IT as a Strategic Enabler of Effective Securitization

By Andreas Wilmsmeier

and Alex Santos

Growth of a Market: Over the last 20 years securitization has grown from a specialized and slightly esoteric funding vehicle for government-sponsored housing agencies to a primary mode of funding used by a wide range of financial services firms (see Table 1) – from commbaercial banks to credit card companies to mortgage companies. Almost any financial asset, be it a consumer loan, a mortgage, a boat loan, a car loan, a credit card receivable or even trade receivables, is a potential candidate for securitization. The more standardized the financial asset (such as 30-year fixed-interest mortgage), the more easily it can be securitized.

The increasing sophistication and depth of capital markets matched with a benign regulatory environment has helped this growth, but it has been driven by the profit motive of financial services firms:

• When well thought-out and correctly structured, asset- and mortgage-backed securities (ABS and MBS)¹ allow financial services firms to lower their overall funding costs by exchanging the long-term cash-flow and residual risk of the underlying assets in the securitization with immediate financial proceeds from investors.
• It allows for much greater capacity in lending. By securitizing and then selling these assets rather than holding them to maturity, firms can leverage an abundant and relatively inexpensive source of funds to achieve rapid growth.
• By “shrinking” their asset base, firms free up additional assets previously tied up as zero or low-yielding regulatory capital, thereby enhancing asset utilization.
• Finally, financial services firms (and, potentially, their non-financial corporate parents) can improve the management of their own credit ratings (and hence, their credit costs) with the all powerful rating agencies by judicious use of securitization.

securities

loans

loans

receivables

Table 1: Securitization deals (in billions)

Source: Board of Governors of the Federal Reserve System

Critical IT Capabilities in Securitization

As financial services firms become more reliant on securitization, they must develop best-in-class capabilities in the enabling processes: from pool design, to investor relations, to pool valuation and pricing, to partner relations (insurers, loan servicers, and so on). Our experience with a premier player in auto lending has shown us that IT, or more specifically, business intelligence and data warehousing, goes a long way in supporting, facilitating and enhancing the securitization efforts of financial service firms.

Critical capabilities enabled and driven by IT include:

• Data quality. A key element to effective securitization is trust. From an IT perspective, establishing and maintaining trust requires truthful, reliable and up-to-date statements on the current status and development of the portfolio based on correct information.
• Auditability. Data reconciliation facilities need to be available for internal and external auditors for all data processing and transformation between the source of the data and the securitization IT system.
• Openness. The system needs to be open for multiple deals with multiple asset classes and deal configurations (for example, support revolving deals).
• Planning and Simulations. Preparation of new deals requires substantial planning effort, functionality to simulate deals with preliminary sets of criteria and the ability to analyze and compare simulated deals.
• Comprehensive Reporting. Analysis and reporting at different levels is required by investors, servicers, issuers and auditors. High-level time-series analysis is necessary to monitor portfolio development, while drill-down reporting is needed to check details down to the level of single assets.
• Flexibility and Ease of Use. Most of the users of the securitization system will not be IT experts. Easy to use analysis and reporting tools allow expert users to follow their own analysis paths, while casual users will have access to self-service, web-based reporting features.

Securitization and Enterprise Data Warehousing

Data Warehousing in general, or Enterprise Data Warehousing (EDW) in particular, is not a new concept in the financial services industry. Our client has been running an EDW based upon the SAP Business Information Warehouse (SAP BW) for some time now, and has established it as a single point of truth with a defined, consistent and constantly improving quality of data. As part of the EDW implementation project, many data quality issues have been identified and addressed by developing data validation or data cleansing rules or by improving data entry screens or validation rules in the original source systems.

Naturally the architecture of the next generation securitization solution at this client leverages the investments made in this area (see Figure 1). Extensions to the functionality and the scope of the EDW required by the securitization solutions have been developed as part of the securitization project and are now being reused in other analytic applications (such as regulatory reporting).

