To any reader of military history the following adage is very familiar: the military always prepares to fight the last war. One could say that this adage applies equally well to the SEC proposals. The more one plows through them the more one is struck by how its formulation of the problems, and thus the solutions proposed, have been dictated by the specific character of the 2007-09 RMBS collapse. For instance, it is received wisdom that at the root of the collapse was the deteriorating underwriting standards of originators. The SEC appears to believe that this deterioration might have been revealed earlier had there been adequate asset-level disclosure. Accordingly, it proposes to make mandatory in any public issue and for all asset classes (other than credit cards, for which certain groupings are contemplated) certain very specific disclosure points.
As we have seen previously, in formulating its proposals, the SEC has not adequately taken into account the fact that the RMBS market was unique in various ways. First, as discussed in an earlier blog piece, it made almost unique use of the originate-to-distribute model. RMBS was also typified by very complex structuring of securities with multiple tranches which, in many cases, were completely distributed. As a result, small changes in pool performance could have major impacts on those specific narrowly-tailored securities. Products involving mortgage loans also involved many fewer discrete assets of a much larger per-asset size than transactions involving most other asset classes. Finally, mortgage assets are subject to refinancing risk and involve protracted liquidation.
In contrast, assets such as vehicle ABS are homogenous, short term, not particularly interest rate sensitive, generally not subject to financing risk and are liquidated quickly. Pools typically contain many more assets than would a RMBS pool. The securities involved are much simpler and less structured and the tranches are ‘thicker’ than RMBS and much less sensitive to changes in pool performance. It is rare for these structures to be tranched and distributed beyond the mid-to-high investment grade level. The more senior the investor, the less it is subject to the types of risks that require asset-level data to properly assess.
Perhaps most importantly, there has been no evidence that there was deteriorating underwriting standards in other sectors. This is probably because of the fact that originators had always kept more “skin in the game”, as discussed in our earlier blog piece, than RMBS originators. Any increase in obligor defaults in these other sectors have been more attributable to general economic downturn and, even at the height of the recession, were not of such a magnitude as to threaten default in respect of offered securities.
For a detailed review of the problems which the application of rigid asset-level disclosure would cause for other sectors see the comment letter submitted on August 2, 2010 by U.S. auto finance companies and posted on EDGAR. Some of their more salient concerns are as follows:
- The credit models applied by finance companies are proprietary and competitively sensitive and there is significant risk that the required disclosure could be reverse engineered by competitors.
- Disclosure of asset-level data could pose significant threats to consumer privacy and the originators’ related legal obligations.
- The burden placed on issuers would be extraordinary given the number of loans in the usual vehicle ABS transaction (approximately 50,000). Producing the stipulated 59 or 61 required data points would mean producing approximately 3 million separate bits of information. (For a floor plan transaction this could be as much as 13.6 million data points.) By contrast, a typical RBMS offering would include 3,317 loans and require 534,037 data points.
- .The data points are mandatory yet many of them are simply not applicable outside of RMBS.
It is feared that the requirement to provide asset-level data may deter securitizations, restrict capital formation and eliminate market access for some issuers without supporting meaningful additional due diligence by investors or otherwise providing a benefit to investors.