ON THE FRONTIER OF CREATIVE FINANCE:

How Wall Street Can Securitize Anything

By Kim Clark

Financiers have shown remarkable ingenuity over the past decade in finding new and unusual things to turn into tradable securities. Home mortgages, car loans, and lottery winnings are just a few of the streams of income that have been "securitized" and peddled on Wall Street. The latest innovation in this usually arcane field even made it onto the nightly news: the $55 million of what will forever be known as "Bowie bonds"--securities backed by revenues from future sales of David Bowie's early albums.

The rock star's highly publicized bonds are only a tiny part of a $150-billion-a-year-and-growing market of investments with the deceptively boring name of asset-backed securities, but they reveal how prevalent the practice of securitizing cash flow has become. The fact that Wall Street is getting into deals that, say, securitize the weird oeuvre of a weird rock star shows that "securitization is going to change the world," says Frank Fabozzi, who teaches finance at Yale and is generally recognized as a guru of securitization. He says that apart from proving once and for all that Wall Street can and will securitize anything, this trend toward ever more imaginative securitizing shows that financiers are finally addressing the economy's shift to the production of intellectual assets. Driving this blossoming creativity is the growing enthusiasm of companies for a financial technique that will save them millions of dollars, and the desire of investors for securities that pay premiums over corporate bonds.

So far, securitization seems to be a great deal. In Bowie's case, he makes at least $5 million annually from sales of his records, but decided he'd rather have lots of money up front to buy out a former manager and make other investments. His problem--like that of many businesses--is that he wouldn't be considered a good loan risk. So Bowie's investment bankers set up a trust to receive his royalties and had the trust issue ten-year-average bonds that paid 7.9% and got an A3 rating from Moody's. Bowie got a cheap loan; the buyer, Prudential Insurance, got a premium over similarly rated corporate bonds.

 The popularity of securitization eats into the traditional lending business of banks. But even banks that are losing loan customers to the new form of financing are happy because many of them are getting a lot of securitization business themselves. For example, last year Citibank sold $1 billion in commercial paper backed by Twentieth Century Fox's future movie revenues; the bank is also spreading securitization's low-interest loans to emerging markets such as Indonesia, Brazil, and Thailand. Al Hageman, Citibank's securitization chief, says this is the beginning of a vast global expansion of the cheap financing. The competition from all these new issues is grinding away the premiums investors used to get for buying up the once exotic securities. That means businesses everywhere should see their borrowing costs drop even further, which should both improve profits and, in theory, allow for lower prices to be passed on to consumers.

 Skeptics say all this may be too good to be true. Richard Scott, chief investment officer for the Houston-based insurer Western National Corp., says his company lost most of its $15 million investment in securities backed by Towers Financial's health care receivables. (Towers Chairman Steven Hoffenberg was sentenced last month to 20 years in prison for fraud.) Scott says he's staying away from bonds backed by potentially unreliable payment streams, like royalties, or poor credit risks such as subprime auto loans. Many of the nouveau securities were devised--and have paid off quite handsomely--during a strong economy. "But I'd like to get them a little stress tested" by a recession to see how they really work out, he adds.

Investors do need to beware, of course. Financial markets are notorious for pushing investment ideas into the absurd. Some of these exotic securities will undoubtedly collapse, which will undoubtedly cause a backlash. But when the market returns to reality, securitization will likely remain a crucial source of capital to businesses that create some of the economy's most important assets: content, research, and ideas.

Fortune. April 28, 1997