Refinancing
To varying degrees, all the sources of prepayments in pools are interest-rate-sensitive, but the most variable source of prepayments is refinancing. Just how interest-rate-sensitive refinancing can be is illustrated in Exhibit 3-11, which tracks the weekly level of refinancing seasonally adjusted according to the Mortgage Mortgage Application Refinance Index and 30-Year Mortgage Rate 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Mortgage Application Refinance Index and 30-Year...
Tba Trading Turning Poolspecific Securities Into Generic Securities
Every agency pass-through pool is unique, distinguished by features such as size, prepayment characteristics, and geographic concentration or dispersion. However, most agency pass-through securities trade on a generic or to-be-announced TBA basis. In a TBA trade, the seller and buyer agree to the type of security i.e., agency, program , coupon, face value, price, and settlement date at the time of the trade, but they do not specify the actual pools to be traded. Two days before settlement, the...
Loan Limit and Size
Because the benefit of a refinancing is largely determined by the size of a loan, prepayment speeds are closely related to average loan size. Hence size is a very important loan characteristic. Size also plays a role in credit performance. Low-balance loans typically have higher loss severities than do large loans. All agency loans must be within the conforming size limit. The limit is determined each year by the agencies based on the prior year change in the Federal Housing Finance Board's...
Failure to Deliver
Occasionally, sellers cannot provide pool information by the notification date or cannot deliver pools on the settlement date. Sometimes an originator must delay a delivery date with a dealer, or a dealer may not be able to cover a short position in TBAs. In these cases, a fail occurs. All sellers have a strong economic incentive to deliver pools as soon as possible because buyers pay only the amount agreed to plus accrued interest through the original settlement date, and they do not pay until...
Prospectus Supplement
To Prospectus Dated November 22, 2004 Banc of America Mortgage Securities, Inc. Mortgage Pass-Through Certificates, Series 2005-A Principal and interest payable monthly, commencing in February 2005 Four groups consisting of eleven classes of Senior Certificates. Six classes of Class B Certificates all of which are subordinated to, and provide credit enhancement for, the Senior Certificates. Each class of Class B Certificates is also subordinated to each class of Class B Certificates, if any,...
The Nonagency Market
In the early days of the secondary mortgage market, life was simple. Investors could buy Freddies, Fannies, or Ginnies. Mortgage loans originated outside the agency guidelines were held in portfolio by the originating institution or were sold as whole loans to another institution familiar with mortgage collateral. This was the way the world worked. Then things became a bit more complicated as issuers began securitizing their jumbo loans. As time went by, investors became more comfortable with...
Defaults
Given the strong credit performance of prime conventional loans, defaults generally are ignored as a component of prepayments in conventional pools. For example, in 2004, Freddie Mac reported serious delinquencies delinquent 90 days or more or in foreclosure of 0.73 to 0.87 on loans in portfolios and securities, whereas Fannie Mae reported 0.57 to 0.64 . Government loans, on the other hand, experience serious delinquencies at two to three times higher rates. For example, in its National...
Trading And Settlement Procedures For Other Mbs Products
Nonagency MBS and REMICs backed by both agency and nonagency collateral are composed of specified pools and do not trade on a TBA basis. New issues settle on the date provided in the prospectus. In the secondary market, these securities trade on an issue-specific basis and generally settle on a corporate basis five business days after the trade . Unlike TBA securities, they have nothing to gain from a monthly settlement schedule whereby pools are pieced together to create more generic totals.
An Overview Of Mortgages And The Mortgage Market
Managing Director Countrywide Securities Corporation Frederick Frank Adjunct Professor of Finance School of Management Yale University Executive Vice President Countrywide Securities Corporation The mortgage market in the United States has emerged as one of the largest asset classes. As of the end of 2004, the total face value of one- to four-family residential mortgage debt outstanding was approximately 8.1 trillion, with roughly 60 of the outstanding balance securitized into a variety of...
Securities 1
Vice President Mortgage Strategy RBS Greenwich Capital Pass-through securities represent ownership interests in pools of residential mortgage loans secured by single-family homes one- to four-family units . Principal and interest payments are passed through to the owners of the pool on a pro rata basis, with the proviso that a small portion of the interest is held back by the issuer servicer to cover administration expenses and guarantee fees. The amount of this servicing strip varies across...
