Global Structured Finance Market
 The structured finance business is spreading across the globe and the market expects to see numerous developments and innovations. Countries throughout the world are easing the way for securitization, usually by encouraging home ownership, which they hope will lead to the development of a residential mortgage-backed securities (RMBS) market. Following that, oth! er consumer assets, such as credit cards and auto loans, are generally securitized. Indicating growing sophistication among issuers and investors, commercial mortgage-backed securities (CMBS) and other, more complex instruments, including credit derivatives and credit default swaps, are embraced. Throughout the cycle, the market broadens and deepens, becoming more and more global.

It is possible to consider the changes taking place in each of the three market segments—RMBS, CMBS, and asset-backed securities (ABS)—only in general terms. Given the vast differences among the various countries involved in the markets, it is simpler to discuss the specifics of individual ones that have already participated in securitization, or those that are expected to increase their activities soon. Regardless of each nation’s experiences, structured finance technology is traveling around the world. 
RMBS, CMBS Markets Experience Pockets of Growth

The RMBS sector is the longest-standing segment of the structured finance market, but unlike the ABS market, it is still very much a regional one. It has taken hold firmly in the U.S., Canada, the U.K., and Australia, but other countries, despite having developed residential mortgage lending businesses, are not necessarily ready to securitize their assets. Some countries in which lending institutions are sufficiently capitalized prefer to hold the loans on their books. Where the move to securitization is imminent, issuers say they are trying to maximize shareholder value.

After years of speculation about when the CMBS market would gain a foothold outside the U.S., it finally seems to be making substantial gains on the international front. International CMBS issuance is expected to rise to as much as US$15 billion in 2000. Although this amount is far less than the US$55 billion that is expected to be issued at the same time in the U.S., it is still a respectable figure. Moreover, it marks a trend toward growth. The rise to US$15 billion would be a 70% increase over 1999’s level of US$9 billion. This is even more dramatic when considering 1998’s level of issuance of only US$628 million. The international scene has been dominated by a few familiar issuer names, notably Morgan Stanley Dean Witter, which issued more than US$3 billion outside the U.S. in 1999, or about one-third of total international issuance, but new issuers will likely be encroaching on the international scene fairly soon.

However, the CMBS market, like the RMBS market, shows pockets of growth, rather than broad-based trends. Because each domestic situation is unique, it is difficult to generalize about different countries. Nevertheless, it’s clear that CMBS issuance is gaining ground in certain European countries, as well as Japan and Australia.

Although international CMBS players may lag behind the U.S. in experience, they are able to borrow from the new technologies and know-how that have been developed in the U.S. and apply them to their own markets. In fact, structures can range from long-term, fully amortizing transactions in the U.K., to shorter-term, bullet refinance deals in France, Japan, or Australia, or to the credit default swap ones now being structured in Germany. 
ABS and Credit Derivatives Attain Broadest International Reach

Despite the growing visibility of RMBS and CMBS, the segments of the structured finance business that have attained the broadest international reach are ABS and credit derivatives and related instruments. The ABS market continues to grow and diversify on a global basis, and derivatives are boosting that effort.

As the U.S. moves toward more niche assets, European issuers are discovering traditional consumer receivables. Activity in the Asia-Pacific region continues to be centered around Japan and Australia, although some emerging economies within the region could make headway within the next several years. Asset-backed commercial paper (ABCP) is also grabbing its share of attention. In Latin America, future flow transactions continue to be the bread and butter of the cross-border structured finance market, but domestic securitization markets are emerging in Argentina, Mexico, and Brazil. 
Hybrid Transactions Achieve Increased Visibility

Globally, the most notable trend may be the development of hybrid transactions—those that share attributes of corporate and public finance deals, as well as securitizations. “This melding of technologies is both a European and an American phenomenon,” said Patrice Jordan, Standard & Poor’s managing director of global asset-backed securities.

For instance, Formula 1 Finance B.V., backed by certain assets of auto racing’s Formula One Championship, was rated using an approach that involved both corporate and structured finance techniques. Essentially, Formula One Administration Ltd. securitized the revenues from its entire business operations, including television and promotional contracts, merchandising, and licensing. Unlike traditional ABS transactions, the cash flow comes from income generated by intellectual property assets, such as trademarks, copyrights, goodwill, and business contracts. Television and promotional contracts, in particular those with the race tracks that sponsor the events, account for a large portion of Formula One’s business.

