Tuesday 1400 Introduction to Structured Securities · Introduction to the Structured Securities...

© 2016 National Association of Insurance Commissioners


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Introduction to the Structured Securities

Introduction to the Structured Securities

Eric Kolchinsky Director, Structured Securities Group

NAIC


This presentation is pre-qualified for NAIC Designation Renewal Credits (DRCs). If you currently hold an NAIC APIR, PIR, or SPIR designation and are pursuing continuing education credit to maintain it, you may be awarded credits for your participation. To receive credit, you must be in attendance for the duration of the presentation.

Attention APIR, PIR, or SPIR Designees…



Learning Objectives

At the end of this presentation, you will be able to:

• Familiarize yourself with the Structured Securities Group

• Understand Insurance company exposure to RMBS and CMBS.

• Acquaint yourself with the annual RMBS/CMBS valuation process.


Structured Securities Group



About Us• Structured Securities Group (SSG) was formed in

2013 and is based in NAIC’s New York Office.

• SSG’s primary function is to oversee an annual valuation of insurance company held Residential Mortgage Backed Securities (RMBS) and Residential Mortgage Backed Securities (CMBS).

• In 2015, SSG analyzed approximately 27,716 CUSIPs consisting of 22,406 RMBS and 5,310 CMBS.


Our Origin• Non-agency RMBS market suffers substantial losses and securities’

downgrades.

• AIG on the brink of bankruptcy due to non-insurance subsidiary’s investment in RMBS and RMBS related instruments.

• Fannie Mae and Freddie Mac taken into conservatorship by the FHFA in 2008.

• Mortgage originators sued over misrepresentations regarding the quality of the mortgages sold into RMBS transactions.

• Monoline insurers which wrote financial guarantees on RMBS and RMBS-related instruments suffer from higher than expected claims. Many are in rehabilitation.



Impact on Insurance Regulation

• Recognition of the data and methodological shortcomings of Credit Rating Providers (CRP)

• Broader concerns about the extent of regulatory reliance on credit ratings

Development of an alternative methodology for measuring the credit risk of RMBS and CMBS


NAIC’s Financial Modeling

In 2009, NAIC responded to the impact of rating downgrades by the Credit Rating Providers (CRPs) on insurers’ risk-based capital (RBC) charges amid the burst of the real estate bubble.

In 2013, NAIC’s in-house Structured Securities Group (SSG) was formed to institutionalize the relevant regulatory functions.

Subsequently, the scope of financial modeling was expanded to commercial mortgage-backed securities CMBS for year-end 2010.

2009 2010 2013

The change in risk measurement for RMBS in the regulatory framework first became effective for the statutory reporting in year-end 2009.



Introduction to Structured Securities


Introduction• Structured Securities are fixed income investments

whose source of repayment is limited to a defined and legally segregated pool of assets.

• The most common underlying assets are mortgage related – residential and commercial.

• Statutory accounting for structured securities is defined by SSAP 43R, while analytical procedures are defined by Part Seven of the Policies and Procedures Manual of the NAIC Capital Markets and Investment Analysis Office.



RMBSResidential Mortgage Backed Securities

Description Securitizations of one to four family homes, separated by borrower and loan type (e.g. fixed/ARM).

Sub-types

1) Jumbo Prime – loans to borrowers typically above GSE limit2) Subprime/Alt-A – loans to borrowers with poor credit or loans non-

standard features.3) Resecuritization – repackaging of previously issued securities.

History Widely blamed for the recent financial crisis. Issuance of non-agency (non Fannie/Freddie) RMBS has dwindled in the aftermath.

Credit AspectsDue to the large number of loans and privacy limitations, the analysis is statistical in nature. Several consultancies provide macroeconomic projections by MSA and loan type.


INVESTORSInvest in MBS Certificates

UNDERWRITERSSells Certificates to Investors

ORIGINATORS(LENDERS)

Fund Individual Loans

MORTGAGORS (BORROWERS)

MORTGAGES

Fund

Indi

vidu

al L

oans Prom

ise to Pay

SPONSOR

TRUST (ISSUER)HOLDS POOL OF LOANS AND ISSUES

CERTIFICATES

Class A1

Class A2

Class M1

Class M2

Class B1

Class B2

DEPOSITOR

TRUSTEE & ADMINISTRATOR

SERVICERS/MASTER SERVICER

MORTGAGE POOL

RMBS Cash Flows



RMBS Outstanding ($Bil)

0

500

1,000

1,500

2,000

2,500

3,000

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Subprime Alt-A Jumbo Prime Resecuritization OtherSource: SIFMA


CMBSCommercial Mortgage Backed Securities

Description Securitizations of commercial property, primarily 1) office, 2) multifamily, 3) retail and 4) hotel.

