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Debt to go

Securitisation does not deserve the opprobrium heaped on it during the credit crisis, says Cass research. Now banks are once again set to sell-on loans and mortgages, reports Steve Lodge.

Securitisation was seen as a key cause of the credit crisis, but is now talked about as an important ingredient of economic recovery.
The process whereby banks package up some of their loans and sell them on to investors has been blamed for lending decisions becoming ever more lax in the run-up to the crisis. While banks were allowed to offload credit risk, they had less incentive to screen out borrowers who might not be able to repay.
The value of outstanding mortgage and other asset-backed securities in the US ballooned to more than $12 trillion by 2008. But, when Lehman Brothers collapsed that autumn, securitisation markets seized up and losses soared on what became known as "toxic" securities. With investor confidence blown, markets have remained largely frozen since.

Capital idea
Now, however, with policymakers keen to get banks lending again to stimulate growth, reviving securitisation markets is seen as a way of creating extra credit at a time of scarce bank capital.
As an unnamed senior US regulator explained in The Economist magazine recently: "Securitisation is a good thing. If everything was on banks' balance sheets there wouldn't be enough credit."
Likewise there has been an assumption that, whatever its contribution to the crisis, securitisation is a useful tool that should help banks to improve their performance.
Proponents point to a range of potential benefits for banks, including reduced funding costs compared with, say, issuing corporate debt; improved risk management from being able to choose which loans to keep on their books; and greater levels of profitability.
In practice, however, securitising banks did not always capture these benefits in the years leading up to the crisis, according to research by Dr Barbara Casu, Reader in Banking in the Faculty of Finance at Cass; Andrew Clare, Professor of Asset Management at Cass; Stephen Thomas, Professor of Finance at Cass; and Anna Sarkisyan, Lecturer in Banking and Finance at Essex Business School.

A question of risk
In fact, the stark conclusion of their study, Securitisation and Bank Performance, is that securitisation had no impact on the performance of US commercial banks - who were among the major securitisers globally - between 2001 and 2008.
Across a range of measures, including profitability, interest income, liquidity and capital, there was no evidence that securitisation had a significant effect on performance when compared with non-securitising institutions.
The research also considered different timeframes of up to three years from when individual banks starting securitising to test whether the benefits took a while to come through, but they were still no better off than the non-securitisers.
"They were no better on anything at all," says Dr Casu. "They could have had the same performance by doing something else" - lending better or having a different corporate strategy, for example.
The findings differ from other studies which found that securitising banks outperformed non-securitisers in the credit boom.
However Dr Casu says that while they were generally bigger and more profitable, it was not securitisation that gave them better performance. Typically it was because they undertook higher-risk activities.
Part of the explanation for US commercial banks not capitalising on the potential benefits of securitisation reflects the "poor techniques" they employed, the study suggests.
Where they sought to offload poor-quality loans they often had to give guarantees on losses to gain investment-grade ratings for the securities they were creating. This offset the benefit of potentially cheaper funding.

Room for regulation
And banks which wanted to establish and maintain a reputation in the market "cherry-picked" their better assets for securitisations, or provided recourse to investors against poor performance. This left credit risk sitting with the bank. Professor Clare likens the way many banks practised securitisation to parents remaining a financial backstop even when their children grow up and leave home.
The findings support the need to improve regulation and supervision of securitisation to ensure risks do not outweigh benefits in the future.
Poor securitisation techniques took hold among banks, the study suggests, because of the increased complexity of transactions and lack of transparency in the market as well as lenient regulation and supervision. Increasing transparency and bringing more simplicity and standardisation to securitisation should help restore confidence to the markets.
"There's definitely room for more regulation," says Dr Casu. "Markets are not correcting themselves and not restarting. There's no trust."
The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes a requirement on securitising banks to retain a proportion of the issued securities or of the loans being packaged up. Similar rules are expected to be adopted in other countries.
Changes should encourage banks to undertake more responsible securitisations as well as helping to revive the market by giving investors more information on risks, says the study. "Securitisation is not evil," says Dr Casu, "but it does need to be used wisely."

Steve Lodge is a freelance writer. He can be contacted at stevealodge@yahoo.com

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