J.P. Morgan, Citigroup Winning in Asset-Backeds
By Edward Leefeldt
>>ABS investors can add Congress to their list of worries. More people may rush to file for bankruptcy in coming months because lawmakers are considering enacting legislation that would make it tougher for people to seek protection from creditors, says Barclays Capital's Salmon. While similar proposals have bogged down in Congress in the past, President George W. Bush has said he'd sign the current bill if lawmakers pass it.<<
New York, Sept. 19 (Bloomberg) -- These are uneasy times in the $7 trillion market for asset-backed securities -- bonds typically backed by payments on credit card debt, auto loans or second mortgages or by corporate bonds.
Since January, a record 21 ABS issuers have defaulted, according to Standard & Poor's. This year, S&P has cut the credit ratings of 409 ABS issues, an all-time high.
Another 2002 record for this market was set in the area of sales. Even as the risks grow, banks are selling new asset backeds as never before. U.S. sales of those securities rose 15 percent to $265 billion during the first eight months of 2002, according to data compiled by Bloomberg. At that rate, sales for the entire year may reach $398 billion, topping the 2001 record of $372 billion, bankers say.
``It's a huge market,'' says Joseph Lorusso, who manages about $2 billion at Structured Finance Advisors in Hartford, Connecticut.
Investors in this mostly AAA-rated world may be headed for more shocks. Many of the raw materials that bankers have used for constructing the securities have grown weaker since the U.S. economy slid into recession in March 2001.
WorldCom
This past July, the bankruptcy of just one company --WorldCom Inc. -- touched off a chain reaction of trading losses in the market for collateralized debt obligations, or CDOs. Those securities use money generated by pools of corporate bonds to pay holders interest and principal. Underwriters had packaged WorldCom bonds into about a hundred different CDOs, according to Merrill Lynch & Co. People who bought those investments could lose $400 million, Merrill says.
The U.S. Congress, meantime, is considering at least two measures that could pose new dangers for ABS investors.
``These are uncertain, painful times,'' says Jeff Salmon, director of ABS research at Barclays Capital Inc.
Uncertain, painful -- and profitable for underwriters. Over the past four years, firms such as J. P. Morgan Chase & Co. and Credit Suisse First Boston have shot to the top of this business at the expense of Goldman Sachs Group Inc. and Merrill Lynch, according to data compiled by Bloomberg.
Banks Win
Big banks have an edge in the ABS market because their large balance sheets enable them to offer credit lines to companies in exchange for underwriting business. At stake in this market are underwriting fees that are likely to reach $1 billion in 2002, according to Bloomberg data.
During the first half of 2002, J.P. Morgan underwrote 22.4 percent of the 50 largest car loan transactions -- measured by U.S. dollar value -- thereby giving the bank the lead in that field for a second consecutive year, according to data compiled by Bloomberg.
J.P. Morgan also underwrote 25.8 percent of the largest credit card deals, ousting Salomon Smith Barney, the securities and underwriting arm of Citigroup Inc., from its No. 1 perch; Salomon dropped to second place, with 19.8 percent. Credit Suisse First Boston sold 29.4 percent of the largest CDO issues, leading that business for a second year. Countrywide Securities Corp., the securities arm of mortgage company Countrywide Credit Industries Inc., underwrote 20 percent of the biggest home equity issues, displacing the 2001 leader, Bank of America Corp., which dropped to No. 3.
Consumer Ills
Underwriters create asset-backed securities by bundling together millions or even billions of dollars of individual loans or bonds and dividing the securities backed by the collateral into classes ranked according to the order in which holders get back cash if borrowers fail to make payments on the underlying loans. Credit card issues typically comprise three or more classes, with the highest -- usually 80-90 percent of an issue -- getting first dibs on payments from the underlying loans. The lower classes absorb any losses first, helping protect the senior securities.
U.S. consumers have missed or delayed so many credit card payments lately that some of these securities have run into trouble. In June, income from credit card loans backing $3.3 billion of securities issued by J.P. Morgan and FleetBoston Financial Corp. fell so low that Daniel Castro, head of asset- backed research at Merrill, warned that soon there might not be enough cash to pay ABS investors. In the end, collections rebounded in July. If they hadn't, Morgan and Fleet might've been forced to repay the $3.3 billion in principal immediately. Like many asset backeds, these securities have early-redemption clauses obliging the issuers to redeem the bonds if the loans no longer generate more than enough interest to cover bond payments.
`Sacrosanct AAA'
While Morgan and Fleet avoided the early payout, the experience suggests that even the highest classes of card securities may no longer be ensured of AAA ratings, Castro says. ``Sacrosanct AAA has become quite vulnerable,'' he says.
These days, many consumers aren't paying their bills, and people in the U.S. are going bankrupt at a record pace. Nearly 391,000 people filed for bankruptcy in the second quarter alone, according to the American Bankruptcy Institute. The percentage of U.S. credit card debt that banks label uncollectible ran at a record 7 percent from March to June, according to S&P.
Companies that make consumer and home loans to customers with weak credit histories and that package that debt into securities have been hit especially hard. From 1999 to 2002, NextCard Inc. sold $1.2 billion of asset backeds while growing into the largest marketer of credit cards on the Internet. Last February, the U.S. comptroller of the currency ordered the closure of the company's NextBank unit, saying NextCard had failed to spot credit problems.
