The Handbook of Mortgage-Backed Securities

by Fabozzi, Frank

• ISBN13: 9780071460743
• ISBN10: 0071460748
• Edition: 6th
• Format: Hardcover
• Copyright: 2006-01-11
• Publisher: McGraw-Hill Education

Summary

Mortgag acked securities continue to be one of the most exciting, fastest-growing sector of the fixed income market. According to the Mortgage Bankers Association, of the estimated $3 trillion in mortgage loans made in 2005, fully 80 percent ended up in mortgage-backed securities, representing a phenomenal 61 percent growth since 2001.

Author Biography

Frank J. Fabozzi, Ph.D., CFA is editor of the Journal of Portfolio Management and the Frederick Frank Adjunct Professor of Finance at Yale University's School of Management.

Table of Contents

Preface	xxi
Contributors	xxv
SECTION ONE MORTGAGE-BACKED SECURITIES (MBS) PRODUCTS AND THE MORTGAGE MARKET
An Overview of Mortgages and the Mortgage Market	3	(32)
Anand K. Bhattacharya
Frank J. Fabozzi
William S. Berliner
Product Definition and Terms	4	(5)
Mortgage-Loan Mechanics	9	(6)
The Mortgage Industry	15	(2)
The Loan Underwriting Process	17	(3)
Generation of Mortgage Lending Rates	20	(7)
Risks Associated with Mortgages and MBS	27	(5)
The Evolving Roles of the GSEs	32	(3)
MBS Investors	35	(10)
Steven Abrahams
The Sources of Competitive Advantage in Investing in MBS	35	(4)
Fannie Mae and Freddie Mac	39	(2)
Insurers	41	(1)
Total-Return Portfolios	42	(2)
Change in the Competitive Landscape	44	(1)
The Portfolio Meets the Market	44	(1)
Mortgage Pass-Through Securities	45	(36)
Linda Lowell
Michael Corsi
Federally Sponsored Mortgage Pass-Through Programs	46	(6)
Pass-Through Cash Flows	52	(6)
Impact of Cash-Flow Variability on Yield and Average Life	58	(4)
Determinants of Prepayment Speeds	62	(6)
Gauging a Pool's Prepayment Risk	68	(6)
Anatomy of the Pass-Through Market	74	(7)
Trading, Settlement, and Clearing Procedures for Agency MBS	81	(12)
Jeffrey D. Biby
Srinivas Modukuri
Brian Hargrave
TBA Trading: Turning Pool-Specific Securities into Generic Securities	81	(1)
Settlement Procedures for Agency Pass-Throughs	82	(1)
BMA Good Delivery Guidelines	83	(2)
Variance	85	(1)
Trading and Settlement Procedures for Other MBS Products	86	(1)
Clearing Procedures for MBS	86	(1)
Summary	87	(1)
Appendix: What Happens When an Investor Buys a Mortgage-Backed Security?	88	(2)
What if the Dealer Fails to Deliver	90	(3)
Defining Nonagency MBS	93	(20)
Thomas Zimmerman
The Nonagency Market	93	(1)
Defining Characteristics	94	(4)
Credit	98	(3)
Distribution of Characteristics	101	(3)
Evolution of Loan and Borrower Characteristics	104	(2)
Credit and Prepayment Performance	106	(5)
Agency Expansion into Nonagency Zones	111	(1)
Summary	111	(2)
Credit Enhancements for Nonagency MBS Products	113	(14)
Frank J. Fabozzi
External Credit Enhancements	113	(3)
Internal Credit Enhancements	116	(6)
Use of Interest-Rate Derivative Instruments	122	(5)
Understanding the Prospectus and Prospectus Supplement	127	(30)
David M. Lukach
Yogesh Gupta
Thomas Knox
John Gibson
Securities Act Registration Statements: The Disclosure Framework	128	(1)
Disclosures for Form S-3 Registered MBS Offerings	129	(3)
