Asset-backed securitization (ABS) took off in a big way in Europe last year, with the value of transactions soaring to a record $35.4 billion, roughly the level of the US market about seven years ago. Growth potential is still huge, especially as countries in Europe and elsewhere are beginning to put enabling legislation into place, but securitization teams don’t expect the boom to rival levels in the US, where issuance last year rose to $150 billion. In its relatively short life the European ABS market has flourished to a point where today’s outstanding volume is about $360 billion, equivalent to nearly 80% of the total German bond market.
“There will be a continuing increase in the market but I do not anticipate a dramatic move upwards,” says Dorian Klein, Merrill Lynch’s director of structured finance. “If you look at 1996, it was a bit of an aberration. Three transactions accounted for about half the total volume.”
Klein argues that the European ABS market will never be quite match the US’s. He sees one-off opportunities for very large deals, but probably not on a annual basis. “The market will do perhaps two to five multi-billion dollar transactions a year,” he says. Karl Essig, head of international securitization at Morgan Stanley, agrees that it would be difficult to match the aggregate total volume of 1996. “Last year we saw three or four of the largest deals ever done,” he says. “If you take these exceptional items out of the league table, the overall market is still developing and growing. I think we saw in 1996 the beginning of a trend of securitization as the currency of acquisition finance. This theme is here to stay.”
Innovative transactions
Essig cites as an example the £1.6 billion ($2.6 billion) property deal by the UK’s Ministry of Defence, which sold 58,000 homes rented to service personnel in a transaction partly financed by £903.8 million in bonds via a special purpose vehicle (SPV) called Annington Finance No 1. The bonds received an AAA rating and a 20% risk weighting as the rental income from the housing has an implicit government guarantee.
Another deal that followed the trend was the securitization of lease rentals due to rolling stock leasing company Porterbrook from UK train operating companies, used to finance the acquisition of Porterbrook by bus and rail operator Stagecoach. The £545 million deal comprised bonds issued in five tranches with an AAA rating and a 20% risk weighting for capital-adequacy purposes.
“Three or four years ago securitization was a novel technique in Europe,” says Irene Ho-Moore, a director in Standard & Poor’s structured-finance division. “Everyone is now getting into it and legislation is being drafted to accommodate it.” Ho-Moore says that after last year’s ground-breaking $5 billion asset-backed securitization by NatWest bank, there have been “numerous enquiries” from banks wanting to do the same thing.
Ho-Moore points out that last year there were a number of innovative transactions in the market. “A lot of securitization was used in ways it had not been used before, in areas such as acquisition finance and corporate restructurings,” she says.
NatWest’s Rose securitization was the most prominent asset-backed transaction last year because of its innovative nature and size. The floating-rate note (FRN) issued through this SPV securitized 200 of the bank’s investment-grade loans, the first public securitization of its kind. NatWest set up Rose to issue sterling- and dollar-denominated FRNs in the Eurobond market as well as in the US 144A private-placement market. NatWest held a global roadshow to sell the deal, 40% of which was placed with US investors.
“We have since had approaches from 30 institutions looking to do something similar,” says Andy Clapham, NatWest Markets’ head of asset securitization. “It created a new market, a new way of looking at corporate lending. It will probably be copied by a number of institutions.”
Clapham, who manages a 30-strong team, says a deal needs to be well structured and priced correctly to ensure that investors are comfortable with the credit side of it and the returns relative to the credit profile. “Rose was a fairly priced transaction, AA rated on its senior tranches and in general three to four times oversubscribed,” he says.
Others were less impressed by the deal. Guy Fletcher, BZW’s head of securitization for Europe, said Rose stimulated a lot of interest from banks considering freeing up regulatory capital with similar collateralized loan obligation (CLO) techniques. But he adds: “There are doubts whether much economic capital is released, the key is the disposal of subordinated and particularly unrated securities. Many are not yet convinced that there is a tangible benefit in such a transaction. We would expect European banks to start to apply CLO technology for targeted balance sheet and portfolio management purposes.”
Andrew Allan, head of asset-backed securitization at Salomon Brothers in the UK, says it is important to ask why someone would want to securitize in Europe. “One of the main reasons is that shareholders are starting to wake up and look at the underlying institution,” he says. “They are asking themselves whether they are being sufficiently rewarded for holding equity shares. A lot of big banks in Europe have been sleeping giants that have not been achieving optimum returns on shareholder capital. So one way to use securitization is to downsize the balance sheet and reinvest the capital in a more efficient manner.”
