LO 35.6: Explain the various performance analysis tools for securitized structures

LO 35.6: Explain the various performance analysis tools for securitized structures and identify the asset classes they are m ost applicable to.
There are a number of performance tools designed to analyze the collateral pool of asset- backed security (ABS) and mortgage-backed security (MBS) products. MBS products were first created to provide cheaper financing for residential homes by issuing pass- through securities. Investors benefited from a new liquid asset class and lenders benefited by removing interest rate risk off the balance sheet. In addition, MBS were backed by a government-sponsored entity with Ginnie Mae issues. Auto loans and credit card ABS products also became more popular with investors during the low interest rate environment of 20022007. Investor demand grew for ABSs because they provided diversification benefits and offered higher returns than the corporate bond market.
The portfolio performance of ABS and MBS products is largely dependent on the ability of individuals to pay off their obligations in the form of consumer debt and mortgages. Performance measures serve as trigger methods to accelerate amortization. ABS structures
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Topic 35 Cross Reference to GARP Assigned Reading – Choudhry, Chapter 12
also have reserve accounts to protect against losses resulting from interest shortfalls. A key difference between the collateralized debt obligations (CDOs) and ABS structures is the number of underlying loans. A CDO portfolio typically consists of less than 200 loans, while ABS or MBS structures often have much greater diversity with thousands of obligors.
Auto Loan Performance Tools
There are specific performance measures that are used for different asset class types. Auto loans have features that are very favorable for investors in this ABS product. Auto loans are collateralized with assets that are highly liquid in the event of default. In addition, most loans have a short three to five year horizon. Thus, there is virtually no prepayment risk and losses are relatively low compared to other ABS.
A good measure of performance for auto loan ABS is the loss curve. The loss curve shows the expected cumulative loss for the life of the collateral pool. The expected losses based on the loss curve are compared to actual losses. Originators of prime loans typically have evenly distributed losses. Subprime or non-prime loan originators have higher initial losses resulting in a steeper loss curve. Losses for all types of loans typically decline in later years of the curve.
.Another important performance tool for the auto loan ABS is the absolute prepayment speed (APS), which indicates the expected maturity of the issued ABS. The APS measures prepayment by comparing the actual period payments as a percentage of the total collateral pool balance. The APS is an important measure that is used to determine the value of the implicit call option of the ABS issue at any time.
Credit Card Performance Tools
Another type of ABS product is collateralized by pools of credit card debt. The fact that credit cards have no predetermined term for outstanding balances differentiates this class from other ABS products. Despite having no predetermined term, most credit card debt is repaid within six months. The repayment speed of a credit card ABS is controlled by scheduled amortization or a revolving period under a master trust framework. Recall that the master trust allows multiple issues and principal collections to be used to purchase new receivables.
Three important performance tools for credit card receivables of ABS are the delinquency ratio, default ratio, and monthly payment rate (MPR). These three ratios serve as triggers to signal early amortization of the receivable pool. The delinquency ratio and default ratio measure the credit loss on credit card receivables pools. An early indication of the overall quality of the credit card ABS collateral pool is the delinquency ratio. The delinquency ratio is computed by dividing the value of credit card receivables that are 90 days past due by the total value of the credit card receivables pool. The default ratio is calculated by dividing the amount of written off credit card receivables by the total credit card receivables pool. The monthly payment rate (MPR) is calculated as the percentage of monthly principal and interest payments divided by the total credit card receivables pool. Rating agencies require every non-amortizing ABS (such as credit cards) to set a minimum MPR as a trigger for early amortization.
2018 Kaplan, Inc.
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Topic 35 Cross Reference to GARP Assigned Reading – Choudhry, Chapter 12