When the European Securitisation Forum held its annual meeting in June 2007, thousands of bankers descended on Barcelona to drink champagne and dance to a bankers’ rock band called D’Leverage.
Last month, when the trade body representing financiers engaged in slicing and dicing debt held its 2009 event, a mood of grim austerity prevailed. Instead of a seaside resort, the proceedings took place in a hotel on Edgware Road, a traffic-clogged London street better known for cheap takeaways. In place of plentiful champagne, there was coffee. D’Leverage were nowhere to be seen, since dancing was “inappropriate”, as one organiser explained.
No wonder. Until two years ago, most bankers, and economists, were celebrating the fact that securitisation appeared to be on an unstoppable roll. In recent decades, bankers have become adept at repackaging all manner of credit, from mortgages to commercial loans, into bonds that can be sold to investors. Five years ago, this activity started to explode at a startling rate, both reflecting and amplifying the wider credit bubble.
However, since mid-2007, it has all come to a dramatic halt as investors have taken fright. Whereas $2,500bn (€1,800bn, £1,500bn) of loans were securitised in 2007, in the US last year almost none were sold to private-sector buyers.
“The securitisation market has seized up,” says Tim Ryan, head of the Securities Industry and Financial Markets Association, a trade body.
For those banks whose business models assumed securitisation would only ever grow, this has all come as a brutal shock. It also creates a huge macroeconomic headache.
Precisely because banks have become adept at repackaging their loans into bonds for sale – and thus removing them from their balance sheets – they have been able to provide more credit than in earlier decades. Or, to put it another way, during the past decade it has been investors holding securitised bonds, not just banks, that have been acting as key lenders to the economy.
Citigroup, for example, calculates that in 2008 the securitisation markets were supplying between 30 per cent and 75 per cent of the credit in different sectors of American finance. The western economy has become akin to a twin-engine plane: driven by one motor of “traditional” banking – and another from securitisation.
But the freeze in securitisation markets has led to a dramatic shortage of lending power – a “credit crunch”. Thus the policy question now is whether there is any way to restart or replace this securitisation “motor” to stop the economy slowing further.
“About $8,700bn of assets are currently funded by securitisation [globally] . . . and [if] this securitised leverage matures with no replacement, global economies will be forced to contract,” warns Citi in a report.
In the past year, governments have experimented with stop-gap measures to plug the financing hole. Western central banks have conducted “repurchase operations”, where banks can post unwanted securitised bonds as collateral to borrow funds from central banks. The US government has been running the term asset-backed securities loan facility (Talf) programmes, which give investment groups access to cheap leverage so they can buy securitised bonds. Western politicians have urged banks to increase “traditional” lending.
But so far none of these measures has fixed the problem. Banks cannot hope to fill the hole left by the implosion of the securitisation market with traditional lending, since they are under pressure from regulators to improve capital ratios. Central bank repurchase and Talf schemes are intended to be temporary. Most politicians vehemently oppose the idea of further taxpayer-funded subsidies to the financial sphere.
So what most bankers and many policymakers are trying to do is find ways to restart securitisation markets. In recent months, the European Commission has been pushing a package of reforms that would make them appealing for investors again by imposing more transparency. This is based on the widely held view that credit markets spun out of control because securitisation became so opaque that it was impossible for creditors to monitor risk.
“Securitisations have become ridiculously complex,” Francesco Papadia, director-general of market operations at the European Central Bank says. “Structures should become simpler, plain-vanilla deals.”
The Commission is therefore demanding that rating agencies and bankers disclose more information about deals. Banks should also keep 5 per cent of any securitised bonds that they arrange, so they have enough “skin in the game” to monitor credit risks properly.
Similar proposals have been unveiled by the US administration. Tim Geithner, US Treasury secretary, and Lawrence Summers, President Barack Obama’s chief economic adviser, said in an article that securitisation should, in theory, reduce credit risk by spreading it more widely – but that the breaking of the direct link between borrowers and lenders “led to an erosion of lending standards, resulting in a market failure”.
They have proposed measures that would “impose robust reporting requirements on the issuers of asset-backed securities; reduce investors’ and regulators’ reliance on credit-rating agencies; and . . . require the originator, sponsor or broker of a securitisation to retain a financial interest in its performance”.
Even before such proposals bite, some bankers are embracing simplicity. For example Tesco, the retail group, raised £430m last month by selling a bond backed by a collection of commercial mortgages on its stores. The deal, arranged by Goldman Sachs, was striking: not only was it the first commercial mortgage securitisation for two years but it was also designed to be extraordinarily simple, easy for investors to understand. This was in stark contrast to the deals popular in early 2007.
Moreover, the investors were mainstream asset managers – rather than the “shadow bank” entities, such as structured investment vehicles, that bought most securitised debt during the credit bubble. “This was like the deals that used to be done 20 years ago,” says one banker. Or as Ralph Daloisio of Natixis, the French investment bank, notes: “If yesterday’s securitisations were plagued by an oversupply of highly varied, complex, opaque and illiquid investments, tomorrow’s should be simpler, more standardised, transparent and liquid.”
But this drive towards “transparency” and “simplicity” comes with a catch: reform tends to raise the cost of finance. Deals such as the Tesco bond are likely to be more costly and time consuming than the structures used during the credit boom and if banks are forced to keep 5 per cent of any deal on their own balance sheets, that will raise costs further.
