Weighted Average Coupon (WAC)
What Is the Weighted Average Coupon (WAC)?
The weighted average coupon (WAC) is a measurement of the rate of return on a pool of mortgages that is sold to investors as a mortgage-backed security (MBS). The underlying mortgages are reimbursed at various time allotments, so the WAC addresses its return at the time it was issued and may vary from its WAC later.
Figuring out a Weighted Average Coupon (WAC)
Banks regularly sell the mortgages they issue on a secondary mortgage market. The purchasers are institutional investors, for example, hedge funds, and investment banks. These purchasers package the mortgages into marketable securities that can be traded to investors on the open market as mortgage-backed securities (MBS).
In the weighted average calculation, the principal balance of each mortgage is utilized as its weighting factor.
MBS holders receive interest or coupon payments which are calculated as the weighted average of the underlying coupon of the mortgage loans backing the MBS.
Working out the WAC
The weighted average coupon (WAC) is calculated by taking the gross of the interest rates owed on the underlying mortgages of the MBS and weighting them as indicated by the percentage of the security that each mortgage addresses.
The WAC addresses the average interest rate of various pools of mortgages with changing interest rates. In the weighted average calculation, the principal balance of each underlying mortgage is utilized as the weighting factor.
To work out the WAC, the coupon rate of each mortgage or MBS is duplicated by its excess principal balance. The outcomes are added together, and the sum total is separated by the leftover balance.
One more method for computing the weighted average coupon is by taking the weights of each mortgage pool, increasing by their separate coupon rates, and adding the outcome to get the WAC.
For instance, assume a MBS is made out of three distinct pools of mortgages with a principal balance of $11 million. The primary mortgage bundle, or tranche, comprises of $4 million worth of mortgages that yield 7.5%. The subsequent pool has a $5 million mortgage balance at a 5% rate. The third pool has $2 million worth of mortgages with a rate of 3.8%.
Utilizing the main method framed previously:
WAC = [($4 million x 0.075) + ($5 million x 0.05) + ($2 million x 0.038)]/$11 million
WAC = ($300,000 + $250,000 + $76,000)/$11 million
WAC = $626,000/$11 million = 5.69%
On the other hand, the WAC a be processed by assessing the weight of every one of the mortgage tranches first:
Pool 1 weight: $4 million/$11 million = 36.36%
Pool 2 weight: $5 million/$11 million = 45.45%
Pool 3 weight: $2 million/$11 million = 18.18%
Sum of the weights is 100%. The WAC is, in this manner, calculated as:
WAC = (36.36 x 0.075) + (45.45 x 0.05) + (18.18 x 0.038)
WAC = 2.727 + 2.2725 + 0.6908 = 5.69%
The weighted average coupon rate might change over the life of the MBS, as different mortgage holders pay down their mortgages at various interest rates and on various plans.
At the point when a MSB Gets Risky
No notice of mortgage-backed securities is complete without a reference to the 2007-2008 financial crisis, which was accused on them to a great extent.
A significant number of the MBS investments of that period were backed by mortgages issued during the cross country housing bubble and, generally speaking, issued to borrowers who couldn't bear to repay them. At the point when the bubble burst, a significant number of these borrowers were forced into default and the value of the securitization of these assets dissolved away.
They were, truth be told, collateralized with subprime loans.
- The WAC will change after some time as the mortgages underlying the security are reimbursed.
- The WAC on a mortgage-backed security is utilized by analysts of these investments to estimate its pre-pay qualities.
- The WAC is the average gross interest rate of the underlying mortgages in a mortgage-backed security at the time it was issued.