By Charles Schorin, Global Director of Securitization Research, Morgan Stanley Dean Witter
Securitization outside the United States grew tremendously in 2000. Issuance in Europe climbed almost 40% from 1999 to the record-setting equivalent of $79.2 billion, while that in Japan jumped more than 20% to the record equivalent of $22.9 billion
We expect even greater issuance in 2001: we look for European securitization to increase 25% to $100 billion, and Japanese issuance to double to about $45 billion. Non-Japan Asia, for which issuance was flat in 2000, should see similar new supply in 2001.
About half of European securitizations' collateral is from the UK, largely due to the prominence of the residential mortgage backed securities market. The Euro has become the dominant currency for securitization issuance in Europe, although the US dollar still accounts for about 1/4 of the issuance, while the British pound accounts for about 1/3. The currency for ABS issuance depends somewhat on the product being securitized.
Consumer loan securitization in Japan is expected to reach $12-15 billion in 2001, from about $3 billion in 2000. The consumer loan collateral derives from restructurings of insurance and finance companies, as well as other financial institutions. These will also be the source of significant amounts of residential and commercial mortgages, which should lead to Japanese RMBS doubling to about $6 billion and CMBS more than doubling to about $12 billion.
As for Europe, we expect residential mortgage securitization to grow about 25%, although this could be somewhat lower if the cost of retail deposits were to drop or the pricing of partially funded synthetics were to cheapen. While we do not expect to see the introduction of a significant number of new issuers, many of these issuers now have securitization programs under way and should be regular issuers of RMBS.
In terms of European commercial mortgage securitization, we are expecting a more than doubling of new supply, to about $13 billion. We are expecting two primary sources of growth: one is the increased use of conduits to securitize collections of relatively small loans and the other is the use of securitization to provide an outlet for European corporates to raise cash via sale/leasebacks of their real estate. More so than in the US, many European corporations own the real estate on their balance sheets, essentially tying up capital. We expect many of these corporations to sell substantial portions of their real estate and lease back the properties needed for operations. This would be a tremendous source of cash for these institutions, and would also provide the CMBS market with collateral for securitizations.
Engines of Growth
Growth in securitization - as in all credit markets in Europe - was spurred by the Euro's introduction on January 1, 1999. Prior to the Euro, institutional investors in Europe had to distinguish themselves by choosing the "right" currency or the "right" part of the yield curve for that currency. Picking up 20 bp or 50 bp or 100 bp with a good credit call could easily be wiped out by losing 500 bp by being in the wrong currency! With the Euro, currency decisions were made largely irrelevant and credit issues came to the fore: investors would now have to compete by evaluating credit, rather than currency.
At the same time that currency trades became less important, the rate of growth of new government debt was being reduced owing to budget surpluses in the UK, Germany, Netherlands and Finland. With a slower rate of supply growth of government bonds, investors were further impelled to consider credit products.
Investors have also found that ABS have less ratings and yield spread volatility than unsecured corporate debt. This latter point will become especially important over the next few years, given the consensus about a deteriorating credit environment. Finally, some European government regulators have begun to encourage investing in securitized products, as witnessed by the proposals in the UK for pension funds' minimum funding requirement. In addition, the UK accounting profession endorsed FRED 20, which also should be positive for ABS.
Several factors on the supply side also contributed to the strong growth in securitization in Europe. One of the key factors was legislation in several European jurisdictions - Spain, Portugal, Germany, France and Italy - over the past few years that facilitated securitization. The Euro also contributed to supply because it has encouraged bank equity analysts to compare and evaluate banks on a pan-European basis, leading some banks to scramble to raise their ROEs to avoid being overtaken by larger institutions; one way to achieve this is to get assets off their balance sheets via securitization.
Some of the more interesting uses of securitization have been to integrate securitization with corporate finance strategic objectives. These operating company securitizations also called whole business securitizations have taken advantage of the Insolvency Act 1986 in the UK, as bankruptcy law in the UK is much more lender-friendly than in the US. Operating company transactions have taken place most notably in the pubs sector and been tied into mergers and acquisition activity. These transactions have enabled the acquiring company to close their transaction at a lower all-in cost of financing than otherwise achievable. We expect to see an even greater use of this financial technology going forward.
Europe also has seen public sector securitizations to raise off-balance sheet debt. Securitization has been employed in these cases to help the governments achieve Maastricht debt/GDP ratio targets.
We have seen securitization employed to recapitalize lenders with non-performing loans. This enables the lender to get non-performing assets off its balance sheet at the same time that it gets an infusion of capital. Securitization also has given some smaller borrowers access to capital markets, which they would not have been able to achieve on an unsecured basis. This has particularly been the case in the non-conforming mortgage sector in the UK.
Furthermore, with the market volatility seen this past autumn in which ABS spreads were markedly more volatile than those of corporates, and which in many cases drove unsecured funding levels well outside those of funding via securitization, we would expect to see more and more issuers turn to securitization to achieve a greater share of their funding targets.
There was a natural demand for securitized products in Japan due to the relatively low yields on alternative investments, whereas supply received a boost from failing and ailing financial institutions in need of capital, as well as securitization-friendly legislation in Japan in late 1998. There were four trends that we saw in Japan in 2000 and that we expect will continue into next year:
*Tremendous demand growth leading to significant spread tightening of ABS;
*The Government Housing Loan Corporation's announcement of its mortgage securitization program, with RMBS structured as pass-throughs rather than soft bullets , to start in 2001;
*Tremendous growth in commercial mortgage securitization, evolving from the single trophy property transactions to less well-known properties, pools of smaller properties and even real estate non-performing loans; and
*Insurance and consumer finance company restructurings being the source of collateral that will lead to increased securitization volume.
Issuance in 2000 in non-Japan/non-Australia Asia was somewhat limited, with only two international issues totaling $450 million, both from Korea. In addition, there was some domestic issuance in Korea and Hong Kong, totaling $35.5 billion, as well as a smattering of deals from India.
Issuance in 2001 is expected to be flat, in the $35-40 billion range. Again, Korea is expected to have the greatest issuance, followed by Hong Kong and potentially Singapore.
The Australian ABS market continues to be dominated by RMBS, with the recent development of a sub-prime RMBS market. CMBS is starting to expand, with Listed Property Trusts converting unsecured bank borrowings to CMBS, as well as the emergence of sale-leasebacks to pull commercial properties out of corporations' balance sheets. Financial institutions, which have been lending and acquiring assets aggressively, have become focused on securitization as a balance sheet management tool.
In terms of 2001, we expect to see continued strong global issuance of RMBS, including the emergence of sub-prime mortgage securitizations. Look also for the continued development of CMBS by the public and private sector, as well as pub securitizations.
What does this mean
While participation in European and Asian securitizations by US investors has been somewhat limited to date, it is growing. US investors have been attracted to these markets as they afford investors an opportunity to pick up incremental spread and hopefully allow them to ride in a tightening spread market.
Both Europe and Asia should receive a boost in demand from investors in the US looking for highly rated investments with wider spreads than are available on domestic US assets. Our long offered recommendation to "Buy the First" - the first of an issuer, first of an asset class, first of a structure - certainly applies to the European and Asian markets. We recommend that investors take advantage of the opportunities available outside the US, both to take advantage of what we believe will be tightening markets, as well as to geographically diversify their holdings.