Sub-types

1) Conduit deals include smaller a large amount of small loans 2) Fusion or Large Loan deal include a smaller number of large "trophy"

properties3) Single Asset – securitizations by a single very large property4) Resecuritization – repackaging of previously issued securities.

History CMBS Market traces its origins to issuances by the Resolution Trust Corp. Like the underlying market – prone to boom and bust cycles.

Credit Aspects

"Modeling plus". Smaller loans can be handled statistically, but large loans need to be analyzed with the aid of a CRE professional. Several sources for CRE relevant projections (e.g. cap rate and vacancy projections by MSA and type)



CMBS Outstanding ($Bil)

0100200300400500600700800900

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Conduit/Fusion Large Loan Resecuritization Single Asset Other

Source: SIFMA


Other Struct. Outstanding ($Bil)

0

500

1,000

1,500

2,000

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Automobile Credit Card Equipment Housing-RelatedCDO/CLO Student Loans Other

Source: SIFMA



Insurance company exposure to Structured Securities


Insurance Industry Holdings YE ‘15

Collateral Type 2015 YE BACV ($Bil)

2014 YE BACV ($Bil) % Change

RMBS 107.82 115.02 -6.3%CMBS 167.12 173.93 -3.9%Loan/CLO 52.36 51.79 1.1%Auto 20.60 23.05 -10.6%CTL 16.87 15.88 6.2%Credit Card 13.79 15.82 -12.8%Equipment Lease 13.44 13.63 -1.4%Student Loan 8.46 7.73 9.5%Aircraft Lease 10.27 7.01 46.5%Trade Rec 3.45 3.34 3.3%Other 110.55 96.98 14.0%Total 524.74 524.17 0.1%

Source: NAIC; Schedule D1s 2014 and 2015. RMBS and CMBS included non-modeled securities.



Exposure Trends

YE 2010 YE 2011 YE 2012 YE 2013 YE 2014 YE 2015CMBS Par 181.397 169.864 157.700 157.402 $160.997 $152.169CMBS BACV 171.637 161.862 151.428 154.848 $159.979 $151.862RMBS Par 151.224 151.516 138.988 132.674 $132.017 $124.613RMBS BACV 127.724 123.170 110.476 107.050 $107.087 $100.879

100.000

110.000

120.000

130.000

140.000

150.000

160.000

170.000

180.000

190.000

$ Bi

llion

sBACV and Par amounts of modeled CMBS and RMBS


Annual Valuation Process



Overview• SSG’s operates under an “outsource and oversight”

model. A vendor, currently Blackrock Solutions, is contracted to provide analysis for RMBS and CMBS.

• NAIC staff oversee all aspects of the process, including:

– Creating macroeconomic scenarios for approval by VOS (E) TF

– Oversight of modeling Credit Modeling including an extensive Quality Assurance process at the loan and pool level, as necessary.

– Delivery of results to Insurers through the AVS+ platform.

• The following slides detail NAIC modeling philosophy and process.


Building Blocks of Modeling

Valuation or analysis of structured securities typically take the form of four distinct steps.

Uses tranche cashflows to calculate some aspect of risk (e.g. rating, price)

Valuation Model

Uses the results of the Credit Model to allocate cashflows/losses to each tranche in the deal

Waterfall Model

Projects the performance of each loan based on macroeconomic scenario and loan characteristics

Credit Model

Projects macroeconomic variables which drive the Mortgage Loan Credit Model

Macroeconomic Model



Macroeconomic Model

“What’s going to happen in the world?”

Four scenarios of the NAIC:• Optimistic• Baseline• Conservative• Most Conservative

Valu

e/In

dex

Year

Illustrative Scenario Curves

Projects macroeconomic variables which drive the Mortgage Loan Credit Model

Macroeconomic Model


Credit Model“In a given macroeconomic environment, what’s going to happen to my loans?”