In a typical securitization, the assets are legally separated from the originator. However, this transaction was based on an operating business that necessitates day-to-day management. This required Standard & Poor’s to assess the underlying business risks along with the financial risks, so that any significant improvement or deterioration in the business may lead to a rating change.

Transactions like Formula One work because, when properly structured, the differences between a traditional securitization involving an outright sale of assets and a properly structured secured loan are very small. This creates interesting opportunities to combine structured techniques with other forms of financing. Nevertheless, legal systems around the world are different and each one needs to be studied carefully when a hybrid transaction is being rated.
ABCP Broadens Asset Purchases

Although hybrid securitizations are expected to attract increasing interest in 2000, the segment of the ABS business with the largest volume is ABCP, which grew by 36% to US$520 billion outstanding in the U.S. alone in 1999. Growth this year is expected to continue at double-digit rates. As the market expands, commercial paper conduits are broadening the types of assets they purchase. No longer are trade receivables the mainstay.

Instead, the financial assets of financial institutions, particularly rated securities, account for about 57% of the market, compared to 28% for trade receivables. Securities including credit card ABS and collateralized loan obligations (CLOs) account for approximately 35% of the market; and mortgage-backed securities (MBS), particularly residential MBS, and auto loan and lease receivables each account for 11%.

“This unprecedented diversification of assets and sellers is having a big impact on the ABCP markets in the U.S. and Europe, and it is starting to spread to Australia,” Ms. Jordan said.

As ABCP issuance soars, issuers are exploring various innovative solutions to meet the growing demand for liquidity back-up facilities. The most recent innovation to mitigate the need for outside liquidity was the use of extendible notes as an alternative liquidity source. BancOne Capital Markets Inc. began issuing secured liquidity notes out of a newly formed entity, Lake Front Funding Co. LLC, in January. Lake Front will use the proceeds of the note issuance to provide liquidity back-up to two Bank One ABCP programs, Preferred Receivables Funding Corp. and Falcon Asset Securitization Corp.
CBOs/CLOs Are Fastest-Growing Segment of Structured Finance Market

Collateralized bond and loan obligations (CBOs and CLOs) are the fastest-growing portion of the structured finance market. Standard & Poor’s rated 105 CBO/CLO transactions in 1999, and the market appears to be moving full speed ahead in 2000, despite the issuance of increasingly complicated structures. Not only have the types of acceptable CBO collateral nearly doubled over the past year, the market is also seeing CBOs composed of ABS, CMBS, and project finance loans, as well as CBOs of CBOs.

One of the most innovative transactions Standard & Poor’s rated last year was Fortress CBO Investments I Ltd., comprising US$473 million of floating- and fixed-rate notes. The collateral was divided roughly in half between CMBS and unsecured debt issued by real estate investment trusts (REITs). Another example from February 2000 is Mozart Funding 1 Ltd., a CLO of ABS sponsored by Bank Austria AG that totaled £650 million (US$102.63 million) of floating-rate notes.

“The supply of ABS continues to grow and these new structures will provide significant new demand for the subordinated and mezzanine pieces of ABS,” said Richard Gugliada, managing director and head of Standard & Poor’s new assets and CBO/CLO group. “This will have a considerable impact on the ABS market as a whole and it could open up a large new investor base for subordinated ABS tranches.”

The majority of 1999’s CBOs were traditional arbitrage structures. Mr. Gugliada predicted a refocusing of this segment of the market in 2000, as tiering continues among portfolio managers. ”One crucial element of the CBO formula has been undervalued—management,” he explained. “Now, investors are paying more attention to management because they realize the manager has significant influence over a transaction’s performance.”

CLOs will continue to be important in certain economies, such as recovering Asian markets. Howe! ver, collateralized debt obligations (CDOs), which are essentially synthetic CLOs, are moving to the forefront in Europe.

European banks are tightly regulated, with nondisclosure rules and sensitivity regarding customer relationships, all of which make them less likely to embrace CLOs. “A CDO is simpler and more efficient for highly rated institutions because there is no true sale of the loans,” Mr. Gugliada explained.

