Wall Street Increasingly Reliant on Asset-Backed Securities

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This Financial Times article, which describes the growing role that asset-backed securities play in investment bank profits, comes as no surprise. Not only are these products significant in terms of total revenues, but they are more profitable than the norm for these firms.

But connect the dots: Wall Street is one of the biggest funding sources to political candidates. The importance of these products to industry results doesn’t bode well for efforts to strengthen consumer protection in highly profitable products like subprimes, which the Street repackages into products like collateralized debt obligations.

Investment banks are increasingly reliant on the business of turning mortgages and other kinds of debt into complex bond-like products to generate a significant share of their profits, according to research to be published Monday.

Banks globally saw revenues of almost $30bn from asset-backed securities business in 2006, which analysts at JPMorgan estimate is as big as the revenues generated by equity derivatives or cash equities trading.

In Europe, Deutsche Bank and Credit Suisse, two of the largest in the field, rely on ABS activity for about 10 per cent of group pre-tax profits, the analysts will say.

Securitisation is the process of turning financial assets into saleable securities and encompasses everything from the mortgage-backed securities that help fund ordinary home loans to the complex structured bonds known as collateralised debt obligations.

Industry growth has been spurred by investor demand for higher-yielding assets and the desire among banks to offload more of their lending risk into the capital markets.

Kian Abouhossein, analyst at JPMorgan, says issuance volumes in these markets has grown more than six-fold from about $500bn in 2000 to more than $3,000bn last year, about 77 per cent of which was from the US. Mr Abouhossein estimates US banks earned revenues of about $19.9bn from this business while their European peers gained about $7.5bn.

“This has become a big market and is significant for the banks. We would argue that it is at least as big as the equity derivatives or cash equities businesses, which have attracted a lot of attention as stand-alone businesses,” he says

The research is mainly focused on European banks and estimates that four of the top 10 institutions saw revenues of more than $1bn from their ABS businesses. Deutsche Bank is the clear leader, generating more than $2bn and earning pre-tax profits from that of more than $1bn, which is almost 11 per cent of group profits.

“The biggest banks have a cost-income ratio from their ABS business of 50-55 per cent, which is much better than the average for investment banking of about 70 per cent,” Mr Abouhossein says.

The second biggest player in Europe is Royal Bank of Scotland, with ABS revenues of $1.7bn and made more than 4 per cent of group profits from the business.

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