Sub Prime Scrutiny
``NextCard cost us $300 million-$400 million,'' says David Barr, a spokesman for the Federal Deposit Insurance Corp., which guarantees U.S. bank deposits. The FDIC stepped in to keep NextCard's asset-backed securities from paying out early by injecting money into NextCard. Most of the company's loans had been packaged into bonds, Barr says.
The Federal Financial Institutions Examination Council, an umbrella group for U.S. financial regulators, has been scrutinizing other sub prime lenders that tap the ABS market. In July, Capital One Financial Corp. stock plunged 40 percent in one day after regulators ordered the consumer finance company to set aside more money to cover loan losses.
Lisa Brown-Premo, who helps manage $32 billion in bonds at Evergreen Asset Management, a unit of Wachovia Corp., says she's reluctant to buy more asset backeds, given such troubles in the market.
``We're not adding assets,'' Brown-Premo says. ``I see more negatives now than in the past.''
Congress Threatens
ABS investors can add Congress to their list of worries. More people may rush to file for bankruptcy in coming months because lawmakers are considering enacting legislation that would make it tougher for people to seek protection from creditors, says Barclays Capital's Salmon. While similar proposals have bogged down in Congress in the past, President George W. Bush has said he'd sign the current bill if lawmakers pass it.
Another bill before Congress, the Employee Abuse Prevention Act of 2002, would give employees and retirees an edge over ABS investors when some companies fail. Right now, ABS buyers get first dibs on the assets backing their securities. As a result, S&P and Moody's Investors Service usually rate a company's asset backeds higher than its corporate debt. The bill would put other creditors first in line when a company collapses because of fraud.
Alexander Dill, an analyst at Moody's, says lawmakers will probably rewrite the legislation so it doesn't hurt ABS investors. If the current bill passes, however, it would radically change the market. ``You could never assign a rating to an ABS that was higher than the company's bonds,'' Dill says.
Accounting Changes
The Financial Accounting Standards Board, meantime, is considering a proposal to tighten the rules governing off-balance- sheet financing -- a switch that could make it tougher to sell new asset backeds. Enron Corp. had used special purpose entities with names like Chewco and Jedi to hide debt and losses. Companies that sell asset-backeds typically set up SPEs to hold the assets backing their securities. The setup lets issuers shift those assets off their balance sheets.
A big change in the rules governing SPEs could hamper the growth of both CDOs and the $700 billion market in asset-backed commercial paper, some investors say.
``A cloud of uncertainty hovers over the market,'' says Joseph Sheridan, a managing director at S&P. FASB officials say they plan to put new rules into effect in 2003.
For now, the deals keep coming: After Moody's cut Ford Motor Co.'s credit rating to Baa1 from A3 in January, Ford went on to sell $17.2 billion of securities backed by car loans during the first half of 2002, up from $9.3 billion in the first six months of 2001. Ford says it's cheaper to sell ABSs than ordinary debt.
`Two Markets'
MBNA America Bank NA, a unit of MBNA Corp., sold $450 million of credit card securities in August after saying it might set aside $300 million to cover losses on its card accounts.
Providian Financial Corp. wants to sell as much as $2 billion of credit card securities by year-end, says spokesman Alan Elias. Since September 2001, Providian stock has plunged 84 percent -- closing at $5.09 on Sept. 17 -- because many of its credit card customers have failed to pay their bills.
And as some investors fret about a potential bubble in the U.S. housing market, Gyan Sinha, head of asset-backed research at Bear Stearns & Co., says sales of securities backed by second mortgages may rise to $90 billion during the second half of 2002 from $63.4 billion in the first half, as more and more people tap equity in their homes.
``This is a tale of two markets,'' says Brian Clarkson, a senior managing director at Moody's. ``The headlines are terrible, but the bankers and issuers say it's great.'' So far, anyway.
Rank Volume Market 2002 2001 Autos (billions) Share% 1 1 J.P. Morgan Chase $11.9 22.4 2 11 Banc One Capital Markets 8.2 15.5 3 4 Bank of America 6.8 12.8 4 5 Deutsche Banc Alex. Brown 6.4 12.0 5 7 Morgan Stanley 4.5 8.5
CDOs 1 1 Credit Suisse First Boston $6.0 29.4 2 5 Deutsche Banc Alex. Brown 3.6 17.8 3 7 Wachovia Securities* 1.9 9.2 4 2 J. P. Morgan Chase 1.7 8.4 5 NA WestLB Panmure 1.0 4.9
Credit cards 1 2 J. P. Morgan Chase $9.5 25.8 2 1 Salomon Smith Barney 7.3 19.8 3 4 Banc One Capital Markets 4.1 11.0 4 3 Deutsche Bank Alex. Brown 4.0 10.7 5 5 Morgan Stanley 3.3 9.0
Home equity 1 9 Countrywide Securities $9.9 20.0 3 5 Credit Suisse First Boston 8.4 17.0 3 1 Banc of America 7.7 15.5 4 2 Bear Stearns 4.2 8.4 5 8 Morgan Stanley 3.9 7.8
*Formerly First Union Securities. Includes the 50 largest Dollar- denominated issues with settlement dates in the first Halves of 2001 and 2002. Lead managers get full credit; co-lead managers share credit equally. Source: Bloomberg
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