HOME LOANSSECURITISATION

Prepared by KELVIN SIPEYIYE

SECURITISATION FUNDING AND THE SOUTH AFRICAN

BANK

By definition securitisation is simply the process of taking a group of assets ie cash producing assets and pooling them together and in the process transforming them into a security .The perfect and most common example of a security would be a Mortgage Based Security ,basically a collection of mortgages.Even though Securitisation has been around for a couple of years, its inception in South Africa only came about in 1989 ,the first securitisation transaction of a home loan.In 2001 ,the South Africa Reserve Bank ammended the regulations governing securitisation which in turn improved the certainity prospects for investors immediately.Commendably and notably as expected , the securitisation market started to grow.

Securitisation : An Intro

SECURITISATION:KEY PURPOSES

What is RMBS

What is the role of a Ratings Agency in an RMBS transactionIdentify the benefits for the SELLER and the INVESTOR in an RMBS transaction

KEY PURPOSE(S) OF SECURITISATION FUNDING FOR A SOUTH AFRICAN BANK

• ADDITIONAL SOURCE OF FUNDING FOR THE BANK • MANAGEMENT OF REGULATORY CAPITAL THAT A BANK

IS REQUIRED TO HOLD• MORTGAGES CAN BE ORIGINATED BY DIFFERENT

INSTITUTIONS• SECURITISATION MOSTLY INVOLVES MORTGAGES AND

THEY CAN BE EASILY DISPOSED THROUGH SELLING TO VARIOUS INVESTORS

RMBSWhat is it ?

Abbreviation for Residential Mortgage-Backed Security.It is basically cash

yields paid to investors emanating from cash payments by homeowners.Cash

flows from residential debt,in our case right now it will obviously be from

mortgages.Others examples could be home equity loans and subprime

mortgages .RMBS are governed largely by the interest and principal agreement

with lenders.

ROLE OF RATINGS AGENCY IN RMBS TRANSACTION OverviewRatings agencies assign ratings to any organization that issues debt instruments, including private corporations and all levels of government. Because investors need to know they are receiving adequate compensation for the risk they are taking by holding an investment, the ratings the agencies issue are essential to the financial industry.

The interest rate attached to a debt is inversely related to its level of risk. Therefore, since investors use the opinions of rating agencies as metrics for the level of risk attached to a debt instrument, credit ratings play a key role in the interest rates of different debt securities.

Moody’s ,Standard & Poor’s and Fitch Ratings are the big 3 rating agencies and by far the most commonly spoken about and trusted.Major role players in the subprime mortgage crisis between 2007 and 2008 in the USA.

Ratings Agencies Help Good Institutions Get Better RatesInstitutions with higher grade credit ratings are able to borrow money at more favorable interest rates. Accordingly, this rewards organizations that are responsible about managing their money and paying off their debt. In turn, they will be able to expand their business at a faster rate, which helps stimulate the economy’s expansion as well.

They Warn Investors of Risky CompaniesInvestors always want to know the level of risk associated with a company. This makes rating agencies very important, as many investors wish to be forewarned of particularly risky investments.

They Provide a Fair Risk-Return RatioNot all investors are opposed to buying risky debt securities. However, they want to know that they are going to be rewarded if they take on a high level of risk. For this reason, credit rating agencies will inform them of the risk levels for every debt instrument and help ensure that they are properly compensated for the level of risk they take on.

They Give Institutions an Incentive to ImproveA poor credit rating can be a wake-up call for institutions that have taken on too much debt or haven’t demonstrated that they are willing to be responsible about paying it back. These institutions are often in denial of their credit problems, and need to be alerted of any potential problems from an analyst before they make the necessary changes.

