ABSTRACT

Recent volatility in financial markets has highlighted the importance of understanding asset

securitization. Asset securitization is a process that allows company to fund their credit

growth, and shed off credit risk. By using the securities markets, company can allocate

capital more efficiently, access diverse and cost-effective funding sources, and better manage

business risks. Therefore, in February 2001, Capital Market Masterplan has identified asset

securitization as a part of the strategy to develop corporate bond market and also as a

competitive source of financing for companies with good assets. This paper is aim to

examine the current state of asset securitization for the Malaysian financial market. At a

glance, the paper outlines the implementation, advantages, disadvantages, prospects and

challenges of asset securitization in Malaysia. The sophisticated process also can be

beneficial to Government Corporation such as National Higher Education Fund (PTPTN) in

solving the problem of capital constraint.

Keywords: Asset Securitization, Asset-Backed Securities, Malaysia

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INTRODUCTION

Asset securitization can be defined as the process in which loans, receivables and

other financial assets are gathered together, with their cash flows redirected to support

payments on securities issued to purchase such assets. (Asset Securitization Consultative

Committee, 2002) Securitization is the process of gathering different types of debt mortgages,

car loans or credit card debt, for example and packaging that debt as bonds, passes through

securities or collateralized mortgage obligations (CMO) which are sold to investors.

Dictionary of Financial Term (http://financial-dictionary.thefreedictionary.com/

Asset+Securitization)

In Malaysia, securitization starts in 1986 when our government introduced a mortgage

financing financing body called National Mortgage Corporation namely Cagamas Bhd.

Cagamas Bhd was formed based on the model of Fannie Mae and Freddie Mae of USA.

Cagamas Bhd will be functioning as a Special Purpose Vehicle (SPV) for the house mortgage

lenders and investors of long term funds. In our country, Cagamas Bhd is the main issuer of

securitized assets. Bank Negara Malaysia owned Cagamas Bhd. However, the agency is only

buying back the housing government loans as opposed to commercial housing loans.

(Rosalan, 2009)

Asset backed securities (ABS) are becoming important in the global capital markets.

In the recent years, ABS market enables companies and banks to finance a wide range of

assets in the public debt market and have become influential in attracting more fixed income

investors. Asset Securitization techniques have became vital for corporate financing and

investment portfolios, because it provides a cheaper source of funding and greater return for

investors. Securitization changes risk by separating good financial assets from a financial

institution with a little loss of income. Since 1986, the importance of asset securitization can

be seen in developing a comprehensive capital framework for asset securitization that

includes the traditional and also the synthetic forms of securitization. (Giddy, 2003)

The term asset-backed security (ABS) is generally applied to issues backed by non-

mortgage assets (Siew, 2004). These asset securitisation techniques are being embraced by a

number of Asian countries seeking to promote home ownership, to finance infrastructure

growth, and to develop their domestic markets, particularly Malaysia. All Islamic ABS issues

in Malaysia must comply with Securities Commission (SC) guidelines issued pursuant to

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section 32 of SCA 1993, as and when they are applicable by follow the guidelines on the

offering of Asset Backed Securities (ABS), Private Debt Securities and Islamic Securites.

With the success stories of ABS issues in US, Europe and Australia as a cheaper debt

financing for companies and better investment returns for investors (Rosalan, 2009), this

points motivates us to do the research on Malaysian financial market.

Objective of this research paper is to introduce the asset securitization in Malaysian

financial market since it is still new in Malaysia. Attention will be given on asset backed

securities (ABS) which was introduced in the year 2001. In this research paper, we also

examined the implementation, prospects, challenges, advantages and disadvantages of asset

securitization in Malaysia.

Malaysia financial market is our scope of study because there is not much studies

been done regarding these market. Asset backed securities is relatively new in Malaysia and

not much research has been done, despite its huge potential for growth in the Malaysian debt

market. Researcher believes that our financial market have room for improvement as

institutional investors who will increasingly buy ABS for diversification, whilst financial

institutions will need to securitize more assets for better capital management. As such, they

believe that ABS by 2010 is set to become a main form of cheaper debt financing for

companies and superior return for portfolio managers. (Norazlina, Wan and Asma 2005)

Our research will be more comprehensive than the previous research because of the

introduction of first Sukuk ABS in year 2005 (Andreas, Peter, Paul & Amadou, 2008). Global

Sukuk received worldwide Syariah compliance endorsement and the Sukuk are accepted in

major markets such as Bahrain, the Middle East and Europe. Sukuk can be a plus point in our

research because not many researchers are focusing on Sukuk ABS.