The Sources Of Competitive Advantage In Investing In Mbs
The duration and cost of funds probably top the list of factors that drive MBS portfolio strategy. The wider the range of duration in funding, then the wider is the range of MBS the portfolio can finance without necessarily taking interest-rate risk. Portfolios with inflexible funding easily can find themselves boxed into narrow and sometimes expensive corners of the market. A portfolio with access only to two-year funds might find itself chasing two-year assets despite better values elsewhere...
Clearing Procedures For Mbs
There are currently two methods for clearing i.e., settling MBS trades physical delivery and electronic book-entry transfer. Physical delivery is still used for only a small portion of nonagency securities. As shown in Exhibit 4-3, all agency and most nonagency Most nonagency REMICs and pass-throughs Some nonagency REMICs and pass-throughs MBS trades are cleared through the electronic book-entry transfer systems of Fedwire and the Depository Trust Company DTC . Fedwire, a system maintained by...
Determinants Of Prepayment Speeds
Prepayments are the chief determinant of a pass-through's investment performance. Over a holding period, the amount of repayment and actual collections of interest are a function of realized prepayments. So too is the price performance of a pass-through a function of the market's expectations of future prepayments. Duration Drift Effective Duration of 30-Year FN5.5s and 10-Year Swap Rate Duration Drift Effective Duration of 30-Year FN5.5s and 10-Year Swap Rate The causes of prepayments in full...
Federally Sponsored Mortgage Passthrough Programs
Two main factors have contributed to the initial success and subsequent massive growth of the agency pass-through programs the guarantee of timely payment of principal and interest1 and the high degree of standardization imparted to the securities. At the same time, the expanding market for pass-throughs has promoted competition and innovation among mortgage lenders and the development of automated underwriting and other applications of technology to mortgage origination and servicing. As a...
Typical Sections Of A Prospectus And Prospectus Supplement
In this next section we will examine a sample of the types of information that are of most interest to prospective investors. We will use an example of a Bank of America residential MBS to walk through the critical sections of the prospectus supplement. Disclosures on the cover page of a prospectus supplement generally are limited and brief. The information should provide a summary of the issuer, the type of collateral, the offered securities, and some class-specific data. Sometimes information...
Modeling Prepayments
Since the mid-1980s, MBS broker-dealers and many investors have attempted to model the relationship between disclosed pool characteristics and actual prepayment experience. As modeling techniques gain in sophistication and the history has grown longer and the sample larger , these models have gained in predictive accuracy over short-term horizons, as we discussed earlier. As such, these models are the backbones of the option-adjusted pricing models market participants use to identify relative...
Product Definition And Terms
A mortgage is a loan that is secured by an underlying asset that can be repossessed in the event of default. For the purposes of this chapter, a mortgage is defined as a loan made to the owner of a one- to four-family residential dwelling and secured by the underlying property. Such loans traditionally have been level-pay fully amortizing mortgages, indicating that principal and interest payments are calculated in equal increments to pay off the loan over the stated term. There are, however, a...
Agency Expansion Into Nonagency Zones
Earlier I discussed the tendency for mortgage issuers to discover new categories of nonagency loans that can be securitized and sold into the capital markets. However, one trend from the past several years runs in the opposite direction. The agencies have expanded their underwriting guidelines so that mortgage originators can include in agency pass-through pools many loans previously not eligible for agency pooling. In particular, agency underwriting guidelines are now broad enough to include a...
The Loan Underwriting Process
After the loan application is filed, the loan is considered to be part of the pipeline, which suggests that there is a planned sequence of activities that must be completed before the loan is funded. At application, the borrower can either lock in the rate of the loan or let it float until some point before the closing. From the perspective of the lender, there is no interest-rate risk associated with the loan until it is locked in. However, after the loan is locked in, the lender is exposed to...
Defining Nonagency Mbs
Executive Director Mortgage Strategy Group UBS In this chapter I describe the loan and borrower characteristics that distinguish the different parts of the U.S. nonagency mortgage-backed securities MBS market. I believe that this description is an important first step in understanding the non-agency market not only because these characteristics define the different sectors but also because they determine each sector's prepayment and credit performance. While many types of loans are found in the...
