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Eight months work to securitise €600 million Back  
Michael Torpey relates the details of the largest Irish debt market event of 1999, when Irish Life and Permanent took €600 million of mortgage assets off its balance sheet.
In November 1999, Irish Life & Permanent securitised €600m (IEP472m) of Irish residential mortgages. While the bank had previously securitised its UK mortgage book through a special purpose company called Auburn Securities 1 plc, this was our first such transaction in the Irish market and it is also the largest such transaction carried out to date in Ireland.

The booming Irish economy and housing market has seen massive growth in lending by Irish Life & Permanent through the 1990’s. From IEP1.1bn at the beginning of 1990, loans to customers had risen to IEP6.2bn by the middle of 1999. This near six-fold increase in loans outstanding in less than a decade, far outpaced the rate of growth of customer deposits over the same period. The inevitable effect of this was substantial and growing recourse by the bank to non-retail sources of funds.

The bank has developed a very active presence in a range of markets in the wholesale arena. We have been regular issuers of senior debt securities in the international market and have also issued a number of bonds in the Irish market. We operate US dollar and euro commercial paper programmes, and are active in the corporate deposits market and in the interbank market. A key element of our strategy is to develop and maintain a very well diversified funding base.

It was against this background that the attractions of securitisation presented themselves.

The concept of securitisation is attractive in that it provides funding which is precisely matched against the loan assets being securitised. It is a very capital efficient form of financing. It introduces a new set of investors to the company and, as a relatively new and fast developing area of business in Europe, it offers considerable future potential. It does have downsides, particularly the very heavy workload involved in launching a first transaction. It is also somewhat more expensive than conventional senior debt as a pure funding mechanism.

First steps – selecting loan assets

Securitisation is the process of converting future cash flows from a pool of underlying assets (mortgages) into a smoothed repayment stream against the security of which debt securities can be issued. The issue is structured such that the holder of the security has recourse only to the assets securitised and not to the originator of the mortgages. The structure is self-liquidating in nature as capital repayments on the securitised mortgages pass through to become capital repayments on the debt securities issued.

Translating this outline definition of securitisation into the practicality of what took place, Irish Life & Permanent selected a pool of mortgages and sold the benefit of their cash flows to a special purpose company called Fastnet Securities 1 plc. Fastnet used these mortgage cash flows as security for the bonds, which it issued and the proceeds from issuing those bonds provided the money to enable Fastnet to purchase the mortgage cash flows in the first instance from Irish Life & Permanent. As mortgages are repaid, the capital repayments are directed towards paying off the bondholders and the credit support to the bonds derives solely from the mortgage cash flows, which have been sold to Fastnet. Irish Life & Permanent contracts, as part of the transaction, to continue to administer the mortgages. From the mortgage-borrowing viewpoint nothing changes.

Three months’ data analysis

Once the decision was taken that securitisation was a good strategic fit for Irish Life & Permanent, we had to put in place the preparation to ensure that when the timing was right, we would be able to launch a transaction cleanly and efficiently. In essence, securitisation involves getting cash now in exchange for a future set of cash flows. In order to maximize the amount, which somebody will pay up-front for the future cash flows, we need to provide as much information as possible about those cash flows. The basic data are very straightforward. Mortgage balances, interest rates, repayment amounts, arrears and such like are all readily available. However, there are a lot of other data, which can add value when analysing the mortgage pool. Such items as loan to value ratios, be it original loan to value or current market valuation based, the geographic distribution of the mortgages, seasoning of the mortgages and historic arrears patterns are all relevant.

It is quite a time-consuming affair to put together all of these data for some eleven thousand mortgages, in a way that facilitates comprehensive analysis of the risk factors attaching to the mortgage pool. We put together a team from our retail banking division in March 1999 to do just this and it took three months of fairly intensive work to produce the detailed analysis necessary to facilitate a securitisation transaction. The result of doing that preparatory work was that when we felt it was right to launch a securitisation transaction, we knew that we had a file ready for analysis and were therefore confident that we would be able to achieve our desired timetable.

We decided at the beginning of August last year to go ahead with the securitisation transaction. Even with the preparatory work that had been done on our mortgage data it still took three months from that point to complete the transaction.

Appointment of advisers

We appointed Greenwich NatWest as arranger for the securitisation issue in August 1999. The choice of arranger is particularly important in this type of issue as the structure is highly technical in nature and requires specialist expertise. We had previously worked with Greenwich NatWest when we securitised our UK loan portfolio and on the basis of that experience found it easy to work with them again. Having said that, there are a number of very strong securitisation teams operating out of the London market in this fast developing area. We appointed Citicorp Trustee Company as Trustee and Citibank N.A. are paying agent. The banks’ auditors KPMG were chosen to audit the pool and Davy Stockbrokers were the listing agents.

We had no less than four legal advisors to the various parties to the transaction. A&L Goodbody and Dillon Eustace were the advisors as to Irish law to the relevant parties, while Freshfields and Weil, Gotshal and Manges were the advisors as to English law.

Structure

The structure employed in the securitisation was designed to meet a number of objectives. From Irish Life & Permanent’s point of view, we had a need to develop a structure that would be both cost effective and capital efficient. From the investors’ perspective, we needed to produce securities, which would be attractive to them in terms of maturity, yield and risk. The structure which we found best met these needs involved issuing three classes of securities, all of them floating rate notes (FRN’s). The first of them, amounting to A210 million, was an AAA rated mortgage backed FRN. This is a fast pay security, which will receive essentially all of the capital repayments on the mortgage pool until such time as this security is repaid. The average life of these notes is likely to be about 1.7 years and they were issued at a rate of interest of Euribor plus 0.20% per annum.