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ANALYSIS

1.0 Implementation

The business of asset securitization in Malaysia started in October 1987 when the

government established Cagamas as the first special purpose vehicle. Its objective is to

support the national home ownership for low and middle income class group in Malaysia

through mobilizing low cost funds. (Cagamas Publication, 2003). Cagamas is by far the most

important issuer of securitized instruments in Malaysia acting on behalf of the government.

The activity of securitization started to grow rapidly in year 2001 when the Securities

Commission issued the regulatory framework and guidelines on the offering of asset-backed

securities. Previously, asset backed securities do not exist in the domestic market. Since then,

asset securitization has been active in private sector. Along with the guideline, the guidelines

on the offering of private debt securities and the offering of structured product also were

issued. According to Ting and Tan (2004), another significant catalyst of asset securitization

development is the introduction of Malaysian Capital Market Masterplan in 2001 by the

government.

These guidelines provide originators and parties involved with a detailed guide to the

regulatory approval for securitization process. Following the issuance of these guidelines,

originators have securitized asset such as auto-loans receivables, commercial properties,

residential mortgages, and credit card receivables.

Starting from 1st July 2000, the Securities Commission is the single authority to give

approvals for securitization applications. All issuance of asset backed securities must follow

the guidelines by Securities Commission. The necessary guidelines are Guideline on the

Offering of Structured Product, Guideline on the Offering of Private Debt Securities and

Guideline on the Offering of Asset Backed Securities. For Sukuk ABS, the issuance will have

to follow another guideline which is Guideline of the Offering of Islamic Securities. (Shafinar

et al, 2008)

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The process of asset securitization is the same globally. Parties involved are playing a

significant role in each step. Step-by-step process is illustrated in Diagram 1.

Diagram 1:

(Source: Securities Commission, 2002)

Based on Diagram 1, the process of asset securitization starts with the asset

origination. The transaction will first be originated when an originator e.g. banks, makes a

loan to a borrower (obligor). The borrower will be required to make a periodic payment to the

originator and thereby creating a stream of cash flows. This is necessary to support a

securitization transaction.

In order to issue asset-backed securities (ABS), the originator transfers those assets

(account receivables) to another entity called special purpose vehicle (SPV). This is a

separate entity from the originator and it is bankruptcy remote. Bankruptcy remote means in

the event of originator defaults, a receiver of the bankruptcy would not be able to claim the

transferred assets. Now the SPV has the right over the assets and in some cases, it has both

the right and obligation over the assets. The assets are legally isolated from the originator

which also means the investors will need to look only to the assets themselves and not to the

originator for repayment on the ABS. After the assets are transferred, the originator will

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Credit Rating

provide collection and management functions on the assets and these activities are called

servicing activities.

The asset pool holding by the SPV is usually supported by the credit enhancement.

The purpose of this step is to make the ABS become more attractive and safer to the investor.

An example of credit enhancement is by collateralizing the ABS with “surety bond” which is

a bond issued by the originator on behalf of the SPV, guaranteeing that the SPV will fulfil an

obligation or series of obligations to a third party. In the event that the obligations are not

met, the third party will recover its losses via the bond. By this way, the investors will have

more confidence on ABS investment because they will have the surety bond as insurance

policy.

Another entity involve in the process is swap counter party. Its role is to hedge against

potential mismatch from interest rate and currency exchange rate movement. This is because

the assets bear floating interest rate while ABS is fixed-rate. Commonly, the assets are also

denominated in different currencies than the currency use for ABS interest payment. Hedging

can solve these matters where the issuing entity will enter into interest rate swaps and

currency swaps.

The trustee as shown in Diagram 1 is a third party who administers the trust that holds

the underlying assets supporting an asset-backed security. They are concerned with protecting

the right of investors and it comes with a fee. Generally, they watch over the stream of

payment to investors as prescribed in the agreement.

