Credit crisis takes steam out of securitization

NEW YORK (Reuters) - The credit squeeze rattling Wall Street may be abating, but it won't reverse a bust in the $3 trillion structured finance market, ending a long boom that lowered funding costs and helped spread risks.

For more than a decade, bonds backed by mortgages and credit card payments have enjoyed nearly uninterrupted growth, providing low-cost funds for companies to expand and high returns for investors who bought the securities.

Following the subprime mortgage crisis, hedge fund investors and money managers who had gobbled up asset-backed securities have begun to question the safety and quality of securitized debt.

Sales of asset-backed securities in the first half of the year, before the worst of the credit crisis, fell for the first time in 15 years, according to the Securities Industry and Financial Markets Association.

As investor appetite wanes, many of the more exotic financial instruments dreamed up in recent years, such as structured investment vehicles and extendible asset-backed commercial paper, may now be threatened with extinction, analysts say.

While such a change could mean higher borrowing costs for companies, it could also restore some rationality to an exuberant market that has roared for years.

COUNTDOWN TO EXTINCTION?

A few of the securitized products that may go the way of the dodo are riskier types of commercial paper, a kind of short-term IOU that banks and companies use to fund their daily operations and investments.

"People fundamentally do not trust the (credit) ratings of (asset-backed commercial paper)," said Christian Stracke, an analyst at research firm CreditSights. "They're going to demand a premium," Stracke said, which "undermines the whole economics of these" vehicles.

European banks HSBC (HSBA.L), ABN Amro AAH.AS and HBOS HBOS.L have concocted an array of investment vehicles in recent years called "conduits" that use cash raised by issuing commercial paper to buy higher-yielding securities, pocketing the difference between their funding costs and investment returns.

Commercial paper issued by "securities arbitrage" vehicles, structured investment vehicles (SIVs) and SIV-lites, along with "extendible" paper issued by borrowers that reserve the right to extend the maturity date, may have a tough time finding buyers.

Analysts at JPMorgan Chase & Co said in a report in August that such vehicles' funding costs are likely to rise after the current market disruption. "SIVs may no longer be viable vehicles to buy and hold" highly rated investments, they said.

The banks that provide backup emergency credit to such conduits, a requirement for most traditional conduits, are likely to demand a higher price for that liquidity, according to Deborah Cunningham, chief investment officer for money markets at Federated Investments in Pittsburgh.

The picture is almost as bleak for sales of some types of collateralized debt obligations.

As ratings downgrades have outnumbered upgrades by six to one in some cases, sales of the debt products, which are backed by other kinds of debt, fell to $17 billion globally in August, the slowest month since the beginning of last year, according to Morgan Stanley analysts.

Sales in the United States alone hit a record $320 billion last year, according to Moody's Investors Service.

Jeffrey Gundlach, chief investment officer at Trust Company of the West in Los Angeles, the No. 1 manager of CDOs, said the market needs to undergo a period of consolidation.

"It's the two-guys-and-a-Bloomberg operations that got put into business in 2005 and 2006 that on a very disproportionate basis served as repositories for the worst quality (loan) originations," he said.

A CDO salesman at a major Wall Street firm said last month that, "There are 250 ABS (asset-backed securities) CDO managers out there right now. A year from now, there will be less than 100. Two years from now, there will be less than 60 or 70."

Still, broad statements that investors are turning their backs on particular sectors or securitization in general may be premature given the steady performance of assets like credit-card securities, said Tom Deutsch, associate director of the American Securitization Forum in New York, an industry group.

"There have been some investors who have dropped out of the market effectively, and certainly that contributes to lower issuance volumes," Deutsch said. "I don't perceive that to be a long-term persisting problem. I perceive it as a short-term potential overreaction by the market," he said.

"I'm not looking for a job yet," he added.