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Account for the tools used to analyse the performance of securitized structures and name the asset classes each suits best.

FRM® Part II · Credit Risk Measurement and Management · An Introduction to Securitisation · FRM2.CR.23.f

The idea

Different assets need different performance tools. For residential mortgage pools the key issue is prepayment, so analysts use CPR, SMM and the PSA benchmark, together with WAL, WAM and WAC. For commercial mortgage pools and similar income-producing property loans they use the debt service coverage ratio, which is net operating income divided by debt service. For credit card trusts, whose balances revolve and have no scheduled amortization, they track the monthly payment rate, excess spread, delinquency ratios and charge-offs or default ratios. Delinquency and default ratios are used across consumer asset classes, including auto loans. The weighted average life summarizes the timing of principal for any amortizing pool. It depends on the prepayment assumption, and faster prepayments shorten it. The typical mistake is applying a tool to the wrong asset class, such as quoting a PSA speed for a credit card trust.

A practice question

From the question bank, with the reason each wrong option is wrong.

Which indicator is most closely associated with the performance analysis of credit card securitizations?

  1. The PSA prepayment speedWhy not: This is a benchmark for residential mortgage prepayments.
  2. The debt service coverage ratioWhy not: This measures income coverage of debt on property loans, not card balances.
  3. The weighted average maturity at originationWhy not: Card balances have no scheduled maturity profile for this measure to describe.
  4. The monthly payment rate - correct

Card trusts have revolving balances, so analysts track the monthly payment rate along with delinquencies, charge-offs and excess spread.

A harder one

Why is the PSA benchmark not appropriate for analyzing a credit card trust?

  1. Card trusts have no credit risk, so prepayment is the only riskWhy not: Card trusts have significant credit risk, tracked through delinquencies and charge-offs.
  2. Card balances revolve with no scheduled amortization, so analysts track the monthly payment rate instead - correct
  3. PSA applies only to commercial property loansWhy not: PSA is a residential mortgage benchmark and not a commercial property measure.
  4. Card trusts pay principal only at final maturity, so prepayment cannot occurWhy not: Principal is paid and reinvested during the revolving period; the problem is the lack of an amortization schedule.

PSA assumes a mortgage-style seasoning ramp. Card balances revolve and have no schedule, so payment rate, delinquency, charge-off and excess spread are used.

The hardest tier

A residential mortgage pass-through has a WAL of 8.4 years at 100 PSA. Market rates fall sharply and the pool's speed rises to 300 PSA. What is the most likely effect on WAL?

  1. WAL is unchanged, because it depends only on the contractual amortization scheduleWhy not: WAL includes prepayments, so it changes with the prepayment speed.
  2. WAL lengthens, because faster prepayments delay the final maturityWhy not: Faster prepayments bring the final maturity forward, not later.
  3. WAL lengthens, because the pool's coupon rises when low-coupon loans prepayWhy not: A falling rate environment makes high-coupon loans prepay first, and the coupon is unrelated to the direction of WAL.
  4. WAL shortens, because principal is returned sooner - correct

Faster prepayment returns more principal early, which pulls the weighted average time to principal receipt down. WAL is sensitive to the prepayment assumption.

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