Figure 1: EDW based Securitization Architecture

The technology decision to use the SAP Business Information Warehouse at our client was driven by strategic considerations. SAP is in use in many areas of the organization, including some of the core banking business. However, a total cost of ownership (TCO) analysis conducted before taking the first steps of implementing the EDW justified the investment by showing reduced TCO compared to their previous reporting environment.

Securitization Business Rules

Not all information required by the securitization process is directly available from the source systems or should be stored in the EDW. Examples include calculations based upon interest rates specific to the securitization deal, like cash-flow generation, net present values or tax implications. The result of applying the securitization business rules is made available for reporting, analysis and for the portfolio selection process.

Portfolio Selection

The portfolio selection process is at the core of the securitization solution. Utilizing the SAP BW meta-data repository, this process provides the flexibility to deal with multiple asset classes and multiple setups of securitization deals

A set of configuration screens enables the definition of general deal parameters as well as the detailing of selection criteria at different levels based upon the underlying asset class:

• Asset level criteria allow for the definition of filters at the data field level, such as:
  • Exclude all loan contracts with a certain status
  • Only include loan contracts below a certain size limit
  • &
• Portfolio level criteria allow for the definition of filters at the portfolio level, such as:
  • Percentage of loan contracts with clients younger than 25 below 10%
  • Total value of loans not to exceed 1bn USD
  • &

The portfolio selection process enables the generation of simulated portfolios which can then be analyzed and compared to other simulated portfolios or actual portfolios sold previously. The approach of simulating deals and analyzing those simulation results in detail makes possible the adjustment of the portfolio to exactly what the investor (or more generally the securitization market) expects while maintaining profitability and deal quality goals of the issuer.

Reporting

Four different groups are interested in analyzing and reporting on the portfolio: investors, servicers, issuers and auditors. It should be no surprise that the primary concern of investors and servicers is portfolio performance. While sharing requirements with investors, issuers need additional reporting capabilities to support their portfolio simulation, preparation and selection process (such as comparison and analysis of different portfolio simulations).

In contrast to investors, issuers and servicers, auditors require data reconciliation reports all along the data transformation steps from operational systems via the Enterprise Data Warehouse to the securitization data storage objects.

Future developments at our client will include projecting portfolio performance and comparing plan versus actual. While reports today are actively distributed to the investor, the implementation of secure, web-based self-service reporting is one of the next steps to be taken.

Closed-Loop Approach

The closed-loop approach taken in this architecture allows reporting sold contracts and details of the deal back to the operational systems (for example, accounting). Options for implementing the closed loop approach largely depend on the interfaces available with the operational system. Common approaches are to automatically create flat files that can be imported into the operational system or – if available – to use an appropriate application programming interface (API) to directly hand over result data sets.

Maximize ROI with an Analytics Strategy

Looking at the return on investment of such a project, the business effect of securitization transactions can be tremendous, and typically the costs of executing on deals will exceed the costs of designing and implementing the IT solution. The most important success factors in implementing the IT solution are data quality and flexibility in defining and executing the deal. Being able to utilize an existing Enterprise Data Warehouse to ensure these factors and speed up the implementation process – as in the case of our client – enhances the ROI even more.

Extending the view to other analytic applications, such as CRM, general risk management or upcoming regulatory requirements (such as Sarbanes-Oxley or Basle II), we recommend developing a global business intelligence strategy incorporating an Enterprise Data Warehouse approach and considering securitization as one of the key analytic applications on top of it (see figure 2). An iterative approach to implementing this strategy and the EDW helps to control the complexity of the project, maintain the data quality of the data and quickly deliver reporting solutions and analytic applications to your users.

¹ Generally speaking, pools of mortgage loans that are securitized are referred to mortgage-backed securities (MBS) while, in general, securitized pools of other assets (auto loans, credit card receivables, etc.) are referred to as asset-backed securities (ABS).

About the Authors

Andreas Wilmsmeier is vice president and general manager of Inforte’s German operations, and he can be reached at andreas.wilmsmeier@inforte.com. Alex Santos is a principal in Inforte’s specialty banking practice, and he can be reached at alex.santos@inforte.com.