NEW YORK - The asset-backed market is approaching a significant milestone, slated to surpass the corporate debt market in issuance for the first time in its history. Because of this threshold, and other reasons, securitization has become required reading for both corporate debt and equity market analysts.
At last week's American Securitization Forum 2004 Annual Meeting - before roughly 400 attendees that had the main ballroom at overcapacity - analysts from all three markets discussed the role of ABS in reshaping the financial landscape over the past two decades and what the future holds.
Although ABS is just a quarter of the unsecured debt market outstanding and one-tenth of the equity market (measured by the S&P 500), "it is a sizeable portion of the total fixed-income debt market," noted Citigroup Global Markets research analyst Ivan Gjaja.
As has become a standard at ASF gatherings, the audience was polled on different topics, including whether an investor would rather be in ABS or corporate debt in the event of seller insolvency. ABS won out 66% to 5%, with 29% unsure (see related graphics for poll results).
While the returns on primarily triple-A rated ABS are sometimes lower than equity and debt, and the upside is limited - such as in a takeover situation - the returns have proven much more stable, noted Gjaja.
Using empirical spread data, Gjaja stated that the yield pickup for triple-B credit card ABS was 18 basis points for Capital One Financial and 10 for MBNA America Bank when compared to comparably rated (Capital One Financial is split rated) corporate unsecured bonds. Credit card ABS spreads, he added, had a "very stable" five basis point standard deviation over.
Sanford Bernstein equity analyst Howard Mason credited securitization as having "opened up a new area of funding" for finance companies, an innovation he compared to the 19th century development of the swivel for cannons on a battleship - leading to development of weapons sights that over the last hundred years has evolved into laser-guided missiles. "ABS de-coupled [an issuer's] reliance on regional bank deposits," and allowed for the development of risk-based pricing for lenders.
The use of risk-based pricing permitted credit card issuers, such as Capital One, and mortgage lenders, like New Century Financial, to offset cost-of-funding disadvantages versus larger, banking competitors, Mason added. In his opinion, this paradigm is set to shift back, as large financial entities acquire the specialty finance companies, ironically having a negative impact on ABS volume in the future. "ABS must innovate further to remain relevant," Mason summed.
From the unsecured debt perspective, not surprisingly, the risk diversion that securitization facilitates was the feature noted by JPMorgan Securities debt analyst Allerton (Tony) Smith. The diversion of risk has led to the differentiation between prime and non-prime lenders, something Smith cautioned may lead to problems as interest rates rise.
Smith hailed the positive effects of the liquidity provided by ABS as allowing the prime borrower to reduce its debt burden through mortgage refinancing and shopping for advantageous rates to borrow. Conversely, the sub-prime borrower group, which includes a higher percentage of people who don't own a home but rather rent, has seen its debt burden increase because rents have not come down. Complicating the situation, as lenders move further down in credit, is the increased debt that borrowers have taken on.
For issuers, it's critical to expand into new investor bases, by market and geography, since they are positives for credit ratings. "Why is liquidity risk the number-one concern of [rating agencies]?" Smith asked. "Because [they] want the widest variety of funding sources in times of distress. For this, ABS, debt [issuance], conduits and off-balance-sheet funding are all critical."
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