If anything, the shakeups and bankruptcies impacting securitization over the last few years have proven that - like everywhere else on Wall Street - anomalies can quickly become trends. Be it Enron Corp. or WorldCom in the
corporate world, or National Century and Spiegel Inc. in ABS - there seems to be a moment of collective stress when the sham houses begin to fall.
While fraud has certainly become one of the most troubling topics in asset-backeds, it has, by many accounts, been folded into a larger weakness, and considered a symptom (and a rather extreme one) of the practices and diverging views on contractually obligated duties and responsibilities versus presumed duties and responsibilities of the several parties to a securitization.
On a panel at last week's ABS West, Joseph Giordano of JPMorgan Trust Bank noted that over the last year, "Ripping the trustee was the topic du jour," who describes the problem as implied versus implicit duties.
Of course, last year and in late 2002, the trustee's role had come under serious fire during the aftermath of alleged fraud at NCFE, where several tens of millions of dollars were being transferred, sometimes day by day, back-and-forth between accounts monitored by two separate trustees. This was being done so that the deals would meet their minimum rating agency compliancy tests.
More recently, trustees have come under scrutiny for the roles they've played and actions they've taken during bankruptcy proceedings.
Early last year, a bankruptcy court allowed a servicing fee restructuring as part of CFN Investment Holdings' purchase of Conseco Finance's MH business and servicing platform. In March, CFN succeeded in moving the servicing fees from the bottom to the top of the waterfall, and increasing the fee from 50 basis points to 150 basis points, with
a scheduled 12-month step-down to 115 basis points.
Servicing fees are generally subordinated in the securitization waterfall, aligning the servicer's interests with the performance of the assets in the deal. The problem with Conseco, however, was that as it approached bankruptcy, its manufactured housing servicing platform had no prospects at profitability, making it a difficult asset to sell to a third party.
Some argue that in the Conseco situation, the trustee should have done more to protect bondholders, even if it were to lose money itself.
Other sources use the DVI Inc. bankruptcy as an example of bondholders being held hostage by the trustee. In this case, a servicing transfer has suffered through delays, in part because of legal proceeds, in which the deal's initial indemnification language will be modified to allow the trustee, or the servicer that will take on the servicing, more power.
"The trustee is supposed to be someone that is trusted by the investors and working in their interests. However, they seem to write their business as to lose no money in any deal,'" said one portfolio manager with a position in Conseco manufactured housing. "The first thing they did was lawyer up, and ask for a new and stronger indemnification language that wasn't in the original pooling and servicing agreement, to protect their own interests."
According to Joe Donovan of Credit Suisse First Boston, if a trustee is contractually obligated to step in as servicer, there should be no issue. To the extent that there is "wiggle room" in the documentation, this needs to be nullified going forward.
Regarding the Conseco situation, "If the trustee had been locked in ironclad to do the servicing, it wouldn't have been an issue.
But they were the first ones out the door."
"We're not paid enough is a good quick defense - but so what?" Donovan added. "Under this logic, trustees are overpaid for every transaction that doesn't get into trouble - 99.5% of the deals."
Offering up a different point of view is Alex Roever, head of ABS research at Banc One Capital Markets. "The trustee is not an insurance company," Roever said. "Each transaction stands on its own basis. If an investor is worried about that, they should buy a wrapped deal."
How will things improve?
"There's a greater degree of linkage between the fate of a company doing securitization and the fate of the securitization," said Mark Adelson during last week's opening session.
As for possible improvements in deal structures, from day one of a transaction, rating agencies may put more distance between the seller/servicer and the assets. In RMBS deals, at new issue, sometimes a third party is made the primary servicer, and the seller is made the secondary servicer.
"In some cases it may not be sufficient to structure with a backup servicer that takes over the servicing function upon bankruptcy," said Michael Kanef, a managing
director in the structured finance group of Moody's Investors Service. "A better structure might permit a backup servicer to take over servicing based upon financial covenants and pool performance statistics which trigger well before a seller/servicer bankruptcy. This could potentially avoid the delay of servicing transfer related to bankruptcy filing and might reduce uncertainty about the costs of servicing post-bankruptcy petition."
Ted Breck of Merrill Lynch noted that the servicers' replaceability, fee amount and priority are a greater focus in new deals nowadays, compared to a few years ago. "The first thing we address now is the backup servicer," Breck said during the opening panel.
Moody's Kanef has also pointed out that recent bankruptcy situations have set precedents as to how investors at different notches of the capital structure make out. In many instances, senior investors seem to fare all right, despite servicing fee re-arrangements.
"Certain of the recent deal experiences have also highlighted the importance of the powers of control parties after the bankruptcy of the seller/servicer," Kanef said. "If senior securitization bondholders have the unfettered ability to control negotiations with the bankrupt, agreements may be reached between the securitization bondholders and the bankrupt which protect the rights of senior securitization investors but not those of the mezzanine holders. While this may be an appropriate outcome, all securitization bondholders need to consider the way in which the control party provisions in structured documentation can impact their returns."
When sellers file for protection
While there have been several recent unsettling bankruptcies in asset-backeds (see accompanying chart), industry professionals are quick to point out that the court rulings - disappointing as they may be - have not challenged the basic tenet of securitization, which is the isolation and true sale of the assets.
"Bankruptcy regulation and bankruptcy law have the most potential for impacting our business, surpassing accounting," said CSFB's Donovan. "The key issue is that securitization is built around the concept that you can isolate the asset. Anything that goes against that basic tenet of securitization could dramatically impact securitization."
If you juxtaposed the LTV Steel challenges - where the ownership of assets was questioned - onto Conseco Finance, DVI Inc., or any other recent headline bankruptcy proceeding, the resolution would have more frightening potential. As disturbing as a court-ordered reorganized waterfall is, these situations have not questioned the true sale or legal isolation of the assets.
"Up until Enron, it was let's protect the lender,' " said one senior securitization banker. "Then it changed to Lenders have plenty of protection. Let's protect the borrower.' "
Indeed, in early 2001, pending bankruptcy reform - specifically an amendment to Section 541 - would have provided that an "eligible asset (or proceeds thereof)" would not (except in the case of fraudulent transfers) be property of the estate "to the extent that such eligible asset was transferred by the debtor, before the date of commencement of the case, to an eligible entity in connection with an asset-backed securitization," according to a piece contributed to ASR back then by attorney Edward Gainor, who is currently a partner at McKee Nelson.
Had this reform been passed, true sale challenges like those in LTV Steel would carry no weight.
During Information Manage- ment Network's ABS West 2002, word began to spread that a group of law professors were specifically targeting this provision with letters to lawmakers, aligning securitization structures directly to Enron.
In September 2002, Sen. Richard Durbin (D-Ill.) and Rep. William Delahunt (D-Mass.) proposed the Employee Abuse Prevention Act (S. 2798/H.R. 5221), which could have made true sale and asset isolation a virtual impossibility in a bankruptcy situation, for the protection of pension funds, among other things. Fortunately, these provisions were never passed.
Parts of this story were printed on site in ASR's Conference Daily at the recent ABS West show.
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