Selling Mortgage Pass-through certificate

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Mar 25, 2007 2:07 pm

Any thoughts or advice on selling these?

Mar 25, 2007 7:57 pm

Yeah, good luck trying to sell these.


If a client has even only casually watched the news, they know that the mortgage business is in the beginning throes of a shakedown. And investing in mortgage debt, at this stage of the game, may entail much more risk than the security returns.


More importantly, you recommending something that the client thinks might be crap (quality-wise), isn't going to enhance your reputation.


Personally, I've never sold them and will never sell them. I've heard nothing but horror stories from clients and brokers alike, who thought they were getting one thing and ended-up (much to their detriment) with something else.


Oh yeah, someone on these boards will give you the opposite case and recommend them as a good investment. And they may be right...but, remember (for those of you who weren't in diapers at the time) Greenspan's "irrational exhuberance" comment and what it did to the NASDAQ, specifically internet stocks? That was the first clue of their overvaluation. Now, in my opinion, the subprime problem is the the first clue to the overvaluation of real estate.


An additional risk is the Fed reducing interest rates sparking a sudden wave of refinancings. In this scenario, your client gets their principal back and you have to look for other investments to replace it.


Just my opinion...

Mar 25, 2007 11:51 pm
doberman:

Yeah, good luck trying to sell these.


If a client has even only casually watched the news, they know that
the mortgage business is in the beginning throes of a shakedown. And
investing in mortgage debt, at this stage of the game, may entail much
more risk than the security returns.





Doberman,



I would agree except that GNMA cert's are backed by the FF&C of the
US Government, and Fannie/Freddie Cert's by the GSE's (Themselves with
AAA ratings).



My theory is that a hardening mortgage credit enviroment, slowing
housing market, and stable interest rates auger well for MBS b/c the
average life goes up.


What I've been thinking of doing is explaining that the difference in
yeild between a Certificate and an Agency Debenture comes from the
embedded call option in the mortgage loans. To the extent that the
howowners do not excerise their call option by prepaying, you collect
time value in the form of excess interest.

Mar 28, 2007 1:58 am
AllREIT:


My theory is that a hardening mortgage credit enviroment, slowing housing market, and stable interest rates auger well for MBS b/c the average life goes up.

 



Um...wouldn't the average life going up be a bad thing?


I agree that GNMAs are "protected" however, if the average life is longer then the rate earned on a pass through certificate is closer to the coupon rate, right? 


Wouldn't it be better if the life were shortened?  With a shorter life the loan is repaid in a hurry and the actual interest "earned" is higher because all of the 7% interest that was amortized over 15 or 30 years was paid back in 18 months to 36 months when the loan was refinanced.  This effectively exploded the rate, right?

Mar 28, 2007 2:54 am
menotellname:

Wouldn't it be better if the life were
shortened?  With a shorter life the loan is repaid in a hurry and
the actual interest "earned" is higher because all of the 7% interest
that was amortized over 15 or 30 years was paid back in 18 months
to 36 months when the loan was refinanced.  This effectively
exploded the rate, right?









Oh lordy,


Residential mortgages do not contain a
clause requiring the full payment of the loans potential unpaid
interest upon early prepayment.



If that were the case people would never move or Refi since the cost of satisfiying the mortgage would be immense.



The embedded call option in a mortgage gives the borrower the ability to end the loan (by
repaying it) any time they want to. They will excercise the call option
when it is favorable to do so (i.e when they can refi to a lower rate
or they move to new house).



In exchange for this call option, the borrower pays a higher interest
rate. Note how callable muni's tend to have higher rates than
non-callable muni's.


Note that FNMA pass-throughs pay more than FNMA debentures. The difference is the value of that continious call option.



The longer the borrower does not excercise the option, the more time
value you collect as excess interest. Hence slowing prepayments is a
good thing.


