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Metropolitan West Asset Management RMBS Research

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  • 1. Metropolitan West Asset Management RMBS Research Spring 2009 By Brian Rosenlund, CFA Senior Analyst, Structured Products CONTENTS page Highlights I. Delinquencies and Severities..... 2 > Delinquencies and Severities – Foreclosures pick up again as moratoriums roll off. II. Prepays and Defaults............... 5 Severities march higher at a slower rate partly due to dwindling REO inventories. III. Delinquency Timelines.............6 IV. Mark-to-Market LTVs............... 7 > Prepays and Defaults – Prime and Alt-A prepays continue their upward trend while Option Arm and Subprime prepays face substantial headwinds. Defaults rise V. Origination Trends.................. 8 reflecting the clearing levels being found in some of the more distressed markets. VI. Mods and Recidivism............... 9 VII. Advancing........................... 10 > Delinquency Timelines – Timelines contract but still are 20% longer than Q3 2007 as Servicers find clearing levels for REOs and the pre-foreclosure period shortens. VIII. Whole Loan Prices.................11 > Mark-to-Market LTVs – The disparity between Case-Shiller and the REO Index continues. Some signs of leveling mark-to-market LTVs emerging in Subprime due to temporary thinning of inventories. > Origination Trends – Credit remains tight as the Agencies give loans to only the most credit worthy borrowers. > Modifications and Recidivism – Modifications continue to trend upwards across sectors. Likewise, recidivism rates continue to increase implying modifications just delay the inevitable reckoning with reality. > Advancing – Servicers continue to indicate higher severities and idiosyncratic servicing risks through advancing trends. > Whole Loan Prices – Eye-popping losses still need to be dealt with.
  • 2. RMBS Research I. Delinquency and Severity Trends Until April remittances were released, we saw a rise in the 90+ grouping at the expense of the Foreclosure and REO grouping due to foreclosure moratoriums and more involved modification vetting processes being implemented. Subprime REO inventories have thinned out resulting in a firmer tone on the ground in the Subprime geographic areas. Servicers are finding clearing levels in these areas at less than half the replacement cost for the homes. Unlevered annual rental incomes of ~25% of the purchase price are too high for investors to pass up. For example, it currently is not uncommon for a property in Lancaster, California to attract 10-15 cash bidders within days of the servicer’s putting the $40,000 REO on the market. A “best-and-final” offer opportunity will be given to the top five bidders and the 1100 square foot home built in the 1950’s will go into escrow with a $55,000 offer. The seasoned investor will be aggressive in this initial stage. When the closing date nears an addendum will be submitted reducing the bid to the original offering level or lower depending upon the work that the property requires. The servicer’s REO manager in charge of liquidating the asset receives a large portion of his/her pay in incentive based partly on how much inventory is moved on a monthly basis. Wishing to close one more sale before month end rather than go back to start the bidding process again, the REO asset manager accepts the addendum and moves on. Overleveraged and with shattered credit, local Lancasterites transition from homeownership to renting. Areas like Lancaster are generating mid-eighty to low-ninety percent severities. However, in April we began to see the delinquency pipeline flow into foreclosure. As this continues, a steady stream of new REOs will replenish the diminishing inventory. Prices will likely head lower and severities will likely head higher until the 90+/Foreclosure/REO grouping comes back down to earth. Lancaster, California 90+ F R 90+ F R Severity (rhs) 50% 110 45% 100 40% 90 35% 80 Delinquency Rate 70 30% Severity % 60 25% 50 20% 40 15% 30 10% 20 5% 10 0% 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Source: MetWest Spring 2009 2