Typical Sections of a Prospectus and Prospectus Supplement	132	(24)
Conclusion	156	(1)
Waterfall Cash-Flow Mechanics in European RMBS	157	(14)
Alexander Batchvarov
William Davies
Altynay Davletova
General Forms of Waterfalls	157	(2)
Variations in European RMBS Waterfalls by Country	159	(6)
Combined or Split RMBS Waterfalls: Compare and Contrast	165	(3)
Summary	168	(3)
SECTION TWO ALTERNATIVE MORTGAGE PRODUCTS
Exploring the MBS/ABS Continuum: The Growth and Tiering of the Alt-A Hybrid Sector	171	(16)
Satish Mansukhani
Exploring the MBS/ABS Continuum: Defining the Risk Space	172	(1)
The MBS/ABS Continuum in the Hybrid Sector	173	(2)
Prepayment and Credit Performance Follow Relative Placement along the Continuum	175	(4)
Deal Structures also Mirror Relative Placement along the Continuum	179	(1)
Sufficient Credit Enhancement to Withstand Multiples of Default Frequency Experienced on Weaker Subprime Mortgages	180	(3)
The Value of Available Funds CAPS	183	(4)
Alt-A Mortgages and MBS	187	(20)
Anand K. Bhattacharya
William S. Berliner
Jonathan Lieber
Background	187	(3)
Loan-Level Characteristics	190	(2)
Factors Underlying Prepayment Behavior	192	(8)
Empirical Prepayment Performance	200	(4)
Recent Developments	204	(3)
Fixed-Rate Alt-A MBS	207	(52)
Satish Mansukhani
Arjune Budhram
Mu'taz Qubbaj
Fixed-Rate Alt-A Collateral	208	(14)
Alt-A Prepayments	222	(6)
Historical Drivers of Prepayments and Defaults	228	(6)
Credit Performance and Enhancement	234	(18)
Practical Portfolio Manager Opportunities and Considerations	252	(7)
Hybrid Adjustable-Rate Mortgages (ARMs)	259	(28)
Anand K. Bhattacharya
Steve Banerjee
Ricardo Horowicz
Wei Wang
Popularity and Issuance of Hybrid ARMs	260	(1)
Characteristics of Hybrid ARM Loans	261	(5)
Hybrid ARM Refinance Incentive	266	(6)
Comparing Hybrid ARM S-Curves	272	(3)
Comparing Hybrid ARM Seasoning Curves	275	(2)
Loan-Level Drivers of Hybrid ARMs	277	(5)
Interest-Only (IO) Hybrid ARMs	282	(2)
Jumbo Hybrid ARM Credit Performance	284	(1)
Conclusions	285	(2)
Hybrids: Product, Performance, Investor Base, and Frameworks to Assess Relative Value	287	(46)
Satish Mansukhani
Adama Kah
Mu'taz Qubbaj
Hybrid Origination and Issuance	288	(2)
Securitization of Hybrids	290	(1)
The Hybrid Borrower	291	(4)
Prepayment Profiles of Hybrids	295	(16)
Trading Conventions in the Hybrid Market	311	(3)
Investors in the Hybrid Secondary Markets	314	(2)
A Conceptual Framework for Relative-Value Assessments of Hybrids	316	(3)
Cap Valuations on Hybrids	319	(1)
Index Levels: Implied Forwards and Historical Peaks	319	(1)
Relative Value of Hybrids	320	(7)
Identifying Characteristics/Features of Hybrids	327	(6)
Interest-Only ARMs	333	(30)
David Liu
Overview of IO ARMs	335	(12)
Credit Implications	347	(6)
Prepayment Experience	353	(8)
Conclusion	361	(2)
Residential Asset-Backed Securities	363	(26)
John McElravey
Market Development	364	(2)
Characteristics of Subprime Borrowers	366	(3)
Prepayment Speeds	369	(3)
Relative-Value Consequences	372	(2)
Key Aspects of Credit Analysis	374	(4)
Structural Considerations	378	(9)
Conclusion	387	(2)
Customized Mortgage-Backed Securities	389	(24)
Anand K. Bhattacharya
Paul Jacob
Historical Perspective	389	(2)
