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OPERATOR: Good morning, and welcome to MBIA's Web Cast for Sub Prime
RMBS and Related Exposures. Throughout this web cast, all callers
will be placed on a listen-only mode. (OPERATOR INSTRUCTIONS) You may
submit questions by e-mail or over the Internet at any time during
this broadcast. It is now my pleasure to turn the floor over to your
host, Mr. Greg Diamond, Director of Investor Relations for MBIA. Sir,
you may begin.
GREG DIAMOND, IR, MBIA INC.: Thank you, Melissa. Welcome to MBIA's
web cast on sub prime RMBS, CDOs and related topics. The presentation
for this web cast titled MBIA's Disciplined and Selective Approach to
Sub Prime RMBS and Multisector CDOs is available on MBIA's Web site
as well as via the web cast portal. Please try to follow along with
the appropriate pages of the presentation, as it includes some
challenging and detailed information. We will refer to the page
numbers from time to time to help you follow along. Information
regarding the recorded replay of this event is available at MBIA's
Web site. Regarding the question-and-answer session for today's
event, we have already received hundreds of questions through the
e-mail address that we furnished in our press announcement. However,
additional questions may be submitted to sub prime RMBS, that is one
word, at MBIA .com or via the question posting feature on the web
casting site. We will be using non-GAAP terms on today's call. For
definitions, please consult MBIA's Web site as well. As a reminder,
all participants for today's event will be listen-only.
Now, let me introduce the MBIA team that we've assembled for today's
event. Chuck Chaplin, MBIA's Chief Financial Officer, Eric Parsen,
Managing Director, Head Credit Officer. Carl Webb, Managing Director,
Head of Real Estate and Secondary Markets. Patrick Kelly, Managing
Director, Head of CDOs and Structured Products. And Anthony Mckerne,
Managing Director and Head of Structured Finance Insurance Portfolio
Management. After the team covers the presentation materials they
will provide responses to questions.
Before we begin the presentation, I will read our disclosure
statement. During this call, we may provide forward-looking
information relating to the future performance of the Company. These
forward-looking statements are not guarantees of our future
performance. Our actual results may differ materially from these
forward-looking statements due to various potential factors.
Descriptions of these potential factors can be found in the Company's
SEC filings which can be accessed by the Company's Web site, at
www.MBIA .com. The Company undertakes no obligation to publicly
correct or update any forward-looking statement, even if at it later
becomes aware that such result is not likely to be achieved. Now,
Chuck Chaplin will begin the presentation.
CHUCK CHAPLIN, CFO, MBIA INC.: Thank you, Greg. And thank you all for
your interest in MBIA and in this topic. We do have an ambitious
agenda today. And it as Greg said, have you submitted hundreds of
questions prior to the call, and we are going to attempt to, in our
prepared remarks, to address many of them, but we should allow plenty
of time for Q&A as well. And the order as follow, first, I will
cover two financial issues, our process for marketing, insured CDOs
to market and the sensitivity of our sub prime RMBS and the CDOs
containing sub prime collateral to rating downgrades. Then the
products surveillance and risk management executives here with me
will describe the portfolio the way we underwrite and manage
transactions and portfolio performance and then of course we will
respond to questions.
So let's dive right in to page two in the presentation materials and
let's talk about marking-to-market. Just a little background, most of
our insurance business is accounted for under FAS60, Accounting for
Insurance Contracts. Basically, we're contingently liable for the
insured obligation, and as such, we don't recognize the value of the
underlying obligation in our financial statements unless there is a
credit impairment. Once there is an impairment, a case loss reserve
is reflected on our balance sheet for the present value of our
expected loss. That is the accounting for $531 billion of our $652
billion of par insured as of June 30, where our insurance is
evidenced by a standard financial guarantee insurance contract. The
other $121 billion is documented differently. Our protection is in
the form of a credit default swap on document forms compliant with
the International Swap Dealers Associations requirement. The economic
terms of the swaps are identical to those of our financial guarantee
policies. The counter party has no right to require acceleration and
MBIA is not required to post collateral, among other similarities.
All of our rights and remedies are the same in the two forms.
However, since these are technically swap contracts, their accounting
is governed by FAS133, Accounting for Derivatives. Under FAS133, the
value of the contract is recognized on the balance sheet, and changes
in the value are mostly reflected in the income statement. Nearly all
of the credit default swaps we've written as protection are ensuring
CDOs as you can see here on page two. These are not the only
derivatives that we mark-to-market; however, we also have insurance
contracts covering derivatives where the rapt instrument itself is a
credit default swap and in a couple of cases we provide principal
protection on equity index funds. The last bullet here is important,
also, we use swaps futures, options, et cetera, in managing our
investment portfolios, and those contracts are also mark-to-market.
Not mentioned here, because it is a little bit off subject, is the
change in value of assets and liabilities that are denominated in
foreign currencies. You will see why I mention that in a moment.
If you go to slide three, slide three shows where to find the marks
in our financial statement, and on the income statement, we have a
caption called net gains or losses on financial instruments at fair
value and foreign exchange. In our 10-Q filing, we provide the marks
at the segment level, so here is a comparison of the first quarter to
second quarter 2007. In the first quarter, in the insurance company,
we had a foreign exchange gain of about $4 million. And net loss on
insured derivatives of $2 million, so the net change is about $1.8
million which is the number shown here. In the second quarter, the FX
impact was de minimus, and we had a $14 million negative
mark-to-market on insured derivatives.
Now, in the investment management segment and in corporate, the marks
are driven by our hedging activities so I'm not going to take them up
now, I've just included them, so that the numbers foot to the value
of this line item that is shown in our operating supplement at the
consolidated level. On the balance sheet, we have derivative
assistants and derivative liabilities which at the consolidated level
are quite substantial. However, most derivative values are driven by
the investment activities that I referred to. The insurance company
derivative assets and liabilities are provided in the 10-Q in the
insurance company only financial statements which come at the very
end of the 10-Q filing, and you can see that the insured derivatives
with positive marks saw those marks increase from $29 million to
almost $32 million in the second quarter. The marks with negative
values, derivative liabilities, increased in value by $18 million. So
the net change in insurance company derivatives was negative $15
million, 18million increase in liabilities, less a 2 or $3 million
increase in assets. And most of this is due to negative marks on
insured CDOs.
Okay. How do we determine the mark? On page 4, we described the
methodology. The derivatives used in the investment management
segment are all of liquid traded instruments so getting values for
them is quite easy. We also have a handful of CDOs where the dealers
provide quotes on the tranches that we wrap. However, most of the
insured CDO tranches that we wrap do not have a quotes on an exchange
or from a dealer so we must mark them to model. Of 233 insured deals,
190 are mark-to-model. The model that we use relies on the buy
nominal expansion technique with real world market spreads used to
estimate the default propensity and that is the driver of the
valuation. We select the market indicator based on its with the
actual collateral in the deal in the hierarchy shown here. Our
preference is generally to use CDS spreads where possible, but where
reliable CDS spreads are not available, we use cash market spreads.
Most of the CDO s for which we use this model have spread inputs that
come from sector-specific cash spread tables, or corporate cash
spread tables. The BET also requires some assumptions about
diversification in the collateral, and recovery rates. Of great
importance is that the model also considers the structure of the
transactions, including subordination.
Now, the question has been asked, why not use the ABX index as a
proxy for a collateral that we have in multisector CDOs where we have
sub prime mortgage collateral and on the next page, we talk about
that and we have considered the ABX and we have rejected it from this
use and this slide explains why. Essentially, the ABX, or its tranche
form, the TabX, is very different from the CDOs that we underwrite.
The index is static, it is concentrated by issue, and vintage, and it
is 100% sub prime, and it does not include protections that are built
into our deals, excess spread and the ability to capture it and the
like. The last point I want to make isn't shown on the slide, it is
that trading in these indices is notoriously thin, and small trades
have a huge impact on reported prices. In some, the indices are not
relevant to the business that we're writing.
Page five shows some sample transactions and the marks we took on
them at the second quarter as well as the total marks for the
quarter. The second deal that is shown here is a transaction where
our subordination is at a fixed minimum level over time, the
subordination level will most likely drop in the potential for that
there to be a P&L impact will increase. The point though of all
of this is that when you're as far out of the money as we are from a
subordination perspective, the marks are going to tend to be small,
even though the cash spreads, as shown here, widen substantially in
the quarter. Finally on mark-to-market, on page seven, it may go
without saying, but I will say it anyway, our marks we believe are
noneconomic. That is, in the absence of credit impairments, since we
hold these positions to maturity, the marks will go up and down with
technical in the market, but will go to zero at maturity. As I said
at the top, if there were credit impairment in one of these deal, the
estimated loss would be accounted for as a mark-to-market until it
were realized. We would make special disclosure, though, so that
investors would have visibility to all the probable and estimateable
losses in our insured portfolio. GAAP does make it hard to see this
in the financial statement but we would be making supplementary
disclosure. To date, that has not been necessary, as we have not had
a deal where our protection was written as a credit default swap that
required impairment. In a few minutes, our team will walk you through
the underwriting, which we hope will make that fact even more
apparent.
But then one more topic, downgrade sensitivities. Marks-to-market are
uneconomic, as I said, but downgrades are real in our business. We
have been monitoring the potential downgrade risk in our portfolio,
as part of our ongoing capital planning, and we have looked
specifically at the potential for sub-prime exposure to trigger
additional capital requirements. The portfolio, though, is very high
quality, with average credit quality of Double-A for direct exposure,
and Triple-A for CDOs, so the exposure to downgrades of a notch or
two are actually quite small. We also consider what might happen if
we saw extreme model error in a part of our portfolio, perhaps due to
fraud, and 10% of the portfolio were to be downgraded from very high
levels, Double-A or Triple-A, all the way to below investment grade.
The impact as shown here would be much larger but still manageable in
the context of our policy of maintaining a capital cushion of at
least $500 million over Triple-A minimums at all times.
Of course right now we believe our capital cushion in the insurer is
higher than that and we have cash on hand at the holding company as
well. Bottom line, there may be downgrades in this portfolio as a
result of an unprecedented housing crunch, but our sub prime mortgage
exposure does not appear to pose a threat to the Company's balance
sheet. So at this point, I will turn the call over to Carl Webb.
CARL WEBB, HEAD OF REAL ESTATE, MBIA INC.: No, actually we will take
it to Eric Parsens.
CHUCK CHAPLIN: Sorry. I will turn it over to Eric Parsen.
