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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 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 NY (tom).ppt U.S. Debt Securities Outstanding

4 NY (tom).ppt Trends in Approved Asset Classes—1998– 2005

5 NY (tom).ppt Risk/Reward — Fixed Income Asset Classes

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

12 NY (tom).ppt Refi Curve

13 NY (tom).ppt Technology Has Moved Refi Curve

14 NY (tom).ppt PSA Curves

15 NY (tom).ppt Mortgage Cashflows for a $100, yr 5.5% Loan

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

17 NY (tom).ppt Pass-Thru Cashflows ($100MM 30-yr GNMA 6% CPR)

18 NY (tom).ppt Pass-Thru Cashflows ($100MM 30yr GNMA 100 PSA)

19 NY (tom).ppt WAL Profile Mortgage Yields WAL

20 NY (tom).ppt Negative Convexity Mortgage Yields 7.5% Mtg 7.5% 10yr Tsy 7.5% 5yr Tsy 7.5% 2yr Tsy Price

21 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, , , , , , , , Months A B D C Principal

23 22 Making PAC CMOs Principal payments from $70 million 7.5% Deal 0 200, , , ,000 1,000,000 1,200, Month 100 PSA 250 PSA A B C D Principal

24 23 Range of CMO WAL Profiles

25 NY (tom).ppt U.S. Mortgage Market

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

27 NY (tom).ppt Loan and Borrower Characteristics

28 NY (tom).ppt Distribution of Credit Scores & LTV Across Products 2005 Vintage Loans FICO LTV

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

30 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 NY (tom).ppt Typical Evolution—OC Target & Actual OC

32 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 NY (tom).ppt Prepayment Sensitivity of Non-Agency Sectors

34 NY (tom).ppt 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.

35 NY (tom).ppt Loss Coverage by Rating Level

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

37 NY (tom).ppt Non-Agency MBS Issuance By Sector

38 NY (tom).ppt RMBS Issuance—By Type ($million)

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

41 NY (tom).ppt Subprime Profitability

42 NY (tom).ppt Evolution of Non-Agency Loan Characteristics

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

44 NY (tom).ppt Dominance of “Affordability” Mortgages

45 NY (tom).ppt U.S. Annual Home Price Appreciation

46 NY (tom).ppt Subprime Cumulative Loss by Vintage & Foreclosure by States Vintage Year

47 NY (tom).ppt 2001 Subprime Mortgages— Loss Severity & Cumulative Loss Rates, by States Loss Severity Cumulative Loss Rates

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

49 NY (tom).ppt Impact of Prepayments & HPA on Subprime Losses

50 NY (tom).ppt Loss Coverage Ratios If Housing Inflation Slows Source: UBS

51 NY (tom).ppt Impact of Lower Housing Inflation on Losses

52 NY (tom).ppt Loss Coverage Ratios If Housing Inflation Slows

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