by Adam Tempkin
NEW YORK, Nov 4 (IFR) - Global capital markets may resemble
a horror movie of late, but that has not stopped film studio
Miramax from resurrecting a film-backed securitization
technique.
The studio, founded by brothers Bob and Harvey Weinstein in
1979, is launching the first-ever US term securitization of a
standalone film library next week, for about US$550m, to
refinance its outstanding debt.
The deal will also securitize all cashflow from existing
contracts associated with the licensing of those films. That
includes cashflows from the movies' different distribution
channels (television, digital, and DVD/BluRay), and all future
sales associated with the unsold inventory related to the
library -- in other words, all cashflows associated with their
future licensing and distribution.
The library consists of well known existing films that were
quite popular during their run, including "Pulp Fiction", "Good
Will Hunting", "Reservoir Dogs", and "No Country for Old Men".
Miramax was acquired by Disney <DIS.N> in 1993, but the
Weinsteins left the company in 2005. Disney eventually
considered the studio a non-core asset, and sold it to a
holding company in 2010. Therefore, while most film libraries
are embedded in major studios, this one is a standalone
entity.
Barclays Capital, the structurer and arranger, is
roadshowing the 144A deal across the US starting on Monday,
according to market sources.
A NEW SPIN
Film-related securitization is certainly not a new concept,
but previous US deals, including more recent privately placed
conduit financings, have not looked quite like this.
Prior uses of structured finance technology in the film
space have involved the future production of new films. In the
past, cashflows would rely on the success or failure of either
movies that were just released, or movies that were in queue to
be produced -- quite a gamble for investors if a film didn't do
well at the box office.
The most recent film-backed securitization to be completed
was a US$975m ABS for Village Roadshow Films, which closed in
August 2010. However, that deal was more of a hybrid, as it
financed the projected cashflows from some existing films, some
that were recently out of the box office, and some that are yet
to be made.
A seminal US$1bn deal from Dreamworks in 2002 kicked off
this film financing trend in the US. That transaction relied
on movies that were already made, but they were brand new.
About two months after the movie release date, the
financing would advance to investors against future film
receipts and distribution rights, which were largely based on
how much the movie made in the original box office.
After the Dreamworks deal, the technology started to be
used to finance the production of new movies -- so-called
"slate" financings.
Many of these used monoline wraps from Ambac <ABKFQ.PK> or
MBIA <MBI.N>, so when the Triple A ratings on those companies
disappeared in 2007 and 2008, the slate financings went south
pretty quickly.
For example, a US$465m film-backed ABS for Marvel Studios,
launched in September 2005, titled MVL Film Finance, was
downgraded from Aaa to Baa3 by Moody's in early 2009. The
ratings were subsequently withdrawn.
The Aaa class of a similar deal, Relativity Media Holdings
I LLC 2007-1, was downgraded several times, and was lowered to
Ba2 by Moody's this past June; the ratings were then withdrawn
"for business reasons", the rating agency said in a press
release. The US$375m deal was originally created to acquire an
interest in future films to be produced by Sony Pictures
Entertainment.
From a credit perspective, the Miramax transaction seems a
lot safer: all of the movies have already been made and were
quite successful. Moreover, the contracts to license the movies
via various distribution channels for specific time periods are
already in place. These time periods are known as
availabilities, or "avails", within the film finance industry.
Moreover, monoline wraps for ABS do not exist anymore, so
like other recent so-called operating-asset securitizations,
the top grade on the Miramax deal will be in the low
investment-grade range, typically either Triple B or Single A.
The deal uses the same construct as the famed "Bowie bonds"
from 1997, which securitized future royalties.
While new in the US, the Miramax film-library offering may
have a predecessor in Europe: In March 1998, Italian media
group Cecchi Gori priced a ITL475bn film-library ABS for a
catalogue of 1,200 Italian films.
However, unlike Miramax, the Cecchi Gorri transaction
wasn't a pure library deal; it was a multi-picture distribution
financing, which included some library movies but some new
films as well.
Additionally, the Italian deal was launched into a motion
picture industry that was materially different than the one
that exists today - i.e., before the advent of digital
technology, Netflix, and Hulu.
(Adam Tempkin is a senior IFR analyst; Editing by Ciara
Linnane)
Friday, November 4, 2011
Tuesday, October 11, 2011
Reuters IFR: CMBS slowdown hobbles real estate lending
The move has been felt acutely in secondary and tertiary real estate markets that have relied solely on CMBS for more than 15 years.
With more than US$1trn in CRE loans maturing between 2012 and 2016, owners of office buildings, shopping malls, large grocery stores and apartment complexes in medium-sized and smaller cities across the country are increasingly finding that they are unable to refinance.
