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Valuation Commentary - Jan. '08
Valuation Modeling Lessons of 2007
by Alex Levin
We usually end each year with an annual MBS roundup, but this time I decided to change the focus. It is hard to add much to what everyone knows. I heard that linguists announced “subprime” to be the word of 2007. It was a disastrous year for holders of long positions in MBS. After thundering losses, the non-agency MBS market froze and marks became uncertain. Agency MBS, especially hybrid ARMs, widened considerably to agency debentures, despite of having similar credit. Many investors liquidated MBS positions to raise cash.
For analysts, this situation presents an opportunity to revisit fundamental modeling methods. It turns out that each troubling point lets us learn more and leads to a reassessment of our knowledge-base. Does the OAS method still hold? Can we compute missing economic values of non-agency MBS and how? And what about the use of prOAS that AD&Co has been advocating for the last several years? In this and the next month’s Pipeline articles, I try to offer possible answers to these questions.
Agency OAS History
Exhibit 1 depicts the crisis-infused OAS widening of the second half of 2007. It began in July-August, seemed to cool off by November and struck again in the last 2 months of the year.
