Amid anxieties over what lies ahead, conference delegates got some strongly worded advice last week on how to promote the ABS industrys recovery: bite the bullet, take losses and structure future deals with larger equity components. If the subdued cocktail parties and many underlying bar-side conversations did not underscore the markets shaken confidence, then the remarks delivered during the opening session of IMNs ABS East conference might have.
The outlook for the structured investment vehicle (SIV) markets health drew some of the most unsparing remarks during the session. SIVs had seen stunning growth over the last several years, and they suffered accordingly when gun-shy investors withdrew liquidity support for the instruments.
SIVs are generally levered by a factor of 21 to one, get 90% of their funding from asset-backed commercial paper (ABCP) and enjoy triple-A ratings, explained Steve Eisman, a managing director at Frontpoint Partners. How then, he asked, could investors perceive them as having the same level of credit risk as a company like Annaly Capital Management, formerly known as Annaly Mortgage Management? That company is levered by 10 to one, sells government-guaranteed mortgages and gets its funding from banks through the repo market, Eisman said.
"Let me tell you whats wrong with your world," he said. "The entire structured-finance world should be levered five to one. You are going to delever a lot, and it is going to involve a lot of pain. People will have to sell assets and take losses.
Eisman also took aim at M-LEC, the conduit sponsored by a bank syndicate and designed to provide liquidity support to the SIV market.
"By the way, M-LEC is an obscenity, said Eisman. "The solution to the SIV crisis is that people need to sell and take losses."
Other panelists did not promote taking that course of action. Instead, they said industry professionals would have to accept lower volumes and restructure vehicles while waiting for the ABS market to come back to life. The ABCP market, which had about $1.2 trillion outstanding debt at its height, will shrink to about $700 billion to $800 billion, said Douglas Jones, president and CIO of Maxim Capital Management. The SIV-lite structures, which have smaller volumes and other simpler structural features than long-standing SIVs, will probably disappear altogether. The same fate likely awaits ABCP structures that make use of extendible-note features, said Jones.
"The magnitude of what's happened is so amazing," he said. Paul Colonna, president and head of fixed income for GE Asset Management, recalled one particularly amazing turn of events during the ABS market's summer of discontent. During the auction of 90-day Treasury bills in August, Colonna said, he heard various estimates of pricing, sometimes hitting on 3% or 5%.
"The U.S. government did not know where it would price itself," Colonna said.
Less startling, he said, was the fall of two Wall Street CEOs, namely Charles Prince of Citigroup and Stanley O'Neal of Merrill Lynch; $35 billion in write-downs and a downgrade of Citigroup at the parent level. The uncertainty surrounding pricing for the 90-day Treasurys, Colonna said, sent an undeniable signal to the world that the capital markets were in a liquidity crunch.
Looking ahead, panelists generally expected ABS issuance volume to be flat in 2008. Richard Johns, head of securitization and global capital markets for credit card ABS issuer Capital One Financial Corp., predicted that companies looking for funding would rely less on the capital markets.
"I've seen the ABCP market suffer" in other ways, Johns said. Notably, some issuers have less access to credit from the ABCP market, a situation that would force them out of that subsector for funding and into the term market.
Although Monday morning's session was sobering, not every moment was gloomy. Session moderator Kevin Duignan, head of Fitch Ratings' term ABS and ABCP groups, facilitated the discussion with dry (and wry) wit in the form of pseudo-proverbs that amused the large audience, even if they did not inspire.
While the Treasury auction uncertainty was a big surprise to GE Asset Management's Colonna, McKee Nelson partner John Arnholz had a shocker that hit closer to home.
"For me it was when my mother-in-law asked me what an SIV was," Arnholz said.
Three major factors-the general economy, investor confidence and legislative issues-will drive activity in the ABS sector during the next 12 to 18 months, said Arnholz. "The housing downturn looks like it has a ways to go," he said, adding that a prolonged shutdown of consumer spending increases the likelihood of an economic slowdown.
In the short term, a couple of distinct buying opportunities present themselves to the ABS market, said Colonna. The ABX is entering a bottoming process, he said. Eager buyers might see more opportunities crop up after investment banks adjust to management changes. Secondly, I/Os and anything that benefits from current conditions like sluggish home price appreciation, make attractive trades.
Jokes aside, the morning session reinforced the idea that recovery would be slow and at times painful, something that many conference delegates have known for weeks.
"Your market has not been tested," said Eisman, addressing Jones during the latter's remarks about the ABS market's near-term outlook. "This [period] will be a real test of your market, so let's see how you do."
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