Headline: Securitization: any flavour but vanilla
Source: Euromoney
Date: September 2000
Author: Michael Peterson 

The European securitization market used to be characterized by small, esoteric deals rather than the large standardized issues dominant in the US. Things are changing, but not towards the US model. Strategic securitizations to finance M&A, synthetic structures and deals to cover non-performing loans are fuelling investment banks’ enthusiasm for the market. Michael Peterson reports

Take a look at the volume of asset-backed bonds issued recently and you could be forgiven for dismissing securitization as the runt of the international capital markets litter. According to Capital Data, some $27 billion-worth of European asset-backed bonds were issued in the First half of 2000, roughly a quarter of the volume of European corporate bonds issued in the same period. And unlike corporate bond issuance, asset-backed volumes have not grown since last year. 
But in securitization, volume Figures can be deceptive. Look instead at the frantic efforts of investment banks to build up a securitization capability and it is clear that something dramatic is happening in the world of asset-backed bonds. 

The biggest move came in May, when Credit Suisse First Boston poached a highly regarded team of 15 bankers from BNP Paribas. The previous month Merrill Lynch had recruited seven securitization specialists from Deutsche Bank. Schroder Salomon Smith Barney, DLJ and ABN Amro are among the many Firms that are quietly staffing up. 

Ready for take-off
These investment banks are convinced that securitization is reaching the point of take-off outside the US. Pressure on banks’ funding costs and returns on equity are spurring ever more Financial institutions to use the tools of securitization to manage their balance sheets better. New laws are easing the use of securitization in countries as far apart as Italy, Japan and Chile. 

In Europe, the previous sporadic use of securitization – to Finance pub acquisitions, Film rights or other unusual cashflows, for example – is giving way to something a little more predictable. “Up to 12 months ago the European securitization market was esoteric,” says Maarten Stegwee, head of European securitization at Credit Suisse First Boston, and leader of the group that recently Fled from BNP Paribas. “Deals came to the market occasionally and they tended to be small in size. Now securitization is happening in more countries. There are more repeat issuers and the commodity side of the business is growing.”

The deal Flow may be picking up, but the pattern of securitization in Europe is still quite unlike that on the other side of the Atlantic. In the US, standardized deals backed by residential mortgages, auto loans and credit cards predominate. 

In Europe the breakdown by assets is quite different and the structures used are much more varied. According to Merrill Lynch strategist Alex Batchvarov, residential mortgages account for around 42% of asset-backed securities in Europe. But the other two big European categories make up only a tiny proportion of issuance in the US. In Europe commercial mortgages back 18% of all issuance and collateralized loan obligations account for nearly a quarter of the volume. 

The simple difference between the two markets is that Europe has a collection of still quite different legal systems, whereas the US is much more homogeneous. As a result, the hardest part of the job of a securitization banker in Europe is thinking up structures to suit each jurisdiction. 

“In the US the top 15 issuers account for something like 90% of the volume,” says Stegwee. “That means the business is primarily driven by distribution. Here we don’t have the same volume of repeat issuers such as credit card companies. The European market is still more about structuring and corporate Finance.” 

And few people believe the European market is going to turn into a mirror image of the US market any time soon. “The European securitization market will remain different from the US market,” says Scott Ulm, head of structuring at Credit Suisse First Boston in London. “It will be driven by different factors. In some ways the US market is becoming more like Europe, rather than the other way round. For example, we are beginning to see more securitization for strategic reasons in the US just as we do in Europe.” 

This use of securitization to Finance acquisitions is what everyone in the market is getting most excited about. Only a handful of these deals have been completed, but every investment bank sees corporate Finance as the big deal-spinner of the future. “For the First time securitization has become a real competitor to funding an acquisition through a bank deal or even an IPO,” says Paul Salama-Caro of Citibank/Schroder Salomon Smith Barney’s securitization group. 

Most of the acquisition-related deals completed so far have been done in the UK. In deals dubbed operating company or whole company securitizations, all or most of a company’s income is used as collateral to fund its buy-out. The technique has been used to buy UK pubs since the mid-1990s. 

