Transaction volumes continue to fall as product originators at investment banks struggle to create safer vanilla-type securitisation products to suit the market mood. The banksÆ corporate trust divisions û responsible for administering the trust accounts and reporting on transactions û meanwhile are also looking for other options.
There are traditionally two primary streams of business for the trust banks. One is the refinancing of existing transactions for which there tend to be competitive tenders. The second is the origination of new business; this means funding trades that continue to exist but are primarily only for higher credit quality originators.
ôWe expect 2008 to be a challenging year where CDO volumes are much reduced,ö says Rachel Hardee, head of Asia-Pacific structured credit, Fitch Ratings in Hong Kong. ôThere will be a return to more simple and less leveraged structures, instead of ones with multiple layers of complexity. We are less likely to see structured finance assets as the underlying collateral for CDOs.ö
Fitch Ratings recently updated its methodology for rating portfolios of corporate debt, which it says is designed to challenge existing CDO rating assumptions and address areas of underperformance.
Experts point to a dearth of market value-based securitisations while off-balance-sheet products, such as structured investment vehicles, have also disappeared from the scene.
ôUntil the collapse of the subprime market last year, we saw incredible inflationary pressures in the fixed-income and equity markets as the worldÆs aggregated wealth poured into financial markets looking for available investments,ö says William Ross, head of structured capital markets, Asia-Pacific at HSBC in Hong Kong. ôThe environment has changed as the financial services industry is now on a massive recapitalisation effort û it is all about finding stability and transparency to address risk concerns. Investors are looking for stability and, on the issuer side, banks are looking for capital; this is how the next generation of products will evolve.ö
One of the main challenges for the corporate trust business in the current environment is to find the next generation of products to solve issues on behalf of third-party clients and continue transactions. The banks are also working to address their own capital issues; then using synthetic securitisation to manage those risks.
ôThere is also a greater amount of due diligence required from the trustee banks, together with a higher degree of scrutiny in terms of the quality of the assets being packaged,ö says Gary Lew, head of global corporate trust for Asia-Pacific at Bank of New York Mellon in Hong Kong. ôInvestors are also going to be more diligent and want more transparency. So I think there is a higher level of care in terms of putting the deals together, making sure they are properly documented as well as providing for enhanced portfolio assessment services and reporting requirements.ö
Another challenge for the trustee banks is the current move to synthetic products via a credit default swap instead of on a cash basis, which effectively cuts the trustee bank out of the picture, as the banks start to undertake risk transfer or capital management exercises synthetically to cut costs.
The credit crunch has given banks a greater incentive to be more proactive in managing their loan risk. Corporate trust banks are also responsible for offloading loans. In the current environment, experts say there is an incentive for banks from a risk-weighted capital standpoint to sell the lower or mezzanine risk of their portfolio. New Basel II banking regulations û expected to come into effect in Asia in late 2008 or early 2009 û are also likely to incentivise banks to offload junior mezzanine risk in their portfolios to achieve greater capital efficiency.
Basel II regulations will also introduce an operating risk capital charge, which some bankers say could increase the profitability bar for trust banks, as they tend to be operationally intensive.
ôInvestment banks are waiting for the new issuance markets for securitisations to come back before they go out to raise new issues, and we are seeing some early signs of improvement,ö says Adrian Lui, head of structured credit products for Asia-Pacific at Citi. ôBanks in general should be looking to hedge their balance sheets and offload risks. They are also waiting for a pickup in new issuance in the CLO [collateralised loan obligation] market.ö
Asia's blessing
Asia, to some extent, remains buffered from the entire fallout; the market here is small for securitisation in comparison to the US and Europe. Higher quality credit originators in the region are still trying to fund trades through securitisation and deals continue to be fought for and won û Citi reportedly recently marketed two residential mortgage securitisations in Asia.
Global ratings agency MoodyÆs has warned it expects the prospects for global synthetic arbitrage CDOs rated in Asia to remain negative for the coming months. However, it says the performance of CLOs rated in Asia will remain stable. The majority of these CLOs have significant exposure to companies across Asia, it says, while no significant credit deterioration on the underlying exposure has been noted so far.
On the upside for the corporate trust business, some bankers point to an increasing trend for more local currency issuance in the securitisation markets. Local banks in Asia continue to be liquid and have also been less prone to the subprime write-downs, they say.
Ross at HSBC concludes: ôThe corporate trust banks need to align themselves with those investors who remain active or have the capacity to be active, to set the standards for the infrastructure that they require. Ultimately it is about coaxing the ability to invest out of different institutions and investors. The challenge for them is to engage directly with those investors to understand what they need.ö
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