Another problem is investor demand. Before the credit crash, shadow banks provided a significant source of demand. Now many of those entities have collapsed and traditional asset managers are often wary of the field. “Investors want to see the performance over time [of the new proposals]. They need to see evidence that [the market] works better,” says Deborah Cunningham, of Federated Investors, who is involved in attempts to reform credit ratings.
A few brave investors are still dipping a toe in the market by buying existing securitised bonds. Two months ago bankers successfully sold triple A rated securitised bonds formerly held by Whistlejacket, a collapsed SIV. Henderson, the asset manager, says this was “an important watershed” for the market.
Some banks are also busy recycling old, sometimes toxic, assets from their balance sheets. Barclays Capital, for example, has developed tools to conduct what it labels “smart securitisation”, which enables clients, including the Barclays parent company, to cut the capital they must hold. This works by pooling the assets with those of other clients into a securitisation vehicle large enough to be rated by a credit rating agency. With a decent rating, such a vehicle requires a lower level of capital to be held against it. “The securitisation market is absolutely not dead. My team is busier than it’s ever been,” says Geoff Smailes of Barclays Capital.
Yet the $9,000bn question is whether activity such as this can actually restart the business of repackaging new loans – and on that front much still rests with politicians, not bankers. After all, as one central banker notes, at the heart of the whole debate there is a crucial “paradox”: though politicians hate the credit crunch, many also remain deeply suspicious of the whole securitisation idea.
Thus when the securitisation conference took place in Edgware Road last month, Paul Sharma, a senior official at the Financial Services Authority, the main UK regulator, admitted that while he personally believes that securitisation will “return and have a significant and irreplaceable role in the financial system” one “should not assume that this is the majority view”. Or as another senior European regulator says: “There are voices saying we should go back to simpler banking ... to stop all this financial engineering.”
The banking industry, for its part, is trying to fight back by pointing out that a clampdown on innovation is likely to raise the cost of capital. Sifma, the lobby group, recently started conducting discreet opinion polls to assess public attitudes towards banking. “We are convinced that getting securitisation started again is the single most important question facing the capital markets today,” says Mr Ryan.
Meanwhile, the American Securitization Forum announced that its 2010 conference will take place in Washington – not Las Vegas, the casino resort that has hosted recent events. But nobody expects this new dance with politicians to yield results soon: for the moment, in other words, the world seems destined to fly with one of its credit motors spluttering or stalled. It will be a long time before champagne flows freely at securitisation conferences again.
With additional reporting by Patrick Jenkins
‘Time bomb’ in commercial mortgages poses big test for the Fed
The US Federal Reserve is trying to defuse a “ticking time bomb” of hundreds of billion of dollars of maturing loans made to finance shopping malls, office blocks and other commercial property.
The ability to refinance commercial mortgages at low interest rates has been hit hard by the credit crunch.
Commercial mortgage loans to the value of $400bn are due to be repaid this year. If the debtors default, the properties backing the debt could be put up for sale, which is likely to push declining prices lower still.
“I am very concerned about the ticking time bomb we face in commercial real estate lending,” Democratic congresswoman Carolyn Maloney said at a Congressional hearing last month. Her comments are echoed in private discussions with regulators, who fear the sector poses risks to the financial system.
Commercial mortgage financing is split into two sectors. One consists of traditional loans – mostly held by banks or insurance companies. The other consists of bonds backed by pools of loans, so-called commercial mortgage-backed securities (CMBS).
It is this latter sector that the Fed needs to fix. Next week it will offer cheap loans to investors, which they can use to buy CMBS. This method is already being used to pump up demand for securities backed by credit card and auto loans. Extending the plan – the term asset-backed securities loan facility (Talf) – to property is highly complex, not least because of the greater risk of losses. Recently, more than $200bn of CMBS with triple A ratings were downgraded.
“It is very important that the CMBS market revives at some point and that the Fed’s plans work,” says Aaron Bryson, analyst at Barclays Capital. “It is too much to ask for banks and insurance companies to refinance all the maturing commercial mortgages. The CMBS market is needed, too, to avoid a worsening of the refinancing problems.”
With interest rates on some of the $3,400bn of outstanding commercial real estate loans high, it has been difficult for developers to obtain new loans. Commercial mortgages tend to be made only once banks believe they can either sell the loans or finance them via CMBS.
William Dudley, president of the Federal Reserve Bank of New York, which runs the Talf, stresses that fixing CMBS is the biggest test yet of attempts to revive the securitised markets. Its roll-out “will be important in determining the overall success of the programme,” he says.
Slice, dice and shift
Say “securitisation” and people “think of on-off balance sheet, manipulation, Enron and Parmalat . . . obscure language, high fees and toxic assets classes”, as PwC, the consultancy, wrote recently. But the technique emerged long before these scandals. In the 1970s bankers hit on the idea of issuing bonds backed (“secured”) by cash flows, such as interest payments, generated from a pool of assets, such as loans. Typically a bank or company places assets in a legally separate special purpose vehicle and the SPV then issues notes to investors – sliced and diced to reflect different levels of risk. In theory, this allows the original company to shift assets off its balance sheet, dispersing risk around the banking system and making room for new loans.