Calculation
And Evaluation Methods
 The Retrospective
Approach in evaluating the interest payment and loan repayment patterns reflects the
likelihood of potential default risks from the borrowers for those existing issues that
helps determine the adequate ratio of provision required for doubtful or non-performing
loans over its lifetime. More importantly, the retrospective calculations provide an open
and fair view of the accounts, which could appropriately affect the pricing of the bond
and its credit quality.
However,
the real quality behind an existing loan portfolio cannot be interpreted merely by its
credit ratings or redemption features being packaged with the bond at the time of issuing,
since they can be changing or may become inadequate over time due to a number of variable
factors such as bankruptcy of the loan borrowers, issuer's or guarantor's insolvency,
devaluation in the collateralized assets, and
other economic and political impacts.
The valuation of an existing mortgage loan portfolio with the
subsequent issue of a mortgage bond covering the
remaining period of the loan should be interpreted in a way of total return to investment
from the first issuing date of the loan to the final maturity date of the bond, which
include the significant interest incomes derive from the early stage together with the
consideration of the total amount of loan outstanding on or before the issue of bond.
Standard Deviation is used to
describe the volatility of a security or portfolio of securities by measuring the amount
of variation in any group of numbers such as interest rates, maturities, yields…etc.
In the investment market, the larger the volatility in a security’s return the more
likely it is to dip into negative territory. However, it is not the absolute case that a
fund that alternately gained a remarkable return of 10% or 50% each month would have a
much higher standard deviation, but it would surely be a preferable investment.
When used to measure the volatility of the
performance of a security or the monthly prepayment speed of a MBS, standard deviation is
generally calculated for monthly returns over a specific time period—frequently 36
months. Our approach in using standard deviation is to quantify the variances of the
returns of the security, not its risk. Based on the huge historic data provided in the
property industry, it is mathematically possible to calculate the standard deviation of
returns on both the upside and the downside by measuring the potential gain or loss with
the security in its magnitude of volatility in a predetermined period.
Beta is used to translate the risk
of a security. Unlike standard deviation, beta measures the volatility of a security to a
benchmark index such as the Property Index of the HIS in Hong Kong or the REIT Index or
the Lehman Brothers Aggregate Bond Index in the U.S.A. Primarily, Beta provides a detailed
chronological monthly return analysis of the benchmark index adopted for the comparison.
Beta is a relational approach of measuring the volatility of a security, if the market or
the respective index goes up 10%, a bond with a beta of 1.0 should go up 10%, while if the
market or benchmark index drops 10%, the bond should drop by an equal amount. However, the
bond will become more volatile if a beta is greater than 1.0 or higher and vice versa.
Regardless the effects of volatility whether it is greater or smaller than the mean value
of 1.0, either upside gain or downside loss reflects a constant deviation of returns with
a security.
Earning Adequacy of a bond is rather simple
and straightforward than evaluating line-of-business or investment strategies of a
company. Unlike the land and property bonds, the underlying assets of a quality-grade
mortgage bond do generate sufficient receivable
to meet regular payment needs. For other lower grade mortgage bonds such as second
mortgage loan and home buyer’s loan, due to their higher than average interest
returns to investors, certain investment strategies may be employed to generate extra receivable to cover potential or seasonal cash flow mismatch throughout their lives.
Operational Performance of a Mortgage Bond is mainly the
measure of how the low-risk reinvestment activities are managed in the cases of excess
funding or principal accumulation account.
The Monthly Prepayment Speed (MPS)
is used to forecast the prepayment rate in the immediate future or to trigger the event of
early amortization. However, the prepayment speed may not accelerate due to the
deteriorating abilities of the borrowers caused by a continuous economic downturn which
hinders the traditional incremental prepayment rate during a historically low interest
rate at the current level.
Adjustments on the pricing or face value
of the bond at the time of issuing. This is the technique of how the issuer wants to
position the respective bond in the market with reference to the prevailing market
conditions and investors’ expectations at that particular time. For example, a
one-time premium may be added to the face value of the bond when the market perception or
demand is favorable. It is not necessarily the case that a demand for investment products
of this kind reveals a good investment sentiment or vice versa. Or a discount is given on
the face or issued value of the bond in order to entice investors by deferring the
payments of the issuer’s earnings from the interest spreads on a scheduled fixed
basis which are payable annually or biannually throughout the lifetime of the bond.
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