It is a practice that is starting to spread to continental Europe and beyond. Nomura’s e400 million securitization of wine stocks for champagne producer Marne et Champagne in January is perhaps the best known example. A number of other transactions, notably one from Telecom Italia, are reported to be in the pipeline. 

Such deals are a long way from the traditional US template of issuing standardized deals in high volumes. “Deals such as operating company securitizations are feeding off the growth of M&A in Europe,” says Salama-Caro. “These are deals designed to solve problems so you have to approach each deal individually.” 

Stegwee at CSFB sees telecom companies as increasingly important users of the securitization market. “Telecoms companies are trending towards single-A ratings,” he says. “Their cost of funding is increasing all the time. But they have high-quality cashflows from telephone bills which they can securitize.” 

The other industry most frequently mentioned in connection with corporate-Finance securitization is utilities, where low share prices and high-quality cashflows suggest a trend towards greater leverage. But ships, shopping malls and airports are also promising candidates for whole company securitization. 

“If there’s a predictable, securable cash Flow, it can be securitized,” says Bob Liao a vice president of the Citibank/Schroder Salomon Smith Barney’s securitization team. And then, there is the banking sector. The other type of M&A-driven securitization that has been in vogue in the past year is very different from these whole-company securitizations. Italian banks have embraced securitization with increasing enthusiasm in the past couple of years as a method of ridding their balance sheet of bad loans. Non-performing loan securitization does nothing to help a bank raise funding at an attractive cost, since by definition the assets involved don’t yield strong cash Flows. But it does allow an institution to draw a line under its bad-loan problems and put a value – ratified by the rating agencies and the market – on the amount of money it expects to recover from its bad debts. This has helped to make banks more attractive merger partners as the consolidation of Italy’s banking industry gathers pace. 

Bad asset deals
The First securitizations of non-performing Italian loan portfolios took place as long ago as 1997, when Morgan Stanley began issuing asset-backed securities to Finance portfolios it had bought outright from banks. But the trend gathered pace in 1999 and 2000. 

Banca di Roma has securitized loans with a face value of more than e5 billion since July 1999, and in each of its two deals it has kept ownership of the bad assets. A number of smaller Italian institutions have launched their own similar transactions in late 1999 and the First half of 2000. 

In Japan, meanwhile, Morgan Stanley has also securitized two portfolios of non-performing loans in the past year, issuing deals of ¥21 billion ($190 million) and ¥31 billion in November and July respectively. In both cases the investment bank had acquired the loans from the originators: it stands to make a profit if it can make the assets sweat a little harder than they had under their previous owners. 

Non-performing loan securitizations are almost the quintessential European asset-backed deal. They are highly complex and highly customized – and they can be highly lucrative for the banks arranging the structure. 

Banks don’t always get paid so well for distributing the securities, however. This was almost certainly the case on last year’s biggest non-performing asset securitization. The client was not a bank but Italian social security agency INPS. The e4.65 billion deal securitized delinquent social security assets. 

Spreads quickly traded wider than their issue price following the launch of the bonds in November, leading to the suspicion that the underwriters – Caboto, Merrill Lynch and Paribas – had lost money on the deal. Not so the Firms who structured the deal – Banca IMI, Morgan Stanley and Warburg Dillon Read – who were handsomely rewarded for their creativity. 

Other similar deals loom on the horizon. Another Italian agency, Inail, has awarded the mandate for a deal similar to that from INPS, and the Greek authorities are considering a transaction to address their own late-payments problem. But the Flurry of bad-loan deals by banks may be coming to an end, at least in Europe where no country has a bad-asset problem to compare with Italy's. 

Synthetics spread
Unusual asset classes such as social security arrears may come and go, but one trend that seems set to stay is the growing use of synthetic securitization in Europe. The concept is simple, and has been used in collateralized loan obligations for several years. 

In a conventional securitization the originator of a portfolio of assets transfers them to a special purpose vehicle which then issues securities to investors. But in a synthetic deal, the originator simply hedges the risk using a series of default swaps or guarantees. The counterparty in the swap can be a third party such as an insurance company, or it can be a special purpose vehicle that then issues securities to bond investors in the conventional way. 