Some have had to sell the properties at a loss or take out a new loan at unattractive terms out of desperation. Others may have to pay exorbitant fees to convince lenders to extend the loans for two more years. Yet others may default.
Meanwhile, CRE projects are being put on hold. Real estate investment trusts, or REITs, which are often dependent on CMBS to fund acquisitions, have had to look for alternative financing options.
And lenders that rely on securitization to fund themselves -- so-called "CMBS lenders" -- have to charge higher interest rates to borrowers in order to account for the less-economic terms they are receiving on the more conservatively structured CMBS that started hitting the market over the past year.
As a result, these lenders are becoming less competitive compared with more conventional lenders, such as life insurance companies, which can offer lower interest rates to borrowers. Insurance companies typically keep the loans in portfolio rather than securitize them.
The only problem: life insurance companies typically only lend in primary and gateway cities, such as
What's more, the wild spread widening and extreme volatility on commercial mortgage bonds over the past two months has made it nearly impossible for originators to accurately quote new loans. So as a result, they just have not.
Last week, the Barclays Capital CMBS AAA Super Duper Index widened out to 323bp, the highest level in more than 18 months, meaning that investors are extremely wary of risk in commercial mortgages.
"This is more than just a momentary pause in CMBS issuance and lending," said Jeffrey Lenobel, a partner at Schulte Roth & Zabel LLP, who represents CRE lenders across the country. "This is serious. Buyers need to refinance. They need money now.
"If you can't sell the bonds, you can't originate the loans."
SUMMER PULLBACK
The CMBS market looked comparatively rosy at the beginning of the year.
The post-crisis brand of more conservatively underwritten CMBS, dubbed CMBS 2.0, was on a very positive trajectory.
This spring, the market was claiming that "CMBS is back" as investors scooped up new issues and risk premiums began to narrow. Deal arrangers were becoming slightly more daring with collateral -- putting in more debt-laden properties compared to similar 2010 deals -- since bond investors were eager for exposure to the juicier yields the product offered.
Some optimistic observers even predicted as much as US$50bn in issuance for 2011, compared to roughly US$12bn in 2010. The market peaked at US$230bn in 2007 before the financial crisis caused CMBS to seize up.
In late July, however, a shocking ratings-criteria snag from S&P caused a deal from Goldman Sachs and Citigroup to get pulled from the market, post-pricing, shattering confidence in the sector. Perhaps more significantly, CMBS further fell out of favor in August amid an aversion to risky spread product due to the deepening European debt crisis, S&P's separate downgrade of the
Now, 2011 full-year issuance has been revised to approximately US$30bn. The expected pipeline for the remainder of the year has decreased by half.
BORROWERS ARE STUCK
Recently, CMBS issuers have had to offer a super-safe 30% Triple A credit enhancement and split their deals into public and private offerings in order to get transactions done and attract a larger pool of investors. And although the Triple A portions of recent deals have been a reasonably easy sell, the riskier, privately-rated slices have not fared so well.
"Investors are not only worried about credit risk; they're worried about funding risk," said Julia Tcherkassova, a CMBS analyst at Barclays. "The recent news from
Investors don't typically finance their CMBS purchases with just their own cash; they take out a so-called repurchase agreement, or "repo" loan, from the bank that sells them the security.
Based on the loan-to-value and other factors of the underlying mortgages, banks can sometimes lend as much as 80% of the value in a short-term financing, in exchange for a certain increase in interest rate. In the current volatile environment, however, when the short-term loan matures, borrowers are not sure if they can roll the loan at the same terms as before.
"The repo terms are getting worse," Tcherkassova said. "Moreover, loan originators don't know what their execution levels will be. Volatility has thrown everything under the table."
Meanwhile, CMBS lenders' rates are no longer competitive: they are quoting 6.5% to 6.75% on new 10-year loans, while life insurance companies are quoting 3.5% to 4.5%.
"Borrowers whose only option is CMBS due to either lack of interest from life companies to lend on their projects or their need for higher leverage and longer amortizations are in a bind," said James DuMars, a Phoenix-based managing director at Northmarq Capital, which helps arrange financing for CRE owners.
CMBS lenders may be able to offer higher leverage than life insurance companies - sometimes lending up to 10% more - but that comes at a steep price.
"If an insurance company is lending US$9m on a property, for example, a CMBS lender may be able to lend US$10m; but look at what you're paying for that extra US$1m. It could be another 150bp added to your rate for that extra US$1m," DuMars said. "That's 15% interest on a US$10m loan. But many of the owners have no other choice; it's painful, and expensive."
Moreover, if borrowers have loans maturing and they cannot refinance, their options are either to sell, or to work out an extension with a special servicer. However, the servicer will want a fee for that extension.