Dollar Roll Financing in the TBA Market
TBA trading gave rise to the dollar roll as a mechanism for dealers to borrow pass-throughs they had sold short. In fact, a dollar roll is a contract to buy an amount of TBA pass-throughs for a close delivery date and sell the same amount of the same pass-throughs back for a more distant delivery date. Similar to a Treasury repo trade, the difference in buy-sell prices the drop implies a cost-of-carry or financing rate, given a prepayment assumption. This expected financing rate, then, is...
Generic Securities
Generic pass-through classes are divided first by agency. Ginnies should trade distinctly from GSE pass-throughs the guarantee is backed by the U.S. government, and the underlying loans are assumable, subject to lower loan limits, and possess demonstrably different credit performance. The market does perceive a difference in credit quality between Ginnie Mae and the GSEs and consequently demands a risk premium for the conventional agency pass-throughs. All other factors being equal, this would...
Deleveraging and Curtailing
The most common way for borrowers to shorten their mortgage terms is to refinance from a 30- to a 15-year mortgage. However, it takes a much larger payment to amortize the same amount over 15 years as over 30 years at 5.5 , the monthly payment on 100,000 is 568 over 30 years, but it is 817 over 15 years. In a steep yield environment, the 15-year rate can be as much as 75 basis points lower presently it is about 50 basis points lower , implying a monthly payment of about 778. In fact, the...
Passthrough Cash Flows
Evaluating the investment characteristics and performance of pass-throughs requires an understanding of pool structure and the cash flows generated. Accordingly, we begin with the most common case, a pool of 30-year, level-payment, fully amortizing, fixed-rate mortgages, a simplified example of which is show in Exhibit 3-1. Five mortgages in different original loan amounts with different interest rates by convention called coupons are pooled to create a 1 million pool. From them, varying...
Mbs Investors
Senior Managing Director Bear, Stearns amp Co. The size and diversity of the investor base for mortgage-backed securities MBS has grown right along with the market itself. And the ups and downs of MBS demand have become critical to understanding the workings of the market. Banks and thrifts today hold more than 40 of the market in mortgage loans and MBS, followed by the roughly 20 share in the portfolios of Fannie Mae and Freddie Mac. Non-U.S. portfolios, which include a wide range of public...
Defining Characteristics
Exhibit 5-2 presents the main characteristics of the nonagency sectors. It covers such loan and borrower characteristics as lien status, loan size, FICO score, LTV ratio, occupancy investor versus owner , documentation full versus nonfull , loan purpose purchase, cash-out refi, or rate refi , and AAA credit support. Note that the exhibit also indicates how the rating agencies have chosen to identify various parts of the nonagency market when they are included in a collateralized debt obligation...
Gauging A Pools Prepayment Risk
From the outset, market participants used the WAC as the primary indicator of a pool's prepayment risk and the average age of the loans as a secondary indicator. Comparing the WAC to current mortgage rates provides a shorthand measure of prepayment incentive. To the degree that the WAC is higher than the market rate, underlying borrowers have, on average, positive incentives to refinance. Pools with WACs equal to or below the current market rate generally depend on turnover and cash-out...
Specified Trades
To be precise, these are trades in which the pool number and original face principal amount outstanding is a function of prepayments and is not known until the next factor date are known at the time of the trade. In practice, the candidates for specified trades are pools with prepayment stories that should command a premium over the TBA price for that program and coupon. Until the late 1990s, prepayment stories within the mainstay 15- and 30-year programs were largely limited to seasoned paper...
Trading Settlement And Clearing Procedures For Agency Mbs
Managing Director Lehman Brothers Inc. Senior Vice President Lehman Brothers Inc. Brian Hargrave Vice President Lehman Brothers Inc. Investors new to agency mortgage-backed securities MBS quickly learn that they offer return and risk characteristics that are unlike other fixed income investments. These differences arise because MBS are collateralized by residential mortgages and because the homeowner has the option to prepay at any time. The features of agency MBS have led to specialized...
Fannie Mae And Freddie Mac
The government-sponsored enterprises GSEs pioneered a new strategy in MBS in the 1990s aggressive, flexibly funded, closely hedged, highly leveraged, and one that has turned out to be generally profitable. Funding and leverage create the edge, and the lack of alternative assets creates a singular focus. Fannie Mae and Freddie Mac traditionally have held a tremendous competitive advantage in the low cost and flexibility of their funding and in their high leverage. GSE funding comes predominantly...
