Mbs (mortgage back securities)

I have an example

• The amount of mortgage outstanding is 150, average cost of mortgage = 11%
-MBS with 3 tranche
+) Senior
Par value: 80
Coupon rate: 8%
+)Mezzanine
Par value: 10
Coupon rate : 9%
+)Equity
Par value: 10

What would happen to 3 tranches of MBS if the loss of mortgage outstanding is 65?

When the mortgage outstanding is 150, the total return is 50. The senior tranche shares 6.4 of the 50; the mezzanine tranche shares 0.9 of the 50 and the equity tranche shares the left 42.7.

However, the mortgage is at a loss of 15. Then the equity tranches absorb the loss first, followed by the mezzanine, and finally, the senior tranche, which is 10 of equity tranche and 5 of mezzanine.

It means that MEZZANINE TRANCHE HOLDER still receive 9% coupon rate of par value : 5 (10-5) in the remaining tenor and Equity tranche holder will receive nothing in the remaining tenor (or in other word Equity tranche is deleted)

Tranche senior and mezzanine will not receive coupons because thereâ€™s no cash inflows.

The common practice is: tranche seniorâ€™s coupon will be paid first when thereâ€™s cash inflow to the asset pool and then tranche mezzanineâ€™s and finally tranche equity. If the cash inflow is not enough to cover the tranche seniorâ€™s coupon then tranche mezzanine and equity will receive nothing. When the MBS gets loss, the first loss is tranche equity and then tranche mezzanine.

Actually, you should know these three tranches have different maturities. And thereâ€™s probability that tranche equity will generate cash flow after the maturity of tranche senior and mezzanine.

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