VideoEven if the legal structure of securitization isn't directly assaulted, bankruptcies can often wreak havoc with the terms of a securitization. One problematic area is the servicing contract that requires the company to collect receivables.
Take, for example, what happened at Conseco, whose Green Tree subsidiary had securitized pools of manufactured-housing loans. As in most securitizations, Conseco acted as the servicer. But the servicing fees it charged were low and, in the event of bankruptcy, could not be collected until other creditors were paid. After its bankruptcy, Conseco threatened to walk away from the servicing unless the fees were raised substantially and paid ahead of other claims. That, of course, would have significantly reduced payments to investors. To mitigate potentially huge losses on the Conseco transaction (the total securitization represented more than $23 billion in bonds), large institutional investors such as TIAA-CREF and Fannie Mae were forced to band together in court to protect their remaining interests in the deteriorating securities.
Conseco's securitization also was worrisome because the company didn't off-load the credit risk, bringing it back on balance sheet instead by guaranteeing the lowest tranche of the securitization. This effectively created a corporate credit obligation where none was supposed to exist — the same sort of problem that triggered Enron's downfall.
Moreover, bankruptcy can change the very nature of the assets underlying the securitization. Investors in credit-card receivables securitized by NextCard got burned when the bank was put into receivership by the Federal Deposit Insurance Corp. Unable to find a buyer for the bank' s credit-card portfolio, the FDIC shut it down. That turned the assets from a revolving pool to an amortizing one and, again, resulted in losses to bondholders. "If a credit-card deal [amortizes] early, [investors] get clipped pretty good," notes Mark Stancher, a vice president at JP Morgan Fleming Asset Management.
The elasticity of bankruptcy proceedings illustrates the fragility of the rating process when it comes to asset-backed securities. "The documents in the Conseco case went out the window, and those are one of the key things we base the rating on," said BMA panelist Jay Eisbruck of Moody's. "If we can't rely on what's written in the documents, we need to modify the way we approach rating transactions."
The fact that both the market and rating agencies are increasingly uncertain about the stability of asset-backed securities calls into question one of the most commonly cited market benefits of securitization — that is, that it converts illiquid assets into the sorts of safe, highly rated investment vehicles investors crave.
Both attorneys on the panel argued that the problems with Conseco, Next-Card, and similar blowups resulted from deals that were poorly structured and had underpriced servicing fees. Translation: a carefully structured securitization can survive bankruptcy, say lawyers, but not if it's done on the cheap.
Moderator Christopher Flanagan (who opened with the joke about securitization in bankruptcy), managing director of global structured finance research for JP Morgan Securities Inc., also asked Moody's Eisbruck if single-B-rated companies should have the ability to issue AAA debt. "The answer is still yes," Eisbruck replied, "but I would say it should require a lot more credit enhancement."
Securitization may yet be saved by legislation or destroyed by an adverse court ruling. In the meantime, that uncertainty is sure to have one result at least: the cost of this type of credit is going up.
Is FASB a Four-Letter Word?
Bankruptcy decisions may sporadically rock the securitization world, but lately, structured-finance professionals worry more about the decisions coming out of the Financial Accounting Standards Board.
Starting July 1, under FASB's Financial Interpretation 46, company and bank financial statements will have to detail — and, in most cases, consolidate — the existing off-balance-sheet special-purpose entities, or SPEs (now known as variable-interest entities), used for securitization. The resulting frustration and anger in the industry was evident in the responses — some of them expletive-laced — to a March survey of reaction to FIN 46 by Standard & Poor's.
"[FIN 46] was rushed to the market with inadequate guidance for implementation," complained one respondent. "The rule makes the asset class more risky in the long run."
More than half of the respondents predicted companies would now choose other debt instruments over asset-backed commercial paper (ABCP), and almost a third said many companies would shut down existing securitization facilities rather than disclose them. Bottom line: More than 72 percent of survey participants believe that the broadened disclosure requirements would result in increased cost to banks, because the requirements would force them to restructure existing conduits used to issue ABCP and collateralized debt obligations in order to avoid consolidation.
But that may not even be possible. At an April meeting of the Bond Market Association, FASB's chairman, Robert Herz, told CFO that the board plans to more clearly define "qualified SPEs" — passive investment vehicles used in securitization that are traditionally excluded from consolidation requirements. "We gave [QSPEs] temporary diplomatic immunity," Herz later warned the audience. "Now we are going to make sure they are qualified diplomats." In response to testy questions from the audience, he added that while FASB was not blind to the market impact of FIN 46, the board's overriding concern was financial-statement transparency.
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