One of DuMars' clients, for instance, had to raise an additional US$1m on a US$5m loan in order to receive a maturity extension from the lender. Another client, an owner of an anchor grocery store in
Yet another client, an owner of a US$50m office building, is seeing the writing on the wall, and is beginning to put cash aside for an impending loan maturity.
"He is losing sleep because he realized we don't have a functioning securitization market," DuMars said. "Moreover, with CMBS loans, you now have to add in lender legal fees running at least $25,000, as all the loan documents have been modified 'to restore confidence'. Add in other legal fees, and a CMBS loan can cost a borrower an extra $50,000; maybe an extra $100,000 at the end of the day."
Still, other borrowers have increasingly taken out Libor-based loans, instead of fixed-rate loans, in order to decrease their interest rate. Then they swap out the loan in the derivatives market through interest rate swaps -- called a 'reverse swap' in the industry -- and wind up with an even lower rate, said Schultz Roth's Lenobel, the lenders' attorney.
"CMBS had created a mechanism for secondary and tertiary markets to be financed since 1996," he said. "When life insurance companies wouldn't look at a US$10m loan in
(Adam Tempkin is a senior IFR analyst)
Wednesday, September 28, 2011
Reuters IFR: Deutsche Bank launches US$609m large-loan CMBS; Also recap of GSMS GC5
The transaction, dubbed COMM 2011-FL1, was announced today and is expected to price sometime next week.
The collateral is comprised of 80% hotel and 20% "mixed use" properties, which could be a combination of both office and retail loans.
The largest loan backing the transaction is a US$225m loan for the Hotel del Coronado, a 757-room luxury hotel occupying1.5 miles of beachfront property located just west of downtown
The second largest loan in the pool, at US$113m, is for The Standard Hotel in downtown
The industry refers to this type of offering as a "large-loan" CMBS, because it comprises fewer, larger loans, and hence offers less diversification than the typical so-called "conduit" CMBS, which consists of many more CRE loans, typically culled from a broader range of geographical areas.
Even during less volatile times, therefore, rating agencies have demanded more credit enhancement to protect the Triple A slices of large-loan CMBS, compared to their conduit CMBS counterparts. Less diversification means that a delinquency on one loan can have a more devastating effect on a transaction's performance, so rating agencies rate large-loans more conservatively.
That trend is even more exaggerated now, given the current global volatility that has recently driven issuers to offer risk-averse investors spread concessions in order to appease them and get deals done.
The COMM 2011-FL1 deal, for instance, is structured with a whopping 41.5% credit enhancement supporting the US$356.295m Triple A rated piece. That's even more conservative then the 30% credit enhancement that has become a recent requirement on conduit offerings.
Moody's, Fitch, and Kroll rated the transaction.
"The rating agencies have always required more subordination for large-loan CMBS, and given recent global volatility, I expect that they will require even more subordination now," said Marc Peterson, a senior CMBS portfolio manager at Principal Global Investors in
The advantage of a large-loan CMBS pool is that investors can more easily conduct due diligence on the underlying properties. Given how well known some of the hotel properties are, some investors view the COMM 2011-FL1 loans as relatively low-leverage and high quality.
Additionally, some buy-siders view a floating-rate, short-duration CMBS as an attractive alternative to the typical fixed-rate, longer-maturity conduits that have been more common in the market, according to securitization specialists.
Only a handful of deals are expected for the remainder of the year, according to market participants.
A conduit from Wells Fargo and Royal Bank of
A fourth-quarter CMBS from Deutsche Bank and UBS is expected as well.
GOOD DEMAND FOR SENIOR BONDS ONLY
Last week, co-lead managers and joint bookrunners Goldman Sachs and Citigroup revived and restructured a US CMBS conduit that the banks had originally pulled from the market, post-pricing, in late July. The deal was withdrawn after an S&P ratings glitch hit the CMBS market.
Some loans from the original offering were dropped and different ones were added, ultimately increasing the size of the new deal, GSMS 2011-GC5, to US$1.75bn from the original US$1.5bn. The July conduit was dubbed GSMS 2011-GC4.
Spreads on several Triple A tranches of the reconstituted offering tightened at pricing last Thursday. For example, the 9.55-year Triple A piece printed 15bp inside guidance at swaps plus 170bp.
In fact, the equivalent tranche of GC4 priced slightly wider at swaps plus 175bp on July 22 – although that deal featured 20% credit enhancement protecting the Triple As, whereas GC5 boasted the now-standard 30% protection.
The snug pricing illustrated investors’ increasing demand for the Triple A part of the sector. CMBS fell out of favor in August amid an aversion to spread product due to uncertainty surrounding the European debt crisis and S&P's downgrade of the
But issuers have had to offer a whole new paradigm -- referred to by some as "CMBS 3.0" -- to attract investors back to the asset class. CMBS 2.0 was the moniker given to the new breed of deals issued as the US CMBS market revived after the 2008 financial crisis.
