Post Issuance Transaction Reporting in the European Securitisation Market
Nicola Davies, ABSReports.com - Computershare Fixed Income Services Limited (October 18, 2000)
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This speech was originally delivered at Euromoney's Securitisation 2000 conference, London, October 2000.
Why is transaction reporting currently so topical?
Historically in the European market there has been a relative dearth of information on the post issuance performance of asset and mortgage backed securities. But over the last 2 - 3 years, the subject has become quite a hot topic. At industry conferences you will hear the lack of such reporting being widely bemoaned. The Council of Mortgage Lenders have been discussing it, and the European Securitisation Forum (an offshoot of the Bond Dealers Association) have set up a working party specifically to deal with it.
But we have managed so far without post issuance transaction reporting, and the market has thrived, so why has is become such a big issue?
There are a number of reasons. Firstly, the European market itself has grown hugely. European ABS volumes grew 84% in 1999, and are expected to grow again substantially this year. Analysts estimate that 80% of European investors in debt have now purchased an asset-backed product.1
The investor base is widening in terms of new entrants to the market, and increasing risk appetite amongst existing investors. In Standard & Poor's recent publication "Structured Finance Viewpoint" they point out that the rate at which ABS bonds have gained favour with European investors has on occasion seen demand outstrip supply in the higher rated tranches, with investors consequently having to content themselves with lower rated tranches. Whilst these lower rated tranches offer potentially much higher returns, they do so of course at the cost of greater risk to the investor. The investor therefore needs to be able to monitor the performance of the securities to a much closer degree than is perhaps the case where you are dealing with a AAA rated bond.
In the U.S. the default rate on ABS has tripled over the past few years. The reasons for this are many and varied, but the rise in defaults does reinforce the point that the ABS market nowadays comprises a lot more than blue chip investment opportunities, and so needs careful monitoring. Investors are not going to feel inclined to move down the credit spectrum in any great numbers, if they have no way of monitoring their exposure.
The general widening of the investor base is being matched by the increasing number of originators. 10 years ago, securitisation was seen as the exclusive preserve of a relatively small club of extremely large corporations, whose deal sizes could justify the then very high entry costs. This has now changed. As ABS transactions have become more commoditised and the use of conduits more common, the entry costs have dropped and securitisation is now a viable financing tool for a whole range of companies and financial institutions across Europe. We now have hundreds of originators in Europe, and increasingly exotic asset classes being securitised.
Every day, the barriers to issuance are coming down across Europe - witness the legislation introduced in France and Italy to encourage securitisation, which will in all probability be emulated in other jurisdictions.
But as the market grows and diversifies, so it is increasingly difficult for investors to keep track of what is going on.
As there is more choice on the market for investors - and the investors in turn are becoming more sophisticated and knowledgeable - they want to know how to select the right deals for them. At present, it is not too difficult for them to do this at the issuance stage. Offer documents tend to be very detailed, and often give a great deal of information about the assets being securitised and the cash flow projections that have been used in pricing the deal. But post issuance, we see a very different story. Investors who have learnt how to analyse a deal on issue, are not likely to want to buy a security on the secondary market when there is no comparative data to see how it has performed since then - it is simply too risky, and certainly extremely difficult to price.
The absence of an active secondary market in European ABS is one of the other driving forces behind the push for greater transparency.
In the past, investors who have bought ABS have generally done so with the intention of holding until maturity. Bankers estimate that, even now, 75% of European investors are buying to hold, although I would question whether that is out of choice or necessity. Nowadays, investors are starting to demand more flexibility (particularly in relation to some of the bigger volume issues, such as the residential mortgage and credit card deals), and the ability to rebalance their portfolio over time to reflect changing circumstances.
In a survey carried out in November of 1999, RBS and Nomura jointly sent questionnaires to 49 investors in ABS and MBS to ascertain their views on these issues. 100% of respondents wanted to see greater liquidity in the market, both to give them this flexibility re whether to hold until maturity, but also to assist with more transparent pricing.
A secondary market cannot really exist in any significant form unless and until the information is made available in a readily accessible form to the market.
Also, we now have a large number of US investors investing in European ABS and MBS. They are used to getting post issuance reporting data on their US deals, as it is commonly available for many different asset types in the US. Those investors do not understand why they should not be able to get similar quality of information from the Europeans.
So investors are generally, on both sides of the Atlantic, becoming more demanding. It is no longer considered acceptable by the market for an originator, or a lead bank, to wash their hands of an issue once the deal is out on the market and to move on to the next project without supporting the existing ones adequately.
What do investors get out of it?
The advantages for investors in having high quality post issuance transaction reporting are fairly obvious.
- They get ongoing information about how their existing investments are performing, so they can make a sensible valuation of the security throughout its life
- They have access to a secondary market, so when they buy an asset backed security they are not obliged to hold until maturity;
- They can select new investments on a more organized basis than before, as they will have comparative performance data from other issuers;
- They have more autonomy. In the past, if an investor needed to get rid of a holding before its maturity date, he often had no choice but to go back to the lead manager, who was the only person with the information to be able to make a market. And whilst I certainly would not level this accusation at all banks, it seems from investors that there certainly have been instances of lead banks having exploited this, either by quoting extremely wide bid/offer spreads, or by insisting that the investor accepts new securities from a fresh issue in lieu of cash.
