Orlando, Fla - Practices for assembling and implementing quality control on home equity loan pools are shifting dramatically on Wall Street, putting more onus on investors - and dealers sometimes - to do more due diligence on the ABS pools that they are interested in buying.
Differences in ABS pool characteristics, such as liquidity, often vary between dealers, shelves and even series from the same shelf, said dealers and investors who spoke at a late-morning session at the Information Management Network's ABS East conference last week. Yet, the speakers stopped short of calling for formal controls on pool quality.
"A lot of the quality control that goes into these deals is very different," said Nunzio Masone, a senior managing director at Aladdin Capital Management. "We take the approach of being selective on a regular basis."
Despite some concerns about quality in some of the newer pools, there is plenty of value in the ABS/RMBS market said some professionals, and that value does not all come from CDOs bids, said Sean Kirk, a trader at United Capital Markets. There are potentially substantial payoffs for those who take the trouble of understanding the nuances of portfolios dating back to 2003 and 2004, and who are not afraid to go after bonds which do not carry a rating from Moody's Investors Service.
"I like to get as far away from the CDO bid as possible," Kirk said. "The CDO bid has driven a lot of what we've seen in the subordinate and distressed sector." Bonds rated Ba1,' or Baa3' by Moody's will sometimes price 200 to 400 basis points higher than similarly rated paper from Standard & Poor's or Fitch Ratings. The best areas to be involved in are 2003 and 2004 portfolios, which get passed over by investors who go after 2005 and 2006 deals to reference CDO transactions.
"It takes a lot more work, a lot more structuring familiarity to understand what happens to the bonds once [they] get more seasoned," Kirk said. "Generally, I've found that it has worked out."
Panelists also debated the usefulness of rating agency triggers for spotting troublesome events in deals and adjusting their pricing accordingly. Some ABS bonds, which had significant reductions in credit enhancement when they passed rating agency triggers, would not have failed if the triggers were set differently, said Alex Wei, head of structured credit investment and chief quantitative analyst at Delaware Investments.
If a bond passes its triggers, then some of the credit enhancement would go away, which means that O/C could be released to the residual and also some of the subordinated bonds could get principal reductions of amortization before the senior bonds do. In theory, a trigger failure launches a deal into a countdown scenario where the lower bonds get paid later. In reality, Wei noted, sometimes the lower bonds get paid out earlier and some of the higher bonds take losses.
"It is very much like a redistribution of economics," Wei said. Despite the fact that triggers play such a big role in the economics of a deal, not all rating methodologies account for the possibility that the trigger event might pass and that some bonds could withstand losses.
Offering the opposite point of view, Aladdin's Masone said he doubted whether it was appropriate to adjust rating agency triggers for scenarios where half of ABS bonds could pass or fail the triggers. It is better for market dynamics to determine what the right spread should be on an ongoing cash flow market and use the synthetic market to reference that if they feel there is an arbitrage.
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