Investment Process

 

The investment process consists of 5 primary elements.

Click on a button of the rotating circle to learn more.

circle image

Deal Flow

Sourcing

Utilize Deer Park's extensive dealer network that has been developed over almost two decades to source undervalued MBS/ABS.

Deer Park often purchases bonds "without competition" due to long standing dealer relationships – a true competitive advantage in this market.

 

Process

Deer Park typically has the opportunity to analyze and bid on 200 to 400+ MBS/ABS securities per day.

After applying "filters" to determine which bonds meet their general criteria, Deer Park typically analyzes approximately 50 to 100 bonds per day.

After a more in-depth analysis, bids may be made on 25 to 50 bonds per day.

Typical success ratio: 1 bid accepted per every 25 bids made.

Proprietary Valuation Process

Step 1: Multi-Scenario Analysis

Potential investments are analyzed, modeled and stress-tested under at least a base case, stress case and optimistic case scenario to determine their potential cash flow and yield.


Underlying Deer Park's assumptions and scenarios is their macro outlook on: home prices, interest rates, government programs, economic activity, borrower behavior, etc.

 

Senerios Underlying Assumptions
Stress Case Collateral deteriorates significantly and rapidly from current performance
Base Case Collateral continues current performance or deteriorates modestly
Modestly Optimistic Case Collateral will perform to our expectations

 

Key Parameters Assumptions
CPR (Current Prepayment Rate) (includes voluntary)
Vectors based on housing and interest rate scenarios - CPRs dependent on collateral type (e.g., prime loans CPR 10 to 20; subprime loans CPR 0 to 5)
CDR (Constant Default Rate)

CDR curve based on the relationship between current CDR
and pipeline (i.e., if current CDR is high relative to its 60+ or REO,
it will come down in the future and vice versa)

Loss Severity (1-Recovery rate) LTV as benchmark;  adjusted by average loan size, modifications, housing price expectation, etc.
Other parameters Trigger, WAC deterioration, settlement recovery, etc.

 

Step 2: Cash Flow Matching

Modeled projected cash flow and losses are compared with actual historical cash flows and losses to detect any potential weaknesses or errors in the industry standard Intex and Bloomberg models.

The complexity of the MBS/ABS sometimes causes modeling errors due to:

Overestimating/underestimating future principal & interest payments

Incorrectly modeling embedded triggers, settlement recovery and structural elements

Matching actual cash flows with modeled projected cash flow sometimes creates an arbitrage opportunity — It's our believe that many MBS/ABS market participants omit this step

Modeled values for each scenario are adjusted accordingly

 

Step 3: Value Determination

Overall attractiveness of a security is guided by a risk/reward equation that places a premium on minimizing potential downside.

A bid range is established for each potential investment based on Deer Park's cash flow adjusted multi-scenario analysis.

 

Tools

Bloomberg, Intex, Crystal Logic, Realpoint, in-house proprietary models

 

Security Selection

The proprietary valuation process narrows the universe of securities to a small subset that meets Deer Park's investment criteria.

Each security meeting the investment criteria is assigned a "bid range," establishing an acceptable purchase price.

Typically looking for attractively priced bonds believed to have the following characteristics:

High cash flow

Short duration – typically targeting 2-6 years

Diversification across the MBS/ABS spectrum

High degree of optionality, i.e., the potential for additional upside gain, but minimal additional downside

Bonds comfortable holding to the end of their life

Seasoned (i.e., older) bonds with extensive payment histories

Select interest-only (IO) securities

 

Trading

Purchase

The extensive experience of Deer Park's investment team, and proprietary valuation process, enables fast turnaround when bids are solicited by dealers.

Deer Park believes their process and methodology provide a competitive edge in the sourcing and trading of discounted fixed-income securities.

Purchases and sales of all securities are executed at prices within pre-determined min/max price limits.

 

Trading

Most securities are purchased under the assumption that they will be held to term.

Adjustments made opportunistically and based on market conditions.

Securities may be sold to:

Take advantage of positive price movements

Protect against negative price movements

Rebalance the portfolio to achieve yield, cash flow and diversification targets

 

Management & Monitoring Process

 

Each bond in the portfolio is re-evaluated using Deer Park's valuation model on a monthly basis.

Securities that have moved outside acceptable risk/reward parameters become candidates to be sold.

Securities may also become sale candidates to re-balance the portfolio to achieve yield, cash flow and diversification targets.  

Interest rate sensitivity of the portfolio is monitored and modeled on a regular basis to determine the impact of rate changes across the yield curve:

Typical portfolio construction minimizes the impact of changes in interest rates, however, the portfolio may be positioned to take advantage of rates moving either up or down.

Portfolio management targets:

High cash flow*

Primary: Deeply discounted residential MBS (60 – 100% of the portfolio*)

Secondary: Deeply discounted other ABS such as - manufactured housing, autos, franchise, airplane, commercial real estate, REITs and/or credit default swaps (0 – 40% of the portfolio*)

Diversified portfolio with holdings typically between 1.5 – 5% of portfolio

*Portfolio allocations are subject to change and should not be considered investment advice.

 

Portfolio Risk Mitigation

 

Diversification within ABS market and security type. Deer Park believes that trading a broad universe of ABS, as opposed to small sub-segment, reduces risk and increases returns over the long-term.

Focus on short-term securities. Targeting a portfolio effective duration that is typically 2-6 years to manage pricing volatility and interest rate risk.

Focus on securities with high current cash-flow. Targeting high portfolio cash flow provides liquidity throughout market cycles and attempts to reduce portfolio risk and volatility.

Focus on deeply discounted securities. Deer Park's deep-discount philosophy dictates that only securities viewed as undervalued are bought. This approach attempts to reduce downside risk to the portfolio.

Hedging market risks through security selection. The enormous size of the MBS/ABS market and the wide variety of securities available allows Deer Park to hedge various market risks through the security selection and overall security composition of the portfolio.

In-house credit risk modeling. Deer Park's bottoms-up approach to valuing and analyzing each security, gives little weight to the major ratings firms (S&P, Moody's, and Fitch) except to note how any recent or pending changes may affect price expectations and/or valuations.

 

 

 

 

  princeton logo