© 2011 Bayview Advisory Services, LLC. All Rights Reserved.
Boardroom Forum on Lending DECEMBER 2011
A Comprehensive Approach to Forecasting Credit Losses: Triangulating Loss Estimates
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Forecasting Credit Losses in Bank Loan Portfolios – Acquisition vs. Lending
Challenges:
Deals continue to be competitive – multiple bidders.
Short time frames and limited data.
The credit environment has completely redefined the “worst case scenario.”
Bank transactions leave little margin for error.
Key Goals:
With respect to NPLs:
Quantify true loss severity.
For Performing Loans:
Estimate default probabilities and loss severities.
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Portfolio analysis is not an exact science; therefore, Bayview employs a three pronged approach
to estimate portfolio losses:
Roll Rate Analysis
Borrower Related Underwriting and Property Level Analysis
Regression Based Models
Portfolio Loss Estimate
A Comprehensive Approach to Forecasting Credit Losses: Triangulating Loss Estimates
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As of August 2011, the portfolio is approximately 3.1% 60+ days delinquent.
Key Observations:
− 90.4% of current loans were still current 6 months later; 4.3% paid in full during the period.
− Only 20.9% of 30 day loans were current 6 months later.
− Only 7.00% of 60+ day loans were current 6 months later.
Assuming the 6 month experience repeats itself:
− In two years, 13.9% of the portfolio will be 60+ day delinquent.
− In three years, 17.9% of the portfolio will be 60+ day delinquent.
− In five years, 23.8% of the portfolio will be 60+ day delinquent.
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A Comprehensive Approach to Forecasting Credit Losses: A Roll Rate Analysis
A Roll Rate Analysis evaluates historical portfolio performance across multiple points in time in
order to predict future performance.
− This approach tracks the actual migration of (a) current loans to delinquent/default; (b)
delinquent to re-performing, and (c) prepayments.
Sample Commercial Loan Pool: 6 Month Illustrative Roll Rate Analysis
(February 2011 to August 2011)
Current 30 60+ Default Prepay
Current 90.4% 2.9% 2.3% 0.1% 4.3%
30 20.9% 16.4% 55.6% 6.4% 0.8%
60+ 7.0% 10.3% 68.5% 13.9% 0.3%
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A Comprehensive Approach to Forecasting Credit Losses: Roll Rate Analysis
− Assuming recent transition rates are at unsustainably high levels, a pure roll rate analysis may reflect
a “severe case” scenario for defaults.
− In fact, recent experience with residential transition rates provides evidence that default rates “burn-out”
from peak levels.
− If we apply the slope of the reduction in subprime transition rates from their peak to the sample pool, it
would result in significantly lower 2 year, 3 year, 5 year, and lifetime default rates.
Severe
Case
Subprime
Trend Slope
2 year 13.9% 10.1%
3 year 17.9% 11.6%
5 year 23.8% 13.7%
Lifetime 40.3% 23.2%
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Benefits of Roll Rate Analysis:
− Accounts for actual performance of a specific population over a recent period, a key factor
not included in any other forecasting tool.
− Illustrates what the portfolio can be expected to look like at specific points in time if transition
rates remain constant.
− Can accommodate expected changes to transition rates as a result of macro variables,
burnout, or servicing practice change.
− Applicable to most asset classes
Roll rate analysis should be performed separately on risk stratified sub-portfolios. Mixing low
quality assets with high quality assets in a roll rate analysis can lead to exaggerated default
expectations. We recommend analyzing roll rates on sub-portfolios by asset type (Residential,
CRE, C&D, etc) and within asset type by loan quality (risk grades, credit score, vintages, etc).
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A Comprehensive Approach to Forecasting Credit Losses: Roll Rate Analysis
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A regression based model correlates the performance of approximately 12 key variables to
historical data of similar loan populations to predict expected portfolio default probability and
severity.
Examples of variables which correlate to long term portfolio performance include:
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A Comprehensive Approach to Forecasting Credit Losses: Residential Modeling
• Occupancy • Property Type • Geography (Zip code, MSA level) • Loan Balance • Credit Score • Documentation Type • Loan Type • Loan Age • Original LTV • Mark to Market LTV • Payment History • Forward Home Price Projections
Key Model Variables
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A Comprehensive Approach to Forecasting Credit Losses: Residential Modeling
0%
10%
20%
30%
40%
50%
60%
70%
Projected Frequency of Foreclosure (FOF) Bucket
Static Pool Performance by Model FOF Groups(Model run as of EOM July 07 (all current loans) and actual performance data is as of EOM Nov 09)
Default
REO
FCL
90+
60
30
0
200000
400000
600000
800000
1000000
0
5
10
15
20
25
Loan
Cou
nt
Vol C
PR
Remittance Date
Fixed Model vs. Actual
Actual CPR Model CPR Sample Size
Credit Model Validation Prepayment Model Validation
To test the validity of the model, projected figures are compared to actual results.