Mar 28, 2007 12:10 pm
AllREIT:
menotellname:

Wouldn't it be better if the life were shortened?  With a shorter life the loan is repaid in a hurry and the actual interest "earned" is higher because all of the 7% interest that was amortized over 15 or 30 years was paid back in 18 months to 36 months when the loan was refinanced.  This effectively exploded the rate, right?





Oh lordy,

Residential mortgages do not contain a clause requiring the full payment of the loans potential unpaid interest upon early prepayment.

If that were the case people would never move or Refi since the cost of satisfiying the mortgage would be immense.

The embedded call option in a mortgage gives the borrower the ability to end the loan (by repaying it) any time they want to. They will excercise the call option when it is favorable to do so (i.e when they can refi to a lower rate or they move to new house).

In exchange for this call option, the borrower pays a higher interest rate. Note how callable muni's tend to have higher rates than non-callable muni's.

Note that FNMA pass-throughs pay more than FNMA debentures. The difference is the value of that continious call option.

The longer the borrower does not excercise the option, the more time value you collect as excess interest. Hence slowing prepayments is a good thing.


Though a valid point, it needs to be noted that soon to be falling rates will probably increase pre-payment risk.  Unless the MBS' are offering a signifcant premium to compensate for the pre-payment, then MBS probably aren't a great idea.

Mar 28, 2007 12:28 pm
menotellname:
AllREIT:


My theory is that a hardening mortgage credit enviroment, slowing housing market, and stable interest rates auger well for MBS b/c the average life goes up.

 



Um...wouldn't the average life going up be a bad thing?


I agree that GNMAs are "protected" however, if the average life is longer then the rate earned on a pass through certificate is closer to the coupon rate, right? 


Wouldn't it be better if the life were shortened?  With a shorter life the loan is repaid in a hurry and the actual interest "earned" is higher because all of the 7% interest that was amortized over 15 or 30 years was paid back in 18 months to 36 months when the loan was refinanced.  This effectively exploded the rate, right?



FWIW an extension of maturity is ALSO advantageous if you purchase MBS that are trading at a premium.  You receive the premium coupon rate for a longer time, and as well the premium paid is amortized over a longer period.  Good for YTM.

Mar 28, 2007 1:40 pm
AllREIT:
menotellname:

Wouldn't it be better if the life were shortened?  With a shorter life the loan is repaid in a hurry and the actual interest "earned" is higher because all of the 7% interest that was amortized over 15 or 30 years was paid back in 18 months to 36 months when the loan was refinanced.  This effectively exploded the rate, right?





Oh lordy,

Residential mortgages do not contain a clause requiring the full payment of the loans potential unpaid interest upon early prepayment.

If that were the case people would never move or Refi since the cost of satisfiying the mortgage would be immense.

The embedded call option in a mortgage gives the borrower the ability to end the loan (by repaying it) any time they want to. They will excercise the call option when it is favorable to do so (i.e when they can refi to a lower rate or they move to new house).

In exchange for this call option, the borrower pays a higher interest rate. Note how callable muni's tend to have higher rates than non-callable muni's.

Note that FNMA pass-throughs pay more than FNMA debentures. The difference is the value of that continious call option.

The longer the borrower does not excercise the option, the more time value you collect as excess interest. Hence slowing prepayments is a good thing.


I agree.  I like GNMA and other pass throughs for pension accounts for the steady income and eventual return of principle in case of an early repayment.  Individual investors who are relying on the income don't alway like that early return of principle.


It also depends on which tranch of the pass through you are looking at offering

Mar 28, 2007 2:24 pm
joedabrkr:



FWIW an extension of maturity is ALSO
advantageous if you purchase MBS that are trading at a premium. 
You receive the premium coupon rate for a longer time, and as well the
premium paid is amortized over a longer period.  Good for YTM.





That's why depending on your expections for interest rates and prepayment speeds you can buy discount or premium MBS.



My theory is that with harder credit conditions/slower housing turnover
there will be less prepayments even if rates go down slightly. Hence
purchases of par or sightly premium MBS is a good idea.