In addition to the apparently bulletproof 30% Triple A credit enhancement, GC5 was also segregated into publicly and privately offered securities. This new structural template, designed to appease risk-averse investors, started with the Deutsche Bank/UBS US$1.3bn DBUBS 2011-LC3 transaction, which was priced on August 11.
The increased credit enhancement in the new format and the publicly registered classes have opened the securities to a much larger account base. All previous so-called CMBS 2.0 offerings were issued in the private market.
"Judging from the market’s demand for the new 30% Triple A public paper, we think this structure is here to stay and will hopefully become the standard for what we have been calling CMBS 3.0," wrote Harris Trifon, head of CMBS research at Deutsche Bank, in a recent article.
A majority of the collateral in GC5 was originally scheduled to be included in GC4. That deal was scuppered when S&P's shocking July 27 criteria review sent the CMBS market into a tailspin. It led the firm to withdraw ratings on two deals and suspend the assignment of all new-issue CMBS ratings. A grim global economic outlook compounded the uncertainty in the market, causing a third deal to be pulled from the new-issue market in August.
S&P's ratings review occurred because it discovered its new-issue ratings and surveillance teams used "conflicting methods" of determining debt service coverage ratios for rating CMBS deals.
Even before S&P's announcement, the beleaguered GSMS 2011-GC4 offering was controversial as investors lobbied the arrangers to increase the credit enhancement to 20% from the paltry initial layer of 14.5%. They got their wish, but it made no difference after the deal was pulled.
However, S&P staged a drastic U-turn several days later, saying that based on an initial criteria review, it would resume assigning ratings to new conduit/fusion CMBS transactions. It also found that its ratings teams actually used consistent methods.
Still, Goldman and Citigroup, not surprisingly, did not hire S&P to rate last week's current transaction. Fitch, Moody's and Morningstar rated it.
Lower-rated portions of deals have not fared as well. A US$243.2m privately placed portion of a larger JP Morgan CMBS conduit that surfaced in mid-September is still struggling to sell, despite the fact that the arrangers have revised price guidance wider two times.
adam.tempkin@thomsonreuters.com
Monday, September 26, 2011
Reuters/IFR: SEC conflict-of-interest ABS rule confuses more than clarifies
by Adam Tempkin
NEW YORK, Sept 26 (IFR) - A rule proposed by the SEC last week to prohibit the conflict of interest between deal arrangers and investors such as the one in Goldman Sachs' infamous Abacus CDO raises more questions than answers about what securitization arrangements will ultimately be permissible under the law, market participants say.
"The SEC has acknowledged that this is a grey area," said a managing director in the structured finance department of a rating agency, who requested anonymity since the SEC is involved.
"Distinguishing between the most egregious abuses of 'conflicts of interest', which is what the SEC is going after, and what is considered 'normal' risk-mitigating activities in the securitization markets, is an extremely difficult task."
The SEC nearly admits as much.
For most of the 118-page proposed rule now out for 90-day comment, the regulator asks for guidance from the market via detailed and open-ended questions.
"Are certain types of ABS more susceptible to conflicts of interest?" the SEC queries market participants.
"What are the key features of the securitization process that bear on the existence or significance of conflicts of interest between participants in that process and investors in the ABS?"
The SEC voted unanimously last Monday to propose a rule intended to prohibit certain "material conflicts of interest" between those who package and sell ABS and those who invest in them.
It is designed to ensure that those who create and sell ABS cannot profit by betting against those same securities at the expense of those who buy them.
One problem: The SEC refuses to define a "material conflict of interest".
"We preliminarily believe that any attempt to precisely define this term in the text of the proposed rule might be both over- and under-inclusive in terms of identifying those types of material conflicts of interest arising as a result of or in connection with a securitization transaction .. especially given the complex and evolving nature of the securitization markets, the range of participants involved, and the various activities performed by those participants," the SEC writes.
The conflict-of-interest proposal, therefore, is clearly just a starting point for the SEC, securitization specialists say. The agency is expecting a hearty response from industry lawyers.
MAKING EXCEPTIONS
The regulator also carved out exceptions to the rule, such as if parties to a transaction participate in risk-mitigating hedging activities, liquidity commitments, or "bona-fide market-making".
The new rule could prohibit a firm from allowing a third party to help assemble an ABS in a way that creates an opportunity for the third party to profit from its failure.
Although the SEC never mentions the Abacus CDO by name in the 118 pages, this aspect of the rule seems like a clear attempt to ban Abacus-like trades.
