W

hen I was asked to lead the securitization team in Danareksa, several things were soon on my mind. The horror of the global markets meltdown was easily associated with this structured finance instrument, since the roots of the meltdown included various securitization products - mortgage backed securities, collateralized debt obligations and their related instruments.

Even some potential investors we visited after we launched the first residential mortgage backed securities in Indonesia, named Efek Beragun Aset (asset backed securities) Danareksa SMF I KPR BTN Class A (ticker code EBA DSMF01), were pessimistic about the product.

So, why do we need securitization? The short answer: to create liquidity in banking and capital market sectors.

Mortgage loans have grown significantly in Indonesia; from Rp 16 trillion in early 2001 to a whopping Rp 122 trillion in the end of December 2008. This is striking evidence during an almost 10 year period of Indonesia's cyclical economic trends. Even more striking is that non-performing mortgage loans never exceeded 4 percent in 7 years.

In the same period we witnessed how the loan-to-deposit ratio of many banks has been climbing up from 38 percent in January 2003 to 75 percent by December 2008.

During liquidity problems at the end of 2008, some banks actually exceeded 100 percent LDR. Not a good move during a time when cash is king. And looking at the maturity profile of loans and deposits, there was a maturity mismatch.

Securitization is a way to help creditors to create liquidity. Securitizing their receivables means the creditor sells receivable assets to investors and the creditor receives cash from that sale.

For instance, take a commercial bank which provides mortgage loans; with securitization of its mortgage loan assets, the bank can create new loans since it receives fresh funds from selling receivables.

By securitizing their assets, commercial banks can mitigate maturity mismatch problems they always face. And with banks disbursing more loans, this creates more economic activities related to housing development in the real sector; in essence, it helps develop the economy.

But, is it safe? Yes it is, if we structure the instrument as safely as it can be done. In case of EBA DSMF01, (Backed Security or EBA) the security of this product comes from several factors.

First, we implemented stricter selection criteria when choosing the mortgage loan receivables to be able to enter the pool of assets. Secondly, we structured the pool of assets to produce two classes of EBA instrument, where the lower class note, class B (10 percent from total securitized assets), guarantees the payment of class A.

Payments from mortgage borrowers fulfill the interest payment of Class A EBA first, then the remains goes to Class B. Besides that, credit enhancement produces another buffer by providing a reserve account, as already mentioned above.

Another important factor is that we make sure that the payment to investors can be continuous until all loan payments finish without worrying about any possible bankruptcy of the issuer.

To prevent possible bankruptcy having a negative effect, we need a Special Purpose Vehicle (SPV).

The transaction structure is not complicated; a company which owns receivables (for example: a bank with mortgage loans, or consumer finance firm with motorcycle financing receivables), which we call the originator, sell these particular assets to an SPV, which will package the pool of assets into securities instruments to be sold to investors, who will earn a certain amount of yield by holding these EBA.

If the type of security is a pass through security, then the principal and interest payments paid by borrowers of these mortgage loans will be passed through the SPV to investors until all loan payments are over.

Problem arises since Indonesia employs civil law, and civil law does not recognize SPVs. However, Bapepam (the Capital Market and Financial Institution Supervisory Agency) has thought of this.

It may not be the perfect solution but a Collective Investment Contract (Kontrak Investasi Kolektif /KIK) can act as the issuer (just like the SPV) so we have the solution; that a KIK cannot be bankrupt.

Then, how can we avoid the tragedy of toxic securitization products which were a major cause of the global economic problem?

First of all, only securitize good assets. Never push to securitize low quality assets (like subprime loans) and guarantee the asset (with credit default swaps) as Wall Street did.

Secondly, structure the pool of assets safely with over collateralization to comfort investors.

Thirdly, offers a guarantor role to competent institutions (which can be taken by Sarana Multigriya Finansial, formed by the government in 2005 to develop the secondary mortgage financing market).

Last but not least, education and education.

Educate the investors about these new securities, educate the banks to understand alternative ways to get fresh funds, and educate the regulators about this infant product. Educate ourselves to understand that asset backed securities are actually safer if we create them the right way.