Indemnity Payments

• Indemnity payments make investing in NHAMBS safer.
  • Protect against adverse shifts in the yield curve.
  • Option to limit the impact of prepayments.

This is why you pass it on.

• Indemnity payments are not one-to-one pass-through.
  • What you collect from borrowers.
  • what you pay to investors.
  • The difference: a source of frustration.

You issued NHAMBS pools. No one is buying. Why?

They fear that:

1. Your mortgages will prepay quickly.
2. They will have to re-invest the proceeds at (lower) interest rates.

The (partial) fix? Indemnity payments.

Indemnity payments ensure that:

1. They are adequately compensated only when the pool prepays.
2. These payments are tied to the value of the NHAMBS pool in the current interest rate environment.

How? This simple:

\[ \begin{equation} \begin{aligned} \text{Price Above Par} = &\text{MBS Clean Price} - \text{MBS Par Price} \\ \text{Indemnity Factor} = &\max{[\text{Price Above Par}, 0]} \\ \text{Indemnity Payment} = &\text{Indemnity Factor}*\text{Prepayments} \end{aligned} \end{equation} \]

• This is what they (investors) expect to receive.
• This is uniform and mandated by CMHC.

But typically*

\[ \begin{equation} \begin{aligned} \text{IRD} & = \text{ Locked-in Rate} - \text{ Market Rate} \\ \text{IRD Penalty} & = \text{ No. of Remaining Years}*\text{ IRD } \\ \text{Standard Penalty} & = 3*\text{Monthly WAC Coupon} \\ \text{Indemnity Factor} & = \max{[\text{IRD Penalty}, \text{Standard Penalty}]} \\ \text{Indemnity Payment} & = \text{Indemnity Factor}*\text{Prepayments} \end{aligned} \end{equation} \]

• This is what you (issuers) expect to collect from mortgagers.
• This is not uniform across credit unions and financial institutions.

For all the gory details, see:

NHA MBS Indemnity Calculation Methodology