Author: | Published: 10 Oct 2001
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The Japanese asset-backed securities (ABS) market continues to enjoy rapid growth in 2000/01. It is reported that the value of Japanese ABS and mortgage-backed securities (MBS) issued in 2000 reached approximately ¥2.4 trillion ($20.5 billion). In particular, an enormous surge has been seen in relation to commercial mortgage-backed securities (CMBS) and other real property-related securitization.

The market for residential mortgage-backed securities (RMBS) also grew steadily last year. In 2000/01, several major Japanese banks securitized their residential mortgage portfolios in both the Japanese and Euro markets. A number of these originators were prompted to dispose of their loan portfolios as a disproportionately large holding of housing loan assets resulted from mergers with another banks. In addition, the Government Housing Loan Corp (GHLC), Japan's largest mortgage lender, embarked upon issuing securitized products in March 2001, which was followed by further issues in June and August 2001. Such actions will promote and expand the Japanese RMBS market.

Another notable development was the introduction of non-performing loan (NPL) securitization. Morgan Stanley completed securitization of a NPL portfolio through the vehicle named International Credit Recovery Japan, Series I, II and III. The Japanese government has also taken an initiative in this field. The Resolution and Collection Corp (RCC), the Japanese equivalent of the Resolution Trust Corp in the US, is reportedly planning to embark on securitizing bad loans and real estate. It has been announced that the RCC will securitize the headquarters of the failed Long Term Credit Bank of Japan. The RCC has recently been granted a licence to engage in trust business with the view to using a trust as tool for NPL securitization.

Among other financial receivables, consumer loan receivable securitization has greatly increased in 2001. Apart from various economic factors in the consumer finance industry, certain new transaction schemes have been developed with a view to overcoming the legal and regulatory obstacles which have so far impeded the growth of the market.

Market participants are vigorously working on Japanese real estate investment trusts (J-REIT), permitted by the Investment Trust and Investment Company Law which became effective in November 2000. The first publicly offered J-REIT transactions have just been consummated in September 2001.



It appears that some consumer loan companies have become aware of the usefulness of using securitization to raise funds. As Japanese banks attempt to divert from the way of the business to which they have been accustomed (eg relationship-oriented banking) and change their credit policy, some consumer loan companies may face more difficulty in raising working capital through bank loans, which may prompt those companies to rely on securitization as a funding tool. In addition, some of the larger consumer loan companies have started using securitization for more strategic purposes, namely, acquisition finance. Recently, a large consumer loan company, in acquiring another failed consumer finance company under reorganization, raised funds by way of LBO finance, where funding was made based on the credit of a pool of financial receivables originated by the target company.

Despite the business trends discussed above, consumer loan securitization is still been at an embryonic stage in Japan, primarily because the regulatory framework is not sufficiently developed to support it. Article 24-2 of the Moneylending Business Law (MBL) requires an assignee of a receivable originated by a licensed moneylender under a loan contract to notify the obligor of the assignment in writing, specifying the information proscribed by the MBL. The incentives to securitize consumer loan receivables have been outweighed by the perception that this notification requirement is overly burdensome and costly.

Against this background, market participants have tried to avoid a conflict with the notice requirement. One way is to prepare loan documentation that includes the name and address of the SPV and a clause stipulating that all loan receivables generated under the loan documentation will be assigned to the SPV, warehouse a pool of loan receivables based on the same documentation and then securitize the receivables. By signing such a loan document, a borrower is deemed to have received notice of the assignment. However, this method will not work where an originator attempts to securitize loan receivables that have already been originated under pre-existing documentation that contains no notice of the proposed assignment.

Trust structure

The trust structure has emerged amid this regulatory environment with a view to dispensing with the MBL notice requirement. Under the trust structure, typically, the originator entrusts loan receivables to a Japanese trust bank. Beneficial interests created under the trust agreement are issued to the originator, who in turn assigns a portion of these beneficial interests (normally, the senior beneficial interests) to an SPV. The SPV in turn issues bonds, payment for which is backed by dividends and other payments in respect of the beneficial interests sold to the SPV. The trustee appoints the originator as servicer of the loans so that the collection and administration of the loans continues to be handled by the originator unless the servicing agreement is terminated. The assignment of the loans to the trustee is perfected by way of registration under the New Perfection Law, without the need to notify obligors. Alternatively, the originator may continue to hold the whole of the beneficial interests without transferring them to an SPV, with the financing by the SPV taking the form of a loan provided to the trustee with a security interest created over the trust assets in favour of the SPV. The trustee will redeem a considerable portion of the beneficial interests held by the originator, using the loan proceeds. Payments on the loan will thereafter be made from collections under the underlying loans.

Faced with repeated inquiries from market participants, the Financial Services Agency of Japan (FSA) has finally acknowledged the merits of the trust structure and has affirmed that the requirement to notify obligors will not be triggered to the extent that certain conditions are met in relation to the trust structure. While there has not been a court case directly ruling on this issue, it is generally felt that the likelihood of the FSA changing its mind and attempting to impose the notice requirement on a sale transaction in a securitization is small. A couple of transactions have now been completed without sending any notice to obligors on the basis of the FSA's acknowledgment. It will be interesting to see how the market develops.

