Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques, 2nd Edition

CHAPTER 12

Evaluating Senior MBS and CMOs

The process of evaluating and analyzing agency MBS is unique, particularly for structured securities. Because of the external backing provided by the government (either explicit or implicit), investors assume that principal will be returned with 100% certainty. The driver of performance of these securities is thus not if, but when principal is paid to the bondholder. While sophisticated techniques such as Monte Carlo simulation and total return analysis (described in Chapter 10) are quite useful, they are best utilized as tools comprising one component of extensive comparative analysis. Simple and straightforward tools, such as yield matrices and vector analysis, are also quite useful in understanding the fundamental attributes of different securities, as well as making comparisons between securities and across sectors. While such techniques are “quantitative” in the sense that they generate a series of numbers, it is more productive to view them as qualitative devices for evaluating tranches and contrasting different securities. A thorough analysis of agency MBS (in the form of both passthroughs and CMO tranches) utilizes both qualitative and quantitative techniques to understand, value, and compare different securities.

In this chapter, we discuss techniques and metrics that investors and traders commonly utilize to evaluate agency MBS. We demonstrate how basic tools, such as yield tables and prepayment vectors, can be used in conjunction ...