Securitisation - A Capital Markets Phoenix?

Within the financial markets in 2008, confidence plummeted regarding the quality of structured products on bank and investor balance sheets. Banks lost faith in structured instruments, were unwilling to trade, and the resulting illiquidity caused an almost total collapse of the securitisation market. Net global issuance slumped by 79% in 2008¹. With the establishment of the Term Asset-backed Securities Loan Facility (TALF) in the US, the government injected a vast sum of money into securitised assets held by banks. The European Central Bank (ECB) took €600bn of such assets as collateral for its (temporary) credit to banks, with further rescue packages from individual EU governments across a two-year period.

A good deal of the early, kneejerk blame on rating agencies, lack of transparency and transfer of risk has been tempered by the realisation that the rating agencies did exactly what they said they were doing and there was really no shortage of information available to the market. The complexity of some transactions was such that every risk nuance could not be comprehensively represented in the shorthand of a rating. The momentum of the market was probably greater than the market’s resources and time for comprehensive analysis and some of the links between assets and markets were underestimated in all the analyses: in hindsight the market could have done with a telescopic as much as a microscopic view.

A raft of regulatory changes are being developed and implemented, the key to which will be to ensure they identify and address the right issues, the real issues behind the breakdown of the market, and do not stifle what has been and could continue to be a valuable and effective form of financing.

Road to Recovery

Despite this dramatic collapse of the securitisation market, there are strong signs of a revival. According to one expert source², securitisation issuance continues, although at a less inflated level than before. Even better, the level of programme credit rating downgrades, certainly in European securitisations, has fallen fast across 2010³.

So what does the future of securitisation looks like? One global consultant has opined that: “Rather than the exotic structures that emerged in the run up to the credit crunch, for the foreseeable future deals are likely to be standalone transactions involving simple structures – for example, one tranche of senior notes, amortising in line with the asset profile, and a small tranche of junior ones, instead of the five or six tranches that had been common.”⁴

Just as importantly, this simplicity of structure will also be twinned with a focus on reliable, solid assets. These will especially focus on residential mortgages, motor and equipment leases/loans, and trade receivables.

Demica’s ongoing research series, the latest phase of which will be published in the spring of 2011, is investigating how top European banks assess the appeal and renaissance of the securitisation. In results received from this research project to date, a majority see securitisation as a significant product area. Some banks predict double-digit growth rates for trade receivables securitisation. One respondent described the current generation of invoice-based programmes as “much more real than the exotic securitisation products and more secure, since it allows banks to spread risks off their balance sheet and to raise funds.”

The collective voice of these major banking players is significant as a barometer of likely growth in securitisation of these stable asset classes. One respondent described invoice securitisation as “vital….. a crucial component in corporate finance.” The detail of this answer noted the attraction for corporates of being able to raise funds based on the aggregated risk profile of their invoice debt pool, rather than their own credit rating, a process that often offers considerable credit price advantage over standard lines of credit.

An international bank responding to the Demica securitisation survey noted that: “It offers more diverse sets of sources/funds, now that traditional tools have dried up.” Another respondent again described the attraction for corporates thus: “The price is cheaper than borrowing; it won’t impact the balance sheet as much as traditional lending products… It offers a method to package and distribute well performing short-tem products and it is an alternative source of funding.”

Conclusion

Although tarnished by the credit crisis, securitisation is evidently still a highly viable, indeed vital, financing tool, so long as the underlying assets are robust and visible. It remains an attractive proposition for originators, arrangers and investors, and retains an important role in corporate financing. Banks will have to raise funds on the wholesale markets to finance their current activities and future growth and so will continue to act as conduits for financing assets such as trade receivables. Corporates need to have the flexibility to restructure their financing in part based on the risk profile of their debtors, rather than just their own credit rating.

The success of these products, however, depends on structuring deals in a way that fosters market confidence. Transparency for originators and investors alike is required to clearly demonstrate what is happening to the underlying asset, right down to the individual transaction level, whether that is the performance of an outstanding invoice, a lease, a loan or a mortgage.

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