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Topic of the month:
How to prevent another
Heilig Meyers
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More on ABS default cases
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Adam Tempkin writing for the Investment Dealers Digest of 30th July talked about the several "body blows" the ABS industry faced in the recent few months: the LTV controversy to start with, and then, the refusal by Lexington Insurance to pay for the investors in Hollywood Funding, and last but not the least, the plight of the investors in Heilig-Meyers furniture bonds.
On this site, we have talked about LTV Corp's legal controversy, as also about Lexington's refusal and the downgrades of Hollywood Funding.
Heilig-Meyers is a Virginia, USA based furniture seller that securitised furniture instalment sale receivables in 1998, and filed for bankruptcy in August 2000. The 1998 securitization consisted of two classes - Class A and Class B which were then rated AAA and A respectively. Simultaneous with the bankruptcy petition, the originator also sought to resign from its position as a servicer. First Union, which was a trustee under the deal, filed a legal suit against the originator seeking to restrain it from giving up the servicing, and in the settlement that was reached, , OSI Portfolio Services was appointed as a backup servicer.
The instalment sale customers of Heilig Meyers were paying their instalments at the stores of the vendor, but as the originator decided to close down virtually all of the stores, it created an additional issue of the logistics of collection.
When OSI Portfolio took over as a backup servicer, it discovered to its shock that a substantial number of instalment contracts had addresses which were not traceable (13.4%) and a larger number had phone nos which were bad (22.29%).
Owing to these problems, the rating of Class A was downgraded by S&P from AAA to BB- and thereafter to CCC. Class B was downgraded from A to CCC, and thereafter to CC.
The case gives rise to several issues.
Structured finance is based on the edifice that originator performance can be divested from the pool performance and that the pool can stand on its own. Does the Heilig Meyers case put a question mark here?
Is the Heilig Meyers case unique by itself, or does it represent a larger sample? Of course, originators do go bankrupt, and they will go bankrupt in future. What is it that could be done to prevent another Heilig-Meyers, as far as the securitization industry in concerned?
Would you like to dismiss it as an isolated problem, or would you see something more to it?
Visitors' views
The H-M case, from the description, appears to represent some fundamental deviations from safe and sound securitization practices. Similar debacles have been experienced in other cases (notably, manufactured housing firms like Oakwood Homes) where perverse incentives and failure to properly control the details of the origination process increased the severity of losses on debt secured by sold product. In the H-M case, it appears that the same entities which did the originating were heavily involved in the servicing side as well, and that the communication between these processes was compromised in ways that could involve fraudulent intent or innocent but inept communication of data betweeen origination and servicing operations, or some combination of these factors.
Given the typical H-M customer, a subprime credit drawn from a relatively transient population, the invalidity of phone numbers and addresses might simply be a result (at least in most cases) of moves and/or service cutoffs for nonpayment. As long as the customers continued to show up at a store to make their installment payments, the fact that they had moved might not be noticed. No doubt there are other cases like this waiting to materialize as the volume of defaulting weak credits grows in the current recession.
Your article states: "Structured finance is based on the edifice that originator performance can be divested from the pool performance and that the pool can stand on its own. Does the Heilig Meyers case put a question mark here?" The lesson to be learned from H-M, Oakwood, and similar debacles is that this important assumption of Structured Finance MAY hold, but in order to increase the assurance that the assumption DOES hold, one must diligently monitor the processes behind any given transaction to verify that the processes which originate the debt being securitized are well controlled, properly incented, and institutionally independent of the processes which service the debt, and that the debt service process includes appropriate verification of the information passed to it by the origination process (including early, and periodically repeated verification and update of information like debtor location and other common contact points).
With the spread of inexpensive mobile phone units and the ease of setting up virtual mailing addresses (driven by the growing population of "Escapee" households, among other factors), validation of origination and servicing process integrity and independence will no doubt grow in importance as time passes. If experience eventually shows that "virtual" creators of "virtual" debt are "virtually" impossible to prevent, or to sanction when illusion ends in default, Structured Finance service providers will definitely face a threat to their franchise.
Frank Meyer
Actuary, R&D Manager,
RMIC Corporation
Box 2514, Winston-Salem NC 27102
[The commentator is presenting his personal perspective, based on information
generally available in trade press, and is not speaking in this matter
as a representative of his company or its management, nor is he personally
familiar with the details of the operations of the firms to which his
comments refer]