Securitization markets involve some of the most esoteric, obscure parts of investment banking. Traders and bankers rarely court publicity, while deals are placed to a specialist subset of the fixed income buy-side. Yet, 10 years after the financial crisis, securitization affects almost every part the real economy.
Driving north of Edinburgh and crossing the Firth of Forth
on the M90 motorway seems an unlikely place to consider the legacy of the
financial crisis — nearly eight hours drive from the skyscrapers of Canary
Wharf and the City, where many deals were, and are, structured.
But the Kingsgate Shopping Centre, in the heart of
Dunfermline, neatly illustrates how securitization has shifted since then.
The layers of abstraction have been stripped away, the
chains of financial intermediation have been shortened. Securitization bonds
are no longer packaged into CDOs, and these are no longer bought by structured
investment vehicles. Maturities are mostly matched, and sponsors or originators
now hang on to 5% of a transaction.
Kingsgate, however, forms part of the security package for
Elizabeth Finance, a CMBS issued in August and arranged by Goldman Sachs. US
alternative asset manager Oaktree bought the centre in 2013, and refinanced the
original loan against the centre, which is worth around £40m, with Goldman —
which packaged it up into Elizabeth and placed it in the market this summer,
defying gloomy predictions about the future of the UK high street and retail
A ticket to the CRE game
CMBS has never made up the majority of the commercial real
estate market, even before the financial crisis — but it is a crucial way for
institutional investors and bond buyers to gain CRE exposure, and a way for
investment banks like Goldman and Morgan Stanley to compete with the fat
deposit books of their commercial peers.
Go inside Kingsgate and the impact of securitization might
not be obvious. The centre has no banks or other financial institutions inside
— and, really, institutions that lend money are where the chain of financing
But Carphone Warehouse, a mobile phone store, might
surprise. After a house and a car, the most valuable possession for many people
is their smartphone. Customers receive a phone up front, which might be worth
£1,000 — but pay for it over the following 24 months, through a phone contract.
Some of the UK’s mobile providers, like Vodafone, raise
investment grade bond finance — but others are more leveraged, and seek other,
more complex financings.
Virgin Media, for example, owned by US media conglomerate
Liberty Global, would be high yield in the unsecured market, so leans on
securitization to cut its costs. It has issued ‘handset ABS’ in small size in
sterling, and uses its trade receivables to raise securitization finance. The
market is more common in the US, with Verizon having done seven such deals, but
pick up a phone, and you might find it’s securitized.
Greasing the wheels of trade credit is where
securitization’s role is perhaps most crucial — and most effectively hidden
from view. The sweet spot is companies that have high borrowing costs in
unsecured markets, but supply better-rated firms.
That’s the situation Smurfit Kappa, the paper and packing
provider, finds itself in. It supplies 60% of its products to fast moving
consumer goods companies — the likes of Unilever, Nestle, Proctor & Gamble
or Reckitt Benckiser. The company is large, but leveraged, paying an average
rate of 4.1% across its financing structure as a whole. But its trade receivables
may face investment grade firms, and spread risk across a wide variety of its
Earlier this year, it signed a €230m five year facility with
Lloyds Bank, using receivables from France, Germany and the UK to back it.
Receivables from Austria, Belgium, Italy and the Netherlands back a different
securitization facility, with Rabobank and Helaba.
According to its last annual report, it paid 1.375% on its
last round of securitization financing — far below its capital markets
borrowing costs. Next time you’re handling packaging from one of these consumer
titans (or if you happen to see the loading bay of a supermarket) consider that
Smurfit’s securitizations helped make it happen.
These financings may never make it into the ordinary capital
markets for term debt, but they are securitizations nonetheless. Lloyds offers
its Smurfit Kappa facility directly from its balance sheet, using
securitization structuring to ensure its security, but Smurfit sold its other
securitization transactions into asset-backed commercial paper (ABCP) conduits
sponsored by Rabobank and Helaba.
These conduits are vehicles separate from the banks — but
often fully backed with bank liquidity facilities — and are one of the most
private parts of the market, and one of the sections most changed from
pre-crisis. Before 2007, dozens of these vehicles sprang up, many of them
“securities arbitrage” conduits, which bought long bonds in the market, and
funded them with 30 day commercial paper.
