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Sep 28

Securitization: don't take it for granted

Posted by dbedell in SIVsecuritizationRiskRepo 105EnronDealsasset backedarbitrageABS


Securitization, at its most basic, is a sound financing technique. This is my basic tenet for today’s blog. With the ABS markets again beginning to pick up, spreads tightening and investor demand growing but supply still limited, it is time for a revisit of just what makes this market so important from a corporate perspective, and why it is way-past time for stakeholders to get it right in rebuilding the market.

I am not here to argue the validity of the regulatory arbitrage that drove the market to such great heights before the crisis. In fact, that is most definitely one of the things that should be addressed as the new world of securitization takes shape. What I am here to argue is the validity and soundness of securitization at its most basic, as a financing structure for corporates.

The basic structure: taking a set of quality assets—or a single quality asset, ringfencing them remotely from the company, and taking advantage of the higher credit quality of those assets to get financing backed by either cash flows from the assets, or the assets themselves, or through the myriad other simple structures that have been used for so long to help companies get cheaper financing backed by strong assets. Simple, basic, sound.

And I would argue that securitization is not only sound, but that it is an important financing technique that provides companies without access to great credit the opportunity for cheaper financing than they would get otherwise and a diverse source of financing away from the bank markets.

Is it true that securitization went a long way to causing much of the upheaval that has plagued global markets and economies over the past two year? Yes, it is likely.

Is it true that securitization has been used to hide fraudulent activity over many years? Well, as it was pointed out to me when considering writing this blog, one has only to point at Enron, Repo 105, SIVs, or the countless other examples to say yes.

But. And this is a big but. How firms have manipulated the basic structure in order to cover their misdeeds—whether legally or not—does not invalidate it as a financing technique. It merely points to the need for greater regulation, greater due diligence, and greater care taken in how it is used and how the market is rebuilt.

I am not here to argue the necessity or lack thereof for that very regulatory arbitrage that made the markets so huge, and made it possible for such increased debt capacity to find its way into global corporate coffers and fuel growth.

That growth may, in fact, come at too high a price if it can only exist in a securitization market landscape such as we saw leading up to the crisis.

One thing is clear. If the regulatory arbitrage is removed, as our illustrious former editor Ron Fink argued for in his blog here, it is certain that the securitization markets will be much smaller than they were in the past. There will be less investor and bank money driven into the markets, offerings will be smaller, and structures simpler.

But it will still exist, and still be an important alternative for companies to make use of their assets in order to raise financing that they might not be able to access otherwise—or would have to pay much more for.

Particularly given the tighter reins that banks are holding on their wallets and the stronger regulatory requirements for lending, having access to diverse sources of funding—including securitization—is ever-more vital to the average corporation.

Given the importance of securitization as a financing mechanism it is high time users—in particular the institutions that took advantage of complex securitization structures to build lending capacity—got it right. Made use of it when it makes sense and did not use it as a mechanism to hide or sell off sub-sub prime assets or to prop up the balance sheet.

As the market redevelops, this is the perfect opportunity for that to happen. I, for one, hope that banks, investors, regulators, corporate users, and other stakeholders take advantage of this opportunity to remember that the structure is sound, but it takes proper care and use to manage.

Because should the securitization market again fall off the rails and create such global havoc as a result of misuse—whether legally accepted or not—it is unlikely that the structure will be given another chance.

The court of public opinion can be very harsh, and hold incredible sway over the legislators that have power to make or break a market.

And should securitization disappear, that would be a sad day for all the myriad companies that use simple securitization to help fund growth.

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