Securitisation has been a dirty word in financial markets ever since the collapse of the US subprime mortgage market.
But any hopes of a much-needed revival have been put on hold pending the outcome of the financial market reforms being planned by the Obama administration and the impact of last week’s Securities and Exchange Commission fraud charges against Goldman Sachs.
The danger, executives say, is that less risky securitised and structured finance products such as those backed by non-mortgage loans could be tainted by the publicity given to the huge losses that resulted from the collateralised debt obligations linked to risky mortgages at the centre of the case against Goldman.
In recent months, activity has resumed in parts of the asset-backed markets such as securities backed by car loans, but activity remains much lower than before the credit crisis.
“We are worried all securitisation will again be thrown into the same bucket as CDOs and get labelled as highly dangerous for the financial system,” says one senior securitisation banker. “Now, with financial reform legislation possible much more quickly than we thought, on the back of the lawsuit, there may not be time to press for new rules which make sense.”
Like other parts of the capital markets, demand for securities backed by mortgage and other loans dried up completely after the collapse of Lehman Brothers in 2008. In the US, the mortgage finance market has been taken over by government-backed mortgage agencies Fannie Mae and Freddie Mac. There has not been a privately financed mortgage-backed security in two years. Investors have proved wary after hundreds of billions of losses on such investments.
However, efforts by the Federal Reserve to restore confidence to other parts of the asset-backed markets – those securities backed by consumer loans such as car loans and credit cards, which did not incur huge losses – did reopen these sectors.
Spreads, which affect the costs of borrowing, fell sharply and deals resumed. In general, the experience of the crisis has resulted in much simpler transactions. Investors and rating agencies have demanded more conservative assumptions, too, about risks and losses in the future.
Even after the Fed’s programme – the Talf – ended in March, several securities backed by car loans and other types of receivables have been sold to investors. Yet asset-backed securities markets remain a fraction of their former selves – limiting the availability of credit.
Global ABS volumes, which excludes mortgage-backed securities, so far this year are at their lowest since 1995, according to Dealogic. This is down even from 2009 – when many capital markets were still in crisis – and is 90 per cent lower than the $349bn raised in 2007. Uncertainty about future regulations and the lack of investor confidence in these types of securities continues.
A long-awaited financial regulation bill is expected to hit the Senate floor as early as Wednesday. The 1,336-page bill includes rules for opaque markets such as derivatives and securitisation, and restrictions on trades banks can engage in, curbing risks of “too big to fail” institutions and the creation of a consumer protection agency.
“As more proposals come out and as the legislative debate heats up, market participants have become much more concerned that securitisation could be severely restricted,” says Tom Deutsch, head of the American Securitisation Forum, which represents participants in the industry, including banks and investors.
“There are so many different proposals out there. If all of them were to pass, the amount of time securitisers would have to spend in compliance would severely limit the ability of this market to continue towards restarting.”
There are two key sticking points.
First, the amount of the loans that banks and other originators need to hold when they repackage them into bonds. This so-called “skin in the game” debate – which is centring on calls for a 5 per cent risk retention stake – aims to ensure that the banks securitising bonds have an incentive to make sure the loans being repackaged are good ones.
The details are important, however. Does there need to be a 5 per cent retention of every tranche of the deal, or just of the riskiest portion? Having to own every slice – “vertical retention” – makes more sense for some asset classes such as mortgage deals than others. For car loan deals, companies such as Ford that securitise the deals often retain a stake, which means they absorb losses before bondholders do.
Second, there are numerous proposals for more disclosure. This makes sense – the lack of information on many mortgage-backed deals meant it became impossible for investors to value them. The reliance by investors on credit ratings proved to be problematic when these ratings were slashed. However, the SEC’s proposed disclosure rules may be useful for restoring confidence in mortgage-backed markets.
“The new rules are in response to the SEC’s perception that securitised products were directly responsible for the credit crisis and ensuing recession,” says Joseph Astorina, analyst at Barclays Capital. “Rightly or wrongly, consumer ABS, which have performed remarkably well through the credit crisis and cannot be causally linked to it, are being lumped together with other asset classes as requiring additional regulation.”