0
200000
400000
600000
800000
1000000
0
5
10
15
20
25
Loan
Cou
nt
Vol C
PR
Remittance Date
Arm Model vs. Actual
Actual CPR Model CPR Sample Size
Projected Frequency of Foreclosure
(FOF) Bucket at July 2007
Actu
al
Sta
tus
at
No
vem
be
r 2009
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BAM has studied the performance of commercial loan (CRE and C&I) portfolios of banks
(over 20,000 loans) to better understand the default probability drivers of these loans.
Bank risk scores (adjusted to the BAM underwriting scale), macroeconomic variables,
historical loan performance, and certain loan characteristics were found to be primary risk
drivers.
Based on this study, BAM has developed regression based commercial loan default modeling
tool to first establish short-term (6 month) projections of performing loans migrating to a non-
performing status.
BAM then employs a cash flow-type modeling tool to take into account prepayments, default
timing, and potential improvements in economic conditions to establish a range of default
probabilities.
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A Comprehensive Approach to Forecasting Credit Losses: Commercial Loan Modeling
•Bank Risk Scoring (Adjusted by BAM)
•Macroeconomic Variables
•Proprietary Property Value Index
•Local Unemployment Levels
•Changes to Unemployment
•Loan Performance (Historical Pay History)
Commercial Loan Modeling (CRE and C&I): Model Input Variables
•Loan Characteristics
•Occupancy (Owner vs. Investor)
•Property or Collateral Type
•Loan Seasoning
•Loan Type (Fixed vs. ARM)
•Loan Balance
•Property/Collateral State & Zip Code
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A Comprehensive Approach to Forecasting Credit Losses: Commercial Loan Modeling
CRE Model Performance C&I Model Performance
0.00%
2.00%
4.00%
6.00%
Portfolio APortfolio B
Portfolio CPortfolio D
CRE Model NPL
Actual Roll to NPL
0.00%
1.00%
2.00%
3.00%
4.00%
Portfolio APortfolio B
Portfolio CPortfolio D
C&I Model NPL
Actual Roll to NPL
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
1 2 3 4 5 6 7 8 9 10
6 M
on
thR
oll
to 6
0+
Actual vs Model by Predicted Decile (C&I)
Model
Actual
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
20.00%
1 2 3 4 5 6 7 8 9 10
6M
on
th R
oll
to 6
0+
Actual vs Model by Predicted Decile (CRE)
prediction
actual
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Benefits of Regression Based Models:
− Provide an indication of how the portfolio should perform based on characteristics
observable about the portfolio.
− Provide a consistent approach to estimating near-term and lifetime default probability for
homogenous and granular portfolios of residential mortgage, CRE, and C&I portfolios
− Take advantage of BAMs extensive data and research to produce default and loss
estimate ranges quickly and with limited data requirements
− Set a benchmark level of performance that can be reconciled against the roll rate
analysis.
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A Comprehensive Approach to Forecasting Credit Losses: Modeling Tools
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While Regression and Roll Rate Analyses provide important data points, there is no substitute for
re-underwriting loan files and evaluating the collateral supporting the loans.
For residential and small balance commercial mortgage loans, strength of a guarantor is an
important factor in long term performance. Underwriting is focused on evidence in the loan files
that the homeowner, investor, or business using the property has strong credit and stable cash
flows. Updated property values are obtained using AVMs and BPOs that are reviewed by internal
appraisers.
For larger balance commercial mortgage loans and C&D loans, property visits by real estate
professionals are essential to understanding the status and condition of the property, verifying
physical occupancy, assessing the market for vacant space, and incorporating market conditions
into an updated valuation.
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A Comprehensive Approach to Forecasting Credit Losses: Borrower Related Underwriting and Property Level Analysis
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Benefits of Borrower Related Underwriting and Property Level Analysis:
− Borrower Related Underwriting is essential for predicting default probabilities:
• Assesses the accuracy and quality of the original underwriting analysis to help determine
the risk profile of each borrower.
