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RMBS Scenario To Include 17% Unemployment Rate

By Allison Bell

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A National Association of Insurance Commissioners panel is pushing ahead with efforts to develop a new approach for calculating the risk-adjusted value of residential mortgage-backed securities.

Members of the Valuation of Securities Task Force at the NAIC, Kansas City, Mo., today approved a set of assumptions to be used in efforts to estimate how likely RMBS are to go bad and how much they are really worth.

The NAIC has hired consultants at Pacific Investment Management Company L.L.C., Newport Beach, Calif., to work with the NAIC’s Securities Valuation Office to come up with the new RMBS valuation system.

Modelers at the NAIC and PIMCO will be testing RMBS to see how the securities might perform under a wide range of conditions, or “scenarios.”

The securities valuation task force has decided that one scenario to be used will be “market neutral.” Modelers will use a median case scenario that appears to have a 50% chance of occurring. A moderately aggressive scenario and moderately conservative scenario used will each have a 22.5% chance of occurring; and a more aggressive scenario and a more conservative scenario will each have a 2.5% chance of occurring.

“PIMCO Advisory will generate the four additional scenarios using a proprietary statistical model that uses Monte Carlo simulation based on historical volatility and the baseline forecast,” Eric Kolchinsky, a senior advisor to the SVO, and Robert Carcano, an SVO senior counsel, write in a memorandum addressed to interested parties.

In the median-case scenario, the assumption is that home prices will be 38% lower in the second quarter of 2010, when the housing market slump will bottom out, than they were when the market peaked in mid-2006, Kolchinsky and Carcano write. In that scenario, unemployment will peak at 10.6% in 2010, then fall to 7.4% in 2012. The Consumer Price Index would increase 1.4% in 2010, 2% in 2011 and 2% in 2012. Gross domestic product will increase 2.2% in 2010, 5% in 2011, and 4.9% in 2012, according to a collection of questions and answers posted on the securities valuation task force website.

In the most aggressive scenario, the difference between home price appreciation at the peak and at the trough will be 33%.

In the most conservative scenario, the difference will be 61%. In that scenario, the trough in home price appreciation will occur in 2020.

The models also will incorporate factors such as job losses.

The base scenario assumes 11% unemployment over the next 12 months, with more than 400,000 new jobless claims per week. The pessimistic scenario assumes unemployment will level off at 17%, with workers filing 550,000 new jobless claims per week for 24 months.

U.S. life insurers ended 2008 with about $145 billion in RMBS holdings issued by entities other than federal mortgage agencies.

Insurers will be using the results of the new modeling approach when they compute risk-based capital ratios, a measure of insurer financial stability.

In the past, insurers used rating agency ratings when adjusting RBC ratios to reflect the possibility that some assets might turn out to be worth less than expected.

This year, the rating agencies responded to the financial crisis by slashing RMBS ratings. Life insurers said sticking with the old, rating-based system would wipe out the RBC value of RMBS holdings, even if it seemed likely that the RMBS would end up paying most or all of what they were originally expected to pay.

The NAIC agreed to change the system, and it announced in November that it would be using PIMCO to serve as the financial modeler for a new valuation program.