For Banks Flush With Trading Profits, Securitization Is Poised To Make A Comeback

The following is the second part of a 2-part series of posts on the future of the securitization business. To read Part I, which details a less rosy outlook for credit derivatives, go here.

It’s (semi-)official: securitization is making a comeback. Barring any country-size defaults, most expect the securitization market to pick up rapidly in the next year or so, as evinced by the Federal Reserve’s unwinding of its mortgage-related assets purchase program.

Securitization is the process of creating tradeable financial products out of assets and obligations such as property, mortgages and debts. In the period from 2007 to 2008, securitization deals became almost extinct, as investors rushed to the doors to exit positions weighted down with defaulting mortgage payments.

As the economy begins to recover again, however, there are signs of life appearing back in the market. Last Friday, Bank of America (BAC) said that it is preparing to sell $460 million of commercial mortgage-backed securities in December. The 7-year issue will be backed by properties owned by private equity firm Fortress Investment Group (FIG), and will pay a fixed rate of interest.

More significantly still, investment giant Morgan Stanley (MS) is posing an aggressive revamping of its securitization business. Recently, the firm hired former Merrill Lynch top gun David Moffitt to head up its global credit solutions division, and it is hiring an additional 400 sales and trading personnel to help manage the task of rejuvenating this once-lucrative area of finance.

Raj Dhanda, co-head of global capital markets at Morgan Stanley, told Bloomberg that he expects the securitization business to come back in a big way in 2010. “Within our capital markets business this is one of the big growth areas,” he said. “Nobody expects underwriting to double, but securitization or structured solutions business can double, or triple.”

Earlier in the year, some readers may recall that banks had already begun plans to securitize life insurance packages. LIBS, as they are known, effectively give institutional punters such as hedge funds the opportunity to speculate on the death timelines of policyholders who can no longer meet the payments of their monthly premiums. Apparently, the phone was “ringing off the hook” when the products were first announced.

Still, it’s not all a downhill slope for firms seeking windfall gains as a result of packaging and selling obscure niches of the recovering economy. In the aftermath of the subprime fallout, regulators are putting pressure on banks to clean up their act this time round.

For example, recent accounting rule changes stipulate that banks engaging in the securitization business must from next year on keep a portion of capital on their balance sheets vs. the securities they issue. Banks argue that this process will limit their ability to package multifarious slices of debt together and thus expand the business as fast as they would like, which indeed seems to be regulators’ primary aim.

With debt running back up at unprecedented levels, it still remains to be seen how solid the market is too. But judging by all the commotion, and flush with Fed-funded capital, banks may well take securitization to a whole new level next year.