  • 3. RMBS Research Observe the Severity Impact of a 12% Reduction in 90+/FC/REO Inventory in Stockton, California 90+ F R 90+ F R Severity (rhs) 600 110 100 500 90 80 Number of Loans 400 70 Severity % 60 300 50 200 40 30 100 20 10 0 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Subprime 90+ F R 90+ F R Severity (rhs) 40% 100 35% 90 80 30% 70 Delinquency Rate 25% 60 Severity % 20% 50 15% 40 30 10% 20 5% 10 0% 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Option Arms 90+ F R 90+ F R Severity (rhs) 35% 100 90 30% 80 25% 70 Delinquency Rate 20% 60 Severity % 50 15% 40 10% 30 20 5% 10 0% 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Source: MetWest Different assumptions produce different results. Spring 2009 3
  • 4. RMBS Research Alt-A 90+ F R 90+ F R Severity (rhs) 25% 100 90 20% 80 70 Delinquency Rate 15% 60 Severity % 50 10% 40 30 5% 20 10 0% 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Prime 90+ F R 90+ F R Severity (rhs) 4.5% 100 4.0% 90 3.5% 80 70 Delinquency Rate 3.0% 60 Severity % 2.5% 50 2.0% 40 1.5% 30 1.0% 20 0.5% 10 0.0% 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Source: MetWest Different assumptions produce different results. Spring 2009 4
  • 5. RMBS Research II. Prepay and Default Trends Voluntary prepayments are showing signs of life in the Prime and, to a lesser extent, Alt-A sectors. Low mortgage rates are driving this wave. The impact of low rates is muted, however, due to the extremely tight credit conditions and the precipitous drops in home values. Barring a 100% (500-1000% in some areas) rally in home prices, a credit refinancing wave, or drastic government intervention voluntary prepayments in the Subprime and Option Arm sectors are likely to remain low for a long time. Defaults are starting to tick up due to the rolling off of foreclosure moratoriums. That trend should continue as the backlog of supply comes out, causing CDRs to spike even more. 1 Month Voluntary Prepays Subprime Prime Option Arm Alt-A 20 18 Voluntary Prepayments (CRR) 16 14 12 10 8 6 4 2 0 Aug-07 Jul-08 Feb-08 Apr-08 Jun-08 Sep-08 Jan-09 Dec-07 Nov-08 Mar-09 May-09 Oct-07 1 Month CDRs Subprime Prime Option Arm Alt-A 25 20 Default Rate (CDR) 15 10 5 0 Aug-07 Jul-08 Feb-08 Apr-08 Jun-08 Sep-08 Jan-09 Nov-08 Mar-09 Dec-07 May-09 Oct-07 Source: Intex, MetWest Spring 2009 5
  • 6. RMBS Research III. Timeline Trends Delinquency/Foreclosure/REO timelines impact a distressed loan’s severity in two ways. As timelines extend the home is exposed to a declining housing market for a longer period of time and the delinquent principal and interest due to the trust grows. These two factors negatively impact a loans loss severity. The political pushback, foreclosure moratoriums, servicer staffing shortages, and high inventory levels can all be seen in the 20% timeline extension that has occurred in the industry since Q3 2007. The foreclosure timeline, in particular, has extended by 37% since Q3 2007. Recent REO supply trends have brought the REO timeline back to trend from peak levels as servicers find clearing levels in distressed areas and REO inventory levels remain artificially low as a consequence of foreclosure moratoriums. The pre-foreclosure delinquency period has extended by 20% since Q3 2007 as servicers seek more ways to contact borrowers and help them stay in their homes. Pre-foreclosure delinquencies are off the highs as foreclosure moratoriums roll off and the only solution available is liquidation. Average Days in Pre-Foreclosure Delinquency, Foreclosure and REO Delinquencies Foreclosures REO Total 600 550 500 450 Number of Days 400 350 300 250 200 150 100 Aug-07 Jul-08 Feb-08 Apr-08 Jun-08 Sep-08 Jan-09 Nov-08 Mar-09 Dec-07 May-09 Oct-07 Source: MetWest Spring 2009 6
