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Emerging From Distress: Euro Issuers Stir Still Waters
Asset Securitization Report--SourceMedia (January 28, 2008)
Bad news continues to hit the ABS sector. Nonetheless, in these times of economic stress, securitization could still be used as a viable financing tool. But how can investors be lured back?
"We remain convinced that despite some of the recent problems, there is a macroeconomic benefit of securitization providing efficient credit to consumers and corporations," said Hans Vrensen, director of European securitization research at Barclays Capital. "Since we are talking about structured finance, we are convinced that through creativity, determination and cooperation, structures will adequately address investors' concerns and restart those markets that are now stalled."
The million-dollar question now is how does the market get investors to regain confidence. Fraser Malcolm, head of ABS syndicate at Dresdner Kleinwort, said that his trading desk has been fairly active with investors looking to go long through credit default swaps and occasionally through AAA' paper, although only on selective names. "In the wider market, it's been nothing but bad news, and the European cash ABS market has become increasingly illiquid over the past few months," he said. "More worryingly for the future of the market, we are now seeing a number of significant mezzanine investors put up the white flag and sell down their portfolios."
Nevertheless, Malcolm said there are still a good number of deal mandates, although most of this activity continues to be retained for repo funding. Through the end of 2007, the market saw many European banks hoarding liquidity. A huge amount of cash is expected to be redeployed in 2008 as more normalized conditions develop. "The ECB will have to downscale its repo facilities eventually and push issuers back into the market," a market analyst said.
Short-term bank-related funding spreads, as measured by ABCP or interbank rates, have normalized appreciably in the first few weeks of 2008 and, based on some measures, spreads are back at pre-crisis levels, Deutsche Bank analysts said. On the flip side, price action in corporates and financials continues to widen, with credit spreads reaching historic wides on recessionary fears. Leveraged loans have also sold off in recent weeks, with the key synthetic indices hitting new lows. Deutsche analysts said a stabilization of financial credit is probably necessary before ABS spreads can stage a recovery. Even in such a scenario, they expect the recovery to lag that of vanilla debt based on the asset overhang and potential weakening in credit fundamentals.
But there is anecdotal evidence that the market is gearing for a comeback, including talk that some investment houses have already garnered mandates for transactions that are ready to come to market as soon as the time is ripe. For instance, sources said Linklaters is currently working on at least seven deals.
"A lot of deals are reaching the point where they are ready to come to market, but no one wants to be the person to launch them with the increased pricing," a law firm source said. "Players are going to be in a wait-and-see mode."
Paul-Michael Rebus, co-head of the securitization and structured finance group at McDermott Will & Emery UK, said that, in the last two quarters of 2007, his firm has kept reasonably busy, earning approximately $10 million from its securitization practice. Last year actually saw the debut of the structured finance team's London base, Rebus said. The firm could have done more, but with four partners and seven other fee earners, there are only so many transactions that can be worked on and supervised, he said, adding that he intends to double his team over the course of the year.
"We've been working on a number of different types of transactions including restructuring SIVs on behalf of capital noteholders, restructuring a number of European multiseller ABCP conduits and doing a number of synthetic based securitization structures," he said. A testament to the times is that there has been very little activity from the pure arbitrage conduits. "People are still tweaking structures to work better with Basel II requirements. Additionally, sponsors are looking to make their structures more streamlined and, given the tightening of the markets, giving the conduits more flexibility from both the funding and asset side."
As a result, Rebus said his firm is seeing requests for more credit derivatives instruments to take assets and/or risks out of the conduits, a move aimed at making investors feel more comfortable.
"In the future, we expect the European ABS derivatives trading market to get much bigger as new participants, notably hedge funds, get involved," Dresdner's Malcolm said.
Rebus said that his firm is also looking to do three fairly large deals that are like synthetic CLOs issuing credit-linked notes while trying to improve disclosure on ABCP conduits.