With legislation either in the pipeline or already on the books in other European countries to allow for asset-backed securitization, more jurisdictions are expected to have recourse to this source of issuance. Belgium has enacted changes to its legislation on SPVs to allow them to be used for private transactions. Germany is expected to issue guidelines shortly for securitization by credit institutions, and the Dutch central bank is in the course of establishing a framework for securitization by Dutch banks.
Freeing up capital
New legislation in Spain, where until recently only mortgages could be securitized, enabled Morgan Stanley and Bear Stearns to bring to market one of the biggest deals in recent months. They were advisers to Spain’s nuclear moratorium deal, a transaction that raised Pta715 billion ($5 billion) for four Spanish utilities. The deal securitized the compensation rights of utilities whose nuclear power stations were ordered to close by government decree. The transaction was structured into three sequential floating-rate tranches including a bond and two syndicated-loan tranches that were sold into the Spanish market. Two of the utilities, Iberdrola and Sevillana, which accounted for about 98% of the transaction, were able to reduce by half their leverage ratios and the securitized debt was not consolidated into the Kingdom of Spain’s budget.
“The next logical step would be for Spanish banks to securitize consumer loans,” says Allan of Salomon Brothers in London. “This would help with their balance-sheet efficiency as they would be able to remove those 100% risk-weighted assets from their balance sheets. The same process has taken place in France. This has been a method for them to free up capital and reduce their funding requirements.”
Morgan Stanley also joint-lead-managed the Cyber-Val transaction, the single largest European asset-backed bond offering to date, involving the securitization of a Ffr40 billion ($6.9 billion) first priority on a Ffr145 billion loan between Crédit Lyonnais and EPFR, a French government restructuring vehicle. The deal forms part of the French government’s plan to restructure Crédit Lyonnais and the structure obtained an Aaa/AAA rating because of the implicit support provided by the French government to EPFR.
The same bank acted as adviser and lead underwriter for the securitization of 229 aircraft valued at $4.5 billion for Irish leasing company GPA. The transaction was a critical component in the company’s corporate restructuring, allowing it to remove assets from its balance sheet and thus improve its credit quality. The issue was global, with 60% placed in the US while British investors took up 41.5% of the European tranche.
Issuers are keen to promote large transactions for a number of reasons, but primarily because they bring down costs and generate more investor interest. “If you’re playing around with $25 million you have a problem getting enough investors to focus on the deal and do their homework,” says Morgan Stanley’s Essig. “If they’re only going to get $1 million of funds, they generally won’t bother. Last year proved that more big investors felt they needed to be in on it. Cyber-Val was a deal that was launched and priced in five working days in July and fund managers felt they could not afford to be left out of it.”
Asset-backed securitization of credit cards has provided another funding vehicle in Europe which at the same time brings new investors into the market. Typically a company that provides credit-card loans issues FRNs with the interest and capital repayment being provided by repayments from credit-card borrowers.
Salomon Brothers did two Deutschmark deals using a new structure involving credit-card receivables using US collateral. The bank took the collateral and placed it in an SPV and issued Deutschmarks at a fixed rate. A number of similar transactions followed, including Morgan Stanley’s Dutch guilder and Deutschmark deals which repackaged Citibank credit card debt. Credit-card issuer MBNA recently did a 10-year Dutch guilder transaction. In the US the top-10 credit card issuers now control 55% of the market and are looking to spread their names and diversify their investor base throughout the world.
“We have achieved a couple of goals by undertaking these transactions in different currencies,” says Salomon Brothers’ Allan. “One of the most important achievements was to introduce the credit-card structure to a new group of European fixed-income investors. These credit-card structures were triple-A and this investor group found value in these bonds compared with other triple-A bonds. Credit-card issuers are gaining access to a new group of investors and are therefore reducing their dependence on the existing asset-backed investor base.”
Problematic placement
Last year the international credit-card market made approximately $47 billion of new issuance and this year it’s on track to be roughly the same. Hence, as a head of asset-backed securitization at a London bank says: if you keep coming to the market with this size of volume year on year, then placement becomes more problematic.
He says the existing investor base can only absorb a finite amount of the product and so new investors and markets are required. Pricing of these credit-card transactions has not been overly complicated as credit spreads have contracted over the past few years. However, headline risk has become an issue with the deterioration in the quality of US consumer credit, and investors are now focusing on the underlying credit-card servicer. The credit-card market has plain-vanilla structures and investors understand that these can withstand catastrophic losses before there is any loss of principal. When it comes to the home equity market in the US, where there are prepayment issues coupled with caps and floors, and convexity issues if loans are fixed rate, a deeper understanding of the underlying issues is required in order to make a proper valuation.
