The current fallout from the sub-prime mortgage crisis has many origins, but perhaps the two most significant direct contributors were declining home prices and the creation of increasingly complex financial instruments. Sub-prime residential mortgage Investors spend a tremendous amount of time, effort and money trying to obtain data pertaining to loan repayments, earned interest and ancillary fees associated with the underlying loans
2. Copyright 2008. Watkins: CSI ™ Problem Summary <ul><li>Creation of complex financial instruments- </li></ul><ul><li>particularly CDOs and CDS- which allowed the leveraging of small aggregated cash flows, to back structures with values calculated at multiples of the underlying assets </li></ul><ul><li>Cash flows backed by residential mortgages – </li></ul><ul><li>especially in complex structures are difficult to quantify, analyze and predict </li></ul><ul><li>Economic Factors : </li></ul><ul><ul><li>Fair Value Accounting </li></ul></ul><ul><ul><li>Liquidity Issues </li></ul></ul><ul><ul><li>Compunction to write-off large investment amounts </li></ul></ul><ul><ul><li>Investment Managers are using ABX indices to glean evaluated prices- there is no “market” to mark to </li></ul></ul>
3. <ul><li>Actions taken to assist the troubled economy is predicated upon the fundamental notion: </li></ul><ul><li>distressed assets will eventually recover some value </li></ul><ul><li>Incorporated in this strategy: </li></ul><ul><li>ability to properly assess current value and predict future worth </li></ul>Government Response
4. "The essence of resolving the sub-prime mortgage challenge is to intelligently reset the predictive cash flows of the underlying collateral within models more accurately sensitive to loss severity.” Anthony Mazza, Senior Managing Director Resolving the Problem
5. Response <ul><li>Methodology that is reliable, repeatable & verifiable: </li></ul><ul><ul><li>Aggregate Data </li></ul></ul><ul><ul><li>Forensic Examination </li></ul></ul><ul><ul><li>Formulate Policy Compliance Strategy </li></ul></ul><ul><ul><li>Operational Re-execution </li></ul></ul><ul><ul><li>Regulatory Compliance Assessment </li></ul></ul><ul><ul><li>Documentation </li></ul></ul><ul><ul><ul><li>Assumptions </li></ul></ul></ul><ul><ul><ul><li>Procedures </li></ul></ul></ul><ul><ul><ul><li>Economic Variables </li></ul></ul></ul>
6. Approach <ul><li>Investors in product backed by residential mortgage cash flow are interested in managing their holdings at: </li></ul><ul><li>Deal Level </li></ul><ul><li>Portfolio Level </li></ul><ul><li>Both views require Model of cash flow at loan level to create aggregate cash flow predictions at the Bond level </li></ul>
7. 5 Step Process <ul><li>Aggregate Loan Level Data from Deal Level </li></ul><ul><li>Rapidly Re-underwrite Individual Loans </li></ul><ul><li>Generate Cohort Level Metrics (Default, Prepayment & Loss Severity) </li></ul><ul><li>Re-model Tranches within Deal with Updated Cash Flow Information </li></ul><ul><li>Produce Valuations based upon updated Cash Flow Predictions </li></ul>
8. Process Model: Step 1: Aggregate Information Trustee Data Vendor Microeconomic info, neighborhood profiles, etc. Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components 1 <ul><li>The driving principle is to calculate assets at the loan cash flow level- straightforward for RMBS </li></ul><ul><li>Analyze Portfolio at DEAL LEVEL to determine whether asset to be priced a WHOLE LOAN -or-TRANCHE (CUSIP) within a structure (RMBS, CDO, etc.) backed by Loan Cash Flow </li></ul><ul><li>If asset is a Tranche (CUSIP), ascertain the Trust to which it belongs </li></ul><ul><li>Examine the Trust Indenture to ascertain whether there is cash flow stratification among the collateral (Group Cash Flows pertaining to specific Tranches) </li></ul><ul><li>If Cash Flows backing CUSIP are from assets other than residential mortgages, Cohort Pricing tactics will be utilized </li></ul>
9. Process Model Step 2: Rapid Re-underwriting Trustee Data Vendor Microeconomic info, neighborhood profiles, etc. Credit Bureau Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components REO Data Rapidly Re- Underwrite Delinquent Loans Loan Ref ID Loan Characteristics Historic Cash flow Updated Anonymous Credit Score Microeconomic info, neighborhood profiles, etc. Non-performing Loans Fraud detection 1 2 Work-out Option Cash flow Impact Work-out Cost Work-out Program Options <ul><li>The output of the Aggregation exercise is: </li></ul><ul><li>Loan to Deal Association </li></ul><ul><li>Loan Characteristics </li></ul><ul><li>Loan Level Historic Cash Flow </li></ul><ul><li>Loan Payment Velocity & Periodicity Report </li></ul>Payment Velocity & Periodicity An automated re-underwriting will be performed on Loans “ underperforming” Loans Work-out options Will be identified; Impact analyzed
