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| Basel ii and Off-Balance-Sheet |
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What has Basel ii to do with
Off-Balance-Sheet
arrangements and structures?
Securitisation is another creative way to use Special Purpose
Entities and Off-Balance-Sheet structures. We can even avoid to
allocate capital for our risks. This is exactly what the Basel ii
framework tries to stop.
What is securitisation?
Banks group together assets or rights to future income streams
(mortgages, loans, credit card receivables, bonds, royalties,
leases etc) and convert them into bond-style securities, or other
debt market instruments. The transferred assets can be on-balance
sheet or off-balance sheet, using special purpose entities (SPEs).
The
Obligor
has an obligation to pay for products or services received.
For example, he has to pay for his mortgage.
The
Originator
is the bank that has given the loan to the obligor. This bank is
the owner of the assets and sells the receivables to a
special purpose entity (SPE).
The
SPE issues securities that provide the funds, to pay the
originator. It is a bankruptcy-remote entity (the creditors of the
originator can not make any claim against the assets sold to this
entity) so the
credit rating agencies
love it.
The
Servicer
is the entity that collects the cash flow from the obligors (the
originator is usually the same entity with the servicer).
There are also several other entities and persons involved, like
investment banks
(to structure, underwrite and market),
tax
and accounting advisers
(why
should we do all these things without any tax advantages?),
legal advisers
(lawyers are always involved in creative things that rely on sale
and purchase agreements and contracts) etc. etc. etc. ------------------------------------------------------------------------------------------------------------------ Reading the new Basel ii paper (Basel Committee on Banking Supervision, International Convergence of Capital Measurement and Capital Standards, A Revised Framework, June 2006) you will find some very interesting pages about securitisation. Page 25, Higher-risk categories "Securitisation tranches that are rated between BB+ and BB- will be risk weighted at 350% " (!) (Compare it with the Basel i risk weight of 100% ) Page 120 - "Banks must apply the securitisation framework for determining regulatory capital requirements on exposures arising from traditional and synthetic securitisations or similar structures that contain features common to both. " "Since securitisations may be structured in many different ways, the capital treatment of a securitisation exposure must be determined on the basis of its economic substance rather than its legal form" "Supervisors will look to the economic substance of a transaction to determine whether it should be subject to the securitisation framework for purposes of determining regulatory capital" 539. "A traditional securitisation is a structure where the cash flow from an underlying pool of exposures is used to service at least two different stratified risk positions or tranches reflecting different degrees of credit risk. Payments to the investors depend upon the performance of the specified underlying exposures, as opposed to being derived from an obligation of the entity originating those exposures. The stratified/tranched structures that characterise securitisations differ from ordinary senior/subordinated debt instruments in that junior securitisation tranches can absorb losses without interrupting contractual payments to more senior tranches, whereas subordination in a senior/subordinated debt structure is a matter of priority of rights to the proceeds of liquidation." 540. "A synthetic securitisation is a structure with at least two different stratified risk positions or tranches that reflect different degrees of credit risk where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of funded (e.g. credit-linked notes) or unfunded (e.g. credit default swaps) credit derivatives or guarantees that serve to hedge the credit risk of the portfolio. Accordingly, the investors’ potential risk is dependent upon the performance of the underlying pool. 541. Banks’ exposures to a securitisation are hereafter referred to as “securitisation exposures”. Securitisation exposures can include but are not restricted to the following: asset-backed securities, mortgage-backed securities, credit enhancements, liquidity facilities, interest rate or currency swaps, credit derivatives and tranched cover as described in paragraph 199. Reserve accounts, such as cash collateral accounts, recorded as an asset by the originating bank must also be treated as securitisation exposures. 542. Underlying instruments in the pool being securitised may include but are not restricted to the following: loans, commitments, asset-backed and mortgage-backed securities, corporate bonds, equity securities, and private equity investments. The underlying pool may include one or more exposures." Read, read, read the Basel ii paper, and do not say that it is boring!!! Let's have a look at another document: Basel Committee on Banking Supervision, Quantitative Impact Study 3, Technical Guidance, October 2002 (vi) Special purpose entity (SPE) "502. A special purpose entity (SPE) is a corporation, trust, or other entity organised for a specific purpose, the activities of which are limited to those appropriate to accomplish the purpose of the SPE, and the structure of which is intended to isolate the SPE from the credit risk of an originator or seller of credit exposures. SPEs are commonly used as financing vehicles in which credit exposures are sold to a trust or similar entity in exchange for cash or other assets funded by debt issued by the trust." (Recommended Reading: C. Operational criteria for the recognition of risk transference) Read, the other papers from the Basel committee (otherwise you will never understand the Basel ii framework), and do not say that these papers are also boring. You can not comply watching sports. Note The new "structured" world Structured financial markets. Structured financial products. Structured financial planning. Structured financial solutions. Structured financial analysts. Structured financial instruments. Structured financial vehicles. Even fund is becoming ... fund structure. Or, even better, sophisticated fund structure. Everything is becoming "structured". We need Basel iii (3). What exactly they structure? Regulatory capital raise the costs to banks, so it makes sense to consider it carefully before assuming an on-balance sheet or off-balance sheet position in a transaction. There are several creative structured finance transactions designed by banking organization with a single purpose in mind: To avoid regulatory capital The “synthetic” securitization ideas are becoming more and more unpredictable, and the ways to avoid to allocate regulatory capital become more complex and sophisticated. Unfortunately, Basel ii did not solve all the problems. The new ideas and "solutions" that experts develop in order to "help" banks avoid the Basel ii capital allocation, are definitely amazing. And very structured. |
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