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The Impact of a Certain MBS Attribute

by Natalie Regan

The Mortgage-Backed Security (MBS) sector has a little something for everyone: Yield, Spread, Duration and Cashflow. At different parts of the interest rate cycle, certain structures from a price, coupon and collateral standpoint become more or less appealing.

As we are currently in a flat/falling rate environment, we continue to take a hard look at coupons and dollar prices on both new purchases and holdings in the portfolio. As the sector is freely prepayable, avoiding premium risk and limiting cashflow comes into focus when and if there could be a refinance wave ahead.

Beyond dollar price and coupon, there are other attributes that impact how a pool could perform in a different rate environment: 
  • Geographic concentration 
  • Number of Loans in the Pool
  • Loan Size
MBS pools are called “pools” because loans are pooled together. The traits we see on the underlying loans are weighted averages: loan size, coupon, age, etc. – but there could be a broad spectrum on each – these are generics. There are also pools that have been constructed with limitations – similar to building a CRA pool with specific loans in your neighborhood, a pool is assembled with loan size limitations. Low loan balance pools:
  • Loans under a certain threshold are pooled together to create low loan balance pools: $85k – 300k max loan size
  • Perform similarly to low coupon because there is less incentive to refinance on a lower balance
  • Regardless of rate, these historically lag in prepays
  • Better convexity if rates fall and outperforms by keeping a longer WAL 
The last point is the one that attracts the most attention in this part of the cycle.

Below is an illustration of the performance in various rate scenarios on a 200k max loan size pool, a 300k max and a generic pool (542k avg loan size), same 5% coupon.  Our preferred model to analyze MBS continues to be the BAM model as it adjusts for individual pool characteristics (versus Bloomberg Median which is cohort level).  

Optically, the generic pool has slightly wider spread / higher yields. In the range of outcomes in every scenario but the base case it underperforms. 
 

So investors can still find some of the higher yielding 5% coupon in a falling rate environment with the security of knowing the low loan balance would likely stick around longer than its generic counterpart.
 
 


This information is intended for institutional investors only. The material provided in this document/presentation is for informational purposes only and is intended solely for private use. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instruments.

•Not FDIC Insured •No Bank Guarantee •May Lose Value