Major Categories of Customized MBS	391	(6)
Determinants of Market Payups	397	(3)
Evaluation of Customized Pools: Current-Yield Approach	400	(1)
Evaluation of Customized Pools: Option-Adjusted Spread Analysis	401	(6)
Measuring the Duration of a Customized Pool	407	(3)
Challenges and Issues in Customized MBS Valuation	410	(3)
The Prepayment and Credit Characteristics of Reperforming FHA/VA Loans	413	(28)
Anand K. Bhattacharya
William S. Berliner
Jonathan Lieber
The Process of Delinquency Curing	414	(2)
Prepayments	416	(10)
Credit Fundamentals: Overview	426	(15)
Prepayment-Penalty Mortgage-Backed Securities	441	(24)
Anand K. Bhattacharya
William S. Berliner
Jonathan Lieber
Legal Framework for Imposition of Prepayment Penalties	442	(1)
Prepayment-Penalty Loan Structures	443	(5)
The Dynamics of the Prepayment Penalty	448	(1)
Borrower and Lender Dynamics	449	(3)
Prepayment Behavior of Prepayment-Penalty Loans	452	(6)
The Impact of Prepayment Penalties on Security Performance and Duration	458	(4)
Conclusions	462	(3)
SECTION THREE MORTGAGE DERIVATIVES: CMOS AND STRIPPED MBS
Stripped Mortgage-Backed Securities	465	(16)
Cyrus Mohebbi
Gary Li
Todd White
Overview of the SMBS Market	466	(4)
Investment Characteristics	470	(10)
Summary	480	(1)
PAC Bond Features and Performance	481	(14)
Linda Lowell
Michael Corsi
Collars	482	(2)
Effective Collars	484	(1)
PAC Collar Drift	485	(1)
How Likely Is Breaking the PAC Bands?	486	(2)
Pay Order and Average Life Stability	488	(2)
Average-Life Profile versus Option-Pricing Models	490	(1)
Wide Window versus Tight Window	491	(2)
Conclusion	493	(2)
Z Bonds	495	(12)
Linda Lowell
The Basic Accrual Structure	495	(4)
How the Z Interacts with Other Bonds in the Structure	499	(4)
Accretion-Directed or VADM Bonds	503	(1)
Z Bonds in PAC Companion Structures	503	(1)
Performance of Z Bonds	504	(2)
Conclusion	506	(1)
Companions with Schedules	507	(16)
Linda Lowell
Companion Basics	508	(4)
Companion TAC Bonds	512	(2)
Reverse TACs	514	(4)
Layered PAC Bonds	518	(4)
Scheduled Companions	522	(1)
Conclusion	522	(1)
Inverse Floating-Rate CMOs	523	(12)
Cyrus Mohebbi
Raymond Yu
Structural Features	523	(3)
Investment Characteristics	526	(4)
Conclusion	530	(5)
SECTION FOUR PREPAYMENT MODELS AND BEHAVIOR
Overview of Recent Prepayment Behavior and Advances in Its Modeling and Valuation	535	(20)
Michael Bykhovsky
Generic Model	536	(12)
Modeling Reliability and Accuracy	548	(1)
Overview of Valuation of the Prepayment Option	549	(2)
Prepayment Score	551	(2)
Conclusion	553	(2)
Agency Prepayment Model: Modeling the Dynamics of Borrower Attributes	555	(48)
Dale Westhoff
V. S. Srinivasan
Housing Turnover	557	(6)
Cash-Out Refinancing	563	(6)
Rate Refinancing	569	(21)
The GNMA Sector: Special Modeling Considerations	590	(6)
Putting It All Together: The Case of the 1992 FNMA 7.5%	596	(2)
The Value of Attribute-Sensitive Prepayment Models	598	(2)
Appendix: Mortgage-Rate Prediction	600	(3)
Loan-Level Prepayment Models	603	(20)
Anand K. Bhattacharya
Steve Banerjee
Minimizing Loan Dispersion	604	(1)
The Full Picture	605	(9)
Loan-Level Modeling	614	(3)
Predictive Strength of Loan-Level Models	617	(2)
Appendix: Use of Survival Analysis in Loan-Level Modeling	619	(4)
