White Paper

Unfreezing the Asset-Backed Securities Market 

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TYI, LLC (TYI) is offering a revolutionary information service for the structured finance market which will restore depth and liquidity across the approximately $20 trillion worldwide asset-backed securities (ABS) and collateralized debt obligations (CDO) marketplace.  The information service will do this by bringing transparency to the market.  Transparency means that sufficient information about the performance of the underlying collateral is known to all market participants so that risk can be adequately priced.   In the continued absence of actual performance data on which to value these securities, firms like Swiss Re are writing down their sub-prime mortgage backed securities to 62% of original purchase price and their CDO holdings to zero.  Clearly, the value of all structured finance securities, including sub-prime backed securities, is not zero but, in the absence of actual performance data, there is no obvious stopping point to the current security devaluation cycle. 


In August, 2007, a unit of PNB Paribas announced that, despite Wall Street’s implicit guarantee of a tradable quote, it was no longer able to price the sub-prime mortgage backed securities in its portfolio.  Subsequently, trading in the structured finance market seized up.  Why did the market seize up?  Buyers don’t want to buy and sellers don’t want to sell until they know what the securities they are trading are worth.


Why can’t buyers and sellers assess the value of the securities?  

·         First, structured finance is inherently complicated and this complexity makes the securities difficult to value.  Structured finance is complicated because the securities are designed to allow investors to purchase the risk exposure and return they would like.  For example, asset-backed securities (ABS) are securities backed by a specific pool of assets (like mortgages, credit card receivables and auto loans; collateralized debt obligations (CDOs) are ABS securities backed by, among other assets, buy-out loans and other ABS securities). Initially, it is anticipated that the assets in the pool will generate more cash flow than is needed to repay the securities they back.  Dividing up this anticipated cash flow is complicated and makes the securities appear opaque.  The cash flow is divided into pieces with a higher return paid to investors who assume a greater risk of loss of interest and principal if the assets don’t generate the expected cash flow.  The pieces are sold to investors based on the investor’s risk/return profile.  As a result, the lowest risk pieces are attractive to investment grade bond funds while the highest risk pieces are attractive to hedge funds.


·         Second, price is what a security can be sold for and value is what the underlying collateral is worth.  Based on Swiss Re’s current carrying value of 62% of original purchase price, prices have decline significantly on what Deutsche Bank estimates to be $3.3 trillion of securities backed by the riskiest types of mortgages (sub-prime, second mortgages and alt-A).  Feeding into this price decline, leading commercial and investment banks are engaged in a cycle of multi-billion dollar write-downs as, because there is no active trading in the securities, each bank has to match its competitors’ lower carrying price for these securities.  While it is obvious that the true value of all of these securities is not zero, so long as nobody knows what the value of the underlying collateral is, there is no obvious stopping point to the devaluation spiral.


How can the devaluation spiral be stopped?  Provide transparency into the actual performance of the underlying collateral so that buyers and sellers can value the collateral. It provides little meaningful information to the market to disclose the details of the inner workings of proprietary asset pricing models used by the portfolio managers and investment banking firms that structure and hold these securities. Instead, true transparency is achieved by collecting timely, detailed information on the repayment performance of the underlying assets at one central location.  This detailed data is then compiled into meaningful, standardized reports by a third party.  The results are made available over the Internet or through the existing market data services.  Anyone, investors or investment bankers or financial guarantors or analysts, could apply the analytics and pricing models of their choice to this objective data.  Rating services could perform an independent analysis based upon this data and incorporate it with the other information available to them to produce their published ratings.  

That transparency into the underlying collateral performance directly influences valuation, pricing and trading strategies was shown by Paulson & Co., a hedge fund that made billions of dollars shorting mortgage backed securities.  According to an article in Bloomberg, rather than depend on evaluations of mortgage- backed assets by rating companies such as Moody's Investors Service and Standard & Poor's, he and his staff dig into the securities and look at thousands of individual loans. ``Selecting individual securities in which to invest is highly complex and a virtual minefield for the uninitiated,'' Paulson & Co. wrote in its third-quarter report. ``Investors who rely on faulty agency `ratings,' Street research, or off-the- shelf models will invariably get burned.''

            Along with investors, issuers benefits from transparency.  By providing transparency on existing public and private deals, they attract investors for current and, more importantly, future deals.  In addition, they potentially receive higher ratings on their securities from the Rating Agencies.  In its September 2007 Special Report on Structured Finance, Moody’s Investor Services explained how transparency through a qualified third party would factor positively into its credit rating decisions.


TYI, LLC is offering an information service which has the capability of bringing collateral performance transparency to all corners of the structured finance market.  TYI is a Needham, MA based organization that has a patent portfolio covering the processes involved in collecting, standardizing and reporting on the individual asset level performance of securitized debt.


The information system underlying TYI’s service is designed to provide transparency into the performance of the collateral and does not replace any existing information systems used by issuers, servicers or trustees.


If all of the issuers, servicers and trustees work with TYI, transparency across most of the structured finance market could be accomplished in as little as two years with a significant percentage of the market covered in one year.  To reach these goals, TYI plans on working with all of the major consultants and information system vendors to the structured finance marketplace.


At a minimum, any information system that is going to bring transparency to the structured finance marketplace must have the following capabilities:

·         It has to be able to capture and filter on a daily basis the collateral performance data at the individual asset level.  This data can come from either the issuer’s, servicer’s or trustee’s accounting system.  The system has to be able to do this for all the different types of ABS collateral (including mortgages, auto loans and credit card receivables). 

·         The captured data must be standardized within each collateral type.  This allows investors to make comparisons across securities from the same and different issuers and it eases the burden on independent third parties when they build their analysis and pricing models.  The accounting steps to standardize each issuer’s data have to be reported. 

·         It has to analyze the data, create expanded performance reports and disseminate the performance information.

·         It must track the individual asset-backed securities in a manner that allows the performance data to be rolled up to show how a collateralized debt obligation (CDO) or structured investment vehicle (SIV) is performing.

Ultimately, the cost of transparency will be a part of the financing transaction.  In the short run, the sponsors and issuers of the financing will have to pay the expense. 


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