The Breakpoint Grid

Abstract

This article describes a model that combines the ideas of dynamic continuous credit rating, stress risk analysis, and a probabilistic view of losses. The article defines a breakpoint, a market scenario out of a sorted set that forces a non-agency bond to lose its first dollar of principal; a breakpoint ratio, an estimate of distance to default that is used as a basis for dynamic rating; and a breakpoint grid, a set of stress scenarios sorted in order of increasing losses that is useful for calculating a breakpoint ratio. A sample portfolio loss report is presented that provides the necessary information to assess credit risk; it combines the assessment of a portfolio’s credit risk, in terms of both loss levels and odds of occurrence, with a probability analysis.

TOPICS: MBS and residential mortgage loans, asset-backed securities (ABS)