Investor demand for asset-backed securities has been so strong for the past year, that issuers could sell securities before they had assets to back them. But issuers can't count on that trend continuing.
Investors came to the American Banker Asset Securitization Conference last week with the message that they will need more time and information before they'll commit money to new deals.
Robert Persons, a vice president in the global bond group at Scudder, Stevens, & Clark Inc., a Boston-based mutual fund company, said investors now must decide whether to invest without even a "red herring" or prospectus to guide them.
In recent years, the relatively high level of quality and yields offered by asset-backed securities have lured investors looking for better returns than they could get on the corporate debt market. As a result, issuance in the public asset-backed market has more than doubled in the past three years, to $108 billion last year. And some experts are predicting it could top $135 billion this year.
The result of this competition among investors is that new deals as large as $1 billion or more are gobbled up by yield-hungry investors, sometimes in a matter of hours. To make sure issuers get the best rates, some deals have been sold without giving investors anything more than a cryptic description of who the issuer is and what kind of assets will back the offering.
It is a trend that worries some investors.
"The practice nowadays is that the underwriter sends out a disclosure statement on a deal and says, 'Get back with me in two to five hours or all of it will be gone, '" said Mark Adelson, managing director of asset-backed finance at Moody's Investors Service.
He said a lot of investors take the view they can buy a deal safely if a rating agency has given it a high rating. But these ratings are often based on the existence of credit enhancements that insure against default. However, should loan losses rise faster than expected, the credit enhancement will also pay off the bonds faster than expected, a factor that affects how much investors earn on a deal.
This reliance on third parties for assurance highlights a potential problem for new investors in this market. Namely, they may not know how a deal could go wrong, Mr. Persons said.
"The market is so fragmented and there is so much demand out there, that the deals are going to get done," he said. "Until somebody gets burned, new investors won't know what to ask for."
Most small issuers aren't waiting. In order to compete for investors with big issuers like Citicorp, Chemical Bank, General Motors, or Ford Motor Co., they must show why their deal makes sense.
Joseph Leone, chief financial officer of CIT Group, said he has spent a lot of time recently at road shows and in teleconferences in an effort to enhance the secondary market for CIT's securities.
"We think we need to improve the dialogue between issuers and investors, so we're making strides to open the communications lines," he said.
Henry McCall, a senior vice president with Baton Rouge, La.-based United Companies Financial Corp., said his company also orchestrated a series of road shows last fall to reassure investors about the quality of their home equity market. More importantly, he said the meetings were designed to educate people about the market, a factor he said is needed to expand the company's base of investors.
"Investors see a lot of deals come across their desks," he said."What we're doing is getting information into the hands of the people who need it."
Until more companies follow suit, Mr. Persons suggests that investors require issuers have at least 75% of the loans they plan to use as security for the deal already on the books. He also said underwriters should provide simplified descriptions of the deal structure, its credit enhancement, prepayment history of the loan pool, and schedule of expected cash flows. And they should do so at least two days before pricing of the deal.
While the trend is worrisome, he said there is no need to turn on the sirens just yet.
"To a degree, you need a regulatory body to say this makes sense, and if you leave it to market forces you may get a calamity," he said. "But why wait?"