Proceeds from the sale of the securities issued by the SPV are paid back to the

originator including any surplus from it. The cash flows from the assets are used to pay the

interest to the Investors. Upon maturity, investors will receive their principal which was paid

to the SPV at the first time. In the case of private SPV, the entity will be terminated after all

the transactions are done where the assets no longer produce cash flow and investors have

received the agreed interest and the principal paid. (Asset Securitization Consultative

Committee, 2002)

Prior to the issuance of securities to investors, the securities are being rated by rating

agency. The rating is an added value to the securities which will make it more appealing to

the investors. The highest rating applied to the securities is AAA which is regarded as the

safest investment. It is follows by AA, A, BBB, BB, B, C, and D. It is arranged by the level

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of riskiness which it means D rating is the riskiest but it comes with the highest return. The

different rating of the asset backed securities structure offers investors with choices since it

has different risk and return. Detail explanation of each rating will be discussed in Picture 1.

Picture 1:

(Source: Rating Agency Malaysia, 2006)

The issuance process of Sukuk ABS is basically the same with conventional ABS

though the explanation is different. According to Shafinar et al (2008), the originator of the

assets first enters into least contract with the SPV. The lease contract creates a stream of

income in the form of rental payments in favour of the SPV. The SPV then issues the Sukuk

ABS that is supposed to represent an undivided proportionate ownership over the leased

asset. From the Islamic legal perspective, the buyers of the Sukuk ABS effectively bought a

portion of the leased asset, and thus, become co-owners of the asset. As owners, the Sukuk-

holders are also the lessors to the originator, and are therefore entitled to the stream of rental

payments. Finally, at the end of the lease period which reflecting the maturity of the Sukuk

ABS, the originator will redeem it from the holders, effectively buying back the underlying

asset from them.

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2.0 Advantages

According to Asset Securitization Consultative Committee (2002), as a capital market

financing mechanism, securitization supports a number of objectives and may generate a

wide range of benefits, whether viewed from the standpoint of an originator or an investor, or

from a broader social and economic perspective. According to them, Asset Securitization

does bring benefits to:

i. Benefits to Originators;

ii. Benefits to Investors;

iii. Social and Economic Benefits

I. Benefits to Originators

From an originator’s perspective, securitisation provides a vehicle for transforming

relatively illiquid individual financial assets into liquid and tradable capital market

instruments. Through securitization, an originator can refill its sources of funds, which can

then be used for additional origination activities.

Rosalan (2009) evaluated the financial performance of originators by selected

financial ratios on the basis of one year before, during the year and one year after issuance of

their respective real estate ABS. The author believes it is sufficient to determine the ability of

the original owners of real estate (originators) to obtain a cheaper debt financing after

measured the selected financial ratios.

Securitization also provides an originator with what is frequently a more efficient and

lower cost source of financing in comparison with other banks and capital market financing

alternatives. The primary reason for this greater efficiency and lower cost of financing is the

ability of an issuer, through securitisation, to issue securities that carry a higher rating and

thus a lower interest rate than the long-term credit rating of the originator. This affords

originators cheaper financing than may be supported by their unsecured claims-paying

ability.

Another vital objective and benefit of securitization from an originator’s standpoint is

that it facilitates the removal of assets from the organization’s balance sheet. This outcome

can help an originator improve various financial ratios, utilize capital more efficiently and

achieve compliance with risk-based capital standards. As many banks must either increase

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capital may be quite expensive, disposing of assets through a securitisation transaction has

become an increasingly attractive means of assisting commercial banks in complying with the

Basel framework.

Other benefits allied with securitisation relate to the more flexible and adaptable

nature of this form of financing in comparison with more traditional alternatives. For

example, the ability of an originator to subdivide and redirect cash flows from underlying

financial assets often provides it with a better ability to manage its balance sheet, and to

achieve a more accurate and capable matching of the duration of its assets and liabilities.

Similarly, many originators have found that securitisation permits a greater scale of

specialisation and corresponding efficiency by allowing a financial institution to set aside and

unbundle its loan origination, funding, and servicing functions in a manner that best responds

to that institution’s competitive advantages and desired strategic focus.

II. Benefits to Investors

Assets Backed Securities (ABS) does offer variety of product choices at attractive spreads

that attract a diversified investor profile. Pension funds and insurance companies would

constitute a large investor segment for certain types of ABS due to the relatively high credit

ratings and predictable cash flows of an ABS. Conversely, money managers would be

attracted to invest in other categories of ABS issues which offer higher total return.

