There is an abundance of "street" research providing delinquency and loss performance for manufactured housing and home equity issuers. The data tracks levels of 30 and 60-day delinquencies, current losses and cumulative losses with a focus on whether the respective triggers are passing or failing. These "triggers" have important implications for the ultimate principal payout as a pro-rata or sequential structure, with further implication on the timing of return of principal and yield (prepayment and extension scenarios). However, investors who rely on this information as an indicator of actual deal performance are missing a critical element of future default trends.
Deal performance can only be properly assessed through a careful examination of the servicing reports, an exercise which Structured Finance Advisors, Inc. ("SFA") performs on a monthly basis for its clients. SFA has determined that a leading indicator of defaults is contained in two additional measures: the amount of repo inventory and level of servicer advancing. Taken together these two measures provide a barometer of pending defaults.
There are two significant features in manufactured housing and home-equity structures which are important to recognize. First, losses are generally reported at the time that a property or unit is ultimately disposed, not after a set period of delinquency. The lack of a defined write-off policy enables the reporting of losses to be delayed. Second, servicers are required to advance payments on delinquent or defaulted receivables deemed by the servicer to be ultimately collectible. Servicing advances are thus at the discretion of the servicer, allowing the servicer to inject liquidity into a transaction which otherwise would not be supported from cash flow on the underlying assets. This can be an issue to the extent that the level of servicing advancing grows to a significant amount of monthly cash flow.
SFA has identified several potential concerns. Since both servicing advancing and write-offs are at the servicer's discretion, issuers could be managing the timing of defaults in order to remain in compliance with loss trigger levels or to present a desired level of defaults. The categorization of severe delinquencies (including real-estate owned and foreclosures) varies substantially among transactions resulting in inconsistency or, in a worst case, a complete disconnect in tracking various parameters in comparison to the trigger levels. For example, repossessed inventory may not be reflected in either of the delinquency or loss trigger measures. Another concern is that a transaction may be reporting excess spread, generally understood to be excess cash flow available to cover losses, in cases where there would be no excess spread if not for the level of servicing advancing. Finally, there is concern as to the long-term ability of servicers to continue advancing, particularly those who are themselves financially strapped. This concern points to the long-standing debate as to whether the credit risk of servicers can truly be separated from the bankruptcy-remote issuer.
SFA questions whether most investors have the information required to properly analyze transaction performance on an ongoing basis and whether the nuances of the reporting definitions are well understood. Have investors obtained final copies of the underlying trust document and are they receiving monthly servicing statements? Does the investor have direct access to the issuer? Furthermore, SFA is concerned as to whether intermediaries and rating agencies appreciate the implications of the servicing advance mechanism and the resulting effect on ultimate transaction performance.
