Asset Backed
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Transcript of Asset Backed
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Asset-Backed Securities
ABS derive their cash flows from a pool of
underlying assets
MBS = mortgage backed securitiesCARS = certificates for automobile receivables
CARDS = certificates for amortizing revolving
debts
HELS = home equity loan securities
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Asset-Backed Securities
The underlying assets generate cash flows of
principal and interest which can be repackaged
and sold to investors.
Fixed income
assets
Principal
Interest
Asset-backed
securities
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Asset-Backed Securities
In ABS, the underlying assets are collectedinto a pool.
Pool assets are standardized.
The asset pool is placed in trust.
Claims on the cash flows generated by theasset pool are structured:
Pass-through structuresMulti-class structures
Securities representing these claims are sold.
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Securitization
By pooling and repackaging cash flows, ABSissuers can convert illiquid fixed income assetsinto marketable bonds.
Requires trust structure to hold underlyingassets, and
Credit enhancement to achieve investment
grade bond ratingExternal: guarantees
Internal: over-collateralization.
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Issuers
Mortgage related agencies
Ginnie Mae (pass-thoughs)
Freddie Mac (PCs)Fannie Mae (MBS)
Private label MBS
Citi, GE, Prudential
Private label ABS
GMAC and other auto companies
Finance companies
Credit card issuers
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Investors
Insurance companies
Pension funds
Mutual funds
Wealthy individuals
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MBS
Backed by mortgage loans.
A mortgage loan is a loan secured by real
estateThe mortgage is a security agreement that gives
the lender the right to seize by foreclosure theproperty securing the loan if the borrower defaults
Mortgage loans are originated by banks andother financial firms.
Once originated, a mortgage loan may be held,sold to an investor for cash, or pooled andsecuritized.
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Mortgage Loan Types
Fixed-rate, level pay (plain vanilla)
Term of loan is fixed (30 years is common in US)
Contract rate of interest is fixed for the life of theloan.
Payments (usually monthly) are constant for the
term of the loan
The payments fully amortize the loan.FHA, conventional, conforming,
nonconforming, jumbo
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Mortgage Loan Types
Graduated payment loans (GPMs)Low initial payments and period of negative
amortization
Graduated equity loans (GEMs)
Fixed coupon with growing payments
Balloons
Adjustable rate mortgages (ARMs)Various index rates
Caps and collars
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Mortgage Loan Payments
The payments on a plain vanilla mortgage are
determined by
X P0i12
1 1 i12
12T
Initial
principal
Contract
rate of
interest
Mortgage
term in
years
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For Example
The monthly payments on a $187,000 loan
written at 10% for 15 years is
X$187,000.10
12
1 1.1012
180
$2,009.51
In Excel, you can use the financial function
PMT(rate, nper, pv,fv,type)
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Mortgage Loan Payments
Each payment consists ofinterest equal to i/12 times the amount of principal
owing at the time the payment is due, and
scheduled principal repayment
Payments are calculated such that the interestdue is paid first and then the remainder of the
payment is used to reduce the principal owed.
A table listing the payments and how they aredivided between interest and principal is calledan amortization schedule.
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Amortization Schedule
For example, here are the first few lines of an
amortization schedule for a 15-year, 10% fixed
rate loan with an initial principal of $187,000Balance Scheduled Balance
Before Principal After
Payment Due date Payment Payment Interest Repayment Payment
1 1/15/93 $187,000.00 $2,009.51 $1,558.33 $451.18 $186,548.822 2/15/93 $186,548.82 $2,009.51 $1,554.57 $454.94 $186,093.88
3 3/15/93 $186,093.88 $2,009.51 $1,550.78 $458.73 $185,635.154 4/15/93 $185,635.15 $2,009.51 $1,546.96 $462.55 $185,172.605 5/15/93 $185,172.60 $2,009.51 $1,543.11 $466.41 $184,706.206 6/15/93 $184,706.20 $2,009.51 $1,539.22 $470.29 $184,235.907 7/15/93 $184,235.90 $2,009.51 $1,535.30 $474.21 $183,761.698 8/15/93 $183,761.69 $2,009.51 $1,531.35 $478.16 $183,283.539 9/15/93 $183,283.53 $2,009.51 $1,527.36 $482.15 $182,801.38
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Amortization Schedule
A better way to visualize the amortization
process is to look at a graph of the payments
$0.00
$500.00
$1,000.00
$1,500.00
$2,000.00
$2,500.00
1 23 45 67 89 111 133 155 177
Principal
Interest
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Amortization Schedule
The principal balance remaining after any