ERIC PARSEN, HEAD CREDIT OFFICER, MBIA INC.: Thanks, Chuck. I was
looking through some of the questions in the queue that we've
referred over the past couple of days and I just want to make sure
that there is no misunderstanding about who MBIA is. We're not the
credit card company. And we're not in the mortgage insurance
business. We never have been in the mortgage insurance business. And
we don't even have that much exposure to mortgage insurers in our
portfolio. So MBIA is a mono life financial guarantor, we guarantee
municipal bonds, we structured financial securities around the world.
For the first 15 years of our 30 years of existence our main business
was only to insure U.S. municipal bonds. Structure finance did not
really come into the picture until the early to mid-90s. So over the
past 32 years of our existence and because we were focused almost
solely on the municipal bond insurance for the first 15 year, you can
see on page nine of the presentation, that about two thirds of our in
short portfolio is comprised of municipal bonds.
At June 30, we had about 652 billion net par insured with an average
credit quality of Single-A. About two-thirds was public finance and
the bulk of that two-thirds is comprised of U.S. public finance. The
remaining one-third is structured finance and this one-third carries
a weighted average rating of about Double-A. Drilling down on the
average quality of the exposures in the structured finance segment,
our CDO portfolio is Triple-A, our direct RMBS portfolio is single A,
but the average credit quality of the sub prime portion of our direct
RMBS portfolio is a very strong Double-A, and really just short of a
Triple-A on a weighted average basis. The combination of our direct
sub prime RMBS exposure and the sub prime RMBS exposure that is
imbedded within multisector CDOs, is as a percentage of our total
$652 billion portfolio less than 2%. And the average rating of this
segment of our portfolio is a very strong Double-A. So within the
context of MBIA's overall portfolio, sub prime mortgage exposure is
relatively small, less than 2% and of high credit quality with an
average rating that falls into the strong Double-A range.
Turning to the next page on page 10, this provide provides a rich
type breakdown of our insured portfolio. You can see that about 28%
of our portfolio still is comprised of our original core municipal GO
business that we started 33 years ago, and in fact, we still have
exposure to one municipal GO bond that we insured back in 1975 when
Gerald Ford was president. Over time we diversified our municipal
bond portfolio into structured finance. Generally speaking structured
finance securities tend to have much shorter lives than public
finance securities and the probability that we will have any exposure
to any of the RMBS or any other structured finance credits in our
portfolio today, that are in our portfolio today, 32 years from now,
is low. Because of this relatively rapid run-off of the structured
finance portfolio and the size of our public finance portfolio, it is
likely that public finance will continue to comprise more than half
of our book for some time to come.
On page 10, I provided some additional detail on the components of
our RMBS and CDO exposures. You can see that the CDO portion of our
overall portfolio comprises about 17.5% of net par outstanding. And
that the RMBS sector makes up about 8%. Multisector CDOs make up
about 21% of the CDO portfolio, and about 4% of MBIA's overall
portfolio. Within the multi-sector CDOs, multi-sector CDOs with sub
prime RMBS content make up about 30% of the multi-sector bucket.
About $7 billion, or about 1% of MBIA's total portfolio. About 2
billion of this collateral is triple B rated and the rest are rated
single A or better with significant exposures in the double -A range.
It is a diverse portfolio with no material single issue or single
issue concentration and has a variety of originators. Direct, sub
prime RMBS, makes up less than 1% of MBIA's total portfolio and about
10% of our RMBS portfolio. The average rating of the sub prime
portfolio is a very strong Double-A, just shy of a Triple-A on an
average basis. So to sum up page 10, our direct sub prime RMBS
exposure, plus our sub prime exposure inside multisector CDOs is less
than 2% of MBIA's total portfolio. The direct exposure average rating
is a very strong Double-A, the CDO exposure is all Triple-A, and the
underlying collateral in the CDOs is weighted toward the higher end
of the credit quality spectrum of single A or better.
Turning to the next page, page 11, I've already mentioned in my
comments that the credit quality of these segments of our portfolio
is quite high. This slide provides some additional details for each
segment by rating. To summarize, 81% of our direct sub prime RMBS
portfolio is rated Triple-A, and 86% is rated Double-A or better. The
below investment grade portion, about 370 million, or 6 basis points
of our total portfolio represents some legacy business that we did
about 10 years ago and I will talk more in a minute about how we
changed our criteria since that time. Our CDO portfolio is 95%
Triple-A, and 99% Double-A or better.
Turning to page 12, I mentioned before that we have a small bucket of
below investment grade exposure in our sub prime mortgage portfolio.
In the early and mid '90s MBIA worked with some smaller originators
and services. As a result of that experience, in 2003, we decided to
pull back from the sub prime RMBS market. We decided to only insure
natural Triple-As, and only work with the top tier originators in
terms of financial wherewithal and operational capabilities. We
certainly have had many opportunities in the last year or two to
insure Triple-A rated transactions for lower tier originators in the
secondary market but consistent with our strategy we have chosen not
to do so. You can see in the disclosure of our presentation, of our
direct sub prime RMBs services. Most of the services that we have
exposure to in the direct sub prime arena are of investment grade
quality or have a parent who is of investment grade quality. In
addition most of these services had operational ratings of above
average or strong by two of the rating agencies. We think this
strategy has served us extremely well. We followed suit in the CDO
portfolio. You will see from our disclosures that we did not insure
any mezzanine ABS CDOs in 2005 and 2006. This is because we made a
conscious decision to move up in the credit spectrum to high grade
transactions with Single-A rated or better collateral, often times
Double-A, and strong structural features that help us outrun and
solve problems if they arise. We also in this market decided to
require more credit support on these transactions than would be
necessary for a rating agency Triple-A, we do our own credit analysis
and set our own credit standards and we decided that it was in our
own best interest to have more credit support in these transactions.
Page 13 summarizes some of the data I've already discussed so I won't
go into additional detail here but I just do want to reemphasize that
MBIA's portfolio is not at all representative of the market as a
whole. This is because we are very selective about what we insure,
and we are very careful and disciplined about our approach to the
market. Now, I am going to turn the presentation over to Carl Webb,
who is the head of our real estate group, and Carl is going to talk a
little bit more -- in a little bit more detail on how we select
transaction has we insure.
CARL WEBB: Thanks, Eric. Over the next few slides, I am going to talk
about what a direct exposure to the RMBS market is and how we stack
up against the market in terms of total RMBS we've done and give an
appreciated version of how we underwrite and stress on the
transactions and then I'll conclude with a summary in terms of what
our strategy is, in the mortgage market.
Let's turn to page 14. Page 14 shows that we play primarily in the
last five years in the prime sector. We have exposure of 38.9 billion
net. Alt -A has been 2.8 billion. Sub prime is 5 billion. If you go
back a few year, you will see that this has been consistent in terms
of what our approach is in terms of the market in terms we have not
played in the sub prime specter.
Let's turn to page 15, the next chart gives indication, it goes back
to 2005, but you can actually put this chart back to 2002, it has
been pretty consistent in terms of what our exposure has been in the
sub prime market, and any exposure has been at the Triple-A level.
Actually as Eric said going back to 2003, I think the last
transaction was Triple-A also and going back three years, so that has
been pretty consistent. You look at the 2006/2007 vintages in terms
of HELOC/CES, there was some risk reward characteristics that were
very appealing to us, so we took advantage of that. But our exposure
to sub prime market has been consistent, has been low, has been at
the Triple-A level. Okay.
Let's turn to page 16. How do we underwrite this collateral? Looking
at the collateral characteristics, with the most significant thing we
do, in the transaction, we spend a lot of time looking at the
attributes in the collateral pool. If we're not comfortable with the
collateral characteristics, we don't move forward on the deal. I mean
we look at a number of different things as listed on page 16. The
product types. The FICO score. The property type. Loan purpose.
Affordability. First time home ownership. We look at a lot of detail
characteristics. We're not comfortable, we don't move on. As Eric has
said we have turned down a number of Triple-A transactions that you
would say there is no risk of loss here, probably no risk for
downgrade, but doesn't fit our underwriting criteria, so we've passed
on some.
Take a look at page 16. It gives you some of the characteristics we
look at. This is an exhaustive review in terms of what we do when we
look at these characteristics.
Let's turn to page 17. Most of the transactions we do at the -- that
are in the sub prime arena that are Triple-A already have four to
five times coverage, over coverage. At the time the transaction is
closed. There are also some other collateral performance triggers
that we have in these transactions, and that further strengthen the
transaction. I mean the delinquency trigger, cumulative net loss
triggers and excess spreads that can be diverted also to build up on
the strength of the transaction. You currently look at our book right
now, the protections that are in these transactions, it is somewhere
between 22 and 35%. Very strong robust Triple-A's.
Going back to how we stress a lot of these transaction, look at page
18, what is very important to our stress analysis is looking at
collateral performance. We try to go back as far as we can with an
originator of the term, I mean if that performance has been
consistent, have the pools been homogenous, we try to stack these
against various transactions we've done in the past to make sure we
are consistent. As I said before, the credit enhancement is normally
four to five times. We stress that to make sure that is robust in the
cash flows. There are a number of scenarios that are not listed here
but we see prepayment interest rate stressors and we will stress also
timing curves in our capital models and we have very robust models,
very strong analytical tools, we will use various recovery
assumptions, we will -- I mean depending on what the contents of the
pool, we will look at a lot of different types of attributes and
stress those. Page 19.
Let's just take an example of a typical sub prime transaction. As
we've stated, those transactions are rated Triple-A, there is really
-- we don't think the risk is to loss but potentially downgrade, so
let's take an example. Let's assume that our expected loss is at 5%.
A double. We expect that potentially there could be a downgrade to a
Single-A range. Not a loss. Just a downgrade. I've listed at the
bottom of page 19 some other scenarios you can take a look at in
terms of increasing the multiple of loss, and what the potential is
in what the downgrade scenario would be and take a look at that and
give a better indication in terms of what we're looking at.
Let's go to page 20 and talk about what our strategy has been to
date. We are very aware of what the credit cycle is in the market
right now. We have made significant changes to our underwriting
criteria. We remain very cautious. We require, as Eric has said, and
I will repeat it that any sub prime transaction we look at right now
needs to be Triple-A, it has to be Triple-A by at least with two
rating agencies. We're only dealing with the top tear originators and
services. In order for us to move forward on any transactions, the
collateral characteristics have to be very strong, very compelling
for us to move forward on this transaction. We put a lot of reliance
on collateral performance. That's very significant in terms of our
overall analysis. And extensive due diligence. We put a lot of
emphasis in terms of reviewing the seller service, reviewing the
originators, looking at the collateral, reunderwriting collateral, so
we put a lot of effort in that. Hopefully in some of the
questions-and-answers we can go dig down a little deeper in terms of
what our exposure is in terms of prime and sub prime but now what I'm
going to do is turn the presentation over to Patrick Kelly who is
going to go over our CDO tragedy.
