a newtwork of opportunties
The value attribution and yield attribution models are derived from a set of established and widely cited
models including Ho – Lee Interest Rate model, Dunsky-Ho Prepayment Default model (also described in
FHFA Mortgage Analytical Platform) and Ho -Stoll Dealer Bid-Ask Pricing model. Extensive descriptions of
these models are available in public websites for readers’ reference.
Value Attribution and Yield Attribution
Historically, earnings have primarily been evaluated on net interest income using $ value and the margin
between the loans’ effective yield and the funding rate using %. In the ALCO process, the yield and $ value
measures are used together to measure revenues. For example, the income of a 30- year fixed rate mortgage
can be quoted as 3.5% rate with a one-point fee as opposed to a mortgage of 3.6% with no upfront fee.
Government Sponsored Enterprises (GSE) charge for a G spread in rate (%) while adding the Loan Level Price
Adjustment (LLPA) in value ($). The conversion between rate and value is expected to be done by institutions,
even though the conversion is far from simple. Also, while banks use price convention to transact, much of
ALCO management decisions are based on rates in percentages.
How should ALCO evaluate the credit charge of loans? If all loans and funding sources are simple bullet
payments, then the use of yields (or rates) is somewhat tractable. However, most loans are not bullets, and
converting fees to rates is simple only if community banks and credit unions are willing to make
approximations. Indeed, capital market participants exploit these approximations to profit in market
transactions. Credit risk can illustrate the problem in mixing of rate and $ value in ALM. The current ALLL
approach reports the expected annualized charge off as a rate, even though the balance sheet is $ value-
based. In fact, CECL is introduced with a life-of-loan principle, in part, to remedy this problem.
Also, the credit charge should relate directly to profitability. I have discussed many deficiencies using yield as
profitability measure elsewhere. For example, there are significant problems with the yield measures for
hybrid ARMS, such as 10-1, 7-1 and others as the project interest rates affect the repricing of these loans and
hence the yield measure. Also, the prepayments of loans results in mismeasurements of yields. Furthermore,
yields cannot capture the life-of-loan concept. Economic Value of Equity, a regulatory interest rate risk
measure, was introduced to capture the long-term interest rate risk to augment the Earnings-at-Risk report
that uses a short-term horizon. Likewise, CECL is introduced to make sure that the long-term credit risk is
captured and incorporated in ALM.
For these reasons, ALCO decisions should use rate and value interchangeably based on robust models. The
ability to relate value and rate accurately and with one consistent methodology enables institutions to
originate loans or execute any transactions more profitably. The tools used to present profitability in rates
or value are yield attribution and value attribution.
Consider a whole loan based on the THC whole loan
Yield attribution decomposes a reported yield to
valuation model using a multi-factor prepayment-default
model. The rate of a mortgage loan at origination can be
decomposed as presented below.
the rates of all the economic components of a
balance sheet instrument.