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U.S. Mortgage Backed Securities Market

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0 U.S. Mortgage Backed Securities Market
January 29, 2006 Thomas Zimmerman Executive Director U.S. Securitized Products Strategy Group

1 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 NY (tom).ppt

2 U.S. Debt Securities Outstanding
US debt sec outstd.xls NY (tom).ppt

3 Trends in Approved Asset Classes—1998–2005
0621lg (tab1-2, fig 1).xls NY (tom).ppt

4 Risk/Reward — Fixed Income Asset Classes
Wil Big Index (SSB).xls Strat 1/3/06 0103lg (tab 1).xls NY (tom).ppt

5 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 FSLIC = Federal Savings and Loan Insurance Corporation NY (tom).ppt

6 Mortgage Types Fixed-rate Adjustable-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 NY (tom).ppt

7 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: 3rd party guarantee— GNMA, FHLMC, FNMA for agencies AAA monoline for non-agency Internal to deal— Excess spread Overcollateralization (OC) Subordinated classes NY (tom).ppt

8 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 NY (tom).ppt

9 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 NY (tom).ppt

10 Components of Prepayment Speeds (Agencies)
CPR Housing Turnover (moving) 6-10% Cash-out Refinancing 2-8% Rate Refinancing % NY (tom).ppt

11 Refi Curve refi curve.xls NY (tom).ppt

12 Technology Has Moved Refi Curve
Glenn seminar B (Ramps) a.xls NY (tom).ppt

13 PSA Curves pt cashflow zero ppay.xls Jeff (60min pres)
NY (tom).ppt

14 Mortgage Cashflows for a $100,000 30-yr 5.5% Loan
Jeff (60min pres) pt cashflow zero ppay.xls NY (tom).ppt

15 Mortgage Cashflows for a $100MM GNMA Pool With 0% Prepayments
Jeff (60min pres) pt cashflow zero ppay.xls NY (tom).ppt

16 Pass-Thru Cashflows ($100MM 30-yr GNMA 5.5% @ 6% CPR)
Jeff (60min pres) pt cashflow zero ppay.xls NY (tom).ppt

17 Pass-Thru Cashflows ($100MM 30yr GNMA 5.5% @ 100 PSA)
Jeff (60min pres) pt cashflow zero ppay.xls NY (tom).ppt

18 WAL Profile Jeff (60min pres) 2 4 6 8 10 12 11 9 7 5 3 Mortgage Yields
NY (tom).ppt

19 Negative Convexity Jeff (60min pres) 80 90 100 110 120 130 140 11 10 9
7 6 5 4 Mortgage Yields 7.5% Mtg 7.5% 10yr Tsy 7.5% 5yr Tsy 7.5% 2yr Tsy Price Jeff (60min pres) NY (tom).ppt

20 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. NY (tom).ppt

21 Making Sequential CMOs Principal payments from $100mm 7.5% Deal
100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 60 120 180 240 300 360 Months A B D C Principal

22 Making PAC CMOs Principal payments from $70 million 7.5% Deal
200,000 400,000 600,000 800,000 1,000,000 1,200,000 60 120 180 240 300 360 Month 100 PSA 250 PSA A B C D Principal

23 Range of CMO WAL Profiles

24 U.S. Mortgage Market Issuance & Outstanding (IMF) v.xls
Data from Wilfred NY (tom).ppt

25 U.S. Mortgage Market—Agency vs. Non-Agency
Part I_abs tables.xls “Sec Mkts” NY (tom).ppt

26 Loan and Borrower Characteristics
Vicki_abs tables.xls NY (tom).ppt

27 Distribution of Credit Scores & LTV Across Products
2005 Vintage Loans FICO FICO Suprime Alt-a Prime.xls RFC (Ln sze & ltv).xls Fig 6 LTV NY (tom).ppt

28 Loan Size Distribution Across Products
2005 Vintage Loans Loan Size— ARMs FICO Suprime Alt-a Prime.xls Top: RFC (Ln sze & ltv).xls Fig8 Bottom: Chapter 1 (exh 6).xls Loan Size— Fixed NY (tom).ppt