Mortgage poolMortgage pool

Outputs of Credit Model:A time series of aggregate performance statistics including Principal, Interest, and Loss projections that are required to determine Cashflow distribution and Loss allocation

Projects the performance of each loan based on macroeconomic scenario and loan characteristics

Credit Model



Waterfall Model“If the loans perform in a certain way, how does my investment (tranche) perform?”

Outputs of Waterfall Model:A time-series of cashflows for the tranche including principal and interest paid and losses taken.

Uses the results of the Credit Model to allocate cashflows/losses to each tranche in the deal

Waterfall Model


Valuation Model“If the investment performs in a certain way, what does that mean?”

The valuation block takes the raw cashflowsand transforms them into a form of risk/value measurement.

The NAIC currently uses Intrinsic Price defined as ‘Weighted Average of

(1 – Discounted Principal Loss)’.

Uses tranche cashflowsto calculate some aspect of risk (e.g. rating, price)

Valuation Model



Price Breakpoints

Intrinsic Price, output of financial modeling

CUSIP Type AVR or NON-AVR NAIC 1 NAIC 2 NAIC 3 NAIC 4 NAIC 5 Zero Loss05952XXX9 RMBS AVR 96.79 98.89 103.53 114.93 130.57 N05952XXX9 RMBS NON-AVR 96.6 97.43 99.19 103.47 119.96 N07383XXX2 CMBS AVR 100.86 103.04 107.87 119.76 136.05 Y07383XXX2 CMBS NON-AVR 100.65 101.52 103.36 107.82 125 Y

Reflect relevant RBC charges

Zero Loss:No Loss across All Model ScenariosAVR or NON-AVR:

Life and Frat. Maintain AVR

Breakpoints:min. BACV for Corresponding NAIC Designation

Type:RMBS or CMBS

CUSIP:Nine-Digit CUSIP Field

Structured Securities results can be accessed in AVS at https://avsplus.naic.org/avsplus/pages/public/home.jsf

Structured Securities in AVS Tutorialhttps://naic.adobeconnect.com/_a932356480/p75du85lrdr/?launcher=false&fcsContent=true&pbMode=normal

Risk-Based Capital FactorSchedule D Long Term Bonds (Unaffiliated)NAIC Desig. AVR (pre-tax) Non-AVR

NAIC 1 0.4% 0.3%NAIC 2 1.3% 1.0%NAIC 3 4.6% 2.0%NAIC 4 10.0% 4.5%NAIC 5 23.0% 10.0%NAIC 6 30.0% 30.0%


Final DesignationCUSIP Type AVR or NON-AVR NAIC 1 NAIC 2 NAIC 3 NAIC 4 NAIC 5 Zero Loss05952XXX9 RMBS AVR 96.79 98.89 103.53 114.93 130.57 N05952XXX9 RMBS NON-AVR 96.6 97.43 99.19 103.47 119.96 N

• Step 1: If Zero Loss security, report NAIC 1 with FM suffix; otherwise, apply Amortized Cost to the breakpoint values. This security is NOT Zero Loss (It has the value 'N'); move to Step 2.

• Step 2: Amortized Cost of 99.50 maps to Initial Designation of NAIC 4of ‘NON-AVR’.

• Step 3: Since it is a P&C company, the BACV to be reported is Amortized Cost (for Initial Designation 1 or 2) or lower of Amortized Cost and Fair Value (for Initial Designation 3 - 6). BACV Rate of 95.50(Amortized Cost of 99.50 vs. Fair Value of 95.50)

• Step 4: Since it is a P&C company, the breakpoint values to be used are for ‘NON-AVR’.When applying BACV_Rate of 95.50 to the breakpoint values (NON-AVR), the Final NAIC Designation to report is NAIC 1.

CUSIP:0552XXX9

AVR or Non-AVR: AVR (P&C)

Amortized Cost:99.50

Fair Value:95.50

For more complete information, please refer to: SSAP No. 43R, Accounting Practice & Procedures Manual, and Purposes and Procedures Manual of the NAIC Capital Markets and Investment Analysis Office.



Conclusion• SSG’s origins lie in the recent financial

crisis and the failure of structured finance ratings.

• Today, NAIC analyzes approximately 28,000 CUSIPs annually.

• NAIC continues to monitor developments in structured finance and insurance companies’ exposure to these ever-changing securities.

Tuesday 1400 Introduction to Structured Securities · Introduction to the Structured Securities...

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