RMBS TRANSACTION

BENEFITS TO SELLER• GUARANTEED RETURNS• TANGIBLE COLLATERAL• THEY CAN SEE THEIR

MONIES WORTH

BENEFITS TO INVESTOR• EASY REPAYMENT PLAN• FLEXIBILITY• CREATES CASH

RESERVES

(2) SUB-PRIME CRISIS

• TIMELINE• CAUSE(S)• EFFECT• IMPACT ON THE ENDURING GLOBAL CREDIT CRISIS• 3 AMERICAN INVESTMENT BANKS(NON-EXISTANT)

AFFECTED BY THE SUB-PRIME CRISIS• COMMENTS ON THE CONTINUING EUROPEAN DEBT CRISIS

SUB-PRIME CRISIS:INTRODUCTION

• LOAN GIVEN TO PEOPLE WITH BAD CREDIT RATING AND ARE INELIGIBLE FOR A PRIME LOAN

• PRIME LOAN BEING THE NORMAL LOAN• SUB-PRIME IS DERIVED FROM SUBORDINATE TO PRIMARY• CHARACTERISTICS :I. HIGH INTEREST RATESII. POOR QUALITY COLLATERALIII. LESS FAVOURABLE TERMS (COMPENSATION FOR HIGHER CREDIT

RISK

SUB-PRIME CRISIS : TIMELINE

2000 - 2005• Very low Interest Rates• Property prices on a rising trend• Sub-prime borrowers were able to meet obligations by

selling the properties or getting the properties refinanced• Emergence of the ,´Housing Bubble’

SUB-PRIME CRISIS:TIMELINE cont’d

2006 – 2008• Sub-prime borrowers started failing to pay their debts• Securities held by mortgages lost value globally• Global investors drastically reduced purchases of

mortgage-backed debt and other securities

SUB-PRIME CRISIS: TIMELINE cont’d

2008 – 2009• Global recession hit the financial sector and the world• Global recession cost nearly 9 million jobs between 2008

and 2009,second only to the Great Depression of the 1920s

• Concerns about the volatility of US credit and financial markets led to tightening credit around the world

• Economic growth became to slow in the US and Europe

SUB-PRIME CRISIS : CAUSES• The American Dream , probably the main cause .Basically the American Dream was/is

to ,´own a house’ . Houses are expensive and hence people needed to borrow money to get them.

• Perfect conditions in early 2000 since mortgage interest rates were low and there was also lower monthly payments on borrowed money.

• Rising prices of homes also meant that lenders understood that homes make good collateral so they were willing to participate

• This process and situation built momentum that triggered the crisis• Low Interest Rates• Increase in loan incentives • Easy credit conditions

SUB-PRIME CRISIS : EFFECTS• Stock markets tanked. Crisis caused panic in the financial markets

and investors sold out and withdrew their money ,resulting in sharp drop in prices.

• Many banks,mortgage lenders and investment trusts suffered significant losses

• Credit got tighter because banks became extremely careful parting with their capital and decreased lending activities to both businesses and private households ,even to each other

• Job losses especially in the financial sector

SUB-PRIME CRISIS : RELATIONSHIP WITH THE ENDURING GLOBAL CREDIT CRISIS

• CAN ALSO BE TERMED THE GLOBAL FINANCIAL CRISIS• FIRST MAJOR SIGNS NOTABLE BETWEEN 2007 AND 2008• PROBABLY EXACERBATED BY THE SUB-PRIME CRISIS TOO• INTENSIFIED AROUND 2009• POSITIVE RELATIONSHIP BETWEEN SUB-PRIME CRISIS AND GLOBAL CREDIT

CRISIS• BECAUSE LENDERS HAD REDUCED LIQUIDITY ,REDUCING ABILITY TO MAKE

NEW LOANS OR REFINANCE EXISTING LOANS,CREDIT BECAME A CRISIS• OTHER SOURCES CLASSIFY SUB-PRIME CRISIS AS PART OF THE GLOBAL

CREDIT CRISIS,TERMED PHASE 1 OF THE GLOBAL CREDIT CRISIS

SUB-PRIME CRISIS : IMPACT ON AMERICAN INVESTMENT BANKS

LEHMAN BROTHERS• 4TH LARGEST INVESTMENT BANK IN THE USA BEFORE DECLARING BANKRUPTCY• RENDERED SERVICES IN INVESTMENT BANKING,RESEARCH,FIXED INCOME

