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Unformatted text preview: Subprime Hybrids Under Different HPA and Interest Rate Scenarios Bad prediction Interest Rates Annual HPA -5% 0% 5% Forward+100bp 11.9 8.4 5.5 3.7 Forward 11.6 8.1 5.3 3.6 11.3 7.9 5.2 3.5 Current S&P Scenario 12.8 10% Source: Citigroup. Figure 5. Cumulative Loss Projections for Current-Origination Subprime Fixed-Rates Under Different HPA and Interest Rate Scenarios Annual HPA Prepayment Speed S&P Scenario -5% 0% 5% 15HEP 12.1 11.8 8.6 5.6 10% 3.7 23HEP 10.5 9.7 7.1 4.8 3.4 Source: Citigroup. Our loss projections in the S&P scenario are vastly different from S&P’s projections under the same scenario. For 2005 subprime loans, S&P predicts lifetime cumulative losses of 5.8%, which is less than Asset Backeds and Mortgage Credit Source: December 2005, Citi half of our number. (S&P does not break down the pool letter researchinto fixed- and floating-rate loans.) We believe that the S&P numbers greatly understate the risk of HPA declines. ctions in the uch higher ctions in the e scenario. ely scenario 0% increase the current level. Among the scenarios we analyzed, we take the 5% annual HPA as the most likely scenario going forward. In that case, our models project losses for subprime hybrids of 5.3% using the forward curve. These losses are 47% higher than the losses in the bullish scenario of 10% annual HPA. (The bullish scenario is comparable to the actual economic environment of the past few years.) Therefore, even a home price Bad prediction 300 Los Angeles Composite 20 250 200 150 100 50 1985 1990 1995 2000 Year 2005 2010 What were the problems? Fraud Borrowers Lenders Securitizers Agency problems: moral hazard Mistakes by credit rating agencies Poor estimation of default correlation Validity of FICO scores Originate to distribute vs. originate to hold This only matters if there is fraud or mistakes by end buyers...
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