Furthermore, the significant and practically limitless variety and flexibility of credit,

maturity and payment structures and terms made possible via securitisation methods that

allow investment products to be tailored in a manner that responds to be exact, and

sometimes unique that fulfils investors need. This variety and flexibility are the hallmarks of

securitisation structures and instruments, and is a key investor consideration.

III. Social and Economic Benefits

A number of public, social and economic benefits have been realised where securitisation has

been employed on a broader scale in markets. For example, the existence of liquid and

efficient secondary securitisation markets has had the effect of increasing the availability, and

reducing the costs, of financing in the primary lending markets. The financing needs being

serviced often relate to areas that are favoured by social and governmental policy, such as

increasing the supply of funds for home ownership.

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Asset securitisation could also contribute significantly towards the reduction of risks

within the banking system. From a regulatory and financial markets supervisory perspectives,

securitisation offers a useful mechanism by which financial institutions may shift

concentrated credit, interest rate and market risks associated with their perspective portfolio

of activities to the more broadly dispersed capital markets. This reduces risk to individual

institutions, and systemic risk within financial systems.

It has also been observed that strong securitisation markets facilitate and encourage

the efficient allocation of capital by subjecting the credit – granting activities of individual

financial institutions to the pricing and valuation discipline of the capital markets. In this

manner, securitization helps to promote the allocation of scarce societal capital to its most

efficient uses.

3.0 Disadvantages

The disadvantages of asset securitization have not been discussed by other researcher

in depth. However, it can be clearly seen in US subprime mortgage crisis 2008 because one

of the reasons behind the crisis is the asset securitization. Prior to the crisis, securitization of

mortgage asset has been tremendous and the participants make good money from it. The

assets were formed into collateralized debt obligation (CDO) which is a product of asset

securitization. Investors start to invest in CDO heavily and they demanded for more CDO.

But after much securitization has been done, there were no more assets for originator to be

securitized so originator turned into subprime mortgages. Subprime mortgages lenders are the

riskier borrower of homeowner. The subprime mortgages continue to be securitized and

formed into CDO for the investors. However, the process stopped when homeowner failed to

continue their mortgages payment and then home price start to drop. The cash flow of

payment stop and investors stop receiving their interest payment as well. All participants

caught in the middle holding unwanted and worthless CDO. At the end, they end with being

bailed out by government or filed for bankruptcy.

The event is an example of what asset securitization can caused if it is not strictly

regulated and supervised. Participants in asset securitization would be badly affected,

investors confidence plunge, and country economic could fall into depression.

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4.0 Prospects

Tremendous potential for securitization growth driven by auto loan receivables, credit

card receivables, portfolio of housing loans, portfolio of small and medium enterprise (SME)

loans and property rental receivables. According to Rosalan (2009), Malaysian ABS will

become the premier cheap debt financing to the Malaysian companies and profitable form of

investment to the Malaysian institutional and individual investors. With the number and size

of issues are on the rise since 2005, notably syariah ABS and synthetic assets, Malaysian

ABS is in a position to lead the development and growth of private debt market.

The broadening and deepening of the Islamic financial market has seen the rise of

Islamic debt, in particular Islamic asset securitization or Sukuk as an alternative to

conventional debt as a means of raising financing. Islamic securitization is an appropriate

financing technique for Islamic countries where originators are seeking new local funding

sources. Rating Agency Malaysia reported that, as of March 2006, the banking sector had

expanded its asset portfolio to over Malaysian ringgit 1 billion, with Islamic assets

representing 11.4% of the total. In the first half of 2006, two Islamic securitizations were

issued in the local Malaysian market (Rating Agency Malaysia's Islamic Finance Bulletin for

April-June 2006).

Shafinar Ismail, Rosalan Ali, Antoaneta Serguieva and Andros Gregoriou (2008)

discovered the overview on the mechanics of Sukuk Asset Backed Securities (ABS) as a form

of corporate debt financing and measure the ability of the originators to reduce their debt

obligations and enhance their earning capacities in the Malaysian capital market. In finance

literature, Asset-Backed Securitisation (ABS) is defined as a creative way of raising funds

through the issuance of marketable securities backed by future cash flows from revenue-

producing assets.

Sukuk structures that have been developed in the International Islamic market include

Sukuk al-Ijarah and the Sukuk al-Salam. The Sukuk market was originally the domain of

sovereign issues.  The governments of Malaysia, Qatar, Pakistan and Bahrain have all tapped

this market.  It is rumoured that the governments of Indonesia, Turkey and Iran are looking to

enter this market.  More recently, a number of corporate in the Gulf Co-operative Council

(GCC) region (in particular in Bahrain, Saudi Arabia and the United Arab Emirates) have

begun to tap the Sukuk market.  Emirates Airlines recently launched a $500 million issue.

