Collateral Pools Research Articles

Prepayment and Default Risks of Mortgage-Backed Security Collateral Pools

Mortgage-backed securities (MBS) are structured financial products that are produced via securitization of mortgage loans. Due to the nature of securitization, all risks of mortgage loans are transferred from originators to MBS investors. Prepayment and default risks of mortgages lead to uncertainty in MBS cash flows and create a complex problem for valuation of these instruments. Therefore, estimating these mortgage termination risks has become the focus of valuation of MBS collateral pools. This study explores two questions by using a publicly open dataset provided by Fannie Mae. First, two machine learning algorithms (Random Forest and Multinomial Logit Regression) are used for classification to predict whether a mortgage loan is likely to be prepaid, defaulted or current. Afterwards, Competing Risks Cox Regression Analysis is performed to see determinants of when mortgage termination risks are likely to happen. It is found that not all mortgage borrowers behave optimally in their prepayment and default decisions. Therefore, in addition to refinancing incentive and negative equity which depend on variations in prevailing mortgage interest rates and housing prices, heterogeneity in mortgage borrowers’ behaviors and loan characteristics, and also local economic factors are significantly important in estimating mortgage termination risks. It is worth noting that prominence role of mortgage payment delinquencies in particularly predicting defaults emphasizes the essential need of monitoring payments by servicers to keep safety of MBS investors and financial markets.

Are CLO Collateral and Tranche Ratings Disconnected?

Abstract Between March and August 2020, S&P and Moody’s downgraded approximately 25$\%$ of collateral feeding into CLOs and only 2$\%$ of tranche values, with rating actions concentrating in junior tranches. Both S&P and Moody’s modeling indicate that the impacts should have been considerably larger, especially for higher-rated tranches. Neither changes in correlation nor the accumulation of pre-COVID-19 protective cushions can explain the downgrade asymmetry on upper tranches. Instead, CLO managers repositioned their collateral pools to dampen the negative credit shock and rating agencies incorporated qualitative adjustments in their CLO ratings. Important potential policy and market implications from these findings are discussed. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Collateralization and asset price bubbles when investors disagree about risk

Abstract Survey respondents disagree strongly about the dispersion of future returns and, increasingly, macroeconomic uncertainty. Such disagreement about risk may raise asset prices when collateralized debt products allow investors to realize perceived gains from trade. Investors who expect low volatility in collateral cash-flow appreciate senior debt as riskless. Those who expect high volatility, in contrast, value the upside potential in junior debt or equity claims. We show how such self-selection may have had a sizeable effect on the prices of RMBS and CDOs before the crisis, as investors disagreed about the volatility of aggregate economic conditions and their importance for default rates in collateral pools.

How Informed Were Non-Agency MBS Investors? Evidence from Mortgage Servicing Fees

This paper examines the informativeness of servicing fees regarding the quality of mortgage collateral pools in non-agency securitizations and, ultimately, the value of the mortgage securities. We find that servicing fees capture some unobservable credit risk that explains mortgage default and differentially affects the performance of various security classes. However, junior bond yield spreads at issuance account for this risk, which suggests that investors were more sophisticated than previously thought or that deal issuers were more transparent about collateral credit risk than recognized in the literature. The slow reemergence of non-prime lending as non-qualified mortgage lending makes this study still relevant.

Climate-related Risks and Central Banks’ Collateral Policy: A Methodological Experiment

Central banks increasingly acknowledge that climate change is a source of financial risks, which is likely to also impact their conduct of monetary policy. Against this backdrop, the aim of this paper is to explore one potential approach to factoring climate-related transition risks into a central bank’s collateral framework. Given the radical uncertainty associated with measuring such risks, this approach relies on so-called climate “alignment” methodologies, which enable to assess the consistency of eligible and pledged marketable assets with specific climate targets. Moreover, this paper proposes a “climate-hedging portfolio approach”: instead of seeking to “align” the collateral on an asset-by-asset basis, central banks could aim for “alignment”, in aggregate, of the collateral pools pledged by their counterparties with a given climate target. The rationale for this choice is that assessing climate-related risk at the pool level avoids the Eurosystem having to decide on which assets/issuers in the pools should be excluded or capped, and is therefore more compatible with a market neutrality approach. The numerical experiment using Eurosystem marketable criteria data suggests that, in aggregate, neither the Eurosystem eligible collateral universe nor the collateral pledged is “aligned” with the climate targets of the European Union. From this perspective, the Eurosystem marketable collateral can be considered to be exposed to climate-related transition risks. We discuss the potential practical implications of aiming to “align” collateral pools, and suggest avenues for further work

