TIB Ticker - A Different Type of PAC

March 19, 2010Daily Rates & Viewpoints From the Officers & Staff of TIB.

A Different Type of PAC

I am often receiving information about how I can help with various Political Action Committee’s, especially given the community banking environment we work in and all the good things these PACs have done for the industry. However, there is a different kind of PAC I wanted to discuss today. A couple of Tickers ago, I began to skim the surface of Collateralized Mortgage Obligation structures and how they work. Sequential pay and accrual “Z” tranches were the topic of that particular article. This Ticker will move into the next most common type of CMO structure – a Planned Amortization Class bond, or a PAC.

When describing a sequential pay tranche in my previous Ticker, I used the example of four tranche’s A, B, C, and D. Interest and principal is collected for all collateral, but all principal collected goes towards retiring the principal of the A tranche first. Interest is still paid to all tranches based on the amount of outstanding principal remaining, but until the first $25M in returned principal is used to pay-off tranche A, tranche B will not receive any principal. Once tranche A is retired, all principal will be used to retire trance B before tranche C or D see the return of any principal, and so on. However, depending on the prepayment speeds seen for the underlying collateral, each tranche’s average-life can still vary substantially with this type of structure. That variability continued to concern some investors who needed an even more stable expected prepayment schedule.

In order to provide a product to fit the needs of these investors, the PAC structure was created and came to market in 1987. PAC bonds are formed using the following feature – if the prepayment speed is within a particular range throughout the life of the collateral, then you will know the cash flow pattern. With a schedule of prepayments that must be satisfied for the owners of the PAC tranche, that tranche has priority over all other non-PAC tranches. Those non-PAC tranches are called the support tranches, and the cash-flow certainty gained by creating the PAC comes at the expense of those support tranches.

An upper and lower prepayment rate must be specified when creating the tranche, and those speeds become the initial PAC band. The PAC band is usually based on the current market. In order to provide an example, let’s assume a particular PAC tranche has a band of a 50-250 PSA. The prepayment schedule of the PAC bond is set while the collateral prepays at a speed within the band. The way the schedule is set is by looking at a schedule of principal repayments at each of the banded speeds. The amount of principal you will receive is set and is equal to the lowest amount you would receive between the two speeds. Initially, that amount is based on the speed at the lower end of the band, but as more principal is paid off at the higher speed, the amount paid is based on that higher speed. PAC investors could see principal prepayments that are higher or lower in the event the underlying collateral is prepaying at a speed outside the band. Even in those circumstances, the average-life associated with the PAC tranche can be much more stable than with a back-end sequential pay tranche.

Okay, now that we’ve know how a PAC works, we’ll throw another aspect into the mix. Most CMOs don’t have just one PAC tranche, but have multiple PAC tranches that receive principal based on a sequential prepayment schedule. We talked about an initial band of speeds associated with a PAC, but with PAC tranches that are supporting earlier PAC tranches, an even longer “effective” band can be created for the earliest tranches. This becomes a little complicated when looking at the numbers, but essentially creates an even more stable PAC tranche of which to invest.

Even more types of CMO structures will be discussed in future Tickers, but we’ve covered a few of the most common types. Hopefully, this will help us better understand CMOs and some of their various characteristics when making an investment decision. For help with your bank’s investment needs, please contact your TIB Capital Markets Investment Officer.

Reed Bateman
Trading Assistant
rbateman@mybankersbank.com

Market Levels @ 9:13 AM CDT

TIB Fed Funds Rate - Previous Day
Agent	0.03%	Principal	0.20%	STAR Principal	0.25%

Key Indices/Commodities
1 - Month LIBOR	0.24%	Dow Jones	10771.76
3 - Month LIBOR	0.27%	NASDAQ 100	2382.88
1-Yr LIBOR	0.87%	S&P 500	1159.50
1-Yr CMT	0.41%	Spot Gold	1123.20
Prime	3.25%	Spot Silver	17.35
3-yr LIBOR Swap/Offer	1.75%	Spot Crude Oil	81.88
5-yr LIBOR Swap/Offer	2.66%	CRB Index	274.97
3 Mo - Fed Fund Futures	0.23%	6 Mo - Fed Fund Futures	0.33%

US Treasury Yields		US Non-Callable Agency Yields
Yield	Maturity	Yield	Spread
0.04%	90 - Days
0.13%	180 - Days
0.92%	2 - Year	1.04%	12bp
1.49%	3 - Year	1.63%	14bp
2.40%	5 - Year	2.65%	25bp
3.65%	10 - Year	3.88%	23bp
4.55%	30 - Year
273 BPs		Yield Curve(2's-10's)

Sample 1x Callable Agency Issues
Description	Call Date	YTC	YTM
FNMA 2.15 10/01/13	4/11	2.15%	2.15%

Select MBS Levels
Description	Coupon	Yield	Spread/Duration*
15-Yr FNMA	4.00%	3.5%	95 / 4.53
30-Yr GNMA	4.50%	4.3%	55 / 8.05
*Duration @ 12 month Historical CPR

Morning Commentary:	David Terrell
There isn’t any economic data being released today, and the treasury market is fairly quiet, in spite of happenings abroad. India has hiked their benchmark rate after inflation hit a 16 month high, and French President Sarkozy opposes IMF involvement in Greece. The French and German governments, the two biggest in the Euro coalition, do not agree on how best to help Greece. The confrontation over this will shape equity markets next week. The treasury curve peaked at 291 spread on February 22^nd, and it has been steadily flattening ever since. It’s flatter by a few bps this morning, bringing it to 270 bps. There are rumors of another discount rate hike, which will put further pressure on the short end of the curve.

Morning Commentary:

David Terrell

There isn’t any economic data being released today, and the treasury market is fairly quiet, in spite of happenings abroad. India has hiked their benchmark rate after inflation hit a 16 month high, and French President Sarkozy opposes IMF involvement in Greece. The French and German governments, the two biggest in the Euro coalition, do not agree on how best to help Greece. The confrontation over this will shape equity markets next week. The treasury curve peaked at 291 spread on February 22^nd, and it has been steadily flattening ever since. It’s flatter by a few bps this morning, bringing it to 270 bps. There are rumors of another discount rate hike, which will put further pressure on the short end of the curve.

Information contained herein is based on sources we believe to be reliable but its accuracy is not guaranteed. Customers should rely on their own outside counsel or accounting firm for specific circumstances. The securities, yields or levels discussed herein are for illustration purposes and are not guaranteed, not obligations of any bank, thrift or other entity and are not insured by the FDIC.

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