number of payments can be determined by
constructing an amortization schedule or byemploying the formula
Ps P0
1 1 i12
12Ts
1 1 i12
12T
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Amortization Schedule
The logic of this formula is that the principal
balance remaining after s payments is always
the present value of the remaining 12T-spayments discounted at the contract rate of
interest
Ps P0
1 1 i12
12Ts
1 1 i12
12T
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Amortization Schedule
Graphically
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Mortgage Servicing
Servicing
Collection and forwarding of payments
Administration of escrow accountsServicing fees
Typically 50 basis points
Right to service loan is sold by owner of
mortgage loan
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Mortgage Servicing
For example
Scheduled Balance
Servicing Principal After
Payment Payment Fee Interest Repayment Payment
1 $2,009.51 $77.92 $1,480.42 $451.18 $186,548.822 $2,009.51 $77.73 $1,476.84 $454.94 $186,093.883 $2,009.51 $77.54 $1,473.24 $458.73 $185,635.154 $2,009.51 $77.35 $1,469.61 $462.55 $185,172.605 $2,009.51 $77.16 $1,465.95 $466.41 $184,706.206 $2,009.51 $76.96 $1,462.26 $470.29 $184,235.90
171 $2,009.51 $8.00 $152.03 $1,849.48 $17,354.50172 $2,009.51 $7.23 $137.39 $1,864.89 $15,489.61
173 $2,009.51 $6.45 $122.63 $1,880.43 $13,609.18174 $2,009.51 $5.67 $107.74 $1,896.10 $11,713.08175 $2,009.51 $4.88 $92.73 $1,911.90 $9,801.17176 $2,009.51 $4.08 $77.59 $1,927.84 $7,873.34177 $2,009.51 $3.28 $62.33 $1,943.90 $5,929.44178 $2,009.51 $2.47 $46.94 $1,960.10 $3,969.34179 $2,009.51 $1.65 $31.42 $1,976.43 $1,992.90180 $2,009.51 $0.83 $15.78 $1,992.90 ($0.00)
This servicingannuity is worth
about $5,450 at a
9.5% discount
rate
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For Example
Consider a mortgage thats been outstanding
for two years and rates have fallen 2%
Original loan amount: $187,000.00Term (yrs): 15
Contract rate of interest: 10.00%
Monthly payment $2,009.51
Balance after 24 payments $175,067.73
New rate 8.00%Value of balance remaining $194,517.70
Benef it of ref inancing $19,449.97
New montly payment $1,808.58
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Prepayments
To the extent that prepayments cannot be
perfectly predicted, they create uncertainty
about the term of mortgage loans.This uncertainty is a disadvantage from the
standpoint of an investor.
Whats worse: Prepayments are more likely
when rates fall and less likely when they rise,so prepayment risk is positively correlated with
interest rate risk
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Pass-throughs
The simplest type of MBS
Similar mortgages are pooled and
Principal and interest payments are passed throughto investors (pro rata)
Less servicing and insurance (credit enhancement)
fees
Pass-through cash flows are uncertain becauseprepayments of mortgages within the pool are
uncertain.
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Prepayment models
To price a pass-through bond, an estimate of
prepayments is needed.
Prepayments will affect the duration of the bonds(Can you see how?)
There are several models for estimating
prepayments
However, none of these models is designed todescribe borrower response to changes in
interest rates.
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CPR
The constant prepayment rate model assumes a
constant percentage of the outstanding principal
will prepay each month.CPR is an annual rate that can be translated to
a single monthly mortality rate (SMM) as
SMM
1
1
CPR
112
An SMM of z% means that z% of the principal remaining
in the pool after all scheduled payments have been made
will prepay during the month
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CPR
For example, a CPR of 6%
Translates to an SMM of .514%
So if you owned a pass-through with abeginning of the month balance of $181,824.99
and $494.30 of scheduled principal payments,
then prepayments would be predicted at
.00514 $181,824.99 $494.30 $932.58
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PSA
The Public Securities Association standardspecifies that the CPR is .2% during the firstmonth of a pool,
Increases by .2% per month until the 30thmonth
Levels off at 6% for the remainder.
Prepayment speeds are quoted as % of PSASlow: less than 100% PSA
Fast: greater than 100% of PSA
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FHA Experience
HUD publishes data on FHA insured
mortgages that can be used to extrapolate
prepayment speeds.Patterns can be discerned for different types of
pools.
The pattern for a given pool type can then be
used to estimate a prepayment speed for otherpools of that type.
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Example with 165% PSA
$0.00
$500.00
$1,000.00
$1,500.00
$2,000.00
$2,500.00
$3,000.00
$3,500.00
$4,000.00
1 21 41 61 81 101 121 141 161
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Effect of Changing PSA
Impact on duration
Excel spreadsheet
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