Revolving structure

The consumer loan agreements used by Japanese consumer companies often give a borrower the ability to make borrowing on a repeated basis up to a pre-fixed limit. This is called a "revolving-type borrowing". Payment terms for loans originated under revolving-type loan agreements are often reset each time a further borrowing is made, as if the old loans and new loans were amalgamated to constitute a single loan.

In structuring a consumer loan securitization, the originator and the arranger will often attempt to securitize all or a substantial part of the cash flow to be generated from such revolving-type borrowings. It is generally believed that the trust scheme will accommodate such a purpose. Typically, all the existing and future receivables originated or to be originated pursuant to the underlying loan agreements are entrusted to the trustee. This makes it easier to perfect the transfer of the underlying loan receivables because it is not necessary to differentiate the transferred receivables, which must be perfected, and the receivables which continue to be held by the originator and thus which do not have to be perfected. (Given the revolving nature of the underlying loan agreements, it is difficult to sever the receivables generated under a loan agreement into the two portions, namely transferred receivables and untransferred ones.) In addition, if the size of the loan portfolio is larger than the expected issue amount of the securitization, the excess portion may be structured to constitute a "seller's interest", with only the investor's interest being the subject of securitization. If the originator desires to raise further funds, it will be able to do so by converting the seller's interest to a new series of the investor's interest and causing the issue of new securities backed by such new series of investor's interest.

The trust structure with the revolving feature has been employed in certain recent consumer loan securitization, and given the associated benefits, such a structure is likely to become more common.


Amendment to the SPC Act

The Japanese Parliament passed an amendment to the Law Concerning Securitization of Specified Assets by a Specified Purpose Company (SPC Act) in May 2000. The law is now called the "Asset Securitization Act" and it came into effect in November 2000. Under the previous law, an asset securitization plan was required to be examined by and registered with the FSA. However as a result of the amendment, only a pre-transaction notice, together with the plan, need be filed with the FSA. The amendment has also reduced the minimum share capital of a SPV from ¥3 million to ¥100,000. Generally, the amendment attempts to enhance the flexibility for structuring a transaction although procedural aspects under the amendment could be further streamlined. There is also a feeling among market participants that the FSA and its subordinated institution, the Financial Affairs Bureau, could be more cooperative and efficient in their processing of pre-transaction notices. It will take more time to see whether the amendment will prove its merits.

Amendment to the Servicer Act

Under Japanese law, it used to be that only attorneys could engage in debt servicing business on behalf of their clients. This regulation is partly aimed at suppressing the activities of "loan sharks". However, the government's reform plans, which were aimed at bringing solutions to the bad loan problem from which Japanese banks suffer, began to recognize that this blanket restriction on commercial development of a debt servicing business was hampering the ability of banks to cope with their bad debt crisis.

In 1998, the new legislation called "The Law Concerning Debt Servicing Business by Servicing Companies" (Servicer Act) was passed at the Diet. Under the Servicer Act, a servicing company with a minimum capital of ¥500 million can become licensed by the Minister of Justice to engage in servicing. A licensed servicer may manage and collect debts on behalf of its clients or in its own name. Given that the lack of a servicing industry in Japan has sometimes presented problems in the context of Japanese securitizations, especially where rating agencies specifically require a back-up servicer to be nominated in advance, market participants had hoped that the enactment of the Servicer Act would resolve such problems; however, this has not necessarily been the case. For various reasons, including political ones, the scope of financial receivables that were eligible to be serviced by a licensed servicer (called "specified receivables") was still limited, so that, for instance, consumer loan receivables were excluded from the definition of "specified receivables".

Faced with increasing complaints from industry as to the limited services that could be provided by a licensed servicer under the Servicer Act, the government has finally decided to amend the Servicer Act to permit licensed servicers to engage in servicing of a broader range of assets. As a result of the amendment passed this year, consumer loans are now included in the definition of "specified receivables". This will facilitate the structuring of consumer loan securitization in that a back-up servicer may be appointed by a licensed servicer to service consumer loans, including defaulted receivables. Before the amendment, due to the regulations on the debt servicing as set out above, only a licensed attorney could render such services, and this was not always workable in the context of securitization. Likewise, commercial mortgage-backed loans originated by non-banks have been added to the list of "specified receivables". This will have favourable effect on CMBS transactions in that a special servicer may be selected from such licensed servicers to engage in a work-out and/or restructuring of such mortgage-backed loans. Given the importance of the roles to be played by a special servicer in CMBS transactions, the merit of the amendment cannot be overemphasized. In any event, the amendment will be a good development given the expansion of the underlying asset classes that are now being considered for securitization in Japan.

Future outlook

A number of market factors combined with reform-minded legislation resulted in the growth of the market in recent years. A new surge in market growth can be anticipated as a number of asset classes, such as residential mortgages and consumer loan receivables, are just beginning to be tapped.

Mori Sogo
NKK Building
1-1-2 Marunouchi
Chiyoda-ku, Tokyo
Tel: +813 5223 7700
Fax: +813 5223 7600
Internet: www.morisogo.com