Best securitization borrower

Asia: Kamco

Last July the Korean Asset Management Corporation (Kamco) disposed of Korean non-performing loans through an asset-backed securitization (ABS) structure that won awards from most of the leading financial magazines, including Euromoney.







Korea is the leading Asian expert on securitizing NPLs

The $367 million, nine-year notes were three times oversubscribed and incorporated some very complex structures to securitize 135 dollar- and yen-denominated corporate loans. The transaction had been rightly hailed as a milestone for the Korean economy which has to deal with its mounting NPLs.

But the ABS deal has done even more good. By catapulting Kamco into the limelight of ABS expertise, it attracted the interest of other government agencies and led to unprecedented cooperation between them. Last November Kamco hosted the first Non-performing Loan Forum for Asia Pacific issuers in Seoul, where 15 countries from Asia and emerging Europe discussed ways to resolve NPLs and exchanged ideas and experiences.

One year after the deal, Kamco finds itself at the forefront of these developments. It cooperates with agencies in Japan, China, Thailand, Indonesia and the Czech Republic and has been man-dated an advisory role by China Huarong Asset Management Corporation (CHAMC) for its first domestic ABS issue in China.

But Kamco is not only sharing its knowledge in the field of ABS. “ABS is only one tool for agencies like us to dispose of NPLs,” says Kim Cheon-Hong, executive director at Kamco. “We have also used alternative options such as sales of NPLs at international auctions or through joint ventures with the private sector.”

In fact a securitization issue is usually the final – since most sophisticated – step in tackling NPLs. Countries firstly have to implement a good legal framework specifying the conditions for setting up a special purpose vehicle, transfering a loan and its collateral, transfering interest and principal of an ABS to investors, and so on.

Once the legal rules are in place, the securitization itself is another time-consuming undertaking. It took Deutsche Bank and UBS Warburg more than six months to sort out all the features of the Kamco deal. Because of the nature of the NPLs – 90% were in dollars, 10% in yen and all had a put option attached allowing Kamco to sell them back to the banks in case of default – the leads had to employ some of the most complex swaps ever done in a securitization. And to further secure investors’ interest the banks also created a controlled pass-through structure – the first in an Asian securitization – which was supported by a credit facility provided by a quasi-sovereign bank, the Korean Development Bank.

But before any asset-management agency can access the international markets with an ABS, it first has to establish its name in the domestic market. This is why “agencies from other countries are very eager to come to the market,” says Kim.

Kamco also continues issuing domestically. By the end of 2000 it had issued 12 ABS worth W3.8 trillion ($2.9 billion). The first deal for 2001, around W240 billion in size, will be completed by the end of June. Kamco also plans a second international ABS. But there are no details available because it has not yet accumulated enough foreign currency NPLs on its books to go ahead. Kamco is unlikely to issue won-denominated NPLs internationally because the currency risks are too high. “You cannot find a dollar-won swap for a period longer than three years, which is what we need for the NPLs that usually have an average life of 10 to 12 years,” says Kim. “We are currently bringing in more foreign currency loans from the private sector, and will surely come back to the market again once we are satisfied with the type and size of the next issue.”

But Kamco now finds it infinitely more difficult to get hold of NPLs denominated in foreign currencies. Ironically, its own ABS success has encouraged other Korean banks to dispose of NPLs on their own. Already Korea’s ABS market has grown from W6.7 trillion in 1999 to W49.4 trillion in 2000, making it the most prominent product in the capital markets, says Kim.

Western Europe: Punch Group

Punch Group’s £1.5 billion securitization refinancing of the bridge loan it had taken out to buy over 3,000 pubs from Allied Domecq in July 1999 led to one of the most impressive whole business securitizations in the European market, last June.

Pub securitizations are not new, having being pioneered in the mid 1990s by Nomura’s principle finance group. But Punch, which is itself owned by a series of private equity investors well-versed in sophisticated financing techniques – Texas Pacific Group, CVC Capital Partners, Deutsche Bank and George Soros’s Quantum Fund – took this to a new level. Previous pub securitizations have concentrated on analyzing and packaging cash-flows from pubs that are leased from owners by a tenant landlord. The portfolio that Punch acquired from Allied Domecq comprised many of these but also many pubs that were not leased out but managed by employees of the company. Managed pubs do not have the same kind of contracted cash-flows streams as tenanted pubs and earnings from them are therefore harder to isolate and analyze. Future performance is clearly variable and securitization of such flows amounts to whole business securitization.

