Monday, June 16, 2008

Whither originate and distribute?

(FT Alphaville) Is the model broken, impaired, or about to make a come back? There’s some interesting stuff today from banks at the Goldman Sachs European Financials Conference in Berlin.

One thing agreed upon by all is that the originate and distribute model has been reset by several years. It’s “back to the future” in the words of Barclays CFO Chris Lucas.

A copy of Lucas’ presentation - delivered on Friday - is available here. The broad point he makes though is that originate and distribute is an economic imperative- simply as a function of a supply and a demand, it’s not going to go away anytime soon: in origination, infrastructure spending will create huge demand for lending ($40,000bn over the next two decades) while in distribution, ageing populations and growing pools of capital in emerging economies will provide ready and eager investor communities. Matching the two is the way forward for IBs.

The detail, of course, is where the interest lies. “What is clear” says Lucas “is that the model has been stretched too far.”

And as Credit Suisse analysts today remarked:

…apart from vanilla syndicated lending (the most bank-like and lowest-margin originate & distribute activity, and the one in which the capital velocity is lowest and the proportion of each deal retained is highest), the originate & distribute model is in serious trouble.

It’s worth looking to SocGen’s analysis to tease that point out. They break down the originate and distribute model into six streams:

  • Investment grade syndication
  • Non Investment grade syndication
  • Commercial Conduits
  • Securitisation
  • Structured credits
  • SIVs
Of those, only the IG syndication stream can expect a return to pre-crunch business levels anytime soon. Non-IG syndication and commercial conduits will need serious adjustment before market normalisation. The final three meanwhile - SIVs, securitisation and structured credits - are “structurally impacted.”And it’s those final three which really capture the exuberance of the credit crunch and what it was all about. From a financial perspective: the utter erosion of underwriting standards and its reverse - the erosion of investor due diligence. A willingness to price - and buy - risky securities as triple A.

That whole dynamic grew through a complex interplay of factors which centred around the ratings: SIVs, for example, represented an investor community which was utterly indiscriminate in buying products based solely on their rating. RMBS and CMBS securitisation similarly, became a routine of targeting triple A through minimum overcollateralisation ratios. Super senior tranches developed as a further layer of leverage on the triple A brand.

The remarkable thing is that pre-crunch, people used to talk of risks in the market being sliced up and spread around so much that it was difficult to know where the bodies lay. People used to talk about pension funds or hedge funds collapsing under the weight of all that subprime mess. So where was the old maid? Where were the bodies?

As the dust settles, it seems they are more or less all in the same place: at the banks. SIVs have been consolidated, basis trades collapsed and CDO super-seniors brought back onto balance sheets as LSS conduits unwound. Each collapse has hit the banks as more VIEs come back to the books or more credit lines are drawn down on. The rest - Peloton, Fannie, Freddie et al - is, for want of a better term, collateral damage.

Was the explosive growth of the originate and distribute model then, beyond its vanilla origins, just a impressive juggling act?

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