Since the Act Concerning Asset-Backed Securitization (the ABS Act) was enacted in 1998, securitization has become one of the most widely used financing techniques in Korea. At the time it was enacted, the Korean securitization market was dominated by Korean financial institutions disposing of non-performing loans (NPLs) to reduce their liabilities in an effort to comply with the BIS ratio. However, as the Korean economy gradually recovered from the shock caused by the Asian financial crisis in 1997, the Korean structured finance market has turned its focus on the securitization scheme as an effective means of financing, using existing or future receivables such as credit card receivables, automobile loans, and mortgage loans. The master trust securitization technique was introduced in 2004 and adopted in many securitization transactions.

With enactment of the Korea Housing Finance Corporation Act (the KHFC Act) and the establishment of the Korea Housing Finance Corporation (KHFC) in 2004, mortgage-backed securitization (MBS) transactions pursuant to the KHFC Act entered into the market. In 2005, student loan-backed securitization (SLBS) transactions were first introduced. Now asset-backed securitization is adopted as a means to raise capital in complicated structured finance transactions such as project finance and infrastructure projects.

Master trust securitization

The Korean structured finance market has begun to use a variety of assets, such as credit card receivables, automobile loans, student loans and home/residential mortgage loans as underlying assets in securitization transactions. But although the securitization of credit card receivables marked record highs in 2002, the volume of these securitization transactions dropped shortly after, due to a sudden downturn of the Korean credit card industry in 2003. However, in 2004, a new technique using a master trust scheme (master trust securitization) was introduced to the Korean ABS market. Master trust securitization is expected to give the market a much-needed jump-start.

Under the master trust securitization scheme, a trustee issues multiple beneficial certificates to multiple special purpose companies for securitization (SPC) and each SPC issues securities backed by the beneficial certificates it holds. As the cash flow from the assets entrusted to the master trust is distributed to each SPC on a pro rata basis based on the face value of the beneficiary certificate it holds, the beneficiary certificates each share the same credit risk and cash flow relating to a pool of assets that have been entrusted to the master trust.

The Financial Supervisory Service (the FSS) had formerly taken a narrow interpretation of the concept of one SPC per securitization plan under the ABS Act and so prohibited any master trust securitization. In about 2004, the FSS changed its stance and started to permit the use of the master trust securitization. From the procedural point of view, in a master trust securitization: (i) at the time of initial closing, a master trust files a master ABS plan with the Financial Supervisory Commission (the FSC), whereas each SPC existing at that time respectively files a separate ABS plan with the FSC; and (ii) whenever new assets are entrusted to the master trust later on, the master ABS plan is amended to reflect the additional entrustment and each newly established SPC files a separate ABS plan with the FSC for the additional issue of asset-backed securities. Under the former scheme of securitization through a stand-alone trust, a separate trust had to be established for each securitization. However, under the master trust securitization, if there were additional assets to be securitized after the initial issue of a series of ABS, further issuance of ABS would be possible by simply issuing additional beneficial certificates after entrusting such assets to the existing master trust. A trust in securitization through a stand-alone trust is analogous to a space ship that, once launched, must be abandoned, whereas in a master trust securitization the master trust is a space shuttle that can be continuously reused. Even in the latter case, however, one SPC incorporated to issue one series of securitization cannot be reused for another series of securitization under a common master trust.

Residential mortgage-backed securitization (RMBS)

Up until the incorporation of the Korea Housing Financing Corporation in March 2004, most residential/home mortgage loans have been short-term loans. The KHFC Act explicitly provides that KHFC has been established to carry out the securitization of residential/home mortgage loans to induce steady, longer-term residential/home mortgage financing. This is to help the Korean government's economic policy goal to reduce the financial burden of the mid- to low-income homeowners by helping them to purchase homes.

The differences between securitizations under the ABS Act and the KHFC Act are as follows:

1. Originators are different: Originators under the ABS Act are the financial institutions that have come to own mortgage loans, including residential/home mortgage loans, in the course of their normal lending business. The mortgage-backed securitization under the ABS Act is a means of procuring cash from the existing pool of mortgage loans. However, issuance of RMBS under the KHFC Act is carried out by KHFC, as the originator, after purchasing the mortgage loans, as qualified under the KHFC Act, from the financial institutions that have extended the qualified mortgage loans pursuant to KHFC's pre-arranged purchase of the same mortgage loans. So in the securitization transaction under the KHFC Act, KHFC is the originator.
2. The KHFC Act has a special legislative intent: The financial institutions extend mortgage loans, as planned, based on a premise that KHFC will buy all of these loans. According to the KHFC Act, residential/home mortgage loans with a maturity term of 10 years or longer are qualified loans. From the financial institutions' perspective, the risk associated with long-term credit exposure is eliminated immediately upon sale of the mortgage loans and student loans to KHFC. Provided KHFC takes over the long-term credit exposure risk from the financial institutions, the KHFC Act only requires KHFC to acquire the residential/home mortgage loans with a maturity of 10 years or longer and low-interest, long-term student loans. In doing so, the KHFC Act has the effect of inducing commercial financial institutions to provide long-term residential/home mortgage loans and student loans. So the KHFC Act's main purpose is to promote and reinvigorate the long-term, low-interest residential/home mortgage and student loans, whereas ABS is intended to facilitate easy securitization of the assets owned by originators, including the financial institutions.
3. RMBS issued by KHFC enjoy a higher credit rating: Because the RMBS issued by KHFC may be guaranteed by KHFC, the credit rating of the RMBS is improved whereas no such guarantee is available in respect of the ABS securities issued by a special purpose company (SPC) pursuant to the ABS Act.