The great benefit of synthetic securitization is that the assets don’t have to leave the originator’s balance sheet. That makes it very well suited to European portfolios, where loans may have been extended in several different legal jurisdictions. “Cross-border complications, different legal regimes and foreign-exchange issues all disappear when you’re just transferring pure credit,” says Oldrich Masek, head of Financial institutions structured Finance at JP Morgan in London.

This year, several German landesbanks and mortgage banks have securitized mortgage portfolios using synthetic structures. In its Europa One deal, for example, Rheinische Hypothekenbank issued e1.3 billion worth of securities backed by mortgages in several different European countries in a transaction led by Barclays Capital and Commerzbank. 

“The switch to synthetic structures is the most important trend in the securitization market at present,” reckons Tamara Adler, head of securitization at Deutsche Bank in London. “Synthetic transactions are moving beyond corporate loans and are being utilized for all asset classes.” 

The range of assets that are being securitized in this way is growing fast. JP Morgan arranged an earlier synthetic mortgage-backed deal for Rheinhyp and has also led deals in which portfolios of asset-backed securities were themselves securitized. “ABS-backed securitizations are no different from any other sort,” says Masek. “You take a portfolio of assets which is sitting on someone’s balance sheet, tranche it and sell out different pieces. It’s a way for investors to participate in a very broad portfolio without having to build it up themselves.” 

Deceptive numbers
The rise of synthetic securitization is the most important reason for the apparent standstill in asset-backed volumes. There has been no substantial growth in volume of asset-backed securities issued in the past 12 months. Capital Data calculates that $58 billion-worth of European asset-backed bonds were issued in 1999. Volumes in the First half of 2000 were less than half that amount, at just under $27 billion. 

In synthetic securitizations, particularly collateralized loan obligations, only a small part of the risk is transferred to bond investors by issuing securities. The bulk of the portfolio is hedged in the credit derivatives market. So, although the notional volume of assets securitized has grown strongly in the past year, not all of it has been funded. 

In a very short space of time, synthetic deals have become a very normal part of Europe’s securitization market. Some of the First synthetic structures paid a premium over conventional asset-backed bonds, but Adler at Deutsche Bank believes this synthetic premium has now disappeared. “There is a dearth of supply of asset-backed paper,” she says. “The volume of asset-backed securities issued this year compared with last is Xat, but the actual activity in the market is much greater because of the use of synthetic structures. Our most recent Cast deal, for example, was a e4.5 billion transaction, but only e340 million of bonds went into the market. Consequently, you are seeing demand outstrip supply right now and you are not seeing a premium being allocated to synthetic deals. In addition, investors are becoming much more comfortable with these issues, so what you might call the education premium on these deals has disappeared.” 

The other reason that the securitization market is growing faster than Capital Data’s Figures suggest is that growing volumes are being funded not by issuing securities but through commercial paper conduits. “There is increasing use of the asset-backed commercial paper market to securitize assets,” says Adler. “Increasingly we are seeing issuers make use of both markets. They may use medium-term Financing for a steady stream of receivables and utilize the asset-backed commercial paper market to take up their variable funding needs.” 

Although synthetic structures have been one of the main growth areas in recent months, conventional securitization is also becoming an increasingly popular tool for certain Financial institutions. UK banks, in particular, have taken to the market with enthusiasm in the past year, after a long period of leaving securitization to specialist niche mortgage companies. 

“In the past, UK banks did not really use securitization,” says Batchvarov at Merrill Lynch. “Now mainstream institutions such as Barclays and Abbey National are becoming important issuers with both mortgage and credit card deals. These banks are losing their traditional sources of cheap funding as customers move their savings around, so they are looking to diversify their funding sources and raise funds off balance sheet.” 

Different customs
One innovation that may encourage the growth of this market is the use of master trust vehicles. This is a structure that has been used in the US to securitize credit cards, but has not been previously applied to mortgages. As with so much to do with securitization in Europe, bankers are Finding that they need to reinvent the business to take account of the different legal systems, customs and products outside the US. 

