The Depository Trust & Clearing Corporation (DTCC) has proposed further automating the processing of the structured securities market in a new white paper issued today.
This would save the industry millions of dollars and help reduce manually intensive and error-prone procedures.
The paper, entitled "Transforming Structured Securities," calls for substantial cost and time savings by reducing the number of late principal and interest rates (P&I) each month and the number of adjustments that must be made after an incorrect P&I payment is made. DTCC, through its subsidiary, The Depository Trust Company (DTC), processed close to $1 trillion in P&I payments for structured securities in 2006.
Structured securities include collateralized mortgage obligations (CMOs) and asset-backed securities (ABS). CMOs are bonds backed by pools of mortgage loans and issued by various organizations, including Fannie Mae, Freddie Mac, investment banks and insurance companies. ABS are structured bonds or notes backed by loan payments or accounts receivable such as credit cards or auto loans.
Increasing costs
"As a major custody participant we are negatively impacted by the issues related to the P&I payments processing for CMO and ABS issues," said an executive from one of the largest investment banks processing structured securities. Because of these problems, he said his firm annually:
- Responds to more than 6,000 client inquiries regarding late allocations and post-payable adjustments.
- Manages more than 9,000 adjusted payments due to post-payable adjustments.
- Incurs increased processing fees.
- Devotes an increasing amount of time to inform customers on these processing issues in order to manage client expectations.
He estimated that his firm alone spends approximately $300,000 each year to handle these processing problems.
New initiativesIn the white paper, DTCC has proposed four new initiatives to further automate structured securities processing:
- Extend the deadline for submission of payment information on structured securities.
- Categorize DTC-eligible structured securities into two classessses - conforming and non-conforming.
- Charge an "exception processing fee" for those securities that fall in the non-conforming category.
- Distribute a new "paying agent report card" to the industry that will track the performance of the largest paying agents.
"Even with the current problems in the sub-prime mortgage market and the structured securities market in general, CMOs and ABS continue to show rapid growth among both domestic and global investors," said James Balbo, managing director for Asset Services, DTCC. "The average monthly distribution of principal and interest for these securities by DTCC's depository grew to $65.1 billion in 2006, up 27% from $51.4 billion in 2005."
With this growth, however, come increased processing challenges because of the many different parties that add or forward information on structured security deals. Thousands of these information exchanges fail to be handled in an accurate and timely manner each year, and late and inaccurate notifications of payment rates for these issues continue to pose a major challenge for the industry.
DTCC developed the paper in collaboration with a working group of industry professionals. It states that there is an "overall lack of consistent, industry-wide awareness of the magnitude and severity of structured securities principal and interest processing problems" and that there is "disproportionate displeasure and frustration felt by certain parties" involved in structured securities.
Financial lossesAccording to the paper, it is the broker/dealers, custodians and institutional and retail beneficial owners that suffer losses because of the problems in the processing chain. Late rates result in monies not being allocated to beneficial owners on a timely basis, creating inefficiencies in their cash management as well as increased processing costs for DTC customers. Incorrect rates result in post-payable adjustments causing incremental processing costs, inefficient cash management and write-offs. Issuers and underwriters, on the other hand, do not experience the same processing problems or losses since they originate the securities themselves.
In addition to shortening the deadline for receiving rate information to one business day prior to payable date - currently it's a minimum of two business days - and extending the 7:00 p.m. cutoff to 11:30 p.m., the paper calls for the categorization of two classes of structured securities: conforming and non-conforming. Conforming securities are those whose structures permit their paying agents to meet the new deadlines for reporting rates. Non-conforming are those that, because of their structure, are unlikely to ever allow paying agents to report rate information on time.
Underwriters of non-conforming issues will be assessed the "exception processing fee" to cover the costs created by the non-conforming issues. The new fee is subject to approval of DTC's Board of Directors and the Securities and Exchange Commission.
The industry group believes that this fee should be added on as a new underwriting fee since it is the underwriter community - and not others in the processing chain - that create the non-conforming issues. These monies would be rebated annually to DTC holders of structured securities - pro rated based on the number of structured securities principal and interest payments - to compensate for their added processing costs, said Peter Gleeson, DTCC vice president for Asset Services. DTCC estimates that the exception processing fee for 2008 will be $4,200 per CUSIP.
The new report card will track the performance of paying agents - by name - including timeliness and accuracy of payments and will be distributed throughout the industry as well as posted on the DTCC Web site.
The paper was written by representatives from DTCC, major banks, financial services firms, the Securities Industry and Financial Markets Association (SIFMA), and the American Securitization Forum (ASF). It can be accessed on the DTCC Web site "Thought Leadership."