PHOENIX, Ariz. - Despite the recent challenges facing the securitization of net-interest margins, the technology is adaptable and is anticipated to survive the current legislative challenges and the perceived stagnant interest rates that some had theorized would snuff this sector out. NIMs are still hailed as one the most innovative areas of the asset-backed market.
Speaking at the Residual Interest Finance & Securitization session at last week's ABS West conference, panelists noted the innovations that were added throughout last year as proof that the sector can adapt to change. What's more, the technology - which essentially leverages excess interest - has been quietly, and sporadically, introduced to the auto sector and will soon be attempted in the credit card sector.
The success of the NIMs has already been applied to a few recent small auto loan and lease transactions, with AmeriCredit Corp. having completed two such deals and Capital One Finance currently planning an upcoming auto loan NIM off its 2002-2 auto loan deal. The idea was tried with a lease deal last year, sources said, but due to negative investor sentiment in the fourth quarter, the deal was shelved for the time being. Over the past several years, Onyx Acceptance Corp. has successfully closed a few residual repackagings as well, in the private market.
The three main obstacles for the NIM market, panelists noted, have been the credit quality of the first-loss collateral, rapid prepayments and interest-rate volatility. All three have been mitigated via insurance policies, rate caps and rate "corridor" hedges as well as other hedging strategies. The strong performance of NIMs in the most adverse of conditions has created the strongest demand for NIM bonds among triple-B ABS investors. Issuers have even been able to re-NIM residuals as the original NIM transactions have paid off faster than expected.
This trend of rapid payments of NIM securities, however, is expected to die down due to stagnated interest rates this year, compared to the record-low interest rates that spiked refinance activity in subprime MBS and caused 2000 and 2001 vintage NIMs to pay down so rapidly. Davie Wells, vice president in the capital markets group at Option One Mortgage - one of the leading NIM issuers - noted that a backup in rates would cause NIMs to amortize more slowly than they did in 2002, but that the issuer and underwriter communities would seek ways to reduce the extension risk that investors would face if prepayment penalties, which make up roughly 25% of NIM cashflows, came to a screeching halt.
In addition to the interest-rate hedges incorporated into the structures last year, the innovation of using residuals of collateral with lender-paid insurance (deep-MI), combined with a monoline wrap, has alleviated many investor's fears of the sector.
"The investor audience is like an upside-down pyramid for triple- and even double-B rated ABS, but the audience for triple-A rated uncapped securities with short durations is much broader," noted Chris Hentemann, managing director and head trader at Banc of America Securities.
Even on an unwrapped basis the demand for triple-B NIMs is stronger than for its comparably rated home-equity subordinated counterpart, added Matt Lewis, a senior vice president at Lehman Brothers. Jason D'angelo, associate portfolio manager at TIAA-CREF agreed, "NIMs offer the best cashflows in the structured world."
While the credit card sector has yet to attempt a securitization of residual interest, it is very likely in the near term. In fact, due to the over-subordination of credit card ABS, it might actually be a perfect fit. The short duration of net interest ABS could add liquidity to even troubled issuers, if they can complete the transaction prior to a trust triggering cash-traps. Speaking of the Metris Companies, which unfortunately has already begun to trap cash, one source said that while the timing might not be ideal right now, "Six months ago, making a bet that Metris would last another year was not out of the question." And for financially stable issuers, with investment-grade ratings, "Viability over a one-year period is not even much of a question."
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