Goldman Sachs GS.N
agreed to pay $550 million in July 2010 to settle civil fraud charges relating to its marketing of the Abacus 2007-AC1 CDO. Although the bank did not admit or deny any wrongdoing, it did acknowledge that it was a mistake for the marketing materials not to disclose the role of hedge fund Paulson & Co. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors.
Paulson was not charged at all.
"The SEC rule is reasonably well crafted to reduce this type of conflict of interest," said Darrell Duffie, a professor at Stanford University graduate school of business.
"By ruling out these types of conflicts of interest, however, it is also ruling out what some investors may want to do with bona-fide reasons, completely open-eyed. It's not a cost-free improvement in the law, and it may reduce the liquidity of the securitization market. The SEC itself mentions this tradeoff."
Indeed, the regulator acknowledges that there are a number of conflicts of interest inherent in, and possibly essential to, the securitization process. It refers to one commenter wholisted more than 20 categories of potential conflicts of interest that may be inherent in the ordinary course of securitization but, in the commenter's view, should not be prohibited by the SEC.
Examples include the basic risk transfer that occurs in structuring a securitization; the tranching of debt; risk retention; and providing financing through a warehouse line of credit.
MORE CLARITY NEEDED
Some say the SEC may be walking a fine line as it attempts to differentiate between transactions that have a clear conflict of interest and were designed to fail, and others that represent the desire of a fully knowledgeable party to take a point of view on a trade.
"Generically, our concern is that a general definition of 'material conflict of interest' may be hard to apply to specific areas of the market," said Tom Deutsch, the executive director of the American Securitization Forum.
"There are many potential conflicts in individual situations that we don't think should be prohibited under these rules without additional clarity.
"The devil is in the details."
One pressing concern is that a broad interpretation of "material conflicts of interest" could prohibit mortgage servicers from pursuing customary servicing activities, including loss mitigation efforts such as loan modifications under the Home Affordable Modification Program (HAMP), he said.
If a loan servicer holds a subordinate tranche of a securitization, for example, this can be construed as an inherent conflict of interest.
In a statement released on Friday, Fitch Ratings said that it is concerned for the potential for confusion among market participants between true conflicts and certain normal hedging or risk management practices.
"The securitization market's recovery remains fragile," said Ian Linnell, group managing director of Fitch's structured finance group. "There remains the risk that multiple layers of regulation may become burdensome for certain market participants."
Moreover, Stanford University's Duffie suggested that this rule, by itself, may ironically not apply to Goldman's specific role in the Abacus CDO, since the bank was actually on the long side of the trade, and did ultimately take some losses.
Every example cited by the SEC in its proposal references situations where a party shorts a transaction. Paulson & Co shorted the Abacus CDO, yet was not sued by the SEC; Goldman was not directly involved in the short side of the deal -- unless one makes the argument that it received a fee associated with Paulson's participation.
Some market participants will likely also demand more concrete examples of what it means to be a "liquidity provider" or "market maker" in a transaction -- two statuses that exempt deal participants from the rule.
As a theoretical example, had Goldman Sachs merely taken a position on a trade in order to allow the deal to go ahead and meet the needs of a client -- in a liquidity provider role, for instance -- the bank may actually be protected under this new rule, Professor Duffie said.
"The rule might actually serve to protect intermediaries in situations where it can be shown that they are just providing liquidity services," he noted.
(Reporting by IFR senior analyst Adam Tempkin)
NEW YORK, Sept 26 (IFR) - A rule proposed by the SEC last week to prohibit the conflict of interest between deal arrangers and investors such as the one in Goldman Sachs' infamous Abacus CDO raises more questions than answers about what securitization arrangements will ultimately be permissible under the law, market participants say.
"The SEC has acknowledged that this is a grey area," said a managing director in the structured finance department of a rating agency, who requested anonymity since the SEC is involved.
"Distinguishing between the most egregious abuses of 'conflicts of interest', which is what the SEC is going after, and what is considered 'normal' risk-mitigating activities in the securitization markets, is an extremely difficult task."
The SEC nearly admits as much.
For most of the 118-page proposed rule now out for 90-day comment, the regulator asks for guidance from the market via detailed and open-ended questions.
"Are certain types of ABS more susceptible to conflicts of interest?" the SEC queries market participants.
"What are the key features of the securitization process that bear on the existence or significance of conflicts of interest between participants in that process and investors in the ABS?"
The SEC voted unanimously last Monday to propose a rule intended to prohibit certain "material conflicts of interest" between those who package and sell ABS and those who invest in them.
It is designed to ensure that those who create and sell ABS cannot profit by betting against those same securities at the expense of those who buy them.
One problem: The SEC refuses to define a "material conflict of interest".
"We preliminarily believe that any attempt to precisely define this term in the text of the proposed rule might be both over- and under-inclusive in terms of identifying those types of material conflicts of interest arising as a result of or in connection with a securitization transaction .. especially given the complex and evolving nature of the securitization markets, the range of participants involved, and the various activities performed by those participants," the SEC writes.
