Richard Cooperstein, president of RangeMark Analytics, answers SCI's questions

Q: How and when did RangeMark Analytics become involved in the structured finance markets?
A: RangeMark Analytics was formed when I joined RangeMark Financial Services along with my analytics platform - Fixed-Income Valuation Platform (SCI 18 January). The aim is to supplement RangeMark's existing advisory business by licensing the platform and our other applications to financial institutions, institutional investors and government agencies for valuation and risk assessment of mortgage loans, RMBS and CMBS.

I've been building option-based mortgage simulation models for over 20 years, beginning in the White House during the first thrift crisis when we were trying to value the government's exposure to financial guarantees. I've rebuilt the platform four or five times at different organisations during this time.

The theory behind the platform hasn't changed over those 20 years: it is based on finance and consumer economics theory. What has changed since then is computer power, which permits granular analysis at loan level with multiple scenario simulations.

Q: What are your key areas of focus today?
A: We focus on clients with credit-sensitive mortgage-related assets, who lack the requisite analytics to manage and understand their risks as well as they would like to. In the aftermath of the financial crisis, much of the industry's analytics capability was dismantled, yet the risky assets remain. Our clients range from those with orphan portfolios but inactive businesses, to asset managers, domestic financial institutions and even European financial institutions that own US RMBS.

Some clients are fairly small and cannot support a full valuation infrastructure that requires data, sophisticated architecture and models, and thus are ideal candidates for our turn-key solution. Larger clients may have sizeable assets under management and may have their own model but want a second opinion or may not be completely satisfied with their own solution.

Current activity is primarily directed towards distressed or legacy assets, but we will naturally transition to assessing the risk of newly originated mortgages when the non-government market restarts. At present, the government accounts for about 90% of new mortgages. This concentration of mortgage risk to the taxpayers is itself an important risk to consider.

The platform can be used to determine fundamental asset values, as well market-implied values in the portfolio application. Further, our simulation approach is designed to assess extreme risks and capital adequacy, which is especially useful in this time of high uncertainty. While recognising these risks, good returns relative to other asset classes remain.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: We saw an opportunity to launch our licensing business and expand our advisory for CMBS and RMBS because there is so much product at risk and in distress, yet quantitative capabilities have been broadly dismantled. Outside of the top firms with their own research departments, few have the infrastructure to continue managing these assets. Consequently, there is a persistent need for analytic solutions in the market.

Q: How do you differentiate yourself from your competitors?
A: We differentiate ourselves in two major ways. First, with a platform that fully integrates economic fundamentals and consumer behavioural models with a cashflow engine.

The point of this integration is to seamlessly generate value distributions for portfolios of assets quickly and beginning at the loan level. Many inputs are required to achieve this, but most other vendors only provide part of the solution.

The second way we differentiate ourselves is by using thorough scenario analysis. Most vendors build models based on historical data and apply them to a particular scenario or handful of scenarios. But the last decade has demonstrated that there are many potential scenarios to consider: we've had the best and worst of economies during this time, both of which were nearly impossible to predict before they happened.

As a result, thorough scenario analysis must be used to generate the appropriate range of potential future outcomes and deviation of returns. Proper asset valuation begins with expected returns, but requires measuring the variance of those returns.

Thus, we focus on getting the distributions right. To generate expected losses and extreme losses, we benchmark extensively to prices of traded credit assets - highly rated and liquid, as well as unrated and illiquid.

The current innovation in mortgage analytics is the ability to benchmark models against market prices. There was no such mechanism a decade ago - models could be back-tested, but that does not mean such models could adequately price risk.

While some vendors do test their models against traded prices, we make market benchmarking a core part of our fundamentals-based approach. Thus our clients can see how fundamentals drive performance, while simultaneously assessing model value against market. Simply matching historical curves and prepayment/default projections is not sufficient in today's environment.

Q: What major developments do you need/expect from the market in the future?
A: Looking ahead, three factors will presage a recovery of the mortgage market generally and the non-governmental segment in particular: employment growth; resolution of the large 'shadow inventory' of homes with distressed mortgages; and government mortgage agencies charging unsubsidised fees for the credit risk taxpayers bear, so that private executions are again economic.

US jobs peaked at 138 million in 2008 and bottomed at 129 million at end-2009. The country has gained three million jobs since then, so we're on an upward trend, but it will likely be several years until we reach a healthy level of unemployment. We may be about five million jobs below where we need to be.

We're clearly also several years away from resolving the glut of residential mortgage delinquencies. The issue is how fast this inventory can be absorbed.

There are two driving economic policy principles that we should strive for: insuring orderly markets and that financial incentives flow through the system. The US government took extreme measures to recover orderly markets in 2008 and - except for the failure of Lehman - has largely achieved this.

However, financial incentives have not been allowed to flow through the US mortgage market. Foreclosure of the unprecedented inventory of underwater and delinquent mortgages has been constrained for several years. There is a practical limit to the rate that distressed housing can be liquidated.

There is also great political reluctance to permit foreclosure of millions of households and to realise the attendant losses on balance sheets. Finally, home ownership is declining to levels seen in the 1980s before housing was viewed as a 'free lunch' investment that would always rise. Thus, billions in investor financing are needed but not currently available.

The government has not effectively facilitated the resolution of problem mortgages and thus has forestalled housing market recovery. There is no good and quick way out of this situation: on the one hand, delinquent loans have to be resolved at a rate that preserves orderly markets; on the other hand, the rule of law needs to be upheld and existing valid contracts honoured.

Ending the government's current dominance in mortgage origination and re-growing a private sector with appropriate oversight should be accomplished using the market mechanism. We cannot make private sector activity emerge; we need only permit it to do so by the government refraining from financing mortgages more cheaply than the private sector can.

Three years ago I thought the recovery would take three years; that was clearly very wrong. It will likely take three or four more years because of the number of jobs that need to be created and the size of outstanding distressed housing inventory.

Ultimately, the fundamental resilience of the US economy will drive us through. However, the market is still waiting for appropriate regulation and oversight.

CS