The RMBS issued pursuant to the KHFC Act consist of two types of securities: (i) mortgage-backed securities (MBS), which take the form of a beneficial certificate and (ii) mortgage-backed bonds (MBB), which are mainly secured bonds. Structures of each transaction are illustrated in diagrams 1 and 2.

As the diagrams show, financial institutions that have residential/home mortgage loan obligations transfer the loan obligations to KHFC in a loan sale transaction where KHFC pays them a purchase price. Using these residential/home mortgage loan obligations as the underlying asset, KHFC issues either beneficial certificate (MBS) or secured bonds (MBB).

Issuance of MBS means that KHFC issues beneficial certificates after transferring the underlying asset from KHFC's own account to the designated trust account within KHFC. KHFC also guarantees the beneficial certificates through its own account.

In the case of MBB, KHFC is authorized to issue secured bonds to the extent that the aggregate amount does not exceed 50 times KHFC's equity capital. The KHFC Act has made it easier for KHFC to issue MBBs, in the form of secured bonds, by exempting KHFC from the application of the Secured Bond Trust Act, which restricts the type of securities/collateral to the extent it is almost impossible to issue secured bonds otherwise.

The procedures required for securitization under the KHFC Act are similar to those required under the ABS Act. Upon issuance of beneficial certificates or secured bonds, KHFC Act requires the issuance to be registered with the Financial Supervisory Commission (FSC) by submitting the securitization plan (together with the details required under Article 23 of the KHFC Act), a copy of the loan sale agreement (together with the details stipulated under Article 24 of the KHFC Act), and creation of a trust as well as the details of the underlying assets (that is, the residential/home mortgage loan obligations).

The other similarities between the ABS Act and the KHFC Act are: (i) the true sale requirement; and (ii) special perfection provision regarding the transfer of the underlying assets for the securitization.

Compared with the ABS Act, however, securitization under the KHFC Act does not require incorporation of an SPC or appointment of a third party qualified trustee. The KHFC Act provides that KHFC is considered the qualified trustee under the Trust Act of Korea.

The SPC under the ABS Act is required to appoint a business administrator and a servicer, but KHFC can carry out the management, operation, and disposal of the underlying assets while keeping these assets separate from KHFC's own assets. In this regard, KHFC's duties are the same as the business administrator (asset management company) and a servicer under the ABS Act. However, with respect to servicing the loans, the KHFC Act provides that KHFC can delegate such tasks to a qualified servicer such as any financial institution, Korea Asset Management Co (Kamco) and a licensed credit information company incorporated pursuant to the Act Concerning Use and Protection of Credit Information.

Diagram 1: Mortgage-backed securities

Diagram 2: Mortgage-backed bonds

Student loan-backed securitization (SLBS)

Considering that low-interest student loans have not been readily available in Korea, the KHFC Act has mandated KHFC to carry out the securitization of student loans and issue SLBS. The legislative purpose is to induce financial institutions to provide to college and graduate school students, as a means of financial aid, low-interest, long-term student loans.

According to the KHFC Act, the structure of the SLBS is the same as the MBS. (See diagram 1.) As in the case of RMBS, financial institutions provide student loans pursuant to KHFC's promise to acquire all of the qualified student loan obligations. The requirement of a true sale, and the procedures for issuing SLBS, such as FSC registration and perfection of the transfer, are the same as those relating to RMBS.

The volume of SLBS transactions has not been large – KHFC has completed only three transactions since the KHFC Act was enacted. Nevertheless, SLBS transactions are expected to bring vitality to the student loan market as well as the securitization market as they could make it easier for financial institutions to extend loans to qualified students and so increase the pool of eligible underlying assets.

Merits of the RMBS and SLBS

Low risk for financial institution lenders

Securitization under the KHFC Act eliminates the financial institutions' concern for the immobility of the capital during the entire term of the long-term residential/home mortgage and student loans because these long-term loans can be turned into cash immediately upon sale to KHFC.

If financial institutions have raised the funding through short-term borrowings in the international money market, long-term loans at the domestic retail market might present a risk of funding mismatch. However, this risk of funding mismatch is solved upon sale of the long-term loan obligations to KHFC because the financial institutions can repay their short-term borrowing obligations with the proceeds from the sale.