РОССИЙСКИЙ РЫНОК ИПОТЕЧНОГО КРЕДИТОВАНИЯ И РЕЕСТРЫ ИПОТЕЧНОГО ПОКРЫТИЯ ОБЛИГАЦИЙ С ПОРУЧИТЕЛЬСТВОМ ИПОТЕЧНОГО АГЕНТСТВА ДОМ.РФ

The article examines the main trends in the development of the Russian mortgage market and the market of mortgage-backed securities (MBS) associated with government incentive measures. We consider the importance of the registers of mortgage collateral of MBS for the assessment of various risks arising when working with these securities. We analyze the quantitative aspect of mortgage loans in collateral pools for issues covered by the guarantee of the mortgage agency DOM.RF. The analysis of pools includes the aspects of time to maturity, yield, difficultness of the collateral loans and the changes in the Loan/Value ratio. We propose the directions for the development of models for predicting the prepayment levels for mortgage collateral pools.

АНАЛИЗ РЕГИОНАЛЬНОЙ СТРУКТУРЫ РЕЕСТРОВ ИПОТЕЧНОГО ПОКРЫТИЯ ОБЛИГАЦИЙ С ПОРУЧИТЕЛЬСТВОМ ИПОТЕЧНОГО АГЕНТСТВА ДОМ.РФ

In the article we consider the regional structure of aggregated mortgage collateral pools of MBS issues covered by the guarantee of the mortgage agency DOM.RF. We analyze the regional structure of outstanding mortgage loan balance in collateral pools and select the regions that represent the bulk of the collateral portfolio. We consider the link between socio-economic and pool characteristics. We find the links, which pass the test for significance. We find the possible presence of the burnout effect.

Risk Retention and Adverse Selection: New Evidence from Corporate CDOs

Recent regulatory policies require collateralized debt obligation (CDO) issuers to retain a portion of any securities they issue, but market participants argue this requirement unnecessarily restricts the flow of capital to firms. This paper tests whether removing these risk-retention requirements causes adverse selection in corporate CDO collateral pools. Using a natural experiment from a surprise 2018 legal ruling affecting a subset of the market, I find that bonds in CDOs with low skin in the game are riskier at issuance and become riskier after securitization, but find no evidence of increased at-issuance spreads. These results suggest that other safeguards in the corporate lending market are insufficient to prevent adverse selection in the absence of risk retention requirements.

Collateral Pools Shift as Aircraft ABS Accelerates

Aircraft asset-backed security (ABS) issuance has picked up in the past two years after coming to a halt following the 2007–2008 recession, and strong issuance is expected to continue into 2016. Stable performance and ratings are expected for outstanding transactions, supported by solid passenger-demand expectations. In this article, however, the author notes some softness in values and lease rates, particularly with regard to certain small-variant wide-body aircraft. The recent increase in ABS issuance has also introduced the market to collateral pools that represent a shift from what has typically been seen in the space. Notably, a few transactions have been completed that feature mid- to end-of-life aircraft and increased concentrations in regional jets and turboprop aircraft. Meanwhile, the author’s outlook for aircraft lessors is stable to positive because they are supported by strong industry fundamentals.

Applying the Volcker Rule’s Covered Fund Definition Separately to Individual Asset Pools within Multi-Issuance Special-Purpose Vehicles

The Dodd–Frank Act was signed into law in July 2010 in response to what is generally considered one of the worst financial crises in modern history. One of its more controversial provisions is the “Volcker Rule,” which prohibits banks from engaging in proprietary trading and from investing in and sponsoring private equity and hedge funds. Such funds are defined largely by reference to the concept of an “investment company” under the Investment Company Act of 1940, as amended, and certain exemptions from that definition. Although applying the Volcker Rule generally can be extraordinarily complex, additional complexity arises in the context of certain types of vehicles that issue on multiple occasions separate series of notes backed by separate collateral pools. Such vehicles are frequently used for “repackaging” transactions. Although they share the same corporate issuer, each series of notes issued is completely separate from each other series, and only the collateral underlying that particular series is available to creditors relating to that series. However, under the Investment Company Act of 1940, and thus under the Volcker Rule, the definition of investment company goes beyond the normal corporate boundaries such that things like insurance company separate accounts or analogous constructs, even within the same corporate entity, will be treated as separate issuers. Accordingly, the authors argue in this article that two of the more significant portions of the Volcker Rule (relating to determining what constitutes a prohibited hedge fund or private equity fund) must be applied, in the context of such multi-issuance vehicles issuing separate series of notes, on a collateral pool by collateral pool (i.e., a series by series) basis and not more generically to the nominal corporate issuer and/or all its issued series in aggregate. In other words, for a banking entity considering whether the Volcker Rule is implicated by a particular contractually ring-fenced (CR) series under an multi-issuance special-purpose vehicle (MSPV) program, it would generally look only to that particular CR series and how it fits into the MSPV program. Conversely, where a banking entity is considering whether the Volcker Rule is implicated by an MSPV program in general, it would need to analyze each CR series separately thereunder (in the context of that MSPV program). The status of one or more such CR series as covered funds is not in itself dispositive as to the status of any one or more other CR series issued by the same MSPV program. Of course, the desirability of intentionally being involved in an MSPV program that has some CR series that are covered funds and others that are not is highly questionable. Nevertheless, in circumstances where many non-covered funds exist under the same umbrella as a handful of covered funds, this approach may obviate the need to expend vast resources to build new structures or to restructure existing platforms.

