Digital Risk In The News

Securitization industry prepares for serious soul searching in the desert

February 01, 2008
By Paul J Davies, Stacy-Marie Ishmael and Gillian Tett
Financial Times

Standard & Poor's dealt a body blow to the already-bruised securitization sector when it aggressively increased its predictions this week for banks' losses from mortgage-backed debt and other complex bonds to more than $265bn - far higher than the $90bn hit so far.

Such news will further depress delegates due to descend on Las Vegas next week for an annual conference that is usually a vast celebration of the money-making abilities of the structured finance industry.

The gathering will be dramatically different from last year's record-breaking event, which attracted more than 6,000 attendees to what now appears to have been the high-water mark for the industry.

"This is not a winter frolic," says George Miller, executive director of the American Securitization Forum, which organizes the event.

The industry, which en-compasses all aspects of re-packaging and distributing debt, such as mortgages, car loans and corporate finance, has been at the centre of a credit storm that began in the US sub-prime mortgage market but is causing losses in countries as diverse as Norway and Australia.

Its products - residential mortgage-backed securities, collateralized debt obligations, structured investment vehicles and asset-backed commercial paper - have been linked to mounting losses at investment banks, bond insurers and money market funds.

These upheavals have cast a pall over the world's debt and equity markets, and attracted intense scrutiny - and criticism - from investors, policymakers and regulators.

The big question for delegates this year is whether they can see a way out of the troubles - or indeed any future for their profession.

"Securitization is a good idea that has gone to excess," says Jamie Dimon, chief executive of JP Morgan. "It is not going to go away but there need to be some changes made."

Some fear the losses from mortgage-backed bonds, CDOs and other products could lead to an overly punitive regulatory backlash.

The banking industry is working hard to offset such risks, with committees on both sides of the Atlantic drawing up plans to improve industry practices.

But most regulators do not think it would be possible, or even desirable, to clamp down too far on securitization. "The originate-to distribute model has basically been a good one," says Malcolm Knight, head of the Bank for International Settlements.

Still, if the economy keeps worsening, the risk of a regulatory backlash will almost inevitably rise too. Or as Charles Dallara of the Institute of International Finance says: "Political pressure on the regulators is growing with every day you see the financial stresses moving into the real economy."

Mark Adams, president of Edenbrook Hill Capital, the Canadian asset management company, says the industry model has to change. "There's going to be a lot more discussion about the needs of investors, and making certain whatever products we build will meet those needs."

For instance, investors are demanding more transparency from structured products, which can be notoriously difficult to analyze, price and, often, to trade.

"In future, what type of deals do we expect to see? It will be back to basics - simpler products with fewer features and more transparency and, where possible, shorter durations," says Citigroup credit strategist Michael Hampden-Turner.

However, in the near term, one of the biggest problems is an almost complete lack of appetite among traditional investors for any deals - and especially for the safest bonds, which make up the lion's share of the funding that flows into the securitization markets.

"With few banks and no SIVs in buying mode, the market requires new investors to recover," says Birgit Specht at Citigroup.

Bruce Miller, a structured finance consultant at Digital Risk, says the conference has come at an opportune time. "The market is in poor shape, and this year, a lot of people are going to Las Vegas primarily because they need to figure out how to bring liquidity, stability and investors back to the market."