#42: ABS Flashcards
An investor in mortgage-backed securities who is concerned about extension risk but willing to accept contraction risk should most appropriately invest in:
Sequential pay CMOs; In a sequential-pay CMO, the early tranches are more exposed to contraction risk, and the later tranches are more exposed to extension risk. PAC securities limit both contraction and extension risk for a range of prepayment rates
A covered bond that may postpone the originally scheduled maturity date by as much as a year, to delay default is
soft-bullet covered bond
Covered bond converts to a pass-through bond on the maturity date if any payments remain due
conditional pass-through covered bond
Covered bond is in default if the issuer fails to make a scheduled payment
hard-bullet covered bond
For Commercial MBS, a ____ LTV ratio indicates better credit quality
The lower, the more protection the mortgage lender has in making the loan
For Commercial MBS, a ____ debt-service coverage ratio indicates better credit quality
Higher, indicates that the borrower have more income from which to pay interest and principal on their debt
Provide prepayment protection for one or more PAC tranches
The purpose of a support tranche
A synthetic collateralized debt obligation (CDO) is backed by a pool of:
Credit default swaps
In contrast with most asset-backed securities (ABS), a collateralized debt obligation (CDO):
employs a collateral manager; Collateral manager buys and sells within the asset pool to generate cash flows from cap gains or interest
A renegotiable or rollover mortgage has an initial fixed-rate period after which the interest rate changes to:
another fixed rate
A hybrid mortgage has an initial fixed-rate period after which the interest rate changes to:
variable rate
Mortgage may be changed from fixed-rate to variable-rate or from variable-rate to fixed-rate at the borrower’s option
convertible mortgage
Which class of asset-backed securities typically includes a lockout period?
Credit card ABS typically have a lockout period during which principal payments by credit card borrowers are used to purchase additional credit card debt, rather than paid out to the ABS holders.
All automobile loan ABS have some sort of _____ to make them attractive to institutional investors.
credit enhancement:
A senior/subordinated structure in an ABS, in which risk of losses due to defaults on the underlying loans is redistributed among different classes of ABS holders.
credit tranching
Redistributes prepayment risk among different classes of ABS holders
Time tranching
Time tranching addresses the uncertainty of a decline in interest rates, because if interest rates drop people are more likely to prepay sooner
An annualized measure of the prepayments experienced by a pool of mortgages is its:
conditional prepayment rate (CPR)
Annualized SSM: the amount not being prepaid in a year
the percentage by which prepayments have reduced the month-end principal balance
single monthly mortality rate (the amount that is being prepaid) SSM
monthly series of CPRs to which a mortgage pool’s CPR may be compared
PSA prepayment benchmark
= mortgage rate – fees
Pass-through rate (less than the interest rate on the underlying pool of mortgages because of issuance costs and fees)
the coupon rate of the a mortgage pass-through security
Security holders receive the pass-through rate
Asset-backed securities (ABS) may have a higher credit rating than the seller’s corporate bonds because:
they are issued by a SPE; seller’s do not have claim against the pool of assets, bankruptcy remote
The process in which a set of bond classes or tranches is created that allow investors a choice in the type of prepayment risk—extension or contraction—that they prefer to bear
Time tranching
Allow investors to choose the amount of credit risk that they prefer to bear
Credit tranching: Senior and subordinated bond classes are used
Credit tranching is a form of credit enhancement called:
Subordination (Waterfall structure)
Bond classes are created with a waterfall structure, for sharing losses (credit tranching)
Cascading flow of payments between bond classes in the event of default (waterfall structure)
Mortgage with no scheduled principal repayments over the entire life of the loan.
At maturity, a balloon payment equal to the original loan amount, is required
Bullet mortgage (interest-only mortgage)
In the event of a borrower default on a loan, the lender can look to both the property and the borrower to recover the outstanding mortgage balance.
recourse loan
The bank will sell the home & recover the difference in what’s still owed from the borrower
Mortgage rate on the underlying pool of mortgages:
Weighted average coupon (WAC)
Pass through rate: coupon rate of the mortgage pass-through security = Mortgage rate (WAC) - fees
have limited (but not complete) protection against both extension risk and contraction risk; This protection is provided by the support tranches
PAC tranches
Investors are willing to accept prepayment risk in exchange for higher returns
Use Support tranches
This agency RMBS is designed to distribute prepayment risk to various tranches
collateralized mortgage obligations (CMOs)
Used to achieve the desired credit rating
subordination
Investors in commercial mortgage-backed securities (CMBS) face balloon risk, which is most likely a type of:
extension risk; the risk that the borrower will not be able to arrange for refinancing or sell the property to make the balloon payment typically associated with commercial loans backing CMBS. As a result, the CMBS may extend in maturity, implying that balloon risk is a type of extension risk.
For commercial mortgage based securities:
structural call protections:
loan level call protections:
- Tranching
- Prepayment lockout:
- Penalty points: charged against borrowers who repay mortgage principal
- Each point is 1% of the principal amount prepaid
- Defeasance: borrower purchases securities as collateral to cover remaining principal balance plus an amount to substitute for what the yield would have been
- Give the SPE enough money to buy the treasuries that provide the cash flows that take care of the remaining required payments
- Yield maintenance charges: designed to make the borrower indifferent to refinancing at lower rate
- If refinanced, borrower must make yield whole
Which type of loan is often used in CMBS?
balloon loans
a form of internal credit enhancement that limits credit risk.
It is an amount that can be retained and deposited into a reserve account and that can serve as a first line of protection against losses
An excess spread account, sometimes called excess interest cash flow
During the lockout period, the cash flow that is paid out to owners of credit card receivable asset-backed securities is based only on
finance charges collected and fees
period during which the principal repaid is reinvested to acquire additional loans with a principal equal to the principal repaid
lock out period for non-amortizing, non-mortgage ABS (autos and CC)
In the event of a default by the borrower, the lender can only foreclose the property and recover those assets
Non-recouse loan
The lender is not able to come after the borrower for any of the outstanding loan, after the sale of the property
What is the collateral often used in agency mortgage pass-through securities:
Conforming mortgages
Conforming mortgages simply meet all of the underwriting standards and can be included in the pool of assets
