Investors are slowly returning to structured securities, the mechanism widely regarded as having triggered the financial crisis, but the market isn’t what it once was — and probably won’t be for a long time.
“A little over a year ago, there was still some stigma attached to collateralized debt obligations and collateralized loan obligations, even though their performance has been very good — more like consumer asset-backed securities than the subprime mortgage CDOs that took a really bad turn,” explains Rishad Ahluwalia, who with Amy Sze leads J.P. Morgan’s first-place team in ABS Strategy, a sector added to the All-America Fixed-Income Research Team survey this year. “In the last six to 12 months, a lot of that stigma has gone away.”
Spreads on securitized products, which widened as investors fled from them in the immediate aftermath of the market meltdown, have tightened over the past year. One reason is that there just aren’t many structured products anymore, so investors must compete for what relatively little is available. Matthew Jozoff, who captains the top-ranked team in Mortgage-Backed Securities Strategy and co-directs, with Brian Ye, the No. 1 teams in MBS/Adjustable-Rate Mortgages, MBS/Agency Pass-Throughs and MBS/Agency-Structured Products, estimates that by the end of the year the securitized-products market will be down about $200 billion from its precrisis high.
“We expect the total securitized-products market to be about $7.6 trillion at the end of the year, which is down from the peak of about $7.8 trillion in 2007–’08,” Jozoff says. “This masks some of the shrinkage in the nonagency market, however, because this number includes agency plus nonagency mortgage-backed securities.” Remove agency debt from the equation, and the remainder of the market will shrink from about $3.9 trillion in 2007 to $2.7 trillion by the end of 2010, he adds.
Jozoff says there are a number of factors “acting as headwinds to securitization right now,” including the “negative economics” of securitizing — simply put, the cost of creating these products has spiked — and the newly embraced conservatism of rating agencies, which destroyed their own credibility by assigning improbably high ratings to some of the most toxic securitized products and now face increased regulation and a flood of lawsuits (see “Downgraded,” Institutional Investor, July/August 2010).
Rating agencies have since taken steps to improve transparency and tighten their standards, efforts that are “aimed at getting the investor back and having an active market where investors like what they see and buy the products,” says Sze, who also co-leads (with Edward Reardon) the first-place crew in ABS/Real Estate.
But the question of rating agency regulation remains largely unanswered — at least for now. The mammoth, 2,300-page Dodd-Frank Wall Street Reform and Consumer Protection Act passed in July revoked a key provision of the Securities Act of 1933, Rule 436(g), which had exempted the agencies from liability, on the grounds that their assessments of various instruments were statements of opinion not investment recommendations. The Dodd-Frank legislation requires any entity that registers debt securities or preferred shares to obtain the written consent of a Nationally Recognized Statistical Rating Organization to include an agency rating in prospectuses and registration statements. The agencies were united in their refusal to grant such consent, arguing that doing so might expose them to claims of liability if the instruments failed to perform as expected.
Once the agencies dug in their collective heels, the ABS market shuddered to a halt. The first casualty was Ford Motor Credit Co.’s planned sale of more than $1 billion in bonds backed by auto loans. The Securities and Exchange Commission, recognizing that a market poised for takeoff had been effectively grounded, agreed to a six-month transition period, until January 24, to allow market participants time “to implement changes to comply with the new statutory requirement while still conducting registered ABS offerings”; in the interim ratings are being included by issuers but with disclaimers indemnifying the agencies. (Once the agencies and the SEC reached a compromise, the Ford sale went through, about a week later than originally planned.)
The transition period seems merely to have postponed an inevitable showdown between government regulators, which seem insistent that agencies be held accountable for their ratings, and the agencies themselves, which favor self-regulation. Nonetheless, many analysts are confident that a mutually agreeable solution can be reached.
“One of the goals of all the regulation is to have a robust securitization market that can support consumer lending, and I think that goal is still in sight,” says Sze. “Yes, the consumer ABS market is shrinking, and the ABS market will be changing over time, but it will still be there to try to fill that role.”
