Australian Securitisation Market Surges and Sputters

As we recorded earlier in the year, in many respects, the Australian securitisation market can be viewed as a trial balloon for the general recovery of global structured finance.

Partly because of its relatively small size but mostly because its track record for close collaboration between issuers (mostly Aussie banks and mortgage companies) and the Australian Government has been quite remarkable and a model for others to follow.  This close cooperation was once again evident earlier this month as the Australian Senate Economics Committee published a report detailing its inquiry into competition in the Australian banking sector.  The Senate report was very clear in its view that the slow recovery of the securitisation market is a “key factor” to reduced competition in the banking market.  This conclusion has once again raised the level of conversation about the role that the Australian Government can and should play in the revival of the structured finance market and the committee appears to be throwing its full weight behind a series of initiatives to help the market recover.

Issuance of Aussie securitised debt has increased on a year-over-year basis and 2011 issuance levels are expected to beat the AUS$20Billion issued in 2010.  The continued and pro-active support of the Senate and other governmental bodies will, no doubt, continue to feed the confidence of both issuers and investors.

However, until such time as offshore investors return to Australia,  securitisation will continue to sputter.  Since the late 1990’s the Aussie structured markets and the RMBS market, in particular,  have relied on offshore investors to fuel its growth.  Not unlike the capitally constrained bank that cannot meet loan demand, the Australian domestic investor market is simply too small to digest the leverage available to banks and other issuers of securitized debt.  In its heyday, the Australian RMBS market offshore investors held more than two-thirds of the AUS$170Billion outstanding. 

Issuers and arrangers are fully aware of this phenomenon, as is the Australian Government, and they seem to have undertaken a concerted effort to work with industry groups, including the Australian Securitisation Forum, to alert the international investor community that the Australian securitisation market is back open for business and that the national government will do all it can to make this market, once again, a model to be envied.

Perhaps it is easier for a smaller market to get its proverbial “act together”.  Nevertheless, it is a good sign to see at least one market getting serious about how to re-open this vital market.

ASF Tries to Make a Stand

On May 18th, the US Senate Banking Committee held a hearing on the State of the Securitization Markets.  Headlining a mixed group of industry professionals was Tom Deutsch, Executive Director of the American Securitization Forum.

The ASF’s written testimony provided the Committee with a very comprehensive analysis of how all the recent legislation and new regulations have negatively impacted the securitization markets.  The cumulative impact of all this “surgery” has effectively ground the securitization markets to a halt, with only a few asset classes such as auto and credit card securitizations, performing at anywhere near pre-crisis levels.  Most estimates have the US securitization industry operating at just 20% of what it was back in 2006 and early 2007.

We think that Mr. Deutsch got it just about right when he suggested in his testimony that the only real way out of the legislative and subsequently proposed regulation quagmire was for the regulators to closely review the comments and formal communications from the industry, including both  issuers and investors, and for them to agree that they will recast the originally proposed regulations in a revised form which is much more conducive to the revival of the securitization markets.

Essentially, what the ASF is trying to say (without actually saying it)  is that the cumulative effects of all the piecemeal legislation and regulation, often written and passed by folks with little or no real experience or understanding, must be redone or you can kiss securitization as a financing tool goodbye. 

We could not agree more completely with the ASF on this point.  We just wish they had been as succinct and as forceful about this message a long time ago.  Hopefully, this case of “better late than never” is not too late because, if it is, the next hard lesson to be learned by the regulators on the backs of the US economy might be that there is not enough balance sheet capacity in all the banks to support a full recovery of the US economy.  We worry that it may be too late before they figure out that the answer to spurring the recovery of the US financial services industry had been securitization all along. 

As we have said in the past, too much leverage may be bad but zero leverage is a recipe for disaster.  Securitization provides banks and other lending institutions with a most efficiently consistent method for managing the leveraging of their balance sheet and it provides non-financial investors with an efficent way to invest in financial instruments without having to underwrite those activities themselves. 

We hope that enough people in the right place come to understand this or, better yet, they remember this before the new regulations are finalized.

The FDIC’s Rose Colored Glasses

Over the past year, we have often come back to critique the performance of the various banking and securities market regulatory bodies during the recent financial crisis.  These would include both Federal and State agencies including the Federal Reserve, OCC, SEC and NYS Banking.  However, our most pointed criticism has been reserved for the FDIC, mostly because their Chairman, Sheila Bair, has been the most vocal about what went wrong and how her agency would have handled things differently.

What gets under our proverbial “skin-in-the-game” the most are the attempts by the FDIC to ignore their own shortcomings during the 8-10 years leading up to the financial crisis.  As a regulator for so many small and medium-sized lending institutions, the  FDIC had perhaps the best opportunity among all the US regulatory bodies to single out the US mortgage market as increasingly out-of-control.

We have before utilized the analogy of the state trooper snoozing on the side of the highway while an increasing number of motorists test the speed limit.  It was the FDIC who had the best view of banks that were failing, why they were failing and how these “smaller experiments” were likely related to their bigger cousins in the banking industry (i.e. the larger regional and “Wall Street” banks). 

However, we are not here to throw more stones at the FDIC for missing the call.  What is galling to us though is the continued lack of any remorse or even acknowledgement by the FDIC that they screwed up and, even if the rules and regulations could have been more transparent, there were enough tools at their disposal to have been a better safekeeper of the public interest.

