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Mortgage Backed Securities Market

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    • 1. U.S. Mortgage Backed Securities Market January 29, 2006 Thomas Zimmerman Executive Director U.S. S ecuritized Products Strategy Group
    • 2. U.S. Mortgage Backed Securities Market
      • Size and importance
      • History
      • Securitization concepts
      • Cash flow basics
        • Prepayments
        • Average Life Variations
        • Option Adjustment Spread
      • CMOs
      • Non-Agency market
      • New affordability products
      • Impact of housing price appreciation
    • 3. U.S. Debt Securities Outstanding
    • 4. Trends in Approved Asset Classes—1998–2005
    • 5. Risk/Reward — Fixed Income Asset Classes
    • 6. History of U.S. Mortgage Market
      • 1930s—Great Depression led to 30-year fixed rate mortgage
      • 1932—Federal Home Loan Bank system for thrift and FSLIC to insure depositors. Major source of residential mortgages until 1970s. Role greatly reduced with thrift crisis of 1980s.
      • 1934—FHA—established to insure high LTV loans
      • 1938—FNMA—established to purchase & hold FHA loans
      • 1968—FNMA became private corporation—split into FNMA & GNMA
      • 1970—First GNMA pass-through security
      • 1970—FHLMC chartered as second GSE
      • 1971—FHLMC issued first pass-through
      • 1983—FHLMC issued first sequential pay CMO
    • 7. Mortgage Types
      • Fixed-rate
        • 15-year
        • 30-year
      • Adjustable-rate
        • Treasury
        • LIBOR
      • Hybrid (fixed period, then adjustable period)
        • 3/1s
        • 5/1s
      • Balloon (30-year amortization, then balloon payment)
        • 5-year
        • 7-year
    • 8. Securitization Process or (Conversion of Mortgage Collateral into Mortgage-Backed Securities)
      • Securities issued by a bankruptcy remote trust not an originator
      • Securities payment comes from cash-flow of underlying collateral, not payment from originator of loans.
      • If originator of loans goes into bankruptcy, does not impact cash-flow to security holders
      • Credit enhancement:
        • 3 rd party guarantee—
          • GNMA, FHLMC, FNMA for agencies
          • AAA monoline for non-agency
        • Internal to deal—
          • Excess spread
          • Overcollateralization (OC)
          • Subordinated classes
    • 9. Prepayments—The Key to Agency MBS Valuation
      • Homeowner has right to call his loan at any time.
      • MBS = Treasury + Short a “Call”
      • Very few prepayment penalties in Agency MBS
      • When rates decline, homeowners prepay faster
    • 10. Prepayment Terminology
      • SMM = Single Monthly Mortality Rate
      • = Actual Principal Payment – Scheduled Principal Payment
      • Beginning Principal
      • CPR = SMM Annualized
      • PSA = Public Securities Association Standard Prepayment Ramp
    • 11. Components of Prepayment Speeds (Agencies)
        • CPR
        • Housing Turnover (moving) 6-10%
        • Cash-out Refinancing 2-8%
        • Rate Refinancing 0-80%
    • 12. Refi Curve
    • 13. Technology Has Moved Refi Curve
    • 14. PSA Curves
    • 15. Mortgage Cashflows for a $100,000 30-yr 5.5% Loan
    • 16. Mortgage Cashflows for a $100MM GNMA Pool With 0% Prepayments
    • 17. Pass-Thru Cashflows ($100MM 30-yr GNMA 5.5% @ 6% CPR)
    • 18. Pass-Thru Cashflows ($100MM 30yr GNMA 5.5% @ 100 PSA)
    • 19. WAL Profile 2 4 6 8 10 12 11 10 9 8 7 6 5 4 3 Mortgage Yields WAL
    • 20. Negative Convexity 80 90 100 110 120 130 140 11 10 9 8 7 6 5 4 Mortgage Yields 7.5% Mtg 7.5% 10yr Tsy 7.5% 5yr Tsy 7.5% 2yr Tsy Price
    • 21. Calculation of Prepayment Option Cost
      • OAS approach
      • Simulate 500 interest rate paths.
      • Calculate prepayments on each path.
      • Calculate yield spread of MBS to LIBOR (Treasury) curve so average price across all paths just equals price of MBS.
