Investors’ worries about credit risk have been exacerbated by the proliferation of new products in the primary market. Mortgage products such as interest-only loans or loans with 40 years terms are unfamiliar to most investors, and most investors fear that these new products do not share traditional risk profiles observed in the historical data.
Investors face a “double whammy” with these new products. On the one hand, these products often have little, no, or even negative principal amortization. Moreover, there is a perception in the market that originators, particularly in Alt-A or subprime products, have expanded their underwriting criteria in an effort to sustain volume. There is sufficient concern for the regulators to have proposed new rules to monitor exposure to these “non-traditional” mortgage products.
What’s Required to Address Investors’ Needs
Clearly today’s investors in non-agency MBS/ABS face a combination of market and credit risks that can affect substantially the value of their investments. As a result, non-agency investors have a tremendous interest in better understanding borrower behavior and its
• direct impacts, such as delinquency triggers, on bond cash flows; as well as
• indirect impacts, such as prepayments or defaults, on bond cash flows via collateral cash flows.
Historically, investors performed scenario-based analyses of market risks for MBS, calculating metrics such as option-adjusted spread (OAS) using software tools built internally or by vendors such as QRM, Wall Street Analytics, etc. The schematic below illustrates a typical “process flow” for evaluation of market and credit risk for MBS.
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