Peterson, James R., ABA Banking Journal
The market gives a thumbs up to a growing list of assets, including bad debts. Lessons from one veteran bank securitizer
Just a few years ago, critics viewed banks as economically irrelevant. Some still do, citing increased competition from a long list of new players entering markets once reserved for banking, loan losses, and the phasing in of new regulatory requirements. So why have bank profits continued to soar?
The strong economy is one answer. Stable, low interest rates are another. And there are creative factors, usually ignored by analysts, such as Internet lending and investing in derivatives. But no creative strategy is making more of a stir among bankers than the growing use of asset-backed securities (ABSs), which can guarantee more liquidity, a greater return on equity, and provide an avenue for banks to cut their potential loan losses by ridding themselves of questionable credits. ABS originators will issue some $228 billion in securities in 1999, 17% more than in 1998.
Mortgage-backed securities (MBS) have long been the mainstay of the ABS market, and that hasn't changed yet. But a whole new range of asset-backed security categories is striking a cord of excitement. Some, like credit card loans and auto loans, are hardly new, but are surging in volume. But originators are also bundling insurance premiums, corporate loans, and student loans, as well as leases on ship containers, rail cars and aircraft, and bringing them to market to feed an eager pool of investors (Figure 1). Even rock star David Bowie has securitized his future earnings. Basically, any pool of assets that can generate predictable cash returns is a potential candidate for securitization.
"Investors in mortgage-backed paper have grown comfortable with the risks," explains Patricia Jordan, managing director of Standard & Poors global asset-backed securities group. "They're more willing to look at less well-known asset types in order to achieve higher yields on their investments."
While overall ABS issuance grew only 5.4% in 1998 (Figure 2, p.46), this was mostly due to a poor showing produced by last autumn's rough and tumble financial markets, according to Moody's Investors Service. The projected 17% increase in 1999 issuance is fueled by automobile loans and lease-backed securitizations, which are expected to increase 40%, and by credit card securitizations, with a projected 18% growth rate. Both categories have come on so strong that they threaten to topple mortgage backed securities for king of the ABS hill.
Moody's says growth in the vehicle sector will be driven by the return of issuers that postponed transactions in 1998 due to second-half market turbulence and by record auto sales. Credit card ABS growth will be aided by large card issuers returning to market after the most recent round of consolidations.
Enter a new bad-debt player
ABS originations are mostly the purview of larger banks, but, recognizing the potential for profit, smaller institutions have been entering the arena. In February two such companies, Enhance Financial Services Group in New York and MGIC Investment Corp. in Milwaukee, announced a joint venture to purchase, service and securitize delinquent unsecured consumer assets. The initial focus will be on the large market for charged-off credit card receivables. During the S&L crisis, federal agencies liquidated insolvent thrifts, making very collectable debt available at cheap prices. They also created a new pool of capital for the purchase of nonperforming assets. Several of pioneering brokers realized that if the FDIC could sell the bad debt of insolvent institutions, then they could market traditional bank bad debt, too.
Enhance and MGIC are the most recent of these brokers to get into the act, but with an important distinction. They have acquired Alegis Corp., a Houston-based collection agency and New York-based Sherman Financial which has an agreement with a large receivables management firm. …