Analyzing Specified MBS Pools Using Agency Enhanced Data and Active-Passive Decomposition	623	(22)
Dan Szakallas
Alexander Levin
Andrew Davidson
Prepayment Modeling Using Active-Passive Decomposition	624	(6)
Enhanced Agency Data and Prepayment Modeling	630	(7)
Valuation Consequence: A Payup	637	(8)
Prepayment Models to Value Nonagency MBS	645	(48)
Dale Westhoff
V. S. Srinivasan
Innovative Features: A True Loan-Level Implementation	646	(1)
The Bear, Stearns Nonagency Prepayment Database	647	(1)
The Impact of the Agencies on Nonagency Prepayment Behavior	648	(1)
Defining the Subsectors within the Nonagency Market	649	(3)
Deconstructing Our Nonagency Prepayment Forecast	652	(1)
Defining the Baseline Nonagency Refinancing Profile	653	(1)
Understanding Borrower Self-Selection and Burnout	654	(2)
Modeling Borrower Refinancing Intensity	656	(3)
The Impact of Loan Size on Nonagency Refinancing Behavior	659	(7)
Credit Quality	666	(3)
Rate Premium	669	(2)
Secondary Refinancing Effects: Documentation, Loan Purpose, Occupancy Status	671	(3)
The Yield Curve and Refinancing Transitions	674	(2)
The Value of Updated LTV Ratio Information	676	(1)
Housing Turnover Prepayments: Seasoning and Lock-In	677	(3)
Seasonality	680	(2)
Adverse Selection in Housing Turnover Prepayments	682	(1)
Involuntary Prepayments and Curtailments	682	(1)
Refinancing Efficiency: The Next Frontier	683	(2)
Modeling the Mortgage Rate Process	685	(2)
Model Testing	687	(1)
Conclusion	688	(1)
Appendix: Model Projected versus Actual Results for Representative Deals	689	(4)
A Prepayment Model for Hybrid Mortgages	693	(26)
Dale Westhoff
V. S. Srinivasan
Market Background	693	(10)
Modeling Hybrid Prepayments	703	(13)
Summary and Valuation Implications	716	(3)
Modeling Nonprime Mortgage Prepayment, Delinquency, and Default	719	(40)
Glenn Schultz
Christopher Flanagan
Christopher Muth
Modeling Framework	719	(4)
Model-Building Strategy	723	(8)
Adjustable-Rate Analysis	731	(4)
Fixed-Rate Analysis	735	(4)
Other Factors Influencing Prepayments	739	(5)
Collateral Credit Performance	744	(3)
Involuntary Prepayments	747	(5)
Loss Severity and Cumulative Losses	752	(1)
Summary	753	(6)
SECTION FIVE PORTFOLIO MANAGEMENT TOOLS AND TECHNIQUES
Valuation of Mortgage-Backed Securities	759	(24)
Frank J. Fabozzi
Scott F. Richard
David S. Horowitz
Static Valuation	760	(1)
Dynamic Valuation Modeling	761	(8)
Illustrations	769	(12)
Summary	781	(2)
Risk-Neutral Prepayment Modeling and Valuation with prOAS	783	(16)
Alexander Levin
Andrew Davidson
Prepayment Risk and OAS	784	(2)
Equivalent Risk-Neutral Prepay Model	786	(2)
Stochastic Property of Prepay Risk Factors	788	(1)
A prOAS Pricing Model with Refinancing and Turnover Risk	789	(2)
Determining Prices of Risk: Calibration to TBAs	791	(3)
Valuation of MBS Strips with prOAS	794	(2)
Modernized Greeks	796	(2)
Concluding Remarks	798	(1)
An Option-Theoretic Approach to MBS Valuation	799	(24)
Andrew Kalotay
Deane Yang
Frank J. Fabozzi
Traditional Approaches to MBS Valuation	800	(1)
An Option-Based Prepayment Model for Mortgages	801	(4)
Valuation of Mortgages	805	(8)
A Closer Look at Leapers and Laggards	813	(4)
Valuation of MBS	817	(6)
