In December 2008, when the word was experiencing the worst financial meltdown since the Great Depression, Rose Tree Capital Management was weighing the acquisition of a share of U.S. housing loans. The company had created an investment tool to obtain problematic housing loans from banks and other inclined sellers. The concept was to buy the mortgaged loans at a concession and to work with each borrower to reschedule their debts. Functional mortgages and loans could then be floated in the secondary markets. The case gives an insight into cash flow projections in different economic situations that reflect on the economics of problematic and tricky mortgages and house foreclosures. Rose Tree needed to determine if and how much to offer for these mortgages.
CF for Moderate Recession, CF for Severe Recession, Expected, CF, DF, PV
1. In early December 2008, Isabel Villegas and her team at Rosetree Capital Management produced Loan Portfolio Annual Cashflow Projections for three different economic scenarios. For the Slow Economic Growth scenario, their projections assumed that real GDP would be positive from year-end 2008-2009. Under the Moderate Recession scenario the projections assumed that real GDP would decline by 0.1 percent to 1 percent from year-end 2008-2009. Finally, under the Severe Recession scenario, their projections assumed that real GDP would decline by 1.1 percent or more from year-end 2008-2009. Make a recommendation to the Rosetree team on how to calculate the loan portfolio’s expected annual cashflows taking into account all of the three different economic scenarios.
2. Recommend how to calculate annual cashflow discount factors to be used to calculate a present value for the loan portfolio’s annual cashflows.
3. What price should Villegas offer the selling bank for the pool of mortgage loans?