Punch’s decision to attempt a combined securitization of managed and leased pubs was the more remarkable because it involved bringing in a new investment bank, Schroder Salomon Smith Barney, to refinance a bridge loan that had originally been provided by Morgan Stanley. Itself renowned as the most innovative firm in the European securitization market, Morgan Stanley had envisaged separate deals for the two classes of pubs. When Punch adopted Schroder Salomon Smith Barney’s plan instead, SSSB extended its own bridge loan, to repay Morgan Stanley and take it out of the equation while the multi-tranche bond deal was put together.

This took several months and extensive work with the three major rating agencies and with Ambac Assurance, the UK insurer which provided a guarantee that allowed AAA ratings to attach to the two key tranches of the deal. These were a £350 million floating rate tranche with a 15-year legal maturity but likely to be called after five years and a £300 million fixed rate tranche with a 20 year final legal maturity. In addition to these, investors were offered a £450 million single-A tranche, fixed and floating BBB tranches and a BB tranche.

The deal was marketed extensively to sterling bond buyers including conventional institutional investors such as pension funds and insurance companies, credit arbitrage vehicles and bank treasuries that specialize in buying securitized bonds. Investors were attracted by the absence of event risk on asset-backed bonds at a time of growing dislocation of spreads in the European corporate bond market. Pricing ranged from Libor plus 35 basis points on the AAA-rated portion to Libor plus 575bp on the £69 million of BB notes.

The two fixed rate tranches provide long term finance for Punch of £450 million, while the floating rate tranches are likely to be called after five years. From 2005 Punch will have to pay much higher spreads over Libor on all floating rate notes with the margin on the AAA notes rising to Libor plus 105bp and on the BB notes to Libor plus 1,725bp.

The documentation for the deal allows some flexibility to Punch to achieve a partial IPO exit from the purchase, which, if it happens at all, will likely involve mainly the managed pubs.

Latin America: Salta province

It was the sort of situation structured finance was invented for. Salta province is about as remote as Argentine provinces get without being in Patagonia: right up in the country’s north-western corner, it borders on Chile and Bolivia. And at the beginning of the year it found itself with $670 million of debt, 40% of which was due in the next three years and nearly two-thirds of which would have to be paid back in the next five years. Fortunately it is also located above one of the richest natural gas deposits in Argentina.

So Lehman Brothers put together an extremely complicated transaction, in which an entity called Salta Hydrocarbon Royalty Trust issued $234 million in “targeted amortization notes” with an 11.55% coupon and a legal final maturity of 15 years.

Part of the complexity of the deal comes from the fact that the structure had to generate an investment-grade credit rating, even though it was backed by payments made onshore in Argentine pesos.

That necessitated the creation of an offshore account, containing two quarterly interest payments, which was designed to cover the panic period should Argentina be forced to devalue.

Salta also purchased political risk insurance from Sovereign Risk Insurance Ltd, giving it another 31 months of interest cover.

The underlying securitization is of 80% of the royalty payments from the owners of seven existing concessions, all of which last at least as long as the bonds. The other 20% had already been pledged to local municipalities.

In the end, the trust received investment-grade ratings from Standard&Poor’s, Moody’s and Fitch – the first time any Argentine province has been rated above the sovereign ceiling, let alone at investment grade.

Salta also tried to boost the creditworthiness of the structure by promising to pay down the principal amount on the bonds over 12 years, giving them an expected maturity of 12 years rather than 15, and an expected average life of just 8.5 years. But although the amortization schedule is rigidly defined, there is no penalty for the province should it fail to make the principal repayments.

The headline numbers seem compelling enough: the $234 million in bonds compares with $11 billion in proven hydrocarbon reserves (at 1999 prices) which will last (at 1999 production levels) for about 30 years.

But the complexity of the transaction and the difficulty in quantifying the political risk involved meant that Lehman was not going to attempt a public transaction. Rather, it placed the deal privately with nine investors in the 144a market. These were targeted for their knowledge of, and ability to invest in, deals that were highly structured, cross-border and based on oil and gas receivables.

The notes were priced through the sovereign, although neither Salta nor Lehman will reveal exactly how much the funding cost. Part of the sensitivity surrounding the deal is that it was politically controversial: there was domestic opposition to selling off oil and gas revenues which the inhabitants of the province consider to be their own. And because the funds from the issue were used to refinance outstanding debt, rather than invest in the province, the locals see little direct benefit from the deal.

However, viewed simply as a capital-markets transaction, Salta did manage to prove that a highly structured deal can give Latin regional governments access to non-emerging-market investors that are willing to receive sub-sovereign yields. That’s some achievement, even if the region concerned has to mortgage its future in the process.

best borrowers of 2001