Recent developments and prospects for 2010

Edward M De Sear
Bingham McCutchen LLP
New York

Three years ago I highlighted in this space the emergence of securitisation in Russia and the Middle East. At that time the high-volume issuance of residential mortgage securities, asset-backed securities and CDOs in the US and Europe appeared to provide fully tested models for financings of virtually every type of financial asset throughout the world. The intervening global financial crises has humbled the securitisation industry and required rethinking and reworking of assumptions and structures. Our industry's resilience, ingenuity and intrinsic optimism should not, however, be underestimated – an upcoming Moscow conference devoted to the proposed use of Islamic securitisation within Russia, combining the two themes highlighted three years ago, serves as an example of this dogged persistence.

In the US securitisation's resilience can be most clearly seen in the increasing issuance of non-mortgage asset backed securities outside of the New York Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF). The Chase Issuance Trust, for example, completed its first public offering of credit card securities subsequent to the October 2008 market meltdown in May 2009 by qualifying the issuance under the then new TALF programme, thereby offering investors financing for their investment with limited exposure to the credit of the credit card securities themselves. This $5 billion offering was very favourably received by investors, and the interest rate required by the investors of LIBOR plus 1.55% was very attractive when compared to the yields at which credit card securities were then trading in the secondary markets. 1% of the 1.55% spread over LIBOR had to be paid by the investors to the New York Fed as a fee for the TALF financing. Many investors indicated that they would prefer to not pay the TALF fee and retain the full risk of owning high quality asset-backed securities. Investor appetite for Chase Issuance Trust securities has enabled the bank to complete five additional non-TALF issuances at ever declining yields, with the latest issuance on September 23 requiring a spread of only 0.45% over LIBOR. Other issuers, including the GE Capital Master Note Trust, have also moved from TALF to non-TALF financing over the course of 2009, or in a few cases, have issued securities solely on a non-TALF basis.

Even so called esoteric structures are finding investor acceptance. A dramatic example is the recently completed offering by BAA Limited (the owner of a number of UK airports, including Heathrow) of $1.15 billion of securities issued on a whole business securitisation basis. The whole business securitisation model provides for physical assets and intellectual property (such as patents, brands, software, ) essential to the generation of the business's cash flow to be transferred to a bankruptcy-remote entity owned by the securitisation investors. The officers and employees who had managed these assets prior to the securitisation continue to do so, but on a contractual basis through a separate operating company. If the operating company experiences financial difficulties due to poor management, the structure allows the replacement of the operating company and, thereby, the investors' collateral, the physical and IP assets, remain isolated from the operating company's insolvency risk. Although at first glance these structures appear complex, they are in fact much easier to understand and analyse than many of the computer-modelled asset-backed securities that have experienced massive rating downgrades during the last two years, for example CDO's containing multiple tranches of subprime mortgage securities and CDO's containing multiple tranches of other CDO's. It is therefore not surprising that whole business securities are perceived as relatively transparent and are, accordingly, receiving renewed investor acceptance.

Clouding the picture for securitisation in 2010, on the other hand, are the various statutory and regulatory proposals being considered by lawmakers and regulators in the US and Europe that attempt to deal with perceived abuses of securitisation. In the US wholesale securitisation reform has been proposed in the form of Senate and House bills that differ in many important respects. Both bills, however, require that securitisers retain an economic interest in a material portion of the credit risk of the assets being securitised (10% in the Senate bill and 5% in the House bill, but subject to adjustment up or down in the case of the House bill based on the sufficiency or insufficiency of the underwriting standards and the due diligence). This risk retention, often referred to as "skin in the game," may diminish the economic efficiency of securitisation of fixed asset pools, such as mortgages and auto loans, but should not pose a significant problem for revolving asset securitisations, such as those financing credit card receivables or dealer floor-plan loans, given the amount of retained seller's interest inherent in revolving structures.

Additionally, the FDIC has announced an intention to promulgate regulations which will add to the conditions for use of its securitisation safe harbour rule which gives investors and rating agencies comfort that the FDIC as receiver for a failed bank will not interfere with the bank's securitisations that meet the requirements of the rule. Revisions to this rule are required in order to continue the protection of securitisations which will no longer qualify for accounting sales treatment after new accounting rules go into effect in 2010. Requirements that the FDIC is reported to be considering for its permanent rule (an interim rule continuing the rule's protections expires on March 31 2010 but could be extended) include elements of the House and Senate bills mentioned above, but also may include provisions designed to tie the compensation of underwriters and credit raters to the performance of the securities they underwrite or rate.

If new laws or regulations have the effect of materially diminishing the issuance of mortgage-backed or asset-backed securities, it is highly likely that they will be promptly revised, as the US economy's complete recovery requires active and efficient securitisation markets. The $1 trillion TALF programme is evidence that the US government fully backs responsible securitisation. Other government programmes around the world have similarly devoted substantial financial resources to the revival of securitisation. There is every reason to hope that we will see this revival in 2010.