Self-Reporting Under SEC Reg AB and Transparency in Securitization: Evidence from Loan-Level Disclosure of Risk Factors in RMBS Deals

This paper is designed to illustrate the limitations and potential bias in securitized residential mortgage data and examine the importance of such data issues for typical studies of RMBS market and the financial crisis. We use trustee data on mortgage characteristics provided by BlackBox Logic – the BBx data – to study the extent to which undisclosed mortgage characteristics distort the available data and impact risk analysis of RMBS collateral pools. We illustrate that substantial amounts of loan characteristic data in crucial fields like Occupancy, Property Type, Loan Purpose, and FICO are missing from the trustee data. The frequency of missing values is staggering, ranging from just under 9% for Property Type to 29% for FICO, up to almost 85% for Originator Name, all variables used in recent studies. The omissions are correlated to some degree with the securitization sponsor and even more dramatically with the identity of the deal trustee. Analysis of RMBS collateral should be built not upon the entirety of mortgage databases, but on stratified samples and should otherwise control for important sponsor and trustee fixed effects. The revisions for Regulation AB which require loan-level disclosure should be adopted in order to standardize mortgage disclosure. This is the first paper that examines selection bias in loan characteristics relied upon for a wide variety of mortgage market research that has substantially affected policy decisions in the post-crisis era.

Self-reporting under SEC Reg AB and transparency in securitization

Purpose – The purpose of this paper is to illustrate the limitations and potential bias in securitized residential mortgage data and examine the importance of such data issues for typical studies of residential mortgage-backed security (RMBS) market and the financial crisis. Design/methodology/approach – We use trustee data on mortgage characteristics provided by BlackBox Logic – the BBx data – to study the extent to which undisclosed mortgage characteristics distort the available data and impact risk analysis of RMBS collateral pools. Findings – We illustrate that substantial amounts of loan characteristic data in crucial fields like occupancy, property type, loan purpose and FICO are missing from the trustee data. The frequency of missing values is staggering, ranging from just under 9 per cent for property type to 29 per cent for FICO, up to almost 85 per cent for originator name, all variables used in recent studies. The omissions are correlated to some degree with the securitization sponsor and even more dramatically with the identity of the deal trustee. Research limitations/implications – Analysis of RMBS collateral should be built not on the entirety of mortgage databases, but on stratified samples and should otherwise control for important sponsor and trustee fixed effects. Practical implications – The revisions for Regulation AB which require loan-level disclosure should be adopted to standardize mortgage disclosure. Originality/value – This is the first paper that examines selection bias in loan characteristics relied upon for a wide variety of mortgage market research that has substantially affected policy decisions in the post-crisis era.

The Changing Collateral Space

This paper highlights the changing collateral landscape and how it may shape the global demand/supply for collateral. We first identify the key collateral pools (relative to the old collateral space) and associated collateral velocities. Post-Lehman and continuing into the European crisis, some aspects of unconventional monetary policies pursued by central banks are significantly altering the collateral space. Moreover, regulatory demands stemming from Basel III, Dodd Frank, EMIR etc., new net debt issuance, and collateral connectivity via custodians (e.g., Euroclear/ Clearstream/ BoNY etc) will affect collateral movements.

The Changing Collateral Space

This paper highlights the changing collateral landscape and how it may shape the global demand/supply for collateral. We first identify the key collateral pools (relative to the “old” collateral space) and associated collateral velocities. Post-Lehman and continuing into the European crisis, some aspects of unconventional monetary policies pursued by central banks are significantly altering the collateral space. Moreover, regulatory demands stemming from Basel III, Dodd Frank, EMIR etc., new net debt issuance, and collateral connectivity via custodians (e.g., Euroclear/ Clearstream/ BoNY etc) will affect collateral movements.

