Structuring the deal (the devil's in the details)

[Joanne98]

If securitization of intangible assets is to move forward once the credit freeze is over, it must deal with a little glitch in the process. That glitch -- the power of the pool servicing agent -- has come to the forefront in the mortgage foreclosure problem. The general securitization process works like this: mortgages are bundled into a pool and bonds are sold backed by the pool. The revenue produced by those mortgages is used to pay off the bonds. An agent, called a servicer, handles all the administrative details.

Here is the problem. What happens if adjustments need to be made? For example, what happens if the mortgages start to go into default? That was the topic of yesterday's hearing in the House Financial Services Committee. As the New York Times relates, the answer is not straightforward:


“The servicers are telling me they’re not in power at this time,” Representative Brad Sherman, Democrat of California, said. “You have 10 investors, and any one of them can allege from a purely negligence standpoint that the value of the portfolio has not been maximized.”

At the hearing, panelists disagreed on whether modification was allowed with bundles of mortgages that had been resold. An executive from Bank of America said that the contracts behind some securitizations expressly prohibited changes to the underlying mortgages. The executive, Michael Gross, the bank’s managing director of loan administration loss mitigation, said that banks had more flexibility to modify terms in loans they held.

But an executive with the American Securitization Forum, an industry group, said that contracts did allow bundled mortgages to be modified. The forum is in discussions with a range of investors who bought mortgage bonds to streamline the process of such modification, said Thomas Deutsch, deputy executive director of the group.

“Servicers do have the legal authority, right and responsibility to modify loans in appropriate circumstances, even if those loans are in mortgage-backed security pools,” Mr. Deutsch said.

Mr. Deutsch’s assertion faced skepticism among lawmakers. Barney Frank, Democrat of Massachusetts and chairman of the committee, said he was hearing evidence that servicers were having trouble modifying loans that had been securitized.

“They can’t get this worked out,” Mr. Frank said. “Who am I going to believe? You or my own eyes?”

Some hedge funds, including Greenwich Financial Services and Braddock Financial, told banks in October that they might sue the banks if they changed mortgages that were within mortgage bonds that the hedge funds had purchased. Modifying the terms of mortgages underlying mortgage bonds can change how much those bonds are worth.

One can see the same thing happening in intangible securitization. What happens if the royalty terms on a patent or a brand need to be renegotiated to prevent the collapse of a company? Can the servicer act as post-deal deal maker?

So working out this little detail will be important not only for the mortgage crisis, but also for the future monetization of intangibles. The rules that re developed need to make sure that they don't in some unintended way end up hurting intangibles.

http://www.athenaalliance.org/weblog/archives/2008/11/structuring_the_deal.html