The second class of notes amounted to A350 million and was also rated AAA. Repayment on these notes will only commence when the first class is repaid. With an average life expected to be about 5.6 years, these notes were issued at an interest rate of Euribor plus 0.28% per annum.

Finally, under the third class, we issued A40 million ranking subordinate to the two AAA classes in terms of priority of security and payment of interest and principal. These notes, rated A by S&P and A1 by Moody’s, were issued at a margin of 0.75% over Euribor and have an expected average life of almost six years.

The expected average lives mentioned above cannot be accurately predicted as they depend on the repayment rate of mortgages by the borrowers. While in theory, all of the note issues have final maturity dates in 2031, we have built-in a redemption option from the end of 2005 onwards, as the amount outstanding will be falling very rapidly at that stage and it is likely to make sense to redeem the remaining balance to tidy up affairs.

Another feature of the bonds, unfamiliar to most Irish investors, is the payment of interest monthly. This reflects the normal monthly pattern of payments by mortgage borrowers and is common practice in mortgage backed securities issued internationally.

Mind-boggling documentation

I have already mentioned the data preparation that is necessary for securitisation. That pales into insignificance along-side the sheer volume of legal documentation needed for such a transaction. We had some advantage in this area, as we were able to borrow in large part from our experience in securitising our UK mortgage portfolio in 1998. None the less the sheer volume of documents (38 in number) that has to be entered into to cover all of the parties and all of the obligations in the transaction is mind-boggling.

Because of the particular structure there were, as mentioned previously three classes of notes issued by Fastnet. Documentation included a 70-page offering circular, a paying agency agreement, trust deed, deed of charge, mortgage sale agreement, mortgage management, agency agreement, subscription agreement and so on. All of these documents have to be agreed by the various parties and also have to meet the criteria of the credit rating agencies that are engaged rate the notes being issued. Credit ratings are most important in issues of this type where the fine details of the technical and legal structures surrounding mortgage lending in various countries may not be known in detail to investors internationally and they depend very heavily on the ratings assigned by rating agencies.

Because this was a very major transaction for us being our first securitisation of Irish residential mortgages and indeed the largest such transaction in the Irish market to date, we elected to have the issue rated by both Moody’s and S&P rating agencies. This process involved having the rating agencies perform a detailed investigation of the mortgage pool being securitised and also of the originator of the mortgages to establish that the process and procedures for originating and servicing mortgages are robust.

Market comfortable with Ireland story

Having gone through the process of analysing the mortgage data, creating the structure, documenting the deal and arranging to have the credit ratings assigned, the next stage was selling the issue to potential investors. A comprehensive briefing note was put together describing the background of the Irish economy and focusing, naturally, on the mortgage market. A number of investor presentations followed internationally including London, Amsterdam, Luxembourg and a number of other European cities. This was a most interesting exercise in that it gave me the opportunity to meet investors who were unfamiliar with the Irish story and observe their reactions to that story. It is fair to say that there is a very high degree of interest in the success story of the Irish economy of 1990’s. There was naturally a degree of concern about the relatively rapid inflation of house prices over the past few years. Overall we found that investors were very comfortable with the fundamentals underpinning the Irish economic story and this was reflected in the very wide distribution of the bonds in the market place when they were finally issued at the beginning of November.

Maintenance

The completion of the mortgage bond issue is but the start of a process. All repayments of principal and interest on the securitised mortgages must be segregated and applied towards servicing the bonds. An essential part of preparation for the issue was to ensure that the accounting systems at Irish Life & Permanent were capable of performing this task on an automated basis. While in the first couple of months it was important that we policed this process carefully, it is in practice fully automated and is expected to become a routine task.

There is also a continuing reporting obligation of information about the pool of securitised mortgages. While the bonds remain in issue, bondholders are provided with monthly data on the mortgage pool via electronic information systems. This again is a standard part of the service provided by managers of mortgage backed securities to their investor base and is important in providing reassurance to investors that they will be able to keep in touch with the quality of their investment and its expected repayment profile.

Worth the pain
The process of securitisation is time consuming and sometimes frustrating. As a once off transaction, when compared with the alternative of raising senior debt in the capital markets, the cost in both money and time would hardly seem worth the effort. But to leave that as the conclusion would be to miss the key strategic value behind the process.

While heavily utilised in the US, securitisation is relatively new to Europe. As such, it is still in a developmental stage and I have no doubt that the process will become more streamlined over time. I believe that it will form an essential part of the weaponry of any mortgage provider in a very competitive European mortgage market. It is a very capital efficient way of financing mortgage lending and in a world where capital is scarce and shareholders expect companies to maximize the efficiency of the their capital usage, securitisation has a clear advantage over other forms of financing. The relative costs of securitisation compared to senior debt issuance may also fall, if proposed changes to the regulatory capital requirements for credit institutions are implemented. In essence, these would lead to a lower risk weighting of mortgage backed securities in the hands of investors and should, therefore, lead bank investors to be prepared to buy these assets at a finer margin than in the past. So the bottom line for Irish Life & Permanent is that securitisation makes sense. We have had a very satisfactory experience with it to date and securitisation will form an important part of our strategy in the future.

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