Sidebar Information:
Securities rules "not clear"

Make no mistake about it, 2009 will be another tough year for securitisation and structured finance in the Cayman Islands. Cayman has established itself as a premier offshore jurisdiction and, for structured finance and securitisation, this is definitely the case.

Cayman special purpose vehicles are routinely used for myriad securitisation transactions including South American future-flow transactions, Middle Eastern Sukuk or Islamic-financed deals, Japanese bank balance sheet securitisations, European synthetic collateralised debt obligations, South African and Indian-originated project finance deals and US securitisations of any number of underlying assets including credit-card receivables, corporate loans, residential and commercial mortgage- or asset-backed securities.

Even the most news-averse person will be well aware that the past 18 months have been the most turbulent in international financial markets in living memory. Most people will be familiar with terms such as the sub-prime meltdown and credit freeze and will be aware that key financial market participants such as Bear Stearns, HBOS, RBS, Citigroup and Lehman Brothers have fallen victim, to a greater or lesser extent, to the financial fallout.
 
Securitisation in the Cayman Islands reached its zenith in 2007 with record numbers of transactions structured utilising Cayman entities. Structured finance transactions such as collateralised debt obligations, collateralised loan obligations and securitisations of residential mortgage-backed securities such as net-interest-margin deals, had increased steadily from 1998 though 2007 and many of these deals used Cayman special purpose companies, trusts or partnerships. These types of securitisation helped oil the wheels of the debt-capital markets by repackaging assets and securities originated by US and non-US banks and corporations into securities that could be sold all over the world using a Cayman tax-neutral platform attractive to foreign investors. This enabled corporations and individual consumers and homeowners in the US and Europe to access cheaper credit which, in turn, increased spending and stimulated economic growth and prosperity.

The bubble burst, in spectacular fashion, in August 2007 with the onset of the sub-prime meltdown. The subsequent fallout has been dramatic and widespread. Unsurprisingly, the credit markets have frozen up and banks are unwilling to lend. Securitisation activity, especially in some areas, has ground to a complete halt. Collateralised-debt-obligation issuance is down in excess of 90 per cent on 2007 levels and some forms of the investment, such as those that are asset-backed securities, are dead. Any type of securitisation involving US residential mortgages is also unlikely to make any type of comeback in 2009 and potentially well beyond. Securitisations of corporate loans are also down significantly on 2007 levels and, with corporate default rates set to increase beyond ten per cent during the course of 2009, the outlook for securitisations of corporate loans, via structures such as collateralised loan obligations, is bleak. Other staples of the Cayman securitisation market over the past few years, such as structured investment vehicles which used short-term funding via commercial paper and medium-term note issuances to fund the purchase of longer and higher paying AAA-rated debt to produce steady returns for investors, became unable to meet their borrowing obligations as the market for commercial paper dried up. Most of these structured investment vehicles have had to unwind or restructure and it is questionable whether this particular structured product will ever make a comeback.

In terms of the outlook for 2009 for Cayman securitisation, there are a number of roadblocks that must be passed before we can expect to see the market come back in any real volume. The rating agencies, which have been fundamental to the development of many structured-finance products, will need to regain investor confidence. This is no small task as many investors blame the rating agencies for losses they have sustained over the past 18 months. The rating agencies will certainly need to formulate new rating methodologies that work and to stick to them. Structured-finance transactions had also become incredibly complex and structurers will need to go back to basics and ensure that securitisations are transparent and simple so that investors can understand them. Government intervention, which most will admit is necessary to kick-start the financial markets, may also hamper securitisation in some areas.
 
Take the Homeowner Affordability and Stability Act, which is before Congress in the US. It aims to assist homeowners by enabling mortgages to be restructured to provide borrowers more favourable terms. This will, undoubtedly, assist homeowners in the US who are having trouble meeting mortgage repayments. However, there is a good chance that this will result in significant losses to banks and mortgage lenders. In addition, many of the affected mortgages have been securitised and the investors who purchased the mortgage-backed debt securities which are secured on these mortgages will suffer greater losses as a result. The repercussions for the US mortgage-backed securities market could be catastrophic. Why would anyone invest in these securities in the future if there is a risk that the US government could step in at any time and rewrite the terms of the underlying loans? If the US government does it once, who is to say they will not do it again? The other main threat for Cayman securitisation lies in international initiatives aimed at regulating the financial markets. While it is clearer that greater regulation and oversight is necessary, no one is able to say with any certainty how this might affect the Cayman Islands or the Cayman entities used in many forms of securitisation.

Cayman securitisation has certainly been dealt a severe body blow over the past 18 months. While it may be down, we would certainly not characterise it as out. The outlook for 2009 is rocky but there is still plenty to be optimistic about. Certain types of securitisation continue to remain active, albeit not at the levels of recent years. Diversified payment rights and future flow transactions continue unabated and Islamic finance remains a bright spot. South American and, in particular, Brazilian securitisation transactions, remain robust. In addition, Cayman has a huge portfolio of existing securitisation transactions and structured finance deals. Many of these are producing significant amounts of work for Cayman lawyers, administrators and accountants as they are restructured or worked out. Many have become or will become the subject of litigation and this will provide a big shot in the arm for Cayman litigation and insolvency practitioners. The next year will not be rosy, by any means, but it will be an interesting year for securitisation in Cayman and there are some bright spots to be optimistic about.