FIs find securitisation a practicable option

Our Banking Bureau
13 May 2002

Chennai: Financial institutions are increasingly employing the concept of risk transfer through synthetic securitisation as a cost-effective source of funding and numerous other benefits, says Elwyn Wong, a director in the structured finance collateralised debt obligations (CDO) group of Standard & Poors (S&P).

Risk transfer securitisation is the application of insurance and credit derivative technology to transfer credit risk from protection buyer to protection seller, says Wong. This transfer could be funded through a true sale of assets; and it could also be unfunded, or performed synthetically, through credit default swaps.

Protection buyers are motivated to securitise for a host of reasons, from balance-sheet management and dynamic allocation of credit exposure to increasing liquidity, says Wong. Other benefits include: regulatory or economic capital relief; avoidance of true sale; increasing assets under management; and arbitrage between the credit market and credit warehouse on the one hand and the securitisation market and investors on the other. Protection buyers could either be single-party or multiparty.

On the other side, he says, protection sellers are motivated to purchase securitisation to expand to an alternative asset class and diversify; match coupon spread and subordination risk appetite; and to create a tailor-made investment in terms of tenure and cash flow characteristics. Funded protection sellers purchase liabilities issued by depositing cash with the special-purpose vehicle. Unfunded protection sellers are called on to perform when there is a credit event.

Wong says S&Ps approach to evaluating these synthetic CDO is based on the stressed historic default studies and correlation characteristics. We assign default probabilities to the underlying asset portfolio according to rating, tenure, and industry category. S&Ps CDO Evaluator, in turn, gives subordination levels according to the rating sought on liabilities, Wong adds.

Speaking about securitisation in the life insurance industry R Ramakrishnan, a member of the Malhotra committee on insurance reforms and chairman of the Reserve Bank of Indias advisory group on insurance and a consulting actuary, says life premia could be securitised. But it may not serve any purpose. The liability under a policy is defined as: The present value of benefits payable in future LESS the present value of future premiums receivable.