Thursday, November 12, 2009

U.S. Securitization Likely to Become More Expensive

Posted in the Wall Street Journal by Anusha Shrivastava:

The $1 trillion market for bonds backed by consumer loans is facing fresh challenges on its road to recovery, thanks to some accounting-rule changes designed to have issuers, mainly banks, retain a larger stake in these deals.

The rules, which take effect in companies' next fiscal year, will make issuers hold capital against the so-called asset-backed bonds they sell to investors. In this way, the issuers will no longer be able to pass on the entire risk of the security to the investors, which is designed to encourage them to be more careful in lending.

But some market participants said that keeping these packaged loans on issuers' balance sheets will make banks' finances less flexible and will make it cost more to bundle auto loans, credit card balances and other consumer debt into bonds sold to investors. This, they added, will raise consumers' borrowing costs.

Until these rules take effect, issuers are required to set aside reserves for bad debt based only on the amount they keep on their books, not for debt they bundle into bonds and sell to investors or parcel into their own quasi-independent companies or off-balance-sheet entities.

"Barring any significant changes to the regulatory capital framework, this will make securitization a vastly less economic proposition for would-be issuers, as beneficial capital treatment is lost," Deutsche Bank analyst Katie Reeves wrote in a recent note to clients. Deutsche Bank underwrites several asset-backed deals each year.

Another wrinkle is that by making banks hold capital against these bonds, the institution shows assets on its balance sheet even though the credit risk has been sold to investors. "Since the seller of the transaction has sold the risk, they shouldn't be required to hold additional capital to protect against losses they didn't incur," said Tom Deutsch, deputy executive director of the American Securitization Forum.

That said, growth in the securitization market spurred the lending boom which, in turn, encouraged loose underwriting standards. Eventually, that led to the credit crunch as investors withdrew from the market, having grown wary of the assets backing these bonds.

The rule changes, emanating from the Financial Accounting Standards Board, could create a logjam in the securitization market, which is currently propped up by the Federal Reserve through its Term Asset-Backed Securities Loan Facility. Under TALF, the central bank makes below-market-rate loans to investors who purchase newly created bonds.

More than $90 billion of such deals have been sold using TALF financing. As markets have calmed and then rallied over the last few months, investors have increasingly been willing to use their own money rather than leaning on the Fed to buy these bonds.

These new rules, however, could stymie the market's recovery, critics said. Requiring banks to hold reserves against asset-backed securities they have sold to others could "curtail the frequency and reduce the size of issuance," said Jim Harrington, senior portfolio manager at Ryan Labs Asset Management in New York.

Already, new credit card-backed deals have plummeted--there have been none since the beginning of October. This is because the Federal Deposit Insurance Corp. would have first right to credit-card securities on a bank's balance sheet if the bank goes into receivership. That would diminish the rights of the bondholders.

The FDIC is aware of this catch, and could issue guidelines on its position this Thursday.

Until there is clarity on these issues, Deutsch of the ASF said new deals will be slow to emerge, "which will leave less credit available for consumers."

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