: US$ 1,659.5 billion) Source: ADB, Asia Bond Indicators

11. East Asia: Bond Market Composition (1995-Sept 2005)

12. East Asian Bond MarketsOutstanding Domestic Bonds (1998-2005)

13. Fixed Income Securities Market in USA Source: The Bond Market Association

14. Role of Asset-Backed Securities Markets in the Economy • Development of domestic bond markets • 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.

15. 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-Securitization Market in Selected East Asian Countries, Ismail Dalla, World Bank, May 2006.

16. 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.

17. 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. • 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.

18. 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.

19. Why invest in ABS? • Attractive yields ( a yield pick up of 30-70 basis points over treasury) • High Credit Quality • Diversification • Predictable cash flows • Reduce Event Risks.

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

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

22. Korea is the largest ABS market in East Asia (ex Japan)

23. 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.

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

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

26. 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.

27. 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 2002. • Lack of liquid market can create valuation problem for ABS and the calculation of capital adequacy (marked to market issue).

28. The Future of Asian Securitization

29. Banks Dominate in China

30. Prospects for ABS markets (2006-2010) • Rapid Growth : Malaysia, China China: Potential size : $300-500 billion assuming 10% securitization • Moderate growth: Hong Kong Korea, and Singapore • Emerging growth: Indonesia, Thailand, Philippines • ABF III Assets: RMBS: China, Indonesia, Thailand, Korea Non-Performing loans: China Infrastructures(Malaysia, Indonesia and Thailand Reits (Hong Kong, Singapore, Malaysia) Credit Cards: Thailand, China, Indonesia. Student loans: Korea, Malaysia

31. Thank you Ismail Dalla idalla@worldbank.org Asset Securitization Markets in Selected East Asian Countries East Asian Finance-Selected Issues, World Bank (2006)