Default or Prepayment? When the Answer Depends on the Data Source

Abstract

In 2005, the SEC promulgated CFR§229.1100-1125 (Reg AB) requiring public disclosure of the type of data used to make structured ratings. This was a milestone in reducing asymmetrical information. Reg AB has since been further enhanced and expanded (Regulation AB II and Exchange Act Rules 15Ga-2 and 17g-10) to include loan-level static pool data. Yet, as the authors report, even a decade after the Financial Crisis, large differences exist between consumer ABS prepayment and default seller data purchased from a commercial data provider and that residing in the US government’s EDGAR data base. The commercial data had much larger numbers of prepayments and fewer defaults, a pattern suggesting that defaults have been classified as “involuntary” prepayments. Given that asymmetrical information persists in the structured market, the authors recommend moving the focus from data disclosure to establishing more consistent informational standards in order to realize the full transparency potential of the US ABS disclosure framework. Specifically, the authors recommend that the classification of the data type be required by regulation to match its implementing algebra for purposes of cash flow modeling.