Approaches for Measuring the Duration of Mortgage-Related Securities	823	(34)
Bennett W. Golub
What Do We Mean by the Term Duration?	825	(7)
Current Approaches to Measuring Mortgage Durations	832	(19)
Comparison of Alternative Duration Measures	851	(1)
Future Approaches to Mortgage Durations	852	(3)
Implications for Investors	855	(2)
Duration and Average-Life Drift of CMOs	857	(12)
David P. Jacob
Tim Lu
Review of Duration and Convexity for Treasuries	858	(1)
Evolution of Average Life for CMOs	859	(2)
Implications for Performance and Risk Management	861	(6)
Conclusion	867	(2)
Managing Against the Lehman Brothers MBS Index: MBS Index Prices	869	(32)
Bruce D. Phelps
Overview	869	(14)
The Lehman MBS Index and Index Pricing	883	(2)
Calculating the Index Price	885	(13)
Conclusion	898	(3)
Managing Against the Lehman Brothers MBS Index: MBS Index Returns	901	(30)
Bruce D. Phelps
Overview	901	(17)
Example: Comparing Return Calculations Using Index and PSA Prices	918	(10)
Conclusion	928	(3)
Dollar Rolls	931	(12)
Frank J. Fabozzi
Steven V. Mann
Determination of the Financing Cost	932	(1)
Illustrations of Dollar Roll Agreements	933	(4)
Risks in a Dollar Roll From the Investor's Perspective	937	(1)
MBS Dollar-Roll Automation	938	(5)
Uncovering the Risk-Adjusted Carry in MBS	943	(8)
Steven Abrahams
Adam Rilander
Uncovering the Risk-Adjusted Carry in TBA	944	(1)
Start with Carry, and Hedge Duration	944	(1)
Move on to Hedging Convexity	945	(1)
Finish with Hedging Long-Term Volatility	946	(2)
The Art of Interpreting the Risk-Adjusted Carry	948	(1)
Summary	948	(3)
Mortgage Credit Quantified	951	(28)
Thomas Zimmerman
Laurent Gauthier
Delinquencies and Defaults	952	(18)
Loss Severity and Losses	970	(7)
Summary	977	(2)
Specified Pool Trades: Ranking the Alternatives	979	(18)
Laurie S. Goodman
Specified Pool Payups	979	(1)
Prepayment Protection: The Data	980	(3)
Credit Curing	983	(6)
Prepayment Protection: The Ranking	989	(1)
Extension Protection: The Data	990	(3)
Ranking Extension Protection	993	(1)
Nonagency Investor Pools	994	(2)
Conclusion	996	(1)
Analysis of Cleanup Calls	997	(12)
Laurent Gauthier
Factors Driving the ``Optimal'' Call Decision	998	(1)
A Tricky Exercise	998	(1)
Nonagency Call Exercises	999	(1)
Call Decisions by Issuer	1000	(1)
Call Decision Timing	1001	(8)
SECTION SIX HEDGING TOOLS AND APPROACHES
A Three-Factor Approach for Hedging Mortgage-Backed Securities	1009	(14)
Kenneth B. Dunn
Frank J. Fabozzi
Michael M. Luo
Roberto M. Sella
Yield-Curve Risk and Key Rate Duration	1009	(3)
How Interest Rates Change Over Time	1012	(1)
How to Implement Three-Factor Hedging	1013	(9)
Summary	1022	(1)
Mortgage Options	1023	(18)
Joseph R. Prendergast
Mortgage Option Markets	1023	(1)
Mortgage Option Users	1024	(5)
Pricing Mortgage Options	1029	(3)
Mortgage Option Risk Characteristics	1032	(5)
Conclusion	1037	(1)
Appendix: Decomposing Mortgage Option Duration and Convexity	1037	(4)
Mortgage Prepayment Derivatives	1041	(12)
Andrew Aymen Samawi
Prepayment Derivatives History and Products	1042	(3)
Prepayment Derivatives Hedging Applications	1045	(6)
Auction Announcements	1051	(1)
Conclusion	1052	(1)
Hedging IOs and Mortgage Servicing	1053	(16)
William L. Smith, Jr.
