Zvi Wiener

Fall-01

Fixed Income Instruments 4

Zvi Wiener

02-588-3049 mswiener@mscc.huji.ac.il

http://pluto.mscc.huji.ac.il/~mswiener/zvi.html

FIBI

Zvi Wiener

Fixed Income 4

•

Mortgage loans

•

Pass-through securities

•

Prepayments

•

Agencies

•

MBS

•

CMO

•

ABS

FIFIBI - 4 slide 2

Mortgage Loans

Mortgage is a loan secured by a specified real estate property.

Conventional mortgage - credit of the borrower and collateral.

Mortgage insurance - FHA, VA, FmHA guaranteed by US government, there are some private insurers as well.

Zvi Wiener FIFIBI - 4 slide 3


Mortgage Market

Mortgage originator - thrifts, banks origination fee (in points = %)

PTI = payment to income ratio (include tax)

LTV = loan to value ratio later on mortgages are securitized.


Mortgage Services

Collecting payments, maintaining records

Servicing fee - % of outstanding plus some other benefits.

Mortgage insurer required when LTV>80%.

Credit life - voluntary life insurance.


Zvi Wiener

Fixed Rate Mortgage

A series of equal payments with PV=loan.

Example: 100,000 for 20 years with 6% and equal monthly payments.

100 , 000



12 * 20 i





1

1 x

0 .

06

12 i


Adjustable-Rate Mortgage (ARM)

The contract rate is reset periodically, based on a short term interest rate.

Adjustment from one month to several years.

Spread is fixed, some have caps or floors.

Market based rates.

Rates based on cost of funds for thrifts.

Initially low rate is often offered = teaser rate.

slide 8 Zvi Wiener FIFIBI - 4

Balloon Mortgage

One payment at the end.

Sometimes they have renegotiation points.


Two-Step Mortgages

A loan carries a fixed rate for some period

(usually 7 years) and then reset rates.

For example: 250 basis points plus average of

10-years Treasuries.


Risk in Mortgages

Default risk

Liquidity risk

Interest rate risk

Prepayment risk


Risk in Mortgages

Default risk is highly affected by LTV.

LTV>80% in 40% of loans

LTV>90% in 15% of loans different state laws give different rights to lenders.


Zvi Wiener

Prepayment Risk in Mortgages

Sale of home

Better interest rates

Irrational factors


Mortgage Pass-Through Securities

A group of mortgages form a pool which is securitized.

Payments are pooled, service fee deducted and the rest divided.

WAC = weighted average coupon rate

WAM = weighted average maturity slide 14 Zvi Wiener FIFIBI - 4

Mortgage Pass-Through Securities

Ginnie Mae = Government National Mortgage

Association, MBS - guaranteed by GNMA.

Freddie Mac = Federal Home Loan Mortgage

Corporation, PC = participation certificate.

Fannie Mae = Federal National Mortgage

Association, MBS.


Role of Agencies guarantee timely payments

1. Coupon only

2. Both coupon and principal

Ginnie Mae is guaranteed by the US government. Securities guaranteed by Ginnie

Mae are called MBS = Mortgage Backed

Securities.


Non-Agency Pass-Through

Credit enhancement to AA or AAA.

Overcollateralization

Senior/subordinated structure shifting interest structure months % of prepayment to senior

1-60

61-72

70

60

73-84

85-96

40

20

97-108 12


Prepayments

Prepayment speed, conditional prepayment rate

CPR (prepayment rate assumed for a pool).

Single-Monthly mortality rate SMM .

SMM = 1 - (1-CPR) 1/12


Example of prepayments

Example : let CPR=6%, then

SMM = 1-(1-0.06) 1/12 = 0.005143.

An SMM of 0.5143% means that approximately

0.5% of the mortgage balance will be prepaid this month.


Example of prepayments

If the balance at the beginning of a month is

$290M, SMM = 0.5143% and the scheduled principal payment is $3M, then the estimated repayment for this month is

0.005143 (290,000,000-3,000,000)=$1,476,041


Prepayments

A general model should be based on a dynamic transition matrix, very similar to credit migration.

But note the difference of a pool of not completely rational customers and a single firm.


Prepayments

Prevailing mortgage rate relative to original.

Path of mortgage rates.

Level of mortgage rates.

Seasonal factors (home buying is high in spring summer and low in fall, winter).

General economic activity.


Bond Equivalent Yield

Bond equivalent yield = 2[ (1+y

M

) 6 - 1]

Yield is based on prepayment assumptions and must be checked!

PSA benchmark = Public Securities

Association. Assumes low prepayment rates for new mortgages, and higher rates for seasoned loans.


PSA prepayment benchmark

The Public Securities Association benchmark is expressed as monthly series of annual prepayment rates.

Low prepayment rates of new loans and higher for old ones.

Assumes CPR increasing 0.2% to 6% with life of a loan.

Actual rate is expressed as % of PSA.


6

Annual CPR in %

100 PSA

0.2

0

Zvi Wiener

30

FIFIBI - 4

Age in months slide 25





Effective Duration

GNMA 30 YR Inde x

100

75

50

25

0

98

Jan M ar

98

M ay

98

-

Ju l

98

-

S ep

98

N o v

98

-

99

Jan M ar

99

M ay

99

-

Ju l

99

-

S ep

99

N o v

99

-

00

Jan M ar

-

00

M ay

00

-

Ju l

00

-

S ep

00

N o v

00

-

01

Jan M ar

-

01

M ay

01

-

Ju l

01

-

S ep

01

-

6.00

8.25

10.50

6.50

8.50

11.00

7.00

9.00

Average

7.50

9.50

8.00

10.00


PSA standard default assumptions

0.6

Annual default rate (SDA) in %

0.3

Month 1 - 0.02% increases by 0.02% till 30m stable at 0.6% 30-60m declines by 0.01% 61-120m remains at 0.03% after 120m

0.02

0 30 60 120 Age in months slide 31 Zvi Wiener FIFIBI - 4

Special Properties

Negative convexity - if interest rates go up the price of a pass through security will decline more than a government bond due to lower prepayment rate.


