[PEN-L:30379] ABS troubles ahead?

["Ian Murray" <seamus2001@xxxxxxxxx>]

09/19 10:51
J.P. Morgan, Citigroup Winning in Asset-Backeds (Update1)
By Edward Leefeldt


New York, Sept. 19 (Bloomberg) -- These are uneasy times in the $7 trillion
market for asset-backed securities -- bonds typically backed by payments on
credit card debt, auto loans or second mortgages or by corporate bonds.

Since January, a record 21 ABS issuers have defaulted, according to Standard &
Poor's. This year, S&P has cut the credit ratings of 409 ABS issues, an all-time
high.

Another 2002 record for this market was set in the area of sales. Even as the
risks grow, banks are selling new asset backeds as never before. U.S. sales of
those securities rose 15 percent to $265 billion during the first eight months
of 2002, according to data compiled by Bloomberg. At that rate, sales for the
entire year may reach $398 billion, topping the 2001 record of $372 billion,
bankers say.

``It's a huge market,'' says Joseph Lorusso, who manages about $2 billion at
Structured Finance Advisors in Hartford, Connecticut.

Investors in this mostly AAA-rated world may be headed for more shocks. Many of
the raw materials that bankers have used for constructing the securities have
grown weaker since the U.S. economy slid into recession in March 2001.

WorldCom

This past July, the bankruptcy of just one company --WorldCom Inc. -- touched
off a chain reaction of trading losses in the market for collateralized debt
obligations, or CDOs. Those securities use money generated by pools of corporate
bonds to pay holders interest and principal. Underwriters had packaged WorldCom
bonds into about a hundred different CDOs, according to Merrill Lynch & Co.
People who bought those investments could lose $400 million, Merrill says.

The U.S. Congress, meantime, is considering at least two measures that could
pose new dangers for ABS investors.

``These are uncertain, painful times,'' says Jeff Salmon, director of ABS
research at Barclays Capital Inc.

Uncertain, painful -- and profitable for underwriters. Over the past four years,
firms such as J. P. Morgan Chase & Co. and Credit Suisse First Boston have shot
to the top of this business at the expense of Goldman Sachs Group Inc. and
Merrill Lynch, according to data compiled by Bloomberg.

Banks Win

Big banks have an edge in the ABS market because their large balance sheets
enable them to offer credit lines to companies in exchange for underwriting
business. At stake in this market are underwriting fees that are likely to reach
$1 billion in 2002, according to Bloomberg data.

During the first half of 2002, J.P. Morgan underwrote 22.4 percent of the 50
largest car loan transactions -- measured by U.S. dollar value -- thereby giving
the bank the lead in that field for a second consecutive year, according to data
compiled by Bloomberg.

J.P. Morgan also underwrote 25.8 percent of the largest credit card deals,
ousting Salomon Smith Barney, the securities and underwriting arm of Citigroup
Inc., from its No. 1 perch; Salomon dropped to second place, with 19.8 percent.
Credit Suisse First Boston sold 29.4 percent of the largest CDO issues, leading
that business for a second year. Countrywide Securities Corp., the securities
arm of mortgage company Countrywide Credit Industries Inc., underwrote 20
percent of the biggest home equity issues, displacing the 2001 leader, Bank of
America Corp., which dropped to No. 3.

Consumer Ills

Underwriters create asset-backed securities by bundling together millions or
even billions of dollars of individual loans or bonds and dividing the
securities backed by the collateral into classes ranked according to the order
in which holders get back cash if borrowers fail to make payments on the
underlying loans. Credit card issues typically comprise three or more classes,
with the highest -- usually 80-90 percent of an issue -- getting first dibs on
payments from the underlying loans. The lower classes absorb any losses first,
helping protect the senior securities.

U.S. consumers have missed or delayed so many credit card payments lately that
some of these securities have run into trouble. In June, income from credit card
loans backing $3.3 billion of securities issued by J.P. Morgan and FleetBoston
Financial Corp. fell so low that Daniel Castro, head of asset- backed research
at Merrill, warned that soon there might not be enough cash to pay ABS
investors. In the end, collections rebounded in July. If they hadn't, Morgan and
Fleet might've been forced to repay the $3.3 billion in principal immediately.
Like many asset backeds, these securities have early-redemption clauses obliging
the issuers to redeem the bonds if the loans no longer generate more than enough
interest to cover bond payments.

`Sacrosanct AAA'

While Morgan and Fleet avoided the early payout, the experience suggests that
even the highest classes of card securities may no longer be ensured of AAA
ratings, Castro says. ``Sacrosanct AAA has become quite vulnerable,'' he says.

These days, many consumers aren't paying their bills, and people in the U.S. are
going bankrupt at a record pace. Nearly 391,000 people filed for bankruptcy in
the second quarter alone, according to the American Bankruptcy Institute. The
percentage of U.S. credit card debt that banks label uncollectible ran at a
record 7 percent from March to June, according to S&P.

Companies that make consumer and home loans to customers with weak credit
histories and that package that debt into securities have been hit especially
hard. From 1999 to 2002, NextCard Inc. sold $1.2 billion of asset backeds while
growing into the largest marketer of credit cards on the Internet. Last
February, the U.S. comptroller of the currency ordered the closure of the
company's NextBank unit, saying NextCard had failed to spot credit problems.

