On this leap day edition of the Pipeline, we present four articles.
Our first article outlines recent macro developments that impact potential interest rate scenarios over the next year. I look at the ongoing convergence between market views as captured by Fed Fund futures/the yield curve and Fed views from the last dot plot, risks from the CRE space and finish with implications for the agency coupon stack.
In this article, we look at recent macro developments, the discrepancy between the Fed’s view and the rate path views embedded in Fed fund futures and discuss some potential scenarios that could evolve over the course of the year. We finish by looking at the agency coupon stack and the potential implications of these scenarios.
Much to the dismay of securities markets, which have struggled to price risk in an uncertain environment, the auto market has been on a joy ride for the past few years. When reflecting on just how strange the market has been, several things come to mind: appreciation of new and used vehicles; a couple of ABS deals are positioned to incur losses on a few lower tranches; manufacturers’ wide production of electric vehicles—and a sports car launched into outer space.
2024 CCAR SCENARIOS: MANDATORY AND EXPLORATORY STRESS-TESTING THROUGH AD&CO’S ANALYTICS
By Alex Levin & Daniel Swanson
On February 15, the Federal Reserve Board (Fed) released two scenarios—Base and Severely Adverse—for the 2024 Comprehensive Capital Analysis and Review (CCAR). In addition, the Fed released two exploratory scenarios (A and B) that combine economic stresses with higher, rather than lower, interest rates, thereby increasing the cost of funding. These scenarios describe three-year trajectories based on key economic indicators.
As financial professionals, we spend much of our time evaluating financial products such as credit cards, mortgages, insurance, and investments to determine how to manage risk and grow net present value for our employers. We spend less time, perhaps, thinking about why these products exist at all and if they are providing benefit to our customers. Much of our financial and regulatory system is built on the idea that it is the duty of the customer to determine which products are right for them and what price to pay.
As part of a larger initiative underway at Andrew Davidson & Co., Inc. (AD&Co) to incorporate the impacts of climate change risks into several of our models and economic analyses, we use inputs from risQ (now part of Intercontinental Exchange, Inc. and hereinafter referred to as ICE) on underinsured flood risk for the state of Florida. Assuming a fair hike in insurance premium, we convert it into a change in the economic cost of borrowing and home price outlook. In search of economic consequences for our industry, we focus on loan guarantees: premium rate and economic capital.
FLOOD INSURANCE SPIKE IN FLORIDA: EFFECT ON HOME PRICES AND THE ECONOMICS OF LOAN GUARANTEES
By Alex Levin
As part of a larger initiative underway at Andrew Davidson & Co., Inc. (AD&Co) to incorporate the impacts of climate change risks into several of our models and economic analyses, we use inputs from risQ (now part of Intercontinental Exchange, Inc. and hereinafter referred to as ICE) on underinsured flood risk for the state of Florida. Assuming a fair hike in insurance premium, we convert it into a change in the economic cost of borrowing and home price outlook. In search of economic consequences for our industry, we focus on loan guarantees: premium rate and economic capital.
MSR VALUATION AND HEDGING STRATEGIES VIA MSRKINETICS
By Richard Cooperstein & Vivian Li
Andrew Davidson & Co., Inc. (AD&Co) was a bronze sponsor of IMN’s 9th Annual Residential Mortgage Servicing Rights Forum held on November 9 – 10 at the New York Marriott at the Brooklyn Bridge. Richard Cooperstein, Director of Alliances & Policies at AD&Co, spoke on a panel titled “Valuation, Modeling & Risk Inputs: Volatility, Liquidity, Credit, Market, Duration & Correction.” The panel discussion continued the conference theme of managing interest rate risk in a higher rate environment. Using AD&Co’s Mortgage Servicing Rights Kinetics (MSRK) product, Richard presented the rate risk dynamics of various MSR note rates and a simple example of hedging rate risk and stabilizing returns across various future interest rate scenarios.
The CRT Monitor is a monthly report analyzing traded tranches of Agency Credit Risk Transfer deals. We evaluate the CreditProfile Category (CPC), the underlying credit metrics, and OAS given market levels at month close. The underlying analysis is performed using RiskProfiler, AD&Co's end-user valuation solution, and the LoanDynamics (Credit) Model.
The AD&Co US Mortgage High Yield Index (USMHY) tracks the total return of bonds issued within the Credit Risk Transfer (CRT) program of Fannie Mae and Freddie Mac. USMHY is an informational, investment-oriented monthly index of the return components: price, coupon, paydown, and credit loss. Accompanied by standard risk metrics from AD&Co models, the index is useful for comparisons with individual CRT bonds or relative value to other credit markets. CRT bonds are grouped into risk tiers corresponding to initial credit support. AD&Co’s Mid-tier index combines bonds with factors greater than 25%, excluding first loss bonds and old M1 bonds that are no longer issued.
LoanKinetics (LK) is our multi-functional whole loan application that evaluates legacy and newly originated residential mortgage loans. It can be used to project credit performance, assess value (using multiple approaches), and perform loan loss analysis for reserving and understanding attribution.
MSRKinetics (MSRK) is the first of our new Kinetics offerings focused on assessing MSR risk. It evaluates mortgage servicing rights (MSR) and projects the impact of hedging with mortgage-backed securities (MBS) and TBAs.
LoanDynamics (LDM) is our flagship prepayment and credit model. It comes in several mortgage versions depending on asset class: Agency LDM and Agency LDM+; Non-Agency LDM, and Multifamily LDM. We have expanded our LDM offerings by developing the Auto LoanDynamics Model (AutoLDM), which projects life of loan delinquency migration until payoff, prepayment, or default and loss given default.
Thanks to a cooperative effort with Equifax (EFX), Andrew Davidson & Co., Inc.’s (AD&Co) Impact Trended Credit for LDM now includes Equifax’s Revolver/Transactor metric that characterizes consumer behavior on their credit card tradelines over time. We can now quantify the impact of trended data on credit risk, prepayment rates, and the price of mortgage related assets such as loans, securities, mortgage insurance and servicing rights.
The OAS Subroutine is our flexible valuation engine. It can evaluate mortgage backed-securities, combining LoanDynamics, our suite of MacroDynamics models, and our original and highly efficient cash-flow engines. MacroDynamics includes InterestRateDynamics, HomePriceDynamics, and UnemploymentDynamics.
The OAS Subroutine is our flexible valuation engine. It can evaluate mortgage backed-securities, combining LoanDynamics, our suite of MacroDynamics models, and our original and highly efficient cash-flow engines. MacroDynamics includes InterestRateDynamics, HomePriceDynamics, and UnemploymentDynamics.