Some ABS pros are predicting a small wave of seller/servicer disruptions resulting from the increased financial disclosure environment and the personal liability written into the Sarbanes-Oxley Act of 2002.
The fear is that public specialty finance companies with niche-like servicing exposures, such as residual devaluation, may be prompted to disclose what otherwise might have been swept under the rug. The resulting impairment charges, in turn, could spur investor lawsuits and/or breaches of warehouse covenants, particularly should stock prices tumble.
A source pointed to the lawsuits that followed Comerica Inc.'s announcement in October that it would take a $213 million after-tax charge associated to "incremental provisions for credit losses," among other things. While this has little to do specifically with securitization, similar impairments could start showing up in this industry as well, perhaps inciting the same sort of lawsuits, such that arbitrators allege that these companies have violated securities laws by issuing misleading statements to investors.
Similar in nature to Comerica's impairment charge, MicroFinancial Inc., an issuer of micro-ticket equipment ABS, indicated in its third quarter earnings report dated Oct. 30, that it would include a $35 million increase in allowance against past due accounts. MFI increased its provisions to 104% coverage from the 50% to 60% range previously used.
"If you run through all the independent finance companies, can you be looking at a situation of bad reporting and consider it to be a financial disclosure issue on the fundamental corporate side," the source asked.
MicroFinancial breached its warehouse facility covenants, and is the process of restructuring its revolving debt into a three-year term loan. A share of MicroFinancial, currently trading at about $1.50, was trading between $4 and $5 as recently as late September. The company announced on Oct. 11 that it would pair down its origination effort as a result of difficulty raising funds. Ambac insures most of MFI's ABS.
"This is more of an issue for companies with share values trading well below book value, which may have been less inclined to take impairments charges in the past that could related to marking-to-market," said one source at a boutique.
"Remember that if we're talking about the penny ante servicers, it's not going to be in the major asset classes," said Mark Adelson, head of ABS research at Nomura Securities, noting that there was a shakedown for securitizers of home-equity and subprime auto loans in mid-to-late 1990s. "In home equity, we shook out a lot of the accounting shenanigans a few years ago. So I don't think there's as many skeletons in the closet."
Separately, the American Securitization Forum, the Bond Market Association and its contributing members are lobbying for Sarbanes-Oxley to allow dual certification in publicly filed securitization trusts, said Anna Glick of Cadwalader, Wickersham & Taft.
The problem for securitization is that no one party is in a position to certify the two primary post-closing functions: the collection and reporting on the assets and the direction of the cashflow to investors. If all goes as the industry proposes, the servicer would be allowed to certify the collections aspect of a deal, while the trustee would be allowed to certify trust cashflows paid out to investors.
Also, the industry is hoping that some sort of grandfathering will be written into the regulations for existing securitizations.