Laurie S. Goodman
Growth---Mortgage Servicing Industry	1054	(1)
Difficulties in Hedging IOs and MSRs	1054	(2)
Hedge Instruments	1056	(1)
Hedge Correlations	1057	(3)
Measuring Hedge Effectiveness	1060	(1)
Empirical Hedge Results	1060	(2)
Hedging with TBAs	1062	(2)
Use of Options	1064	(1)
A Few Additional Comments	1065	(2)
Thoughts On Servicing Models	1067	(1)
Caveats	1067	(1)
Conclusion	1068	(1)
Mark-to-Market Methodology, Mortgage Servicing Rights, and Hedging Effectiveness	1069	(36)
Bennett W. Golub
Sree Sudha Yerneni
Approach to Back Testing	1074	(13)
Extending the Analysis to Servicing	1087	(2)
Alternative Hedge Methodology (``Swap + Mortgage'' Hedge)	1089	(6)
Conclusion	1095	(2)
Appendix A: Monthly Durations and Prepayment Speeds	1097	(5)
Appendix B: OAS, Spreads, and Yields Used in Computing Daily Prices	1102	(1)
Appendix C: OASs and Key Rate Durations as of 7/31/03	1103	(2)
Prepayment-Linked Notes	1105	(14)
Laurie S. Goodman
Themes and Variations	1105	(2)
Why Will Prepayment-Linked Notes Gain Popularity?	1107	(1)
Relative Value	1108	(8)
Conclusion	1116	(3)
SECTION SEVEN COMMERCIAL MORTGAGE-BACKED SECURITIES
Commercial Mortgage-Backed Securities	1119	(14)
Anthony B. Sanders
The CMBS Deal	1119	(6)
The Underlying Loan Portfolio	1125	(4)
The Role of the Servicer	1129	(2)
Loan Origination, the Lemons Market, and the Pricing of CMBS	1131	(1)
Summary	1132	(1)
The Impact of Structuring on CMBS Bond Class Performance	1133	(24)
David P. Jacob
James M. Manzi
Frank J. Fabozzi
Loan Cash Flow: The Raw Material for CMBS	1136	(5)
CMBS Structures	1141	(4)
The Impact of Maturity Dispersion	1145	(1)
The Impact of Coupon Dispersion	1146	(1)
The Impact of Prepayments	1147	(2)
The Impact of Defaults	1149	(1)
Sample Default Scenarios	1150	(1)
Effects of Servicer Modifications on CMBS	1151	(4)
Summary	1155	(2)
Investment Characteristics of GNMA Project Loan Securities	1157	(30)
Arthur Q. Frank
Tim Lu
A Brief History of GNMA Multifamily Pools	1157	(1)
Major FHA Project Loan Insurance Programs	1158	(5)
Prepayment Behavior of GNMA Multifamily Pools	1163	(12)
Default Behavior of GNMA Multifamily Pools	1175	(1)
Cumulative Defaults by Production Year and the GNMA Project Loan Default Curve	1176	(5)
Recent Breakdown of GNMA Multifamily Prepayments into Defaults, Refinancings with Penalties, and Refinancings without Penalties	1181	(1)
The Refinancing History of Health Care Loans Compared with Apartment Complexes	1181	(4)
On the Investment Characteristics of GNMA Multifamily Pools and REMICs	1185	(2)
CMBS Collateral Performance: Measures and Valuations	1187	(12)
Philip O. Obazee
Duane C. Hewlett
Mortgage Loan Default Rates and Loss Severities	1187	(3)
Factors Influencing Default Rates and Loss Severity	1190	(3)
Age	1193	(1)
Default Rate, Loss Severity, and Valuation Issues	1193	(5)
Conclusion	1198	(1)
Value and Sensitivity Analysis of CMBS IOs	1199	(10)
Philip O. Obazee
Duane C. Hewlett
Value Drivers of CMBS IOs	1200	(5)
CMBS IO Relative Value	1205	(3)
Conclusion	1208	(1)
Cash-Flow CDOs for CMBS Investors	1209	(8)
Peter Leffler
John Malysa
Jennifer Story
Susan S. Merrick
Capital Structure	1210	(3)
Reinvestment (or Revolving) Period	1213	(1)
Cash-Flow Diversion Tests	1214	(1)
Preferred-Share Caps and Reverse Turbos	1215	(1)
Interest-Rate Hedging	1215	(1)
Conclusion	1216	(1)
Index	1217