Researchers from Morgan Stanley delved deep into the obscure realm of post-NIM securities, last week. Post-NIMs, or "baby equity," offer an attractive alternative to mortgage derivatives for ABS and MBS investors seeking yield, claims the firm. "We believe that post-NIM residuals should not be considered an off-the-run market, but a clear alternative to traditional yield enhancers," write Morgan Stanley researchers, who estimate $10 billion worth of post-NIMs are being produced each year.
The health and payment rates of NIMs, and especially post-NIMs, are closely tied to excess spread and collateral losses. If loans in a deal begin to prepay too quickly, the post-NIMs will not be paid down until late in its term, as prepayments thin the excess spread.
Morgan Stanley ran five different loss curve stress scenarios to analyze post-NIM performance, starting with 1.75% cumulative losses and rising to 1.875%, the base case of 2.5%, 3.125% and 3.75%. In the 1.75% loss case scenario, a post-NIM on a transaction with a 2.53 average life would yield 15%. On the other end of the spectrum, the 3.75% loss case scenario, the yield on a post-NIM would be 8.4%.
To analyze the effects of loss timing for post-NIMs, researchers plotted the distribution of the time it takes losses to reach 20% after 40 months of seasoning. Most deals reach that point within 16 to 24 months with the peak being roughly 19 months. The 20% level was used because it represents the normal period when a NIM is paid off and the post-NIM begins cashflowing.
Morgan Stanley adjusted the timing curve by two and five months in both directions and calculated the following yields for post-NIMs on deals with 2.51 average life. When the curve was shifted back five months, yield totaled 10%, and when shifted back only two months, yield increased to 10.9%. At the base case scenario, the post NIM yielded 11.5%, pushed forward two months 11.9%, and five months yielded 12.7%.
In conclusion, Morgan Stanley writes that with a post-NIM residual, the investor is, in effect, selling options on prepayment rates and credit in order to increase yield. Post-NIMs are preferable to IOs because in worst-case scenarios, the post-NIMs deliver greater yield.
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