PATRICK KELLY, HEAD OF CDO, MBIA INC.: Thank you, Carl. There are
three areas I would like to cover and it is going to encompass
probably the next 10 or 11 slides. Those three areas would be a
review of the general business strategy for CDOs. And then move on to
talk a little bit about CDO risk management and how we underwrite
these deals and what our approach is to underwriting the creditors
and then walk through a simple, very simplified high grade ABS CDO
example and talk a little bit about the stress that would have to be
incurred on those transactions to breach a super senior attachment
point and I will turn it over to Anthony McKerne to talk a little bit
about the performance of our current portfolio.
So turning to page 21, on the CDO business strategy, the overall
business strategy for CDOs is really to participate in the most
senior layer of the capital structure, and create a balanced book of
business across multiple underlying asset classes. The asset classes
that we play in predominantly are investment grade corporate, high
yield loans, multisector CDOs which really are our RMBS-backed CDOs,
CMBS, and emerging markets to a lesser degree. One thing I would like
to point out is we made a pretty important business decision back in
2000 which related to attachment points and credit support required
in these transactions. In 2000, we made the decision to only transact
CDOs at a minimum Double-A level. In reality, the vast majority of
deals we do in the current market are transacted at Triple-A or what
we would call super Triple-A levels which are really multiples of the
loss coverage required for Triple-A rating. This decision was really
driven by a desire for rating stability in this product. CDOs by
their very nature lack a level of granularity that can be present in
other structured credit products. Because of that lack of
granularity, rating stability or instability could be present in
these deals. And that was obviously from early vintage CDOs. Moving
up in the credit rating spectrum, protected us, we feel, a little bit
better from rating and stability.
Another critical decision point for us was in 2004 and I think Eric
mentioned this in his presentation, we made the decision at that
point to de-emphasize mezzanine ABS-backed CDOs and multisector
space. At that point, we decided instead to focus on the high grade
CDO market and just for definitional purposes, we hear at MBIA define
high grade ABS CDOs as those backed by Triple-A, Double-A, and
Single-A collateral and mezzanine ADS CDOs and those backed
predominately by Triple-B collateral and buckets Single-A and
potentially even Double-B. That decision was really driven by some
strong feelings we had about the mezzanine ABC market at the time and
we had concerns about the structures that were being put in place for
those deal, predominantly the prorata pay structure which we didn't
feel fit for this asset class, weaker adjusted pricing for the asset
class, and then certainly moving into 2006 and the advent of
synthetic reference collateral, issues with liquidity, at the super
senior level of these deal, due to the synthetic pay as you go
contract. The super senior notes transactions is typically unfunded
and because of that, you could have liquidity issues at the senior
level due to delivery of collateral into the CDO.
The final point on slide 21 is just talks a little bit about CDS
execution. I think Chuck actually hit on this point as well in his
presentation, but the majority of protection written in the monoline
base on CDO exposure now is in synthetic form, but it is important to
emphasize or reemphasize that the payment characteristics under our
CDS mimic that of a financial guaranteed policy so there is no
acceleration. We're only covering timely interest and ultimate
principal on the CDO or exposure on the deal maturity.
Moving to page 22, we will talk a little bit about the underwriting
strategy, and how we approach these transactions. This is a theme
continuing on Carl's presentation which is being cognizant of the
credit cycle. We want to recognize where we are with different
sectors in the credit cycle. We want to try to emphasize rational
markets and de-emphasize markets that are becoming irrational, but
more importantly, we want to build transactions to withstand
deterioration throughout the credit cycle and even look to take
advantage of pockets of illiquidity. I think I touched on this in the
previous slide. But the predominance of our deals are Triple-A and
super Triple-A rated, and the high grade ABS space, and certainly in
the mezzanine space which we participate to in a lesser degree and
all of our deals are at a super Triple-A level with attachment points
ranging anywhere from two to three times the level required for
Triple-A rating. We do model to our own internal threshold, and we
are not solely dependent on outside ratings. I will come back to in a
later slide.
This business strategy, and underwriting strategy, culminates in a
relatively diversified portfolio of credits. CDO portfolio is about
114 billion in total right now, and investment grade corporate
represent about 40% of that exposure, and CMBS pools and commercial
real estate CDOs is 29% and multisector CDOs are 21%, and high yield
corporate CDOs is 10% and emerging market CDOs at less than 1%.
Moving on to the next slide, to talk a little bit about structural
protections in these deals, to insure a level of diversity within our
portfolio, we have built in limit structures, at an aggregate level,
and we have limit structures by asset class, each of those asset
classes I mentioned on the previous slide, we have collateral par
limitations or exposure par limitations to each of those sectors, and
we also have asset manager limits, that scale based on manager rating
and I will get back to this in a later slide when we talk about
manager due diligence and then we have single risk limits, per
exposure, within and cross collateral pools than really affects our
corporate pools, where the corporate exposures are referenced
synthetically so if you're not careful, you can end up with a
significant amount of overlap on a given name. It is less of a factor
for high grade ABS deals and it is mostly a cash market than the CDOs
that we deal with.
Chuck touched on this as well, in his presentation, market stress and
income state volatility, income statement volatility, we're very keen
at a transaction level to monitor our income statement volatility,
and stress with that, that is a big driver as well, in our super
Triple-A attachment points, we're moving up in credit, not just to
protect against credit losses but also against rating volatility, and
mark-to-market volatility. Each transaction that we do as part of the
underwriting process, we do a deal by deal estimation of the
mark-to-market impact under a set of stress scenarios, and Chuck did
cover how we do that right now. We do have deal by deal
mark-to-market stress exposure limits, so each transaction that we
undertake has to meet those limits on a deal by deal basis.
As well as firm-wide aggregate mark-to-market stress exposure
capacity, so each deal that we do gets aggregated into our aggregate
mark-to-market stress, and we have to maintain within those limits.
We also do obviously a continual review of our valuations and
processes for compliance with best market practices. Continuing on
structural protections, with CDOs and this is on page 24, and the
first bullet point which is eligibility criteria, deal performance
and CDOs is going to be heavily influenced by the initial portfolio
selection and that's goes hand in hand with manager selection and
approval on these deals. And on the CDO side, we use sector
specialists to review each underlying security for compliance with
internal sector risk criteria and potential credit rating volatility
and what that means is especially in this market, for RMBS
collateral, we would use the sector specialists from Carl's group and
the underwriting group for the primary RMBS product, and use them to
look at every transaction or every reference piece of collateral
within the transaction. And we're looking for much of the same things
that Carl mentioned when we do a primary deal, and that deals with
the layered risk in these transactions that are really going to drive
performance and things like high CLT-TV, low FICO, lower no doc
property type and affordability products.
Based on this eligibility criteria review, we also exclude certain
aspect classes and sectors depending on manager experience. We will
also establish credit quality and rating distribution targets to make
sure we're not ended up with a barbelled portfolio. We will also set
tenure restrictions on collateral to minimize extension risk. Another
important factor within these deals is setting concentration limits
within them and the individual asset classes within these deals, we
will establish single obligor limits which we will scale by rating so
1%, 1.5% for Single-A exposures and 1.5 to 2% for Double-A underlying
exposures and 2.5% to 3% typically for Triple-A rated exposures. We
will establish industry limits within corporate deals and sector
limitations within the transactions as well so limitations on
different buckets such as aggregate CDOs, CLO tranches, and ABC CDO
tranches, et cetera. Again everything geared towards trying to create
as much diversity in the transactions as possible.
And finally we will also establish servicer or collateral manager
limits and the servicer limits for scale for the mortgage payment
based on underlying rating or operational rating of the servicer
varying from strong down to weak and those scale, within that range.
Also within our review of the collateral, we will actually review
each underlying credit for acceptance within the deal and we will
actually ask for certain credits to be removed or predefault on
acceptable credits within the portfolio, based on that asset by asset
review. And occasionally, we will also notch ratings of collateral
within the pool, for weaker credits which will serve to increase the
default propensity of those assets within our modal.
Turning to page 25, I think I already hit on this, but again, worth
reemphasizing, our policy coverage at the super senior level in these
deals is predominantly in CDS form. And those -- the form of that CDS
specifically mimics those of a financial guarantee policy, with
timely interest in ultimate principal, and no acceleration and no
collateral posting, and in addition we retain a walk away right upon
counter party default. A couple of other important structural
protections I think worth going over is the second bullet point on
page 25, refers to control rights and these control rights would be
triggered by performance deterioration within the deal, or certain
documentation breeches or events of default within the transaction.
The two key ones here for us and Anthony can talk about this later,
or in the Q&A, are our ability to remove or replace the asset
manager and manage transactions upon certain events of default or for
cause events, or performance deterioration. The second is the ability
to either direct asset portfolio investment or liquidation of the
portfolio of assets upon certain events of default or performance
deterioration. And I'm going to come back to that in a second after
the third bullet point.
All of our transactions in the ABS space interest interest coverage
and overcollateralization tests. These are customized triggers on a
deal by deal basis which improved MBIA's or any senior level risk
within the transaction if collateral performance deteriorates.
Typically there are two water falls within these deal,which one deals
with interest collections and the other deals with principal
collections and both water falls will have these tests which would
divert cash to repay the senior obligations until cured. And an
important note is all of our deals, we haircut asset value for
downgraded collateral so what this means in the overcollateralization
tests, as assets are downgraded within the pool, their haircut for
that overcollateralization test. Typically Triple-B in our high grade
deal, Triple-B assets are haircut 5%,Double-B assets, 10 to 15%
Single-B assets, 30% and Triple-C assets the lower of 50%, market or
recovery value for the rating agencies. We also haircut asset value
for discounted collateral.
I'm just going to loop back to control rights for a second and it is
important to note that these haircuts also come into play in the
overcollateralization tests which are in all of our deals allowing us
to remove our replace the asset manager or liquidate the portfolio.
Typically, our transactions allow us to replace the manager on what
we would call an ABOC test breach which means once the OC level
reached the Double-A tranche, we can replace the manager. Once the OC
test breeches the base Triple-A tranche, we would typically have the
right to liquidate the portfolio at that point. And I think this is a
very powerful mitigant to performance outliars within the portfolio,
because you've taken a test and you've applied rating-based haircuts
to that test, to enable it to trip more quickly than if you were just
relying on the OC breach to be caused by asset defaults, and then you
also have a cushion to our position of approximately -- depends on
the transaction, but anywhere from 6 to 8 to 10% additional
overcollateralization upon liquidation before we would have to take a
hit to our position. So an important mitigant.
