Domestic Markets Spur Asia-Pacific Securitization

2001/01/11

While the nature of securitization activity in the Asia-Pacific region varies greatly across its different markets, two common elements that have emerged over the past year are the growing importance of domestic issuance and local investors in shaping market development. This is happening both in established markets like Japan and Australasia, as well as emerging ones in Hong Kong, Korea, and Singapore.

Furthermore, domestic market execution is the likely route issuers will take in other countries that are contemplating future securitizations, including China, India, Indonesia, Malaysia, the Philippines, and Thailand. With the exception of Australasia, this trend represents a major shift away from cross-border issues sold to European and U.S. investors.

While these recent developments will greatly impact the pace and direction of future market development, it is difficult to generalize about the way it will play out in each country. Some global market participants lament the growth of the domestic markets and the decline of cross-border issuance from the region, excluding Australasia and Japan, particularly if the transactions do not meet global standards for credit quality and structuring. On the other hand, the lessons from the Asian financial crisis suggest that the gradual development of a robust domestic securitization infrastructure may be an important first step in creating a global securitization capability of sufficient depth and resiliency that can withstand the next economic downturn.

Japan Makes a Dramatic Shift
The trend toward domestic execution is most evident in Japan, where virtually all public issues of asset-backed securities (ABS), residential mortgage-backed securities (RMBS), and commercial mortgage-backed securities (CMBS) that Standard & Poor's rated during first-quarter 2000 were Japanese yen-denominated and marketed exclusively in Japan or ultimately sold to Japanese investors. Since 1994, when Japan's ABS market started, until 1999, the majority of public issues were swapped into U.S. dollars and sold abroad. Several factors account for this shift, including local investors' growing familiarity with structured securities and strong demand for higher-yielding investments, given Japan's low interest rate environment.

Furthermore, Japanese investors are more willing today to buy pass-through securities. Previously, they would only buy bonds with bullet maturities, which are more costly for issuers to structure. It is also noteworthy that domestic investors are readily buying newer asset classes that were introduced only recently, including RMBS and CMBS.

From an issuer's standpoint, transaction economics favor domestic execution as pricing spreads have narrowed relative to those available in the cross-border market. Furthermore, domestic issues do not require currency swaps and-from legal, regulatory, and taxation standpoints-they allow for less complicated structures.

Australian Domestic Market Broadens
As both its domestic and cross-border investor markets broaden, Australasian securitization activity will move closer to its full potential. Unlike the rest of the region, the predominant trend in Australia over the past several years has been increased issuance in the European and U.S. markets. However, this activity is limited primarily to the largest and most frequent RMBS issuers, including Westpac Banking Corp., Macquarie Bank's Puma Finance Ltd. vehicle, Australian Mortgage Securities Ltd., and RAMS Mortgage Corp. Ltd.. Offshore issuance is driven by the local market's limited ability to absorb large issues. In addition, offshore issues typically provide more attractive pricing, which results from the strong track record of Australian RMBS and offshore investors' greater interest in and familiarity with the product.

Perhaps a more significant trend relating to this market's longer-term growth prospects is the continued broadening of the local investor base and the expansion of its risk appetite. Over the past few years, institutional investors have demonstrated greater interest in structured products other than highly rated, 100% mortgage-insured RMBS. Investors are now keen to buy newer asset classes, such as ABS, CMBS, and nonconventional residential mortgages, as well as mezzanine and subordinated debt tranches that previously remained on issuers' balance sheets. Multiseller asset-backed commercial paper and medium-term note programs, which have proliferated, represent a large component of Australia's primary and secondary markets for rated term securitizations.

Aftermath of Financial Crisis Energizes Domestic Markets
The 1997 financial crisis effectively shut down what was an active and potentially huge cross-border securitization market, particularly in Hong Kong, Thailand, and Indonesia. Today, the outlook for Asian cross-border issuance appears highly uncertain. On the other hand, domestic markets are actively pursuing structured financings, with new securitization-related legislation, plentiful liquidity in certain sectors, and strong local demand for higher-yielding securities of good credit quality.

The crisis rendered cross-border issuance impossible or too expensive as investors pulled back due to concerns about deteriorating credit quality and increased event risk. Financial guarantors and interest rate and currency swap counterparties, who had played critical intermediary roles that supported this market, also pulled out or became prohibitively expensive. Standard & Poor's downgraded two Hong Kong commercial real estate securitizations due to declining debt service coverage. Problems with the SITCARS Funding Ltd. automobile loan-backed deal in Thailand highlighted the unanticipated risk of regulatory interference and the pitfalls of servicer transitions.

As the impact of the financial crisis has waned, the economics of cross-border issuance remain unattractive for most issuers. Nevertheless, domestic liquidity is abundant in many of these countries. Banks resumed lending to the real estate and finance company sectors, while institutional investors and fund managers became attracted to structured securities because of their high yields and well-regarded credit quality. New securitization-related regulations and legislation have facilitated domestic issuance activity in Singapore and Korea.

While some of the recent transactions in Singapore and Korea are not true securitizations by global standards and were not rated by international agencies, they represent a positive initial step in the development of the regional debt capital markets. They provide a testing ground for the development of structuring techniques best suited to the local markets. They also afford an experience base for the development of critical operational capabilities, such as performance data collection, investor reporting, and loan servicing, all of which can help facilitate the eventual globalization of these markets.