Rebus also expects more banks to have increased dialogue with investors who are now more vocal about what they want. "We are seeing a bit of a different approach in the deals we are working on. The banks we are working with are placing deals with limited investors and structuring these deals to meet with investors' specific needs," he said, and added that the team was recently working on a structure that, although near completion, had to be overhauled because an investor who was buying up a majority of the deal had a shift in their investment requirements. "Fortunately, the structure and the arranger were flexible and we could facilitate that change," Rebus said. "More than ever, it's become about having flexibility to give clients and investors what they need. I think this is the sort of communication between investors, arrangers and legal counsel that will continue for the foreseeable future."
Additionally, there has also been a heightened level of disclosure even on regular deal reporting, which has given the rating agencies a way to compare conduits with one another.
Investors in most U.S. and European subsectors are holding back, Royal Bank of Scotland analysts said, because they are unclear as to how the initial liquidity problems will translate into wider credit concerns, focusing specifically on the possibility of a U.S. recession.
"The problem the sell side community is now facing is that, due to the unprecedented spread volatility we have seen in a market that was previously deemed to be a safe haven and even a bit boring, there has been a significant breakdown in trust among the buy-side on issues ranging from the value of the rating to the level of liquidity that will be provided going forward on a transaction," Dresdner's Malcolm said. "If you add this to the fact that a lot of leveraged investors have been taken out of the market due to their funding being pulled, then there's quite a challenge ahead to bring some sort of form of normality back to the European ABS market."
Before 2007, the relative rating stability and outsized returns provided by European securitizations led to new entrants coming in each year from a wide range of sectors. However, market confidence has waned and buyers just don't trust the rating agencies and deal structures, Royal Bank of Scotland analysts said.
"Monoline downgrade risk, collateral fears, Merrill's results and SIV disposal risks spooked the market and sent nervous buyers back into hiding," Societe Generale said. "We had expected volatility, but the timing and magnitude were beyond our expectations."
ABS Always Steps Up
With mezzanine investors shut out of the market, it's likely that there will be appetite for only AAA' securities, sources said.
A 2007 RBS investor survey found that most of the bank and nonbank participants expressed an interest in shifting away from lower-rated tranches and climbing higher in the capital structure, behavior consistent with the banks' Basel II and insurance companies' Solvency II regulatory regimes, RBS analysts said.
This flight to quality has caused some players to move away from securitization.
"The problem we are facing now is people at the senior levels, those with the cash and not securitization specialists, saying to their junior people to stay out of (securitization)," Dresdner's Malcolm said. "You are seeing a lot of investors, like leverage investors, who essentially have had their funding cut off from banks and are no longer able to tap the market."
A combination of banks either closing down or interested buyers being excluded has virtually shut down the primary market pipeline. An observer said that the market has generally been misunderstood. Over the last six months, headlines have defined European securitization as synonymous with subprime. "Investors are dead set on avoiding any of that subprime stuff,' even when what is being sold is paper that has no risk associated with subprime," a market source said.
However, securitization remains an important funding tool, especially when other segments of the financial markets are out of sync. In Europe, banks have forayed into the covered bonds or senior secured markets, but as the crisis lasts longer, it's likely that these institutions will have to use securitization once again to diversify their funding options. "When the market does resume, issuers will have to be price takers - investors will call the shots and buy where they see value," a market source said.
McDermott's Rebus said that, at the moment, the team is also working on a big multi-jurisdictional deal for a company that wants to vary its financing options, and the securitization structure they are looking at is tied to company receivables.
"Securitization still comes up as inexpensive when compared to bank lending, especially considering where the interbank rates are and the cost and difficulty for corporates raising funds through equity offerings in such a tough market environment," he said. "Given discussions with clients over prospective securitization deals, I expect the third and fourth quarter especially to be very busy - securitization is such a valuable financing alternative, especially when the markets tighten up."
Rebus added that he expects to see more corporate transactions placed via the ABCP market and more derivatives- based funding solutions, including the use of funds structures in conjunction with traditional securitization techniques.
The consensus remains that for the first two or three quarters of this year, the European securitization market will remain relatively quiet. Expect to see some activity throughout the fourth quarter. But, for the time being, investors seem more than willing to wait.
(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.