Turn page 26, typically within our transactions there are collateral
portfolio quality tests. These would include weighted average test,
weighted average spread tests, weighted average maturity or average
life tests and average recovery tests and all these do or serve to
cause the manager to either maintain or improve the portfolio and any
additional trades going forward if any of these tests are breached. I
just covered collateral manager termination but in all of our deals,
under note, there is a performance event of default as I mentioned
based on a triggered OC level, and these manager termination can also
be caused by a failure to pay interest or principal or any other for
cause events within the transaction. And then again, events of
default, typically any event of default within our transactions would
give us easily to liquidate the collateral.
CDO, this is page 27, CDO collateral manager review, this is very
significant part of our underwriting process on every CDO that we do,
every managed CDO that we do, that is. Our due diligence includes an
extensive on-site due diligence and internal manager ranking process.
That typically would include three to four to even five people on the
transaction team, going out, visiting with a manager, and going
through things like their organization history, structure, staffing,
are they staffed appropriately, where is their level of staffing,
where does it come from? What is their institutional affiliation? Are
they part of a bank? Are they a start up, how are they capitalized?
That really get's to is this an entity that's going to around for the
life of the transaction, long deal, 8 to 10 to 15 years. We want to
make sure these entities are going to be around. We want to look at
their asset -- their underlying asset class, and CDO management
experience. Obviously, these transactions are heavily weighted toward
RMBS, so our RMBS experts will be part of the due diligence team. We
also want to see that the manager has experience managing CDO
vehicles, and these are complicated transactions, and we want to make
sure they are the requisite experience to be able to manage within
the constructs of a structured vehicle. We also obviously will look
at track record, past return, defaults, distress sales, losses and
recoveries, and just as important the buy and sell side discipline,
what we want to avoid and what we look for are managers who actually
don't sell, especially in the high grade space, we would like to see
a manager take a little built of pain up front, rather than sitting
on a distressed asset or something that could become distressed. We
also look at the process, controls, monitoring compliance, and
certainly data and modeling capabilities which is critical in the
RMBS and CDO space. And then obviously, we will have in depth
discussions with analysts on individual credits within the portfolio.
Our strategy is to really deal with top tier managers. I mentioned
earlier we rate every manager that we visit. We have a rating scale
of one to four. Four are excluded managers, and we can deal with
managers who are rated one through three. We also have a manager
limits model as I mentioned which scales with regards to how much
capacity we have to a given manager, based on their manager rating.
We also look for alignment of interests in these deals and I think
this is absolutely critical in the CDO space. We look at the
objective of the deal, and the economic interest of all parties, and
you know, we look to see whether there is any equity participation,
or subordinated note investments by the manager. Any subordination of
management fee, based on performance. And in general, we're looking
to avoid deals that are purely risk transfer or are done for pure
hedging or hedging of pipeline risk. In general, we also want to work
with managers who manage for the whole capital structure, not just
for equity within the deals.
Turning to page 28, this really deals with quantitative analytics and
it is just a quick rundown of how we approach these transactions.
Just worth reemphasizing we run our own test tests in addition to all
of the rating agency models. These tests do frequently produce
Triple-A attachments well in excess of the rating agency
requirements, and not as relevant when we're attaching at super
Triple-A but we do have thresholds which is for the bullet point, for
super Triple-A that we have to maintain. Our stress tests use the
worst possible permitted portfolio within the deal, so depending on
how much the manager has in flexibility to manage the portfolio, we
use the worst possible combination of portfolio characteristics, and
use the minimum collateral coupon or spread for the life of the deal.
Within our models, we use a law of normal distribution to come up
with a stress loss rate. This leads to an extremely high default rate
for the underlying collateral, at a 99.9 no loss scenario, or 99.9
confidence interval for no loss for our super senior attachment
points. We also use conservative interest rate and default timing
scenarios on top of the stress default rates. In total, we run on
average about 500 or so scenarios on each cash flow transaction, and
for us, we have to pass every one of those scenarios to achieve the
desired super senior or Triple-A attachment point. The recovery
assumptions we use in our model are staggered based -- and based on
collateral priority, whether it is senior mezzanine, security,
whether it is secured or unsecured, and certainly instrument type
bond or loan. And then we will also apply additional stress for
excess sector or obligor concentrations, whether they're large
individual concentrations, or large sector concentrations, especially
within corporate transactions.
Turning to page 29, what I thought I would do is just pull together a
very quick and easy example of the high grade multi-sector CDO that
has both sub prime RMBS and CDO content. This is a very high level
example. And you can certainly play around with any of these
assumptions and the performance of any of the high grade deals or any
CDO for that matter in the market is going to be dependent on a
number of factors beyond the scope of this example, but for
discussion purposes, maybe I will walk through this now. At the first
bullet point, we will talk a little bit about structural assumptions.
This would be a high grade typical high grade transaction for us, and
assuming a 15% attachment point for the super senior. There would be
25% combined Single-A and Double-A-rated sub prime RMBS collateral
exposure, in the transaction, the Single- A and Double-A rated sub
prime class is on average would be 4% of their related capital
structures, and average above 15% of loss coverage before they
sustain losses.
In addition, there would be 10% ABS CDO collateral exposure within
the deal rated Single-A and Double-A and 65% other collateral which
could be CLO tranches, CRE, CDO tranches other types of mortgage
product including prime mortgages. In this scenario, we will say that
-- we will assume that there is 100% loss on the Single-A, and
Double-A, ABS, CDO collateral, relatively stress scenario given our
underwriting approach and the collateral managers that we deal with
and then 15% losses on the sub prime RMBS, which is about three times
an assumed 5% expectation for high quality originators. We will also
make the assumption that no other collateral experience is losses on
this high grade portfolio. Looking at the outcome, again it is going
to be highly dependent on the actual portfolio compensation, deal
structure and loss timing but under this simple scenario, the super
Triple-A would have no loss. Assuming that there is 15% loss
absorption within the deal, have you 10% losses -- you have 10%
losses on the ABS CDO tranches, and then zero percent loss on the
RMBS collateral, the Single-A, and Double-A RMBS collateral, because
of their 15% average loss coverage. If you wanted to look at it on a
break-even basis, for the super senior, the sub prime, the break-even
sub prime loss rate, in addition to the defaulting the Single-A and
Double-A CDOs at 100%, would be about 15.8%, before the super senior
pays the claim.
This would again equal the 10% loss on the ABC CDOs we assumed, plus
15.8% which is the loss rate minus the 15% loss coverage, before the
underlying collateral, on the sub prime bonds, start to take a hit,
and divided by the 4% which is their tranche thickness, that gives
you about a 20% loss on those tranches, times the 25% they represent
of the aggregate CDO structure. That would give you a 5% loss rate on
the RMBS collateral. That, plus the 10% would get you to 15%. Again,
a very simplified example, but it puts the transaction somewhat into
context with regards to what you would have to do to breach the high
credit score within the deal.
Turning to page 30, just to summarize, and wrap things up, MBIA's ADS
CDO business strategy over the past three years has focused on super
senior attachments on high grade transactions. The theme there,
again, is really moving up in credit quality, both on the underlying
credits, we allow within the portfolios, but then also our attachment
points. We have an extremely robust underwriting process for these
deals. That includes both an in depth review of the collateral
manager, and the portfolio to prevent adverse selection and actually
promote positive selection within the deals. Structural negotiations
within the transactions lead to collateral rating and concentration
limits that reflect the experience of the manager. We certainly over
the last two or three years have passed on a lot of transactions
where we couldn't get our control rights or certain structural
provisions within the transactions to our satisfaction. Key control
rights within the deal allow for manager transfer, and even
collateral liquidation upon certain performance-based events. Both of
those certainly upon an overcollateralization breach would allow for
additional overcollateralization before the senior was hit.
We certainly feel broader market performance is going to get worse
before it gets better but performance within vintages is going to be
dispersed and that is both on the underlying RMBS collateral but also
on CDOs. And we expect to see better-than-average performance within
our aggregate portfolio of exposures, as a result of our selective
and disciplined approach, and our ability to remediate outliers
buyers. So with that I will turn the presentation over to Anthony
McKerne who again runs our structured finance and insured portfolio
management group and he going to talk a little bit about performance
within the transactions both the direct RMBS and the CDOs.
ANTHONY MCKERNE, STRUCTURED FINANCE INSURANCE, MBIA INC.: I would
like to start off by taking a minute just tot walk through how MBIA
looks at the back of a good business in both the RMBS and the CDO
sectors and then I am going to summarize the impact of the recent
rating actions taken in the sub prime RMBS sector by the rating
agencies in July. As Patrick and Carl stated, MBIA takes great
efforts to put substantial structural protections in both our direct
RMBS and CDO transactions. Therefore, proactive monitoring is
critical to the ongoing analysis of these deals. Both the RMBS and
CDO portfolios are monitored extremely closely, with special
attention paid to adherence to performance and trend parameters such
as cash diversion and over collateralization triggers as well as pool
quality triggers and overall industry performance. We engage in
proactive and aggressive remediation when need and we are
consistently interacting with the client base. And in the event that
a servicer or asset manager or replacement event were to occur, a
deal liquidation were to be required or remedies to trigger breaches
to be demanded, our surveillance teams have a strong remediation
record and we have successfully transferred servicing and asset
management on RMBS and CDO transactions over the last five years.
If we turn to page 31, in a minute, I will address the ratings
actions on the CDO and our RMBS book, but first, I am going to take a
second to just reiterate what our exposure is in the CDO and RMBS
book to address some of the questions that we've received over the
last few weeks on the multi-sector portfolio. As of the second
quarter, ended 2007, our multisector CDO net par outstanding was 24.2
billion or approximately 21% of our $114 billion CDO portfolio. The
multisector book features deal ratings of Triple-A for 96% of the
portfolio, with 99% of the portfolio rated at least Double-A. Of the
$24.2 million multisector total, approximately $15.9 billion of net
par contains RMBS collateral. The collateral supporting those deals
is broken down essentially to 79% high grade collateral, and 21%
mezzanine collateral. With this general sub prime collateral
supporting these deals totaled approximately 31%, of the collateral
base, as we reported in our frequently-asked questions on the Web
site. With this general description of the portfolio, coupled with
what you've heard about the underwriting process, asset manager
selection process, and deal modeling techniques as a backdrop, let's
take a look on page 31, at the impact of the of the rating agency
actions in the sub prime RMBS space as it relates to the CDO book of
business.