We would hope that we can stop writing about this topic within the next few months, as Ms. Bair wraps up her farewell tour and slides into the sunset (we assume to run for office).  Nevertheless, last week, she was back on Capitol Hill placing another chapter in the book which attempts to both exonerate and anoint the FDIC.  We can’t help but to note the contrast in the posture of the other regulators, when compared to the self-justification of the FDIC over the past few years.  We sense a significantly more humble and remorseful tone coming out of nearly every other regulatory body in and around the crisis.  Nevertheless, the FDIC has continued to chirp away and last week’s session with the Senate Banking Committee was another opportunity for Ms. Bair to shape history.

There were several key points that the Chairman made in her remarks and we would like to refer to a few of them here.  Of course, we have added our own alternative views, as well:

1- “The Central Cause of the Crisis in the US was Excessive Leverage”:  This is accurate and it applies not only to the banks but to individual consumers.  But wait a minute…… did this happen overnight or were the FDIC and other regulators simply unable or, worse, unwilling to take note?  Maybe it’s us but do you think her testimony could have acknowledged that her agency, with its fingers into so many banks across the Country, should have done a better job identifying these risks and then using the tools available at the time to help mitigate these problems?

2- “There was a Prevailing Assumption that Some Banks were Too Big to Fail”:  If we are following this theory correctly, the reason that the excessive leveraging and lax business standards were allowed to perpetuate was that everyone had this false sense of security that these companies were too big to fail and had the implicit backing of the US Government.  We have heard this “urban legend” told so many times over the last 4 years that it is no wonder that many people now take it as a provable fact.  We, on the other hand, would argue that nothing could be further from the truth.  Even the rating agencies, with their supposedly broken models, were drawing starkly different views of the creditworthiness of the larger financial  institutions in the years leading up to the crisis.  Perhaps the “main street regulators” at the FDIC saw the world that way from their perch in Decatur or Springfield but that’s not what the institutional investors backing Merrill, Lehman and JPM were thinking at the time.

3- “The Answer for Too-Big-To-Fail is SIFI”:  The answer to dealing with large signficant institutional failures is to designate them beforehand as Systematically Important Financial Institutions (‘SIFI”).  Without going into detail, let’s just say that no bank CEO in their right mind would want to have that “Scarlet Letter” hung over their door.  How about this alternative solution….. maybe the regulators could do a better job of understanding the businesses they are responsible for monitoring.

4- “Deeply Flawed Servicing Practices were a Key Contributor to the Crisis”:  Essentially, this theory attempts to place some of the blame for the crisis on how the banks tried to clean up the mess they had created in the residential mortgage industry.  While it is without question that the lack of fair standards in the servicing of mortgages were exposed by the crisis, this phenomenon should not be lumped in with the causes for the crisis itself.  Instead, what we have is many, including the FDIC, trying to alter the conversation.  Let’s face it, the lack of cohesive servicing standards did not cause the financial crisis and, if the negotiations over the Dodd-Frank bill had not dragged on as long as they did, this topic would have become a part of a another important piece of legislation or perhaps just a reinvigorated utilization of the regulations already at the disposal of the banking regulators.  We usually like to remind folks that it’s not the number of rules but how the rules that you have are applied that is most important.

5- “Lack of Skin-in-the-Game”:  No Bair speech would be complete without a rendition of the  most famous “war cry” of the “Great Financial Crisis of 2007” (i.e. Skin-in-the-Game).  How is it that the Chairman continues to misread the impact of a 5% retained interest on someone trying to abuse the system.  Additionally, the failure to understand that any enterprise that regularly utilizes the securitization markets to finance their activities already has their reputation (i.e. their ability to rely on the markets for their next issue) on the line.  The fact remains that if the regulators don’t do an adequate job of monitoring the lenders that originate the underlying assets in the first place, it won’t matter if you set the Retained Spread at 5%, 10% or 25%; abuses will occur.  We prefer to go the source of a problem rather than try to fix it after the fact.  Of course, in this case, this would put the onus on the regulators to do a better job; a result that isn’t quite as attractive to the FDIC, we assume.

Keep an Eye on CDS Probe

Given the European Commission’s track record for tenacity, we will be closely watching developments surrounding their recently announced probe into possible collusion among leading market participants and their hand-picked market data and trade clearing providers in the Credit Default Swaps (“CDS”) market.

Bank of America, Barclays, BNP Paribas, Citigroup, Commerzbank, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley, RBS, Societe Generale and Wells Fargo are among the group of 16 investment banks that have been accused of colluding to impede equal access to detailed trading data provided by Markit and level access to trade clearing platforms, other than their prefered provider,  known as ICE Clear Europe.

The Commission is pursuing two anti-trust cases, the first against the banks and Markit and the second against the banks and ICE.  In both cases, the Commission is investigating whether the banks have intentionally limited competition by placing a stranglehold on information that might otherwise be available to other providers of market data (in the case involving  Markit ) and by limiting access to most efficient execution by limiting access to the CDS market for competing clearing organizations (in the case involving ICE).

Given the ownership makeup of both Markit and ICE (i.e. many of the same banks named in the investigation are also “owners” of these two utilities), it is not hard to understand why the commission might be concerned.

For many years the CDS market has operated on the fringe of the mainstream markets, with many otherwise sophisticated market participants knowing little and often understanding less about how this market operates.  Given how deeply the Commission has sunk its teeth into other antitrust investigations it has pursued over the past 10 years, we suspect that this one has some legs and will be a story worth following.