29 Enhancement Reflects Collateral Differences
“Six-Pack” Deal Deal with XS / OC 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 AAAs AAAs Deal Collateral Face Value - Total Principal Payments AA “M1” A “M2” AA “M1” BBB “M3” Classic “Six Pack” Credit Enhancement A “M2” BB “B1” Excess-Spread O/C-based Credit Enhancement B “B2” BBB “M3” N.R. “B3” IO XS – OC Interest Payments Residual Interest on the bonds Interest on the bonds NY (tom).ppt

30 Typical Evolution—OC Target & Actual OC
0604abs-fig a (1).ppt NY (tom).ppt

31 Credit vs. Prepayment Stability
(More) Prepayment stability a key attribute of Subprime Subprime Prepayment From Special Topics report “Intro to the Home Equity Loan Market (pg 19) Stability Agency Alt-A Jumbo (Less) (Lower) Credit (Higher) NY (tom).ppt

32 Prepayment Sensitivity of Non-Agency Sectors
Chapter 1 (exh 11).xls NY (tom).ppt

33 Historical Cumulative Loss Comparison*
Resi A—Prime-Jumbo Resi A— Alt-A Resi B&C— Subprime bps 50 – 80 bps 400 – 500 bps *Cum losses for vintages will be much less because of strong housing price appreciation. NY (tom).ppt

34 Loss Coverage by Rating Level
Chapter 1 (exh 13).xls NY (tom).ppt

35 MBS Issuance By Sector—Agency vs. Non-Agency
Non-Agency Issuance 05.xls NY (tom).ppt

36 Non-Agency MBS Issuance By Sector
Non-Agency Issuance 05.xls NY (tom).ppt

37 RMBS Issuance—By Type ($million)
Non-Agency Issuance 05.xls NY (tom).ppt

38 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 NY (tom).ppt

39 GNMA 1s and 2s 30-Yr / All Pass-Thru Production
prod.xls NY (tom).ppt

40 Subprime Profitability
strat 0103lg (fig 6).xls NY (tom).ppt

41 Evolution of Non-Agency Loan Characteristics
evolution of non-agency.xls NY (tom).ppt

42 IO% Peaked When Option ARMs Took Off
IO%—1st Lien Fixed and ARMs New: IO%.xls Top -- Fig 1 David Seminar.xls Bottom -- Fig 2 David Seminar.xls Option ARMs %—1st Lien Fixed and ARMs NY (tom).ppt

43 Dominance of “Affordability” Mortgages
IO%.xls Fig 3 David Seminar.xls NY (tom).ppt

44 U.S. Annual Home Price Appreciation
FHLMC Annual Increase Q2 05.xls NY (tom).ppt

45 Subprime Cumulative Loss by Vintage & Foreclosure by States
Vintage Year Top: Cum Loss Rate.xls Bottom: 0301David (fig 1-7, t1).xls Fig 3 2001 NY (tom).ppt

46 2001 Subprime Mortgages— Loss Severity & Cumulative Loss Rates, by States
Both: 0301David (fig 1-7, t1).xls Fig 5 & fig 7 Cumulative Loss Rates NY (tom).ppt

47 Subprime 2/28 ARM with 2-year Penalties
0322Davidt (fig4,5,6).xls Fig 4 NY (tom).ppt

48 Impact of Prepayments & HPA on Subprime Losses
0913abs-tables a.xls strategist NY (tom).ppt

49 Loss Coverage Ratios If Housing Inflation Slows
loss formula (new).xls Source: UBS NY (tom).ppt

50 Impact of Lower Housing Inflation on Losses
loss formula (new).xls NY (tom).ppt

51 Loss Coverage Ratios If Housing Inflation Slows
loss formula (new).xls NY (tom).ppt

52 ABC corp. Layout Box: Layout Box: Layout Box: Layout Box: Layout Box:
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