      • This is the expected yield pick-up to LIBOR (Treasury) curve, after adjusting for prepayment risk.
    • 22. Making Sequential CMOs Principal payments from $100mm 7.5% Deal 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 0 60 120 180 240 300 360 Months A B D C Principal
    • 23. Making PAC CMOs Principal payments from $70 million 7.5% Deal 0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 0 60 120 180 240 300 360 Month 100 PSA 250 PSA A B C D Principal
    • 24. Range of CMO WAL Profiles
    • 25. U.S. Mortgage Market
    • 26. U.S. Mortgage Market—Agency vs. Non-Agency
    • 27. Loan and Borrower Characteristics
    • 28. Distribution of Credit Scores & LTV Across Products 2005 Vintage Loans FICO LTV
    • 29. Loan Size Distribution Across Products 2005 Vintage Loans Loan Size— ARMs Loan Size— Fixed
    • 30. Enhancement Reflects Collateral Differences
      • In Non-Agency MBS, credit enhancement structures come mainly in two flavors
        • “ Six-pack” structures where several locked-out subs provide credit enhancement. Mainly used on Jumbos and Alt-As
        • Excess-spread / Over-collateralization structures, where locked-out subs are complemented by excess interest from the collateral to cover losses. Mainly used in Subprime, High-LTV, Scratch & Dent, sometimes Alt-A
      Deal Collateral Face Value - Total Principal Payments AA “M1” AAAs A “M2” BBB “M3” BB “B1” B “B2” N.R. “B3” AA “M1” AAAs A “M2” BBB “M3” Interest on the bonds Interest Payments IO XS – OC Interest on the bonds Residual Excess-Spread O/C-based Credit Enhancement Classic “Six Pack” Credit Enhancement Collateral “ Six-Pack” Deal Deal with XS / OC
    • 31. Typical Evolution—OC Target & Actual OC
    • 32. Credit vs. Prepayment Stability (More) (Less) (Lower) (Higher) Credit Prepayment Stability Subprime Alt-A Jumbo Agency Prepayment stability a key attribute of Subprime
    • 33. Prepayment Sensitivity of Non-Agency Sectors
    • 34. Historical Cumulative Loss Comparison* Resi A—Prime-Jumbo Resi A— Alt-A Resi B&C— Subprime 10 - 20 bps 50 – 80 bps 400 – 500 bps *Cum losses for 2003-2005 vintages will be much less because of strong housing price appreciation.
    • 35. Loss Coverage by Rating Level
    • 36. MBS Issuance By Sector—Agency vs. Non-Agency
    • 37. Non-Agency MBS Issuance By Sector
    • 38. RMBS Issuance—By Type ($million)
    • 39. Factors Behind Growth in Subprime HEQ Issuance
      • More subprime borrowers
        • Increase in consumer debt burden
      • Greater % of subprime borrowers taking out mortgages
        • Aggressive marketing programs
        • Internet access
      • Expanded definition of subprime
        • Includes more Alt-A
      • Securitizers accounting for greater share of subprime lending
        • More aggressive lending
        • Rapid expansion into new geographic areas
      • Consumers shifting installment debt to mortgage debt
      • Lower rates = Increased rate refis
      • Greater housing inflation = Increased cash-out refis
      • Competitive pricing
    • 40. GNMA 1s and 2s 30-Yr / All Pass-Thru Production
    • 41. Subprime Profitability
    • 42. Evolution of Non-Agency Loan Characteristics
    • 43. IO% Peaked When Option ARMs Took Off Option ARMs %—1st Lien Fixed and ARMs IO%—1st Lien Fixed and ARMs
    • 44. Dominance of “Affordability” Mortgages
    • 45. U.S. Annual Home Price Appreciation
    • 46. Subprime Cumulative Loss by Vintage & Foreclosure by States Vintage Year 1998-2003 2001
    • 47. 2001 Subprime Mortgages— Loss Severity & Cumulative Loss Rates, by States Loss Severity Cumulative Loss Rates
    • 48. Subprime 2/28 ARM with 2-year Penalties
    • 49. Impact of Prepayments & HPA on Subprime Losses
    • 50. Loss Coverage Ratios If Housing Inflation Slows Source: UBS
    • 51. Impact of Lower Housing Inflation on Losses
    • 52. Loss Coverage Ratios If Housing Inflation Slows
    • 53.
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