Mark Kahn is an executive vice president at Principia Partners – a provider of operational software for the management of structured finance portfolios. In the latest installment of In This Corner, Kahn talks about dramatic shifts in both the landscape and scope of his business, which is leading us down the path of innovation.
HousingWire: Your technologies played a significant role in the management of SIVs and other off-balance sheet vehicles and also enabled many to have the flexibility to restructure their operations when the market changed so dramatically. What developments have been made to Principia’s structured finance platform in the last year to address the issues the broader market faces today?
Mark: We provide the infrastructure for managers of structured finance portfolios, helping them gain control over and an understanding of their ABS, MBS and CDO positions. Prior to and throughout the credit events over the last 24 months, some of these institutions were managing these investments within the confines of Structured Investment Vehicles (SIVs) and off balance sheet structured finance conduits. As “AAA” rated entities, SIVs were required to demonstrate strict operational and procedural controls. But long before the growth of SIVs, we also provided the platform to asset managers and to on-balance sheet credit investment managers. Portfolio management, risk oversight and accounting operations have always been critical to such entities and forward looking institutions focused on having the right procedures and systems in place from the start. My view is that these are the players that will be best prepared to tackle the challenges the market faces going forward.
Our development focus is to continuously build out the depth and breadth of the platform, centred on the requirements of structured finance participants. That is where we see the unique challenges and where we have the expertise. The marketplace has demonstrated quite clearly that it is no longer acceptable to attempt to manage these assets without the right business operating guidelines and systems. Transparency is increasingly critical at every level – from the loan level detail of the underlying collateral, through to the methodology used for asset surveillance and accounting. We have worked to help standardize investor and securities reporting for the users of the platform and to deliver a consistent means by which to integrate and present deal and valuation data from multiple data sources. The latest releases deliver an operating infrastructure to support the end-to-end management and administration of our client’s portfolios. It does this in a single environment that also satisfies the need for independent valuations and drill-down into the performance of assets for on-going risk surveillance and disclosure.
HW: I hear you have had interest from new clients, such as distressed asset investors and the like. In the future, will Principia expand beyond the structured finance universe…and what can you tell us about this recent interest and how it relates to the market?
Mark: We are seeing increasing levels interest from fund managers and new structured finance participants who see good opportunities in the market now. In addition, long time market participants looking for ways to gain greater control and integration of risk management across their organizations are expressing interest as well. Asset managers and distressed buyers appear to be at the forefront of a valuation recovery – the US TALF program and the upcoming PPIP program are bringing many of these players off the sidelines. As spreads continue to normalize we believe the more traditional managers will return to the market. This would encompass investment managers such as pension funds, insurance companies and on-balance sheet credit investors.
From Principia’s point of view it makes sense to stay focused on the structured finance market. No matter what type of investor, structured finance operating challenges can best be addressed by dedicated solutions providers with a history and understanding of the industry. There has been an increase in the number of loan level data providers. Firms such as Lewtan, Markit, ABSXchange and Intex have all focused on expanding their asset coverage and the quality of their cashflow models. Trustees and servicers are improving access to detailed structured finance data to support investment decision making. Our objective is to provide a system that helps portfolio managers bring this data together in a consistent way so they can meet the compliance, control, risk management and accounting requirements of their business. Investment managers are realizing that spreadsheets, internal builds and treasury management systems are not sufficient for the unique aspects of structured finance. Investor and regulatory pressure will challenge everyone in this regard.
HW: There has been a lot of debate about the clarity of MBS issuer data in the US and in Europe. What are the main challenges and solutions to those problems?
Mark: Many segments of the industry have been focusing on data standardization and transparency, across the MBS market in particular. Project RESTART from the American Securitization Forum and the proposed issuer reporting guidelines from the European Securitization Forum will provide much greater standardization in investor reporting. The US and Europe have somewhat different challenges. The US is a bigger and more mature market; underlying loan level data is generally available, although often provided in different formats. The detail is there but is still difficult for investors to digest it all on a timely basis. In Europe, data provision is less consistent and more highly fragmented. The ESF is doing a lot to try to improve standardization, pushing its RMBS Issuer Principles for Transparency and Disclosure to bring in some level of consistency. Recent reports suggested at least 12 banks - running 17 different mortgage bond issuing trusts - are ready to comply with those standards, and the rating agencies have agreed to a common reporting template. We will see more bodies in Europe mandating the adoption of these guidelines. The UK Treasury and the FSA have endorsed the principles and other countries are looking to implement them. Prior to the crisis, the depth of issuer data on the underlying loans in Europe was sparse. One report recently mentioned that less than five issuers provided the drill down information that is now recognized as essential.
As foundations for good origination practices are put in place, data providers will have greater coverage and be able to build the cashflow structures and models that investors demand. These can then be brought together with operating systems to gain a single way of looking at portfolios - within a robust and controlled operational and risk oversight environment. This will be particularly important in Europe as it is much more of a risk to rely solely on a single data source. Different countries look at mortgage pools in different ways. The Loan to Value ratio or delinquency information can be described and presented in a variety of formats depending on the country you are in. It is important to be able to access the delinquency and default information and the stratification of the collateral so managers can easily view their exposures on a macro portfolio basis.
HW: We met at a structured finance conference back in September 2007. In fact, I overheard you say that the market disruption showed potential to big and perhaps greater than anything we have ever seen before. Turns out, you were heading more in the right direction than most of the other attendees who were pushing rosier outlooks. Now that EVERYTHING has changed, has your outlook?
Mark: The last two years have challenged market participants beyond almost anyone’s expectations. External economic factors, such as housing prices, continue to cause disruption. As the economics underlying good securitization practices normalize, our industry will continue on its path of innovation. In the end it is all about confidence, the availability of liquidity and valuations, good lending criteria and the impact of regulation. The proposed Basel II securitization framework lays down much more stringent ground rules about what participants will be able to invest in and the capital charges associated with those assets. The possible move to countercyclical capital charges and how that functions alongside changes to international accounting rules also needs clarity. It will be interesting to see how this evolves, and it is encouraging to see the US taking the steps to build a model which is consistent with international accounting practices.
The commitment shown globally by market participants gives me confidence that the right practices are being deployed for a market recovery. The fundamentals must be addressed within a properly regulated framework. It is also very important that the core incentives for investors, issuers, trustees, servicers and service providers are properly established and aligned across the industry. While steps are being made to address these issues we remain cautiously optimistic.