Improvement of BIS ratio for financial institutions

According to the Bank for International Settlements (BIS) rating system, residential/home mortgage loans are rated as high-risk assets. So possessing too many residential/home mortgage loans increases a financial institution's burden to meet the BIS ratio. This could cause financial institutions to become reluctant to extend long-term residential/home mortgage loans. However, if the residential/home mortgage loans are transferred to KHFC during the process of the securitization transactions under the KHFC Act, the number of high-risk assets for the relevant financial institution will be decreased. This reduction will help financial institutions to meet the BIS ratio requirement.

Guarantees for investors

From an investor's point of view, RMBS and SLBS are a safer means of investment because the underlying assets (that is, the residential/home mortgage loans and student loans) are backed by KHFC's guarantee for 90% of the loss as well as the payment of the principal and interest payments even if certain obligors default under the loan agreements.

Because MBB are secured bonds, the holders of MBB have priority against third-party creditors of the underlying asset (that is, the residential/home mortgage loans) unless otherwise excluded pursuant to other relevant laws. Even in excluded cases, the MBB holders' right to the payment of the principal and interest under the MBB is protected by the KHFC Act, which mandates KHFC to pay the principal and interest payment to the MBB holders with assets other than the underlying asset of the MBB.

Investor protection

Because the RMBS and SLBS are intended for trade on the Korea Exchange, an investor protection measure is needed. To this end, the KHFC Act stipulates that the information registered with the FSC, such as the securitization plan, details concerning the transfer of the residential/home mortgage loans, as well as the details of the trust, to be disclosed and made available on the FSC website. The KHFC Act also requires KHFC to register with the FSC the securitization plan, transfer, trust and details of the residential/home mortgage loans and have this registered information disclosed on the FSC website.

Easier conversion of securities to cash

From an investor's perspective, RMBS and SLBS are an attractive form of investment. They can easily be turned into cash because they are considered securities under the Stock Exchange Act of Korea and so are easily traded on the Korea Exchange. Moreover, KHFC endeavours to standardize the RMBS and SLBS and continues to issue such standardized RMBS and SLBS. This standardization makes it easier for the investors to analyze investment worthiness as well as the risks related to the distribution of such securities.

This is likely to induce investor demand for RMBS and SLBS, which in turn will create a bigger pool for securitization. With the increased securitization volume, it will become easier for financial institutions to raise funds for residential/home mortgage loans as well as student loans.

Not just a financing tool

In less than ten years, the Korean securitization market has indeed come a long way. Used as a rudimentary means to dispose of NPLs during its early years, securitization has moved forward a few steps by introducing new, sophisticated techniques such as the master trust securitization and using various types of assets. Securitization is now applied not only as a financing tool in many complicated structured financing transactions such as real estate development projects and infrastructure projects but also as to further government economic policies to boost the housing market and promote equal educational opportunities.

Considering the volume of credit card receivables and other types of recurring/future receivables (especially those resulting from airline ticket sales), the master trust securitization is likely to continue to revitalize the securitization of various types of future receivables.

Korea's securitization market has now set its course on using complicated, sophisticated techniques as well as diversifying the types of the underlying securitization asset. These trends will not only reinvigorate the once depressed market but also put the Korean securitization market on the sophisticated financing world map.

Author biographies

Helen Sohn Lee & Ko Helen Sohn is a partner of the structured finance and banking team at Lee & Ko. Her structured financing experience includes securitization of non-performing loans (NPLs) on behalf of Korean entities such as Korea Asset Management Corporation, Cho Hung Bank, Woori F&I Co and LG Credit Card Co, acquisition financing transactions on behalf of Hana Bank, Korea First Bank and DBS Bank, asset financing transactions involving aircraft on behalf of Korean Air Lines, and derivative transactions on behalf of many Korean companies and commercial banks. Sohn holds a Bachelor of Arts degree from University of California, Los Angeles (UCLA) and a JD degree from Brooklyn Law School. She is a member of the New York State Bar Association. Mee-Hyon Lee Lee & Ko Mee-Hyon Lee is a partner and head of the structured finance team at Lee & Ko. With 19 years' banking and finance experience, Lee has been the principal transaction lawyer on many of Korea's largest and most innovative structured finance transactions, which include: representing Korea Asset Management Corporation in the first cross-border securitization in Korea, securitizing non-performing loans (NPLs) whereby issued ABSs were sold to foreign investors selected through an auction proceeding. This transaction has become a model in all NPL sales by other financial institution in Korea; representing JP Morgan and other co-arrangers in the W314 billion ($268 million) loan financed for the acquisition of Haitai Food Products, which was selected by IFLR as the Debt and Equity-Linked Deal of the Year 2001. Lee holds Bachelor of Laws (honours) and LLM degrees from the Seoul National University as well as an LLM degree from Harvard Law School. She writes and lectures frequently on structured finance. Lee is a member of the Korean Bar Association and New York State Bar Association.