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.
SUMMER SUMMARY
by Eknath Belbase
After the last two Fed meetings, the economy appears to be on track for the Fed to gradually begin balance sheet re-normalization some time later this year, barring any unexpected surprises in upcoming data. The minutes of the June meetings, released in early July, laid out the process by which the Fed expects to begin re-investing less and less principal from maturing Treasury securities and MBS. This announcement appears to have had little discernible impact on the stock market or Treasury and MBS markets. This could be because the market has fully processed this announcement and factored it in, or it could be that the eventual start of the process is viewed as too distant to react to at this time.
Our first article in this edition of the Pipeline examines interest rate back-up scenarios from an agnostic perspective relative to the market’s recent behavior. Using only prior interest rate change history and the current distribution of coupons, how much duration and prepayment risk is in the market? Our analysis shows that on an unhedged basis, a 95% tail risk back-up corresponds to approximately a $400 billion quarterly loss; on a duration-hedged basis, and assuming hedge effectiveness as modeled in prior work by Alex Levin, north of a $100 billion loss would remain.
Our second article, by Alex Levin and Harry Qin, looks at the dynamics of agency credit risk and implied G-fees. Using CRT prices of different tranches and deals over time and a combination of risk-neutral pricing as well as comparisons using the physical credit model, they determine that implied G-fees do not vary systematically across different CRT types (STACR vs CAS, low-LTV vs high-LTV); that market perception of credit risk has been visibly trending down over the last year, including 2017Q2; and that the technical (crOAS) component is also down.
Finally, in our Graphs of the Month section, Hikmet Senay presents graphs which show more details by type of deal, with subordination level and time period showing both implied G-fee and both physical and RN CrOAS results.
AD&Co News
Andrew Davidson & Co., Inc. officially celebrated our 25th Birthday on July 21, 2017. From the start, our goal has been to empower our clients with analytical tools, to help them to manage risk and identify value in the complex world of mortgages and mortgage-backed securities. We maintain the same goals today as we did in 1992, even as the market has fluctuated and technologies have changed. Another constant is that we remain grateful to the users of our models and services who put their trust in us. We recognize the tremendous obligation of your reliance on our models and we thank you for making these past 25 years possible.
If you missed Andy’s letter celebrating our first quarter century, please email ashlea@ad-co.com and she’ll email you a copy.
Mortgage Risk Conference in Santa Monica Oct 2-3, 2017
AD&Co’s Richard Cooperstein and Eknath Belbase will be featured speakers at IMN’s inaugural conference on Mortgage Risk Management Strategies, a forum on hedging, analytics and modeling technology. Stay tuned for updates and check out this link for more details about the conference. We hope to see you there. Please contact nancy@ad-co.com for more information.
In this article, we first examine recent data suggesting underlying strength in the labor market that has led the long end of the curve and mortgage current coupon to give back the rally that occurred after the last Fed meeting. Then we examine historical data on mortgage current coupon going back to 1984 to look at interest rate-tail risk. We suggest that this may be an opportune moment to think about hedge ratios, model error and risk-based capital in the context of interest rate risk-a topic that has been neglected in the aftermath of a financial crisis that was sparked by credit and origination risks.
THE DYNAMICS OF AGENCY CREDIT RISK AND IMPLIED G-FEE
by Alex Levin and Harry Lijia Qin
At a Glance
Implied G-fees remain consistent across different CRT types: STACR vs CAS, low-LTV vs high-LTV
The cost of selling credit risk has been visibly trending down over the last year, including 2017Q2
The technical (crOAS) component is also down: Market liquidity has improved
Figure 1 depicts the historical dynamics of implied G-fees assessed using AD&Co’s Risk-Neutral Agency Credit Model. This methodology is summarized below and also detailed in our October 2016 Quantitative Perspectives (QP). Implied G-fee is computed as the sum of annualized risk-neutral loss in each reference pool and the “cost of OAS” (illiquidity) of all tranches (sold or retained).
GRAPHS OF THE MONTH: IMPLIED G-FEES FOR CRT ISSUANCE
by the AD&Co Modeling Team
This month, we present graphs depicting historical dynamics in implied G-fees assessed using the AD&Co’s Risk-Neutral (RN) Agency Credit Model, followed by historical graphs showing both physical and RN crOAS levels. Overall, we can see a decrease in both average levels and at different levels of dis-aggregation, stemming from improved liquidity and technicals against a strong backdrop in terms of fundamental credit performance.
