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May 5, 2009
MORTGAGE BACKED SECURITIES AN ACTUARIAL APPROACH TO
CASH FLOW ANALYSIS
Kyle S. Mrotek, FCAS, MAAANeal Dihora, ASA, CFA
CAS Spring Meeting
May 5, 2009
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May 5, 2009
Disclaimer
This presentation contains our views and these views are not necessarily identical to the views of the cosponsors of the program nor the employers or clients of the speakers
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May 5, 2009
Agenda
Background on the MBS market
Current situation
Actuarial model presentation
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May 5, 2009
Background
Gross Issuance
Agency vs. Non-Agency Issuance
Split by non-agency type (prime, subprime, alt-a)
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May 5, 2009
Gross Issuance
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
Gross MBS Issuance ($ millions)
Agency
Total Non‐Agency
Total MBS
Source: Inside MBS & ABS and UBS
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May 5, 2009
Agency vs. Non-Agency
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Percen
t
MBS Market Share
Agency
Total Non‐Agency
Source: Inside MBS & ABS and UBS
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May 5, 2009
Non-Agency by Type
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
500,000
Non‐Agency Gross MBS Issuance($ millions)
Alt‐A
Jumbo
Subprime
Other
Source: Inside MBS & ABS and UBS
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May 5, 2009
Non-Agency by Type
0%
5%
10%
15%
20%
25%
Percen
t
Non‐Agency (% of Total MBS Issuance)
Alt‐A
Jumbo
Subprime
Other
Source: Inside MBS & ABS and UBS
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May 5, 2009
Current Situation
• What happened?• Liquidity evaporated
• Market values eroded
• Why is valuation needed?• GAAP Accounting regulations still require a value (FAS 157)
• Risk quantification• Distribution of assumptions and valuations
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May 5, 2009
Liquidity Evaporated
Broker/Dealers of non-Agency MBS unwilling to provide liquidity 1
Forced liquidations of MBS set market prices 1
Pricing vendors find it difficult to obtain “real” prices
Bid - Ask spread is 10-30 points depending on collateral and the depth of distress 2
1AD&Co's 16th Annual Conference: The Times They Are A-Changin‘2”Getting Out of the Mess” by Dave Hurt at the Loan Performance Symposium March 11, 2009
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May 5, 2009
Liquidity Evaporated
100
120
140
160
180
200
220
240
260
280
300
1/9/04
3/9/04
5/9/04
7/9/04
9/9/04
11/9/04
1/9/05
3/9/05
5/9/05
7/9/05
9/9/05
11/9/05
1/9/06
3/9/06
5/9/06
7/9/06
9/9/06
11/9/06
1/9/07
3/9/07
5/9/07
7/9/07
9/9/07
11/9/07
1/9/08
3/9/08
5/9/08
7/9/08
9/9/08
11/9/08
1/9/09
3/9/09
Mortgage Spread (Conventional Mortgage Loan less 10‐year Treasury)
Mortgage SpreadSource: Federal Reserve Board
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May 5, 2009
Erosion of Market Values
50
75
100
125
150
175
200
225
1890 1910 1930 1950 1970 1990 2010
Real Home Price Index (1890‐2008)
Source: http://www.econ.yale.edu/~shiller/data.htm
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May 5, 2009
Erosion of Market Values
100
120
140
160
180
200
220
Jan‐00
Apr‐00
Jul‐0
0
Oct‐00
Jan‐01
Apr‐01
Jul‐0
1
Oct‐01
Jan‐02
Apr‐02
Jul‐0
2
Oct‐02
Jan‐03
Apr‐03
Jul‐0
3
Oct‐03
Jan‐04
Apr‐04
Jul‐0
4
Oct‐04
Jan‐05
Apr‐05
Jul‐0
5
Oct‐05
Jan‐06
Apr‐06
Jul‐0
6
Oct‐06
Jan‐07
Apr‐07
Jul‐0
7
Oct‐07
Jan‐08
Apr‐08
Jul‐0
8
Oct‐08
Jan‐09
Case‐Shiller Home Price Index Since January 2000
'Case Shiller 20 City Compsite'Source: Standardand Poor's
Jul06: 206.5
Jan 09: 146.4
Decline: ‐29%
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May 5, 2009
Erosion of Market Values
0
10
20
30
40
50
60
70
80
Price
ABX HE AAA 2007‐2 Index
Source: Bloomberg
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May 5, 2009
Erosion of Market Values
ABX HE AAA 2007-2 Index ComponentsACE Securities Corp. Home Equity Loan Trust, Series 2007-HE4Bear Stearns Asset Backed Securities I Trust 2007-HE3Citigroup Mortgage Loan Trust 2007-AMC2CWABS Asset-Backed Certificates Trust 2007-1 First Franklin Mortgage Loan Trust, Series 2007-FF1GSAMP Trust 2007-NC1 Home Equity Asset Trust 2007-2 HSI Asset Securitization Corporation Trust 2007-NC1 J.P. MORGAN MORTGAGE ACQUISITION TRUST 2007-CH3Merrill Lynch First Franklin Mortgage Loan Trust, Series 2007-2 MERRILL LYNCH MORTGAGE INVESTORS TRUST, SERIES 2007-MLN1 Morgan Stanley ABS Capital I Inc. Trust 2007-NC3 Nomura Home Equity Loan, Inc., Home Equity Loan Trust Series 2007-2 NovaStar Mortgage Funding Trust, Series 2007-2 OPTION ONE MORTGAGE LOAN TRUST 2007-5 RASC Series 2007-KS2 Trust Securitized Asset Backed Receivables LLC Trust 2007-BR4 Structured Asset Securities Corporation Mortgage Loan Trust 2007-BC1 SOUNDVIEW HOME LOAN TRUST 2007-OPT1 WaMu Asset-Backed Certificates WaMu Series 2007-HE2