SALES AND TRADEPRIVATE EQUITY,PRIVATE BANKING AND INVESTMENT MANAGEMENT

• HUGE STOCK LOSSES• FILED FOR BANKRUPTCY AFTER MASSIVE EXODUS OF CLIENTS (LARGEST IN US

HISTORY)• CREDIT RATINGS AGENCIES DEVALUED ALL THEIR ASSETS• NO BAILOUT BY FEDERAL GOVERNMENT

IMPACT ON AMERICAN INVESTMENT BANKS cont’d

MERRILL LYNCH • ANNOUNCED WRITE DOWN OF 8,4BILLION LOSSES LATE 2007• LOSSES ASSOCIATED WITH NATIONAL HOUSING CRISIS • REMOVED ITS CEO AT THAT TIME • MID 2008 : ANNOUNCED 4.9BILLION 4TH QUARTER LOSSES FROM BAD

INVESTMENTS AND DEFAULTS IN THE ONGOING MORTGAGE CRISIS• DECLINE IN STOCK PRICES• LOST ABOUT 52MILLION A DAY BETWEEN JULY 2007 AND JULY 2008• LATER ACQUIRED BY BANK OF AMERICA FOR 50BILLION

IMPACT ON AMERICAN INVESTMENT BANKS cont’d

BEAR STEARNS INVESTMENT BANK• SPECIALISED IN CAPITAL MARKETS,INVESTMENT BANKING AND

WEALTH MANAGEMENT• INVOLVEMENTS IN SECURITIZATION• ISSUES OF LARGE AMOUNTS OF ASSET BACKED SECURITIES • INVESTOR LOSSES INCREASED IN 2006 AND 2007• BANK COULD NOT BE SAVED EVEN BY THE FEDERAL RESERVE BANK

OF NEW YORK• LATER ACQUIRED BY JP MORGAN FOR 1,2BILLION

EUROPEAN DEBT CRISIS : COMMENTS

• ALSO KNOWN AS THE EUROZONE CRISIS• MULTI YEAR DEBT CRISIS IN THE EUROPEAN UNION THAT EVOLVED AROUND LATE 2009• MOST AFFECTED COUNTRY HAS BEEN GREECE• GREECE TOGETHER WITH PORTUGAL,SPAIN AND IRELAND HAVE ALL AT LEAST ONCE FAILED TO REPAY

THEIR GOVERNMENT DEBT OR TO BAIL OUT OVER INDEBTED BANKS WITHOUT THE ASSISTANCE OF OTHER EUROZONE COUNTRIES

• FISCAL POLICY CHOICES RELATED TO GVT REVENUES AND EXPENSES• PRIVATE DEBT EG PROPERTY BUBBLE• GLOBALISATION OF FINANCE• EASY CREDIT CONDITIONS (2002 – 2008)• FINANCIAL CRISIS(2007 – 2008)• INTERNATIONAL TRADE IMBALANCES• GREAT RECESSION (2008 – 2012)

BASEL : INTRO TO THE BASEL ACCORD

• AGREEMENTS SET BY THE BASEL COMMITTEE ON BANKING REGULATIONS AND SUPERVISION WITH REGARDS TO RISK –CAPITAL,OPERATIONAL,MARKET

• INTENTING TO ENSURE THE FINANCIAL INSTITUTIONS HAVE ENOUGH CAPITAL ON ACCOUNT TO MEET OBLIGATIONS AND UNEXPECTED LOSSES