Relating Top Down with Bottom Up Approaches in the Evaluation of ABS with Large Collateral Pools

This paper provides asymptotic valuation formulas for credit derivatives on baskets, including synthetic and cash flow CDOs. As such, it provides the link between the bottom up and top down approaches used for the pricing of these credit risky securities.

RELATING TOP-DOWN WITH BOTTOM-UP APPROACHES IN THE EVALUATION OF ABS WITH LARGE COLLATERAL POOLS

This paper uses a conditional law of large numbers and a conditional central limit theorem to provide simplified asymptotic valuation formulas for credit derivatives on baskets, including synthetic and cash-flow CDOs. In particular, approximate pricing procedures are provided for synthetic and cash-flow CDOs. In the process, this paper also clarifies the relation between the "top-down" and "bottom-up" approaches for pricing credit derivatives.

Did Investors Outsource Their Risk Analysis to Rating Agencies? Evidence from ABS-CDOs

Based on a sample of 3254 floating rate tranches from 617 ABS-CDOs (collateralized debt obligations backed by asset-backed securities), this paper tests the 'rating overdependence' hypothesis – i.e., that ratings of structured products are a sufficient statistic (in terms of predicting future credit performance) for yield spreads at origination. The paper’s findings are fourfold. First, yield spreads at issuance predict future performance of ABS-CDO tranches even after controlling for the information contained in ratings. Second, the ability of yield spreads to predict future performance, however, is driven exclusively by ratings below AAA (and, to a lesser extent, also by the lowest priority AAA tranches), whereas spreads of super senior AAA tranches show no information content. Third, the predictive ability of yield spreads is lower for tranches from later vintages and for tranches from deals with more complex collateral pools. Fourth, the conditional correlation between ratings and spreads, in turn, is increasing in time and higher for tranches from complex deals. In sum, the evidence indicates that investors in (especially AAA) tranches from later and more complex deals have avoided performing costly due diligence on the securities they bought.

Did investors outsource their risk analysis to rating agencies? Evidence from ABS-CDOs

Based on a sample of 3254 floating rate tranches from 617 ABS-CDOs (collateralized debt obligations backed by asset-backed securities), this paper tests the “rating overdependence” hypothesis – i.e., that ratings of structured products are a sufficient statistic (in terms of predicting future credit performance) for yield spreads at origination. The paper’s findings are fourfold. First, yield spreads at issuance predict future performance of ABS-CDO tranches even after controlling for the information contained in ratings. Second, the ability of yield spreads to predict future performance, however, is driven exclusively by ratings below AAA (and, to a lesser extent, also by the lowest priority AAA tranches), whereas spreads of super senior AAA tranches show no information content. Third, the predictive ability of yield spreads is lower for tranches from later vintages and for tranches from deals with more complex collateral pools. Fourth, the conditional correlation between ratings and spreads, in turn, is increasing in time and higher for tranches from complex deals. In sum, the evidence indicates that investors in (especially AAA) tranches from later and more complex deals have avoided performing costly due diligence on the securities they bought.

Bankruptcy and the Collateral Channel

ABSTRACTDo bankrupt firms impose negative externalities on their nonbankrupt competitors? We propose and analyze a collateral channel in which a firm's bankruptcy reduces the collateral value of other industry participants, thereby increasing their cost of debt financing. We identify the collateral channel using novel data of secured debt tranches issued by U.S. airlines that include detailed descriptions of the underlying collateral pools. Our estimates suggest that industry bankruptcies have a sizeable impact on the cost of debt financing of other industry participants. We discuss how the collateral channel may lead to contagion effects that amplify the business cycle during industry downturns.

Securitization Rating Performance and Agency Incentives

This paper provides an empirical study, which assesses the historical performance of credit rating agency (CRA) ratings for securitizations before and during the financial crisis. The paper finds that CRAs do not sufficiently address the systematic risk of the underlying collateral pools as well as characteristics of the deal and tranche structure in their ratings. The paper also finds that impairment risk is understated during origination years and years with high securitization volumes when CRA fee revenue is high. The mismatch between credit ratings of securitizations and their underlying risks has been suggested as one source of the Global Financial Crisis, which resulted in the criticism of models and techniques applied by CRAs and misaligned incentives due to the fees paid by originators.