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Securitisation Seeing The Light Of The Day

 

January 11, 2014

The US “subprime-cum-securitisation” crisis was a key catalyst for the global liquidity crisis that mutated into a full-blown credit crisis, bringing the international financial system to the edge of the abyss. In hindsight, the numerous structural shortcomings of the structured- finance securitisation market - particularly in the US - may have seemed obvious. The misalignment of incentives was evident in every link along the structured-finance securitisation chain. Proper risk evaluation was not always undertaken by professional investors and intermediaries, while too much faith was put in credit rating agencies whose own methodologies for valuing complex structured finance products were at times flawed. In addition, other gatekeepers of the public trust including auditors, securities lawyers, regulators and supervisors failed, to varying degrees.

At least theoretically, it cannot be defined that Securitisation provides benefits to both issuers and investors. Securitisation has traditionally offered banks with a key source of long-term funding, and thereby allowed for improved balance sheet management. It has been praised for increasing the availability of credit, while decreasing its cost. Investors also benefit from securitisation by gaining direct risk exposure to diversified sectors of the economy. More generally, the key benefit of structured finance securitisation was said to be the ability to disperse and redistribute credit risk to a broader and more diverse investor base.

Yet due to practices that were abusive and disoriented, the market for securitised products ballooned before the crisis and then burst open. However, there are clear signs of recovery. As evident from the data provided by the SIFMA, global CDO issuances (in USD millions) have increased steadily after a sharp decline from 2007 to 2010.

 

Year

 

Arbitrage

Balance Sheet

Total

2000

 

 

 

67,987.7

2001

 

 

 

78,453.8

2002

 

 

 

83,074.3

2003

 

 

 

86,629.8

2004

 

 

 

1,57,820.7

2005

 

2,13,306.4

37,958.9

2,51,265.3

2006

 

4,54,970.8

65,673.8

5,20,644.6

2007

 

4,31,862.4

49,738.3

4,81,600.7

2008

 

47,938.0

13,948.8

61,886.8

2009

 

3,443.3

892.7

4,336.0

2010

 

3,491.0

5,174.9

8,665.9

2011

 

5,358.6

25,772.8

31,131.3

2012

 

36,291.5

14,436.4

50,727.9

2013

 

78,064.9

8,177.5

86,242.4

 

If we look at the ABS market data provided by SIFMA, we also see that the market is slowly recovering to the levels prevailing during the boom period.

 

 

Year                Auto                Credit Card   Equipment     Other  Student           Total

2000

 

71,026.90

57,143.30

11,464.90

36,055.70

18,562.00

1,94,252.80

2001

 

83,946.90

68,618.40

8,499.60

30,897.40

14,883.90

2,06,846.20

2002

 

94,659.00

70,336.90

6,419.50

19,353.20

27,739.90

2,18,508.50

2003

 

82,525.70

66,730.90

9,451.40

30,367.90

42,993.00

2,32,068.90

2004

 

79,381.40

53,742.30

8,462.80

36,504.00

48,042.80

2,26,133.30

2005

 

1,06,096.00

67,833.50

10,442.80

44,969.30

63,239.60

2,92,581.20

2006

 

90,440.20

66,899.00

8,777.60

36,516.20

67,129.20

2,69,762.20

2007

 

78,599.80

99,527.20

5,768.90

44,389.10

61,370.90

2,89,655.90

2008

 

36,164.20

59,059.50

3,070.30

8,870.20

28,204.00

1,35,368.20

2009

 

62,748.00

46,094.50

7,655.10

10,249.50

22,095.90

1,48,843.00

2010

 

59,318.61

7,371.69

7,826.40

14,920.50

15,451.98

1,04,889.19

2011

 

68,219.07

16,151.77

9,525.52

14,274.77

13,963.40

1,22,134.53

2012

 

90,183.18

39,820.65

19,499.38

26,328.87

25,338.81

2,01,170.89

2013

 

87,522.75

35,634.66

13,585.75

31,493.92

17,851.91

1,86,088.99

 

The comeback of securitisation can be causally linked to the growth in demand from investors eagerly looking for yield. Securitised paper can offer decent returns, particularly at the riskier end of the spectrum. And unlike American capital markets, Europe remains far more dependent on bank lending to fuel economic growth. European banks need more capital, because they are failing to meet demand for credit from consumers and small businesses.

Although we cannot rule the inherent risks in the system, there is reason to expect securitisation should be safer in the future than in the past because of new, post-crisis regulations to reduce the danger of excesses. The principle of “skin in the game” should help ensure that underwriting standards do not get too slack. That will hamper the desirable transferring of risk completely but it is probably the best solution for all.

 

Shambo Dey

 
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