  • 7. RMBS Research IV. Mark-To-Market LTV Trends Using a Case-Shiller/OFHEO blend, we observe that the administration’s push to refinance underwater loans (up to 105 LTV) might have an impact. The main problem with using this approach is granularity. Case-Shiller has Los Angeles down by 40% from the peak. Included in that number are Santa Monica and Lancaster. Santa Monica is down ~20-25% while Lancaster is down ~80-85%. For every one subprime loan made in Santa Monica, 40 loans were made in Lancaster. We use a more granular method of calculating mark-to-market LTV based on the loan’s outstanding balance and the average monthly REO sales price in each zip code. The results paint a grim picture both for modification programs and underwater-refinancing programs. Case-Shiller/OFHEO Mark-To-Market LTV Subprime Option Arm Prime Alt-A 130% 120% 110% LTV 100% 90% 80% 70% Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 REO Index Mark-To-Market LTV Subprime Option Arm Alt-A 230% 210% 190% 170% LTV 150% 130% 110% Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Source: MetWest, Case-Shiller, OFHEO (FHFA) Spring 2009 7
  • 8. RMBS Research V. Origination Trends These charts show Freddie Mac new origination by FICO grouping. With the non-agency residential mortgage market closed, virtually all mortgages wind up at the Agencies or FHA. Yet the Agency credit standards have tightened dramatically. Near perfect credit and low debt-to-income ratios are required to get a mortgage these days. Precipitous drops in home values combined with extremely tight credit standards will result in slow voluntary prepays despite the Fed’s efforts to keep mortgage rates low. Freddie Mac New Origination by FICO Grouping > 730 680-730 < 680 100% 90% % of New Origination Volume 80% 70% 60% 50% 40% 30% 20% 10% 0% Aug-06 Aug-07 Aug-08 Apr-06 Jun-06 Feb-07 Apr-07 Jun-07 Feb-08 Apr-08 Jun-08 Feb-09 Apr-09 Nov-05 Mar-06 Dec-05 Dec-06 Dec-07 Dec-08 Oct-06 Oct-07 Freddie Mac DTI Ratios on New Origination by FICO Grouping Oct-08 > 730 680-730 < 680 43% 41% 39% Debt to Income Ratio 37% 35% 33% 31% 29% 27% 25% Aug-06 Aug-07 Aug-08 Apr-06 Jun-06 Feb-07 Apr-07 Jun-07 Feb-08 Apr-08 Jun-08 Feb-09 Apr-09 Nov-05 Mar-06 Dec-05 Dec-06 Dec-07 Dec-08 Oct-06 Oct-07 Oct-08 Source: MetWest Spring 2009 8
  • 9. RMBS Research VI. Modification and Recidivism Trends Modifications as a percentage of deal balance outstanding continue to rise as servicers respond to the increasing economic incentives and political pressures in the market. Recidivism, however, also continues it’s march upwards as the modification of choice (rate reduction + delinquent balance recapitalization) does little to motivate a borrower whose neighbor’s home was just sold by the bank for 20 cents on the dollar. Modifications as a Percentage of Outstanding Balance Subprime Option Arm Prime Alt-A 20 18 16 14 12 10 % 8 6 4 2 0 Aug-07 Jul-08 Sep-07 Jan-08 Sep-08 Jan-09 Nov-07 Mar-08 May-08 Nov-08 Mar-09 May-09 Recidivism Rate on Modifications that Have Seasoned at Least Six Months Subprime Option Arm Alt-A Prime 60 55 50 45 40 % 35 30 25 20 15 Jan-09 Feb-09 Apr-09 Nov-08 Dec-08 Mar-09 May-09 Oct-08 Source: MetWest Spring 2009 9
  • 10. RMBS Research VII. Advancing Trends Servicers are required to advance principal and interest payments on delinquent loans unless they deem those advances unrecoverable. The decision to stop advancing reflects higher loss expectations and idiosyncratic servicer struggles. The graph below answers the question, “Of all the seriously delinquent loans in the pool what percentage has stopped receiving advances?” As balance sheets remain constrained and severities continue their march upward, we expect the upward-stop-advancing trend to continue. Percent of First Liens with 60+ Delinquency Status Not Advanced Upon Subprime Option Arm Alt-A Prime 7 6 5 4 % 3 2 1 0 Aug-07 Jul-08 Feb-08 Apr-08 Jun-08 Sep-08 Jan-09 Dec-07 Nov-08 Mar-09 May-09 Oct-07 Source: MetWest Spring 2009 10
