Asset-backed Finance: Europe takes to securitization

Until now. Changes in legislation, changes in corporate culture and the euro are now helping the market for collateralized loan obligations (CLOs), credit-card receivables and other asset-backed products to take off in Europe.

So far the limelight has been stolen by the more esoteric deals such as financings for UK leisure group (and owner of the waxworks museum) Tussauds and for the Formula One motor racing event, as well as the much-mentioned Bowie bonds for rock star David Bowie in 1998. But the growing volumes of business, in both CLOs, receivables and the more unusual products, are beginning to justify the attention given to the market.

Tamara Adler, head of European securitization at Deutsche Bank, estimates that about $60 billion of deals will have been done by the end of 1999, compared with the $40 billion done last year.

There are three main factors propelling the growth of the asset-backed market in Europe. First, the launch of the single currency is making it easier for investors to diversify portfolios away from their domestic markets, and is forcing them further down the credit curve to find yield. Securitizations usually comprise several tranches of varying price and risk weightings according to their level of subordination. Investor demand for the lower-rated tranches is growing. "The euro has had a tremendous effect on the asset-backed market," says Adler. "Investors are taking more time to understand credit structures."

As well as attracting new investors to the product, the euro enables existing asset-backed investors to buy into more markets. Adler points to growth of securitization in Portugal, which has produced three big asset-backed deals already in 1999. "Portfolio managers can use the great diversity of the eurozone without forex and swap problems," she says. "Issues from what would have previously been a small niche market like Portugal can now be sold to any asset-backed investor."

In many European countries regulations have made it difficult, or even illegal, to use many securitization products, but the legislation is gradually changing. Regulations are being harmonized across the eurozone. At the end of 1997, banks in Germany were allowed to start securitizing their assets, and Deutsche Bank is now the largest issuer in the European asset-backed market. This year, securitization in Spain has been widened to include non-mortgage assets, and in Italy, France and Switzerland many barriers to doing an asset-backed deal have been removed.

The changes to risk weightings that will result from changes to the Basle accords on bank capital adequacy will also affect the market. As asset-backed deals become lower risk-weighted, spreads will decrease, making it more appealing for issuers to securitize and making the asset class more competitive in the wider market.

Although most asset-backed deals so far have securitized repayments on loans made by banks, credit-card lenders or car companies, non-financials are now starting to securitize other revenues. This reflects the final big factor boosting the asset-backed market.

As corporates try to compete in the single European market, the new focus on shareholder value causes them to scrutinize their balance sheets. Rather than increasing debt through bank financing or the bond markets, some companies see an advantage to be gained through lower-cost financing from selling the rights to future incomes to investors.

Larger companies are now beginning to securitize regularly for funding and balance-sheet management. "Corporates are now looking at funding alternatives and using securitization as an accepted form of financing, and not just as a one-off transaction to solve a specific problem," says Adler.

Steve Skerrett, head of European asset securitization at Greenwich NatWest, agrees that the asset-backed market is attracting a wider range of borrowers. "The market is moving towards more deals with a corporate finance angle rather than just receivables," he says.

Securitization is also being used as an increasingly common form of acquisition finance, particularly in the UK, which has a conducive legal framework. In June Bankers Trust launched a £305 million ($485 million) deal for UK pub company Pubmaster backed by future revenues from beer sales. This will allow the company to retire some £120 million of debt accrued in the management buy-out that formed Pubmaster in 1996. Pub securitizations are emerging as an asset class in themselves after similar deals from Unique Pub Finance and Punch Taverns.

Deals backed by revenue streams allow companies to transcend a low credit rating and unlock the potential of their future cashflows. An unrated company can do a deal rated triple A on the basis of its revenues and achieve a much lower cost of borrowing than if it accessed the debt or loan markets.

Skerrett at Greenwich NatWest predicts more deals from the entertainment industry. "Famous names and brands excite the investor imagination," he says. Rock star Elton John is currently reported to be considering securitization as a way to tap future sales of his records to repay his debts.

In the more traditional parts of the market - flow business rather than one-off financings - there is also big growth potential. "The bulk of the growth in volumes is a function of CLOs and deals backed by auto loans, mortgages and consumer finance," says Adler at Deutsche. In May, Adler's 40-strong team completed a £1 billion securitization of UK student loans called Honors, and although the sterling market is small it was much in demand from investors. In the same week deals were launched for Tussauds, the Broadgate commercial property portfolio, and Deutsche's Globe portfolio of large corporate loans. "It is a strong sign of the maturing of the market that it can absorb this much activity," says Adler.