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

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Presentation on theme: "U.S. Mortgage Backed Securities Market January 29, 2006 Thomas Zimmerman Executive Director U.S. S ecuritized Products Strategy Group."— Presentation transcript:

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

2 1 1-29-06 NY (tom).ppt 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 2 1-29-06 NY (tom).ppt U.S. Debt Securities Outstanding

4 3 1-29-06 NY (tom).ppt Trends in Approved Asset Classes—1998– 2005

5 4 1-29-06 NY (tom).ppt Risk/Reward — Fixed Income Asset Classes

6 5 1-29-06 NY (tom).ppt 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 6 1-29-06 NY (tom).ppt 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 7 1-29-06 NY (tom).ppt 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 8 1-29-06 NY (tom).ppt 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 9 1-29-06 NY (tom).ppt 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 10 1-29-06 NY (tom).ppt Components of Prepayment Speeds (Agencies) CPR Housing Turnover (moving)6-10% Cash-out Refinancing2-8% Rate Refinancing0-80%

12 11 1-29-06 NY (tom).ppt Refi Curve

13 12 1-29-06 NY (tom).ppt Technology Has Moved Refi Curve

14 13 1-29-06 NY (tom).ppt PSA Curves

15 14 1-29-06 NY (tom).ppt Mortgage Cashflows for a $100,000 30-yr 5.5% Loan

16 15 1-29-06 NY (tom).ppt Mortgage Cashflows for a $100MM GNMA Pool With 0% Prepayments

17 16 1-29-06 NY (tom).ppt Pass-Thru Cashflows ($100MM 30-yr GNMA 5.5% @ 6% CPR)

18 17 1-29-06 NY (tom).ppt Pass-Thru Cashflows ($100MM 30yr GNMA 5.5% @ 100 PSA)

19 18 1-29-06 NY (tom).ppt WAL Profile 2 4 6 8 10 12 11109876543 Mortgage Yields WAL

20 19 1-29-06 NY (tom).ppt Negative Convexity 80 90 100 110 120 130 140 1110987654 Mortgage Yields 7.5% Mtg 7.5% 10yr Tsy 7.5% 5yr Tsy 7.5% 2yr Tsy Price

21 20 1-29-06 NY (tom).ppt 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 21 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 060120180240300360 Months A B D C Principal

23 22 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 060120180240300360 Month 100 PSA 250 PSA A B C D Principal

24 23 Range of CMO WAL Profiles

25 24 1-29-06 NY (tom).ppt U.S. Mortgage Market

26 25 1-29-06 NY (tom).ppt U.S. Mortgage Market—Agency vs. Non-Agency

27 26 1-29-06 NY (tom).ppt Loan and Borrower Characteristics

28 27 1-29-06 NY (tom).ppt Distribution of Credit Scores & LTV Across Products 2005 Vintage Loans FICO LTV

29 28 1-29-06 NY (tom).ppt Loan Size Distribution Across Products 2005 Vintage Loans Loan Size— ARMs Loan Size— Fixed

30 29 1-29-06 NY (tom).ppt 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” DealDeal with XS / OC

31 30 1-29-06 NY (tom).ppt Typical Evolution—OC Target & Actual OC

32 31 1-29-06 NY (tom).ppt Credit vs. Prepayment Stability (More) (Less) (Lower)(Higher) Credit Prepayment Stability Subprime Alt-A Jumbo Agency Prepayment stability a key attribute of Subprime

33 32 1-29-06 NY (tom).ppt Prepayment Sensitivity of Non-Agency Sectors

34 33 1-29-06 NY (tom).ppt 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 34 1-29-06 NY (tom).ppt Loss Coverage by Rating Level

36 35 1-29-06 NY (tom).ppt MBS Issuance By Sector—Agency vs. Non- Agency

37 36 1-29-06 NY (tom).ppt Non-Agency MBS Issuance By Sector

38 37 1-29-06 NY (tom).ppt RMBS Issuance—By Type ($million)

39 38 1-29-06 NY (tom).ppt 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 39 1-29-06 NY (tom).ppt GNMA 1s and 2s 30-Yr / All Pass-Thru Production

41 40 1-29-06 NY (tom).ppt Subprime Profitability

42 41 1-29-06 NY (tom).ppt Evolution of Non-Agency Loan Characteristics

43 42 1-29-06 NY (tom).ppt IO% Peaked When Option ARMs Took Off Option ARMs %—1st Lien Fixed and ARMs IO%—1st Lien Fixed and ARMs

44 43 1-29-06 NY (tom).ppt Dominance of “Affordability” Mortgages

45 44 1-29-06 NY (tom).ppt U.S. Annual Home Price Appreciation

46 45 1-29-06 NY (tom).ppt Subprime Cumulative Loss by Vintage & Foreclosure by States Vintage Year 1998-2003 2001

47 46 1-29-06 NY (tom).ppt 2001 Subprime Mortgages— Loss Severity & Cumulative Loss Rates, by States Loss Severity Cumulative Loss Rates

48 47 1-29-06 NY (tom).ppt Subprime 2/28 ARM with 2-year Penalties

49 48 1-29-06 NY (tom).ppt Impact of Prepayments & HPA on Subprime Losses

50 49 1-29-06 NY (tom).ppt Loss Coverage Ratios If Housing Inflation Slows Source: UBS

51 50 1-29-06 NY (tom).ppt Impact of Lower Housing Inflation on Losses

52 51 1-29-06 NY (tom).ppt Loss Coverage Ratios If Housing Inflation Slows

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