SECURITISATION IS NOT A DIRTY WORD

Paul Volcker remarked in 2009 that the only valuable financial innovation of the last 20 years had been the ATM. He was wrong. Securitisation is an incredibly powerful financial innovation. But as Peter Parker was so memorably told by his father in Spiderman, "with great power comes great responsibility". Volcker, like many pundits and market participants since, tarred the entire structured finance spectrum with the brush of the subprime CDO explosion. The credit crisis teaches us that responsibility was not properly respected and observed, it does not tell us that securitisation is worthless. Just like not all sovereign debt is good, not all securitisation is bad.
 
Even the FT recently fell into this pitfall, with an article calling out JP Morgan's CIO unit for its holdings of 'risky' ABS. My response to that letter follows: “Securitisation is an easy target for lazy journalism.”  

“From Mr Pete Drewienkiewicz.
 
Sir, I was disappointed to read your May 18 article JPMorgan unit has $100bn of ‘risky’ bonds (my inverted commas), which at best constituted sloppy journalism and at worst wanton scaremongering.
 
JPMorgan has indeed accumulated significant holdings across a variety of highly rated, lightly structured asset-backed products, but to call these products “risky” simply because they fall into the “three-letter acronym” camp and to associate them with the collateralised loan obligations of US subprime, which caused so many problems, is inaccurate.
 
Although the mark-to-market experience in some of these asset classes was undeniably rather more hair-raising than many holders would have liked, the cumulative loss rate in UK prime RMBS, which comprises one of the largest JPMorgan holdings, through the entire credit crisis so far is of the order of 0.10 per cent.
 
Analysis shows that well over 10 per cent of UK homeowners would have to default on their mortgages in order to generate any significant losses in these assets. For reference, the worst year on record to date was 1991, when just 0.78 per cent of UK mortgagees defaulted. Some 90-95 per cent of US collateralised loan obligations (although it is unclear whether JPMorgan has large holdings of senior CLO paper from the data I have seen so far) are still paying out at the equity level, let alone at the super senior level.
 
Securitisation has a bad name and represents an easy target for lazy journalism, but the reality is that well-structured propositions with appropriate underlying collateral have continued to pay holders throughout the credit crisis and perform robustly even in current markets. JPMorgan certainly does appear to have plenty of questions to answer with regards to visible and misjudged positioning in the CDS index market, but this particular story was ill-judged.
 
Pete Drewienkiewicz, London SE11, UK”

 
Interestingly the Sunday Times had a rather different spin – its Money section noted that JP Morgan had indirectly financed huge swathes of the UK residential mortgage market since the credit crunch, effectively keeping borrowing rates lower than they would have been, had the UK banks not been able to sell prime RMBS tranches to the US giant. So whether you accept securitisation because of its power in allowing both borrowers and lenders to tailor their risk-reward profile, or just because it keeps your mortgage rate down, the asset class deserves a second look.

[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice.  Click here for full disclaimer]

Author: Pete Drewienkiewicz

Pete is Chief Investment Officer, Global Assets at Redington. He started at Barclays Capital in 2002 on the Frequent User derivatives desk, providing hedging solutions for banks, building societies and project finance issuers before moving to UBS in the Summer of 2004 in order to build out UBS’s coverage of derivative frequent users. In 2006 he formally took over responsibility for coverage of LDI pensions managers and life insurance companies. In 2009 he moved to RBC where he initiated coverage of pensions and insurance clients on both interest rate and inflation derivative products as well as gilts, including gilt TRS and forwards. He was also responsible for covering bank liquidity managers and assisted a number of the UK’s new start up banks in the construction and acquisition of appropriate liquidity buffer portfolios for FSA purposes.