Market value CDOs are also seeing increasing vigor. Securitized assets include mutual fund fees, brokerage margin accounts, and residential mortgages, in addition to high yield bonds, leveraged bank loans, equities, and distressed assets. “In a market value structure, because the reliance is on the assets’ market values rather than their cash flows, it is possible to securitize any type of asset that is marketable or tradable,” said Soody Nelson, a director in the market value group.

The phenomenal growth of the global CBO/CLO segment has led, in turn, to growth in the credit derivatives business. “This has been a tremendous boom for the credit derivative markets because of the demand from CBOs,” Mr. Gugliada said. “ABS, corporate loans, and credit derivatives–all of these markets are expanding. And they are being symbiotically pulled together by CBOs.”
Credit Derivatives Gain Market Acceptance

Not only is there growing market acceptance of credit derivatives, their applications in securitizations are also expanding. Many financial institutions are developing innovative structures by applying credit derivatives to a variety of asset types, such as emerging market debt, project financings, and small business loans.

“Not long ago, credit references were exclusively the obligations of corporations, financial institutions, and sovereign entities,” said Reza Bahar, managing director and head of Standard & Poor’s Structured Finance Ratings derivatives/specialized operating companies group. “We are now witnessing new applications of credit derivatives in securitization. We rated a very large transaction that used ABS as reference credits,” he continued. “Securitized assets are now acting as reference collateral in synthetic securitizations.”
Specialized Operating Companies Breed Innovations

Credit derivatives are also the focus of a new breed of derivative product companies (DPCs) called credit derivative companies (CDCs). “There is increased attention to structures that have the ability to engage in credit derivatives,” Mr. Bahar noted.

An innovative CDC structure was rated by Standard & Poor’s in December 1999. Bavaria Delaware Finance I LLC, administered by the New York branch of Bayerische Hypo- und Vereinsbank AG, is the first credit-enhanced operating company authorized to provide credit default swaps. In this respect, it is fundamentally different from other DPCs. It will enter into credit default swaps, total rate of return swaps, and reverse repurchase agreements. “Clearly, other sponsors are interested in pursuing similar structures,” Mr. Bahar said.

He continued, “There are greater applications for credit derivatives these days, hence the demand for credit derivative product companies. Bavaria combines elements of DPCs, structured investment vehicles (SIVs), and CBO/CLO structures. This is a true evolution in the area of specialized operating companies.”

Another type of specialized operating company that is expected to see future growth is the repo vehicle. Repo vehicles engage in repurchase and reverse repurchase transactions. Such vehicles sometimes specialize in providing investment agreements to municipalities and other market participants.

The growing sensitivity to counterparty ratings could inhibit the derivative activities of financial institutions that have low credit ratings. In particular, Mr. Bahar noted that credit-enhanced structures are viable instruments for accessing global capital markets. “Over time, some financial institutions—for example, Japanese institutions—could improve their access to the capital markets by sponsoring a credit-enhanced DPC,” he said.

Nevertheless, future growth in the number of DPCs and their practices is not likely. “Consolidations and improvements in credit quality in some regions make it unlikely that the number of vehicles will increase much,” Mr. Bahar noted. ”Nevertheless, the scope of their activities is constantly evolving.”

In February 2000, Standard & Poor’s rated Nomura Derivative Products Inc. (NDPI), a wholly owned subsidiary of Nomura Holding America Inc. NDPI, with an initial capitalization of US$100 million, will intermediate a wide variety of derivative transactions between its affiliate, Nomura Global Financial Products Inc., and third-party counterparties. After entering into a transaction with a third party, NDPI will simultaneously enter into an offsetting transaction with Nomura Global Financial Products, thus eliminating NDPI’s exposure to market risk.
Structured Investment Vehicles Expand Investment Activities

The explosive growth of the ABS market bodes well for structured investment vehicles (SIVs). “The growth of SIVs depends on the growth of the ABS market,” said Fiona Gregan, a director in the derivatives/specialized operating companies group. “The next five years will see significant changes in the scope and function of SIVs.”

Five Finance Corp., a Cayman Islands corporation rated by Standard & Poor’s in December 1999, is the fifth SIV created and managed by Citibank N.A. It issues commercial paper and medium term notes. However, Five Finance differs from the previous four entities principally in that it may purchase loans and noninvestment grade assets as eligible investments.

