What is the New Plain Vanilla (NPV)?

NPV is a combination of financial techniques that modernize and “symmetrize” residential mortgage asset securitization transactions. Specifically, such techniques deal with (i) symmetric and just allocation of credit and prepayment risks among the parties to such transactions, (ii) payment-centric information flow and disclosure and (iii) innovation in the financial markets’ securities structures.

The overall objective of NPV is to optimize the residential mortgage lending securitization transactions, particularly in the areas of structural symmetry, surveillance quality and resilience to cyclical movements in economic variables.

NPV Technology has the following 5 pillars or major building blocks:

1. mortgage borrowers must become parties to the securitization transactions and participate in the credit and prepayment optionality of such instruments;

2. takedown and periodic disclosure related to mortgage backed securities (RMBS) must be simplified, standardized and focus on asset behavior data;

3. retail mortgage products must reflect the target audience perceived risk profile in a positive and not negative manner, i.e. the applicants with the worst perceived risk profile should received the most resilient and adaptive mortgage loan;

4. taxpayer monies shall be routinely applied to securitization transactions in a long-term guarantee fashion so that the government housing and related economic policies are reflected directly on the federal balance sheet;

5. transaction documents shall be standardized and available online, in electronic, software accessible format; appropriate software shall automatically construct risk relations and pathways from such documents.

NPV introduction could be achieved in stages, thus RMBS structures can be amended almost instantaneously, without a need for other listed changes.

Specifically, the Phase I New Plain Vanilla technology elements are:

1. Conversion of the hybrid and adjustable rate mortgages of select non-prime obligors to fully amortizing fixed rate mortgage loans. This accomplishes the goal of providing payment amount certainty to the borrowers who were hit hard by the upward movement in reference interest rates in the form of higher monthly mortgage payments. Additionally, various interest-only mortgage products impact the household equity particularly negatively when coupled with falling real estate prices, which was the case since 2006. The effect of such conversion would also be a much more easily predictable cash flow from the household to the investor.

2. NPV Bond. Issuance of a simplified RMBS security with one of the classes distributed free of charge to the mortgage obligors of the collateral pool underlying such security. This is the key financial innovation of NPV technology and aims to (i) increase the mortgage obligor’s symmetry of the household balance sheet, (ii) incentivise responsible mortgage payment practices by tying the payments from such tranche to the accuracy of the borrower remittances and (iii) materially increase the borrower equity in the mortgaged property by offering a deferred lump sum payment.

Individual mortgage obligors of the loans comprising the asset pool of a New Plain Vanilla Security receive a high-ranking tranche of such security. They become, in addition to being borrowers, investors, essentially in own cash flow. NPV class, besides offering a periodic interest payments (rebates), also contains, like a plain vanilla bond, a principal component payable to the obligors at end of the security’s life.

3. CASH PATH analytics. Simplified, cash-payment centric deal surveillance and instrument quality indicators. This is a particularly important part of the New Plain Vanilla Technology as it remedies a glaring deficiency of the current investor disclosure regulation by focusing on the ongoing payment data. By obtaining reliable information on asset performance AND the effects of such performance for the security holder, NPV enables prudent instrument pricing and risk assessment by the investors.

Major NPV beneficiaries include:

1. Mortgage borrowers. This group directly participates in mortgage asset securitization transactions in the form of receiving a specific class of the overall issuance. The mechanism of such participation involved linkage of individual borrower payment discipline to receipt of periodic and back-end payments from the NPV Tranche. The result of such participation is improvement in default, delinquency and prepayment profile of the mortgage assets. Further on NPV Tranche see below.
2. Investors in mortgage backed securities. This group benefits from NPV technology in two aspects – (i) by receiving a risk-symmetric instrument with an improved credit and prepayment profile and (ii) by receiving a payment-pathway focused risk centric analytics and surveillance.
3. All parties with exposure to mortgage backed securities. This group benefits particularly significantly in times of material market disturbances in liquidity and valuations of RMBS. Thus, under current conditions, application of NPV techniques to RMBS portfolio restructuring would allow for 5-10% reduction of mark-to-market equity allocations per deal. NPV is a technique with a singularly efficient application at times of trust and information deficit.

A rather simplistic financial modeling was performed to stress test the NPV technology in its basic application – structural modernization of a RMBS security. A NPV financial modeling tool was designed to construct a financial instrument which would be viable under the current market conditions. Calculations show that such an instrument, building on current RMBS structures, is expected to withstand current and expected delinquency levels, as well as provide the borrowers, who are also START bondholders, with meaningful “rebates” periodically and also at end of the mortgage loan life.

The following summarizes the quantitative benefits for the above mentioned parties.

1. Mortgage borrower real estate equity increase – 10-15% of loan amount outstanding; i.e. mortgage loan LTV reduction by 10-15%.

2. Mortgage borrower periodic payment rebate – 10% of payment amount; i.e. a borrower receives 10% of the mandatory monthly mortgage payment in the form of the NPV coupon payment.

3. Default resiliency – up to 7% CDR; i.e. underlying asset default profile could worsen up to such number without adverse events for the bondholders. Such rate of default is very high; for comparison, under normal market conditions it does not exceed ½ of a percent per year. Current data indicates CDR rates of 5-10%.

The effect of implementing New Plain Vanilla-compliant financial instrument should be primarily dramatic for the current holders of RMBS, RMBS CDO and mortgage whole loan portfolios.