Where possible, holdings are marked
at the quoted market price in an active
market. In the current market
environment, such price information is
typically not available for instruments
linked to the US sub-prime residential
mortgage market, and UBS applies
valuation techniques to measure such
instruments. Valuation techniques use
“market observable inputs”, where
available, derived from similar assets in
similar and active markets, from recent
transaction prices for comparable
items or from other observable market
data. For positions where observable
reference data is not available, UBS
uses valuation models with non-market
observable inputs.
For the year ended 31 December
2007, UBS used valuation models
primarily for super senior RMBS CDO
tranches referenced to sub-prime
RMBSs. The model used to value these
positions projects losses on the
underlying mortgage pools and
applies the implications of these
projected lifetime losses through to
the RMBS securities and then to the
CDO structure. The primary inputs to
the model are monthly remittance
data that describe the current
performance of the underlying
mortgage pools. These are received
near the end of each month and
relate to the preceding month’s cash
flows on the mortgages underlying
the relevant mortgage-backed
securities. Since this valuation model
was adopted in third quarter 2007,
UBS has sought to calibrate the model
to market information and to review
the assumptions of the model on a
regular basis. In fourth quarter 2007,
UBS calibrated its loss projection
estimates to ensure the super senior
RMBS CDO valuation model would
value relevant market indices (for
example, ABX indices) consistently
with their observed levels in the
market. Despite the various limitations
in the comparability of these indices
to UBS’s own positions, it was felt that
adopting this approach would be best
in view of the further deterioration in
liquidity and resultant lack of observed
transactions to which the model could
be calibrated.
The valuation model also considers the
impact of variability in projected
lifetime loss levels and applies a
discount rate for expected cash flows
derived from relevant market index
prices (for example, ABX indices). The
external ratings of the RMBSs underlying
the CDO tranches or the CDO
tranches themselves are inputs to the
valuation model only to the extent
that they impact the timing of
potential “events of default”. The
valuation model incorporates the
potential timing and impact of such
default events based on an analysis of
the contractual rights of various
parties to the transaction and the
estimated performance of the
underlying collateral. However, there is
no single market standard for
valuation models in this area and such
models have inherent limitations, and
different assumptions and inputs
would generate different results.
The super senior RMBS CDO valuation
model is used to value transactions
where UBS is net long the super senior
RMBS CDO exposure and transactions
where UBS holds a gross long position
hedged one-to-one with an offsetting
short position provided by a monoline
insurer. The valuation model therefore
provides an estimate of the current
credit exposure to monoline insurers
via such transactions. The fair value of
these positions also takes counterparty
credit risk of the monoline insurers
into account. Where valuation
techniques based on observable inputs
are used to value RMBS positions, a
consistent approach is used to value
related hedge positions with monoline
insurers.
The valuations of UBS’s sub-prime
related positions in the future will
depend on developments in the
performance of the underlying
mortgage pools as well as market
developments. UBS continues to
manage, trade and hedge these
positions.
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