Source: markit.com 3/16/09
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May 5, 2009
GAAP Valuation Still Needed
Mark to Market – FAS 157 required companies to value holdings
• Level 1 – based on market price– Recent observed prices could be due to forced liquidation
• Level 2 – based on related price (ex. spread to treasuries)– Spreads can reflect lots of different risks (credit, liquidity,…)
• Level 3 – based on model price
Mark to Model pricing developed from loan level data– FASB relaxation of mark-to-market rules – Perhaps an ‘intrinsic value’ based on full range of scenarios
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May 5, 2009
Risk Quantification
The following table has daily percent changes of DJIA under a Normal Distribution assumption and reality
Percent Move (1916-2003)
Normal Distribution Assumption Reality
<>3.4% 58 1001
<>4.5% 6 366
<>7% 1 in 300,000 years 48
Source: Benoit Mandelbrot, Economist 1/24/2009
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May 5, 2009
MBS Valuation Flowchart
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May 5, 2009
Model FrameworkPurpose: to model the prepayment and loss rate assumptions to beused in a cash flow engine
Prepayment Model
– Willingness
– Ability
Loss Model
– Ultimate loss rate development methods
– Frequency of foreclosure
– Severity of foreclosure
Cash Flow Engine
– Assigns collateral cash flows to security structure based on triggers
• Triggers include prepayments, delinquencies and loss rates
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May 5, 2009
Model Characteristics
Transparent– Actuarial Standards of Practice– Model documentation
Credit FocusUtilize loan level experience– Loan Performance or other sources– Macro assumptions such as default rates, home price changes
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May 5, 2009
Prepayment ModelGoal: estimate percentage of loan amounts that will prepay
Willingness– Interest rate differential (refinancing, cash-out)– Loan/Product type– Fixed/Adjustable rate– Seasonality
Ability– Home price changes– FICO scores– LTV – original and current– Lending standards/policies
Federal government initiatives
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May 5, 2009
Ultimate Loss Rate Development MethodsGoal: estimate percentage of loan amounts that will default and severity of default
‘Paid’ Loss Development Factor (LDF)
‘Incurred’ LDF
A priori ultimate loss rate (ULR) development
Adjusted ‘paid’ BF method
‘Incurred’ BF
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May 5, 2009
Ultimate Loss Rate ‘Paid’ LDF
‘Paid’ losses to date– Can calculate from loan level data
– Providers such as Bloomberg also provide this data• Receive data from trustees/servicers of loans
Cumulative loss curve by age of loan– Examples on next slide
– What % of the losses should we expect to see at a certain loan age
Ultimate loss = ‘paid’ losses / % expected to be ‘paid’
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May 5, 2009
Ultimate Loss Rate ‘Paid’ LDF
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 102
105
108
111
114
117
120
Percen
t
Illustrative Loss Curves ‐Moody's and Fitch
Moody's Alt‐A FRM/ARM First Lien
Fitch Prime/Alt‐A
Fitch Subprime
Moody's Subprime FRM First Lien
Age (months)
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May 5, 2009
Ultimate Loss Rate “Incurred” LDF
‘Paid’ losses to date
Take current delinquencies to ultimate loss– Roll rate projections (project the % of delinquencies that default)
Severity (% of loan that is not recoverable)
Incurred losses = ‘paid’ losses + estimate of defaults x severity
Utilize incurred loss curves to calculate ultimate loss rate
Challenges/pitfalls
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May 5, 2009
A Priori ULR Development
• Frequency of foreclosure
• Severity given default
• Unadjusted a priori ultimate loss rate = frequency x severity
• Critical considerations for loan level collateral• Underwriting characteristics (FICO, LTV, documentation, etc.)