  • 11. RMBS Research VIII. Whole Loan Prices and Flow of Funds MetWest Structured Product Analyst Harrison Choi gathered indicative mid-market whole loan levels from Barclays. Using Intex generated 30+ delinquencies (including BK, FC and REO), MetWest projects a delinquency weighted average dollar price by asset class. Applying these prices to the Fed’s latest Flow of Funds Report related to the residential mortgage market we can observe the impact of a true mark-to-market across sources of credit. The 4.9 trillion loss implied is staggering. A thirty point rally in performing whole loan prices would bring us down to a 2.1 trillion loss across all lenders with a 675 billion pre-tax loss allocated to the commercial banking sector. The need for equity to absorb losses will be with us for a long time. Perhaps debt for equity swaps at major financial institutions can start putting a dent in some of these losses. Whole Loan Prices – Mid-Market – Barclays - 04/07/2009 Performing Non-Perf 30+ DQs Dollar PX Dollar PX Avg PX Prime 8.1% 70 37.5 67.4 Alt-A 30.2% 57.5 37.5 51.5 Subprime 48.3% 50 37.5 44.0 Option Arms 41.3% 35 32.5 34.0 HELOCs 13.2% 20 5 18.0 Seconds 19.3% 10 1.75 8.4 Source: Intex, Barclays Mark-To-Market Pre-Tax Loss Based on Whole Loan Prices Home Mortgage Distribution 12/31/08 Prime Alt-A Subprime HELOCs Total Agency- and GSE-backed mortgage pools 4,811 FNM 2,731 (621) (150) (291) 0 (1,062) FRE 1,850 (429) (90) (197) 0 (715) Commercial banking 2,251 (262) (126) (231) (636) (1,255) ABS issuers 1,839 (135) (282) (473) (37) (927) Savings institutions 667 (97) (47) (86) (98) (328) Government-sponsored enterprises 462 (106) (24) (49) 0 (179) Finance companies 376 (53) (26) (47) (62) (188) Credit unions 348 (44) (21) (39) (82) (186) Household sector 81 (14) (7) (13) 0 (34) State and local governments 88 (16) (8) (14) 0 (37) REITs 50 (9) (4) (8) 0 (21) Nonfarm noncorporate business 16 (3) (1) (2) 0 (7) Nonfinancial corporate business 12 (2) (1) (2) 0 (5) Federal government 15 (3) (1) (2) 0 (6) Life insurance companies 11 (2) (1) (2) 0 (5) State and local govt. retirement funds 4 (1) (0) (1) 0 (2) Private pension funds 2 (0) (0) (0) 0 (1) Total 11,030 (1,796) (789) (1,457) (914) (4,957) Source: Flow of Funds Report L.218, FNM 10K, FRE 10K, Intex, MetWest Spring 2009 11
  • 12. RMBS Research Issue selection processes and tools illustrated throughout this presentation are samples and may be modified periodically. Such processes are not the only tools used by the investment teams, are extremely sophisticated, may not always produce the intended results and are not intended for use by non-professionals. Certain tools and databases are the proprietary property of the vendors mentioned. Investment strategies may not achieve the desired results due to implementation lag, other timing factors, portfolio management decision-making, economic or market conditions, or other unanticipated factors. The views and forecasts expressed in this material are as of the date indicated, are subject to change without notice, may not come to pass and do not represent a recommendation or offer of any particular security, strategy, or investments. Data displayed with this report represents the most current available at the time of publication. Subsequent data results, or release of different data, could lead to different conclusions, as could a differing view of the importance of certain data points. Securities discussed are not recommendations and are presented as examples of issue selection or portfolio management processes. They have been picked for comparison or illustration purposes only. No security presented within is either offered for sale or purchase. MetWest reserves the right to change its investment perspective and outlook without notice as market conditions dictate. While we have gathered this information from sources believed to be reliable, MetWest cannot guarantee the accuracy of the information provided. This presentation contains material that is protected, individually and collectively, by copyright, trademark or other proprietary rights of Metropolitan West Asset Management, LLC or others as indicated. Spring 2009 12