Fannie Mae MBS
Fannie Mae has the longest history but was the last of the three agencies to enter the pass-through market. Fannie Mae originally was created as a federal agency in 1938 by the National Housing Act. Its mission was to provide liquidity to housing lenders, primarily by purchasing mortgage loans funded by issues of debentures and holding them in portfolio. In 1968, an amendment to the National Housing Act split the agency in two into the private corporation Fannie Mae, which was charged with...
DebttoIncome DTI Ratio
Whereas FICO score is used as an indicator of an individual's willingness to repay his or her loan, DTI ratio is a measure of the individual's ability to repay it. Note that DTI ratios are not provided in Exhibit 5.2. Two DTI ratios are used commonly in mortgage underwriting, the front end and back end. The front-end ratio divides a homeowner's housing-related payments including principal, interest, real estate taxes, and home insurance payments by gross income. A back-end ratio divides total...
Generation Of Mortgage Lending Rates
The determination of mortgage lending rates is a complex interplay between levels in the secondary market for MBS, the value of servicing, the pricing of credit enhancement, and the costs associated with generating the loan. In this process, the pricing of different MBS quoted directly and through the mechanism of intercoupon spreads is very important in determining the eventual disposition of loans because the MBS market allows providers of funds investors and users of funds lenders to...
Banks and Thrifts
At banks and thrifts, the securities portfolio usually dances to the tune set by the rest of the balance sheet. If loan demand is up, then interest in mortgages and MBS typically is off. If loan demand is weak and deposits are on the rise, then mortgages get hot. Banks and thrifts turn to securities for income and earnings when loan demand falls short. And when the portfolio does jump into the market, funding and accounting shape the strategy. Banks and thrifts come to the mortgage market with...
Mortgageloan Mechanics
Mortgage loans traditionally are structured as immediately and fully amortizing debt instruments, where the principal balance is paid off over the life of the loan. As noted previously, fixed-rate loans generally have a monthly payment that is fixed for the life of the loan, based on loan balance, term, and interest rate. A fixed-rate loan's monthly payment can be calculated by first computing the mortgage payment factor using the following formula interest rate 1 interest rate loan term...
Coupon Stacks
Within programs, such as 30-year Gold PC or Ginnie I SF, pools are aggregated by coupon. While it is feasible to create pass-throughs with coupons that vary by as little as 1 8th of a percent, concentrating issuance in whole and half coupons simplifies relative-value analysis and trading strategies and maximizes liquidity. Most standard market reports, such as daily price reports or monthly prepayment reports, ignore the small amounts of quarter and eighth coupons outstanding. Market slang...
Impact Of Cashflow Variability On Yield And Average Life
The actual economic performance of a pass-through is a function of the timing and amount of cash flows, on the one hand, and the degree of discount or premium from par paid, on the other. We can illustrate this in Exhibit 3-7 by considering the impact of different CPRs on the yield14 and average life of a 5 pass-through with a 357-month WAM, similar to the example in Exhibit 3-1, and having a 54-day delay, similar to a Fannie Mae pass-through . Prepayments are varied in CPR in the top half, PSA...
External Credit Enhancements
External credit enhancements come in the form of third-party guarantees that provide for first-loss protection against losses up to a specified amount. Historically, the most common forms of external credit enhancements have been 1 a letter of The author is grateful to Bill Berliner and Jonathan Lieber of Countrywide Securities Brian Grow, Ray Morel, and Weili Chen of Standard amp Poor's and Patrick Fitzsimonds of UBS for their helpful comments. credit, 2 bond insurance, and 3 pool insurance. A...
Use Of Interestrate Derivative Instruments
I conclude this chapter with a discussion of the use of interest-rate derivatives in nonagency MBS products to hedge interest-rate risk. The three types of interest-rate derivatives used in recent mortgage securitizations have been interest-rate swaps, interest-rate caps, and interest-rate corridors. These derivatives are over-the-counter or dealer products, not exchange-traded products. As a result, they expose the trust to counterparty risk. The use of derivatives in a transaction will be...
Internal Credit Enhancements
Internal credit enhancements come in more complicated forms than external credit enhancements and may alter the cash-flow characteristics of the loans even in the absence of default. Credit enhancement levels i.e., the amount of subordination for each form of enhancement used within a deal are determined by the rating agencies from which the issuer seeks a rating for the tranches. This is referred to as sizing the transaction and is based on the rating agencies' expectations for the performance...
