Repackaging risk

At the biggest US securitisation industry gathering held in Las Vegas in February, the hundreds of guests attending were asked when a “new equilibrium” for the markets would be reached. Financial markets around the world were, at that time, still in crisis. With the financial system reeling from the impact of hundreds of billions of dollars of losses on securities backed by loans, mainly from US subprime mortgages, all parts of the securitised markets had closed down.

Yet even in such a pessimistic context, the message from those present was surprisingly negative. A handful even voiced fears that the securitisation market would not recover. Yet today, more than six months after the Las Vegas conference, there are signs of life.

In recent months, prices for securities backed by assets – from mortgages to credit cards and car loans – have surged. As well as price gains in the secondary market for already existing deals, new transactions are also being conducted.

“The last few months have shown that securitisation remains a useful and valid way of accessing the capital markets,” said Valerie Kay, managing director at Morgan Stanley.

Yet in spite of signs of a return to normality, much has changed behind the scenes. Large parts of the securitisation market remain dysfunctional and, in some cases, closed to new business.

In fact, a divide has opened up between those parts of the securitised markets that are working and those that are not. In particular, the efforts by the US Treasury and Federal Reserve to encourage investors to buy securities backed by loans have worked well to rekindle the markets aimed at consumer loans.

Through its Term Asset-Backed Securities Loan Facility, or Talf for short, the Fed has lent nearly $50bn to investors to buy securities backed by credit cards, car loans and other forms of lending. “The Talf programme has been very successful in rescuing the securitisation market,” analysts from JPMorgan said recently.

Talf works by lending investors, such as hedge funds, cheap loans as long as they use the money to buy asset-backed debt. The attractive terms mean the potential profit on these deals is significant. The resultant increased demand for these securities has led to a sharp drop in funding costs, which in turn has spurred more credit card companies and others to issue them. Volumes this year are predicted to be higher than 2008, although they are still well down from the peak reached during the last bull market. The American Securitization Forum expects $130bn in asset-backed securities – which excludes mortgages – in 2009 compared with $140bn last year and $750bn in 2006.

Elsewhere, parts of the securitisation market, such as for commercial mortgage-backed securities, which property developers rely upon to finance new deals, remain largely closed for new issues. The ASF estimates that less than 1 per cent of the $1,200bn of finance for residential mortgage-backed securities in the US has come from private sources of finance.

“Notwithstanding the success of the Talf programme and the restoration of a modest degree of securitisation financing and liquidity in some market segments, significant challenges remain,” George Miller, executive director of the ASF, told a recent Senate committee hearing.

Efforts to fix the asset-backed markets continue. Mary Schapiro, who took over as chairwoman of the Securities and Exchange Commission earlier this year, said recently that current securities legislation was outdated and called for the introduction of dedicated legislation to regulate the new investment products that were at the heart of the financial crisis. Schapiro called for new laws targeting “gaps” in the regulation of securities backed by assets such as mortgages and credit cards.

Yet few expect the securitisation market to return to where it was prior to the financial crisis, not least because confidence in credit ratings has been severely dented. One of the crucial building blocks that allowed the asset-backed markets to surge in the boom years was the widespread allocation of triple-A credit ratings, even to securities backed by low-quality loans, such as subprime mortgages.

At the same time, some analysts worry that the nascent revival in parts of the market – such as the recent car loans deal involving German vehicle manufacturer Volkswagen and a mortgage-backed transaction by HBOS, the UK bank – could make investors too complacent about risks, which in turn could hinder moves to improve the market.

CreditSights, the research group, has highlighted fears that securitised markets could again become “repositories for low-quality toxic assets”. While there may be signs of life, the future of the securitisation markets remains far from clear.

Aline van Duyn is the FT’s US markets editor

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