AssetBackedSecurities

ABSderivetheircashflowsfromapoolof
underlyingassets
MBS=mortgagebackedsecurities
CARS=certificatesforautomobilereceivables
CARDS=certificatesforamortizingrevolving
debts
HELS=homeequityloansecurities

AssetBackedSecurities
Theunderlyingassetsgeneratecashflowsof
principalandinterestwhichcanberepackaged
andsoldtoinvestors.
Fixedincome
assets

Assetbacked
securities
Principal
Interest

AssetBackedSecurities
InABS,theunderlyingassetsarecollectedinto
apool.
Poolassetsarestandardized.

Theassetpoolisplacedintrust.
Claimsonthecashflowsgeneratedbytheasset
poolarestructured:
Passthroughstructures
Multiclassstructures

Securitiesrepresentingtheseclaimsaresold.

Securitization
Bypoolingandrepackagingcashflows,ABS
issuerscanconvertilliquidfixedincomeassets
intomarketablebonds.
Requirestruststructuretoholdunderlying
assets,and
Creditenhancementtoachieveinvestment
gradebondrating
External:guarantees
Internal:overcollateralization.

Issuers
Mortgagerelatedagencies
GinnieMae(passthoughs)
FreddieMac(PCs)
FannieMae(MBS)

PrivatelabelMBS
Citi,GE,Prudential

PrivatelabelABS
GMACandotherautocompanies
Financecompanies
Creditcardissuers

Investors

Insurancecompanies
Pensionfunds
Mutualfunds
Wealthyindividuals

MBS
Backedbymortgageloans.
Amortgageloanisaloansecuredbyrealestate
Themortgageisasecurityagreementthatgivesthe
lendertherighttoseizebyforeclosuretheproperty
securingtheloaniftheborrowerdefaults

Mortgageloansareoriginatedbybanksand
otherfinancialfirms.
Onceoriginated,amortgageloanmaybeheld,
soldtoaninvestorforcash,orpooledand
securitized.

MortgageLoanTypes
Fixedrate,levelpay(plainvanilla)
Termofloanisfixed(30yearsiscommoninUS)
Contractrateofinterestisfixedforthelifeofthe
loan.
Payments(usuallymonthly)areconstantforthe
termoftheloan
Thepaymentsfullyamortizetheloan.

FHA,conventional,conforming,
nonconforming,jumbo

MortgageLoanTypes
Graduatedpaymentloans(GPMs)
Lowinitialpaymentsandperiodofnegative
amortization

Graduatedequityloans(GEMs)
Fixedcouponwithgrowingpayments

Balloons
Adjustableratemortgages(ARMs)
Variousindexrates
Capsandcollars

MortgageLoanPayments
Thepaymentsonaplainvanillamortgageare
determinedby

i
12
X =P0
12T

i
1(1+ 12)

Initial
principal

Contract
rateof
interest

Mortgage
termin
years

ForExample
Themonthlypaymentsona$187,000loan
writtenat10%for15yearsis

.10
12
X =$187,000
.51
180 =$2,009
.10
1(1+ 12)

InExcel,youcanusethefinancialfunction
PMT(rate,nper,pv,fv,type)

MortgageLoanPayments
Eachpaymentconsistsof
interestequaltoi/12timestheamountofprincipal
owingatthetimethepaymentisdue,and
scheduledprincipalrepayment

Paymentsarecalculatedsuchthattheinterest
dueispaidfirstandthentheremainderofthe
paymentisusedtoreducetheprincipalowed.
Atablelistingthepaymentsandhowtheyare
dividedbetweeninterestandprincipaliscalled
anamortizationschedule.

AmortizationSchedule
Forexample,herearethefirstfewlinesofan
amortizationschedulefora15year,10%fixed
rateloanwithaninitialprincipalof$187,000
Payment
1
2
3
4
5
6
7
8
9

Due date
1/15/93
2/15/93
3/15/93
4/15/93
5/15/93
6/15/93
7/15/93
8/15/93
9/15/93

Balance
Before
Payment
$187,000.00
$186,548.82
$186,093.88
$185,635.15
$185,172.60
$184,706.20
$184,235.90
$183,761.69
$183,283.53

Payment
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51

Interest
$1,558.33
$1,554.57
$1,550.78
$1,546.96
$1,543.11
$1,539.22
$1,535.30
$1,531.35
$1,527.36

Scheduled
Principal
Repayment
$451.18
$454.94
$458.73
$462.55
$466.41
$470.29
$474.21
$478.16
$482.15

Balance
After
Payment
$186,548.82
$186,093.88
$185,635.15
$185,172.60
$184,706.20
$184,235.90
$183,761.69
$183,283.53
$182,801.38

AmortizationSchedule
Abetterwaytovisualizetheamortization
processistolookatagraphofthepayments
$2,500.00
$2,000.00
$1,500.00

Principal
Interest

$1,000.00
$500.00
$0.00
1

23

45

67

89

111 133 155 177

AmortizationSchedule
Theprincipalbalanceremainingafterany
numberofpaymentscanbedeterminedby
constructinganamortizationscheduleorby
employingtheformula
( T s)
11+ i 12

(
)
12
Ps =P0
12T
( i 12)
11+

AmortizationSchedule
Thelogicofthisformulaisthattheprincipal
balanceremainingafterspaymentsisalways
thepresentvalueoftheremaining12Ts
paymentsdiscountedatthecontractrateof
interest
( T s)
11+ i 12

