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.
Bid CalculationsTotal Loan Cash Flows ($000), Discounted Cash Flows ($000), Net Cash Clow, Discount Rate
Probability of Economic Scenario, Required Portfolio Value ($000)
Cash Flows to GSE ($000), Cash Flows to Rosetree ($000), GSE Discount Rate, Rosetree Discount Rate, Rosetree Bid Price
Total Loan Cash Flows, Expected Cash Flows*, Discount Rate, Discounted Cash Flows, Fair Market Value of Loan Portfolio
Default Spread, MV of Loan Portfolio Discount to Face Value
1. Come up with a bid for Rosetree, explain how you got to that bid, and justify it."
2. Key Questions for Rosetree:
What are the key risks that you have identified in your bid?
Which loans do you view as most risky? How will you manage the portfolio upon purchase?
How would the sale of modified and restructured loans increase or decrease your returns?
3. Assume that you are working for the GSE's. Your objective is to create a program that will support the restructuring of troubled mortgages to help assist people stay in their houses and continue to make housing affordable:
What are the objectives of a program that you would create? What types of loans and borrowers should be eligible?
Would you provide incentives to the purchaser of this mortgage portfolio to obtain these goals? If Yes, how and what kind? If No, why not?
There have been several attempts at loan modification programs to assist distressed homeowners: what are the key principles of these programs, the lessons learned from them and issues raised that help to guide the establishment of a new program for borrowers in portfolios like Rosetree.
4. Additional Financial Analysis. Exhibit 6 outlines the returns ina Severe Recession (with Loan Renegotiation). Could you estimate the impact of loan sales if loans could be made to conform to a new GSE program to purchase loans upon restructuring? How would you adjust your bid?
1. Why is the $65 million loan portfolio a potentially interesting investment?
2. Using information provided in the case on portfolio cash flows under alternative scenarios and the Treasury yield curve, what it the portfolio’s fair market value? Feel free to undertake some sensitivity analysis at different discount rates. What should Rosetree pay for the portfolio and why?
3. What do we learn from this case about the cost and difficulty of ameliorating the housing crisis?