Wall Street's leader in asset-backed securities is spreading its wings.
As the world of asset-backed securities expands, matures, and becomes more commoditized, Merrill Lynch & Co. is putting its muscle behind selling newer and more exotic securities.
This represents a major shift in strategy for the brokerage.
Merrill has sold more asset-backed securities than anyone else primarily by placing multibillion deals backed by such assets as auto loans or credit cards.
Carlos Valle, head of Merrill's asset-backed sales, says the firm will continue to underwrite such deals. But he says Merrill will increasingly try to push the envelope with more novel securities.
"We're going to change our focus a little bit," Mr. Valle says. "To maintain our position in the asset-backed market, it's important we develop new securities to broaden our investor base."
And, not to be overlooked, to bring in higher fees.
The new regime made its mark last month when it tacked an index- amortizing note onto a plain-vanilla credit card securitization from First USA Inc. These notes, a kind of mortgage-backed derivative, helped make the securities attractive to investors who ordinarily shun credit cards because the yields are too small.
This innovation was quickly imitated by other investment banks and helped invigorate normally sleepy August sales. Only a few analysts-such as Anthony Thompson at rival Goldman, Sachs & Co.-detailed how would-be investors expose themselves to prepayment risks in buying such securities, a risk ordinarily not of concern to asset-backed investors.
In its 10-year existence, the asset-backed market as been remarkably problem-free. That's in part because issuers have been quick to shore up portfolios when the underlying assets have faltered and because many deals are insured against default.
Additions such as index-amortizing notes to the securities may indicate investors are ready for Wall Street's fastest-growing debt market to show them something new, different, and higher-yielding - even if it exposes them to new risks.
As Mr. Valle sees it, his biggest challenge is "to expand the investors base to satisfy growing issuance." This means word is getting out among small and midsize companies that they don't need a bank loan for capital when they can securitize anything with reliable cash flow. Asset-backed issuance reached about $150 billion in the public markets last year and is expected to be higher this year.
But in recent months many investors have shied away from much of the asset-backed market, particularly credit card securities, citing concerns with rising chargeoffs and the lack of return they get for the risks they take investing in the securities.
Merrill and other brokerages have responded to the slackened demand by courting foreign asset-backed securities investors.
This month alone, banks, credit card specialists, and other companies seeking financing are expected to issue $25 billion to $40 billion in asset-backed securities. While most issuers typically wait until the end of quarters to securitize assets, dealmakers like Mr. Valle are bracing for an unprecedented flood that could drive dwindling yields down even further.
It is a flood that may take all of Mr. Valle's sales experience to navigate.
After nine years at Merrill's private placement desk, Mr. Valle, 38, took the helm at its asset-backed division last month in a major reshuffling that began when David H. Komansky became chairman and chief executive in April.
Mr. Valle has the troops - five traders and a sales force of 30, huge numbers for asset-backeds- to move the market. The depth of Merrill's desk helped the firm underwrite $23.4 billion worth of asset-backed securities last year, more than any brokerage or bank, according to Securities Data Co..
Fifty-two percent of Merrill's deals last year were for securities backed by credit card bills or auto loans, according to Securities Data. But these "cookie-cutter" deals pay the lowest fees, because so many firms on Wall Street compete for them. So the dealmakers at Merrill, along with everyone else in asset-backeds, are looking for the next new, high-fee- generating deal.
Like many in his business, Mr. Valle hopes investors will continue to develop an appetite for exotic securities called collateralized loan obligations and collateralized bond obligations. CLOs are essentially bank loans packaged into securities, and CBOs are packages of junk bonds.
He predicts that banks will become more frequent buyers in asset-backed securities, particularly the fast-growing sector for securities backed by home equity loans "because that's their franchise," he says.
And he envisions growth in market securities backed by yet-unmade products from Latin America and Asia.
Mr. Valle forecasts growth for bonds related to the weather, so-called "catastrophe bonds."
Three offerings have been sold this summer, including a $477 million issue co-managed by Merrill from the United States Automobile Association.
These bonds insure the issuer against loss should a natural disaster occur. If the disaster doesn't occur for a year, investors get all their principal back plus interest. Should a disaster happen and damages pass a certain threshold, then payment to investors would be delayed and interest lost.
It's newfangled deals such as this that have dealers like Mr. Valle checking to see whether they can make a security of most any unsecure situation.
"Anytime there's risk involved and historical performance information so you can measure the likelihood of default and performance, in there lies the potential for securitization," he says.