• Helps assure that the data used in the Regression Model is accurate (documentation type,
DSCR, LTV).
• Provides for a re-grading of loans to normalize for institution specific risk grading process.
• Facilitates comparisons to other portfolios based upon strength of underwriting.
− Property Level Analysis provides a baseline forecast for portfolio loss severity:
• Determines the value of the collateral today.
• Integral to analysis of cash flow stability.
• Incorporates current and projected market conditions.
• Evaluates reasons for property value decline:
Capitalization rate deterioration vs. decline in property operating income due to
vacancy increase.
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A Comprehensive Approach to Forecasting Credit Losses: Borrower Related Underwriting and Property Level Analysis
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Benefits of A Comprehensive Approach: Triangulating Loss Estimates
Portfolio Loss Estimate
• Serves as a benchmark
performance baseline
• Provides indication of future
portfolio performance based on
observable characteristics
• Works for homogeneous and
granular portfolios
Roll Rate Analysis
Borrower Related Underwriting and Property Level Analysis Regression Based Models
• Provides for normalizing of risk grades
• Determines value of the collateral today
• Assesses the accuracy and quality of the
original underwriting analysis and the loan
tape data
• Accounts for actual performance of a
specific population over a recent period
• Illustrates what portfolio can be expected
to look like at specific points in time
• Can accommodate expected changes to
transition rates
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Why Risk Grading Alone is Insufficient:
− Risk Grades are not uniformly applied.
− They reflect, in many cases, only relative grades--not an absolute risk metric (i.e. what is a
1, 2, or 3 rated construction loan in a tough market?).
− They do not directly translate in loss estimates.
They should, however, be incorporated as inputs in all three approaches to forecasting losses
that we have highlighted:
− Roll rates can be stratified by loan type and risk grade to illustrate how each loan type’s
best and worst risk grades are actually performing.
− Loans should be re-risk graded through the loan level re-underwriting process.
− Risk grades, where available, can be included in the Regression Model on a BAM-
adjusted basis.
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Benefits of a Comprehensive Approach: Why Risk Grading Alone is Insufficient
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Three approaches may not produce a consistent outcome and therefore must be reconciled
for financial modeling purposes. Consider the following 3 examples:
A: All Three Approaches Reconcile
• The Regression model says that loans that have the observable characteristics of the
target institution’s portfolio should perform well based upon the regression equations
that fit the large pools of loans upon which the models were based.
• Roll rates to delinquency are low over the previous 3 to 6 months.
• The underwriting and property analysis revealed strong, well documented files
signaling high credit guarantors and large commercial properties with stable cash
flows.
Conclusion: If only all deals looked like this!!
B: Roll Rates are Inexplicably Worse than Expected
• The Regression benchmark suggests that loans should perform well and the
underwriting appears sound but over the prior 3 months, the roll rates suggest that the
portfolio is declining quickly.
Recommendation: Further stratify the roll rate analysis to identify if the deterioration is broad
based. Re-underwrite the actual defaults during the period to ascertain whether the defaults
are idiosyncratic to certain large borrowers, loan types, or geography. Determine if problem is
isolated or widespread.
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Benefits of a Comprehensive Approach: Reconciling the Three Approaches
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C: Roll Rates Look Too Good
• The portfolio appears to be outperforming its observable characteristics. The loan
underwriting casts further doubt on the roll rate analysis as the credit culture of the target
institution appears weak.
Recommendation: Re-underwrite the loans that appear to be the highest risk in the
Regression model. Is the institution rolling due dates as part of an aggressive modification
campaign? Confirm payment histories.
Conclusions:
• Loan tapes can have inaccuracies and servicing practices can mask delinquency issues
but loans rarely significantly over perform or underperform their loan characteristics
without the reasons being observable in the loan underwriting and property analysis.
• A “triangulation” approach to credit is essential in the current high risk environment.
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Benefits of a Comprehensive Approach: Reconciling the Three Approaches
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About Bayview
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© 2011 Bayview Advisory Services, LLC. All Rights Reserved.
Bayview was founded in 1984 and now has 964 employees. Our senior management team has an
average of 12 years company tenure.
Bayview Asset Management is minority-owned by affiliates of Blackstone Capital Partners.
Since 2008, Bayview has advised many clients on whole bank acquisitions ranging in asset size from
less than $200 million to greater than $50 billion.
Bayview services nearly 55,000 loans with an aggregate UPB of approximately $13.0 billion.