What do Originators get out of it?
But what about the Originators? Why should they share performance information with people who have not invested in their product, or even with their competitors?
As recently as two years ago, the investor appetite for reporting was already growing, but the Originators were less keen. Many of the blue chip issuers felt that their name would be sufficient to sell a deal, and some of the sub-prime issuers were worried about whether their performance data would look poor, because of the nature of their market. And many others in between simply worried about making what they considered to be commercially sensitive information available on the market.
There was also simply a huge sense of inertia, and as there was at the time no proof of compelling reasons for persuading Originators to report, no-one was prepared to be the first to jump.
This has now changed.
Firstly, a number of high profile purchasers of ABS introduced a policy that stipulated that they would not invest in a particular deal if there was to be no ongoing performance reporting. M&G Investment Management have gone on record as taking this stance, but they are the tip of an ever-increasing ice-berg. In the ABS/Nomura survey, when asked if they would buy investments where there was to be no post issuance performance reporting, 50% said no, 32% were unsure, and only 18% said yes. So Originators who refuse to report should be aware that they are cutting themselves off from at least half of the investor community at a stroke, and possibly up to 80%. This trend is undoubtedly set to continue.
This policy shift coincided with a small number of investment banks beginning to have difficulty of placing some deals on the market, where the Originator concerned had a history of poor reporting, or no reporting. In past years, issuance volumes had been relatively modest, so the banks were usually able to find purchasers, even absent any reporting. But as issuance volumes increase, so investors can afford to be able to rule out buying certain issues of securities, where they will not be given performance information.
In reaction to all of this, some issuers have begun to publish performance information. Once some issuers publish information, so it becomes increasingly difficult for other to refuse to do so without being seen to be out of line with the market.
Perhaps more importantly, Originators are now starting to see the significant benefits to them in allowing a secondary market to develop in ABS. Not only does the existence of a secondary market lead to an enlarged investor base (as you are including people in the investor community who may not be able to buy assets where they would be forced to hold to maturity) but it also leads to finer pricing for the Originators.
It was reported to me recently that GMAC-RFC have recently undertaken some research on the effects on pricing of post issuance reporting. I am told that this research indicates that the pricing spread between deals where accurate and regular reporting is made available and those where it is not, is 30 basis points. If this is correct (and I have not seen the data first hand) then it clearly pushes the issue of post issuance reporting very high up the agenda of Originators.
Originators who are prepared to make their performance data available can therefore benefit from better pricing, easier selling, a larger investor base, and being seen to be responsive to investor demands. This should more than offset any perceived downside.
Exploring Current Reporting Practice
So what post issuance reporting is currently being made available at the moment?
There have been lots of developments in this field over the last year or two.
Many Originators are now publishing data in some form or another, either directly or by delegating the task to another party in the transaction, such as the trustee or servicer. Some, such as Europa One (a jumbo securitisation of commercial mortgages) are making the data available to the original purchasers of the issue. Others, such as Paragon, have gone further, and made their information publicly available either in paper form or on the internet. The quality and quantity of information being reported from all the different originators is hugely variable, but as time passes things are improving significantly.
The Rating Agencies are all providing, to a greater or lesser extent, some degree of post issuance reporting on the transactions which they rate. Most of the Rating Agencies have excellent reporting on security level data (ie. the performance of the securities issued themselves, in terms of whether they are paying down on time and whether any shortfalls have occurred), and some have reporting on the performance of the underlying collateral pool. The great strength of the Rating Agencies is of course that at the same time as providing all of this data, they also give a detailed analysis of the raw data.
During this period the European Securitisation Forum have put together a working party to look specifically at the issue of post issuance performance reporting, and have got their members to sign up to a voluntary undertaking to make such information available. They have also been one of the first organisations to tackle the issue of what to report, and to try and produce some minimum common standards across the industry. They have succeeded in making excellent headway in relation to standardisation of bond level data, and have dealt with some generic collateral pool definitions. The issue of the more complex collateral pool reporting has been dealt with by requiring members to agree reporting standards in relation to each transaction prior to issue.
Some other service providers are also now entering the market. A number of US based organisations who currently report in relation to US originated deals have announced their intention to look at the European markets in the future and a small number of independent organisations, such as absreports.com are considering this to be their main focus.
Limitations of Existing Practice
Enormous progress has been made over the last couple of years, but we should not get too complacent.
Originators must not only provide information, but do it in a way that is accessible to investors. Ease of accessibilty is crucial to the establishment of a secondary market. At present, some Originators report in paper format and some electronically, either by e mail or, less often, on the internet. Given that there are hundreds of European Originators now, there are hundreds of different sources of information that investors have to be able to track down.
