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Issue No. 157 | Mar 2018

Welcome to the Pipeline, Andrew Davidson & Co., Inc.‘s monthly newsletter,
a “pipeline” of relevant and useful information, focused on recent trends, changes
and advances in the mortgage investor’s market.




RATES, SPREADS & CCAR CHANGES

by Eknath Belbase

Interest rates and spread changes, and the resulting volatility in other sectors, have been in the financial news recently.

In our first article, I offer some perspectives on rates and spreads. The article begins with a look at progress on the Fed’s balance sheet unwinding to date. I also look at Treasury yield curve changes as well as a selection of corporate credit spread changes. Finally, I show some data on Treasury debt issuance and interest expenses as a share of GDP going back to 1970. The main idea behind this article is that it is a reasonable time to stop viewing rates and spreads from the perspective of the post-crisis 2009-17 period and take a longer-term view when thinking about interest rate risk management. For assets (such as CLOs) where interest rate and spread increases naturally impact fundamental credit risk, the corollary of this idea is that it is a reasonable time to widen perspectives on credit risk as well.

Our second article, by John Gao, Alex Levin and Daniel Swanson, is about the CCAR scenarios released by the Fed for 2018. The severely adverse scenario is different from 2017 in that interest rates rise, reflecting a “stagflationary” outlook, or one reflecting difficulty financing our debt (which overlaps with the outlook towards the end of our first article). In this article, the authors next examine how model results look on a number of different prime, sub-prime and Alt-A assets and place the base, adverse and severely adverse scenarios in the context of AD&Co’s scenario grid. The article concludes with a section on what clients of each of our different products will be getting, as well as a longer appendix with a number of technical details on interpolation and extrapolation processes required to turn the Fed’s descriptions of the scenarios into usable model inputs.

We look forward to your comments.

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THINGS (FINALLY) START CHANGING

by Eknath Belbase

In previous Pipeline articles, we have focused on the planned roll-off of mortgage-backed security (MBS) holdings from the Federal Reserve (Fed) balance sheet as well as expressed some surprise at the relatively weak impact that expectations of increased Treasury and MBS net supply have had on the level of rates and spreads. In this article, we look at the most recent data on these holdings—recent yield curve and spread developments—and finish with some longer-term musings.

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CCAR 2018: AD&CO’S ANALYTICS AND DATA FILES

by John Gao, Alex Levin, and Daniel Swanson

On February 1, the Federal Reserve Board (Fed) released three scenarios—Base, Adverse, and Severely Adverse—for the 2018 Comprehensive Capital Analysis and Review (CCAR). These scenarios describe three-year trajectories based on key economic indicators; of these 28 indicators, or variables, the ones used by AD&Co’s mortgage models are home price (CoreLogic national HPI); interest rates (3-month, 5-year, and 10-year Treasury, Prime index, and mortgage primary rate); and national unemployment.

The information provided by the Fed is not sufficient to project credit losses and bank capital levels without some transformation (including interpolation and extrapolation) of its assumptions. In order to assess lifetime losses or changes in market values, a much longer projection of the variables is required. Furthermore, most adjustable-rate mortgages are not indexed to the three Treasury rates provided, and the forecast of the national HPI is not an accurate indicator of diverse geographical stresses.

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