Mortgage Backed Securities Market

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Information about Mortgage Backed Securities Market

Published on September 24, 2008

Author: numbersgal

Source: slideshare.net

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

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

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

U.S. Debt Securities Outstanding

Trends in Approved Asset Classes—1998–2005

Risk/Reward — Fixed Income Asset Classes

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

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

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

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

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

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

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

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

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

SMM = Single Monthly Mortality Rate

= Actual Principal Payment – Scheduled Principal Payment

Beginning Principal

CPR = SMM Annualized

PSA = Public Securities Association Standard Prepayment Ramp

Components of Prepayment Speeds (Agencies) CPR Housing Turnover (moving) 6-10% Cash-out Refinancing 2-8% Rate Refinancing 0-80%

CPR

Housing Turnover (moving) 6-10%

Cash-out Refinancing 2-8%

Rate Refinancing 0-80%

Refi Curve

Technology Has Moved Refi Curve

PSA Curves

Mortgage Cashflows for a $100,000 30-yr 5.5% Loan

Mortgage Cashflows for a $100MM GNMA Pool With 0% Prepayments

Pass-Thru Cashflows ($100MM 30-yr GNMA 5.5% @ 6% CPR)

Pass-Thru Cashflows ($100MM 30yr GNMA 5.5% @ 100 PSA)

WAL Profile 2 4 6 8 10 12 11 10 9 8 7 6 5 4 3 Mortgage Yields WAL

Negative Convexity 80 90 100 110 120 130 140 11 10 9 8 7 6 5 4 Mortgage Yields 7.5% Mtg 7.5% 10yr Tsy 7.5% 5yr Tsy 7.5% 2yr Tsy Price

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.

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.

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 0 60 120 180 240 300 360 Months A B D C Principal

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 0 60 120 180 240 300 360 Month 100 PSA 250 PSA A B C D Principal

Range of CMO WAL Profiles

U.S. Mortgage Market

U.S. Mortgage Market—Agency vs. Non-Agency

Loan and Borrower Characteristics

Distribution of Credit Scores & LTV Across Products 2005 Vintage Loans FICO LTV

Loan Size Distribution Across Products 2005 Vintage Loans Loan Size— ARMs Loan Size— Fixed

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” 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

Typical Evolution—OC Target & Actual OC

Credit vs. Prepayment Stability (More) (Less) (Lower) (Higher) Credit Prepayment Stability Subprime Alt-A Jumbo Agency Prepayment stability a key attribute of Subprime

Prepayment Sensitivity of Non-Agency Sectors

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.

Loss Coverage by Rating Level

MBS Issuance By Sector—Agency vs. Non-Agency

Non-Agency MBS Issuance By Sector

RMBS Issuance—By Type ($million)

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

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

GNMA 1s and 2s 30-Yr / All Pass-Thru Production

Subprime Profitability

Evolution of Non-Agency Loan Characteristics

IO% Peaked When Option ARMs Took Off Option ARMs %—1st Lien Fixed and ARMs IO%—1st Lien Fixed and ARMs

Dominance of “Affordability” Mortgages

U.S. Annual Home Price Appreciation

Subprime Cumulative Loss by Vintage & Foreclosure by States Vintage Year 1998-2003 2001