“As new structures are established and existing ones restructure to expand their investment opportunities, the use of credit derivatives in managing risk or enhancing yield is expected to grow,” Mr. Bahar said. 
U.S. RMBS to Remain Healthy Through 2000

The U.S. is the world’s largest and most developed RMBS market. Although it is expected to remain healthy throughout 2000, Standard & Poor’s anticipates that the total U.S. origination level will fail to reach the US$1 trillion mark for the first time since 1997. Factors that will influence this moderate decline include the anticipated steady rise of the 30-year fixed mortgage rate, which ratcheted up 122 basis points (bps) in 1999, and the resultant drop in refinancings, which are expected to remain a mere 25% of aggregate volume throughout 2000.

The maximum conforming balance for government-sponsored enterprises (GSEs) increased by 5.29% for 2000, to US$252,700, the third consecutive annual increase of 5% or more. As a result, the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corp. (FHLMC) are expected to encroach further on prime jumbo securitizations in 2000. Many subprime mortgage lenders may be forced to re-examine their lending activities if proposed legislation intended to regulate subprime mortgages of low credit quality is adopted. In response to these perceived pressures, Standard & Poor’s will pay special attention in 2000 to underwriting guidelines, which may become more lenient as banks seek to attract business.

Technological innovations, such as electronic loan signatures and business-to-business online financing, are poised to make the securitization process faster and more efficient in the U.S. Most Web-based solutions for originating, pricing, and selling or securitizing residential mortgages have been introduced recently; for this reason, 2000 may be the year those issuers begin to feel the pressure to acquire a strong sense for technological innovation. 
U.S. CMBS Market Is Influenced by Investor Behavior

The U.S. CMBS market is expected to be influenced strongly by investor behavior in 2000, resulting in more focus on liquidity, less focus on the real estate characteristics of any specific loan, and less tolerance for story pools. Investors are gravitating toward well-diversified pools containing the four basic types of real estate assets: multifamily, retail, office, and industrial. Transactions with large hotel concentrations, nursing homes, cold storage facilities, and other assets that were viewed as operating businesses rather than real estate properties will not be as popular in 2000 as they had been previously.

The investor population for ‘AAA’ rated CMBS is dividing, as traditional buy-and-hold investors compete for product with relative value buyers, who are acquiring CMBS instead of consumer assets, such as RMBS and credit card ABS. Standard & Poor’s believes that investors will begin to make themselves felt in the ‘AA’ and ‘A’ rated classes, as well. There is even an active group of B-piece investors that is increasingly influencing the composition of CMBS pools by successfully excluding loans that they believe heighten the potential for losses to junior certificates. 
U.S. ABS Market Turns to Innovative Assets

In the ABS sector of the U.S. market, the focus is on the most innovative asset and structure types—ABCP, CBOs/CLOs, and niche assets—because there has been growth in volume and diversification in the types of assets that are being funded, Ms. Jordan said. Within the new assets market, up-and-coming segments include life insurance and other insurance-related products, and viatical and senior settlements.

Municipal securitizations, such as the Westchester Tobacco Asset Securitization Corp., which sold US$103.352 million of tobacco settlement asset-backed bonds in December 1999, are also an area of interest. Other notable sectors include the securitization of revenues from utilities; telecommunications, including cable television fees and wireless time; and the Internet, such as Internet service providers, according to Ellen Welsher, director of Standard & Poor’s new assets group. 
Europe Focuses on Basics in RMBS, ABS

As the U.S. turns toward more niche assets, Western Europe is focusing on the basics—namely, consumer assets such as residential mortgages and unsecured consumer loans. By the middle of the first quarter 2000, Standard & Poor’s anticipated that it would rate double the number of RMBS transactions it rated in all of 1999, with pending offerings from the U.K., the Netherlands, and France.

“Europe is going to continue to grow rapidly and it will probably have another record year,” Ms. Jordan said. “We will see the broader use of securitization as more traditional assets are securitized as a portion of total volume.”

The popularity of traditional asset classes will allow the market to gauge the coming of age of the European securitization business, according to Kurt Sampson, managing director and head of Standard & Poor’s Structured Finance Ratings group in Europe. “Financial institutions in Europe have a tremendous amount of financial assets on their balance sheets and these assets are perfect candidates for securitization,” he said. “If European banks decide to remove these assets from their balance sheets, the opportunity for securitization could be tremendous.”

