Friday, January 16, 2009

Follow-up on MBS

I got several reader e-mails (accruedint *AT* asking questions about my MBS analysis. Here is a quick and dirty...

That's the basic Bloomberg screen for MBS yield analysis. The "FNCL 6" at the top indicates this is a generic Fannie Mae 30-year 6% mortgage. In the top right you can see the actual pre-payment experience. Where it says "Life 444 18.1" that means that generic Fannie Mae 6's have paid at a rate of 444 PSA or 18.1 CPR. Again, I don't want to go into the minutia how the prepayment models work, but 100 PSA is sort of a base prepayment level assuming no real refinancing incentive. 444 PSA is therefore 444% of the base speed. CPR is closer to a straight prepayment percentage. So this thing has actually paid at a rate of 18 CPR.

On the far left, near the middle you see 103-23. This indicates a dollar price of 103 and 23/32. Or 103.71875% of principal amount. Above this in the yellow boxes is the prepayment speeds which I've entered in. By default it comes up with Bloomberg's model estimates.

In the blue box below the 51 CPR speed is the yield (3.067%) assuming that speed. Then to the right of that is the yield at alternate speeds.

Near the bottom of the page is the average life at each given speed. You can see the average life at 51 CPR is 1.46 years. Note that this is how long it takes for half of principal to be returned. Not all of principal, which is a common misunderstanding.

Investors in MBS should always remember that when you type 15 CPR in for a mortgage, that's assuming a level prepayment rate. But in reality, given that interest rates will rise and fall over time, the actual prepayment experience will be lumpy. Under normal circumstances (which isn't now, for sure), I usually assume that my MBS positions will go through a prepayment spike at some point even if they are currently out of the money.

Post your questions to the comments or e-mail me.


Unsympathetic said...

Could you please explain how (or if) the recent changes in refi law will change the way you analyze FNM/FRE MBS?

In long form, this is discussed over at Mr. Mortgage.

In short, if an underwater homeowner refi's through either, they cannot change terms ever again. The specific language is "Fannie Mae and Freddie Mac will not purchase or accept delivery of a restructured loan refinance. Therefore, all restructured loans are ineligible for conforming loan financing."

Given this change to the rules, I would think your prepayment assumptions are far too optimistic..

paul huang said...

Thanks for the additional comments on the Bloomberg screens.

Can you elaborate on average life being the time it takes for half of the principal to be returned?

I always thought, as you noted, that average life means how long it takes for the full principal to paid down using a particluar CPR.

Accrued Interest said...


Average life is supposed to be the average time it takes to get all your pricipal back. So if you got exactly 25% of your principal back every year for 4 years, the average dollar would be returned in 2.5 years.

25% = 1
25% = 2
25% = 3
25% = 4

Weighted average is 2.5.