The conflict-of-interest proposal, therefore, is clearly just a starting point for the SEC, securitization specialists say. The agency is expecting a hearty response from industry lawyers.
MAKING EXCEPTIONS
The regulator also carved out exceptions to the rule, such as if parties to a transaction participate in risk-mitigating hedging activities, liquidity commitments, or "bona-fide market-making".
The new rule could prohibit a firm from allowing a third party to help assemble an ABS in a way that creates an opportunity for the third party to profit from its failure.
Although the SEC never mentions the Abacus CDO by name in the 118 pages, this aspect of the rule seems like a clear attempt to ban Abacus-like trades.
Goldman Sachs GS.N
agreed to pay $550 million in July 2010 to settle civil fraud charges relating to its marketing of the Abacus 2007-AC1 CDO. Although the bank did not admit or deny any wrongdoing, it did acknowledge that it was a mistake for the marketing materials not to disclose the role of hedge fund Paulson & Co. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Paulson was not charged at all.
"The SEC rule is reasonably well crafted to reduce this type of conflict of interest," said Darrell Duffie, a professor at Stanford University graduate school of business.
"By ruling out these types of conflicts of interest, however, it is also ruling out what some investors may want to do with bona-fide reasons, completely open-eyed. It's not a cost-free improvement in the law, and it may reduce the liquidity of the securitization market. The SEC itself mentions this tradeoff."
Indeed, the regulator acknowledges that there are a number of conflicts of interest inherent in, and possibly essential to, the securitization process. It refers to one commenter wholisted more than 20 categories of potential conflicts of interest that may be inherent in the ordinary course of securitization but, in the commenter's view, should not be prohibited by the SEC.
Examples include the basic risk transfer that occurs in structuring a securitization; the tranching of debt; risk retention; and providing financing through a warehouse line of credit.
MORE CLARITY NEEDED
Some say the SEC may be walking a fine line as it attempts to differentiate between transactions that have a clear conflict of interest and were designed to fail, and others that represent the desire of a fully knowledgeable party to take a point of view on a trade.
"Generically, our concern is that a general definition of 'material conflict of interest' may be hard to apply to specific areas of the market," said Tom Deutsch, the executive director of the American Securitization Forum.
"There are many potential conflicts in individual situations that we don't think should be prohibited under these rules without additional clarity.
"The devil is in the details."
One pressing concern is that a broad interpretation of "material conflicts of interest" could prohibit mortgage servicers from pursuing customary servicing activities, including loss mitigation efforts such as loan modifications under the Home Affordable Modification Program (HAMP), he said.
If a loan servicer holds a subordinate tranche of a securitization, for example, this can be construed as an inherent conflict of interest.
In a statement released on Friday, Fitch Ratings said that it is concerned for the potential for confusion among market participants between true conflicts and certain normal hedging or risk management practices.
"The securitization market's recovery remains fragile," said Ian Linnell, group managing director of Fitch's structured finance group. "There remains the risk that multiple layers of regulation may become burdensome for certain market participants."
Moreover, Stanford University's Duffie suggested that this rule, by itself, may ironically not apply to Goldman's specific role in the Abacus CDO, since the bank was actually on the long side of the trade, and did ultimately take some losses.
Every example cited by the SEC in its proposal references situations where a party shorts a transaction. Paulson & Co shorted the Abacus CDO, yet was not sued by the SEC; Goldman was not directly involved in the short side of the deal -- unless one makes the argument that it received a fee associated with Paulson's participation.
Some market participants will likely also demand more concrete examples of what it means to be a "liquidity provider" or "market maker" in a transaction -- two statuses that exempt deal participants from the rule.
As a theoretical example, had Goldman Sachs merely taken a position on a trade in order to allow the deal to go ahead and meet the needs of a client -- in a liquidity provider role, for instance -- the bank may actually be protected under this new rule, Professor Duffie said.
"The rule might actually serve to protect intermediaries in situations where it can be shown that they are just providing liquidity services," he noted.
(Reporting by IFR senior analyst Adam Tempkin)
Monday, January 10, 2011
Reuters/IFR: Rating agencies ignored internal feedback during CDO frenzy
15:57 07Jan11 RTRS-IFR-ABS-Raters ignored internal feedback during CDO frenzy
by Adam Tempkin
NEW YORK, Jan 7 (IFR) - During the peak of the CDO boom, analysts
at one rating agency may have ignored warnings from their very own
surveillance department in order to continue handing out high ratings
on complex securities, says a research paper to be presented this
Sunday at the annual meeting of the American Economic Association and
featured in the 2011 edition of the American Economic Review.
