Securitisation sector braced for a long, painful haul - FT

Securitisation sector braced for a long, painful haul By Aline van Duyn Published: December 5 2008 02:00 Last updated: December 5 2008 02:00 The toxic assets backed by mortgages and other consumer loans, which have contributed to more than $1,000bn of writedowns and losses across the global financial system, continue to cast a dark cloud. These markets face a huge problem: the biggest buyers of securitised bonds have disappeared, and there are few, if any, new ones on the horizon. "We are back to where we were several years ago, with real investors who pay cash for assets [the only buyers]," said Sanjeev Handa, head of global public markets at TIAA-CREF, which manages pensions for teachers. The effects of this enormous overhang of excess supply continues to push down the value of thousands of billions of dollars worth of securities, from those backed by mortgages to other categories including securities backed by car loans, credit cards and student loans. "The problem is liquidity," said Cecilia Tarrant, managing director at Morgan Stanley. "This may be a great price to buy these securities at. But most buyers [of triple A securitised debt] were levered buyers and these are now not around." These comments were made at a meeting aimed at discussing ways to restore confidence in the securitised markets, which have in the last decade in particular financed large numbers of mortgages and other loans made to individuals and businesses. Yet the collapse of house prices across the US and the large spike in foreclosures and defaults, particularly on risky mortgages which were used as collateral in many mortgage-backed securities, has resulted in huge losses and exposed gaping holes in banks' capital bases. Many former buyers of securitised debt have suffered from banks' reduced ability to lend due to capital constraints. Some of these buyers were vehicles owned by banks, and most of them relied on borrowing money in order to make the purchases. New issuance activity has ground to a halt. "A large, large portion of the asset-backed investor base, anywhere from 65 per cent to 75 per cent, is gone," said Chris Flanagan, head of asset-backed research at JP Morgan, in a recent interview with the Financial Times. "It's going to be gone for a very, very long time." Calls continue to be made for the US government to step in as a buyer of these assets, the original intent of the $700bn Troubled Asset Relief Programme (Tarp) when it was proposed by Hank Paulson, the Treasury secretary, in October. That aim - complicated by the difficulties around valuing many mortgage-backed securities in the absence of trading and the fact that many bonds have unique characteristics and cannot easily be lumped together - was replaced with a programme of direct capital infusions into the banking system. Mr Paulson, with the Federal Reserve, has since introduced a plan to use some of the Tarp funds to potentially fund investors to buy securities backed by credit cards and car loans, but the most toxic mortgage assets continue to exist with no sign of relief. A fresh round of price declines contributed to the recent crisis at Citigroup, which required US government help. Mr Flanagan said "it would be very difficult to rule out" the possibility of further price falls hurting banks' balance sheets. "Eventually the government will have to buy," said Timonthy Ryan, chief executive of the Securities Industry and Financial Markets Association (Sifma). "We have not had much luck with the current administration but are all over the next administration [to get them to buy the securities]," he said. Timothy Geithner, the current head of the New York Fed, is President-elect Barack Obama's choice for US Treasury secretary. There is no shortage of ideas about how to improve the securitised markets when they return, such as better disclosure of information. However, the problems that have built up in the last decade are far from being resolved. Analysts at Barclays Capital said there was still "no real practical guidance to market participants as to how to deal with the upcoming structural problems and the challenging fundamentals impacting current deals". In addition, they said that help from "central banks and the respective governments can help balance sheet issues and provide financing to some of these assets creating some demand. But it is unclear if that would be enough to return to a more normal market". As well as the lack of buyers, the availability of cheap funding to banks and providers of credit through government-guaranteed debt also makes it less likely that activity will resume in the securitised capital markets, where funding costs are relatively much higher. "Until the system works through both of these issues we will not see securitisation start up again," said Jeff Perlowitz, co-head of global securitised markets at Citigroup. In a report compiled by McKinsey with recommendations to restore confidence, causes of the current crisis are highlighted. First, deteriorating loan underwriting standards undermined underlying asset quality. Second, investors relied too extensively on ratings. Third, the level of complexity of products, such as collateralised debt obligation of asset-backed securities, "exceeded the analytical and risk management capabilities of even some of the most sophisticated market participants", says the report. In addition, there was a lack of shared responsibility; plenty of people worried about extending mortgages to people with no proven incomes, but they did nothing about it. "[We now realise that] every member of the securitised industry has a stake in the system as a whole," said Jason Kravitt, senior partner at Mayer Brown. "We all are responsible for all of us."