Condos and "The Borg"

Written by Jack Broad

What possible connection could the infamous “Borg” have with the condo market here in the U.S.? Well read on and you’ll see how my crazy mind works some times.

In the weekend edition of the WSJ there is an article on the coming glut of condos on the market. The article is not talking so much about the already completed glut of condos, but the fact that many developers back at the height of the housing boom committed some of their own funds initially, started development of condos, rushed around and got loan commitments that would enable them to go ahead and complete the project and really got themselves STARTED on their projects to a point where they can’t really back away from completing the projects now. They’re COMMITTED in other words.

The article is attempting to explain why there was such a furious building up of condos in the U.S. during the years 2004 through 2006. It says: “Speculation was rampant as investors believed empty nesters and young professionals seeking an urban experience akin to what they watched on ‘Friends’ would prop up the condo market for years.”

Huh!! Are you kidding me? You mean to say that a bunch of people dutifully glued to their TV sets watched a sufficIent number of episodes of “Friends” that they were thereafter infected with the idea of “Friends”and their condo-living existence complete with congregating in their ‘hive-like’ structures in urban environments because it maybe reminds those yuppies of their dorm-like existence with their collegiate buddies and that somehow this idiocy became so embedded in their minds that it was as if ROOTED in the very cores of their collective psyches, so much so that it was the CAUSE of a furious condo build out. Ha ha ha!! That is an utter fallacy. Who are they kidding? Does the WSJ really believe that investors are so utterly stupid as to believe the above nonsense. What an insult to investors, yuppies and empty nesters alike.

What are we some sort of damn termite with a deeply embedded genetic goal to “build-build-build-until-we-reach-the-very-stars”. I must admit that some of the images of termite nests I found on a Google search do look quite a bit like some of those structures lining the shores of Miami and other cities around the U.S. if only because of how many of them are dark at night because no one is actually living in them.

Are we sort of like an ant colony pre-programmed by nature out of many millions of years to do things that way because “this is what ants do so we must do it.” Sort of like doing the “CC” (colonially correct”) thing.

This idea of “Friends” causing the excess building of condos in America is just another financial “insanity of the day” or another “lunacy of the month” being foisted off on the financially interested public.

I can just see them now… Millions of yuppies and investors, dark-eyed and unthinking sitting there thinking about their American Dream. Repeat after me in a robotic monotone voice: “I have watched ‘Friends’. I want to live like the lovely people on that show and laugh and say silly things. This must be one of my life-long sought after goals. It is now engraved on my inner being. I will forever more strive to achieve that end.” Give me a break.

If you repeated the above in that monotone are you starting to hear how it’s a bit like the unthinking Borg of Star Trek fame: “Resistance is futile. You will be assimilated.”

This even harkens back to my childhood when getting the bejesus scare out of me by watching a British show called, “Dr. Who”. There were these killer robots called the “Daleks” shaped like big salt shakers with rounded bumps all over them frightening little kids all over the United Kingdome with their: “You will be exterminated.” line of utter terror.

Okay, reel me back in please. I’ve drifted off into a no man’s land of utter silliness.

So you now see the connection between the condo craze and the Borg right? Sorry, we ain’t robots. We’re not the Borg. We’re not ants. We’re not termites. We are not even “herds of animals”. We’re living, breathing, thinking, beings – who can make judgements and decide and are aware of our environments and of ourselves. We are not machines.

What does this have to do with finance. Not too much, I guess.

Thetica Systems’ ABS Trader Tools is a high performance suite of tools that boosts productivity for ABS, CMBS, CDO and CDS traders and analysts.

Thetica Systems is a sister company to Thetica LLC, a consulting firm which over the last two decades, has developed a reputation for consistently providing top quality IT solutions to the financial industry in record time. Our deep understanding of the industry and what clients really need and want are the basic building blocks of Thetica Systems’ success. For more information visit us atwww.TheticaSystems.com

ABS Market Makers and the great Transparency Myth

As mentioned in the previous article, rating agencies have taken a huge hit to their reputations because they have been very slow to react to the market and have been outright wrong about their “opinions” as to ratings. So if there is so much dependency that financial institutions have soldered into the rating agencies disclaimed opinions (see how little they trust even themselves), what else can be done to come up with better and more timely quotes for market participants. There’s been a lot of press relating to howUN-transparent the market in ABS and mortgage backed securities has been and how this has contributed to the problem.Today’s rant is not so much of a rant as a series of things that can be done to provide varying degrees of market transparency and thereby add liquidity to the business of offering prices for ABS securities:

