hard · Asset-Backed Securities
Two RMBS pools have identical weighted-average coupons, WALs, and 60+ delinquency rates today. Pool X is seasoned 48 months with a current weighted-average LTV (mark-to-market) of 62%; Pool Y is seasoned 8 months with a current WA mark-to-market LTV of 62% reached via rapid recent home-price appreciation rather than amortization. An investor must price expected LOSS SEVERITY (loss given default), not default frequency.
Why might Pool Y's severity be materially understated by the identical 62% current LTV, relative to Pool X?
- Pool Y's 62% rests on recent HPA that is more likely to mean-revert in a downturn, so its effective LTV at the moment of default can be far higher, while Pool X's 62% was earned through amortization that does not reverse
- Pool Y's shorter seasoning means its borrowers have lower FICO scores, which raises severity independently of LTV and is the true driver of the difference
- Pool X faces higher severity because longer seasoning implies more deferred maintenance, depressing recovery values below the marked LTV
- Both pools have identical severity because severity is a deterministic function of current LTV, and the path by which 62% was reached is irrelevant once marked to market
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