As many of you know, Moody's and S&P downgraded or placed on
watch well over 1500 sub prime first lien closed and second RMBS
securities and classes of CDOs. When we look at our multi-sector CDO
portfolio what is important to note first and foremost is that none
of the underlying ratings of MBIA's primary market wrapped CDOs were
downgraded by S&P or moody's or placed on watch. Actions were
limited to a small number of individual securities within several
MBIA wrap deals with no material impact. Let's break this down a
little bit further. Only 88 basis points of the total collateral base
supporting the multi-sector CDO book were downgraded by the rating
actions. In any one deal, the amount of collateral impacted generally
ranged from 0.5% to 2.5% of the total collateral base which is quite
minimal. Moody's S&P also downgraded several hundred classes of
CDOs in their July actions. Within those action, subordinated classes
in 12 MBIA insured transactions which were primarily secondary market
transactions with small net par exposures written to a natural
Triple-A level were placed on watch or downgraded totaling
approximately $580 million.
In addition the underlying ratings of two older vintage MBIA insured
classes totaling $25.4 million of net par, were placed on watch or
downgraded. We anticipate no material impact from these actions. Of
note, very little closed ends second exposure within the CDO
collateral base was impacted by all the rating agency actions. To
summarize the CDO impact, although it is expected that further
actions will follow this round of actions by S&P and Moody's,
this round has had minimal impact on MBIA's position and CDO
portfolio. The majority of downgraded credits were related to issuers
that MBIA and its CDO collateral managers sought to avoid or minimize
exposure to. Subordination levels for these deals remains strong.
If we turn to page 32, let's address the direct RMBS book. To
reiterate Carl's comments from earlier, the consumer mortgage
portfolio totaled $46.9 billion of net par as of 6/30/07 not
including manufactured housing and home improvement loans. Of that
amount, approximately $5.1 billion was comprised of sub prime net par
exposure. Approximately 84% of our sub prime exposure is rated
Triple-A, reflecting the strategy we've told you about throughout
this presentation, starting in 2003 and 2004, to only participate in
the sub prime space at the Triple-A level to the highest quality
issuers, the largest of which are outlined on the next page which I
will get to in a minute. And a way to bring vintage into context,
approximately $1.5 billion in MBIA wrapped originations at the
Triple-A level were executed in 2006. Let's look at the rating
actions by S&P and Moody's in July. First and foremost, none of
the underlying ratings of MBIA's wrapped securities were downgraded
by S&P or Moody's. The subordinated tranches of several MBIA
secondary Triple-A wrapped deals were included in the rating actions.
Let's break this down a little bit further. S&P and Moody's
downgraded subordinated classes of 19 transactions of which a senior
Triple-A rated tranche is wrapped by MBIA in the secondary market.
The total of these classes impacted were approximately $448 million.
The highest rating category which was downgraded in any one deal was
the Single-A class with the majority of ratings impacted focusing on
the Triple-B plus to Double-B range. Also important to note is that
the recent rating actions on closed ends seconds produced no impact
to any MBIA-related closed end second transaction. Based upon our
review of the existing enhancement levels and senior position of the
certificates MBIA is wrapped, the remains adequate protection for the
wrap certificates in the portfolio. Current credit enhancement for
MBIA wrapped Triple-A bonds remains robust and to give you a general
range of protection, we look at approximately 22 to 35% enhancement,
depending on the deal type and structure. To summarize the direct
impact, the strategy that we employed in 2003 to only wrap at the
Triple-A level has clearly positioned us well in the current
marketplace.
If we finish up on page 33, what we've provided you here is a list of
the top sub prime RMBS service or exposures to reinforce the points
that you've heard earlier that we have attempted to select doing
business with the higher quality servicers from both the financial
strengths and operational capabilities standpoint. You can see that
Countrywide is our largest sub prime servicer, followed by Wells
Fargo, and Lehman Brothers, and you look down the list of the top 15,
and generally they are very strong entities from the financial and
operational standpoint, with strong rating agency servicer ratings.
You will note that there is exposure to C-Bass(Litton), and to Bear
Stearns in the portfolio, just to give a little clarity on that
exposure, the majority of those exposures were originated between
1999 and 2003. They are performing well, and we expect no issues at
this time. So to summarize the rating agency impacts and the
condition of the back book at this point, to date, the strategy
enacted by MBIA on CDO and direct RMBS side, has resulted in
protective action measures designed to consider market issues such as
those we're experiencing today and while we believe that the market
will likely get worse before it gets better and we would expect
additional rating agency actions as the marketing situation develops,
we believe that the back book is well prepared due to the strategies
and underwriting disciplines that we've employed and that you've
heard about today. With that, I will turn it over to Chuck for
closing remarks.
GREG DIAMOND: Actually, I will do it, Anthony. In summary, MBIA has a
very disciplined approach to the marketplace in everything that we do
but in particular since 2002, we've increased the discipline with
respect to RMBS and particularly sub prime RMBS. 2005 and 2006
vintages of sub prime RMBS that we have in our portfolio both on a
direct basis and through CDOs, demonstrate our very limited
participation in that space. We have only one mezzanine CDO
transaction that we've insured since 2005. We have no direct exposure
to the deals that have been downgraded by the rating agencies or put
on negative credit watch. And there is very de minimus exposure
associated with the CDOs that is collateral for the CDOs that we've
crafted. As Chuck indicated earlier in the presentation, our MTM
movement is entirely noneconomic to date and if that were to change,
we would provide disclosure associated with credit impairment
associated with the mark-to-market mover. We use spread data to price
and calculate our mark-to-market changes. Although the housing market
is stressed and we expect that there will be further headlines and
further difficulties for individuals and operators in that space, we
do not believe that it will be problematic for MBIA's participation.
That concludes the formal presentation for today. Now, we will use
the remaining time to respond to questions that we have received. As
I mentioned earlier, in the beginning of the web cast, we've received
hundreds of questions in advance of today's event. Many of them have
been responded to in the materials that we've just presented. Of the
remaining questions, we have organized them by similarity and we will
respond to them based upon most commonly-asked basis. Due to the
volume of questions and the time constraints, it will not be possible
for us to answer each and every question that has been submitted so
far. However, we will review all of the questions in the context of
our considerations for future disclosure, and without further ado,
let's move to our first question.
GREG DIAMOND: First question will be for Eric Parsons. I don't
understand how to interpret the last two columns on page seven of
your CDO strategy disclosure document. What do those two columns
mean?
ERIC PARSEN: Well, we mentioned earlier that MBIA uses its own models
and its own criteria to determine credit support levels and
structures in our CDO transactions. And what the last two columns on
page seven of the disclosure mean, are meant to do, are to compare
what we believe rating agency Triple-A levels are to the level that
MBIA requires for its own Triple-A deals so the last column on the
right indicates the amount of subordination that MBIA has in the
deal, and you know, as I mentioned earlier, our modeling methodology
results in current enhancement levels in excess of the rating agency
Triple-A so for example on the first line the Triple-A subordination
level is about 5% but we have 12.5%, so our actual credit support is
about 2.5 times that which would be needed for Triple-A rating by the
rating agencies so again, we're just trying to show that you we are
modeling the transactions to our own standards and again, we are not
playing at the market average level here, we are playing at a level
that we think is better than market average.
GREG DIAMOND: And Anthony, next question is yours, what is MBIA's
exposure to multisector CDOs with U.S. RMBS collateral, and two part
question, actually. What is the percentage of 2006 vintage sub prime
collateral, as of June 30, 2007?
ANTHONY MCKERNE: Sure. To start with, we've got $15.9 billion in net
par exposure that consists of multisector CDOs with U.S. RMBS
collateral, as of 6/30/07. That 15.9 billion, when you dissect the
underlying collateral, is supported by 79% high grade collateral
which we define as basically Triple-A and Double-A securities with a
small A-rated bucket and the 21% remaining is mezzanine which we look
at is primarily Triple-B collateral which in some instances a small
bucket for Double-B. The vintage analysis, if you look at the high
grade and the mezzanine separately the approximate percentage of sub
prime collateral originated in 2006 on the high grade portfolio was
approximately 56.8%. If you look at the mezzanine portfolio, the
amount of sub prime collateral originated is approximately 27.2%.
GREG DIAMOND: Okay. Carl, the next question is yours. Could you give
further detail on your $33.6 billion of direct RMBS exposure beyond
the amount of the sub prime portion? More specifically, how much of
the balance is in second liens and HELOCs?
CARL WEBB: Okay. Thanks. Our portfolio stands right now at 46.8
billion. The close seconds and HELOCs consists of 23.8 billion,
approximately 51% of the portfolio.
GREG DIAMOND: Okay. Chuck? How would you reflect the total loss on a
CDO on your GAAP financial statements? Would it mirror the payments
or would you post loss reserves for the entire par amount, the par
amount less expected recoveries, or the entire amount of payments
principal and interest that you expect to make over the life?
CHUCK CHAPLIN: For our CDOs we would do the same kind of impairment
analysis that we do for financial guaranteed policies. And although
as I said earlier, the amount of the impairment would be reflected in
the mark-to-market line on the income statement, as opposed to the
way that we account for impairments of policies that are evidenced by
financial guarantee insurance policies. From a calculation
perspective, we would look at the present value of the probable and
estimatable losses on the transaction, less any expected recoveries.
So the process is exactly the same, and we would disclose it in the
gain/loss on financial instruments at fair value, on the income
statement, and we would provide additional supplementary disclosure
to allow you to see that there is a portion of that mark-to-market
line item that is applicable to a credit impairment.
GREG DIAMOND: Okay. Carl, how much of your $5.1 billion of direction
sub prime exposure was written from January 1, 2005, through the
second quarter of 2007?
CARL WEBB: That number stands at 3.1 billion. I would also refer you
back to page 15 of the presentation, as a break down by 2005, 2006
and 2007, and in 2005, we had 1.6 billion, and 2006, 1.4 billion, and
2007, about 200 million. So $3.1 billion approximately.
GREG DIAMOND: Another question for you, Carl. Does MBIA have any
exposure to piggyback loans? How about no doc loans? Are you able to
review the collateral up front and influence what is included in the
deal?
CARL WEBB: Okay. MBIA's insured transactions include both piggyback
and no doc loans, however early in the underwriting process we
stratify the loan file and that is the collateral analysis that we
look at, and access to risk -- to access the risk land of the
collateral and subsequently we make modifications to the loan pools
that better suit our credit appetite. What we are trying to do is
basically shape the collateral to what our risk criteria is.
GREG DIAMOND: Okay. Patrick, what is the claim process on a
CDO-insured by a CDS, and how do your claims payments differ for your
CDS insurance contracts versus your financial guarantee insurance
policies?
