Incoming EU regulations for investors in securitisations are a clear example.
Originators contemplating raising capital or reducing exposure to credit risk via securitisation or sale need to ensure and, critically, demonstrate adherence to regulations, practices, criteria and policies. Portfolio data also needs to be accurate and complete. Therefore originators who have enabled this through their own surveillance will be more likely to ensure a smooth transition to sale or securitisation.
But what precisely is portfolio surveillance and how does it differ from monitoring or transparency? In a nutshell, surveillance is an ongoing process that allows an investor or orginator to remain on top of all risks associated with a portfolio of loans. Unlike pure monitoring, surveillance is based on proactive risk management: when an issue is identified, it is not merely noted, it is addressed – even anticipated.
RMBS lend themselves particularly well to surveillance as do loan portfolios. The key is the ability to ring-fence the portfolio, thus minimising the impact of the broader environment. These investments also benefit from comprehensive, regularly-produced performance data capturing all the key drivers of credit and other risk.
At its most fundamental, the greater the degree of control you can exert over a portfolio and the more precise the available data, the greater its suitability for surveillance. This should be a key selling point for an investor.
Surveillance examines four broad sets of factors, the first of which relates to the characteristics of the assets in the portfolio itself, asking the questions: what will drive performance over time? These include the factors obviously familiar to originators such as loan-to-value, income and seasoning.
Second are micro and macro-economic factors. No one can anticipate how the economy will evolve, but it’s vital to stay on top of the changes and to understand the impact of different potential scenarios on the portfolio.
Third is the servicing of the assets. Two servicers working on the same portfolio can produce widely differing results. What we want is rigorous and effective servicing that minimises delinquencies and losses. A sometimes overlooked part of the servicer’s role is to ensure compliance with regulation and relevant codes of practice.
Finally, there are the structural cash flows and the behaviour of counterparties.
Effective surveillance enables ongoing, accurate valuation which allows appropriate pricing; it reduces delinquencies and ultimate losses; it ensures pre-payment rates can continually be measured against assumptions; it prevents unpleasant regulatory surprises; it ensures appropriate capital treatment and, for an RMBS portfolio, it allows anticipation of rating changes and potential forced sale.
These uncertain times make the argument for surveillance all the more compelling. It may not seem the most exciting of functions, but everything suggests it’s going to swing into the regulators’ sights. Originators and investors overlook it at their peril. So having a clear sense of what surveillance is – and what it isn’t – is a positive first step on the road to enhanced security.
