HOFIS 31 - Nonagency Residential MBS Flashcards
Nonagency RMBS
Residential Mortgage-Backed Securities: Not guaranteed by government-sponsered entities or government agencies
Nonagency RMBS Characteristics
- Collateral: Many small loans
- Term: Longer-Term (15-30 years)
- Rate: Floating
- Prepayment: more frequently
- Transaction structure: varied
- Modeling: Probabilistic modeling on historical datasets
RMBS Prospectus
Offering document that
- describes collateral characteristics and deal structure,
- and discloses the associated transaction parties and investment risks
RMBS Warehouse Lenders
Provide short-term financing to originators allowing a critical mass of loans to be accumulated for a deal.
RMBS Issuers role
package loans and structure into tranches
RMBS Trustees
Administrate deals, release reports, distribute cash flows to investors
RMBS Mortgage Servicers
Collect payments from borrowers and pass onto the trustees
RMBS Conduits
Vertically integrated securitization business
RMBS Vintage
- Refers to the origination year
- Can help determine the level of underwriting standards at the time
- 2002/3 best, 2006/7 worst/most lenient years of underwriting
What are the key measurements of RMBS collateral performance?
- Delinquency – the 2 standards for measuring contractual delinquency status are the Mortgage Bankers Association (MBA) standard and the Office for Thrift Supervision (OTS) standard;
- Default – commonly defined by liquidation (via short sale, foreclosure sale, or REO sale) and the remaining default balance;
- Voluntary prepayments; and
- Loss severity
RMBS Roll Rate
Rate at which previously current or delinquent loans are rolling into another status
RMBS Short Sale
Sale of the underlying proprety in which the sale proceeds falls short of the remaining balance of the loan
RMBS Sequential vs Pro-rate Payments
- Sequential - AAA paid in full, then AA paid in full, etc.
- Pro-rata - payments are made proportional to each tranche’s unpaid principal balance
RMBS Lockout Perior
Subordinate bonds are often locked out of receiving prepayments for a given period of time after deal settlement (e.g. 5 years)
RMBS Triggers (capital structue)
Tests to place limits on the amount and timing of any release of credit support
RMBS Linear structure
has one collateral group and the cash flows from the single collateral group are distributed to all bonds
Y and H-structures (RMBS Capital Structure)
have several collateral groups (more complicated than linear structure)
RMBS Clean-Up Call
- Holder has an option to purchase remaining bonds at prespecified price when less than a certain factor (e.g., 10%) remains
- Manly to minimize admin costs
RMBS 6-pack structure
- AAA - senior
- AA, A, BBB - mezzanine
- BB, B - junk/subs
Losses are absorbed from the bottom up, starting from the junk/subs
The senior/subordination shifting interest (Senior/Sub) structure typically consists of a AAA-rated senior class/tranche followed by 6 subordinated classes/tranches with lower credit ratings. The Senior/Sub structure is commonly used for mortgage pools with lesser credit concerns, such as prime jumbo loans. The subordination mechanism that secures the senior class/tranche’s higher credit rating works by allocating principal prepayments first to the senior class and then as a waterfall descending through the various subordinate classes/tranches, while default losses are assigned in reverse order from the most junior class/tranche first and then ascending through the various classes/tranches to the most senior class/tranche last
RMBS OC/EX (overcollateralization / excess spread)
- Internal Credit enhancement technique
- Usually done when credit loss is a larger concern
- OC/EX structures have a predetermined OC target (e.g. 2%), and excess spreads go to the residual holder
- Step-down date - the time when junior bonds can start receiving principal and the OC can start to be released
- Usually OC builds up until the lockout period ends at the step-down date, and then release begins
- OC/EX are usually much more complicated than 6-pack deals
- Like the Senior/Sub structure, the Overcollateralization and Excess Spread (OC/XS) structure includes a subordination mechanism with various classes/tranches of different credit ratings. But the OC/XS structure also includes overcollateralization and excess spread credit buffers. Overcollateralization involves adding more collateral to the mortgage pool than the notional amounts of securities issued, and excess spread is the difference between the interest paid on assets in underlying mortgage pull and interest paid on the issued securities. In the OC/XS structure, default losses are recovered first out of excess spread, followed by the overcollateralization, and finally work their way up the subordination structure from the most junior class/tranche up to the most senior class/tranche. OC/XS deals are typically used for mortgage pools with more significant credit concerns, such as subprime mortgages.
External credit enhancements definition and examples
third-party guarantees that provide protection for losses up to a specified amount
Examples of external credit enhancements:
- Letters of credit
- Pool insurance
- Bond insurance
- Reserve Funds
What are the two main risks for nonagency RMBS?
- Prepayment risk
- credit risk
Measures of Housing Condition (RMBS)
- HPA = Home Price Appreciation
- Dropped to -18% per year in 2009
- EHS = Existing Home Sales
Mortgage Modification (RMBS)
- Principal foregiveness, forbearance
- Recidivism - redefault after loan modification
RMBS Roll rate analysis
- Form a transition matrix for various states, including delinquency buckets (DQ30 days, DQ60 days, etc.)
- Disadvantage - ignores economic drivers and does not have changing dynamics over time
Explain how non-agency RMBS deals are structured to manage these credit and prepayement risks.
- The structure of nonagency RMBS deals separate cash flows from the udnerlying loans into principal and interest and redistributes the cash flows and associated losses to individual tranches according to rules specified in the deal prospectus (i.e. waterfall)
- Prepayment risk: Nonagency RMBS manage prepayment exposure and average life variability through time-tranching the cash flows. Each senior tranche has a different expected maturity and expected time window for principla repayment.
- Credit risks in nonagency RMBS deals were addressed through credit enhancements: external, internal through deal structure, or both.