This sector is neither confined to countries in the Muslim world nor is it the sole domain of

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Islamic financial institutions.  Increasingly, Sukuk linked to assets based in the UK,

continental Europe and the USA, are being structured as Islamic investors want to include

securities with these risk profiles in their portfolios.  In addition, non-Islamic issuers are

seeking to take advantage of the increased liquidity in the Islamic world.  A clear example of

this trend was seen when the German Federal State of Saxony-Anhalt issued a $100m sukuk

in 2004.

5.0 Challenges

As new structured financial instruments, asset securitization in Malaysia has some challenges

coming from accounting and regulatory issues. On the other hand, Ting and Tan (2004) are

examining the current state of asset securitization in the Malaysian financial market on their

research. In the 1990s, they found that securitization in Malaysia has not developed due to

several issues such as to control inflation, due to lack of transparency and unfavourable

taxation issues. In the development of the securitization, Securities Commission, Finance

Ministry, Inland Revenue Board, Malaysian Accounting Standards Board and Bank Negara

Malaysia are in efforts to remove the tax and accounting impediment, creating a more

efficient and facilitative framework to facilitate the development of securitization in

Malaysia.

i. Absence of tax incentives for asset securitization and lack of support from tax legislation.

There is currently no specific tax legislation that deals with asset securitisation. As such, each

transaction will be examined in relation to its own facts and circumstances by reference to

existing tax legislation and practices. Under such circumstances, tax uncertainties are bound

to arise which not augur wells for the development of the securitisation market.

ii. Lack of clarity on accounting issues

Another possible benefit to an Originator in an asset securitisation transaction, as previous

outlined is the possible off-balance sheet treatment for such asset transfers. However, there is

a lack of clarity on the accounting treatment of ABS transactions as the Malaysian

Accounting Standards Board (‘MASB’) has not issued any standards or guidelines of its own

in relation to asset securitisation transactions to-date. In addition, the MASB has yet to adopt

the relevant International Accounting Standard (IAS) for asset securitisation i.e. IAS 39 –

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Financial Instruments: Recognition and Measurement which was issued in March 1999 and

has taken effect internationally from 1 January 2001.

iii. Absence of tax incentives – Without tax neutrality, securitization may lead to additional

tax burdens for originators.

Among the tax issues pertinent to the originator is the transfer of assets under securitization

transactions that include determining the disposal price and gain or loss on the sale or

receivables (and other assets to special purpose vehicles and the treatment of lump sum

receipts from sale of future receivables (and other assets).

iv. Financial institutions are governed by the Banking and Financial Institutions Act and

come under the purview of Bank Negara Malaysia (BNM).

A new guideline on securitization is required to be prepared by BNM for financial institutions

to get involved in ABS. BNM to grant a categorical exemption from the banking secrecy

provision under section 99(1)(i) BAFIA to enable the disclosure of information pertaining to

obligors to necessary parties in a securitisation transaction. In granting such an exemption,

BNM should not impose a time restriction during the tenure of the transaction, particularly on

those revolving securitisation structures which involves continuous transfer of assets. The

secrecy exemption should also be extended to credit rating agencies for certain types of

securitisation transactions involving a small pool of obligors such as collateralised loan

obligations.

v. Investors are reluctance to accept debt papers rated lower than single “A”

On more basic level, the Malaysian debt market appears paying the price of the 1997 crises.

The reluctance of investors to accept debt papers rated lower than single “A” has been a

reason often cited for the sluggish growth of the corporate bond market. Likewise, a number

of structured and securitization deals have been stalled. If the market in general is to develop,

it is up to the investors to provide a broader demand base and kick start the market. With the

market at still infancy stage, investors are still getting acquainted with the intrinsic

differences between ABS and corporate bonds. Though take up has been slower compared to

corporate debt securities, all ABS have been well received with subscription rates almost two

times or more. In fact, according to merchant banks as lead managers and RAM as a rating

agency, investors are willing to hold until maturity because Malaysian ABS issues seem to

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offer regular superior returns and secured principal repayment as compared to other long-

term fixed income securities.

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