By creating a formidable investor base, the introduction of the euro has been an important factor in the development of the European securitiza! tion market. Swapping transactions into multiple currencies to satisfy the demands of different investors introduced costs and complexity that, at times, made transactions uneconomical. The euro-centered investor base has created a market that rivals the U.S. market, Mr. Sampson said.

Europeans are also molding existing securitization techniques to fit specific purposes, building on the success of the German mortgage bonds known as Pfandbriefe. ”Pfandbriefe technology is being exported to other European countries to allow for the large volume issuance of a mix of commercial and residential properties,” Ms. Jordan said. 
European RMBS Poised for Boom

Economically, Europe seems poised for a boom in the next decade, and Standard & Poor’s expects significant RMBS growth throughout most of the region. It should be noted, however, that the prospects and motivations for RMBS within each European country remain diverse. High housing prices and low rates in the U.K. and the Netherlands should propel impressive growth in their respective markets, but the situation will be less dramatic in less vital economies.

The RMBS market is expected to be robust in the U.K., where securitization volume, fueled by housing prices that rose by 13% last year and a resultant surge of refinancing activity, is expected to double in 2000. The securitization process is now well understood by U.K. banks that are looking to diversify their funding sources. Moreover, innovative mortgage products, such as the country’s new flexible mortgages, continue to foster create a favorable borrowing climate. Most flexible mortgages allow the borrower to make overpayments and pay interest only on that portion of the unpaid principal balance.

The biggest news in France is the government’s adoption of obligations foncières, its version of German Pfandbriefe, which should bring welcome security to France’s gradually expanding RMBS market. Standard & Poor’s expects France’s aggregate issuance volume to exceed US$8 billion in 2000. Because traditional mortgage lenders are not looking to securitize, most activity will be generated by specialized mortgage lenders that have clearly targeted securitization as a strategic refinancing source. The French market should also see its first subprime transaction in 2000.

A major new market development in Germany is the use of residential mortgages for credit default swaps, which entitle banks that use them to receive regulatory and monetary relief. Standard & Poor’s expects to see more growth in similar structures that combine funding and capital relief objectives.

The RMBS market is not particularly active in Italy, where roughly one-third of all homes are rental properties. The rate of new home construction is stagnant, due in large part to a sharp drop in the number of new families and the lack of purchasing power those families enjoy. As a result, Italy’s most commonly securitized asset in 2000 will probably remain nonperforming collateral.

New uses for RMBS should greatly increase Spain’s securitization volume which, in 1999, represented only 1% of all residential mortgages originated in that country. A decision by the Bank of Spain to accept ‘AAA’ rated Spanish mortgage-backed bonds as collateral for liquidity borrowing has jump-started its securitization market. Mortgage loans usually have fixed rates and low loan-to-value (LTV) ratios, and most residential properties are owner-occupied. Banks may also use RMBS as collateral in repurchase agreements. 
Dramatic Increases Expected in European CMBS Issuance

As with RMBS and ABS, the adoption of a common currency, along with the convergence of several other elements, jump-started the European CMBS market. The euro eliminated the need in structured deals for currency hedging among European nations. A pan-European CMBS transaction encompassing multiple currencies and interest rates would have been almost insurmountably complex and expensive before a common currency was introduced.

The biggest players outside the U.S. will come from Europe, which is poised to have a banner year in CMBS issuance, with transactions expected to originate in the U.K., Germany, Italy, France, and Sweden, and possibly Austria, the Netherlands, and Spain. In 2000, Standard & Poor’s expects to rate some 12-20 CMBS transactions, compared to the nine it rated in Europe in 1999. Perhaps more important, the first pan-European deals are expected to be initiated this year, which will mark a major milestone in the market, said Clay Hunt, director of international CMBS in Standard & Poor’s Structured Finance Ratings group.

Another factor spurring interest in European CMBS is less tangible: European banks are collectively developing a sound credit culture and the supervisory practices necessary to support a new global financial architecture. At the forefront of this campaign is the Basel Accord, which is spearheading the banking reforms, notably stricter and more evenly applied capital adequacy requirements which, in turn, will make it much more expensive for banks in several countries to hold loans on their balance sheets. Therefore, securitization is becoming a more appealing option than it has ever been before.