PATRICK KELLY: Mechanically, we write CDS contracts through LaCrosse
financial products, which is a sub of ours. Each CDS, each individual
CDS referencing CDL liability is backed by a financial guarantee
policy from MBIA insurance corp. As I mentioned, most all of our
CDOs, especially in the ABS or multisector space are executed in this
form, and CDS form, and what is happening in the market now, and has
for the past couple of years is large funding banks, such as the
Barclay's, HSBC, ABN Amro, and a host of others, would purchase the
senior liability, senior CDL liability and the concurrently purchase
a CDS from us reference that senior CDL liability. And doing it in
CDS form just allows for the most efficient capital treatment for
that institution. The payment characteristics that I mentioned
earlier of our CDS are done to match of that the financial guarantee
policy so we're only providing payment for timely interest and
ultimate principal at maturity of that insured CDO tranche and again
we don't post collateral at the position and we can't be accelerated
on it. And finally we have a walk away rate upon failure to pay by
our counter party. And I would also relate it back to control rights.
Typically in these transactions, now, we require to be named in the
deals, in the deal documents, as the controlling party. We do have
transactions where we receive that right through a contract with the
funding institution who owns the senior liability. But we would also
have a walk-away right on the CDS if that control right wasn't
exercised per our direction.
GREG DIAMOND: Okay. Here is another one for you, Patrick. Please
describe the CDO manager selection process. What are the important
qualities that MBIA looks for in selecting a CDO manager?
PATRICK KELLY: I think I covered this a little bit earlier, but it is
definitely worth emphasizing. There are a number of things that we're
looking for in doing our manager evaluation. As I mentioned, we do an
on site due diligence, and extensive collateral reviews with all of
the managers we deal with. We do have a ratings process for our
collateral managers and ones that we visit, and again that scale is
one to four, four are excluded managers and we certainly have
managers on that list. And we do have a sliding scale for manager
exposure that is based on that rating level. On the underlying rating
level of the manager, internal rating level. What we're looking for
is experience and a track record. That may be of the principals
within the industry, and it could be together as a group, at the
current institution, we're looking for experience with the underlying
asset classes they're investing in, as the CDO manager. Obviously in
this market, that means primarily RMBS, and CDOs. And we will also
tailor the restrictions within the deal, the collateral buckets and
requirements to match the manager's experience. We also want to see a
strong credit culture based on fundamental credit research. With a
define buy and sell discipline. It is critical that the institution
has strong data and modeling capabilities both for up front purchases
and ongoing monitoring of exposures which obviously leads to that, to
help out with that buy/sell discipline. We also want to see
significant back office operations and portfolio monitoring
capabilities. It just means having a dedicated staff to this
function. These are complex deals. And again, they involve complex
issues outside of pure credit decision more operational decisions
such as managing interest rate hedges, and so we want to make sure
that they both have the expertise and the assistance to be able to
handle that. And then finally, we're looking for institutional
support or significant equity sponsorship and again, what we're
looking for there is just longevity of the institution to make sure
that they're going to be around for the life of the transaction.
GREG DIAMOND: Eric? What criteria do you use to categorize exposure
at either sub prime or prime?
ERIC PARSEN: At MBIA, we have risk types in about 150 different
categories and each of those categories are based on what the source
of cash flow is to repay the bonds. So we have an official definition
for each of the about 150 risk types, and our official definition of
sub prime is based on, as you would expect, our credit history and
third-party credit score. Generally speaking we consider collateral
pools with average borrow FICO scores of less than 650 to be sub
prime, for purposes of our risk type code classification. In
practice, though, the majority of our prime business has weighted
average FICO scores in excess of 700. So it is not in the 600 range
at all. And so they are really very comfortably primed.
As we mentioned earlier, we really have only been insuring sub prime
deals that meet our own Triple-A rating standards, and the Triple-A
rating standards of two rating agencies, and this means that we have
been weeding out a lot of opportunities in the secondary market, and
simply passing on a lot of deals that had some less attractive
features such as MegAM loans or significant all day concentrations,
or geographic concentrations, or pools or buckets of exceedingly low
FICO scores. And also, pools originated by certain originators in
certain servicers consistent with our policy to only deal with top
tier players who have run into trouble in the past six to nine
months. So we really only have two classifications, we have sub prime
and we have prime classifications. And that's how we break the world
on a FICO score basis.
GREG DIAMOND: Okay. Anthony, you would provide more detail on the CDO
collateral within your multisector CDOs, and the general composition
of your CDOs squared?
ANTHONY MCKERNE: Sure. What we will do is let's discuss the
multisector CDO book first. And then we will get to the CDO squared.
When we look at the breakdown of the multisector CDO collateral pool,
as we've reported previously, approximately 19.6% of the collateral
base is comprised of CDO collateral. If we break that down further,
between high grade and mezzanine collateral, approximately 22.4% of
the high grade collateral bucket is CDO content, and 12.9% of the
mezzanine bucket is CDO content. Let's just take these one at a time.
In the high grade book, as we just said, 22.4% of the collateral base
on average is comprised of CDOs. Of that 22.4%, the major components
are 68% CDOs of ABS, and the next largest category is 15% CDOs and
CLOs. If we take that 68% down to the next level, the CDOs of ABS in
these transactions are split approximately 29% high grade CDOs,
versus 71% mezzanine CDOs. It is very important to note with that ;
however, that for all of these collateral bucket that we are only
allowing collateral in the transaction that is high grade in nature.
Which as I said before, we define as Triple-A and Double-A securities
with a small A bucket.
Looking at the mezzanine book, where as we just stated, 12.9% of the
collateral bucket is CDOs, less than 30% of that 12.9% is actually
CDOs of ABS. We don't have an exact breakdown of what that is, it is
a very small dollar amount, but the assumptions is that the majority
of that would be mezzanine collateral in nature.
Turning to the CDO square transactions, as of 6/30/07, MBIA has
approximately $6.1 billion in net par exposure. When looking into the
collateral, approximately 60% of the collateral supporting those
deals are CDOs and CLOs, 22% of the collateral supporting those deals
are comprised of CDO of ABS. When we dig further into, that we note
that approximately 50% of those transactions are mezzanine of CDO
supported by mezzanine collateral and 50% are supported by CDOs of
high grade collateral. It is also important to note there; however,
that we attach, the collateral allowed into those deals are at
extremely high attachment points, predominantly Triple-A and
Double-A.
GREG DIAMOND: Eric, if you had a CDO that was composed 100% of
Triple-B-rated sub prime RMBS, and mortgage loan boss levels were
such that all of the Triple-B-rated RMBS tranches were 100% losses,
would the CDO be a total loss? And if so, how does subordination come
into play under such a scenario?
ERIC PARSEN: This is a good question, and we've actually gotten this
question a few times. So it is a good question. It is not really
applicable to MBIA, because we simply have not insured transactions
that are comprised 100%of Triple-B-rated RMBS, we just don't do that,
and you can see in our latest disclosure gnat largest percentage of
sub prime RMBS in any deal is about 57%, but with that being said,
let me try to answer the question. In a case where you have a CDO
that is comprised 100% of Triple-B-rated RMBS, and mortgage loan loss
levels were such that all of the Triple-B-rated RMBS tranches were
full losses, then, yes, the CDO would be a loss. Barring the
existence of any other cash, or any other kinds of non-mortgage
related credit support. Again, that being said, we don't do this. We
have not insured any CDOs with this type of collateral composition
and so this isn't applicable to us.
In our disclosure on our CDO strategy portfolio analysis, and sub
prime RMBS exposure, you can see that no single deal has more than
57% sub prime RMBS exposure, and that particular deal, the 2004
vintage transaction, where the underlying loans are seasoned and the
underlying borrower have in fact realized some of the benefits of
home price appreciation over the last two or three years. You will
also see in our disclosure that we didn't choose to insure one mez
dealer but that deal only had 44% sub prime RMBS collateral. So again
it falls well within your scenario. I think there are also some other
qualitative factors associated with this. First, we have a very
strong collateral manager in the deal that we did this year who knows
the RMBS market and the sub prime market very well. They have made
very good investment decisions. And they happen to be a subsidiary of
a major financial institution and they can draw on that knowledge
base. We also have, as Patrick alluded to earlier very strong issuer
and issue concentration limits in the CDO, which means no one issuer
can be more than 2%, no Triple-B rated security can be more than
1.25%. And we also have a limit on the percentage of collateral that
can be comprised of CDOs, and that limit is very comfortably within
our first loss protection.
Fourth, and we mentioned this earlier as well, this deal has very
strong triggers that can stop reinvestment, limit trading, remove the
collateral manager or liquidate the collateral pool. The tests are
calculated using collateral haircuts as Patrick described, and the
haircuts assume that the collateral is worth less if it is downgraded
so effectively, it is downgraded to occur, the triggers will be
breached and we can exercise our remedies. In this particular deal
that we did earlier this year, even if the worst case liquidation
triggers are hit, we still have a significant cushion before we would
be confronted with any losses on our deal.
GREG DIAMOND: Okay. Carl, can you talk about your perception of risk
versus the market, and have you seen any change in the demand for
your insurance on RMBS, particularly in the June and July period?
CARL WEBB: Okay. Yes, we have experienced a greater demand for our
product both domestically and internationally over the last two to
three months. The number of calls that we're getting is enormous
right now. But increased perceived market risks over the past several
months has come closer to what our outlook has been in the market
over the past few years. So we have always thought there was risk in
this market, and we just are seeing it become very transparent right
now. So we are positioned for this in the last three or four years.
GREG DIAMOND: Okay. Chuck, regarding mark-to-market, you don't need
to mark-to-market financial guarantee insurance policies, correct?
This is a multiple-part question. Bear we me. How much of your
guarantees are mark-to-market? Where do you provide the information
about your mark-to-market portfolio? Does your mark-to-market
indicate credit impairment? And is it the regulators that require to
you mark-to-market? And lastly, what do the rating agencies say about
your mark-to-market?
CHUCK CHAPLIN: Great. I touched on much of this during the prepared
remarks. Our mark-to-market requirement really goes to any
transaction where our protection is documented as a credit default
swap. And the requirement arises out of GAAP statements 133, which
just provides that any derivative must be mark-to-market, with some
very limited exceptions. Relative to our portfolio, about 121 billion
of the $652 billion of par insured is evidenced by credit default
swaps and we do mark those transactions to market. We don't provide
credit disclosures per se about the portfolio that is mark-to-market.
