Gathering confidence

South Africa's securitisation market is finding its feet again with spreads tightening and a smattering of fresh issuance coming to market. But rising domestic interest rates and breaches in arrears triggers on some existing issues are raising the spectre of default. William Rhode reports

South Africa's securitisation appears to be on the verge of escaping its biggest lull in years. In late 2007, contagion from the global credit crisis triggered by bad US subprime mortgages eventually spread to South Africa. Planned deals were shelved, while the market's runaway growth slowed as new issuance dipped to a fraction of its former levels.

Events during August 2008 have caused some local market participants to take heart. The month saw two securitisation deals in as many weeks from arranger Investec - the first to be completed since June.

The first offering was a R821 million ($104 million) securitisation of equipment leases originated by equipment financier Fintech, which is part owned by Investec. The second transaction, called Private Residential Mortgages 2, saw Investec offer R1 billion of residential mortgage-backed securities (RMBSs) - the first deal of its kind this year.

Although the new issuance has been viewed positively, two deals in a month pales in comparison to the kind of flow the South African market is used to. By the end of August, South African year-to-date securitisation issuance stood at around just 10% of that seen over the course of 2007, at R4.5 billion, according to Moody's Investors Service.

"Following the international credit crisis, South African issuers and investors alike adopted a wait-and-see approach as events unfolded in the US and Europe," says Nick Job, head of debt capital markets at Investec in Johannesburg. "In the South African market, spreads have widened significantly, but not to the same extent as elsewhere. Issuance has understandably slowed during this period of uncertainty, but we believe it may pick up provided spreads remain at these levels."

Investec's competitors also view the deals as a boost to the local market. Richard Hayne, head of securitisation at Nedbank in Johannesburg, says: "The message from these issues is that the market is feeling its way in uncertain market conditions. The deals are relatively small and are quite short-dated, but the fact they were printed is very encouraging."

Private Residential Mortgages 2 comprised a series of notes rated from Aaa to Baa2 by Moody's, which are backed by a pool of 3,147 prime mortgages originated by Investec with an average loan-to-value of 89.75%. The deal was priced at 40 basis points over Jibar for the three-year A2 super-senior tranche and 50bp for the five-year equivalent A4 notes. This is outside the 30bp range that might have been achieved on super-senior tranches pre-crisis, but is inside the 60bp levels that were being seen in the secondary market for prime RMBSs in the first quarter of 2008.

The Aaa rated three- and five-year senior tranches offered launch spreads of 70bp and 80bp, respectively, while pricing for the subordinated tranches ranged from 130bp for the five-year Aa2 notes to 300bp on the Ba2 paper.

The Fintech asset-backed securities (ABSs) transaction, meanwhile, was rated from AAA to BB+ by Fitch Ratings, with pricing ranging from three-month Jibar plus 60bp for the AAA rated notes to 600bp for the lower-rated tranches. With a legal maturity date of 2022, the Fintech portfolio comprises structured rental agreements on a range of office automation, information technology, telecommunications and medical equipment.

Investec's Job believes there remains more appetite from local pension funds, asset managers and conduits that invested in the two deals, noting feedback from investors was positive. "Our experience with the two recent issues leads us to believe domestic appetite for select high-quality securitisation issues appears relatively robust, albeit for smaller issue sizes and at relatively higher spreads," he says.

While this is good news for local originators, it is a far cry from much of the previous decade. In recent years, robust demand has led to year-on-year issuance growth in the region of 30%-50%. In 2006, total issuance climbed to R31.8 billion, more than 25 times the volumes recorded in 2001, according to data from Absa Capital. RMBSs have typically made up the vast majority of this.

By 2007, local investors - obliged by law to invest only in local assets and so providing a strong bedrock of demand - could not keep up with the pace of fresh issuance. Consequently, originators turned overseas in search of investor appetite, and in particular towards Europe (Risk South Africa Autumn 2007, pages 10-12).

But the credit crisis brought this to a swift end. South Africa's market was itself largely uncontaminated by subprime assets, thanks to both restrictive investment mandates and the vanilla character of the local market. However, the crisis offshore had a knock-on effect on local banks' international securitisation plans, hampering efforts to take assets off balance sheets and distribute them to overseas investors (Risk South Africa Autumn 2008, pages 4-7).

Evidence of the diminishing offshore support was highlighted by the fact that although foreign investors attended roadshows for Investec's August RMBS deal, the bonds were bought entirely by local accounts.

Slower issuance

On the back of the global credit crunch, the South African securitisation market saw slower issuance in the second half of 2007, according to a recent report by Moody's. A total of R14.02 billion of notes were rated by the agency in the second half of the year, compared with R15.65 billion rated in the first six months of 2007. "Although total ABS issuance during 2007 surpassed that of 2006, there was a marked year-on-year decrease in issuance volumes during the second half of the year following uncertainty in international capital markets," says Dion Bate, a Johannesburg-based ratings analyst at Moody's.

Nervousness continued into 2008, leading to the cancellation of a planned R3.5 billion RMBS offering by Absa Capital. There has been a total of just four issues rated by Moody's for the entire year so far. They included a R1 billion auto-loan ABS deal by BMW Financial Services and a R650 million securitisation of commercial mortgages from Freestone Finance Company in April. Both were arranged by FirstRand Bank.

In addition to the Private Residential Mortgages transaction by Investec, Moody's also rated a R3.84 billion securitisation of South African taxi leases in June.

"Initially, we had a number of arrangers approach us with larger pools of R2 billion-R5 billion that were forced to downscale because the appetite for large deals domestically wasn't quite there," remarks Bate.

Nonetheless, he believes international uncertainty should not weigh too heavily on the local market. "Domestic appetite for paper, albeit limited, is still there, which is more than can be said for Europe. Issuers are looking at smaller pools with shorter dates and reasonable spreads they can realistically place. With small steps, it's hoped great things can be achieved once again."