Secondly, many Originators only make their information available to existing investors. The fact that access is not made available more widely does limit the potential for a secondary market. It also means that someone somewhere has to take responsibility for verifying the identity of a person requesting data. This was a problem raised by investors in the RBS/Nomura survey. They reported having to chase issuers, lead managers, trustees and paying agents for reports and being required to provide proof of ownership of the securities every time a request was made. For investors holding significant volumes of securities, and who want access to monthly reports, this type of bureaucracy can be extremely problematic.
For secondary investors the position is worse, as they are frequently either unaware of the existence of reports relating to a particular issue, or denied access to them.
There is a big practical problem which Originators should not ignore in relation to reporting. Reporting structures are not developed overnight and they require the establishment of an in-house infrastructure to manage the process. Someone has to design the reports, ensure that the relevant data can be extrapolated from the information made available, arrange publication, and if information is going to be made available only on a selective basis, carry out a verification exercise on the identity of the person requesting the data. If, on the other hand, reporting is to be web-based, the someone has to design and run a user friendly comprehensive web site.
What is perhaps a more serious problem is that at present there is very little commonality in the contents of the reports. Different Originators are all reporting slightly different things, and even when they do appear to be reporting the same things, the lack of standardised definitions often mean that in fact they are not.
For example, if you look at reports on the performance of residential mortgage pools, almost all quote the delinquency statistics and most do so by quoting delinquency figures for 0-30 days, 31-60 days, 61-90 days and 91+ days. You might think therefore that this is an area where there is already a degree of standardisation across that sector of the industry. But when you actually ask the companies involved how they calculated the delinquencies, you will find great diversity.
Some count delinquencies from the day a mortgage payment is overdue according to the terms of the particular underlying mortgage documentation. Others start the clock running only at the end of the month in which the payment was due. Some include in the delinquency figures only the principal amount of the loan that is delinquent, whilst others include all interest, and some others include penalties, costs and expenses. Some also operate a de minimis rule so that arrears of below a certain figure are ignored. So there is actually a huge diversity in how the reporting is currently being done, despite the fact that the originators are giving out the information in perfectly good faith. They quite simply do not have any industry standard to work from, so they have to draw up their own rules and definitions.
What is of serious concern is that in the vast majority of cases, the reports don't come accompanied by detailed definitions of what is meant by a particular term in the context of that report. It is therefore impossible for an analyst to know which of a myriad of possible definitions has actually been applied in a different case.
The task involved in standardizing reporting and definitions should not be underestimated. The European ABS market is very fragmented in comparison to the US and there are still relatively few "commoditised" deals which lend themselves to standardisation. There is no easy solution to this. The only way that progress will be made is to get investors and issuers in each asset class to co-operate with each other in agreeing common practices. This process is difficult, but there is no question that it is vital.
The big danger of reports being available before there is consistency, is that if investors have access to performance reports, they will inevitably make comparisons between different issuers. And if they believe they are comparing like with like, when in fact they are not, they could be seriously misled or simply confused.
A good example of this was quoted recently in relation to the Italian social security deal - INPS. When the Italian Treasury recently published the first report on its ?4.65 billion delinquent social security payments securitisation, investors interpreted the report to mean that the deal was drastically under-performing.2 This cause a flurry of dealing, with spreads widening by up to 20bp, before the Italian Treasury cleared up the confusion and reassured the market that this was unjustified. A report from Barclays Capital published on September 18th states that the "data was sufficiently vague to cause uncertainty in the marketplace. Depending on how the data was interpreted, the collections could have been viewed as being slightly behind schedule to being well behind schedule."
This is why I believe the acceptance by the industry of some standardised reporting principles and practices is one of the fundamental tasks of the next 12 months or so.
Creating Web-Enabled Accessibility
One way that the majority of these problems can be overcome is by using the internet as a tool for a pan-European standardised reporting mechanism.
If there is one central platform on which all European ABS and MBS transactions are reported, then many of the issues raised will fall away:-
- investors will have one central point for accessing post issuance performance data, instead of having to visit hundreds of different web-sites or track down correspondence or e mail addresses;
- the information is instantly available, allowing investment opportunities (or valuations of existing investments) to be evaluated swiftly;
- reports could be standardised across industry sectors, so that every issuer reports at least the same core information, using standard definitions; and
- because of the standardisation, originators need not fear that other originators are using definitions which might skew how their own performance looks in comparison.
This is the approach that absreports.com has chosen to take. We are creating a site which is intended to act as a repository for clear, comprehensive and standardised post issuance reporting data for the whole European ABS and MBS industry, whilst at the same time being a portal from which users can access the sites of the huge number of other web-sites containing important information either about a particular deal, or the industry generally. From one central point, investors should be able to access the web-sites of the Originators, Rating Agencies, Lead Managers etc and to access an electronic copy of the original offering document. In short, they should be able to access all of the information that they need to evaluate and price a security.
Everyone involved in this industry - whether on the issue side, the buy side or an advisor - has a vested interest in seeing the European market mature and flourish. Post issuance transaction reporting is an essential part of this process. I believe that if this can be achieved, then an active secondary market will be a reality for the first time in Europe and this will provide the impetus needed for the European market to truly come of age.
by: Nicola Davies, absreports.com, October 18, 2000
1. "Credit" Magazine, September, 2000
2. www.creditmag.com October 2000 News