The report, titled "Did Credit Rating Agencies Make Unbiased
Assumptions on CDOs?", claims to be one of the first to provide
concrete empirical evidence, as rating agencies remain a prime target
of academics trying to understand causes of the financial crisis.
The paper asserts that in the run-up to the credit crisis, the
group responsible for rating new CDOs within a major rating agency
used far less stringent assumptions to rate the deals than those used
by the firm's own structured-finance surveillance department, which
is a separate group responsible for monitoring the transactions after
issuance.
The evidence supports that this difference can only be explained
by the agency's desire to protect high ratings, the paper says.
"We find systematic discrepancies between the groups -
assumptions made by the ratings division are more lenient than those
by the surveillance department," wrote John Griffin, a finance
professor at The University of Texas at Austin, and Dragon Tang, a
finance professor at the University of Hong Kong.
Moreover, the paper alleges that updated estimates by the
surveillance group "were more accurate but seemingly ignored" by the
new-ratings group, which continued to rate new CDOs with looser
correlation and collateral credit-quality assumptions, despite
signals from the surveillance department that the transactions should
have been rated lower.
The authors say that their data comes from "one of the two
leading rating agencies" but do not divulge which one. However, the
academics discuss in detail a certain model output they analyzed
called "scenario default rate", or SDR - a data point and acronym
only used by Standard & Poor's, a unit of McGraw Hill Cos Inc
<MHP.N>.
The sample CDOs were issued between 2002 and 2007.
S&P said that they did not have a comment on the research paper.
Tom Lemmon, a spokesman for Moody's <MCO.N>, gave the following
statement: "While we have not fully reviewed the paper in question,
the CDO rating methodology it describes does not appear to be a
Moody's methodology. Moreover, the surveillance practices it
describes are inconsistent with Moody's approach to CDO surveillance,
which employs the same methodology when assigning new ratings and
conducting surveillance of existing ratings."
OTHER EXPLANATIONS REJECTED
Significantly, the researchers' dataset is restricted to the 355
CDOs with surveillance reports dated within 180 days of the initial
rating assignment, meaning that the surveillance group's adjusted
assumptions were made known shortly after issuance.
According to the authors, despite the surveillance group's more
negative outlook, there were no downgrades issued at the time of the
first surveillance report for each of the CDOs, and the tightened
assumptions were not immediately incorporated into the new-issue
ratings group's methodology.
The professors also present statistical evidence that the
surveillance reports were more accurate than the ratings group's
initial "pre-sale" or "new issue" reports, which are typically
published around the time the rating is issued to facilitate the
closing of the CDO.
The data indicates that the surveillance group calculated much
more pessimistic collateral credit quality and higher asset-default
correlation for the CDOs compared to the assumptions made by the
ratings team.
"If the rating agency had new information from the surveillance
group and acted on it then it would indicate that the rating agency
was learning from the surveillance team and trying to correct
mistakes made by the ratings group," the paper says.
"However, if the ratings agency did not act on information coming
from the surveillance group, then this would indicate that the firm
was compromising its standards."
Professors Griffin and Tang maintain that the discrepancies do
not appear to be explained by changes in collateral composition, the
length of time between reports, or the collapse of the subprime
mortgage market.
"Since the breakdown in CDO credit ratings was at the heart of
the credit crisis of 2007-2009, our findings suggest that conflicts
of interest may be much more economically important than previously
surmised," the authors wrote.
SURVEILLANCE OFTEN AT ODDS WITH NEW-RATINGS GROUP
According to the paper, common perception is that prior to the
financial crisis, ratings analysts received higher compensation and
more staffing than surveillance teams.
The authors imply that there may have been a natural tension
between the two groups, as surveillance analysts are less influenced
by conflicts of interest, and hence could make more objective
assumptions, the professors said.
"We expect the ratings committee to have more discretion than
the surveillance group - the surveillance group is more reminiscent
of a compliance or risk management division," the paper notes. "While
a surveillance department may be forced to corroborate the ratings
department, they have some autonomy and may not fully communicate
with the ratings group."
As the credit crisis deepened and new issues in RMBS and CDOs all
but dried up, the agencies put more focus on and expanded their
surveillance teams in order to re-assess billions of dollars of
complex securities that needed to be downgraded due to souring
mortgage collateral.
[Adam Tempkin is a senior IFR analyst]
[Adam Tempkin was communications manager of
S&P's structured finance group from 2002 through the end of 2009.]
((adam.tempkin@thomsonreuters.com; Reuters Messaging;
adam.tempkin.thomsonreuters.com@reuters.net))
by Adam Tempkin
NEW YORK, Jan 7 (IFR) - During the peak of the CDO boom, analysts
at one rating agency may have ignored warnings from their very own
surveillance department in order to continue handing out high ratings
on complex securities, says a research paper to be presented this
Sunday at the annual meeting of the American Economic Association and
featured in the 2011 edition of the American Economic Review.
