Financial history doesn't repeat itself, but it often rhymes. You can't be stupid enough to trade off anything I say.... I'm lucky they let me out of the straight-jacket long enough to trade.

J. P. Morgan

"Sell down to your sleeping point"

Tuesday, February 24, 2009

Ok... Toxic Asset-Mark to maturity

I am a bank.

So, I have a loan, an ABS on a home 300K at 4%

it's a performer, made to a borrower paying back at full value.

is it toxic?

Well the value of the home is now 230K, but the borrower is still paying it back at 3%.

so that is $1432 coming in every month.

But... at best it has to be written down to .76 on the dollar.

Now it still is $1432 coming in every month..

but the thesis is, I need to get rid of it.... "Get the Toxic Asset off my books"

Mark to market....

If I take 230K... the value of the bond, which pays 230K at 3% over 30 years.

Right now I can buy Corporate debt AA at 6.86% over 20 years

Which means that the Market rate for my Money the 230K is Twice what it is in my ABS, and the credit risk is much less.

so if the Market rate for my money is twice that of what I'm getting. Then my ABS at .76 cents on the dollar... Is solidly 10-20% below .76 So now the Fair value is .60cents on the dollar.

So if I sell it, I get...$180,000, but it is returning $1400 per month over 30 years. That is $515520 Yield to maturity.

I'm taking 30% of it's yield to maturity value.... Why would I do that??? to make the market happy.

this is very simple look. and there are Tranches, and some mortgages that are not performing, and some ABS that are not at full yield, and will probably only return half of the money. There are some Very bad assets...

but the real problem is that the Value of money has come up, and that instead of bonds at 3% yield, we now have better quality borrowers who will now borrow money at 6-9%. That is where this "Mark to market" thing isn't working.

It's one thing to let the vultures feed, and it's another to Kill someone to Let them feed.


Tony said...

Excellent illustration. One of your assumptions is that the mortgage holder will continue to pay the $1470 per month and thus the ABS is "secure."

The problem is that assumption may be faulty. The only way the guy can make the $1470 per month is if he remains employed, and his wife also remains employed full-time and her employer is cutting her hours.

Furthermore, this is a non-recourse loan so if the mortgage holder defaults he does not need to file bankruptcy... little moral hazard. And he doesn't have any equity in the house anyway, so he'll just walk away.

Sure he needs a place to live, but heck there are tons of houses on the market and someone will surely rent him one for $800 per month after he forecloses.

So the "S" in the ABS illustration is not very "secure." The $1470 and $515,000 is a big big assumption.

That is exactly why deflation is worse in some ways than inflation.

Eric said...

hopefully I was clear that, that isn't all of them... but it is a good illistration why they don't want to let "Some of them" go. and why they shouldn't.

and I'm pointing out that it's not for Santelli to tell them what they need to do it's just the vultures trying to get the "t-bones"

I also am not saying that there are some that are only yielding half of what they were, and they are in total denial.

I could devolve into the actual structure where each abs is broken into 15 different Traunches... and how each of those traunces gets a different position in the pay structure... but that means that some of the ABS are more valuable and stable than some of the later traunches.. Meaning some are better for securitization than others.. Meaning they are More likely to yield in the long term.

Eric said...

I told somebody yesterday "HOPE FOR INFLATION"...

we can do something about inflation...

You also know me, I like that I'm the only guy on the planet who owns a bank...helps me sleep.(if to be honest I call what I keep having sleep) the minute that "They all own banks" i'll be gone down the road.

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