Fitch on the Money About Standardized Definitions for CLO’s

Late this week, Fitch Ratings issued a short statement arguing that more standardization of both defined terms and structural components would have a meaningful impact on drawing more investors into the CLO asset class.

The logic is straight forward.  They rightly point out that throughout the life of the CLO market, each deal has been written in its own code” and with very specific structural components.  The intent has been to customize each transaction to the needs of the initial holders (and the asset manager).  We would argue that definitions for key terms in CLO structures are typically “reverse-engineered” to meet the needs of the structure.  As a result, investors are left to study each transaction very closely, as they cannot take any terms that may seem similar or even the same, from deal to deal, to actually carry the same meanings.  Fitch  points out that this makes for an inefficient market and their recent survey of CLO investors seems to indicate that this lack of consistency is putting a damper on investor participation.

We would agree completely with the idea of trying to establish some consistency in the definitions for several key terms that can be found in most or all CLO agreements.  We are less sure about the idea of trying to bring more consistency to structures.  In our view, one of the reasons that CLO’s are attractive to issuers and investors is the ability to customize each structure to meet the mutual objectives of sellers and buyers.

We can look back at the development of several other securitization structures over the years including RMBS, CMBS and several classes of ABS and point out that over time these structures did benefit from an increasingly consistent use of key terms and definitions.  We would point out that these benefits did not accrue only to the investors, as firms developing analytical software for collateral testing, bond trustees and of course, the rating agencies themselves, all benefited from more consistency and standardization of key terms in these other structures.

Given the relative “boom” in CLO issuance during the first half of 2012, Fitch’s commentary is well-timed.  Perhaps the American Securitization Forum can get behind such an initiative and begin to pound out some useful standards for defined terms for CLO agreements.

MERS Settlement with Delaware AG: Score One for Securitization

You may remember all the hub-bub last year about the culpability of the electronic mortgage registry, MERS, in the residential mortgage securitization “fraud” that had been perpetrated on the market by unscrupulous Wall Street bankers.  Those “in the know” told us that these bankers had schemed to cook-up an organization like MERS just so they could pump and dump  more mortgages into their shady mortgage-backed bond businesses.  You may remember that the conspiracy theorists were out in force suggesting that there was no other explanation for the formation of MERS and now that the market had collapsed, it was standing there in “plain sight” for everyone to see.  The New York State (Schneiderman) and Delaware State (Biden) Attorneys General jumped into the pool as well launching vicious attacks on MERS and anyone else standing close by.  They pledged to prove that the MERS system and, in fact, securitization itself were nothing more than a scam.

Well wouldn’t you know it, last week MERS announced that they had reached a settlement with the Delaware AG.  Did MERS fall on its sword, you may ask?  On the contrary, when you look at the terms of the settlement, which consists of series of agreed upon reporting mechanisms (many of which were/are already in place), it can only look like a slam dunk for MERS and the industry.

Dig a little bit through a description of the settlement and the conclusion you will reach is that this is yet another example of government officials getting in over their heads when it came to understanding how securitization works and how it actually benefits the markets.  We have said it before, there is no way that our elected and appointed officials could have gotten up the curve on the complexities of the structured finance markets in the short time that so many professed to become experts.  Completely understanding how MERS operates, why it was formed and how securitization works and benefits the markets and the economy simply cannot be learned in a few months, in some cases even years.  Nevertheless, we have had a rash of new legislation and high-profile litigation aimed at a market that few, if any, of the antagonists really understand, even to this day.  Securitization is not voodoo but it does take sometime to understand.

If only these officials had taken the time to learn a bit more about what they were railing against before they sicked the dogs on MERS or penned some of those sections related to securitization in Dodd-Frank.