Friday, May 28, 2010

No One Said Re-Creating Securitization Standards Would Be Easy

Originally published on the Housing Wire:

The recently released Mortgage Banker’s Association report, “Anatomy of Risk Management Practices in the Mortgage Industry,” is the latest sign that the industry is connecting some of the dots between what has been done already and what still needs to be done for a sustainable investor base to return in earnest.

(Download here: www.housingamerica.org/RIHA/RIHA/Publications/72939_9946_Research_RIHA_Rossi_Report.pdf

Until now the most prevalent stories in the press have rightly highlighted the important work being done to bring underwriting and issuance standards onto a more level playing field. Attention now though is shifting to the challenges investors face in making use of increasingly commoditized information as disclosure in all its new ‘standard’ forms becomes the norm.

The report highlights much of what we know already about risk taking in the mortgage industry of old and in the structuring and ongoing analysis of the risks in mortgage backed securities. It mentions how, “data and analytical limitations and blind spots led risk managers to grossly underestimate credit losses.”

Nothing new there.

And it calls for a more comprehensive focus on the development of industry-wide data and techniques for measuring risk in mortgage backed securities. Well, we can see that there has been an overwhelming commitment to do that from industry bodies and working groups over the last 18 months.

Achieving a one-size-fits securitization standard is a big thing to ask for but with continued international coordination, a solid platform for a prudent securitization industry can be established. Governments are committed to adopting standards in spirit but the secret to success in the long term will be how the industry translates more openly available data, into more standardized and useful forms that genuinely add value to investors.

More information is one thing, but a sound footing requires a level playing field. Industry bodies such as the ASF and AFME/ESF are doing much to provide a foundation for the most prominent asset classes. The European Central Bank, Bank of England and SEC have all stated the need for standard data points for loan level, pool level descriptors and information in deal documentation, with variations for each asset class.

But they have not yet come to a consensus as to what those should be.

The extension of these efforts into other aspects of disclosure will be critical if investors are able to truly capitalize on the work done so far.

The SEC’s proposals that issuers must provide and publicly disclose a computer program of the securitization’s waterfall could help bridge the gap between loan level data and an investor’s actual investment. Standardizing the way cashflow waterfalls are defined and scripted and trying to implement a common language when non-standardization is the prevailing characteristic, may be nigh on impossible though. There is an opportunity to create a basis from which models’ input assumptions and output cashflow calculations can be standardized across issuers and asset classes. Finding this happy medium, without oversimplifying the modeling that must be provided to investors, will be a sizeable but important barrier to overcome.

Take international accounting standards and securities law as examples of standardization in action. They provide a framework for comparability. In securitization, the equivalent was never going to be created easily such are the inherent complexities of the business. The MBA report describes how consolidation in the industry leading up to the crisis significantly challenged organizations’ IT systems.

It identifies failures in managing complex data in all its various forms and in being able to merge asset performance data with other data across the company so it can be aggregated and reported on in a consistent manner. It’s up to each region to come to a level of agreement on the implementation of standards and to compel issuers and investors to adopt best practices. Once data is disclosed, market participants can find the tools, models and mechanisms to understand it. But if a lack of comparability remains part of the equation then we lose the whole point of having all this readily available information and many of the same challenges will remain.

In the future, turning more commoditized, voluminous data into a value add for investors has to be the desired end game. Investors should be able to focus on their core business rather than spending a disproportionate amount of time collecting data or reverse engineering loan level information and waterfall structures (although more independent analysis is a given in the new environment). Wider adoption of standards by issuers and investors alike can deliver the ammunition to understand investment performance and the fundamental differences between transactions.

Alongside investors building the operational capabilities to merge and analyze all the necessary data, the commoditization and transparency of information will truly be able to play its part in steadying securitization’s footing. Then organizations will be locked and loaded to move from relying on quantitative methods of assessing performance attributes such as delinquency and default risk, and embrace more qualitative assessments of deal, tranche and collateral performance.

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