An Actuarial Approach to MBS Valuation, as presented at the CAS\'s 2009 Spring Meeting in New Orleans, Kyle Mrotek and Neal Dihora

1. MORTGAGE BACKED SECURITIES AN ACTUARIAL APPROACH TO CASH FLOW ANALYSIS Kyle S. Mrotek, FCAS, MAAA Neal Dihora, ASA, CFA May 5, 2009 CAS Spring Meeting May 5, 2009

3. What is a Mortgage Backed Security? Investor B (XYZ Ins. Co.) Investor A (Pension Fund) MBS Issuer/ Trustee Originator A (Retains Servicing) Originator B Servicer Jack Sally Jane John Mortgage Payments Mortgage Payments Mortgage Mortgage Payments Payments Sells Servicing Rights Purchases Jane’s Mortgage Purchases John’s Mortgage Purchases Jack’s Mortgage (Payments) Purchases Sally’s Mortgage (Payments) Buys a Portion of MBS Buys a Portion of MBS Cash Flows Cash Flows Jane & John’s Payments May 5, 2009

4. MBS Valuation Flowchart May 5, 2009

5. Gross Issuance May 5, 2009

6. Agency vs. Non-Agency May 5, 2009

7. Non-Agency by Type May 5, 2009

8. Non-Agency by Type May 5, 2009

11. Liquidity Evaporated May 5, 2009

12. Erosion of Market Values May 5, 2009

13. Erosion of Market Values May 5, 2009

14. Erosion of Market Values May 5, 2009

19. MBS Valuation Flowchart May 5, 2009

24. Ultimate Loss Rate ‘Paid’ LDF May 5, 2009

26. Challenges/Pitfalls May 5, 2009 Source: Moody’s Subprime RMBS Loss Projection Update, March 5, 2009 Source: Moody’s March 5, 2009

27. Challenges/Pitfalls May 5, 2009 Source: Moody’s Alt-A RMBS Loss Projection Update, January 22, 2009 Source: Moody’s January 22, 2009

29. A Priori Development - Frequency May 5, 2009

30. A Priori Development - Frequency May 5, 2009 Source: “Negative equity and foreclosure: Theory and evidence”, Christopher L. Foote, Kristopher Gerardi, Paul S. Willen, Journal of Urban Economics 64 (2008), pp. 234-345

32. A Priori Development - Severity May 5, 2009

35. MBS Valuation Flowchart May 5, 2009

37. Cash Flow Waterfall May 5, 2009 Illustrative NPV of Cash Flow Waterfall Output Net Present Value (NPV) RMBS Tranche Original Rating Scenario 1 Scenario 2 Scenario 3 A AAA 99.71 99.66 99.70 B AAA 77.63 78.52 69.03 C AA 79.09 7.81 1.64 D AA 78.64 9.96 1.66 E A 80.16 2.79 0.70 F BBB 86.83 0.64 0.39 G BBB 85.62 0.49 0.39 H BB 0.94 0.40 0.39 I BB 0.78 0.40 0.39 J Not Rated 5.46 5.34 0.39 K Not Rated 0.40 0.40 0.39

38. MORTGAGE BACKED SECURITIES AN ACTUARIAL APPROACH TO CASH FLOW ANALYSIS May 5, 2009 Questions? [email_address] [email_address]