But in all of the tables in our financial supplements, and in our SEC
filings, where key talk about the insured portfolio, that portfolio
does include all of the transactions which are marked-to-market. The
marks do not indicate credit impairment at this time. Only because we
don't have any transactions, subject to mark-to-market, which are
impaired. However, if a transaction were to become impaired, we would
be reflecting the impairment amount in the mark-to-market line on the
income statement, and again, we would be providing supplemental
disclosure to make sure there is transparency around that. The rating
agencies, and we talk a lot with the rating agencies about the credit
status of our portfolios, and provide them pretty detailed data on a
quarterly basis, about the status of essentially every transaction in
the portfolio, including those that are subject to mark-to-market,
and so they will aware of the extent to which there is any credit
impairments in that portfolio, but as to the period to period marks
that reflect things going on technically in the markets, for the
underlying collateral, we don't believe that those are economic
changes, relative to our portfolio, and in general, the rating
agencies agree with us, with respect to that.
GREG DIAMOND: Okay. Eric, how are you sure that you're stress testing
in multisector CDOs is stressful enough?
ERIC PARSEN: Boy, I think we've talked a lot on the call about the
qualitative factors that we looked at in terms of the quality of the
underlying portfolio, the quality of the collateral manager, the
quality of the servicers. That being said, we also have some
conservative aspects to our quantity side. And this is generally why,
as you saw in our disclosure on page seven that I talked about
earlier why our credit support requirements are generating a multiple
of in actual Triple- A but we do our own analysis and do our own
models and we structure our deals in a way and at a level at which
we're comfortable. But let me describe a couple of the conservative
aspects of our -- of the models that we use most frequently for our
multi-sector CDOs.
First, the first conservative aspect is that we are using corporate
default rates in our models. And we're using the corporate default
rates to estimate cumulative defaults in the collateral pool. Again,
this is typical corporate default rate table that has ratings and
tenors, and historical corporate default rates, and it is
conservative because given that MBIA mostly insures CLOs, not bonds,
CMBS, ABS CDOs, this is very conservative because these other asset
classes in general have much, much lower historical default rates
than corporate.
Second, we assume the worst possible allowed portfolio in our models.
We assume the minimum allowed coupon spread, the lowest rating, and
we use the default rates basically that correspond to the lowest
allowable portfolio rating from day one. But at the same time, we
assume the minimum spread, which is inherently unrealistic. Third,
we're using a lot law of normal distribution which produces high
default rates at a 99.9 confidence default interval, and a log normal
distribution leads to very high default rates at these confidence
levels. For example, a 10-year -- for a 10-year horizon, to
Double-A-rated collateral, the ratio at the 999.9% default rate to
mean default rate is about 11 times, for 95% confidence is five
times. And the same ratio for Triple-B minus collateral is 2.5 times
for 99% and about four times for 99.9%.
The other aspect to our model is that we use conservative interest
rates and default timing scenarios on top of distress default rates.
We run the models as Patrick mentioned earlier, assuming a wide
variety of combinations of stressed interest rate and default timing
scenarios. All of the scenarios are run assuming the stress default
rate, and the deal has to pass each and every scenario to meet our
underwriting standards. In terms of correlation, we look at each of
the underlying bonds to make sure that we're comfortable with the
originator, the servicer, the collateral, and if we're not
comfortable, we can remove the bonds from the portfolio, pre-default
it, reduce the rating for purposes of our analysis, and again, it is
a very detail-oriented and select process as Patrick described
earlier. And I think it is that -- I think it is our select and the
limit structures in the deal that help us reduce the potential impact
of issue and issue correlation. Plus we track all of the different
CDO tracks, we track overlap and we have limits against single issuer
and single issue concentration . Again, also primary collateral
managers are not saying this, we have seen this again and again
through various credit cycles over time and we adjusted our
analytical processes and as we mentioned our criteria over time to
reflect this.
GREG DIAMOND: Okay. Anthony, what are the ratings of the underlying
sub prime RMBS collateral held in your multisector CDOs?
ANTHONY MCKERNE: Sure. The collateral that I will reference will be
the 31% of the multisector collateral base or the 7.2 billion that we
referenced in our recent disclosure, looking at our 630 multisector
CDR portfolio. I will separate this out from the high grade portfolio
and the mezzanine portfolio. When you look at the high grade
portfolio, underlying collateral ratings approximate 12% in the
Triple-A category, approximately 51.5% in the Double-A category, and
about 33% in the A category, and about 3% in the Triple-B category.
There is about a 0 .5 left of other. Looking at the mezzanine
collateral base, approximately 3.2% of the collateral base is
Triple-A, and approximately 7% is Double-A, and about 25% is rated A,
and about 25% is Triple-B plus. And about 26% is Triple-B.
Approximately 7.5% is Triple-B minus. With the remainder being
primarily Double-BB, in the Double-B category.
GREG DIAMOND: Chuck, as the crisis of confidence in the equity and
CDC market have any impact on how MBIA wrapped bonds are trading in
the marketplace?
CHUCK CHAPLIN: We haven't really seen any impact of the downward
trend in our equity price and the upward trend in our CDS price. On
wrapped bonds that we have issued. We're pricing about as well as we
have. We had the issued some guaranteed investment contracts at MTN,
over the past couple of months which are guaranteed by MBIA
insurance. And those transactions have gone up at the same prices
relative to LIBOR that we have been seeing in the recent past over
time. One additional point to make about this is that we've seen this
kind of environment before, in 2002, and our CDS spreads were about
twice what they are today, and in that environment, also, we didn't
really see any impact on the pricing of our guaranteed bonds, or the
pricing of MBIA direct credit in the marketplace. So no, we haven't
really seen any impact to date.
GREG DIAMOND: Okay. Anthony? All market participants have been
speculating about what happens to the various components of ABS and
CDO structures under different loss scenarios. What would be the
cumulative losses within the sub prime universe needed in order for
MBIA to incur a loss in its direct and CDO portfolio?
ANTHONY MCKERNE: Sure, I will make an attempt to answer that. I'm
obviously go be speaking somewhat in generalities because every deal
is different. But just to start, let's start with our direct exposure
first. As we've stated throughout this presentation, MBIA has only
participated in wrapping sub prime exposure at the Triple-A level
since basically the beginning of 2004. Market participants have
expressed a wide range, potential losses for 2006 sub prime classes,
we've seen everything from 7% to 15% more recently. As far as
predictions. Given MBIA's senior attachment point and sub crime
deals, the select of only ensuring top tier players and the
conservative underwriting criteria and up front analysis that we
employ we feel quite comfortable that we're not at a risk of loss of
the direct exposure. Depends on the transaction type and the
structure of our sub prime exposures, we believe generally speaking
that these deals can sustain losses of between 22 and 35% for MBIA,
with sustained any level of loss. And if we turn to the multisector
CDO book, approximately 62% of the underlying sub prime collateral is
rated Double-A or Triple-A. There is significant diversity by issuer,
and as you've heard, as part of our dual diligence process, we look
to exclude assets with layered risk characteristics, or those
originate the by weaker seller servicers, and both of these items, we
view as key, because all issuers are not created equal and therefore
will not necessarily perform in line with weaker issuers. Asset
manager quality is also a key component, as MBIA selects top quality
managers with the absolutely best ability to navigate through
business cycles and carefully select portfolio investment on an
ongoing basis. Finally the initial portfolio screening by MBIA and
the asset manager are aimed at supporting the best possible portfolio
at closing and during the ramp period. With this as a backdrop, and
we've gone through a little bit earlier with some of the examples
that Eric and Patrick have given, if one were to make an assumption
that 100% of the sub prime collateral rated A or below within the
average multisector CDO were to default with a zero percent recovery,
essentially at day one of the action, regardless of the issuer
vintage or underlying deal structure, certainly the CDOs of high
grade mezzanine collateral would be materially impacted.
However, we feel this assumption that 100% of the collateral
defaulting at one time regardless of these items issuer vintage
product deal structure is unrealistic. With recent sub prime vintage
-- although recent sub prime vintage has been negative, a combination
of MBIA's CDO structures, which include interest coverage and
overcollateralization triggers, designed to accelerate senior debt
repayment, should underlying performance lag, top quality experienced
asset managers overseeing the portfolio, and the collateral
performance to date, we feel we have adequate protection to withstand
material market deterioration that exceeds the worst case estimates
in the market today. What doesn't come out in the quantitative aspect
of this is our remediation capabilities, and they are built into
these transactions, in a way that we're able to see problems ahead of
time and we're able to act on problems ahead of time, and whether
that is through asset manager termination, whether it is through
transaction, liquidation or debt acceleration, we are not passively
engaged in these transactions. We're looking ahead of the curve. And
we have a very aggressive remediation strategy. But it all starts
with the proactive communication with the manager and what he is
selecting in this portfolio, in the first place. So all in, we
believe we're well protected for the current environment in the
market.
GREG DIAMOND: Carl, I have two Countrywide questions for you. The
first is we expect the latest news out of CountryWide, that is, to
creep into prime RMBS that is more significant to you than sub prime,
so the first question is, are your countrywide deals performing as
expected? And secondly, countrywide reported that their portfolio of
sub prime total delinquency rate was 24% for the second quarter of
2007, and given this high number, for a high quality servicers,
they're concerned that you will breach the break even numbers
discussed?
CARL WEBB: What I will say on that point is this, Greg. We have seen
increased delinquency in both the closed end seconds and HELOC pools.
Either excess spread trigger or linkages have tripped on three
transactions. We're closely monitoring the portfolio and we're in
constant contact with CountryWide. I would also add that we have a
long-standing very strong relationship with CountryWide, and as I
said, we are monitoring the situation.
GREG DIAMOND: Okay. Eric? Why did you only disclose deals from 2004
forward in your CDO disclosure document that is posted on your Web
site? Incidently, that was the reference that was made earlier to one
of Eric's question. It was not presentation from today. It was the
disclosure document on CDO and sub prime RMBS that is on the home
page of our Web site.
ERIC PARSEN: The answer to that question that deals prior to 2004
only amount to 15% of the total amount of multisector CDO has it are
outstanding. The pre-2004 deals are about 3.7 billion out of 24
billion, plus any RMBS, included in those pre-2004 transactions, are
well seasoned at this point in time. Those transactions are
performing well, and again, they recently only showed transactions
from later periods and that's where the bulk of the exposure is.
GREG DIAMOND: Okay. Patrick, can you talk about your perception of
risk versus the market? Have you seen any change in the demand for
CDOs?
PATRICK KELLY: Sure. I think certainly, on the mortgage side, and
certainly flowing through to ABS, CDOs, our opinion would sync up
with the market's. I would think the performance deterioration is
clearly there for everyone to see. I guess where perception comes in
is related to where people think performance is going in the future.