Risks Associated With Mortgages And Mbs
Holders of fixed income investments ordinarily deal with interest-rate risk, or the risk that changes in the level of market interest rates will cause fluctuations in the market value of such investments. Under most circumstances, interest-rate risk can be hedged through either the cash or derivative markets. Mortgages and associated MBS, however, have additional risks associated with them that are unique to the products and require additional analysis. In the following discussion for the sake...
TBA Coupons
In current practice, in the fixed-rate market, TBA securities, or coupons, are the whole and half coupons of the mainstay 30- and 15-year programs, as well as the 10- and 20-year GSE pools. The term TBA means that the actual pools delivered to settle the trade are to be announced.20 Actual pool numbers are provided within 48 hours of the delivery date those notification or allocation dates are set by the BMA. Unlike other fixed income securities, including CMOs and other structured products...
The Mortgage Industry
Within the mortgage market, a number of different types of financial institutions are involved, either directly or indirectly, in the business of mortgage loans. A number of different classification schemes can be used to distinguish businesses and functions within the aggregate mortgage banking industry. Consistent with terminology, a direct lender accepts and underwrites loan applications and funds the resulting loans. In contrast, a mortgage broker represents clients and will work with a...
The Public Securities Association PSA Prepayment Standard
In the pass-through market, the CPR is the standard unit of measurement. However, pass-throughs are regularly structured into CMOs series of bonds that are solely paid by cash flows from the underlying pass-through commonly referred to as collateral, which is why market jargon now uses collateral as a synonym for pass-throughs . In that application, it is not appropriate to assume a constant CPR because newly issued loans and pools tend to exhibit very small prepayments. Indeed, the likelihood...
Tom Zimmerman And Laurent Gauthier
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, futures securities trading, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. From a Declaration of Principles jointly adopted by a Committee of the American...
Evolution Of Loan And Borrower Characteristics
In the two preceding sections I discussed the main characteristics that distinguish different sectors of the nonagency market. The data in Exhibit 5-2 highlights the main differences between the sectors for the vintage year 2004. Not surprisingly, some of these characteristics have changed over time. In order to capture some of that movement, Exhibit 5-7 shows how several of these key characteristics have evolved over the past nine years. In this exhibit, first note the sharp increase in the...
Differences Between The Fifth And Sixth Editions
Money managers must justify their management and transaction costs to clients. Consequently, all money managers eventually must demonstrate to their clients how much value they have added to portfolio performance above and beyond what could have been achieved by employing a lower-cost buy-and-hold strategy. As the editor of The Handbook of Mortgage-Backed Securities, I am effectively the portfolio manager of the assets of this book the chapters. The sixth edition must justify to my current...
Negative Convexity and Duration Drift
The negative convexity of pass-throughs is directly reflected in their market prices such that prices increase more slowly for each 50 basis point step in coupon above par. This is shown in Exhibit 3-8 using the 30-year Fannie Mae coupon stack. Analyses using a constant prepayment assumption are called static. As the term implies, they are limited in usefulness many scenarios need be compared to arrive at an understanding of the potential variability of pass-through cash flows 15....
Understanding The Prospectus And Prospectus Supplement
Structured Finance Group PricewaterhouseCoopers Structured Finance Group PricewaterhouseCoopers Structured Finance Group PricewaterhouseCoopers Structured Finance Group PricewaterhouseCoopers The registration, disclosure, and reporting requirements for publicly issued mortgage-backed securities MBS are governed by the Securities Act of 1933 and the Exchange Act of 1934. The modern asset-backed securitization ABS market did not exist at the time of the creation of these laws, and as a result,...
Settlement Procedures For Agency Passthroughs
TBA trades of agency pass-throughs settle monthly according to a schedule established by the Bond Market Association BMA , the trade association for primary dealers in U.S. government and municipal securities. The BMA releases a schedule for the upcoming six months on a quarterly basis. It divides all agency BMA Call-Out Settlement Schedule, August 2000 BMA Call-Out Settlement Schedule, August 2000 Class 30 Yr. FHLMC Gold 30 Yr. FHLMC 75 day delay 15 Yr. GNMA I and II 15 Yr. FHLMC Gold 15 Yr....