1. Use the CDS on ABS market as a proxy for quotes on cash. Sure, there will be some “basis” (difference between the quotes on ABS CDS and the underlying quotes on Cash instruments), but as in the Corporate Bond market, CDS quotes go a very long way to giving one and all a pretty good feel for what the market perceives is the riskiness of these securities. The CDS market is so far ahead of the Rating Agencies as an indicator as to make the rating agencies almost “redundant” (I’m using the British meaning of the word here). In fact they’re so bad, I’d be hesitant to even include them at all, except as perhaps the very “tip of the iceberg” with a big warning sign all over it: “use at risk to your own investment health.”
2. Additionally, use the ABX Index market as a secondary proxy. If there are no quotes available for the “single name CDS on ABS” from 1 above, then it’s quite possible to find the ABX tranche that the specific bond is “most like” and use that as an approximation of the price. See www.markit.com for more information on ABX pricing
3. Use actual trade prices. For all corporate bond trades in the US, it is required that no more than 15 minutes after a trade, that it be entered into the NASD TRACE (trade reporting and compliance engine) system. The counterparties to the trades are anonymous, but you can see the date & time of the trade, the price, the yield and most sizes of transactions. Make it a requirement that ALL ABS trades (and even ABX trades be entered into TRACE) and published broadly. Just this step alone would increase transparency greatly.
4. Make it a requirement for all dealers to submit daily indicative pricing for ALL Cusips that they have traded within the last 6-12 months. These need not be “firm” prices, but should obviously be as real as possible and as close to where a firm would trade if required. If all dealers were required to submit pricing daily, then the “bad prices” would be able to be weeded out. Each dealer can be “scored” in some way so as to ascertain the general quality of its routine pricing and these scoring tables could also be kept up to date. Again, www.markit.com would be an obvious candidate for managing something like this as they’re already the “arbiter” for ABX products as well as, to a lesser extent, single name CDS on ABS.
5. To continue further along the “transparency curve”, a given dealer, in the absence of known marks from the the 1^st three sources above, should be able to search through it’s database of “bid lists” and “color” data. Doing this for a single bond or retrieving the data for comparable bonds can go far towards assisting with working out what the price should be. This, of course, assumes that each trading desk has had the foresight to actually create and maintain a database of quotes & color historically. I’ve seen some where the primary source of bid list and related histories are gigantic Excel spreadsheets. These do function, but are very difficult to share amongst the participants of an individual trading desk. Better yet is to provide simple programs for dealing desks to save their quotes away to a real database for use by whoever is permissioned to see those quotes. If you don’t have a database already, you’re basically still in grade school at this point.
6. Use Bloomberg. Bloomberg has got several very useful functions to assist in calculating price based on spread and vice versa. If a firm doesn’t want to commit to a single price/yield, then give a range of prices and yields so as to give at least an idea of price. To make this more detailed, the more information that is given will result in higher quality prices for example, if the CPR rate was disclosed along with the quote. Attribution should be given to indicate that the pricing comes from Bloomberg.
7. Use Intex. Intex has an “applications programmer’s interface” which can be utilized to produce a wide range of complex scenarios. Some of the ways these can be analyzed are as follows:

• CPR’s

• CDR’s

• Loss Severities

• Collateral can be “bucketed-up” into various groupings such as “Fixed”, “ARM” and further into “2/28”, “3/27” and further still with “2/28 with a 2 yr prepmt penalty” etc. Each of these collateral groupings can have separate CPR, CDR and Loss Severity curves applied to them.

• Interest Rate stresses

Creating standard ways of stressing the above and providing matrixes of results for “Px/Yield” tables could go far towards assisting with determining the variability of any given bond to a wide variety of scenarios. The Intex API is quite complex but with some effort and education, the above can be made into a valid means of providing quotes to clients and to the public.Bottom line is that the above presents a fairly wide range of options for giving quotes in the market place. To the degree all of them are used determines the quality of any single dealer. The dealers should be scored according to their ability to not only do the above, but publish the above with the necessary information for other market p
articipants to see how the results were arrived at.So what’s all this about lack of transparency? With the above raft of solutions things should get quite a bit clearer. Let’s hope it’s not too late.

