Interest Only Strip

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Interest Only Strip

A derivative security whose cash flow derives exclusively from interest payments on various debt securities. That is, the underlying asset of an interest-only strip is interest paid on debt securities, rather than the debt securities themselves. Many interest only strips are backed by mortgage interest, but some are also backed by Treasury securities and other debt securities. Interest-only strips are derived from bonds whose coupons are legally separated, or "stripped", from the bonds themselves.
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The rating on the senior securities, classes A-1 through A-8 and the IO strip, reflects the 30.
0 million decrease, before taxes, in the Company's IO Strip which reduced earnings and strengthened the Company's balance sheet.
Prepayment rate assumptions used in valuing the company's IO Strip were revised to 27% for fixed rate loans, 33% for intermediate rate loans and 39% for ARMs.
Following the writedown of its IO strip, Fitch IBCA expects Green Tree's equity to managed assets ratio to decline further.
The revaluation of its IO strip was needed due to prepayments related to correspondent adjustable rate mortgage (ARM) originations that were higher than original securitization assumptions.
The press release also stated that the restatements were made to correct the accounting treatment for the value of its IO Strip portfolio, and the Company's preliminary estimate is that this correction will result in a decrease in the fair value of its floating rate IOs of between $400 million to $600 million as of December 31, 2004.
As a result of such unusual methodologies, during the Class Period: (1) the Company's IO Strip portfolio was materially overvalued; (2) the Company's net income and net gain on mortgage loan sales were materially overstated; (3) the Company's return on equity and return on capital were materially overstated; and (4) the Company's reported net capital was materially overstated.
According to Doral, the restatements are necessary to correct the accounting treatment for valuing Doral's IO Strip Portfolio.
This excess interest (or spread) is economically the same as an IO strip.
The complaint alleges that during the Class Period the Company's: (1) IO Strip portfolio was materially overvalued; (2) net income and net gain on mortgage loan sales were materially overstated; (3) return on equity and return on capital were materially overstated; and (4) reported net capital was materially overstated.
Sale of an IO strip and retention of the PO portion is an obvious example.
After discussions with investors in both assets, I concluded that servicers must replace runoff to utilize their excess capacity (or exit the industry), whereas IO strip investors can stop investing any time they want.