Scaling Back Your Securitization Business

With the end of 2010 fast approaching and the ink on hiring and expense budgets drying quickly, we thought it might be a good time to take a “reality check” on what managers of businesses engaged in structured finance should expect for 2011.

A Shrunken Market

No one should delude themselves as to just how much the securitization markets have shrunk since their zenith in 2006.  Here are some sobering statistics:

* Total U.S. ABS issuance for the last 3 years (2008, 2009 and 2010) has averaged approximately $140 Billion.  That’s a full 80% off issuance levels in 2006 (the peak year for this market)

* Total U.S. Non-Agency RMBS issuance for the past 3 years (2008, 2009 and 2010) has averaged $30 Billion.  That’s just 3% of the non-agency RMBS issued in 2006.

* Total Euro-market ABS issuance is down 50% from 2009 and is just 40% of the levels issued in 2006.  However, recent trends in the Euro market seem to be more positive.

In summary, the new issuance activity for the two major securitization markets is probably no more than 20% of what it was in 2006.  That is a sobering statistic for all the bankers, law firms, accounting firms, bond trustees, rating agencies and technology providers that have carved businesses and product lines out of this industry over the past 20 years.

For the past year, many of these organizations have been occupying their staffs and resources dealing with defaults, re-rating exercises, litigation, etc and, while all hope to recover their costs or, in some cases, profit quite handsomely from the disruption, the bottom line is that it will be some time before we see anything close to the market activity levels for new structured finance issuance to which we had become accustom.

This is not huge news to most companies and businesses operating in this specialized market.  However, we do think that firms should consider whether, after three years of steady contraction, there is any reason to think that 2011 and possibly 2012 will be any different from the historical averages for the last 3 years?

Budgeting for 2011

We would like to focus on the operating platforms that service the market.  These would include the asset managers, trustees, servicers, technology and administrative services companies, etc.  In most cases, these organizations spend significant amounts of time and energy building up staff, processes and technologies to support their products and services.  Under normal market conditions, a typical expense base for one of these providers might be broken down as follows:

– 70% Staffing  (including salaries, incentive pay, benefits, real estate)

-20% Technology (including hardware, software, network)

-5% Business Development (including sales, marketing)

-5% Other (including legal, accounting, etc.)

As we look out to the coming year and companies make final adjustments to their operating budgets, we suspect that each of these expense categories is being heavily scrutinized.   However, to add some sobering thoughts to this analysis, let’s for a minute look at the revenue side of the equation.  

Let’s assume that a provider had a 5% market share for new business in 2006 and, as such, generated some $100mm in revenue off this market share.  Not even considering the runoff from their historic business that we are sure has occurred over the past 3 years and even assuming that they have doubled their relative market share, due to industry consolidation over the past 3 years, the best new business performance that they might expect in a “flat” 2011 might be something in the range of $40mm. 

If 2011 does, in fact, look a lot like the past 3 years, then the absolute best that these providers can expect is to tread water.  It is much more likely, however, that their historical revenue base will continue to fall at between 10% and 15%, at minimum.

So what is a company engaged in securitization services to do for 2011? 

We would make a few suggestions:

1- Look Beyond the Transitional Effects:  While wide cross-sections of staff and other resources may be devoted to sorting through defaults, litigations,etc, make no mistake in understanding that these are temporary situations.  Give serious thought to outsourcing clerical and administrative activities associated with these events as the best method for keeping your expenses as low as possible.

2-Downsize your Business Development Efforts:  Unless you are a relatively new enterprise and particularly if you are an established player in the market, we would recommend a signficant downsizing of your sales and marketing operations in 2011.  Keep only the best and only what you really need.  Reallocate resources that you have retained to chase new clients, new markets, and emerging products.  Simply a smaller version of the what you already have is not the answer.

3- Renegotiate with your Vendors:  Despite the possible ripple effect that might be felt throughout the industry, it is extremely important that each firm become more efficient in its own right.  This should include a re-visitation to each vendor contract to determine if the terms are suitable for the “new normal”.  This doesn’t necessarily have to be a reduction in price only as it might include product/service upgrades, alternate volume thresholds, deferred payment schedules, etc.  Every firm should attempt to find the set of solutions that works best for them.  In a perfect world, each company adopting such a strategy will ultimately improve efficiency across the entire securitization market which will lower funding costs and advance the return to higher issuance levels.

4- Make Acquisitions or Find a Partner:  In the case of larger organizations that have invested significant time and effort to train staff, build technologies and to master processes, we would recommend the development of a defined program aimed at identifying and executing acquisition opportunities to offset low market activity.  Such a strategy should not be taken lightly ( it takes work and commitment) but it has proven, time and again, to be one of the most effective methods for surviving business downturns.  For smaller enterprises, we would recommend the serious consideration of combining your business with a competitor or a related product or service provider.  The benefits that come from scale (efficiency) and revenue diversification cannot be minimized.

Live to Fight Another Day

In summary, all the evidence appears to be in for the state of the securitization industry.  While we continue to be staunch believers in the eventual return of this market to perhaps even rival the heady days of 2006, we should not kid ourselves into thinking that we are out of the woods yet. 

Most providers of products and services to the securitization industry operate within larger companies, ones that service a number of different markets and industries.  It is significantly important that the senior managers, in each segment of the securitization services industry, recognize that the commitment of their respective organizations to their product line is not immortal.  Clearly, the industry as a whole benefits from having more people engaged in developing new products and in enhancing services to support these programs.  It is the responsibility of  “industry management”, across structured finance, to act decisively and to look for answers from outside their organizations, if they cannot find them within.

About markferraris
Managing Principal Orchard Street Partners LLC

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