You Got to Know who’s the Holders, Know who’s the folders, to Know when to walk away, to Know when to run ….

Even with perfect recent trade transparency and cash flow modeling, you cannot truly price structured assets in many cases without knowing something about the distribution of the holders. This was our contribution to the ABS Vegas panel on pricing and valuation. You got to Know Who’s the Holders in order to Know when to fold ‘em:

Abstract of DealVector Discussion:

Pricing and valuation of Structured Credit assets is subject to several complicating factors, quite apart from the questions of disclosure of trade prices or quality of analytic engines. These factors center on the propensity for illiquid structured assets to simultaneously be subject to high-value control and voting issues that are difficult to act upon.

Examples of voting and organizing issues that have contributed material uncertainty to the valuation and pricing of structured assets include:

• RMBS reps and warranties claims in which a threshold of 25% of voters acting in concert could make the difference between poorly underwritten mortgages being held at “0” or becoming “puttable” back to the underwriter at “par”. Such a disparity of result makes it effectively impossible to value these assets, as well as very difficult to trade. The only path to certainty is knowing what percentage of such holders have actually organized.
• TruPs issuers unable to find the holders of their liabilities in order to negotiate recapitalizations. Where such liabilities were purchased into “blind pool” TruPs CDOs, the ability to organize a responsive bid is impeded by the documentation. Substantial recovery in a recap versus low potential recovery without a recap leaves significant valuation uncertainty.
• Call Options in CDOs/CLOs. Lack of knowledge of where all the “pieces” are held and trading, as well as the basis price of the positions held by other users, makes it effectively impossible to truly price call probabilities in CDOs and CLOs. A 51% percent holder with a low basis in other parts of the capital structure may be incentivized to exercise a “non-economic” call, thereby destroying value for a nearly identical 49% equity holder, particularly during periods of high volatility.

These are some examples of cases where positional knowledge of holdings, and the ability to communicate with those other positional holders, implicates exogenous factors to pricing and valuation in structured credit. Just knowing the cash-flows and last prices is not enough even where these inputs are perfect.