Identifying cashflow
Mortgage-backed transactions are still one of the most popular forms of issuance and there is a constant quest to devise original ways to use mortgage assets in the ABS market. SBC Warburg recently collaborated with Bank of Scotland on a new mortgage-backed product the retail mortgage which the bank says has implications for the institutional financial markets since it is a mechanism that can be used to create innovative structures for institutional investors.
“We’re looking to extend it to the US and a number of continental European countries, the Far East and Australasia as well,” says David Garner, an associate director at SBC Warburg. “The concept of the retail mortgage is that the houseowner can take the mortgage on a property at a very reduced interest rate. The offset for the interest-rate reduction is that the customer agrees to give up a certain share of the appreciation which takes place in the property’s value between the time the mortgage is taken out and its redemption.”
This allows institutional investors to gain access for the first time to the owner-occupied residential property sector. The UK residential property sector is valued at approximately £1.2 trillion, equal to the country’s equity and bond markets, about £800 million of which is unencumbered by mortgages.
“We’re helping Bank of Scotland to securitize those mortgages and pass through the exposure to property prices to a whole raft of institutional investors,” says Garner. “The first tranche of the securitization should go through by mid-summer. There will be two bonds, one fixed-rate issue of about £25 million to £30 million and FRNs backed by more in the order of £120 million.”
The urge to keep the momentum going this year and bring new, innovative deals to the market was highlighted in an exotic fashion by rock star David Bowie, who in February issued a bond backed by future music royalties from several of his best-selling albums. The $55 million bond, rated single-A and privately placed, pays a fixed-rate 7.9% coupon on a 10-year average life.
The Bowie transaction, however, was more in line with the trend in emerging European markets to concentrate on future-receivables. SBC Warburg recently closed a deal for Turkey’s Garanti Bankasi, a $115 million future-flow transaction based on the securitization of various cheque receivables through an SPV. The deal has a five-year maturity and a three-year average life and pays a coupon of 200 basis points over Libor.
“In essence the philosophy is to identify a cashflow that can be isolated and allocated offshore and therefore outside the sovereign ceiling of a particular country,” says David Newby, SBC Warburg’s director of asset-backed finance. “In emerging Europe we are seeing things like exports of oil and steel as well as credit-card receivables, where there is a clearly identifiable cashflow that can be captured offshore.”
In western Europe where governments are trying to meet the Maastricht criteria for accession to the EU single currency, there is a trend to take items off the state balance sheet. “We’ve seen this particularly in Britain with the private finance initiative (PFI),” says Newby. “We’ve seen roads built and financed by bonds.”
SBC Warburg joint-lead-managed with Lehman Brothers the first-ever PFI road construction bond in March 1996, a £165 million Eurobond issue for Road Management Consolidated which is using the proceeds, together with a £111 million loan facility from the European Investment Bank, to fund road improvement works. The company will then be paid “shadow tolls” by the government, linked to the volume of traffic on each road.
Other countries have used asset-backed securitization to enable them to comply with criteria for entry to the European single currency. Finland launched Fennica 1 and 2, which securitized social housing loans. The two deals, valued at nearly $700 million and jointly led by ING Barings and Postipankki, were the first public Finnish markka securitizations. This enabled Finland to avoid using government funds to issue loans, using the capital markets instead to raise funds through securitized transactions. Ireland and Belgium are said to be looking to do something similar.
One-off market
Some market participants, such as NatWest Markets’ Clapham, are convinced that the European ABS market is moving to the top of the agenda. “The market is very buoyant from an issuer’s and an investor’s standpoint,” he says. “It really took off last year and it will grow in terms of volumes, issues and number of issuers.”
Despite the dramatic surge in volume over the past 18 months, others involved in the ABS market have noted its largely one-off nature. “There is a lack of repeat issues in Europe,” says SBC Warburg’s Newby. “The market is a bit spotty.”
BZW’s Fletcher says there are different views over whether securitization has finally taken off or not outside the US. “If you look at the deals completed it is quite a mixed bag of interesting and innovative but largely unconnected transactions using securitization technology,” he says. “Overall volumes have been much improved in the last 18 months but there have been a number of solitary high-profile deals with relatively little repeat issuance that would form the backbone of a mainstream market.”
The investor base outside the US and Europe is growing and becoming more sophisticated, especially in areas such as the Middle East and east Asia, where assets being securitized range from personal loans and mortgages to motorbikes, cars and trade receivables. Emerging market transactions tend to be insurance-wrapped to allow institutional investors with risk limitations to enter the market.
ING Barings launched the first securitization out of Thailand last July, a $350 million FRN secured on hire-purchase and leasing receivables originated in Thailand. This was the first Asian asset-baced deal outside Japan or Hong Kong. The deal was structured and lead-managed by ING Barings and priced to yield 22bp over three-month Libor with a 1.5 year average life.