CMO and stripped MBS (ch. 12)

Collateralized Mortgage Obligations - are bond classes created by redirecting the cash flows of mortgage related products so as to mitigate prepayment risk.

CMO is backed by a pool of pass-throughs, whole loans, or strips, structured in order to serve different types of clients.

The bond classes are called tranches.


CMO Example

Since 1983 - sequential-pay CMO. Each class is retired sequentially.

Example: collateral is a pass-through with

• par of $400M

• pass-through coupon rate 7.5%

•

WAC weighted average coupon 8.125%

•

WAM weighted average maturity 357 mo.


CMO Example

4 tranches A,B,C,D divide the whole nominal, coupons will be distributed proportionally, but principals first go to A, until repaid, then to B, etc.

Another example is an accrual CMO when one of the tranches does not get receive current interest. It is accrued and added to the principal.


CMO Example

Some tranches are floaters, others inverse floaters.

Floater: Variable Rate + spread

Inverse Floater: Spread - Variable Rate

Often LIBOR is used as variable rate.


Other CMOs

PAC = Planned Amortization Class,

IO = interest only,

PO = principal only,

IO, PO strips.




ABS Asset-Backed Securities (13)

Collateral, credit enhancement,

Payment structure (priorities), legal structure (SPV=special purpose vehicle)

Auto loan backed securities

Credit Card backed securities

Home Equity loans (second lien) slide 40 Zvi Wiener FIFIBI - 4

Front office Back office

Middle office

Zvi Wiener

Institutional investor (buyer)

Market Maker (dealer)


Zvi Wiener

Front Office

•

Trade execution

•

Investment decisions

•

Contact with counterparties

•

Real-time market monitoring


Zvi Wiener

Middle Office

•

Risk management

•

Benchmark

•

Valuation

•

Economic forecasts

•

Some investment decisions

•

Internal grading, scoring

•

Pricing of services

•

Profitability of business lines


Zvi Wiener

Back Office

•

Trade settlement, clearing

•

Margin management

•

Accounting

•

Administration

•

Record maintenance

•

Regulatory compliance

•

Inventory reporting


Pfandbrief

Zvi Wiener

Fall-01

02-588-3049 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html


FIBI

Pfandbrief

Bonds issued by German banks which are subject to special Pfandbrief legislation.

There are two types of Pfandbriefe depending on the collateral.

Oeffentliche Pfandbriefe are bonds fully collateralized by loans to public-sector entities, while Hypotheken-Pfandbriefe are fully collateralized by residential and commercial mortgages, with LTV<60%.


Pfandbrief

•

Mortgage Banks - about 20% of the business volume of all banking groups.

•

Only few Mortgage Banks are independent, most belong to a larger banking group.

– residential mortgage loans

– commercial mortgage loans

– public sector lending

• refinancing through the issuing of Pfandbriefe


Public Sector Loans in Germany bn Euros

Mortgage banks

Public banks

Savings banks

Commercial banks

Cooperative banks

Agencies

Total 476

2000

259

135

27

30

7.5

16

100

%

54.5

28.4

5.7

6.3

1.6

3.4


Commercial Loans in Germany bn Euros

Mortgage banks

Public banks

Savings banks

Commercial banks

Cooperative banks

Others

Total 218

16

16

1

2000

110

35.5

40

100

%

50.4

16.3

18.2

7.3

7.4

0.3



The Mortgage Loan Portfolio (12/00)

•

36% commercial property

•

64% residential property

Total Volume: 342,726 million Euro

Foreign loans 28,690 million Euro


Refinancing of the German

Mortgage Banks

•

Largest bond market in Europe

•

Outstanding volume in 2000 - 1.1 trillion euro

•

Gross sales 2000 - 216 billion euro

Issuers

• private Mortgage Banks

• private ship Mortgage Banks

• public sector credit institutions


Jumbo Pfandbrief above 500 million euro

Straight bond format

Structured Pfandbriefe maturities 1-10 years are eligible collateral



European “Pfandbrief”countries







PEX <GO>


DAC

Zvi Wiener

Fall-01

02-588-3049 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html


FIBI

Life Insurance

• yearly contribution 10,000 NIS

• yearly risk premium 2,000 NIS

• first year agent’s commission 3,000 NIS

• promised accumulation rate 8,000 NIS/yr

•

After the first payment there is a problem of insufficient funds. 8,000 NIS are promised

(with all profits) and only 5,000 NIS arrived.


Risk

2,000 NIS

10,000 NIS

Client’s

8,000 NIS

• insufficient funds if the client leaves

• insufficient profits

Agent

3,000 NIS


Risk measurement

•

The reason to enter this transaction is because of the expected future profits.

•

Assume that the program is for 15 years and the probability of leaving such a program is



.

•

Fees are

– 0.6% of the portfolio value each year

– 15% real profit participation


Zvi Wiener

Front office Back office

Middle office

Related documents

Products

Support

Zvi Wiener

Front office Back office

Middle office

Related documents

Add this document to collection(s)

Add this document to saved

Suggest us how to improve StudyLib