CDO Insurance?

[tdoucet]

Does anyone have an idea the extent that insurance products have limited losses in residential mortgage CDO's (any tranche)? For example, when mortgage insurance covers some of the losses from an individual borrower default, how much of that coverage filters back into the CDO? Are there other sources of insurance that may cover CDO losses, and if so, what kind of benefits are generated from them?

Thank you!

[financeguy]

CDS is what you're looking for I think... but maybe I don't understand your question correctly

[doug reich]

I think he's describing mortgage insurance (look it up) and its effect on mortgage pool payments/CDO prices.

From what I read online about mortgage insurance, it will have almost no effect on CDOs: although it is only ever used for "risky" mortgages, our risky mortgages of the last two years were so reckless as to exclude it.

If you were to model its effect on prices, you'd have to incorporate the insurance into your asset-side model in your MBS model, probably as increasing prepayments instead of defaults.

[tdoucet]

Mortgage Insurance is required for any residential conforming (prime) loan that exceeds 80% loan to value. Every Fannie Mae or Freddie Mac loan requires MI if the value of the loan exceeds 80% of the value of the property (or purchase price). Thus, a $90,000 loan on a $100,000 property will require MI.

When these loans default, the MI covers some of the holder's loss on the individual loan. I'm curious to know whether people have heard about any of this coverage making its way back to the CDO, and if so, what kind of dent it makes.

I'd also be happy to know how CDS funds benefit a CDO's bottom line, if you know specifics or examples on the size of the financial benefit in relation to the CDO.

Thanks-

[financeguy]

If you hold a tranche of a CDO, then you hold (albeit securitized) debt. If a loan defaults and mortgage insurance dampens the loss, then the holder of the CDO would collect the insurance, assuming it came from a loan whose default affected that tranche. You wouldn't be talking about a FNMA passthrough product, because these CDOs (i.e. the CDOs made up of FNMA passthroughs to hedge prepayment risk) would not carry default risk. FNMA would charge a g-fee, be responsible for interest and principal payments in the case of default, and keep the MI to itself. So in this case the only way an investor would feel the MI in the CDO is within the g-fee that FNMA would charge in an underlying passthrough, which would work its way up to the price of the CMO. If you're talking about a non-agency passthrough, then I'd imagine it's quite a different story. I have not, however, heard much about MI when modeling CMOs. It probably doesn't make a huge difference - how much insurance could someone be required to buy?

A CDS would theoretically not have an effect on the CDO since it's a different product altogether. It just provides insurance on a tranche of a CDO. A holder of a CDO could also buy a CDS by making periodic payments to the seller of the CDS. In the event of a credit event, in this case default, the guy stuck with the defaulted loan would be made whole by the seller of the CDS. It is exactly buying insurance on a loan. Of course it has gotten a bad name for being used in quite a different way, but this is its true purpose.

This seems like too basic an answer to your question, so if it sounds that way, I apologize. I don't have any exact numbers for you unfortunately.

Originally Posted by tdoucet Mortgage Insurance is required for any residential conforming (prime) loan that exceeds 80% loan to value. Every Fannie Mae or Freddie Mac loan requires MI if the value of the loan exceeds 80% of the value of the property (or purchase price). Thus, a $90,000 loan on a $100,000 property will require MI. When these loans default, the MI covers some of the holder's loss on the individual loan. I'm curious to know whether people have heard about any of this coverage making its way back to the CDO, and if so, what kind of dent it makes. I'd also be happy to know how CDS funds benefit a CDO's bottom line, if you know specifics or examples on the size of the financial benefit in relation to the CDO. Thanks-

[tdoucet]

Thank you, that was very helpful.

In the end, I am most interested in the ultimate effects on homeowners facing foreclosure. Many times deficiency judgments are sought against the homeowner as part of foreclosure, and I'm curious to know whether the note holders' lossess have already been partially offset by insurance products like MI or a CDS.

If you know of additional resources or papers on this topic, I would love to have an opportunity to review them!

Thank you!