Prudential Securities' decision last week to bail out of the institutional bond market was further evidence to market players in asset-backed securities that more power is residing in fewer hands.
Issuers and bankers fear that as second-tier players like Prudential depart and other firms like Chase Securities and J.P. Morgan merge, it will create a much more illiquid market that is mainly the province of lending institutions' underwriting arms.
"If you reduce market participants, you're going to have less liquidity than you had before," said Dan Castro, head of ABS research at Merrill Lynch & Co. "It definitely has some impact, because obviously there are fewer people out there. If you have one guy swallowing up another guy, then there's one less guy out there to be providing liquidity."
Market analysts and traders said that Prudential's bowout is a symptom of a growing problem in the structured finance markets, especially asset-backeds, in which mergers are creating an elite class of superpowers capable of knocking former competitors off the board. Prudential, which was ranked twelfth for the first nine months of 2000 in ABS, had little choice but to bail out of a market in which power is becoming concentrated in the hands of Deutsche Bank, Salomon Smith Barney and Chase, all underwriters with direct links to lending institutions.
Bad luck and aggressive poaching by rivals also are roiling the league tables. "Credit Suisse First Boston has fallen from number one to number four and the defection of their entire securitization team led to that," said Gail McDonnell, managing director at Morgan Stanley Dean Witter. "Goldman Sachs has dropped off dramatically, Merrill has dropped down. Basically all of the non-lenders have dropped down."
Morgan Stanley has clung onto fifth place for much of this year. "We've stayed constant even though we're not lending, which is a feat that we're rather proud of," she said.
A growing complaint among some market players, notably those at securities firms, is that issuers are now awarding mandates to firms who either directly or through subsidiaries lend them capital.
"Sometimes for some of these issuers all that matters is, You extended me credit. You're providing me with credit because you can, because you're a bank,'" Merrill's Castro said. "And sometimes it doesn't matter if your execution is really good, it's just Are you giving me money?'"
Castro said that managers should be awarded based on their performance instead. "It's better to award mandates based on all of the merits of what you can do for the issuer as opposed to simply, I've got a big checkbook and I'm going to make it available to you.'"
An aberration is Lehman Brothers, a non-lending institution that has held onto the second-ranked spot in ABS. A rival banker attributes this to self-shelf practices, in which the company buys whole loans and resecuritizes them - a popular choice in the home equity sector.
"They're definitely using the self-shelf technique to prop up their league table in these league table games that everybody plays, and that's how as a non-lender they're able to keep the top of the table," the banker said. "You don't have to compete for the business, you just go straight and make an aggressive bid.
"The long-term challenge is that investors have not been thrilled about the liquidity that these banks are providing," McDonnell said. "So you've got a little bit of a market event going on right there."
More Empty Seats
As consolidation and departures winnow the ranks of ABS players, issuers are concerned their deals will be less liquid and that opportunities to pick good underwriters will diminish.
Alice Young, a director at MetLife, says the industry contraction means fewer bids will be given for her company's bonds. "We view consolidation among Street firms as an issue from a liquidity standpoint," she said at a subprime lending conference in New Orleans last month.
Another point of contention: When an investment bank acquires an issuer, that issuer has fewer chances of getting competitive pricing for their bonds, while the market suffers overall because there are few bids for the deals in secondary. Key examples include MSDW managing all of Discover's credit card deals, and the Salomon Smith Barney unit of Citigroup managing all of Citibank's transactions.
"You do see weaker liquidity in deals where you know the underwriter's captive," Castro said. "They're always going to be doing [the subsidiary issuer's] deal than those issuers who can spread it around and rotate who's lead managing their deals based on performance."
"You've got Salomon and Citigroup acquiring Copelco and Associates [First Capital], and you could put out a list of other people they've absorbed that were issuers," said an investment banker. "So not only do you have fewer places for independent issuers to go, but they're having to choose between dealing with competitors."
However, Eric Scholtz, managing director of capital markets at GMAC-RFC, sees some new ABS players coming in to fill the spots of those that were acquired or killed off. "If you look at what the playing field looks like after some of these moves, it doesn't feel like there's less sponsorship," he said. "There's enough up-and-comers that are growing their imprint in the markets."