The report, titled "Did Credit Rating Agencies Make Unbiased
Assumptions on CDOs?", claims to be one of the first to provide
concrete empirical evidence, as rating agencies remain a prime target
of academics trying to understand causes of the financial crisis.
The paper asserts that in the run-up to the credit crisis, the
group responsible for rating new CDOs within a major rating agency
used far less stringent assumptions to rate the deals than those used
by the firm's own structured-finance surveillance department, which
is a separate group responsible for monitoring the transactions after
issuance.
The evidence supports that this difference can only be explained
by the agency's desire to protect high ratings, the paper says.
"We find systematic discrepancies between the groups -
assumptions made by the ratings division are more lenient than those
by the surveillance department," wrote John Griffin, a finance
professor at The University of Texas at Austin, and Dragon Tang, a
finance professor at the University of Hong Kong.
Moreover, the paper alleges that updated estimates by the
surveillance group "were more accurate but seemingly ignored" by the
new-ratings group, which continued to rate new CDOs with looser
correlation and collateral credit-quality assumptions, despite
signals from the surveillance department that the transactions should
have been rated lower.
The authors say that their data comes from "one of the two
leading rating agencies" but do not divulge which one. However, the
academics discuss in detail a certain model output they analyzed
called "scenario default rate", or SDR - a data point and acronym
only used by Standard & Poor's, a unit of McGraw Hill Cos Inc
<MHP.N>.
The sample CDOs were issued between 2002 and 2007.
S&P said that they did not have a comment on the research paper.
Tom Lemmon, a spokesman for Moody's <MCO.N>, gave the following
statement: "While we have not fully reviewed the paper in question,
the CDO rating methodology it describes does not appear to be a
Moody's methodology. Moreover, the surveillance practices it
describes are inconsistent with Moody's approach to CDO surveillance,
which employs the same methodology when assigning new ratings and
conducting surveillance of existing ratings."
OTHER EXPLANATIONS REJECTED
Significantly, the researchers' dataset is restricted to the 355
CDOs with surveillance reports dated within 180 days of the initial
rating assignment, meaning that the surveillance group's adjusted
assumptions were made known shortly after issuance.
According to the authors, despite the surveillance group's more
negative outlook, there were no downgrades issued at the time of the
first surveillance report for each of the CDOs, and the tightened
assumptions were not immediately incorporated into the new-issue
ratings group's methodology.
The professors also present statistical evidence that the
surveillance reports were more accurate than the ratings group's
initial "pre-sale" or "new issue" reports, which are typically
published around the time the rating is issued to facilitate the
closing of the CDO.
The data indicates that the surveillance group calculated much
more pessimistic collateral credit quality and higher asset-default
correlation for the CDOs compared to the assumptions made by the
ratings team.
"If the rating agency had new information from the surveillance
group and acted on it then it would indicate that the rating agency
was learning from the surveillance team and trying to correct
mistakes made by the ratings group," the paper says.
"However, if the ratings agency did not act on information coming
from the surveillance group, then this would indicate that the firm
was compromising its standards."
Professors Griffin and Tang maintain that the discrepancies do
not appear to be explained by changes in collateral composition, the
length of time between reports, or the collapse of the subprime
mortgage market.
"Since the breakdown in CDO credit ratings was at the heart of
the credit crisis of 2007-2009, our findings suggest that conflicts
of interest may be much more economically important than previously
surmised," the authors wrote.
SURVEILLANCE OFTEN AT ODDS WITH NEW-RATINGS GROUP
According to the paper, common perception is that prior to the
financial crisis, ratings analysts received higher compensation and
more staffing than surveillance teams.
The authors imply that there may have been a natural tension
between the two groups, as surveillance analysts are less influenced
by conflicts of interest, and hence could make more objective
assumptions, the professors said.
"We expect the ratings committee to have more discretion than
the surveillance group - the surveillance group is more reminiscent
of a compliance or risk management division," the paper notes. "While
a surveillance department may be forced to corroborate the ratings
department, they have some autonomy and may not fully communicate
with the ratings group."
As the credit crisis deepened and new issues in RMBS and CDOs all
but dried up, the agencies put more focus on and expanded their
surveillance teams in order to re-assess billions of dollars of
complex securities that needed to be downgraded due to souring
mortgage collateral.
[Adam Tempkin is a senior IFR analyst]
[Adam Tempkin was communications manager of
S&P's structured finance group from 2002 through the end of 2009.]
((adam.tempkin@thomsonreuters.com; Reuters Messaging;
adam.tempkin.thomsonreuters.com@reuters.net))
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