European RMBS: Cashflow dynamics and key assumptions

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European RMBS: Cashflow dynamics and key assumptions

by Domenico Picone of Dresdner Kleinwort, and
Priya Shah of Dresdner Kleinwort

December 2008

Abstract: Attractive opportunities in distressed asset sales if models, underlying assumptions and risks are well understood.

Forced sales, lack of liquidity and of investor demand have pushed European Prime RMBS spreads to unprecedented levels. Currently AAA European RMBS are offering secondary spreads between 450-600bp. Launch spreads (pre-crisis) were in the range of 10-25bp.
Several distressed funds, and some real money investors, are increasingly looking at this sector with the aim of identifying good quality paper trading below fundamental value with the aim of monetising on the current dislocation and thereby capturing the large liquidity premium that markets are presently pricing in. We expect this theme to emerge strongly in the first half of 2009.
However, unlike standard corporate bonds, the increased cashflow complexity of RMBS means that it is important to understand the underlying model framework and the impact of key assumptions on future returns. In our view, ratings are just a starting point.
With this in mind, we have build an excel-based European RMBS model, incorporating all the key features of a typical cashflow model used to structure deals. In addition to showing how S&P and Fitch model the key assumptions, we have also provided the flexibility for user specific assumptions to understand sensitivities of different tranches.
With this model, after having recently published a series of CDO models, we continue our effort to increase transparency in the market. Going forward we also plan to release CLO, CMBS and Longevity Risk models.
In this presentation we initially look at some specific building blocks for a cashflow model before turning to our spreadsheet.