When Financial Security Assurance Inc. was formed in 1985, asset-backed securities were full of potential - but not yet much of a market.
In that year, the total amount of publicly issued asset-backed securities was not much more than $500 million, and almost all those issues were securitizations of auto loans.
In 1991, by comparison, structured asset-backed financings in the worldwide market totaled over $200 billion. During this period of growth, the asset-backed market has truly matured.
Beginning in the middle 1980s, it seemed that every closed transaction was a breakthrough of some kind:
* In the public arena, auto loans came first.
* The securitization of credit cards and manufactured housing came in 1987.
* Boats and recreational vehicles in 1988.
* Home equity loans, timeshare mortgages, and collateralized bond obligations were first securitized in 1989.
As the first monoline insurance company to guarantee asset-backed debt, Financial Security Assurance was an early participant in this market. And in the case of some transaction types, we worked with issuers and their advisers to develop important innovations.
Today, we see two distinct asset-backed markets. The first is characterized by commoditylike transactions with asset types, structures, and issuers that come to market with a high degree of regularity.
The second market focuses on expanding the world of asset-backed securities. We see this type of business in areas such as trade receivables, leases, and international assets.
Commodity-Like Lines
As the credit card, auto loan, and other commodity-like asset-backed markets continue to mature, the financial guarantor works with issuers and investment bankers to utilize the guarantee to add value on the margin. The guarantor adds value in two areas: price and service.
Price is easy to understand. Structural decisions are made based on differences amounting to basis points.
An interesting example of commodity pricing at work can be seen in the private-label residential mortgage-backed securities markets today. Recently, this market has shifted from a double-A to a triple-A rating standard, thereby creating an opportunity for the guarantors to improve the economics of these transactions.
In many cases, it has proven more efficient to reach the triple-A rating standard, which the market demands, through a combination of overcollateralization and a financial guaranty rather than through overcollateralization alone.
Overall Approach
For commodity-like transactions, the guarantor's underwriting approach must be consistent and reliable. This means clearly defined underwriting standards and a commitment to timely execution.
A good example is FSA'S long-standing program for Western Financial Savings Bank of California, under which we have guaranteed over $1.5 billion of securities backed by Western's auto loans.
The relationship has developed to the point where the underwriting, credit approval, and closing mechanics of Western's transactions are extremely efficient, taking only three weeks from the first phone call to closing.
New Opportunities
Western Financial recently expanded the collateral pool to include a new type of loan that it had never previously securitized. This new collateral type was easily incorporated into the structure because all the parties involved understood exactly what the underwriting standards would be.
Noncommodity transactions call for a different underwriting approach. Guarantors that participated in early asset securitization have considerable experience in analyzing and guaranteeing innovative transactions.
When considering a new market or new asset type, the guarantor must, above all else, maintain its overall underwriting standards. In order to do this, a significant investment in the underwriting process is required. FSA has always been willing to do this. For example, we currently are working on programs for issuers of corporate trade receivables.
As Standard & Poor's recently observed, the $30 billion of outstanding asset-backed commercial paper programs is reaching capacity constraints. These conduits have been a major source of financing for trade receivables.
In addition, the Federal Reserve has clarified its reserving guidelines for asset-backed commercial paper conduits. Banks that sponsor the programs may find them more capital-intensive and, therefore, more expensive for their borrowers.
As a result, corporate borrowers are looking at stand-alone receivable-backed securitization. S&P recently rated two such private placements and more are certainly on the way.
International Arena
Another interesting example of how guarantors choose new markets can be found in the international arena.
While some have expressed disappointment in the rate of its development outside the United States, the guarantors clearly believe that the forces driving international securitization are irresistible - and therefore worthy of investment.
Central to this position is the belief that international banks are likely to turn to securitization to fund future growth and achieve an adequate return on capital in light of the new capital requirements of the Bank for International Settlements.
We also believe the dominant role of banks as credit intermediaries is diminishing and securitization is catching on as a means of tapping the growing capital markets.
In our view, it will be impossible for banks to provide profitable loans for all of their traditional borrowers in search of capital. As a consequence, the cost of bank loans will rise, fueling still more interest in securitization.
Tokio Marine Partnership
Three U.S. monolines - Financial Guaranty Insurance Co., Municipal Bond Investors Assurance Corp., and FSA - have all made substantial investments in their internatiounal capabilities.
An important partnership developed by FSA is our long-term cooperation agreement with the Tokio Marine and Fire Insurance Co. Tokio Marine is the largest property and casualty insurance company in Japan, and a minority shareholder in Financial Security Assurance. Together, we are marketing financial guaranty products in Japan under the Tokio Marine name.
Although there is demand from both the investor and issuer sides of the Japanese market for asset-backed securities, the emergence of an asset-backed market has been inhibited by legal and regulatory barriers. Japan represents an enormous potential market for socuritization.
JOSEPH N. WALSH 3d Managing Director Financial Security Assurance
Joseph N. Walsh 3d is the director and senior business development officer of the asset finance group at Financial Security Assurance.
Mr. Walsh is is responsible for marketing Financial Security Assurance's guaranteed products backed by a variety of assets including consumer receivables, home equity loans, and credit cards.
Formerly a vice president of Financial Security's commercial real estate and mortgage finance group, Mr. Walsh also served as an original member of the product development group.
Mr. Walsh is a graduate of Princeton University.
