Module 19 · Fixed Income

Mortgage-Backed Securities (MBS)

EN: Agency vs non-agency MBS, pass-throughs, CMOs, prepayment behavior.
VN: MBS agency vs non-agency, pass-through, CMO, hành vi trả trước.

1. Types of MBS Concept

Agency Backed by US gov agencies (Ginnie Mae) or GSEs (Fannie Mae, Freddie Mac). Minimal credit risk.
Non-agency Private label — full credit risk; subprime crisis exposure.
Residential MBS (RMBS) Pool of home mortgages.
Commercial MBS (CMBS) Pool of commercial property loans.

2. Pass-Through Securities Concept

Investors receive a pro-rata share of all principal & interest from the underlying pool. Subject to all the prepayment risk of the underlying mortgages.

3. Collateralized Mortgage Obligations (CMO) Concept

Tranche types

Sequential pay Principal paid first to Tranche A, then B, etc.
PAC Planned amortization class — protected from prepayment risk within a band.
Support / Companion Absorbs prepayment variability that PAC tranches avoid.
IO / PO Interest-only (loves rising rates) / principal-only (loves falling rates).

4. Prepayment Speed Conventions Core

\[ SMM = 1 - (1 - CPR)^{1/12} \] \[ \text{PSA 100\%}: CPR \text{ ramps from 0.2\% in month 1 to 6\% by month 30, then constant} \]

Drivers of prepayment

Refi Mortgage rates fall → refinancing wave.
Turnover Home sales (relocation, life events).
Curtailment Borrowers paying extra principal.
Default Pool servicer pays off the loan from insurance/recovery.

Practice problem

Annual CPR = 6%. Compute SMM.

Show solution

SMM = 1 − (0.94)\(^{1/12}\)

≈ 1 − 0.9949

SMM ≈ 0.51% per month

Practice problem Practice

Practice problem

Mortgage rates fall sharply. Predict the impact on (a) IO and (b) PO tranche prices.

Show solution

Rates fall → faster prepayment.

PO: receives all principal — accelerated prepayment is good (cash flows arrive sooner). PO price rises.

IO: receives interest only — accelerated prepayment shrinks principal balance, reducing future interest. IO price falls.

PO price ↑, IO price ↓