Part of the reason domestic demand remains available to South African issuers is because of the relatively healthy state of its asset-backed commercial paper (ABCP) conduits. These have predominantly been set up by each of the nation's five major banks - Absa Capital, FirstRand Bank, Investec, Nedbank and Standard Bank. ABCP conduits raise short-term funding through the commercial paper market and invest in longer-term assets, such as ABSs. This enables them to generate returns by taking advantage of the spread differential between their investments and cheaper, short-term financing.

"In contrast to elsewhere, South Africa's conduits have weathered the credit crisis well. However, volume growth has declined," says Moody's Bate. Although they have suffered from higher borrowing costs over the course of the year, local conduits have still been able to obtain funding, he adds.

Local bankers argue the relatively small drop in outstanding bank-sponsored ABCP conduit debt seen in South Africa compares favourably with the plight of similar vehicles in Europe. "I haven't seen conduit outstandings falling off in the in the same way as in the European ABCP market. They are faring much better than overseas," asserts Nedbank's Hayne.

But while bankers hope for a renewed upward trend in new issuance, others are looking harder at existing issues amid growing concern over the quality of underlying assets.

According to Moody's recent report, no South African RMBSs rated by the agency have been downgraded as a result of poor asset performance. In fact, longer-standing loans have benefited from an increase in local property values, the agency says. But it claims foreclosures are nonetheless on the rise as a result of higher interest rates. The South African prime rate has climbed from 10.5% in mid-2006 to 15.5% by June 2008, putting pressure on borrowers servicing their debt.

Stress testing

Kate Rushton, credit analyst at Absa Capital in Johannesburg, recently completed a study of existing securitisation structures and how they have performed in the turning credit environment. Her work reveals the results of stress tests on 18 South African RMBS transactions and examines the transactions against assigned arrears trigger levels.

"Our aim is to determine how changing (and challenging) macro fundamentals could affect the South African RMBS market and then stress test the individual transactions accordingly in order to ascertain how bad things need to get before losses are incurred," she says in the report. "Simply, the object of this exercise is to determine how bad it can get before an investor will face losses with respect to the notes they hold."

In her research, Rushton emphasises house price growth is starting to decline, prime rates have increased a cumulative 500bp since mid-2006 and consumers remain under pressure - something evidenced by depressed household disposable income and higher debt-to-income ratios. "Two RMBS transactions have already breached arrears triggers. This has placed RMBSs under the spotlight. But how bad do things need to get before a particular RMBS note is likely to suffer a loss?"

Two RMBS deals, known as Ikhaya 1 and Ikhaya 2, have already breached their arrears triggers, which stop the deals from revolving and trap excess cash. The deals are R1.7 billion and R3 billion in size, respectively, and were originated in February and June 2007 by FirstRand Bank. In addition, two out of three deals in FirstRand's Nitro series of transactions - the first to be placed internationally by a South African issuer - are thought to have breached arrears triggers.

In her research, Rushton used three different approaches to stress test local transactions. They included using constant default rates (calculating what percentage of current underperforming loans were likely to default once historical prepayment and cure rates were incorporated); assuming all loans more than 90 days in arrears had defaulted; and assuming all loans in arrears had defaulted.

Rushton says the first approach using constant default rates did not result in any note losses, while assuming all loans that were more than 90 days in arrears had defaulted resulted in minimal losses in only a handful of lower-rated notes. The third approach - assuming all loans in arrears had defaulted - produced losses in deals across most of their lower-rated tranches. Losses among AAA notes, however, were minimal or zero in most transactions.

Investors in existing South African RMBSs may take comfort from this exercise, although Rushton warns increasing arrears are putting pressure on some transactions. "A continued increase in 90-day-plus arrears is proving problematic for some arrears triggers. We anticipate a further two transactions will breach their triggers before the end of the year."

Notwithstanding this, she is not overly concerned these breaches will translate into investor losses. "A breach in arrears can mean different things depending on the transaction. In the case of our analysis and the transactions we stress tested, it means they become non-revolving - that is, the excess cash becomes trapped to support the transaction." In a worst-case scenario, this could lead to the early amortisation of a structure but is unlikely to lead to a default, she adds.

Moody's Bate agrees. "We're of the view that rising delinquencies in pools will continue to put pressure on deals going forward. However, all losses to date have been covered by the available excess spread in each respective transaction," he says.

Regardless of higher rates, consumer pressure and rising delinquencies, the fundamental quality of underlying assets remains sound, believes Job at Investec. "South Africa really has no reason to get caught up in the credit contagion - the quality of assets here is very good. And with strong local demand, we can reasonably expect to restart the market without enormous concern about events elsewhere."

Even if conditions were to get tougher, South Africa's bank originators are well-shielded by other sources of funding, he adds. Local banks do not rely heavily on securitisation, and so aren't exposed to the risk the market will swiftly dissipate, which was underlined in late 2007 by the now-nationalised UK mortgage lender Northern Rock.

Major bank originators continue to have reams of assets to securitise - something encouraged in certain areas by Basel II, which requires a risk-weighted approach to regulatory capital. In particular, the regulations give greater incentive for banks to securitise commercial mortgages and credit card receivables than was the case under the Basel I regime. But although the framework was fully implemented from January 2008, South African banks tend to get much of their funding from deposits and a healthy interbank lending market.

"South African banks have never relied heavily on securitisation as a means of funding, but have rather viewed securitisation as one of many funding options available to them," says Job. "For most domestic banks, securitisation makes up less than 10% of their total funding mix, so the reduced domestic level of demand for securitisation notes over the past few months has not had a detrimental effect on the domestic banking sector."