Securitization has been around longer than you may know.
And the obligations on Issuers are not getting any easier. Is your firm properly tooled for the future?
When most people think about the beginnings of the securitization market, they think about Ginnie Mae, Lewis Ranieri, the Collateralized Mortgage Obligation and perhaps even Sperry Corporation who issued the first non-mortgage deal in 1985. However, a form of securitization was actually happening, for a brief period of time long before then, according to Investopedia¹ which specifically cites Texas Christian University research. Namely, in the early 18th century, Great Britain restructured its debt and sold it to a variety of wealthy corporations who in turn sold shares backed by the payments from the British government.
While the complexity of early 18th century financing was likely far less than today’s structures, the fact of the matter is that securitization in any form is a unique and often complicated form of debt issuance. Over the years, different types of collateral, with far reaching payment forms, have been securitized. Likewise, deal structures ranging from simple pass-throughs to master trusts, synthetics and other extremely complicated arrangements have been implemented. And unlike the financing of the 1700s, a myriad of reporting, regulatory, tax, and analytical obligations fall on those who are involved in the securitization market.
With respect to some of the above-mentioned “obligations,” it may not always be obvious just how challenging they can be. Afterall, one would think it should not be all that complicated to administer a securitization program since most Issuers already have servicing and accounting systems in place. However, it is this often misunderstood, and seemingly minor, nuance of having to view and report on an asset or collateral from the point of view of an investor that introduces challenges. In fact, it turns out that this “minor nuance” isn’t really minor at all and instead requires Issuers to put in place a whole new operational infrastructure that is generally not supported by servicing and accounting systems.
Take a traditional auto loan issuance for example. When doing this type of securitization, a variety of data elements, typically not tracked or calculated on other internal systems must make their way onto reports to Investors. ABS contract status, repurchase amounts, delinquencies, losses, pay-aheads, advances, investor balances and more all need to come from somewhere. Likewise, waterfall structures which incorporate payment prioritizations, credit enhancements, how to handle shortfalls, swap obligations and much more have to be set up. In addition, Issuers need to consider how to operationalize all of this in a manner which is automated, controlled, auditable and conforms to the appropriate risk, governance and regulatory controls required by corporations, audit firms, rating agencies and other third parties.
The preceding paragraph is not only applicable to auto issuance. In fact, each asset class has its own set of unique challenges. Credit card and asset classes which utilize a master trust structure have complex structural features like sharing across series. Leasing introduces concepts such as securitization value. Mobile device financing has its unique set of calculations with the added challenge of handling significant volumes of data. And on it goes.
Furthermore, beyond the items described above, today’s securitizations bestow many other requirements upon the Issuers. For example, how does one select assets that are currently in a warehouse into a structure while keeping the warehouse in compliance and at the same time ensuring the selected assets meet the eligibility criteria and compliance rules of the new deal? Or, how does an organization scale so that staff is able to support multiple deals, each with its own set of reporting requirements? Additionally, given the reps and warranties in the issuing documents, how does the Issuer make sure that its reporting is accurate; given the amount of data, the complex rules and the various events that could occur.
Fortunately, technology today is more advanced than it was in the 1700s. Rather than pen and paper, Issuers have at their disposal, capabilities to streamline their operational requirements. That said, the only thing that is really certain is that there is no certainty with regard to the type of calculations, reporting, accounting and analytics that will be required. Every year new, innovative structures are brought to market which test the limits of mainstream securitization technology.
In fact, building technology that truly addresses all requirements that Issuers may face across many different asset classes is an expensive and non-trivial task with many “hidden musts.” Technology has to be flexible and expandable enough to handle the unknowns of the future yet locked down enough to also address audit, compliance and other operational obligations. It takes significant knowledge, massive ongoing investment, a vision of the future and perhaps most often unaccounted for– time. Furthermore, since it is not just one stakeholder within an issuer organization that has requirements, it also takes an architecture that can support many needs. For example, those responsible for reporting require different capabilities than those who are responsible for structuring deals, to those who determine which assets to include in which deals at a given point in time.
The good news for Issuers is that technology solutions that address some or all of these challenges do exist. However, in selecting a solution it is critical that Issuers do their due diligence, think long term, and deeply consider the key words “some or all.” What may, on the surface, seem like a solution could in fact be missing one or more of the “hidden musts” needed to support the inevitable nuances and future uncertainties of a structured finance issuance program. Unless of course, pen and paper is an option.
References
¹ Sean Ross, “How Debt Securitization Got Started”, Investopedia, 2020
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