`You Can Securitize Virtually Everything'By
Few financial innovations have been more of a bonanza to Wall Street than asset-backed securities. Packages of loans and receivables that trade like securities, asset-backed instruments issued by nongovernment entities have mushroomed into a $50 billion market, up from $9 billion in 1987.
Traditionally, these securities have been backed mainly by car loans and credit-card receivables. The biggest securitized market, over $1 trillion, is home mortgages packaged by such government-owned and sponsored agencies as the Government National Mortgage Assn. (Ginnie Mae). But now, investment houses are pushing the securitization trend into a wide array of other credits--everything from loans for boats and motorcycles to computer leases and commercial real estate loans. GPA Group PLC's Guinness Peat Aviation, Citicorp Investment Bank, and Lehman Brothers International recently underwrote a $312.6 million issue backed by aircraft leases, the first such offering. Earlier this year, Salomon Brothers Inc. sold the first issue of securities backed by railcar leases, a $998 million public offering from an affiliate of Itel Rail Corp. and GE Capital Corp. Merrill Lynch & Co. is preparing what would be the first nongovernment securitization of small-business loans, a $200 million deal for a unit of Fremont General Corp., based in Santa Monica, Calif.
FEW LIMITS. Although issuance of traditional asset-backed securities has been growing relatively slowly, securities backed by the newer credits, according to Merrill Lynch figures, jumped 195% in the second quarter of this year, vs. the first quarter. So far this year, these credits have been the second-most-active sector in terms of new issues after auto loans.
Wall Streeters say the sky's the limit when it comes to securitization. "You can securitize virtually everything," says Andrew D. Stone, senior managing director in charge of mortgage and asset-backed securities at Daiwa Securities America Inc. "The imagination is our only constraint--and time, because you can't chase every deal."
Among the new markets being talked about most enthusiastically on the Street are trade receivables, hospital receivables, computer leases, auto leases, loans of bankrupt companies, U.S. receivables of European and Japanese companies, and car-dealer receivables. Perhaps the biggest and the most difficult potential market could be commercial real estate. But even niche markets are finding buyers. Says David Katz, senior vice-president of Ironwood Capital Partners Ltd., which recently sold a $60.3 million issue backed by photocopier leases: "It was extremely well-received. We were oversubscribed."
Stone's division at Daiwa specializes in even more exotic--and often problematic--assets. His deals include nonperforming condominium mortgages in New England, mobile-home-park loans, and home-equity loans from bankrupt institutions, all of which were placed with private investors.
The reasons behind the rush to securitize are abundant. By transforming virtually illiquid, often risky individual loans into much less risky and more liquid securities, securitization has attracted a wide array of eager investors and has vastly expanded the debt market. Investors like the relatively high yields and investment-grade credit ratings of asset-backed securities. Most of the issues receive AAA and AA ratings because of the wide diversification of the loans and because rating agencies insist on further protections to investors. In June, Merrill Lynch was able to sell $250 million in securities backed by mortgages issued by Walter Industries Inc., which is currently in bankruptcy, because the issue was substantially overcollateralized and guaranteed by an AAA-rated bond insurer.
Loan originators, such as banks and insurance companies, like securitization because it allows them to make loans and then quickly move them off their balance sheets, which lessens the capital they need for loan reserves. Borrowers benefit because asset-backed securities attract much more money. And Wall Street, of course, likes the hefty feeincome.
GREATER RISK. Detractors, though, worry that securitization could go too far. The process works best when the packaged loans are homogeneous and have predictable risks and income streams. But that may not be the case with some of the newer categories of loans. "There's more risk associated with these assets because there is less information readily available," says Howard W. Albert, director of asset-backed securities for Financial Guaranty Insurance Co., which has done $3.7 billion in guaranteed asset transactions.
Mortgage-backed securities were first developed in the early 1970s by Ginnie Mae. Along with the Federal National Mortgage Assn. and the Federal Home Loan Mortgage Corp., Ginnie Mae vastly expanded the market for residential mortgages. That laid the groundwork for flourishing nongovernment securitizations.
Although investment firms are the most active proponents of expanding the markets, regulators have also been urging more securitization. In its proposal to overhaul the Investment Company Act of 1940, the Securities & Exchange Commission included a number of changes that would open the door to the public sale of a broader class of asset-backed securities. More specifically, SEC Chairman Richard C. Breeden has emphasized that he would like small-business loans to be securitized as a way to lessen business' credit crunch. To accomplish this, the SEC is expected to modify rules that restrict loans backed by receivables.
Bank regulators are also considering regulatory changes in accounting and capital requirements that would make securitization of commercial real estate loans more appetizing for banks. That could ease banks' capital pressures.
The pioneer in commercial real estate has been the Resolution Trust Corp. To date, the RTC has turned $1.3 billion in performing commercial real estate mortgages into securities. The RTC's first issue yielded 8.8%, about 2 percentage points over seven-year U.S. Treasury bonds. But to get the AAA rating from the rating agencies necessary to attract a large pool of investors, the RTC had to keep a huge 30% cash cushion against losses.
As if that were not enough of a challenge, the RTC is now trying to securitize and sell its $6.6 billion in nonperforming commercial real estate loans. That won't be easy. "These differ from the performing mortgage deals because with them you weren't looking for anyone to do anything with the loans," says Kenneth J. Bacon, director of the RTC's office of securitization. "Here, we're saying clearly that to realize value, someone will have to monitor these mortgages and actively manage them." The RTC plans to recruit workout specialists as equityinvestors.
Outside of the RTC, however, only a very few commercial real estate securitization deals have been concluded. According to David Tibbals, a managing director with Salomon Brothers, investors are uncomfortable with the potential risks. In some cases, they're demanding such high yields that the deals are uneconomical for most banks.
COOKIE CUTTERS. While enthusiasm for securitization is at a high pitch, developing a wider and deeper market for many of the loans will be tough. A major problem is that many of the loans involved with some of the proposed varieties of asset-backed securities may not be sufficiently homogeneous and predictable. Home mortgages packaged by Ginnie Mae and the other agencies are popular because lenders are required to adhere to very strict guidelines, such as loan-to-value ratios. Securitization of home-equity loans, by contrast, has proceeded very slowly because loan standards vary widely among lenders.
Critics of securitization also wonder about the extent of unanticipated risks lurking in unseasoned assets. Many of the newer securities may turn out to be much less liquid than home-mortgage-backed issues. Investors--primarily pension funds and money managers--may not find much of a secondary market if they need to sell.
Regulators, too, are concerned. They fear that the practice will lead to banks making only "cookie-cutter" loans that are easily securitized afterward. That could leave out some legitimate borrowers who don't fit the pattern. Asks Robert F. Storch, chief of the accounting section of the Federal Deposit Insurance Corp.'s Supervision Div.: "Is that serving community needs properly?"
These drawbacks may impede the new securitization boom, but probably only slightly. "It won't explode overnight like some of my investment-banking friends would like it to," says the RTC's Bacon. "But that's probably healthy in the long run. Fast growth often leads to a fast fall, like in the 80s." For overeager securitizers, that's good counsel.
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