In short, European bankers are beginning to see profitability in a different way, Mr. Hunt said. “The old rules said that you were successful if you were big. Instead, bankers are now looking for greater return-on-equity and shareholder value,” he commented.

These reforms will affect German banks more than those in any other European country because they will force them to change their less-stringent capital reserve requirements, which now give them a competitive advantage in pricing loans and holding them on their books. Furthermore, Landesbanks, the state-owned German banks required to lend on property by law, enjoy ‘AAA’ ratings because they are state supported. This gives them a funding advantage that has been challenged recently by the European Banking Federation to the European Union. 
Term Securitizations, ABCP Dominate Canadian Landscape

The Canadian arena is divided into ABCP, RMBS government agency issues, and term securitizations. ABCP comprises a large part of the Canadian structured finance market, but term securitizations continue to grow, as net government issuance shrinks and capacity is diverted to the ABS sector.

ABCP retains its inherent executional advantages over term issues and, despite increases in absolute market size, outstandings are expected to maintain a moderate growth rate through 2000. Throughout 1999, ABCP outstandings grew to about C$52 billion (US$35.9 billion), a 20% increase over the previous year. Many new asset types in Canada continue to be securitized through ABCP, with significant new CLO activity recently noted.

The Canadian term market tailed off slightly in 1999 from 1998, with new issuance down to about C$5.5 billion (US$3.8 billion). However, signs point to stronger prospects during the next year.

New securities regulations, including the use of shelf prospectuses, will greatly ease the public distribution of public ABS; this will likely happen by late 2000. In addition, a Canadian version of FAS 125 should allow more transactions to achieve off-balance sheet treatment, and realize Canadian capital tax relief. This is likely in early 2001.

The trend toward the demutualization of life insurance companies should induce these institutions to securitize more assets. Commercial mortgages are most likely to increase, and a number of CMBS issues could further develop this market during the next year.

Another factor leading to the development of Canada’s term securitization market is the growing level of investor sophistication caused by the new asset classes that are coming to market. Term auto loans and leases will re-emerge in Canada, with a number of auto deals likely coming to market. In addition, CBOs/CLOs may materialize in the term market in 2000.

Large bank-originated personal credit line (PCL) deals currently dominate issuance, with approximately C$3 billion (US$2.06 billion) in PCL ABS volume expected during the first half 2000. Issuance of PCLs could ultimately be greater than that of credit cards. In Canada, these assets are typically prime, revolving (no amortization schedule), and secured, and they frequently have large credit lines that are structured similarly to credit card master trusts. With excellent historical loss and delinquency rates—as low as 1.3 bps per year and seven bps over 90 days—and reasonable monthly payment rates of 6%-10%, these assets can achieve ‘AAA’ credit enhancement levels of about 5%.

Agency issuance in the RMBS market has been relatively dormant during the last few years as restrictions limited issues to simple pass-through structures. Contemplated changes would facilitate agency issuance of semiannual pay bullet maturity notes. If the changes dovetailed with investor needs, agency RMBS could see material growth and, hence, could comprise a larger portion of the term market..

One of the factors that will drive Canadian RMBS is the growing awareness of the impact of securitizations on shareholder value. Currently, many Canadian banks are looking to securitize mortgages in order to achieve greater return on equity and to improve their competitiveness in relation to other global lenders. The banks are also enthused by a recent study by Canada’s Mortgage and Housing Corp., which indicates that demand for housing will continue to grow steadily through 2016.

Despite this optimism, however, only 15% of the C$380 billion (US$262.22 billion) Canadian mortgage market has been securitized because banks realize that releasing residential mortgages from their balance sheets is not necessarily the most efficient way to achieve this goal. There are greater incentives to release commercial mortgages, auto loans, and credit card debt from their balance sheets. Until the Canadian market develops further depth by attracting new investors, the market’s ability to absorb large RMBS issues will be constrained, and banks will likely focus on securitizing other assets. 
Latin America Cultivates ABS, RMBS

There are two important trends taking place throughout Latin America: The introduction of third-party involvement for risk mitigation in cross-border issues, and the development of domestic securitization markets. Latin America is likely to see transactions by new issuers in 2000, while various investment banks will continue to provide their expertise in order to improve the quality of the transaction.

