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Mortgage Credit Events & Floating Rate Payment Events. Document Usage restricted to ISDA/FpML Working Group 10 July 2007. Credit Events & Floating Payment Events. Credit Events (2006 ISDA PAUG Template Definitions):

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mortgage credit events floating rate payment events

Mortgage Credit Events &Floating Rate Payment Events

Document Usage restricted to ISDA/FpML Working Group 10 July 2007

credit events floating payment events
Credit Events & Floating Payment Events
  • Credit Events (2006 ISDA PAUG Template Definitions):
    • Failure to Pay Principal – The Ref Ob fails to make schedule principal payments
    • Writedown – The Ref Ob writes down (decreases) its outstanding principal amount
    • Distressed Ratings Downgrade – The Ref Ob is downgraded to CCC (or it’s equivalent) or lower
  • Floating Rate Payment Events:
    • Interest Shortfall – The Ref Ob pays interest less than the expected interest for that period
    • Writedown – Same as above
    • Principal Shortfall – Same as above
  • Additional Fixed Payments:
    • Interest Shortfall Reimbursement – the underlier pays more interest than the expected for that month, i.e.. Compensates for previous interest shortfall
    • Writedown Reimbursement – the underlier accrues enough money to compensate for the previous writedown
    • Principal Shortfall Reimbursement – the underlier makes up for the principal shortfall

Document Usage restricted to ISDA/FpML Working Group

pay as you go credit default swap payment diagram terms defined later
Pay-as-You-Go Credit Default Swap: Payment Diagram terms defined later

Fixed Payment Amount

the amount, the buyer of the protection pays to the seller every month.

Formula: notional * current factor * rate * day count

Protection

Buyer

/

Fixed

Rate

Payer

Protection

Seller

/

Floating

Rate

Payer

IN CASE OF A Floating Rate Payment Event

Floating Payment Amount

Interest Shortfall Amount / Writedown Amount / Principal Shortfall Amount

Additional Fixed Payment Amount

Interest Shortfall Reimbursement Amount / Writedown Reimbursement Amount / Principal Shortfall Reimbursement Amount

Physical Settlement Physical Settlement Amount

OR

Cash Settlement

Initial Payment

generally comes into question, in case of an assignment / novation.

Document Usage restricted to ISDA/FpML Working Group

settlement mechanics for floating rate payments and credit events
Settlement Mechanics for Floating Rate Payments and Credit Events
  • Credit Events ( Failure to pay Principal, Writedown, Distressed Downgrade)
    • Notice of settlement can be sent by Buyer only
    • Usually if the event is deemed to be a ‘credit event’ by the Buyer the intent is to physically settle. The Buyer of protection has the option to physically settle or cash settle- if the Buyer chooses to physically settle, the a credit event has occurred.
  • Floating Rate Payment Events (Failure to pay Principal, Interest Shortfall, Writedown)
    • Notice of settlement can be sent by Calculation Agent and/or the Buyer of Protection
    • For Failure to Pay Principal and Writedown , the difference between this being a Credit Event and a Floating Rate Payment Event is that when a event occurs the buyer chooses to cash settle and the trade continues (pay as you go).
    • Interest shortfall is not considered a Credit Event in any instance and is always cash settle.

Document Usage restricted to ISDA/FpML Working Group

differences between mortgage and corporate cds
Differences between Mortgage and Corporate CDS

Document Usage restricted to ISDA/FpML Working Group

interest shortfalls
Interest Shortfalls
  • An interest shortfall occurs when current scheduled interest is not paid on the reference obligation
  • As per ISDA, the definition of interest shortfall amount is,

With respect to any Reference Obligation Payment Date, an amount equal to the greater of:

(a) zero and

(b) the amount equal to the product of:

(i) (A) the Expected Interest Amount

minus

(B) the Actual Interest Amount and

(ii) the Applicable Percentage

  • As per ISDA, the definition of interest reimbursement amount is,

With respect to any Reference Obligation Payment Date, the product of

(a) the payment by or on behalf of the Issuer of an Actual Interest Amount in respect of the Reference Obligation that is greater than the Expected Interest Amount.and

(b) the Applicable Percentage.

Document Usage restricted to ISDA/FpML Working Group

slide7
For sub-prime RMBS and CMBS reference obligations, coverage of interest shortfalls by the protection seller can take the form of one of the following options:
    • Cap Applicable – Fixed Cap: Capped at the amount of CDS premium owed by the protection buyer in any period. Under this option, protection seller will not have to go out-of-pocket to cover interest shortfalls.
    • Cap Applicable – Variable Cap: Capped at an amount equal to LIBOR plus the CDS premium owed by the protection buyer in any period. Under this option, protection seller may have to go out-of-pocket to cover interest shortfalls.
    • Cap Not Applicable: Uncapped at the full coupon on the reference obligation. This trade can only be executed at a CDS premium rate equal to the margin above LIBOR or the associated benchmark rate in the coupon and therefore would likely involve upfront payments by either buyer or seller. Under this option, protection seller may have to go out-of-pocket to cover interest shortfalls.

Document Usage restricted to ISDA/FpML Working Group

principal shortfalls
Principal Shortfalls
  • Mortgage backed securities will either have a set pay down principal schedule or will pay down at maturity date
  • A principal shortfall occurs when on a scheduled pay down date there is insufficient funds to pay the predetermined principal amount on the reference obligation.
  • If and when this deficit in the principal is paid back, it is called the principal reimbursement.
  • As per ISDA the definition of Principal Shortfall Amount is,

in respect of a Failure to Pay Principal, an amount equal to the greater of:

(i) zero; and

(ii) the amount equal to the product of:

(A) the Expected Principal Amount minus the Actual Principal Amount;

(B) the Applicable Percentage; and

(C) the Reference Price. (Standard is 1).

  • As per ISDA the definition of Principal Shortfall Reimbursement Amount is,

with respect to any day, the product of

(i) the amount of any Principal Shortfall Reimbursement on such day,

(ii) the Applicable Percentage and

(iii) the Reference Price.

Document Usage restricted to ISDA/FpML Working Group

writedowns
Writedowns
  • Writedown occurs when the reference obligation writes down its outstanding balance (i.e. decides not to pay the outstanding balance to its bond holders). The effect is similar to that of notional amortization, i.e. factor of the reference obligation changes.
  • The impact on the swap:

1. Protection seller has to pay the writedown amount to the protection buyer

2. All the future coupons will be multiplied by the current factor, i.e.. the coupon changes.

  • As per ISDA the definition of Writedown Amount is,

with respect to any day, the product of

(i) the amount of any Writedown on such day,

(ii) the Applicable Percentage and

(iii) the Reference Price.

As per ISDA the definition of Writedown Reimbursement Amount is ,

with respect to any day, an amount equal to the product of:

(i) the sum of all Writedown Reimbursements on that day;

(ii) the Applicable Percentage; and

(iii) the Reference Price.

Document Usage restricted to ISDA/FpML Working Group

additional information on shortfalls
Additional Information on Shortfalls
  • Shortfalls are calculated as of the previous payment period and apply to the current settlement period
  • Shortfalls apply to all open contracts for a given settlement period
  • Support to identify PAUG/floating rate events that apply to a given contract at the confirm level will be introduced as a part of FpML version 4.3. It is already a part of the working draft.
  • DTCC & Shortfall Processing
    • DTCC is set to start a UAT where it will test functionality for calculations of Shortfalls.
    • For Shortfalls, DTCC will provide information
      • the type of shortfall,
      • payer/receiver,
      • settlement date,
      • the amount of the shortfalls

Document Usage restricted to ISDA/FpML Working Group