BASEL : STRUCTURE

BASEL I

• INTRODUCED IN 1988• ALL ABOUT PROMOTING CAPITAL ADEQUACY AND

FINANCIAL INSTITUTIONS• CATEGORISES ASSETS OF A FINANCIAL INSTITUTION

INTO 5 RISK CATEGORIES ie 0%,10%,20%,50% &100%• BANKS OPERATING INTERNATIONALLY ARE REQUIRED

A RISK WEIGHT OF 8% OR LESS

BASEL II

• FIRST PUBLISHED IN 2004• IMPLEMENTED IN 2008• FOCUSES ON 3 MAIN AREAS #PILLARS ie MINIMUM

CAPITAL REQUIREMENTS,SUPERVISORY REVIEW & MARKET DISCIPLINE

• STRENGTHEN INTERNATIONAL BANKING

BASEL III

• FIRST VERSION PUBLISHED LATE 2009• IT WAS A RESPONSE TO THE CREDIT CRISIS• BANKS TO MAINTAIN PROPER LEVERAGE RATIOS AND

TO MEET CAPITAL REQUIREMENTS• REFORM MEASURES DESIGNED TO IMPROVE

REGULATION,SUPERVISION AND RISK MANAGEMENT WITHIN THE BANKING SECTOR

COMMITTED LIQUIDITY FACILITY

• BASEL III FRAMEWORK REQUIRES BANKS TO ADHERE TO A NEW LIQUIDITY COVERAGE RATIO

• IN 2012 RESERVE BANK APPROVED THE PROVISION OF A COMMITTED LIQUIDITY FACILITY TO COMMERCIAL BANKS TO ASSIST THEM IN MEETING THEIR LIQUIDITY COVERAGE RATIO AS THERE IS LIMITED AVAILABILITY OF HIGH QUALITY LIQUID ASSETS IN SOUTH AFRICA

• IT ALSO STATED THAT APPROVED STATUTORY CASH RESERVES TO BE INCLUDED IN HQLA FOR PURPOSES OF CALCULATING LCR

SUMMARY• RMBS - RESIDENTIAL MORTGAGE-BACKED SECURITY• CASH YIELDS FROM CASH PAID BY HOMEOWNERS TO INVESTORS• SUB-PRIME CRISIS • LOAN GIVEN TO PEOPLE WITH BAD CREDIT• CHARACTERISED BY :• HIGH INTEREST RATES• POOR QUALITY COLLATERAL• LESS FAVOURABLE TERMS• CAUSES :• LOW INTEREST RATES• RISE IN LOAN IN LOAN INCENTIVES• EASY CREDIT CONDITIONS• AMERICAN DREAM (OWNING A HOUSE)

SUMMARY cont’d

• EFFECTS OF SUB-PRIME CRISIS• PANIC IN FINANCIAL MARKETS• INVESTORS SOLD OUT• DROP IN SHARE PRICES• CREDIT GOT TIGHTER• LOSSES FOR BANKS AND MORTGAGE LENDERS• JOB LOSSES

SUMMARY cont’d• IMPACT OF SUB-PRIME CRISIS ON BANKS• LEHMAN BROTHERS DECLARED BANKRUPTCY• MERRILL LYNCH WAS ACQUIRED BY BANK OF AMERICA FOR 50 BILLION• BEAR STEARNS INVESTMENT BANK SUFFERED INVESTOR LOSSES AND GOT

ACQUIRED BY JP MORGAN FOR 1.2 BILLION• EURO DEBT CRISIS• TIMELINE: EASY CREDIT CONDITIONS (2002 – 2008)• FINANCIAL CRISIS (2007 – 2008)• INTERNATIONAL TRADE IMBALANCES• GREAT RECESSION (2000 – 2012)

SUMMARY cont’d • BASEL ACCORD• AGREEMENTS BY BASEL COMMITTEE ON BANKING REGULATIONS

AND SUPERVISION WITH REGARDS TO RISK ie CAPITAL,MARKET & OPERATIONAL

• BASEL I,BASEL II,BASEL III • BASEL III WAS INITIATED BY THE RECENT FINANCIAL CRISIS IN 2009• COMMITTED LIQUIDITY FACILITY• APPROVED IN 2012 BY RESERVE BANK TO ASSIST COMMERCIAL

BANKS MEET THEIR LIQUIDITY CREDIT RATIO