Securitization is not going away any time soon despite the market storm that has rocked global credit markets, according to Jose Manuel Gonzalez Paramo, a member of the European Central Bank's (ECB) executive board, who says the reselling of debt such as mortgage loans and credit cards is still a valid business model.
Gonzalez Paramo was at European Securitization Forum's and Information Management Network's Global ABS 2008: Piecing It All Together conference held in Cannes, France last week.
Speaking at the gathering on Sunday, Gonzalez Paramo said "it is clearly not the end of this business model ... securitization is a long-established and broadly-used financing technique that covers a vast range of asset classes. There is still demand for related financial products from certain types of investors. Since the fundamental business idea behind the model is still valid, hopefully a more sustainable version of it will evolve."
The ECB official said securitization, an idea which got its start with U.S. financial institutions in the 1970s, has been embraced by many European banks and took off within European Union nations over the last five to 10 years where a single currency aided issuance.
"The securitization of their loan portfolios has provided banks with access to an additional funding source and enabled them to mitigate some of the risks intrinsically related to their core business of liquidity transformation," Gonzalez Paramo said.
Securitization, the ECB official said, has also played a role in economic growth. The ability for lenders to resell loans has allowed them to "sustain a given level of credit supply with a lower volume of capital enabling the banking sector to reduce the costs of financing for borrowers and favoring financial development, which is ultimately associated with economic growth. Moreover, securitization may be seen as representing a step towards more complete credit markets, thereby contributing to enhancing the efficiency of the economic system."
The ECB official said the securitization market has improved but issuance is still off. He said the industry was still at a stalemate in which sellers of ABS - that is, issuers - were reluctant to bring deals to market at widespread levels while buyers were still holding off from buying bonds in hopes of seeing lower prices.
Gonzalez Paramo said that what started as a subprime mortgage debt problem in 2007 has bled into a wide range of securitized products, including commercial mortgage-backed bonds where issuance dried up in late 2007. According to the ECB official, European CMBS issuance has dropped 28% in the first four months of 2008 from year-ago levels. ABS issuance activity in the Euro region in the last quarter of 2007 dropped to 2 billion from 6.2 billion a year earlier.
Meanwhile, bonds backed by residential home loans in the first four months of the year have dropped 15% from the first four months of 2007. The ECB official noted, though, that the issuance level of residential mortgage bonds in March-April this year was higher compared with the same period last year.
Looking ahead, Gonzalez Paramo said the ABS market needs to have improved transparency. Asked by audience members why or how investors did not understand collateral of bonds Gonzalez Paramo said investors "did not know what was in the structures."
The ECB official said that transparency "was not in the optimum." Gonzalez Paramo said "information provided to the market by institutions involved in the securitization process has been limited, especially in relation to the quality of underlying asset pools. This lack of transparency, both on exposures to instruments and at the level of the instrument itself, contributed to the loss of market confidence and ... led to disruption in various segments of the financial markets. The complexity and opacity in instruments supported also to an over-reliance on ratings and rating agencies.''
Asked if the ECB and the Federal Reserve differ in how they address the current credit crisis, Gonzalez Paramo said he would not try to elaborate issues on which policy makers of both central banks differ, but he did note that the two central banks agreed on how to improve liquidity.
Specifically, he cited a March decision by the Fed's Federal Open Market Committee (FOMC) to authorized increases in its existing temporary reciprocal currency arrangements (swap lines) with the ECB and the Swiss National Bank (SNB). These arrangements provided dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB, respectively, representing increases of $10 billion and $2 billion. The FOMC extended the term of these swap lines through Sept. 30, 2008.
"We understand problems along the same lines," Gonzalez Paramo said, referring to the ECB and the U.S. Fed's collaborative efforts to shore up liquidity.
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