Spirits were as low as the turnout on the first day of the 14th annual Information Management Network ABS East conference in Hollywood, Florida last week.
Instead of the usual wheeling and dealing, conference goers were more focused on valuing their positions, given the relentlessly bleak economic outlook.
One of the main concerns among panelists was the growing breadth of loan modifications, especially in light of the recent government bailout plan and foreclosure-prevention proposals from both presidential nominees.
While all panelists agreed that loan modifications were a necessary step for system-wide economic recovery, "there will be tremendous repercussions for the capital structure," a panelist said.
Panelists were primarily worried about the opacity of the loan modification data. Trustees all have different methods of reporting loan modification information, which makes it hard to analyze, panelists agreed. There is also a lack of uniformity in how loan modifications manifest themselves in the capital structure, which has created uncertainty regarding how they are to be factored into valuation models.
While the market works toward addressing these concerns, loan modifications continue to rise, and most of the current talk is between investors in the capital structure, who are debating - and objecting - to where modifications should hit on a deal's cash flow, a panelist said.
All of this uncertainty adds to the current opacity in pricing assets, another panelist noted, which has made the sector virtually illiquid.
A Rock and a Hard Place
Nonetheless, modifications are critical to stem the rising tide of delinquencies in the MBS market.
Principal forgiveness is currently the most effective loan modification plan, several panelists agreed. "The only way to keep re-default down is to write down the principal," a panelist said. Though rare, another speaker on the same panel said that he had seen as much as 80% of a loan modified.
However, most critical to preventing default is "picking the right guy to modify," a panelist said. To prevent a re-default after a loan modification, selecting the appropriate borrowers to modify is critical, no matter what loan modification plan is used, he said.
Also critical in assessing risk is an increased focus on the broader macro-economic factors. While almost every analytical and data-focused panel last Sunday agreed that increased loan level data was imperative for the due diligence process - looking at the asset type, the borrower characteristics and, most importantly, the geographic region - the big picture is increasingly important in assessing performance and determining a change of payout in a capital structure. "Drilling down doesn't get you anything on macro-economic assumptions," one panelist said.
Indeed, given the unstable broader economic conditions and the impact they will have on servicers - i.e. the unemployment rate and concerns regarding bankruptcy laws that might induce "cram downs" - it is hard to determine the depth of potential losses that might impact a loan or a pool of securities.
While panelists and audience members agreed that transparency was especially helpful in aiding a market recovery, and commended programs like the American Securitization Forum's Project RESTART, an initiative to increase RMBS and ABS transparency and liquidity, they also agreed that credit analysis is the most important. "Transparency and disclosure is not the bulk of why we are here," a panelist said.
"Corners were cut at every level of the process," another panelist said. "You can blame the model, but if you drive a car at 180 miles per hour, whose fault is that?" a speaker on the same panel said.
Slowing Down the Pace
The tone of the conference was not all dire. While downgrades and defaults will continue to pummel the market, September data showed that subprime and Alt-A foreclosures might be leveling off. While several panelists expected delinquencies of over 50% on a fair number of subprime pools, a few of them agreed that the rate of those delinquencies might be starting to slow.
Interestingly, in regions like the Northeast, which has not been a hot zone for rising defaults, the numbers have doubled in severity, according to another panelist, a sign of the increasingly harsh broad economic conditions.
However, prepayment problems still remain most severe where home price appreciation was strongest over the last few years - areas like Florida, Arizona and California. This makes it critical for market participants to segment their loan level data by geography as well as type of loan, agency or non-agency, etc.
As for the riskiest types of assets on investors' books, option arms remain the "deadliest product," according to one panelist. "This will likely burn investors the most."
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