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.
SUMMER SUMMARY
by Eknath Belbase
After the last two Fed meetings, the economy appears to be on track for the Fed to gradually begin balance sheet re-normalization some time later this year, barring any unexpected surprises in upcoming data. The minutes of the June meetings, released in early July, laid out the process by which the Fed expects to begin re-investing less and less principal from maturing Treasury securities and MBS. This announcement appears to have had little discernible impact on the stock market or Treasury and MBS markets. This could be because the market has fully processed this announcement and factored it in, or it could be that the eventual start of the process is viewed as too distant to react to at this time.
Our first article in this edition of the Pipeline examines interest rate back-up scenarios from an agnostic perspective relative to the market’s recent behavior. Using only prior interest rate change history and the current distribution of coupons, how much duration and prepayment risk is in the market? Our analysis shows that on an unhedged basis, a 95% tail risk back-up corresponds to approximately a $400 billion quarterly loss; on a duration-hedged basis, and assuming hedge effectiveness as modeled in prior work by Alex Levin, north of a $100 billion loss would remain.
Our second article, by Alex Levin and Harry Qin, looks at the dynamics of agency credit risk and implied G-fees. Using CRT prices of different tranches and deals over time and a combination of risk-neutral pricing as well as comparisons using the physical credit model, they determine that implied G-fees do not vary systematically across different CRT types (STACR vs CAS, low-LTV vs high-LTV); that market perception of credit risk has been visibly trending down over the last year, including 2017Q2; and that the technical (crOAS) component is also down.
Finally, in our Graphs of the Month section, Hikmet Senay presents graphs which show more details by type of deal, with subordination level and time period showing both implied G-fee and both physical and RN CrOAS results.
AD&Co News
Andrew Davidson & Co., Inc. officially celebrated our 25th Birthday on July 21, 2017. From the start, our goal has been to empower our clients with analytical tools, to help them to manage risk and identify value in the complex world of mortgages and mortgage-backed securities. We maintain the same goals today as we did in 1992, even as the market has fluctuated and technologies have changed. Another constant is that we remain grateful to the users of our models and services who put their trust in us. We recognize the tremendous obligation of your reliance on our models and we thank you for making these past 25 years possible.
If you missed Andy’s letter celebrating our first quarter century, please email ashlea@ad-co.com and she’ll email you a copy.
Mortgage Risk Conference in Santa Monica Oct 2-3, 2017
AD&Co’s Richard Cooperstein and Eknath Belbase will be featured speakers at IMN’s inaugural conference on Mortgage Risk Management Strategies, a forum on hedging, analytics and modeling technology. Stay tuned for updates and check out this link for more details about the conference. We hope to see you there. Please contact nancy@ad-co.com for more information.
Please login to view the full Pipeline article.REMEMBRANCE OF BACKUPS PAST
by Eknath Belbase
In this article, we first examine recent data suggesting underlying strength in the labor market that has led the long end of the curve and mortgage current coupon to give back the rally that occurred after the last Fed meeting. Then we examine historical data on mortgage current coupon going back to 1984 to look at interest rate-tail risk. We suggest that this may be an opportune moment to think about hedge ratios, model error and risk-based capital in the context of interest rate risk-a topic that has been neglected in the aftermath of a financial crisis that was sparked by credit and origination risks.
Please login to view the full Pipeline article.THE DYNAMICS OF AGENCY CREDIT RISK AND IMPLIED G-FEE
by Alex Levin and Harry Lijia Qin
At a Glance
Figure 1 depicts the historical dynamics of implied G-fees assessed using AD&Co’s Risk-Neutral Agency Credit Model. This methodology is summarized below and also detailed in our October 2016 Quantitative Perspectives (QP). Implied G-fee is computed as the sum of annualized risk-neutral loss in each reference pool and the “cost of OAS” (illiquidity) of all tranches (sold or retained).
Please login to view the full Pipeline article.GRAPHS OF THE MONTH: IMPLIED G-FEES FOR CRT ISSUANCE
by the AD&Co Modeling Team
This month, we present graphs depicting historical dynamics in implied G-fees assessed using the AD&Co’s Risk-Neutral (RN) Agency Credit Model, followed by historical graphs showing both physical and RN crOAS levels. Overall, we can see a decrease in both average levels and at different levels of dis-aggregation, stemming from improved liquidity and technicals against a strong backdrop in terms of fundamental credit performance.
Please login to view the full Pipeline article.