Those differences suggest that Firms with a long track record in US securitization have no great head-start in Europe. And indeed, local banks such as Deutsche, Paribas and NatWest were among the early leaders in European securitization. But the pecking order is changing fast as the market grows and as Firms beef up their presence in this sector. 

Some Firms argue that having a strong balance sheet will be the key to success in this business. As Deutsche Bank’s team in particular has shown, a bank’s own lending book can provide a large and steady source of deals that allow it to establish a reputation. And the growing importance of corporate Finance securitization may favour banks that can underwrite large bridge facilities. “Those banks that have the balance sheet to do the bridge loans will be well placed to win corporate Finance deals,” says Salama-Caro. “You need a big gun to take down an elephant.” 

Others argue that the key to winning acquisition-related deals is to have a strong M&A advisory business. At the moment, that is a market dominated not by universal banks but by US investment banks. Significantly, Morgan Stanley is now the acknowledged leader in acquisition-related securitization. 

Credit Suisse First Boston’s ability to oVer a range of investment-banking capabilities is the reason Stegwee gives for taking his team there from BNP Paribas. “As the market develops it is becoming increasingly important for Firms to have access to both corporate Finance expertise and distribution into the US market,” he says. “Firms that lack a full investment-banking platform are missing out on important parts of the business.” 

Stegwee’s team is clearly one of the best regarded in the business. Rivals expect Credit Suisse First Boston to be one of the two or three strongest players in the market in the months ahead – even though the Firm did not make it into the top 10 in the First half of the year. 

Credit Suisse First Boston is one of several leaders of the US securitization business that have until now punched below their weight in Europe. Merrill Lynch is another. Until recently, Merrill has concentrated its European efforts on smaller, novel structures such as the ill-fated Cecchi Gori Film rights securitization – one of the few European asset-backed bonds to have suffered a major credit rating downgrade. Its new strategy, underlined by its recent hirings, is to focus on mainstream business. 

Domestic demise
The US Firm that has made the biggest impact so far on the league tables is Schroder Salomon Smith Barney. By Capital Data’s calculations, the unit of Citigroup can claim leadership of the European asset-backed market in the First half of 2000. Other estimates give Deutsche Bank the edge, thanks in part to the large amount of deals done to securitize its own balance sheet. 

These predominantly US Firms have been quick to take advantage of the demise of two of Europe’s leading home-grown players in the asset-backed market. The months of uncertainty over NatWest’s fate led to an exodus from Greenwich NatWest’s highly successful securitization group. However, the bank’s new owner, Royal Bank of Scotland, which had a sizeable securitization business of its own, is now working hard to make up for this setback. 

BNP Paribas’ position looks less hopeful. Having already slipped to third place in the league tables and lost many of its best bankers, it will struggle to recover the strong position Paribas enjoyed in the European asset-backed market. It may be reduced to a niche position, particularly in southern Europe, where it has retained some of its key dealmakers, notably Italian specialist Andrea Perona. 

But most securitization bankers agree that the days of Europe as a business dominated by discrete niches is over. Europe may never have a standardized, homogenous asset-backed market like the US, but securitization is moving steadily into the mainstream in every European country. Soon, the varied and exotic Flavours of European securitization structures may start to seem bland and familiar. “For investors, all these different structures are just detail,” says one banker. “The important thing is the exposure they give to the underlying assets.” 

The case of the bond that didn’t amortize
Compared with the rest of Europe, the UK has a large and established market for mortgage-backed securities. But even so, only a tiny proportion of UK mortgages are securitized. The main reason is that UK banks have long been able to raise cheaper funding from customer deposits than asset-backed bonds would give them. That has left smaller Financial institutions that specialize in non-conforming mortgages as the main source of UK mortgage-backed issuance. 

But as customers become more choosy about where they leave their deposits, UK banks are fast losing their source of cheap money. In the past year, mainstream UK mortgage lenders have started to look seriously at securitization. 

They faced two big problems. The First was a tax break called Miras which, because it was deducted at source, made it impossible for eligible mortgages to be securitized. Finance minister Gordon Brown removed this obstacle in April when he abolished this allowance. 

