DTCC Announces Initiatives to Further Streamline Structured Securities Processing
DTCC has proposed new initiatives aimed at helping solve the processing problems and cost inequities associated with the structured securities market. The initiatives are outlined in a new white paper titled Transforming Structured Securities and issued by DTCC in September.
The paper was developed during the past 12 months by representatives from major banks and financial services firms as well as DTCC, the Securities Industry and Financial Markets Association (SIFMA) and the American Securitization Forum (ASF). It 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 a pool 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.
Four new initiatives
The white paper proposes four new initiatives:
- Extend the deadline for submission of payment information on structured securities.
- Create two classes of structured securities – 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.
Rapidly growing market
“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,” said James Balbo, DTCC managing director, Asset Services. “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.”
With this growth, however, comes an increasing number of processing challenges because of the many different parties that add or forward information on a structured security deal. 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.
Cost inefficiencies
The paper 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 a “disproportionate displeasure and frustration felt by certain parties” involved in structured securities.
“The originators of these securities – issuers and underwriters – do not suffer from the problems or losses that others in the processing chain do, which includes broker/dealers, custodians and shareholders,” according to the paper. 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 (PPAs) causing incremental processing costs, inefficient cash management and write-offs.
Two classes of securities
In addition to changing 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. on payable date, the paper calls for the creation of two classes of structured securities: conforming and non-conforming. Conforming securities are those that will 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 must be filed with the Securities and Exchange Commission.
The industry group believes that these fees 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. Under the proposed changes, 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 Balbo. DTCC estimates that the exception processing fee for 2008 will be $4,200 per CUSIP.
Report cards
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 Website.
Transforming Structured Securities Processing is the third white paper on structured securities that DTCC has issued in the last five years. To access it, visit the Thought Leadership section on the DTCC Website. @