The survey solicited views from market participants on how to best define, measure, monitor, report, and mitigate operational risk in securitized
transactions. The results of the survey, detailed in a recently released
commentary titled, "Structured Finance Market Opinion Survey Confirms Operational Risk Remains A Serious Concern For Securitization Professionals,"
show that more than two-thirds of respondents chose operational risk as one of
the top-three most important areas of risk in the market, surpassing other
highly touted forms of exposure, such as legal (40%), modeling (39%), interest
rate (27%), regulatory (24%), and correlation risk (9%) by a sizable margin.
In fact, only credit risk received more votes, with 79% of market players
choosing it as one of the most significant factors.
Furthermore, a majority of respondents (78%) identified servicer quality
as the most critical element of a transaction's operational risk profile,
followed by transaction structure. The inherent serviceability of a particular
receivable was in third place, followed closely by deal administration, which
includes the work of the trustee and the general level of a transaction's
"The single biggest mitigant to operational risk for securitized transactions is an experienced servicer in the relevant asset class," said one survey respondent. "There is a need to focus more specifically on internal controls," commented another, "including the amount of resources dedicated to servicing the securitization and management's involvement in and understanding of the securitization structured and obligations."
According to another survey taker, "Revolving deals must have a way of
monitoring any significant changes in underwriting or servicing policies.
Smaller servicers, which are more likely to be at risk in times of financial
or market stress, must be monitored more closely, as they are more likely to
play fast and loose with servicing and reporting to maintain cash flow."
Market participants generally suggested increased or tighter reporting
standards and controls as a primary mitigant to operational risks, including
"third-party audits of operations," according to one participant.
The SF Market Opinion respondents also reported that, as expected, they
view a company's corporate liquidity and cash flow generation as the most
important operational/financial aspect of a seller/servicer (71%). According
to one market participant, "Most, but not all of the big disasters in ABS have
occurred when the sponsoring corporation had weak cash flow or no other
sources of liquidity and put itself (and investors) in a position of moral
hazard, ranging from weak servicer performance to fraud."
A company's funding diversity and flexibility was the second most important aspect of a seller/servicer according to respondents, garnering 58% of the vote. Interestingly, in a tie for second, 58% of participants chose breadth of a company's servicing shop as the most critical factor.
"These survey results indicate a sharp turnaround from prior years in which a seller/servicer's financial strength was seen as the paramount factor affecting seller/servicer risk," said Michael Gutierrez, a director and head
of Standard & Poor's Structured Finance Servicer Evaluations Group, and co-author of the commentary. In other words, it is possible for a well-funded
company to have a flawed servicing operation these days. "Recent industry
events, such as the highly publicized regulatory and compliance issues affecting Fairbanks Capital Corp., which had nothing to do with the favorable
financial strength of its corporate parents - yet ended up adversely affecting
its servicing capabilities - may be a factor in this change."
More than half of the respondents also said that newer or esoteric assets, as well as specialized obligors or industries, are most prone to operational risk, while mortgage/home equity and credit cards were voted least prone.
A total of 197 participants, all of whom were familiar with operational
risk in structured finance, completed the survey. Of these, 28% identified
themselves as investors, 26% as investment bankers, 20% as issuers, and the
remainder represented a mix of other roles in the structured marketplace.
SF Market Opinion is a recurring study covering hot topics pertinent to
the structured finance community. It is intended to create valuable discourse
and give securitization professionals an opportunity to hear what their peers
are saying on critical issues.
The report, "Structured Finance Market Opinion Survey Confirms Operational Risk Remains a Serious Concern For Securitization Professionals", published Feb. 26, 2005, is available on RatingsDirect, Standard & Poor's Web-based credit analysis system. It is also available on Standard & Poor's Web site. Click on Credit Ratings. Under Browse By Business Line, select Structured Finance. Under Commentary & News, scroll down to the report, dated March 2.