HOFIS Ch25

Question 1

Define nonagency RMBS

Answer 1

Nonagency RMBS - Residential Mortgage-Backed Securities that are not guaranteed
government-sponsered entities (e.g. Fannie Mae/Freddie Mac) or government
agencies (e.g. Ginnie Mae)

Question 2

What are the two main risks for nonagency RMBS?

Answer 2

Prepayment and credit risk

Question 3

What are the key measurements of collateral performance?

Answer 3

Delinquency

Default

Voluntary prepayment

Loss severity

Question 4

State the key collateral characteristics to consider when valuing non-agency RMBS

Answer 4

Key collateral characteristics to consider when valuing non-agency RMBS:

Fixed vs Hybrid

Loan-to-Value (LTV) Ratio

Credit Scores

Debt-to-Income Ratio

Other factors including loan size, loan purpose, occupancy, amortization (e.g. low
minimum payments), property type and prepayment penalty

Question 5

How is the debt to income (DTI) ratio calculated?

Answer 5

DTI
Monthly housing payment /
Monthly gross income

Question 6

How is the loan to value (LTV) ratio calculated?

Answer 6

LTV
Current loan amount /
Current house value

Question 7

Describe credit burnout and state the two mechanisms for credit burnout

Answer 7

Credit burnout - after delinquency peak in 2009, performance started to show
signs of improvement

Two mechanisms for credit burnout:
1. Loans with the worst credit quality will become delinquent and exit the pool, leaving
loans with better credit quality remaining in the pool
2. If a high LTV loan is underwater for a long period but the borrower continues to pay,
the chance of the borrower becoming delinquent tends to decrease

Question 8

Describe internal credit enhancements for non-agency RMBS

Answer 8

Internal credit enhancement structures include:
1. Senior/subordination (senior sub) - losses are absorbed from the bottom up,
starting from the junk/subs/unrated up to mezzanine and then senior debt
2. Overcollaterialization/excess spread (OC/XS) - excess spread (XS) is a first
line of defense, overcollateralization (OC) is a second line of defense, and then
the traditional subordinate tranches provide the final protection before losses
reach senior tranches
Ÿ Overcollateralization involves adding more collateral to the mortgage pool than the
notional amount of issued securities
Ÿ Excess spread is the difference between interest paid on assets in the underlying
mortgage pool and interest paid on issued securities

Question 9

Describe external credit enhancements for non-agency RMBS

Answer 9

External credit enhancements - third-party guarantees that provide protection
for losses up to a specified amount

Examples of external credit enhancements:
Ÿ Pool insurance
Ÿ Letters of credit
Ÿ Bond insurance
Ÿ Reserve Funds

Question 10

What is the difference between sequential and pro-rata payments?

Answer 10

Sequential - AAA paid in full, then AA paid in full, etc.

Pro-rata - payments are made proportional to each tranche’s unpaid principal
balance

Question 11

What are the main differences between typical CMBS and nonagency RMBS?

Answer 11

Main Differences between Typical CMBS and Nonagency RMBS
Attributes CMBS Nonagency RMBS
Collateral Few, large loans Many small loans
Term Shorter-term (5-10 years) Longer-Term (15-30 years)
Rate Fixed Floating
Prepayment Less frequent More frequent
Transaction Structure Sequential Varied
Modeling Deterministic Scenario Probabilitic Modeling based on Historical Datasets