(
)
12
Ps =P0
12T
( i 12)
11+

AmortizationSchedule
Graphically
Principal Balance Outstanding
$200,000.00

$150,000.00

$100,000.00
Balance Remaining
$50,000.00

$0.00
1

16

31

46

61

76

91 106 121 136 151 166

($50,000.00)

MortgageServicing
Servicing
Collectionandforwardingofpayments
Administrationofescrowaccounts

Servicingfees
Typically50basispoints

Righttoserviceloanissoldbyownerof
mortgageloan

MortgageServicing
Forexample
Payment
1
2
3
4
5
6
171
172
173
174
175
176
177
178
179
180

Payment
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51
$2,009.51

Thisservicing
annuityisworth
about$5,450ata
9.5%discount
rate

Servicing
Fee
$77.92
$77.73
$77.54
$77.35
$77.16
$76.96
$8.00
$7.23
$6.45
$5.67
$4.88
$4.08
$3.28
$2.47
$1.65
$0.83

Interest
$1,480.42
$1,476.84
$1,473.24
$1,469.61
$1,465.95
$1,462.26
$152.03
$137.39
$122.63
$107.74
$92.73
$77.59
$62.33
$46.94
$31.42
$15.78

Scheduled
Principal
Repayment
$451.18
$454.94
$458.73
$462.55
$466.41
$470.29
$1,849.48
$1,864.89
$1,880.43
$1,896.10
$1,911.90
$1,927.84
$1,943.90
$1,960.10
$1,976.43
$1,992.90

Balance
After
Payment
$186,548.82
$186,093.88
$185,635.15
$185,172.60
$184,706.20
$184,235.90
$17,354.50
$15,489.61
$13,609.18
$11,713.08
$9,801.17
$7,873.34
$5,929.44
$3,969.34
$1,992.90
($0.00)

Prepayments
Paymentsmadebyborrowersinexcessoftheir
scheduledloanpayments.
Entire(aswhenthehouseissoldorrefinanced)
Partial(acceleratedprincipalrepayment)

Mostprepaymentsareoptionaltotheborrower
putoption

Borrowerincentiveswhenrates
Rise
Fall

ForExample
Consideramortgagethatsbeenoutstanding
fortwoyearsandrateshavefallen2%
Original loan amount:
Term (yrs):
Contract rate of interest:
Monthly payment
Balance after 24 payments
New rate
Value of balance remaining
Benefit of refinancing
New montly payment

$187,000.00
15
10.00%
$2,009.51
$175,067.73
8.00%
$194,517.70
$19,449.97
$1,808.58

Prepayments
Totheextentthatprepaymentscannotbe
perfectlypredicted,theycreateuncertainty
aboutthetermofmortgageloans.
Thisuncertaintyisadisadvantagefromthe
standpointofaninvestor.
Whatsworse:Prepaymentsaremorelikely
whenratesfallandlesslikelywhentheyrise,
soprepaymentriskispositivelycorrelatedwith
interestraterisk

Passthroughs
ThesimplesttypeofMBS
Similarmortgagesarepooledand
Principalandinterestpaymentsarepassedthrough
toinvestors(prorata)
Lessservicingandinsurance(creditenhancement)
fees

Passthroughcashflowsareuncertainbecause
prepaymentsofmortgageswithinthepoolare
uncertain.

Prepaymentmodels
Topriceapassthroughbond,anestimateof
prepaymentsisneeded.
Prepaymentswillaffectthedurationofthebonds
(Canyouseehow?)

Thereareseveralmodelsforestimating
prepayments
However,noneofthesemodelsisdesignedto
describeborrowerresponsetochangesin
interestrates.

CPR
Theconstantprepaymentratemodelassumesa
constantpercentageoftheoutstandingprincipal
willprepayeachmonth.
CPRisanannualratethatcanbetranslatedtoa
singlemonthlymortalityrate(SMM)as
SMM=11CPR
(
)

1
12

AnSMMofz%meansthatz%oftheprincipalremaining
inthepoolafterallscheduledpaymentshavebeenmade
willprepayduringthemonth

CPR
Forexample,aCPRof6%
TranslatestoanSMMof.514%
Soifyouownedapassthroughwitha
beginningofthemonthbalanceof$181,824.99
and$494.30ofscheduledprincipalpayments,
thenprepaymentswouldbepredictedat
.00514
($181,824.99$494.30) =$932.58

PSA
ThePublicSecuritiesAssociationstandard
specifiesthattheCPRis.2%duringthefirst
monthofapool,
Increasesby.2%permonthuntilthe30th
month
Levelsoffat6%fortheremainder.
Prepaymentspeedsarequotedas%ofPSA
Slow:lessthan100%PSA
Fast:greaterthan100%ofPSA

FHAExperience
HUDpublishesdataonFHAinsuredmortgages
thatcanbeusedtoextrapolateprepayment
speeds.
Patternscanbediscernedfordifferenttypesof
pools.
Thepatternforagivenpooltypecanthenbe
usedtoestimateaprepaymentspeedforother
poolsofthattype.

Examplewith165%PSA
$4,000.00
$3,500.00
$3,000.00
$2,500.00
$2,000.00
$1,500.00
$1,000.00
$500.00
$0.00
1

21

41

61

81

101 121 141 161

EffectofChangingPSA
Impactonduration
Excelspreadsheet