FBE559.slides.10

No bankruptcy may have occurred during the preceding

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Unformatted text preview: have occurred during the preceding year for borrowers with a FICO score of less than 550; provided, however, that a Chapter 7 bankruptcy for a borrower with a FICO score in excess of 550 (or 580 under the stated income documentation program) may have occurred as long as such bankruptcy is discharged at least one day prior to funding of the loan. ... This was the AA risk! Credit Quality of Borrowers Under the C- risk category, an applicant must have a FICO score of 500, or greater. Unlimited 30, 60 and 90 day late payments and a maximum of one 120 day late payment is acceptable on an existing mortgage loan. An existing mortgage loan must be less than 150 days late at the time of funding of the loan. Why would you not care about borrow credit quality? Going up to 2006, there was unprecedented home price appreciation (HPA). Who cares about credit quality when you have enough collateral? Especially if you think that collateral is relatively liquid. As long as HPA remained high (or least not negative), these investments were very solid. 220 200 Los Angeles Composite 20 180 160 140 120 100 80 60 40 1985 1990 1995 2000 Year 2005 2010 Who buys this garbage? If you are a money market fund you can buy t-bills or you can buy the best part of this $2B mortgage pool that all the credit rating agencies say is AAA and get LIBOR + 0.13%. This was called reaching for yield. If we are trying to construct a portfolio with a maximum chance of loss of 1% and the lowest price possible (i.e. highest yield), how should we do it? Look for the worst possible state of the economic to be the default state. Example Say we agree that: 1 There...
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