Sub Prime Scrutiny

``NextCard cost us $300 million-$400 million,'' says David Barr, a spokesman for
the Federal Deposit Insurance Corp., which guarantees U.S. bank deposits. The
FDIC stepped in to keep NextCard's asset-backed securities from paying out early
by injecting money into NextCard. Most of the company's loans had been packaged
into bonds, Barr says.

The Federal Financial Institutions Examination Council, an umbrella group for
U.S. financial regulators, has been scrutinizing other sub prime lenders that
tap the ABS market. In July, Capital One Financial Corp. stock plunged 40
percent in one day after regulators ordered the consumer finance company to set
aside more money to cover loan losses.

Lisa Brown-Premo, who helps manage $32 billion in bonds at Evergreen Asset
Management, a unit of Wachovia Corp., says she's reluctant to buy more asset
backeds, given such troubles in the market.

``We're not adding assets,'' Brown-Premo says. ``I see more negatives now than
in the past.''

Congress Threatens

ABS investors can add Congress to their list of worries. More people may rush to
file for bankruptcy in coming months because lawmakers are considering enacting
legislation that would make it tougher for people to seek protection from
creditors, says Barclays Capital's Salmon. While similar proposals have bogged
down in Congress in the past, President George W. Bush has said he'd sign the
current bill if lawmakers pass it.

Another bill before Congress, the Employee Abuse Prevention Act of 2002, would
give employees and retirees an edge over ABS investors when some companies fail.
Right now, ABS buyers get first dibs on the assets backing their securities. As
a result, S&P and Moody's Investors Service usually rate a company's asset
backeds higher than its corporate debt. The bill would put other creditors first
in line when a company collapses because of fraud.

Alexander Dill, an analyst at Moody's, says lawmakers will probably rewrite the
legislation so it doesn't hurt ABS investors. If the current bill passes,
however, it would radically change the market. ``You could never assign a rating
to an ABS that was higher than the company's bonds,'' Dill says.

Accounting Changes

The Financial Accounting Standards Board, meantime, is considering a proposal to
tighten the rules governing off-balance- sheet financing -- a switch that could
make it tougher to sell new asset backeds. Enron Corp. had used special purpose
entities with names like Chewco and Jedi to hide debt and losses. Companies that
sell asset-backeds typically set up SPEs to hold the assets backing their
securities. The setup lets issuers shift those assets off their balance sheets.

A big change in the rules governing SPEs could hamper the growth of both CDOs
and the $700 billion market in asset-backed commercial paper, some investors
say.

``A cloud of uncertainty hovers over the market,'' says Joseph Sheridan, a
managing director at S&P. FASB officials say they plan to put new rules into
effect in 2003.

For now, the deals keep coming: After Moody's cut Ford Motor Co.'s credit rating
to Baa1 from A3 in January, Ford went on to sell $17.2 billion of securities
backed by car loans during the first half of 2002, up from $9.3 billion in the
first six months of 2001. Ford says it's cheaper to sell ABSs than ordinary
debt.

`Two Markets'

MBNA America Bank NA, a unit of MBNA Corp., sold $450 million of credit card
securities in August after saying it might set aside $300 million to cover
losses on its card accounts.

Providian Financial Corp. wants to sell as much as $2 billion of credit card
securities by year-end, says spokesman Alan Elias. Since September 2001,
Providian stock has plunged 84 percent -- closing at $5.09 on Sept. 17 --
because many of its credit card customers have failed to pay their bills.

And as some investors fret about a potential bubble in the U.S. housing market,
Gyan Sinha, head of asset-backed research at Bear Stearns & Co., says sales of
securities backed by second mortgages may rise to $90 billion during the second
half of 2002 from $63.4 billion in the first half, as more and more people tap
equity in their homes.

``This is a tale of two markets,'' says Brian Clarkson, a senior managing
director at Moody's. ``The headlines are terrible, but the bankers and issuers
say it's great.'' So far, anyway.

Rank Volume Market 2002 2001 Autos (billions) Share% 1 1 J.P. Morgan Chase $11.9
22.4 2 11 Banc One Capital Markets 8.2 15.5 3 4 Bank of America 6.8 12.8 4 5
Deutsche Banc Alex. Brown 6.4 12.0 5 7 Morgan Stanley 4.5 8.5

CDOs 1 1 Credit Suisse First Boston $6.0 29.4 2 5 Deutsche Banc Alex. Brown 3.6
17.8 3 7 Wachovia Securities* 1.9 9.2 4 2 J. P. Morgan Chase 1.7 8.4 5 NA WestLB
Panmure 1.0 4.9

Credit cards 1 2 J. P. Morgan Chase $9.5 25.8 2 1 Salomon Smith Barney 7.3 19.8
3 4 Banc One Capital Markets 4.1 11.0 4 3 Deutsche Bank Alex. Brown 4.0 10.7 5 5
Morgan Stanley 3.3 9.0

Home equity 1 9 Countrywide Securities $9.9 20.0 3 5 Credit Suisse First Boston
8.4 17.0 3 1 Banc of America 7.7 15.5 4 2 Bear Stearns 4.2 8.4 5 8 Morgan
Stanley 3.9 7.8

*Formerly First Union Securities. Includes the 50 largest Dollar- denominated
issues with settlement dates in the first Halves of 2001 and 2002. Lead managers
get full credit; co-lead managers share credit equally. Source: Bloomberg
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