Moody's Investors Service will be publishing a series of reports that will detail its views on
how operational risks in ABS impact credit in different jurisdictions and geographic regions.
In a special comment published yesterday, the rating firm said that the performance of a securitization depends not only on the creditworthiness of the underlying pool of obligors (i.e., collateral risk) but also on the effective performance by the different parties including servicers, calculation agents, trustees, and cash managers (i.e., operational risk). The specific
details regarding that performance will be a lot different based on the specific legal and operational environments prevailing in each jurisdiction.
The new special comment also has a summary of recent examples of deals that have experienced credit deterioration as a result of operational risk, including deals involving Taylor Bean & Whitaker in the U.S, and DSB Bank N.V in Europe.
"Operational risk has received substantial attention recently as several transactions (some with well performing collateral) have experienced a substantial weakening of credit quality attributable primarily to non-performance of a securitization party," said Nicolas Weill, Moody's chief credit officer for the structured finance group.
Important operational risks and how they are different from region to region will be explored further in the upcoming report series. These include backup servicing, the role of the trustee, the cash manager, liquidity, trust accounts, and sponsor ratings.
In terms of backup servicing, many deals from lower-rated sponsors have a backup servicer. In light of recent events, the rating agency thinks some sponsors might require a higher backup servicing standard to further insulate investors from servicing risk.
When it comes to the role of the trustee, transactions from the EMEA region are different from the U.S. in that the trustee is generally not responsible for servicing or finding a replacement servicer. This is why there is a heightened need for committed backup agents in EMEA ABS.
For cash managers in EMEA, they responsible for preparing servicing reports and offering instructions for paying agents. These managers can either be the servicer or an unrelated party to the servicer, and the trustee does not serve as a backup cash manager. Backup cash managers appointed at closing or upon triggers might be needed to lessen the risk of a deal suffering a payment default from lack of a cash manager in EMEA.
In terms of liquidity, when an event of a servicing disruption occurs, cash flow from the underlying assets might drop considerably since the collateral depends on a number of factors such as the credit strength of the sponsor, asset type, and ease of deterioration, automatic stay in bankruptcy, or servicing transfer. Cash available to meet interest expenses for notes is an important feature that reduces the likelihood of an interest payment default.
For trust accounts, considering the developments in Ocala, the rating agency will take a second look at its trust account benchmarks and re-evaluate their appropriateness for various deal structures and rating levels.
Moodys asks the question: Are high ratings possible for all sponsors? Transactions with enough replacement servicing or cash management arrangements might still not be able to have the highest ratings. For instance, transactions sponsored by originators in asset classes with a high degree of volatility and a history of linkages to the originator/servicer, might have a hard time achieving high ratings because of the lack of certainty in projecting performance, specifically in cases of originator distress.
"We will be publishing this series of reports on operational risk over the next few months," Weill said. "Meanwhile, we will continue to monitor transactions for exposure to operational risks and take rating actions on transactions we believe are most vulnerable to such risks."
The new report called Operational Risks in Securitizations to be Revisited can be found on the rating agency's Web site, moodys.com. Additionally, the firm publishes a weekly summary of structured finance credit, ratings and methodologies.