One of the biggest challenges for the securitization industry in 2011 will be managing through the host of regulatory changes that are set to shape its future.
The market also has to steer through the uncertainty that has made it hard for industry players to forecast how they will position themselves in the new year.
"It's the confluence of the changes to Reg AB with Dodd-Frank and Basel 3 all happening at the same time," said Paul Vambutas, a managing director at UBS, when he spoke at a recent American Securitization Forum (ASF) sunset seminar. "Banks as securitizers, dealers or financiers basically have to take un-hedgeable risk retention in the specter of Basel 3."
At the same ASF gathering, Susan Thomas, associate general counsel at Ford Motor Credit Co., said that for her firm there has never been a question about returning to the ABS market.
Indeed, after a brief hiatus at the height of the financial crisis, Ford and other auto ABS issuers returned to the market supported by the government's Term ABS Loan Facility or TALF initiative. And, even after TALF's expiration, these companies have continued to issue at pre-crisis levels. However, Thomas said that there remain big concerns over the short-term regulatory impact on how Ford will conduct its securitization activity once regulation comes to pass.
Thomas said that Ford does not have the option to not securitize since it does not have many other funding options available that are as cost effective.
Effect on Issuers/Buyers
It is certain that the massive changes ahead will make an impact across the securitization market; for issuers and investors making the decision of re-entering the securitization market, it is all the more difficult because of the uncertainty created by the shifting regulatory environment.
James Mountain, a partner at Deloitte & Touche, believes it is still a lack of confidence that has kept the industry from staging a meaningful recovery. "Consumers and businesses need the confidence to make acquisitions on credit so that we have new financial assets that are essential for new deals," he said. "Lenders need to be able to lend to those consumers, investors have to have confidence in what they are buying - ultimately in securitized products - and regulators need to have confidence that the whole system won't blow up on their watch."
Mountain said that this lack of confidence makes it hard to determine which products will get done by whom and at what costs.
Impact of Changes Felt
On the accounting side, Financial Accounting Standards No. 166 and 167 enacted at the start of 2010 have already worked to deter some of the more traditional securitization issuers that typically turned to securitization for the off-balance-sheet reporting perk that is no longer available.
"The accounting rules that have been in effect since the start of the year support the big thrust to increase transparency by issuers and others primarily by creating a bias having securitization transactions characterized on balance sheet as secured financings," Mountain said. "The theory was that all transactions should get reported on somebody's balance sheet at some point."
Up to January 1, 2010, Mountain explained, the industry had gotten good at moving securitized assets off the books to the extent that nobody could get a good grip on the underlying assets in the securitization pool.
"But the accounting standards setter and the [Securities and Exchange Commission (SEC)] are now pushing that line so that it is much more likely that each deal will be on someone's balance sheet," he said. "They wanted to find a home for all the orphans. It is not impossible that the old result of getting deals off balance sheet won't be achieved; it will just be much harder, and existing techniques are by and large less effective to accomplish."
It means that companies that will be doing securitizations will be those that are insensitive to having securitized assets show up on their balance sheets. Determining who those candidates might be - a bank issuer or a hedge fund investor or a special servicer and B-piece investor - will take some time to shake out, Mountain said.
A Harder Case for ABS
In the future, without the benefit of regulatory capital relief, bank costs will go up and, as a result of the limited available capital, balance sheets will shrink.
More than just pushing out the issuers that traditionally looked at the market as a way to achieve regulatory capital relief, by taking out the issue of regulatory capital advantage, Mountain believes that the market is headed to a situation where securitization will be viewed as not having a significant advantage when compared to other funding mechanisms.
"If you are a depository, it would be neutral to issue securities as opposed to funding deposits or borrowing from banks," he explained. "People who had relied on securitizations historically as a capital adequacy vehicle won't be as happy with results as they previously were, but looking ahead it's just leveling the playing field, and securitization will still get done to a cost of funding without capital arbitrage considerations."
He added that securitization will enjoy fewer, if any, benefits vis-Ã -vis other alternatives that are available to banks. Previously, he said, securitization structures were relatively preferred mechanisms, but their advantages are going to go away.
As an example, Mountain explained the case of securitization versus covered bonds.
It used to be that a covered bond remained on balance sheet where a securitization could have been done off balance sheet. In that situation, Mountain explained, there might have been some preferential capital treatment for securitization because capital starts with a booked balance sheet.
"In the U.S. the concept of covered bonds hadn't been developed, so there wasn't much of a capital treatment to make a claim - for example, to say here are the reasons why funding for covered bond vehicles ought to be preferential from a capital standpoint. It now becomes less beneficial but more neutral. Securitization provided lots of advantages that are going to go away."
Risk Retention Still a Hazy Point
Vambutas believes that the biggest challenge to the market lies with risk retention requirements, particularly because players are facing several layers of these onerous requirements as a result of Basel 2.5 and 3, combined with the other risk requirements under the Dodd-Frank Act.
"There are certainly fewer advantages to securitization, if any," he said. "One of the challenges is if banks are required to hold on to 5% of securitization exposure forever and then be subject to negative capital requirements associated with downgrades on those securities again forever on an un-hedged basis. The forever nature of that will make retention of securitization exposure difficult for banks."
It is likely that for segments of the ABS market such as student loans, issuance might move toward specialist setup as a way to minimize impact of conflict of interest with Basel 3 and Dodd-Frank risk retention requirements.
For municipal securitizers, Vambutas explained that being subject to the Dodd-Frank Act, but not other regulations, has created some debate in the municipal industry. On the one hand, making municipal securitizations subject to the Dodd-Frank Act is a violation of two amendments that prohibit the SEC from requiring municipalities to file documents before the debt is sold.
Vambutas explained that under those amendments, the municipal issuer is arguing that they should not be subject to regulatory regimes.
On the other hand, the disclosure from municipal issuers for the debt that they issue and student loans is far inferior to that of corporate issuers of student loans.
"It will be interesting to see how that will play out," Vambutas said. "If it is ultimately concluded that muni student loan ABS will remain subject to regulatory reforms, it will make it more difficult for them to keep their lesser disclosure regime. If ultimately they do become subject to Dodd-Frank, it could change the framework like auction rate restructuring, and ultimately the student loan sector would look like other sectors in ABS."
Outside of student loans, it is likely that each sector will develop its own methodology of compliance with various regulatory regimes. In some cases, the market will see some specialist issuers buying collateral from others and securitizing based on their own corporate structures.
"The natural bias will be toward people who have a natural tolerance for having securitized assets on their balance sheet because of the additional extra layer of costs and effort to arrange deals that aren't on anyone's balance sheet - that technology has yet to be invented," Vambutas said.