There are a number of participants out there, or others in the market
that think that all Triple-B and Single A collateral tranches are
going to default. We don't share that view. We think there is going
to be a divergence in performance and there will be some better
performing collateral and there will be some worst performing
collateral. The selection process that we use, not to beat a dead
horse but the selection process we use for both underlying collateral
and collateral manager selection, we think is going to tend to favor
us in that regard. But as far as change in demand for our product,
absolutely, certainly the markets for corporate credit have widened
out significantly, particularly in the past two to three weeks and in
sympathy with some of the concerns about mortgage performance and
lately the backup in equity prices. As a result, we're seeing any
extremely strong environment to right protection in the investment
grade corporate space as well as syndicated CLOs. I would dare to say
right now it is project the best pricing environment we've seen in
the last four or five years, and our view is, at least on the
corporate side, is that this is the ideal environment for us, where
we have liquidity or technical issues that are driving pricing, not
actual credit deterioration at this point. The problem on the cash
flow CDO side certainly on the ABS CDO side has been over the last
month or two or three, is to avoid transactions where arrangers are
trying to get collateral off their own balance sheets.
We want to take advantage of the current situation, even in the ABS
CDO market where we can, but we also want to be -- we also want to
avoid getting stuffed with risk that people are just looking to get
off their own books. One of the issues that we're seeing on the cash
flow ABS side though as well is a lack of interest, or some hesitancy
on the part of arranging banks to take on warehouse risk so we think
that is going to slow down the pipeline of transactions, certainly on
the ABS CDO side but then also potentially on the CDO side if
liquidity continues to be stressed there. But in general, it is an
extremely good time to write business from a price and credit
standpoint, especially in the corporate markets.
GREG DIAMOND: Okay. Eric, have you revised any of your RMBS or CDO
underwriting models or approaches in the last 12 or 18 months? And if
so, what has changed?
ERIC PARSEN: Most of the changes that we have make in the last year
and to year and a half have been around internal credit limits. We
have been thinking about how much exposure we want to have to CDOs,
as an asset class, and then within CDOs, how much exposure we want to
have to the various sub segments. And we have a -- I started out my
presentation by saying I had a very diversified portfolio and our
objective is to keep it that way. And we are always looking at
correlation across the CDO portfolio and we have limit structures in
place that are designed to ensure that we don't become too
concentrated in any one name, and so earlier this year, we did review
and enhance some of our structures around the CDO products. I think
generally, we're comfortable with our underwriting criteria, and we
haven't made major changes to, it and most of the changes have been
around limit structures. And we generally don't like to compromise on
our credit standards, and instead, what we tend to do is when markets
get too overheated we will move away from that market, and move
toward the more rational market, and I think this is why we didn't
ensure any mezzanine A BS CDOs in 2005 and 2006, and the market just
didn't seem rational to us, and so we have been focused on other
sectors. We have a very broad reach of asset classes that we ensure,
and we have a lot of different types of expertise in house, so we're
able to move in and out of markets when markets we're in don't seem
to be particularly attractive any more.
GREG DIAMOND: Patrick, how do CDO triggers work? How quickly would
the super Triple-A tranche be paid down once a trigger is tripped? An
MBIA scenario analysis, what percentage of those analyses actually
lead to triggers taking effect?
PATRICK KELLY: Sure. There are both OC- and IC triggers within our
transactions. I mean in the high grade deals, we try to structure
them into both the interest and principal water falls. The way the
triggers work, are that they're set at various levels, which
essentially shut off cash flows to the junior tranches within the
deal, and depending on the individual tests, whether it is an OC or
IC test, and redirect those to clarify what OC and IC are. OC would
be overcollateralization defendants and IC would be interest coverage
triggers. Within the high grade deals, there hasn't been or certainly
when we structured these deals over the last couple of year, a lost
excess interest passing through these deals, so the benefit of that
was muted in our up front modeling, but OC triggers as well, once
breached and again, those always include our collateral haircut,
redirect cash flows, to amortize the senior exposure within the
transaction, once the thresholds are breached. Those can cure over
time. As enough cash flow is redirected to build OC again for that
senior exposure. And the second part of the question with regards to
speed of amortization, that's a little bit more difficult to
quantify. That's going to depend on the collateral portfolio and the
amortization of it. And I would say probably typically the
amortization can be anywhere between 10, 15, and 25% of the
collateral pool per year. Again, but those triggers can be cured, and
turned off at points in time once overcollateralization is built. It
is difficult to answer the last part of the question. Again, we run
about 500 different stress scenarios, and they are all built into our
modeling effort of the CDO. We really don't track how many of those
scenarios have trigger breaches. My guess is the fast majority if not
all of them breached some form of trigger within the deal when we
model the transaction and hit it with our stress losses in different
interest rate scenarios. So my guess there would be the predominance
of the scenarios would be hit. And the benefit of the OC and IC tests
would vary depending on the stress you run and the actual structure
and levels that they're set at.
GREG DIAMOND: And another one, another pair of questions for you
Patrick, do the investment banks structure the CDS that you issue and
who holds the CDS?
PATRICK KELLY: The banks do not structure the CDS. That is a
negotiated document between ourselves and the counter party buying
the liability that the CDS is referencing. So again, the holder of
that CDS protection would be the funding institution that bought the
CDL liability. One of these funding institutions that I mentioned
earlier. But again, that is a negotiated document between they and
ourselves. All their control rights to the deal pass to us, through
those documents, but again, recently, over the past year or so, we
have been getting ourselves named as the controlling party within the
actual deal documentation, so we haven't had the entanglement of
negotiating that with the CDS counter-party.
GREG DIAMOND: Okay. Anthony, how do you track the performance of the
collateral in your CDOs?
ANTHONY MCKERNE: Greg, we monitor the portfolio basically on a
three-tier approach. We look at the asset manager, we look at the
transaction, and we look at the underlying collateral on a regular
basis. What we will do is we receive monthly reporting, obviously, on
every transaction that we've entered into. Step one is to look at the
performance measures of the transaction, such as our over
collateralization triggers or cash diversion triggers, make sure that
the pool quality and eligibility criteria limits are being adhered to
and that investments are being -- they're being brought into the
collateral base, are of what we agreed to up front with the manager,
and then we're looking for any event of default occurrences which,
you know, would control trigger, trigger events such as manager
replacement, portfolio liquidation, and so forth, and primarily we're
also looking just to review the trading activity for reasonableness
and usually this leads to discussions with the asset manager
regarding strategy of investments, and on an ongoing basis, as well
as looking at the macro environment and seeing what their positions
are and trying to work with them to see if their views are the same,
depending on what the investment strategy is and trying to get a
mutual comfort level as to what direction the transaction is going.
When we look at the collateral itself, depending upon the type of
deal it is, and obviously for this call, we've been focusing on our
multisector CDOs, and sub-prime in particular, but obviously, for any
type of collateral that we look at, what is paramount important is
that we know what collateral, or what individual pieces of collateral
we have throughout the portfolio, whether it is in a CDO or in
another part of the company. So doing that call it overlap analysis
across the company is something that we monitor very closely. In the
event you have a corporate credit, like a Ford ar GM that has an
issue, obviously we're looking at that not only on the insured book
of business, direct insured book of business, but also in the CDO
portfolio.
Getting to the multisector book, what we will do, and instances like
we've got with the sub prime mortgage today is we will look at the
pieces of collateral and walk through the different attributes of the
transactions, and look at the performance to date of the individual
pieces of collateral, if necessary, we will work with the manager and
remodel some of these collateral pieces and find out what the
ultimate strategy is but what we try to do is take what is going on
in the market and try to target that to whatever area of the insured
portfolio and the CDO portfolio would require attention, and we're
able to access that information quite quickly and be proactive as far
as whether it is service or asset manager interaction. So it is a
combination of looking at the transaction performance itself,
insuring that our services and asset managers ar adhering to the
transaction documents and looking ahead to what the market is
bringing and looking at individual collateral and what we're seeing
in the rest of the book and making sure that those issues are being
addressed.
GREG DIAMOND: Okay. Another one for you, Anthony. What is your direct
Alt A exposure and the ratings of those deals?
ANTHONY MCKERNE: Sure. As of 6/30/07, our total Alt A direct exposure
is approximately $2.8 billion. The exposures are to top quality
issuers. The ratings of the portfolio are all Triple-A, except for
one transaction, which was closed at Double-A minus.
GREG DIAMOND: Carl, regarding your sub prime mortgages, what's your
break between variable rate and fixed rate mortgages?
CARL WEBB: It currently stands at -- fixed rate is 25%. ARMs are
approximately 75%. It mimics what is in the market right now. I mean
if you look at most of the sub prime has been the hybrid 228
products, we resemble that. If you look at our entire book, the
breakdown is going to be mortgage, 53%, ARMs and 47% fixed. Our book.
GREG DIAMOND: Okay. Another question for you, Carl. For various
reasons, sometimes poor underwriting, rather than a weak economy,
periodically leads to a vintage of loans that are grossly missrated.
How do you avoid the same error in light of the need to have a remote
probability of loss, especially for a relatively untested product or
one that has expanded at an inordinate pace, such as sub prime
mortgages and HELOCs?
CARL WEBB: That is a lot. All right. First and foremost, what we do
is we look at a lot of historical performance, and looking at deals
that we have been insured in the market in the past that we will
review, and we will have to look at the collateral and we have to
look at that is the first and for most, and we know over the time, a
lot of affordability product and what we try to do to get our arms
what we try to get our arms around is how that product is going to
perform. In most instances what we try to do is carve that out. We
try to carve it out. And in looking at the secondary market,
sometimes it is not possible. So what we will do is we will basically
pass on that transaction. And when we have an opportunity, basically,
to basically I would say shape a pool, a mortgage pool, what we will
do is tend to shy away from that product, that basically is untested,
and I mean that doesn't -- we don't have significant performance
history. We will shy away from it. But we have looked at increased
enhancement levels, in terms of -- in certain products. And make
sure, also, that we also have cash at the Triple-A level. And most of
the deals that we've done, look at the issuers, that we've insured,
the top tier, it goes back to the same thing that we've talked about
in the past. So top tier originators, servicers that have
demonstrated track records.
GREG DIAMOND: Okay. Thank you. Unfortunately, that's all the time
that we have for today. I mentioned earlier that there are many, many
more calls that we wouldn't -- or questions that we wouldn't be able
to get to. Some of them were responded to in the presentation. We
will also take those questions into consideration for future
development of disclosures the Company will provide in our filings as
well as our Web site. Thank you very much for your participation. We
do encourage you to read the materials on our Web site for additional
information. Thank you. And have a good day. .
OPERATOR: Thank you. This does conclude today's MBIA conference call.
You may now disconnect.
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