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KAL_II - Introduction This pamphlet is our introduction to the KAL_II Servicing Simulation Model. Please give us this opportunity to explain how we can help to improve your valuation techniques and contribute to the success of your servicing operation. The KAL_II Model is a new and different approach to loan servicing valuation. Mr. Lyle Kalish developed the Model as a result of needs that were not addressed by available valuation software. The Model represents a third generation of valuation software. In the early days of servicing transfers, we used a formula of paying three to five times the first year's service fee. Many companies continue to use this method of pricing servicing portfolios. Second generation models use a simplified present value analysis of the expected future cash flows. These models are static in that there is a single forecast for a group of portfolios starting from today. You cannot add or subtract future portfolios to this forecast. The result of this analysis provides very little information about the expected results of your operation over the next five years. These models also assume that all receipts and payments occur at the beginning or end of each month. This method provides little information about the nature and characteristics of daily receipts and remittances. The KAL_II Model provides three distinct and unique features: The Model uses a functional breakdown of servicing costs that changes over time with the portfolio characteristics. These characteristics include: delinquency ratios, prepayment patterns, cashiering patterns, and remittance patterns. The Model simulates collections, disbursements, and remittances on a daily, monthly, and annual basis. This process closely duplicates the manner in which you actually disburse and receive funds. Finally, the Model will help you develop a Five Year Financial Forecast of the results of your operation. You can develop a simulation of your entire servicing division. Portfolios can be added or deleted during any month for the next five years. The KAL_II Model is an accumulation of experiences from years spent examining loan servicing portfolios. As a result of these experiences we believe that: All portfolios do not have an identical cost per loan. The cost to service a loan depends on prepayments, delinquencies, and remittance patterns. All portfolios have different delinquency ratios which vary over time. When delinquencies rise, revenues increase with an associated increase in delinquency processing costs. Higher delinquencies do not always mean greater value. Each investor has a very different remittance pattern. These patterns have an important effect on the value of the loan servicing and the stream of daily and monthly cash flows. The monthly prepayments affect the value of loan servicing in many ways. The money held as a result of early prepayments is just as significant as the money held from monthly P&I remittances. The benefit of holding these funds should be included in the present value analysis. SERVICING COST The KAL_II Model uses a fnctional approach to develop the servicing cost per loan. To find the servicing costs used by the Model you first divide your servicing operation into functional units. These units might include customer service, escrow, investor reporting, collections, and payoffs. The number of loans processed by each unit is used to determine a unit functional servicing cost. You enter these unit costs into the model. The final servicing cost per loan will then depend on the type of loan, the delinquency ratios, the prepayment patterns, and the remittance schedule required by the investor. The KAL_II Model will tell you what it costs to service a particular type of loan. Changes in segment characteristics are automatically transformed into a new cost per loan serviced. Each portfolio you analyze will have a different servicing cost. You combine all your segments to give a consolidated servicing cost which is unique for your portfolio. An advantage of this approach is the ability to show the value of operational improvements as an increase in the consolidated portfolio value. The KAL_II Model also provides a method for evaluating portfolio additions using fixed and marginal costs. You enter the servicing operation's fixed costs in a separate section of the Model and you enter the current marginal cost as the servicing cost per loan. The Five Year Earnings Forecast shows the effects of different marginal costing strategies. COLLECTIONS, DISBURSEMENTS AND REMITTANCES The KAL_II Model provides a complete analysis of the daily, monthly and annual cash flows associated with loan servicing. The Model simulates the timing of the collections and the estimated amounts of the collections. Tax and insurance payments are remitted at different times of the year. KAL_II uses a daily schedule of mortgagor receipts and investor remittances to find the value of the P&I and T&I account balances. The Model bases the present value analysis of the cash flows on these daily remittances and receipts. This method eliminates the need to determine monthly or annual estimates of your average P&I and T&I accounts. The Model will forecast what the advance balances, and average cash account balances should be. FORECASTING AND PLANNING Last, and most important, the KAL_II Model provides you with a mechanism for quick and easy strategic forecasting. This forecasting function uses the same information you enter in the other sections of the Model. The result is a five year financial forecast of earnings, cash flows, and portfolio balances. This forecast includes your current and projected fixed costs, portfolio additions and sales, debt service, and the amortization of your current portfolio. Construct realistic situations which you believe may occur in the next few years. The Model translates situational goals and objectives into earnings forecasts and future loan schedules. KAL_II is unique in its ability to do three important functions simultaneously: loan servicing valuation, operational evaluation, and long range strategic planning. The Model provides information about cash flow sensitivity that is impossible to determine with any other cash flow model. Only our system provides for the level of detail necessary to investigate critical decisions. Besides the KAL_II Model, we have programs which will help you in the development of your forecast and evaluations. These programs provide you with the ability to examine your operation in ways not possible with other software. We want the opportunity to tell you more about our Model and our servicing support programs. Let us show you exactly what the KAL_II Model can do. You have our assurance that the Model will help you make better decisions about your portfolio and your operation.