To find out more information about Thetica Systems and our products and services visit us on the web. http://www.theticasystems.com/

The Basics on Agency Vs Non-Agency Mortgages

Mortgages are typically broken out into two primary categories. Agency and Non-Agency.

An “Agency Mortgage” is one which is guaranteed or insured as to its interest and principal payments by a US agency. The largest of the agencies that issue these guarantees are: Ginnie Mae (Government National Mortgage Association); Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal National Mortgage Association). Because these mortgages carry a U.S. agency guarantee, lenders are very comfortable making the loan to any particular borrower because the lender does not have to worry about whether he will be paid. The Government guarantees that he will be paid. This increases the lender’s willingness to lend funds due to the fact that there’s no credit risk to the lender and makes mortgage money more available to consumers. Basically, Agency mortgages are considered “risk free”.

“Non-Agency Mortgages” do not have a government agency guarantee and are therefore more risky. If a borrower becomes delinquent, then the risks of non payments are experienced by the lending institutions. This is what is known as “credit risk” – there is some element of risk connected to the belief in a person’s ability to pay principal or interest.

To find out more information about Thetica Systems and our products and services visit us on the web. http://www.theticasystems.com/

Mortgage Grading (Quality)

Mortgage Grading (Quality)

Written by Jack Broad

Residential Mortgage Backed Securities (whether Agency or Non-Agency) are also called RMBS or simply MBS. MBS are a type of “security” called a “bond” whose coupon and principal payments are paid for by the cash flows of a pool of individual mortgages. The individual mortgages “back” (or “support”) the payments on the bonds therefore they are called “Mortgage Backed Securities”.

Mortgages and the MBS related to them are graded as to quality in a variety of ways. For example, “Prime”, “AltA” (short for “Alternative A”) and “Sub-Prime” (this last category has been in the press a lot recently).

The person’s “FICO score” is one primary method of trying to work out how much of a credit risk any given individual is. The world “FICO” comes from the names of two men (an engineer, Bill Fair and a mathematician, Earl Isaac) who teamed up and created a “Corporation”. These guys developed a system for coming up with a “credit score” for borrowers, which incorporates a wide variety of financial information about an individual’s income and expenses resulting in the individual’s “FICO” score. This score is widely used in the industry to assist in determining any individual’s “credit-worthiness” and this assists the lender in knowing what interest rate to charge the borrower. In general, the lower your FICO score, the higher the interest rate the lender will charge you to offset the perceived credit risk of lending to you. After all, the lower the FICO score, the greater is the risk that you may not be able to pay back the lender.

FICO scores range from 300 to 850. A score of 660 and above categorizes a person as prime quality. The “Prime Rate” is defined as the interest rate banks charge their best customers.

From 620 – 659 is “Sub-Prime” – if you are a sub-prime borrower you will have to pay higher than the prime rate by some negotiated amount.

The word “credit” means “belief in a person’s ability to repay principal and interest.” Determining a person’s “credit-worthiness” is a key goal when deciding whether or not to give them a loan – whether it’s for a car, a mortgage, whatever – any kind of loan.

Another way of roughly grading mortgages is basically “A” (Prime); AltA (a variation of or alternative to “A”) and “B/C” (Sub-prime). Down at the very bottom of the barrel is the lowest grade “D” – this can also be called “Scratch and Dent” (S&D).

Recently we’ve been doing extensive work for a major Wall Street client in their Scratch and Dent area. Basically, these loans are normally in a “distressed state” – meaning the borrowers are, to a greater or lesser degree, delinquent on their payments. For example, if the client can purchase those delinquent loans from another for really cheap and then turn the borrower around so that they are no longer delinquent, the client can themselves then sell those loans at a much higher price than they originally bought them. THETICA has used it’s software components to create versatile software that assists the client to capture information relating to Scratch and Dent loans, price them and then analyse the performance of pools of these loans across time.

**Thetica Systems’ ABS Trader Tools is a high performance suite of tools that boosts productivity for ABS, CMBS, CDO and CDS traders and analysts.

Thetica Systems is a sister company to Thetica LLC, a consulting firm which over the last two decades, has developed a reputation for consistently providing top quality IT solutions to the financial industry in record time. Our deep understanding of the industry and what clients really need and want are the basic building blocks of Thetica Systems’ success.

To find out more information about Thetica Systems and our products and services visit us on the web. http://www.theticasystems.com/