Rating Residential Mortgage Backed Securitisations Corporate Valuation 2004 Conference Istanbul 28 M

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Rating Residential Mortgage Backed
SecuritisationsCorporate Valuation 2004
Conference Istanbul 28 May 2004
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Executive summary

• Overview of ratings process
• Valuation and the RMBS rating analysis
• Determination of default probability loss
  severity
• Cash flow analysis
• Worked examples of how credit enhancement is
  determined

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What is mortgage backed securitisation?

• Sale of residential mortgages to a special
  purpose, bankruptcy-remote vehicle (SPV).
• SPV funds the purchase by issuing bonds to
  investors.
• Investors rely on these assets for the payment of
  interest and ultimate principal due on the issued
  notes.
• Investors repaid even if originator defaults!

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What does Fitchs credit rating mean?

• The rating assigned by Fitch is Fitchs opinion
  on the ability of a securities issue to meet
  financial commitments such as interest, or
  repayment of principal on a timely basis.

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Key Steps in Fitchs analysis

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Methodology RMBS ratings

• Asset Analysis
• Considers the underlying assets as security.
• Property valuation is important for this purpose.
• Cash Flow Analysis
• Considers the ability of mortgagee cash payments
  to repay note obligations

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Credit enhancement

• Credit enhancement provides protection to the
  noteholders by absorbing losses.
• The rating assigned to the notes is based on an
  assessment of likely losses and the relative size
  of credit enhancement.
• RMBS Credit enhancement is calculated as
• default probability - first leg
• x
• loss severity second leg
• Analysis is on a loan by loan basis

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FIRST LEG determining default probability

• Loan-to-Value
• The loan-to-value (LTV) ratio measures the loan
  size as a percentage of the property value.
• For this purpose, the property value may be the
  purchase price. However, refinancing bonds may
  require valuation.
• Willingness to pay
• Debt-to-Income
• Debt-to-income (DTI) ratio the monthly mortgage
  obligation relative to each mortgagees income.
• Ability to pay, or financial resilience or the
  obligors.

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AAA default frequencies
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Indexation adjustment

• Adjustment of property values to take into
  account
• The time since valuation
• Property price inflation/deflation
• Nominal recovery value of property.
• Typical approach is to increase property values
  by
• 50 of observed inflation.
• 100 of any observed deflation.
• Effect impacts recovery assumption and default
  probability.

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Further default probability adjustments

• Underwriting quality
• Second homes/investment properties
• Self-employed borrowers
• Type of mortgages
• Arrears
• Limited information

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SECOND LEG determining loss severity

• Credit enhancement is calculated as
• default probability - first leg
• x
• loss severity second leg
• Market Value Decline (MVD)
• Foreclosure costs
• Carrying costs

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Loss severity Market Value Decline

• Stresses property recovery value based on
  historical price movements.
• Analysis undertaking for each region Where is
  the current property price index relative to the
  long term trend?
• The MVD for each rating category is the
  percentage by which the index is reduced,
  expressed as a percentage of the current index
  value.
• Areas with highest volatility and/or highest
  index relative to the trend will have the highest
  MVD.
• High and low priced properties

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Market Value Decline by Rating and Region South
African example
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Worked Example Loss Severity

• Loan Balance 200,000
• AAA Scenario
• Property Market Value 250, 000
• Market Value Decline (45) 112,500
• Foreclosure Costs 16,500
• Carrying Costs 50,000
• Estimated Recovery Value 71,000
• (Loan Balance - Est. Recovery Value)/(Loan
  Balance) 64.5 Loss Severity at AAA

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Worked Example Credit Enhancement

• AAA Credit Enhancement
• Default Probability x Loss Severity
• 14 x 64.5
• 9.03

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Finally dont forget the cash flow analysis!

• Payments under the notes rely heavily on cash
  flows from the assets. Cash flow analysis
  considers
• Excess spread
• Liquidity stresses
• Carry cost arising between default and
  principal recovery

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Contact Details

• Istanbul
• Botan Berker 90 212 279 10 65
• London
• Patrick Kearns 44 207 417 6318
• Adrian Dommisse 44 207 417 3497
• Jennifer ONeil 44 207 417 3550
• www.fitchratings.com

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www.fitchratings.com