The second problem is that the typical UK mortgage looks nothing like those in the US where mortgage-backed securities were invented. “Along with Australia, the UK has one of the most varied mortgage markets around,” says Bob Liao, vice president of Citibank/Schroder Salomon Smith Barney’s securitization group. 

UK homebuyers tend to take out mortgages with repayments linked to the bank base rate. But there are also plenty of products that are more Flexible than those usually offered in the US. They can give borrowers payment holidays, capped rates or guaranteed rates for a certain period. “The US mortgage market is larger and more homogenous,” says Liao. “The long-term Fixed-rate mortgage is standard, whereas the UK market is much more diverse and is driven by variable rate and Flexible mortgages.” 

The traditional US-style mortgage-backed structure, in which the pool of loans is Fixed, is not geared up to cope with many different types of mortgage. In addition, the securities have long legal maturities, but in practice tend to be called much earlier: their effective maturity depends on when the underlying mortgages are repaid. That creates a lot of uncertainty for investors, and it also means that some investors, who are not able to own very long-dated bonds, cannot buy the securities. 

To get round these problems, Schroder Salomon Smith Barney put together a securitization for Abbey National this year using a technique commonly found in US credit card deals – the master trust. The vehicle, Holmes Financing, issued the equivalent of $3.4 billion of securities backed by a pool of £7.2 billion-worth of mortgages in July. Because of the size of the pool of mortgages, and the fact that new loans can be added into the structure to replace those that repay early, Holmes Financing is able to issue securities that look more like conventional bonds. In most cases, the legal maturity of the bonds is only a couple of years longer than their expected life. 

“We wanted to create something that is easily understood and which matched issuers’ needs with investors,” says Liao. “One of the biggest benefits for investors is that there is no prepayment risk. For issuers, the structure is cheaper and more capital efficient.” Far from having to pay a premium for using a novel structure, Abbey National raised cheaper funding on Holmes Financing than it would with a conventional mortgage-backed deal. For example, the euro tranche with a seven-year average life pays 26 basis points over Euribor compared with 45bp on a recent mortgage-backed deal by Commerzbank. 

Abbey National’s previous conventional mortgage-backed deals were dubbed Holmes Funding 1 and 2, in tribute to Abbey’s long-time ownership of Sherlock Holmes’s address in London’s Baker Street. And the bank decided to keep the Fictional detective’s name in its master trust deal. That was a slight disappointment to the arrangers, who were relishing the opportunity to dream up a suitably funky alternative on a Holmesian theme. (“Baskerville” would perhaps have had the wrong connotations.) But whatever cleverly named vehicles are used, most market participants agree that this structure is likely to be replicated in future. “It’s an elegant structure and simple to use,” says Liao. Elementary, in fact.
Leading bookrunners of US asset-backed bonds
1999         2000h    
    Amount ($m) No. issues     Amount ($m) No. issues
1 Lehman Brothers 21,689 131 1 Credit Suisse First Boston 9,047 50
2 Credit Suisse First Boston 18,248 91 2 Morgan Stanley 7,260 25
3 Merrill Lynch 13,173 90 3 Merrill Lynch 4,286 19
4 Salomon Smith Barney 8,772 32 4 Lehman Brothers 3,038 20
5 Morgan Stanley 4,700 36 5 UBS Warburg 1,983 17
6 UBS Warburg 3,051 18 6 Salomon Smith Barney 1,865 7
7 JP Morgan 2,771 6 7 JP Morgan 1,332 5
8 Bear Stearns 1,873 15 8 Bank of America 591 12
9 Credit Lyonnais 1,061 7 9 HypoVereinsbank 460 5
10 Societe Generale 959 6 10 Deutsche Bank 409 4
11 Chase 930 7 11 BSCH 390 3
12 Goldman Sachs 730 9 12 CDC Marches 153 3
13 Bank of Tokyo-Mitsubishi 641 2 13 PaineWebber 142 1
14 Greenwich NatWest 584 4 14 Barclays Capital 138 1
15 CDC Marches 563 3 15 Goldman Sachs 96 1
16 BNP Paribas 398 1 16 Nomura 94 1
17 Dresdner Kleinwort Benson 350 2 17 ABN Amro 90 1
18 HypoVereinsbank 318 2 18 Fortis Bank 31 1
19 Barclays Capital 299 3 19 HSBC 30 1
20 ABN Amro 174 1 20 Toronto-Dominion Bank 26 1
  Total of issues used in the table 81,746 439   Total of issues used in the table 31,505 152
Source: Capital DATA

