Real Estate Capital Markets
Problem 1: Non-agency securities
Consider a non-agency MBS deal with the following characteristics:
Details of underlying mortgages in REMIC trust:
- Total face value: $900m
- Average mortgage interest rate = 6.4%
- Servicing and trustee fees = 40bp
- Average pass-through rate net of servicing fees = 6.0%
Securities issued against this collateral:
There are five different rated securities issued against this mortgage collateral, which are listed below in order of seniority (i.e. most senior first, most junior last).
1. Face value: $500m; Coupon rate: 4%
2. Face value: $300m; Coupon rate: 4%
3. Face value: $40m; Coupon rate: 5.2%
4. Face value: $20m; Coupon rate: 6%
5. Face value $10m; Coupon rate: 6% Now answer the following questions.
1. How large is the total face value of all the MBS tranches in this deal (summed together), relative to the face value of the mortgages in the deal? Are these two equal? Explain why or why not (i.e. explain why the deal is designed this way).
2. Briefly explain the basic purpose of "excess spread". Given the information above, how much excess spread would be generated in the first month, assuming there are no defaults?
Suppose that you find out that two of the securities rated above have a rating of AAA, one has a rating of BB, one has a rating of BBB-, and one has a rating of A.
3. What is the percentage level of subordination below AAA at the start of the month (this is also known as the "attachment point" of the A-class)? What is the level of subordination below BBB? Is subordination below BBB higher or lower than subordination below AAA? Why?
4. Assume that, unexpectedly, $60m of mortgages in this deal are immediately prepaid. What is the new level of subordination below the AAA securities (i.e. below the "A class")? Does this prepayment make the securities more risky or less risky? Why? Be as precise as you can in your answer.
Problem 2: Agency CMOs
Consider an agency CMO with the following characteristics:
Mortgage pool
The mortgage collateral consists of $175 million of 30 year FRMs with a weighted average coupon of 5.05%. Assume that prepayment on the pool is consistent with a 125 PSA assumption. The servicing and guarantee fee on this pool is 55 basis points. Mortgage payments are monthly, as usual.
CMO structure
The pool consists of two classes, an A class of $100m, and a B class of $75m. Both classes pay a 4.5% net coupon rate. The B class is further split into an IO tranche and a PO tranche. (Thus, there are three securities, an A class security, a B class IO security, and a B class PO security).
Given this information, answer the following questions:
1. Build a spreadsheet that builds out the total cashflows generated by this pool over its life. Your spreadsheet should show the cashflows that accrue to investors, and the cashflows paid as servicing and guarantee fees.
2. Based on the structure shown above, calculate how the cashflows of the pool are split between the different types of securities (similar to the sequential pay example posted on Blackboard).
[Hint: To make sure you haven't made any calculation errors, make sure that the principal payments to each of the securities adds up to the total principal (i.e. scheduled principal + prepayment) generated by the underlying mortgage collateral. The same should be true of the interest payments.
i.e. everything should add up].
3. Assume that the relevant discount rate for valuing these cashflows is 3.75%. What is the NPV of each tranche?
[Hint: As above, if you wanted to check, the NPV of each tranche, plus the NPV of the servicing and guarantee fees, should add up to the NPV of the cash flows from the underlying mortgages].
4. Change the prepayment assumption to 200 PSA. What happens to the NPV of each tranche? Explain why the NPV of each tranche changes as it does.