• Economic conditions the loan is exposed to
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May 5, 2009
A Priori Development - Frequency
• Frequency of Foreclosure– Historical data– Specific loan characteristics
– FICO– LTV– Amortization type (fixed, adjustable rate)– Interest only– Loan purpose (refinance, purchase)– Property type (single family, condo) – Occupancy (owner, second home, investor)– Loan documentation (full, low, none)– Loan size (jumbo, conforming)
– Future foreclosure estimates– Take delinquencies to ultimate loss– Economic variables (e.g., home price changes - see chart on slide 32)
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May 5, 2009
A Priori Development - Frequency
Amortization
FICO‐LTV
Interest Only
Loan Purpose
Property Type
Occupancy
Documentation
Loan Size
Illustrative Loan Characteristics
Prime
Alt‐A
Subprime
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May 5, 2009
A Priori Development - Frequency
Source: “Negative equity and foreclosure: Theory and evidence”, Christopher L. Foote, Kristopher Gerardi, Paul S. Willen, Journal of Urban Economics 64 (2008), pp. 234‐345
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May 5, 2009
A Priori Development - Severity
• Severity of Default– Home price changes– Costs of foreclosure (disposal, realtor, legal, upkeep)– Accrued interest– Current economic situation
– Home price depreciation results in higher severity– Government intervention may impact severity
– Bankruptcy law changes– FHA refinancing– Public/private partnerships– Interest claw back from 38% to 31% debt to income– Others…
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May 5, 2009
A Priori Development - Severity
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Loan Level Severity
Illustrative Loan Level Severity Distribution
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May 5, 2009
Ultimate Loss Rate Adjusted Paid BF
Paid losses to date
A priori persistency adjustment– Actual persistency = unpaid balance / original balance
– A priori persistency = anticipated unpaid balance
– Adjustment needed to allow for more/less losses based on actual vs. anticipated exposure duration
Adjust a priori ultimate loss (frequency x severity) by persistency factor
Use loss curve to estimate % yet to be paid
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May 5, 2009
Ultimate Loss Rate “Incurred” BF
Utilize incurred loss curve
Take a priori ultimate loss rate (from a priori development) – Utilize incurred loss curves to estimate % yet to be paid
Incurred BF ultimate loss = incurred to date + estimate of yet to be incurred
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May 5, 2009
Cash Flow Waterfall
Tranche level cash flows based on deal prospectus
Model needs to take into account specifics of the deal
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May 5, 2009
Cash Flow Waterfall
Illustrative NPV of Cash Flow Waterfall OutputNet Present Value (NPV)
RMBS Tranche Original Rating Scenario 1 Scenario 2 Scenario 3
A AAA 99.71 99.66 99.70
B AAA 77.63 78.52 69.03
C AA 79.09 7.81 1.64
D AA 78.64 9.96 1.66
E A 80.16 2.79 0.70
F BBB 86.83 0.64 0.39
G BBB 85.62 0.49 0.39
H BB 0.94 0.40 0.39
I BB 0.78 0.40 0.39
J Not Rated 5.46 5.34 0.39
K Not Rated 0.40 0.40 0.39
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May 5, 2009
MORTGAGE BACKED SECURITIES AN ACTUARIAL APPROACH TO
CASH FLOW ANALYSIS
Questions?
[email protected]@Milliman.com
