All three rating agencies have confirmed that they are deeply involved in the review of several proposed transactions that will securitize receivables generated by the margin loans or "margin debits" made to investors who buy stocks for broker-dealer accounts with borrowed funds - known as "buying on margin."
While this novel type of securitization has shown up sporadically in ABCP conduits, there has never been a margin-loan term deal, sources said, though the first one may be very close to fruition.
"People are currently looking at this and are actively investigating and pursuing it," said Michael O'Connor, senior credit officer at Moody's Investors Service that focuses on new asset classes. "People are looking at specific deals, because there is a lot of margin debt still out there, so there is a huge potential market for this."
"As soon as one firm does this, the floodgates are going to open," added David Howard, a managing director at Fitch. "And the timing may be just right, because there has been a record amount of margin debt over the last year. I have periodically received calls about these deals, and I can see why there would be interest in this now."
Similarly, the market-value group at Standard & Poor's structured finance department is in the midst of analyzing the new structure and quantifying the risk involved, and expects the deals to eventually be done as private placements. "We have several margin-loan transactions on our desk at the moment, so these are live deals," said Erkan Erturk of S&P's market-value group. "We are investigating it in detail and trying to give it a risk rating, and from what we see, it will be a viable new asset class. You will see more interest in this type of securitization going forward."
The time is ripe
Until recently, the use of borrowed funds to buy stocks had risen so drastically that one year ago the New York Stock Exchange asked some big securities firms in the U.S. to provide more-detailed information about margin-lending activity.
As of mid-2000, margin debt stood at a record $265.2 billion, according to the Wall Street Journal. "When the market was at its height last year, more than 13% of all consumer debt was in the form of margin loans, not including residential mortgages," noted S&P's Erturk. "Since then the numbers have declined. But when you have that much percentage in consumer debt, the issue is funding it. Broker-dealers need an alternative funding source in order to diversify."
Additionally, the margin-loan business has changed. In the past, only selective people could get loans, but in recent years more average people used margin accounts as a way of leveraging their position, especially with the use of the Internet.
So the time might be ripe for a margin-debit securitization; and apparently, the idea has been floating around internationally, as well: S&P analyst Ted Burbage confirmed that margin-debit paper has been issued by an ABCP seller/conduit in Australia for the last two years, and the rating agency is currently developing criteria for rating a term deal.
Additionally, several transactions have been attempted before but were never completed. As far back as 1995, National Australia Bank Ltd., one of Australia's four major banks, established a structure to securitize the margin loans provided to private clients of McIntosh Securities Ltd., an Australian stock exchange. The loans made to McIntosh clients secured by eligible shares were to be sold to an SPV called SHARE, which, according to a 1995 press release, was slated to receive a Single-A-1-plus rating from S&P. The deal never happened, however.
Similarly, one investment banker noted that several banks, including Chase Securities, had proposed a margin-loan deal in the past few years, but never completed it. Other likely candidates are banks with large brokerage arms such as Credit Suisse First Boston (which absorbed the former DLJ) and UBS Warburg (which absorbed PaineWebber), sources said.
How it works, risks
The structures presently being looked at relate to brokerage accounts, where a borrower can put stock in, borrow against it, and invest more. When an investor borrows money, the loan becomes the asset, which is collateralized by the stock accounts.
From a market-value perspective, the rating agencies must determine how risky the underlying stock portfolio is, because in a securitization the loans are pooled and tied to the stock account. Secondly, the analysts much look at the diversification of the stock accounts: what percent of the loan is exposed to what type of risk?
Third, the regulatory and legal hurdles inherent in such a securitization are not trivial. Margin loans are governed under a different set of regulations known as Reg-T, and several regulatory bodies, including the SEC, control the loans. In order to write margin loans you must be a broker-trader with a license.
"And since you want the SPV to be able to treat these things as a revolving pool, the broker-trader must write the new loans," said Moody's O'Connor. "How do you make the SPV do that?"
There are also potential regulatory/operating complications: In a bankruptcy, what happens to the assets if the margin loans need to be unwound in order to preserve liquidity? "You want to get your hands on the stock when you need it, but if the broker-dealer goes bankrupt, you want to make sure it's isolated," said S&P's Erturk.
And then there are performance-related considerations - driven by downturns in the market, concentration, the volatility of the assets/loans being purchased, the type of risk management employed and how diversified the pool is.
"Though it sounds like you'd have to be crazy to attempt this type of securitization, in terms of historical data, losses are very, very small," O'Connor said. "It sounds like huge losses due to volatile swings of equities, but this is a fairly safe product. Margining, by its very nature, protects against large swings.
"The turnover is very quick for margin loans; people get a loan, and then speculate for awhile," O'Connor said. "As to whether this will be a 144A, private, or public transaction, that depends on whether the bank can find someone who wants to do it."
