Residual Fair Value

The investment value of a residual interest is based on the net present value of its cash flows, using an appropriate yield or discount rate. Not surprisingly, the amounts and timing of residual cash flows are key determinants of their fair value. The greater the amounts of residual payments and the earlier such payments are received, the higher the net present value and the fair value of the residual.

Review of Residual Basics

Residual cash flows are derived from the cash flow difference that exists, if any, between the payments received on the mortgage loans collateralizing a particular private label MBS transaction and the monies paid out to debt service the bonds issued within that MBS transaction. This excess cash flow differential is derived from essentially two sources:

1. Excess Interest The mortgage loans backing the MBS generally have higher interest rates than the bonds issued. This interest rate differential is a primary source of residual cash flow.
2. Principal and interest payments from over collateralization Typical private label MBS are structured so that the principal balance of mortgage loans pledged as collateral for the MBS exceeds outstanding principal balance of the more senior bonds issued on an ongoing basis. Over time, and subject to the terms and conditions specified in the MBS offering documents, the residual holder is entitled to receive principal and interest payments attributable to the loan balance posted as over collateralization.

Conditional Cash Flows

The amounts and timing of residual cash flows are contingent on the performance of the loan collateral, and on the terms of the senior MBS debt service requirements set forth in the offering documents that specify how and when excess cash flow is distributable to the residual class.

Collateral performance is a determinant of the amount and timing of excess cash flow >>>>