Nevertheless, there are still hurdles to be overcome. Many major markets lack adequate information about loan performance and property values, and lenders have shown a reluctance to provide relevant information about borrowers.

The Overseas Private Investment Corp. (OPIC) has already provided political risk insurance to emerging market issuers of corporate debt, and it is expected to do so for RMBS, ABS, and future flow issuers this year. Additional providers include the World Bank’s Multilateral Investment Guarantee Agency (MIGA) and the Inter-American Development Bank (IADB).

By limiting the risk associated with a sovereign’s interference with the transfer or convertibility of debt service payments, political risk insurance may enable a borrower to issue debt that is rated higher than its sovereign’s foreign currency debt and, in some cases, as high as the borrower’s local currency rating. The insurance is particularly useful to borrowers of foreign currency in noninvestment grade-rated countries that, nevertheless, have investment grade-rated local currency debt.

In Argentina, the prevailing type of securitization is that of existing assets, such as residential mortgages, making it the premier Latin American market for securitization, according to Diane Audino, a director in Standard & Poor’s Structured Finance Ratings Latin America group in New York. Argentina remains committed to the economic reforms that drew investors in the 1990s. Its legal and regulatory environments, coupled with the existing potential for ABS transactions, suggest that Argentina will continue to grow.

For example, the potential for the securitization of residential mortgages in Argentina is significant; the 10 largest private financial institutions still retain approximately US$9.037 billion in potentially securitizable assets.

However, there are challenges. Banks may be unwilling to share information about their customers with other banks. Also, because the concept of an independent trustee in Argentina is still developing, it can be difficult to find impartial third parties to represent investors.

The move to make Latin American issues more attractive to overseas investors comes at a time when Mexico and Brazil are developing their domestic securitization markets. Both countries have taken steps to encourage home ownership, as well as to develop a secondary mortgage market. ”It looks like this could be Mexico’s year,” Ms. Jordan said.

In March 1999, one of Mexico’s governmental housing agencies, Financiamiento Bancario de la Vivienda (FOVI), received a loan from the World Bank to promote residential mortgage securitizations. As part of the development process, in August 1999, FOVI launched a new type of mortgage denominated in inflation-adjusted pesos. This new product makes it easier to securitize future mortgage portfolios by allowing for higher interest rates, thus increasing the transaction’s economic feasibility.

Despite these efforts, Mexico has a great need for residential mortgage financing, and for the proper financial and legal conditions in which to securitize loans. Although many state regulations have been adapted to foster securitization, mortgage terms make securitization difficult. Moreover, Mexico’s legal system still lacks a framework for efficient foreclosures.

As in Mexico, the RMBS market in Brazil has not managed to develop extensively because there is not a high volume of suitable assets to securitize. However, Standard & Poor’s believes that there is hope for an active Brazilian RMBS market due to several key legal and regulatory changes. Mortgage foreclosures or auctions are now allowed, and banks may now transfer assets to newly created bankruptcy-remote, special-purpose entities (SPEs). Relatively new legislation has also fostered the granting of loans by speeding up foreclosure proceedings. After memories fade of the financial turbulence created by the January 1999 devaluation of the Brazilian real, this legislation will encourage banks to originate mortgage loans with the intention of securitizing them in the next few years. 
Australia and Japan Dominate Asia-Pacific Securitizations

Standard & Poor’s is seeing the diversification of issuers in the Asia-Pacific region. In Australia, the majority of the activity is concentrated in the RMBS sector; however, there is a growing trend toward diversification of asset types. In Japan, consumer assets are the ones most often securitized, but commercial assets and commercial real estate are also important.

Elsewhere in the region, South Korea’s market is picking up steam, and countries such as the Philippines, Thailand, China, and India are taking steps to encourage home ownership. RMBS markets are expected to develop there over the next several years. Standard & Poor’s also anticipates the establishment of RMBS markets in China, Taiwan, and Malaysia.

“We are seeing the diversification of both asset types and issuers in Asia,” Ms. Jordan said.