When these bonds had to be marked down, and money market
funds stopped buying ABCP, banks had to step in and support their ABCP
conduits, prompting a big restructuring of the industry, the closure of many
conduit vehicles, and the conversion of most of the rest from partially
supported to fully supported. If these cannot issue ABCP, banks will step in
and fund them through a liquidity facility instead.
European regulation is now threatening the ABCP market, as
new data requirements may force a sudden stop for new issuance. The
transactions bought by the conduits will still be there, but they may no longer
be able to issue ABCP from January 1, forcing banks to bring them back on
Trade receivables make up 25% of ABCP conduit transactions,
or 34% by volume, according to Moody’s, from a global outstanding of $269bn.
The Association for Financial Markets in Europe estimates European banks issued
Having browsed the delights of Kingsgate Shopping Centre,
head to the car park with your shopping and step into your car. Whatever you’re
driving, if you bought it on finance or lease it, there’s a good chance the
securitization market is involved.
The likes of Volkswagen, Peugeot, Renault, Fiat, Ford, BMW
or Mercedes have their own banks, lending money against new cars. Financing a
large purchase like a car is as much a part of their service as is building a
new twin exhaust system. And if you don’t buy new from dealership, you might
approach FirstRand’s MotoNovo Finance, Lloyds Banking Group’s Black Horse, or
Santander Consumer Finance, or a raft of other lenders for a separate loan,
while if it’s a company car, perhaps it’s leased from LeasePlan of the
But wherever the money comes from, there’s a good chance it
tracks back to securitization markets. Car financings are another huge asset
class financed through the ABCP market, making up 20% of the “multiseller”
market, according to Moody’s.
Car loans, however, also form a large part of the public,
term securitization market. Sometimes conduit transactions are taken out in
term markets, while in other cases they themselves offer flexible financing
periods. If the pool of assets is “revolving”, car manufacturers can rotate new
loans into the deals as they write them.
The scale is vast. In 2018, Volkswagen alone has issued
deals backed by car loans in Spain, Japan, Germany, the UK, Turkey, Australia,
Italy, the US and Canada — with more than a few lease deals on the side as
If you stop for some petrol on the way back to Edinburgh,
perhaps you’ll come into contact with the securitization market again. The
vertically integrated supermajors hardly need to touch the market, as blue chip
borrowers in the unsecured markets, with huge internal cashflows of their own
But trading firms are a different matter. Trafigura, one of
the largest independent oil traders in the world, has no public rating — and no
plans to acquire one, stating that its “strategy has always been to obtain
funding from stakeholders who understand its business model, rather than make
investment decisions on the basis of a rating”.
That can also mean securitization markets, and the firm has
been an enthusiastic user. It regularly issues from Trafigura Securitization
Finance, a vehicle which, like Smurfit’s deals, securitizes receivables from
its customers — many of them the investment grade-rated oil majors. But late
last year, the firm took a more unusual step, securitizing its inventories of
physical crude and metals as well as receivables. The vehicle, Trafigura
Commodities Financing, buys the inventory from Trafigura and then sells it
back, akin to a repo — but a brand-new move in the capital markets, and one
with plenty more potential with other firms carrying physical inventory.
Home sweet home
Returning back home, and pulling on to the driveway, should
also prompt some reflection on the role of securitization in the lives of
citizens. Mortgage finance is by far the largest chunk of the European market,
for the simple reason that this is where most people borrow most money.
If your credit is healthy and your bank is a big one, you
may not touch the market. Some firms, such as HSBC, have excess liquidity in
the UK and strong credit ratings, and do not use mortgage collateral to raise
finance (though it does in France and in Canada). The prime, owner-occupied
parts of big bank mortgage books may be financed through covered bonds, rather
But if you’re harder-up, or need something special, be
thankful for the market, which comes into its own for the less straightforward
A mortgage to cover refitting the property? A mortgage for a
professional landlord? A second charge mortgage? A mortgage for the
self-employed? A mortgage for those with a patchy credit history?
These markets are served by a patchwork of alternative
providers, from specialist challenger banks, to non-bank intermediaries, few of
which have the credit quality to access unsecured markets at reasonable rates,
and use their mortgages to back securitizations.
Home is where the heart is. And one of the many places
securitization can be found.