Testing Residual Cash Flow Projections

Validating the accuracy of residual cash flow projections requires painstaking amounts of due diligence analyzing collateral and bond cash flows, reading documents, and confirming indicative data. The unique structure of private label MBS transactions and the leverage inherent within them make it more difficult and risky to use systematic processes to verify residual cash flow projections. Andrew Davidson & Co., Inc. (ADCo) has valued residuals backed by over $10 billion dollars in collateral in the last few years and recognized certain efficiencies associated with a generalized approach that focuses on minimizing the largest sources of expected errors with the minimum amount of effort.

Validating residual cash flows typically involves performing tasks such as:

    1. Reading bond documents
    2. Validating collateral indicative data
    3. Validating bond indicative data
    4. Analyzing historical information
    5. Constructing fair value assumptions (prepay losses, delinquencies, discount rate)
    6. Testing collateral cash flows
    7. Testing bond cash flows
    8. Testing the priority of payments and examining bond payment logic
    9. Analyzing principal allocation, and excess cash flow allocation, OC formation
  10. Analyzing residual cash flows

The approach outlined below can help validate residual cash flows more efficiently.

    1. Test the accuracy of collateral cash flows.
    2. Test the accuracy of non-residual bond interest payments.
    3. Test that the cumulative amount of principal paid to each non-residual class bond is correct.
    4. Check that residual cash flows equal the difference between collateral and non-residual bond         cash flows
    5. Examine bond payment logic; verify the sequence of bond principal payments, OC         accumulation and reductions, and the pattern of residual payments. >>>