Question 5: How reasonable and significant are these aspects of Doral’s valuation of its IOs in its original filing for 2004:
The inaccurate valuation retained for Interest-Only Strips by Doral was the result of intentionally misleading decisions the managers made during the reporting process. Particularly, three main choices had a significant impact on the valuation of IOs and will be further detailed:
1. Using a discount rate based on an internal model rather than using a model based public external market data available to discount future free cash flows.
2. Using the current LIBOR rate in order to project future free cash flows rather than the forward LIBOR yield curve.
3. Estimation of prepayments speed, impacting future cash flows and ultimately the valuation of Interest-Only strips.
Question 5.1) Its use of the current LIBOR rate rather than forward yield curve to project the future cash flows on its IOs and to discount these cash flows.
Choice 1: Using a discount rate …show more content…
This is particularly important when transferring assets to an SPV (Special Purpose Entities), since the risk level associated to the asset is determinant. Based on legal conditions (SFAS 140) regarding the sale and related obligations regarding transfer of risks (as discussed in question 2), a higher risk asset transferred to Doral Financial Corp (or any transferor) should result into a greater substance reaming in the structure.
According to the class action against Doral, “It is likely that there were oral agreements or understandings between the former Treasurer and the former Director Emeritus of the Company and FirstBank Puerto Rico, a wholly-owned banking subsidiary of First BanCorp (“FirstBank”), providing recourse beyond the limited recourse established in the written
The inaccurate valuation retained for Interest-Only Strips by Doral was the result of intentionally misleading decisions the managers made during the reporting process. Particularly, three main choices had a significant impact on the valuation of IOs and will be further detailed:
1. Using a discount rate based on an internal model rather than using a model based public external market data available to discount future free cash flows.
2. Using the current LIBOR rate in order to project future free cash flows rather than the forward LIBOR yield curve.
3. Estimation of prepayments speed, impacting future cash flows and ultimately the valuation of Interest-Only strips.
Question 5.1) Its use of the current LIBOR rate rather than forward yield curve to project the future cash flows on its IOs and to discount these cash flows.
Choice 1: Using a discount rate …show more content…
This is particularly important when transferring assets to an SPV (Special Purpose Entities), since the risk level associated to the asset is determinant. Based on legal conditions (SFAS 140) regarding the sale and related obligations regarding transfer of risks (as discussed in question 2), a higher risk asset transferred to Doral Financial Corp (or any transferor) should result into a greater substance reaming in the structure.
According to the class action against Doral, “It is likely that there were oral agreements or understandings between the former Treasurer and the former Director Emeritus of the Company and FirstBank Puerto Rico, a wholly-owned banking subsidiary of First BanCorp (“FirstBank”), providing recourse beyond the limited recourse established in the written