10. Process Model Step 3: Generate Metrics Trustee Data Vendor Microeconomic info, neighborhood profiles, etc. Credit Bureau Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components REO Data Rapidly Re- Underwrite Delinquent Loans Loan Ref ID Loan Characteristics Historic Cash flow Loan Characteristics Historic Cash flow Economic Stats Macro Economic & Interest Rate Scenarios Updated Anonymous Credit Score Microeconomic info, neighborhood profiles, etc. Non-performing Loans Fraud detection Generate Cohort Default, Prepayment, Loss and Loss Severity Assumptions 1 2 3 LIBOR and Treasury Curves ( for several interest rate scenarios ) Periodic default, loss, prepayment, and total cash flow projections for each economic scenario Work-out Option Cash flow Impact Work-out Program Options Payment Velocity & Periodicity Work-out Cost Utilizing proprietary or in-house Mortgage Performance predictions, re-calculate Defaults, Prepayment Speed, Losses & Loss Severity Include non-residential mortgage cash flow cohorts for other asset types Document economic assumptions and benchmarks
11. Process Model Step 4: Generate Cash Flow Model Trustee Data Vendor Integrate Credit Model with Waterfall Rules, Generate Cash Flows for Each Tranche in Structure Microeconomic info, neighborhood profiles, etc. Credit Bureau Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components REO Data Rapidly Re- Underwrite Delinquent Loans Loan Ref ID Loan Characteristics Historic Cash flow Loan Characteristics Historic Cash flow Economic Stats Macro Economic & Interest Rate Scenarios Updated Anonymous Credit Score Microeconomic info, neighborhood profiles, etc. Non-performing Loans Fraud detection Rating Agency Deal Structure Tranche-level Cash Flows for Underlying Bonds Home Equity & Other Deal Structures Trust Indenture Generate Cohort Default, Prepayment, Loss and Loss Severity Assumptions 1 2 3 4 LIBOR and Treasury Curves ( for several interest rate scenarios ) Periodic default, loss, prepayment, and total cash flow projections for each economic scenario Ratings at Issuance, Subsequent Rating Modifications Work-out Option Cash flow Impact Work-out Cost Work-out Program Options Payment Velocity & Periodicity Using proprietary or in-house Cash Flow Modeling tool, generate Tranche-level payment predictions
12. Process Model Step 5: Produce Prices Trustee Data Vendor Integrate Credit Model with Waterfall Rules, Generate Cash Flows for Each Tranche in Structure Produce Evaluated Price Using Cash Flow Predictions, Generate Waterfall For Re-securitized Structures Microeconomic info, neighborhood profiles, etc. Credit Bureau Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components REO Data Rapidly Re- Underwrite Delinquent Loans Loan Ref ID Loan Characteristics Historic Cash flow Loan Characteristics Historic Cash flow Economic Stats Macro Economic & Interest Rate Scenarios Updated Anonymous Credit Score Microeconomic info, neighborhood profiles, etc. Non-performing Loans Fraud detection PRICES Rating Agency Asset Manager Deal Structure Tranche-level Cash Flows for Underlying Bonds Home Equity & Other Deal Structures Trust Indenture Market perspective, $ Spreads Generate Cohort Default, Prepayment, Loss and Loss Severity Assumptions Trading Platform Decisioning 1 2 5 3 4 “ What-if” Scenarios LIBOR and Treasury Curves ( for several interest rate scenarios ) Periodic default, loss, prepayment, and total cash flow projections for each economic scenario Ratings at Issuance, Subsequent Rating Modifications Work-out Option Cash flow Impact Work-out Cost Work-out Program Options Payment Velocity & Periodicity Create Trading Opportunities Generate waterfall scenarios at Deal Level
13. Overall Process Model Trustee Data Vendor Integrate Credit Model with Waterfall Rules, Generate Cash Flows for Each Tranche in Structure Produce Evaluated Price Using Cash Flow Predictions, Generate Waterfall For Re-securitized Structures Microeconomic info, neighborhood profiles, etc. Credit Bureau Remittance Reports, Collateral Set Up Files, Periodic Cash Flows Aggregate Deal Level Information & deconstruct into constituent Loan-level components REO Data Rapidly Re- Underwrite Delinquent Loans Loan Ref ID Loan Characteristics Historic Cash flow Loan Characteristics Historic Cash flow Economic Stats Macro Economic & Interest Rate Scenarios Updated Anonymous Credit Score Microeconomic info, neighborhood profiles, etc. Non-performing Loans Fraud detection PRICES Rating Agency Asset Manager Deal Structure Tranche-level Cash Flows for Underlying Bonds Home Equity & Other Deal Structures Trust Indenture Market perspective, $ Spreads Generate Cohort Default, Prepayment, Loss and Loss Severity Assumptions Trading Platform Decisioning 1 2 5 3 4 “ What-if” Scenarios LIBOR and Treasury Curves ( for several interest rate scenarios ) Periodic default, loss, prepayment, and total cash flow projections for each economic scenario Ratings at Issuance, Subsequent Rating Modifications Work-out Option Cash flow Impact Work-out Cost Work-out Program Options Payment Velocity & Periodicity
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