As in Europe, the common currency has also helped boost Australian issuance. Australians have found better pricing by using the euro markets with greater frequency and in larger volumes.

There are additional signs that the Australian structured finance market is reaching a new level of sophistication. It has a burgeoning CMBS market, and it is increasingly using credit derivatives to help investors diversify risk.

In 1999, Standard & Poor’s assigned ratings to the first Australian subprime RMBS transaction carrying only top-cover mortgage insurance on some of the loans, as well as the country’s first high LTV deal carrying no mortgage insurance. Commonwealth Bank of Australia’s Series 1999-1 Medallion Credit Linked Trust, a CLO, was the first Australian offering to use credit-linked note technology. This method, which had been employed successfully in Europe, used a swap to transfer corporate loan credit risk to investors.

In Japan, there has been renewed interest in securitizing residential mortgages. Many insurance and nonbank finance companies are looking to RMBS as a possible exit strategy from the mortgage lending business, while the major banks, especially trust banks, seek direct securitization experience. Government Housing Loan Corp. (GHLC), a quasigovernmental organization that owns nearly 40% of the residential mortgage market in Japan, has been preparing RMBS for the past year. Additionally, relevant laws are expected to be revised to allow GHLC to securitize its newly originated mortgages.

RMBS activity in Hong Kong may pick up in 2000. It has been slow since the mid-1990s, when the rapid development of securitizations stemmed from high property values and regulatory guidelines that restricted banks’ property exposure to 40%—a provision that has since been lifted. The country has an existing population of experienced lawyers, bankers, and investors who are familiar with the securitization process. In addition, the prevailing values of home ownership, prudent savings, and aversion to bankruptcy have kept delinquencies of 90 days or more at a staggeringly low 1.2%.

Origination volume is set to rise as consumer confidence in home ownership improves, falling home prices stabilize, and mortgage lenders compete fiercely for customers. Standard & Poor’s has also seen the inclusion of loans with LTV ratios of up to 85% in unrated securitizations that were made possible by the inclusion of mortgage insurance.

The Hong Kong and American currencies are linked so, for this reason, hikes in the American prime lending rate could threaten this optimism. However, greater awareness of the impact of these rate increases should further the popularity of fixed-rate mortgages, which are new to the country.

Standard & Poor’s has released RMBS criteria for the Singapore RMBS market, which is expanding more slowly than expected. Singapore’s banks are abundantly capitalized and, therefore, content to hold mortgages on their books. 
Asian CMBS Take Root

If the increase in European issuance of CMBS is driven by a newly competitive financial landscape, Japan, by comparison, faces a very different set of circumstances, stemming from the legacy of its bubble economy, and the banks with a large number of nonperforming loans already on their books. The situation can most easily be compared to the U.S. in the early 1990s, which was then suffering from the liquidity crisis that helped to jumpstart the domestic CMBS market.

“In Japan, there is very limited liquidity in the private debt markets,” Mr. Hunt said. “The banks are burdened by nonperforming loans, causing them to avoid making further loans. Banks looking to refinance borrowers cannot tie up their capital, hence they are forced to explore securitization through the capital markets.”

Standard & Poor’s expects to rate at least nine Japanese CMBS transactions in 2000. The country’s first nonperforming loan transaction, International Credit Recovery - Japan One Ltd., which closed in December 1999, is viewed as a sign of CMBS growth. It paved the way for future CMBS transactions in Japan in much the same way as the first Resolution Trust Corp. deals in the U.S. Still, the legal infrastructure for securitization is still developing in Japan, making large numbers of transactions difficult to predict.

In addition, Japan’s bond market is also in a nascent stage of development and, until the first deals closed last year, it was difficult to anticipate the appetite for these instruments among Japanese investors. However, investors seem to be appreciating the yields on these transactions, and all the properly structured deals found buyers, leading to this year’s anticipated results. “It is possible that investor demand may outstrip supply in 2000,” Mr. Hunt said.

In Australia, three CMBS transactions closed in 1999, generating strong interest in that market. Although Australia has creditor-friendly laws, the market is limited simply by its size. “There is not going to be an explosion of activity,” said Mr. Hunt. “But you can anticipate a steady growth of issuance.”

By Lisa Tibbitts, Doug French, and Bernice LandryCopyright 2000, Standard & Poor's Ratings Services

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