As any attendee at either of this year's fall conferences would confirm, the asset-backed market has gone through several loud changes in the past year - facing tests hardly anticipated, such as regulatory risk, accounting uncertainty, fraud, terrorism and more.
Meanwhile, a subtler but equally important realization has trickled into the market: Investors can no longer rely on structure to fully mitigate credit risk, management risk and sub-par underwriting. In fact, were this any other year, issuer integrity would be public enemy No. 1.
At Strategic Research Institute's ABS Industry Summit, several panelists argued that the credit of the issuer has become increasingly more important, perhaps as relevant as the transaction's structure, when investors are considering what to buy and what to avoid.
"The old story for ABS was: Here's the collateral and here's the structure; don't really worry about the issuer.' That story is now dead. The market appreciates the impact of the issuer on a deal," pens Nomura Securities researcher Mark Adelson in his assessment of market sentiment.
In some cases, panelists said, investors are doing background checks on the issuer's management.
"Ten years ago, suggesting analyzing the credit of a seller/servicer was like saying wood floats upstream,'" said State Street Global Markets managing director Nelson Russell, the panel's moderator.
The blowups experienced in certain sectors as well as issuer-specific headlines in core-holding sectors show that "you can't structure for fraud," commented Jim Gelwicks, managing director at Artemis LLC. "You can not make enough money on one deal, if fraud will lead to a blowup," he added.
Donna Ennis, a vice president at Mutual of Omaha - and a former credit analyst - said she always looks at the financials and cash flows of issuers when she considers investing. In addition, she conducts background checks on managers within the company, and in the past has found securities fraud convictions, as well as both corporate and personal bankruptcies.
In one case, Ennis had an issuer remove an employee of 10 years (who had a spotless record with the company) from the servicing operations of a deal that was pitched due to a 20-year old conviction for bank fraud. The employee was removed, and Mutual of Omaha bought bonds in the transaction.
"If you are in a situation where the numbers seem to work out, but you have questions about the integrity of management, it is better to walk away," added Artemis' Gelwicks. He added that it is important to look all the way up to the parent company level, noting the Japan Leasing's failure led to the cross default of its U.S. unit, due to corporate-guaranteed debt.
Also, as has always been the case, it is more important to look at the servicer's underwriting and reporting procedures. Chris Bianucci, a partner at Ernst & Young, stressed taking into account varying policies among issuers regarding delinquencies and chargeoffs. In particular, it's important to know the nuts and bolts of each servicer's performance indicators.