2001 Subprime Mortgages— Loss Severity & Cumulative Loss Rates, by States Loss Severity Cumulative Loss Rates

Subprime 2/28 ARM with 2-year Penalties

Impact of Prepayments & HPA on Subprime Losses

Loss Coverage Ratios If Housing Inflation Slows Source: UBS

Impact of Lower Housing Inflation on Losses

Loss Coverage Ratios If Housing Inflation Slows

This material has been prepared by the division, group, subsidiary or affiliate of UBS AG (“UBS”) identified herein. In certain countries UBS AG is referred to as UBS SA. UBS Warburg is a business group of UBS AG. This material is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. References made to third parties are based on information obtained from sources believed to be reliable but are not guaranteed as being accurate. It should not be regarded by recipients as a substitute for the exercise of their own judgement. Any opinions expressed in this material are subject to change without notice and may differ or be contrary to other opinions expressed by UBS. UBS is not under any obligation to update or keep current the information contained herein. UBS and its respective officers and associates or clients may have an interest in the securities or derivatives of any entities referred to in this material. In addition, UBS may make purchases and/or sales as principal or agent or may act as market maker or provide investment banking or other services. UBS accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. All information is correct at the time of publication; additional information may be made available upon request. United Kingdom and rest of Europe : Except as otherwise specified herein, this material is communicated by UBS Warburg Ltd., a subsidiary of UBS AG, to persons who are market counterparties or intermediate customers (as detailed in the FSA Rules) and is only available to such persons. The information contained herein does not apply to, and should not be relied upon by, private customers. Switzerland : This material is distributed in Switzerland by UBS AG. United States : This material is distributed to US persons by UBS Warburg LLC a subsidiary of UBS AG, or by another division, group, subsidiary or affiliate of UBS to major US institutional investors only. UBS Warburg LLC accepts responsibility for the content of materials prepared by another division, group, subsidiary or affiliate of UBS AG when distributed by UBS Warburg LLC to US persons. All transactions by a US person in the securities mentioned in this material must be effected through UBS Warburg LLC. Canada : This material is distributed by UBS Bunting Warburg Inc., a subsidiary of UBS AG and a member of the principal Canadian stock exchanges & CIPF. A statement of its financial condition and a list of its directors and senior officers will be provided upon request. Japan : This material is distributed in Japan by UBS Warburg (Japan) Limited, a registered securities company, or by UBS AG, Tokyo Branch, a licensed bank. For further details of our local services, please call your regular contact at UBS in Japan. Hong Kong : This material is distributed in Hong Kong by UBS Warburg (Asia) Limited. Australia : This material is distributed in Australia by UBS Warburg Australia Ltd (ABN 40 008 582 705) or UBS Warburg Australia Equities Ltd (ABN 62 008 586 481) licensed securities dealers. New Zealand : This material is distributed in New Zealand by UBS Warburg New Zealand Ltd, or UBS Warburg New Zealand Equities Ltd.  2006 UBS AG. All rights reserved. UBS specifically prohibits the redistribution of this material and accepts no liability whatsoever for the actions of third parties in this respect. 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This material has been prepared by the division, group, subsidiary or affiliate of UBS AG (“UBS”) identified herein. In certain countries UBS AG is referred to as UBS SA. UBS Warburg is a business group of UBS AG.

This material is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. References made to third parties are based on information obtained from sources believed to be reliable but are not guaranteed as being accurate. It should not be regarded by recipients as a substitute for the exercise of their own judgement. Any opinions expressed in this material are subject to change without notice and may differ or be contrary to other opinions expressed by UBS. UBS is not under any obligation to update or keep current the information contained herein. UBS and its respective officers and associates or clients may have an interest in the securities or derivatives of any entities referred to in this material. In addition, UBS may make purchases and/or sales as principal or agent or may act as market maker or provide investment banking or other services. UBS accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this material. All information is correct at the time of publication; additional information may be made available upon request.

United Kingdom and rest of Europe : Except as otherwise specified herein, this material is communicated by UBS Warburg Ltd., a subsidiary of UBS AG, to persons who are market counterparties or intermediate customers (as detailed in the FSA Rules) and is only available to such persons. The information contained herein does not apply to, and should not be relied upon by, private customers. Switzerland : This material is distributed in Switzerland by UBS AG. United States : This material is distributed to US persons by UBS Warburg LLC a subsidiary of UBS AG, or by another division, group, subsidiary or affiliate of UBS to major US institutional investors only. UBS Warburg LLC accepts responsibility for the content of materials prepared by another division, group, subsidiary or affiliate of UBS AG when distributed by UBS Warburg LLC to US persons. All transactions by a US person in the securities mentioned in this material must be effected through UBS Warburg LLC. Canada : This material is distributed by UBS Bunting Warburg Inc., a subsidiary of UBS AG and a member of the principal Canadian stock exchanges & CIPF. A statement of its financial condition and a list of its directors and senior officers will be provided upon request. Japan : This material is distributed in Japan by UBS Warburg (Japan) Limited, a registered securities company, or by UBS AG, Tokyo Branch, a licensed bank. For further details of our local services, please call your regular contact at UBS in Japan. Hong Kong : This material is distributed in Hong Kong by UBS Warburg (Asia) Limited. Australia : This material is distributed in Australia by UBS Warburg Australia Ltd (ABN 40 008 582 705) or UBS Warburg Australia Equities Ltd (ABN 62 008 586 481) licensed securities dealers. New Zealand : This material is distributed in New Zealand by UBS Warburg New Zealand Ltd, or UBS Warburg New Zealand Equities Ltd.

 2006 UBS AG. All rights reserved. UBS specifically prohibits the redistribution of this material and accepts no liability whatsoever for the actions of third parties in this respect.

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