At the American Securitization Forum's (ASF) conference held in Las Vegas last week, many of the industry panels looked back at 2007 and reflected on how the market got to the state it's at right now.
Participants also looked ahead to this year, realistic about the market's growth prospects, yet reiterating their faith in the securitization structure.
In the opening general session, panelists were required to evaluate the events in 2007. Vernon Wright, principal at Vernon H.C. Wright, said that securitization has been "an effective tool" that has benefited the American consumer. However, it has been taken to the extreme where the three essential Cs - capital, character and capacity - were forgotten, and there has been a focus on yield with many investors buying what they didn't understand. "Securitization is an extraordinary tool if used well," he said.
Joseph Donovan, principal, Hawthorne Lane Advisors, echoed Wright's assertions. "There is nothing fundamentally wrong with securitization," he said. However, he did say that one of the things that participants failed at is understanding correlation risk such as between triple-A positions and subpieces. He said that it's important at this point to "look back at fundamentals." He added that it's too late to point fingers and that it's important to understand the cyclical nature of the market.
In looking back, participants pointed to the growth of the CDO market as what differentiates this down cycle from others. Mike Nawas, global head of structured finance at ABN Amro, pointed to the "overleveraging effect and the lack of spread tiering in the market."
Another thing that's different this time around is the existence of the ABX Index, which, according to Frank Byrne - panelist and managing director at Deutsche Bank Securities - provided participants with a tool to short the market, which, in turn, has caused volatility.
Market Crossroads
Many participants also looked at this stage in ABS as a crucial turning point. In his speech delivered before the keynote address, Sanjeev Handa, head of global public markets at TIAA-CREF and chairman of the ASF, said that the market is currently at a crossroad where it faces great challenges, and how ABS professionals respond to these will have a "significant influence over the future of the market."
In his remarks, Handa outlined several factors that would position the market for a stronger future. He mentioned that every market participant, from issuers and underwriters to rating agencies, should act responsibly by, for instance, keeping an eye on credit performance. Handa also mentioned transparency, where he emphasized that securitization has very diverse sectors and there should be a focus on what type of information is needed for particular instruments (what data is needed, for example, in cash versus synthetic transactions).
One of the aspects of transparency, Handa said, is the standardization of documentation, especially definitions. The specific example he gave was the term "overcollateralization ratio," the definition of which may vary from agreement to agreement.
In a separate interview, Sherri Venokur, member and head of the derivatives practice group at Lowenstein Sandler, talked about the importance of standardization.
"This the same issue the derivatives market faced prior to International Swaps and Derivatives Association's (ISDA) publication of standard definitions, master agreements and confirmation templates," she said. "Not only did the standardization of derivatives documentation increase transparency and aid in the reduction of credit risk in derivatives transactions but, time and time again, the publication of standard documents for new derivatives products has lead to significant jumps in the volume of trades and the notional amounts experienced in the relevant markets."
Venokur added that the standardization of disclosure documents or even standard definitions would increase investor confidence and is one remedy that should be seriously considered by those in the securitization markets.
Legislative Focus
Another factor affecting securitization, Handa said, is the fact that currently "legislators are focused on our market," although he acknowledged that mortgage finance reforms are national in scope and the goal is to have uniform lending standards. He said that, with these legislative actions, care should be taken that they do not artificially restrict the availability of credit and threaten long-term market liquidity. Such restrictive moves include vesting new rights to bankruptcy courts and overriding rights in legal contracts.
Hawthorne's Donovan said that the government is going to play a more important role as the mortgage market tries to find a balance. "We all feel for borrowers due to the inappropriate behavior of originators." However, he said that the question is how to balance these needs. "Do you create a moral hazard?" he asked.
Aside from the expected increase in government involvement, participants think that it's going to be a very gradual return to normal. Opening general session panelists agreed that liquidity is going to come back slowly into the market, as the price discovery issue still exists even in cookie-cutter sectors such as credit card or autos. Even for these asset classes, they said, the ABS market is still struggling to find a value metric.
Also, securitization players, according to panelists, are still at a point where they are rethinking their modeling assumptions as well as risk considerations for new issue. In a sense, it's back to basics as panelists emphasized the importance of fundamental credit analysis.
Deutsche's Byrne said that the $250 billion core market will still exist in traditional sectors like credit cards. He also expects CLOs to come back in the second half of the year and a smattering of RMBS transactions.
ABN Amro's Nawas said that investors will likely gradually accept the new spread level environment as they broaden their focus. Meanwhile, Byrne added that there is some money out there, although with historically wide levels, new money is tip-toeing. He also mentioned interest from hedge funds that invest in distressed debt. However, the question is whether these buyers could get the appropriate leverage.
It's also going to be a time when executive management in organizations will be more closely aligned with their investment management units to determine where the value is in securitized structures. This point was most often brought up in the different ABCP panels at the conference.
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