– Bayview Loan Servicing, whose predecessor was founded in 1999, now has 688 employees in 6
locations (FL (2), TX, PA, IL and PR) and is comprised of teams of experts in asset valuation, loss
mitigation, loan workouts, bankruptcy and foreclosure
– Senior and mid-level managers average more than 21 years of industry experience, with no change
in management personnel in the past five years
Bayview has proven success in loss mitigation with a focus on servicing delinquent and high-risk
performing loans for itself and third parties.
– Bayview Loan Servicing is one of only four servicers with S&P’s highest residential special servicer
rating and the only one with the highest rating for small balance commercial
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Bayview has a proven track record and is an industry leader in mortgage investment analytics and loan servicing
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Bayview enjoys strong institutional support via a non-controlling investment from affiliates of the Blackstone Group
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Bayview Asset Management is a fully-integrated mortgage investment company with expertise in the analysis and management of distressed and performing mortgage assets
Overview of the Bayview Asset Management Organization:
Founded in 1984, as a leading advisor,
valuation specialist, and broker of
mortgage servicing rights portfolios
Purchased $20 billion in loans from 2,000
counterparties in 9,000 transactions
Sponsored 75 commercial and residential
securitization transactions totaling $28
billion in securities sold to 200 institutional
investors (including securities issued
under Bayview’s small balance
commercial platform)
Raised over $3 billion and manages
three opportunity funds of credit-sensitive
residential and commercial mortgage
loans
Experience
964 employees in six offices
Dedicated teams specializing in:
Mortgage Research and Analytics
Loan and Securities Portfolio Management
Loan Special Servicing
Loan Underwriting and Valuation
Real Estate Construction and
Development
Bayview Loan Servicing manages a $13.0 billion mortgage portfolio of proprietary and third party assets
1 of only 4 servicers with S&P’s highest residential special servicer rating and the only one with the highest rating for small balance commercial loans
Depth
Minority-owned by affiliates of Blackstone
Capital Partners
Senior management team with an
average of 12 years company tenure
Flexible infrastructure and strong
management has enabled Bayview
to successfully navigate the credit
market turmoil
Stability
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Multi-family
Commercial
Residential
Improved
Construction
Raw Land
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Bayview has principal expertise in assessing risk and determining value across the full-spectrum of bank balance sheet assets
Real Estate
C & D Loans (Residential and Commercial)
Bayview also has experience in
Mortgage and Asset-Backed
Securities backed by real estate
asset classes
Bayview’s experience includes
both performing and non-
performing loans in the following
asset classes:
Mortgage and Asset-Backed Securities
C & D Loans (Residential and Commercial)
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23
The same functional teams that drive Bayview Asset Management’s successful proprietary investment process are available to clients of Bayview Advisory Services
Loan Servicing
688 FTEs
Mortgage Research and
Analytics
6 Professionals
Real Estate Construction & Development
10 Professionals
Portfolio Management
4 Loan and MBS Managers
Loan Underwriting &
Valuation
22 Underwriters 21 Appraisers
Highly-rated by all rating agencies
Loss mitigation expertise for high risk and distressed
assets
$13.0 billion portfolio of residential, commercial and
C&D loans
Servicing $3 billion in loss share assets (9 banks)
Dedicated mortgage research
effort
Proprietary loan-level credit &
prepay analytics
Extensive database of proprietary
and industry data
Large balance commercial real estate team
with expertise in troubled and transitional
assets
Team management individuals have an
average 21 years of experience in
development, legal, valuation, construction,
engineering, banking, and property
management
Due diligence process created to
protect buyers of distressed assets
Asset level valuations by staff with
average experience between 15
years (residential) and 23 years
(commercial)
Valuations tracked and analyzed
via a proprietary database
Seasoned team of loan and securities
managers
Manage three funds of distressed
commercial and residential mortgages ($3
billion capital raised)
Active market participants provide detailed
information on capital flows
and capital markets activity
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24
Four core competencies serve as the foundation for the services Bayview delivers to its advisory clients
Credit Loss Forecasts and
Asset Valuation
Loss Mitigation Solutions
Structured Finance
Solutions
Principal Takeout for
Problem Assets
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25
To better understand how Bayview can meet your loan portfolio advisory needs, please contact us:
Jim Dougherty
Managing Director
Bayview Advisory Services, LLC
Office: 212.259.0630 / Cell: 212.960.8119
www.bayviewadvisoryservices.com
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