Leading bookrunners of European asset-backed bonds
1999         2000h      
    Amount ($m) No. issues     Amount ($m) No. issues
1 Deutsche Bank 10,833 85 1 Salomon Smith Barney 4,404 23
2 BNP Paribas 6,832 43 2 Deutsche Bank 3,740 45
3 Morgan Stanley 6,561 31 3 BNP Paribas 2,101 16
4 ABN Amro 4,257 12 4 JP Morgan 1,720 6
5 JP Morgan 4,234 20 5 Morgan Stanley 1,696 11
6 Salomon Smith Barney 3,475 26 6 Royal Bank of Scotland 1,452 13
7 Merrill Lynch 3,242 14 7 Merrill Lynch 1,357 11
8 Goldman Sachs 2,438 11 8 Goldman Sachs 1,148 9
9 HypoVereinsbank 2,125 11 9 UBS Warburg 1,141 5
10 Greenwich NatWest 2,046 16 10 Barclays Capital 1,017 14
11 Barclays Capital 1,981 18 11 Credit Agricole 891 15
12 Caboto - Gruppo Intesa 1,595 3 12 HSBC 806 4
13 Royal Bank of Scotland 1,295 3 13 ABN Amro 753 5
14 Nomura 709 2 14 EBN Banco 685 9
15 CIBC World Markets 635 4 15 BBVA 548 5
16 BBVA 546 1 16 SEB 475 3
17 Credit Agricole 482 6 17 Dresdner Kleinwort Benson 436 7
17 EBN Banco 482 6 18 ING Barings 379 3
17 Societe Generale 482 6 19 Nomura 299 2
20 UBS Warburg 436 3 20 NIB Capital 235 5
  Total of issues used in the table 58,333 318   Total of issues used in the table 26,592 175
Source: Capital DATA

Leading bookrunners of international asset-backed bonds
1999         2000h      
    Amount ($m) No. issues       Amount ($m) No. issues
1 Lehman Brothers 21,821 135   1 Credit Suisse First Boston 10,078 64
2 Credit Suisse First Boston 18,992 98   2 Morgan Stanley 9,337 41
3 Merrill Lynch 17,480 119   3 Salomon Smith Barney 6,866 34
4 Morgan Stanley 14,224 83   4 Merrill Lynch 6,166 33
5 Deutsche Bank 13,692 103   5 Deutsche Bank 4,161 50
6 Salomon Smith Barney 12,456 60   6 UBS Warburg 4,071 31
7 JP Morgan 8,553 33   7 Lehman Brothers 3,190 23
8 BNP Paribas 7,489 45   8 JP Morgan 3,052 11
9 ABN Amro 4,931 16   9 BNP Paribas 2,369 20
10 Goldman Sachs & Co 4,874 40   10 ABN Amro 1,934 9
11 Greenwich NatWest 4,834 26   11 Barclays Capital 1,620 16
12 UBS Warburg 4,196 23   12 Royal Bank of Scotland 1,452 13
13 Nomura 3,225 20   13 Nomura 1,302 8
14 HypoVereinsbank 2,443 13   14 Goldman Sachs 1,243 10
15 Bear Stearns 2,414 27   15 Credit Agricole 891 15
16 Barclays Capital 2,280 21   16 HSBC 836 5
17 Societe Generale 1,854 18   17 EBN Banco 685 9
18 Caboto - Gruppo Intesa 1,682 4   18 Industrial Bank of Japan 633 5
19 Royal Bank of Scotland 1,295 3   19 BSCH 608 5
20 Dai-Ichi Kangyo 1,196 7   20 Dresdner Kleinwort Benson 597 10
  Total of issues used in the table 161,848 899     Total of issues used in the table 66,376 393
Source: Capital DATA