While a large component of the securitization community spent the last two weeks in tumble-weed country, attending either of the two annual Arizona-based conferences, the whole world has gone to hell, so to speak. By that, we are referring to the exponentially mounting regulatory and accounting scrutiny over the treatment of special purpose entities (or companies, or vehicles), and the trickle-down effect that has brought securitization into mainstream headlines.
Why shouldn't it? As noted during a general opening panel at Strategic Research Institutes' Asset Securitization 2002 Symposium, all true securitizations are structured through SPVs (that's thousands and thousands of SPVs), commonly in offshore arrangements. Most of these are structured so as to remove assets from a balance sheet, which, on a surface level, eerily aligns the ever-maturing ABS market with the slimy arrangements under scrutiny associated with Enron Corp.
So what's the upshot for this market, which broke volume records last year, despite facing several tests of market integrity (i.e., CDO downgrades, LTV Steel, Heilig-Meyers, Hollywood Funding)? Next in line: consumer credit. Or how about NextCard's NextBank, which was closed by the OCC and seized by the Federal Insurance Deposit Corp., and whose early-amortization triggers have apparently been frozen by the FDIC? But do any of these match up to (or contribute to) the horrific implications of a rapid, and potentially irrational legislative reaction to Enron, whose bankruptcy has brought the terms "SPC" and "off-balance sheet" to the household level.
Is this ABS Armageddon, or just a bump in the road? At the least, we got to see the word securitization (in quotes, albeit), in the headline of the top story in last week's Money and Investing section of the Wall Street Journal.
"The vast majority of securitization is not at risk, and the regulators are not going to be on a witch hunt," argued Jason Kravitt, a senior partner at Mayer, Brown, Rowe & Maw. According to Kravitt, he has been in contact with the federal regulators concerning the Enron issues. "They recognize the value of securitization... And while they may take a harder look at a variety of transactions, there's not a desire to destroy the industry or the use of that as a mechanism to finance, or to finance your customers."
However, even Kravitt admits that it's somewhat of a wait-and-see situation. Others agree.
"The link between securitization in general, as a financing tool, and Enron, is sort of problematic, because what Enron was doing is not securitization in the way people operating in this market understand it," commented John McElravey, a researcher at Banc One Capital Markets. "What you don't want to see is some sort of knee-jerk reaction to what an individual company was doing, and potentially hurt the hundreds of other companies that are using securitization appropriately."
The short-term impacts could be interesting, however, as it could depress issuance to a degree, something already seen in the ABCP market (see last week's ASR, p. 1).
"If anything, it's going to improve the value of ABS, because it could make it harder to issue new ABS," said Mark Adelson, head of structured finance research at Nomura Securities. "It could boost the value of outstanding ABS."
"If companies get the idea that they have some sort of regulatory problems because of securitization, that could impact issuance," another ABS analyst said. "And that could have an impact on spreads in the secondary market."
Again, as with Enron, the NextCard situation is a wait-and-see situation. Currently, several industry participants are urging the regulators to let the trusts wind down, as is expected in insolvency. However, the FDIC is within its rights to freeze the trusts and keep them going, and the risk of this happening is written into securitization prospectuses from bank-regulated entities.
The FDIC's intention, apparently, is to preserve the value of the NextCard business/receivership. The FDIC initially thought that maintaining the securitizations would make it easier to sell what's left of the bank, although that theory is open to debate. The real issue, for the ABS market, is beyond what happens to the actual trusts, as some investors would actually prefer the deals to keep going. What's more important, however, is the industry-wide implications of the FDIC's decision, as it will set precedent going forward.
"I think that the market would like to know that the FDIC acts in a consistent manner," said a prominent ABS group-head at a highly ranked bank. "If you remove the specific facts and circumstances, it doesn't matter which way it ends, as long as it's consistent, so that the market can evaluate future situations based on past precedence."
Others shades of Enron
Back to Enron, the bottom line is the Texas-based energy traders abuse and secrecy in its balance sheet management is not symptomatic of the securitization market, which, on the other hand, is considered fairly transparent.
"This is a market where issuers are required to regularly report delinquencies, excess spread and a whole lot of other things," said one ABS analyst. "That's not operating in secrecy."
The only good that could come of Enron scrutiny, suggests Banc One's McElravey, is further accounting clarification, investor enlightenment, and increased transparency.
"If what comes out of this is better disclosure, that can't be a bad thing," McElravey said. "If the investor reporting gets better, that helps us all. But obviously you want to have the right regulations in play."