SANTIAGO F. DUMLAO JR. l OCTOBER 5, 2022 l Business Mirror
IN the quest for effective measures, more specifically new products, to promote the capital market, the advocates appear to have overlooked the potential of Securitization.
We have Republic Act (RA) 9267, the Securitization Act of 2004, approved March 19, 2004, which provides the regulatory framework for Securitization. The law precisely announces in its Declaration of Policy (Section 2):
“It is the policy of the State to promote the development of the capital market by supporting securitization, by providing a legal and regulatory framework and by creating a favorable market environment for a range of asset-backed securities. Furthermore, the State shall pursue the development of a secondary market, particularly for residential mortgaged-backed securities and other housing- related financial instruments, as essential to its goal of generating investment and accelerating the growth of the housing finance sector, especially for socialized and low-income housing. The State shall likewise pursue the development of a secondary market for other types of asset-backed securities.”
So, we see that the Securitization Act was enacted especially to develop the capital market. But this purpose has not been achieved nor pursued as could be expected.
Securitization as a source of new capital market instruments is not limited to securitizing residential mortgages but can “refer to loans or receivables or other similar financial assets with an expected cash payment stream.” (Sec. 3(c) of the Act). These debt instruments or financial assets can include: credit card loans; auto loans; consumer loans; SME loans; commercial mortgages; and, corporate loans. It has been noted that since the early 1900s, securitization has been “one of the dominant means of capital formation to the United States.”
But what exactly is securitization? Securitization means the process by which assets are sold on a without-recourse basis by the Seller to a Special Purpose Entity (SPE) and the issuance of asset-backed securities by the SPE which depend, for their payment, on the cash flow from the assets so sold and in accordance with the Plan. (Sec. 3(a) of the Act)
The Seller is the entity which conveys to the SPE the assets to be securitized which form the asset pool that backs the payments to securities holders. Usually, the Seller is itself the Originator who is the original obligee of the financial assets being securitized.
The Plan is the plan for securitization as approved by the Securities and Exchange Commission.
In an attempt to develop a “normative and stipulative definition of a ‘true’ securitization, Jonathan Lipson of Temple University proposes to define a true securitization as a purchase of primary payment rights by a special purpose entity that [i] legally isolates such payment rights from a bankruptcy [or similar insolvency] estate of the originator, and [ii] results directly or indirectly in the issuance of securities whose value is determined by the payment rights to purchase.”
Lipson emphasizes that “the basic point is that it describes the essential elements of a securitization, its inputs [payment rights], structure [bankruptcy-proof legal isolation], and output [securities]. It also embedded its legitimate social and economic functions: if it works, securitization links the buyers and sellers of capital more efficiently than traditional methods of financing such as bank lending or issuing shares of stock…securitization gives originators access to the capital markets which they might not otherwise have. This, in turn, is thought to reduce the cost of capital or make possible financing that would not otherwise have existed.”
One major reason for neglecting, even bypassing, securitization for capital raising is that, it had earned a very bad reputation during the 2007-to-2008 global financial crisis when, across the board, securitized products were steeply downgraded in credit ratings and value by credit rating agencies who themselves had earlier given those products bloated ratings.
This most unfortunate episode in the US financial market, which spread worldwide in its disastrous consequences, is well recorded and remembered.
But the point we make is that securitization in itself, as a concept, is a valid, useful platform for generating good capital market investment instruments. What gave securitization a bad reputation is the way it has been applied to justify complex investment models exacerbated by a marketing hype fed by dubious credit ratings. But again, securitization in its true nature and form, is a valid, useful, valuable process—to convert static financial assets to tradeable dynamic securities for the capital market.
Securitization transfers the financial risks from the Originator of the obligation to the capital market. The concept of “financial risk transfer” through securitization is simple enough. Let’s take the example of residential mortgage-backed securities (RMBS).
The Property Developer (the Originator) buys the land, prepares and develops it for housing, builds the house, financing these with partly his capital and partly from borrowing most probably from a bank. The Property Developer markets and sells the house (houses) by installment. Property Developer has generated Receivables from the installment sales homebuyers.
Normally, Property Developer would have to wait to collect all his Receivables to get back his money. Or, the bank buys out or takes out the Receivables from the Property Developer, and substitutes itself as the Creditor.
Or, they decide to securitize.
Under securitization, the Receivables are sold to an SPE, also known as Special Purpose Vehicle (SPV), which is mandated to do the collection of Receivables. But this is not the whole process.
The SPE sells and issues Debt securities to Investors, using the Receivables to back up payment to Investors. An appointed Servicer does the actual collection service, and the payment to Investors of principal and interest under the terms of the securities issue.
The proceeds from the sale of debt securities to Investors are flowed back or paid to the Originator Property Developer (or to the bank, if it has acquired ownership of the Receivables).
At the completion of the securitization process:
The Property Developer has received his “investment” from developing and selling the land and house, and can do more property development that he knows best what to do. He is relieved of the “financing load;” of waiting to collect the sales installments. He has transferred the financing load and financial risk to the SPE.
In turn, the SPE has generated funds by selling securities to Investors, and flowed back the sales proceeds to the Originator who sold the Receivables.
Meantime, the “financing load” has been transferred to the Investor, assured that he will earn from his securities investment as the Receivables are collected and paid out to him in the form of interest and principal. The Investor achieves his investment purpose.
Looking at the process in a wider perspective, the Investor has eventually assumed the financing of the sale of the house. The residential mortgage loan has been “liquefied” by securitization. The capital market has provided the structure and facilities to move funds from those who have (Investors) to those who need (Property Developers). And securitization has provided the means—conveniently, with all principal parties gaining their respective benefits.
The Philippine securitization story may be found recorded in the credit ratings of Philippine Rating Services Corp. (PhilRatings), which has had experience doing rating assignments of largely housing-related securitized products.
PhilRatings President Angelica B. Viloria said the firm has rated eight securitization transactions as of September this year. The first securitization issue rated in 2003 was that of MRT Funding Corp.; the securitization of equity rental payments.
Then came the Stradcom SPT-LTO-IT securitization of computer fees from motor
vehicle registration and drivers’ licenses; now fully paid and settled. This was followed by the Home Funding Inc. securitization of contract-to-sell receivables.
In 2009, the first five securitization issues from the National Home Mortgage Finance Corp. occurred. These were: Bahay Bonds 1; Bahay Bonds 2; Balai Bonds 1; Balai Bonds 2; and, finally, Balai Shelter.
We can notice that in a span of 19 years, only eight securitization assets have been issued from four originators. Why this poor interest?
The bad reputation of securitization from the US experience continues to hound perhaps. But it is probably more because there is not enough awareness in the market of this capital market product, its nature and its benefits. And there is no champion to get securitization into the mainstream.
*** Santiago F. Dumlao Jr., past president of the Financial Executives Institute of the Philippines, is the current Secretary-General of the Association of Credit Rating Agencies in Asia.