Bond markets analysis and strategies 4th edition_8 ppt

Interest on each Class of REMIC Certificates, other than the Class 89-R REMIC Certificates, at the applicable per annum interest rate described on the cover hereof will be distributed on

280 CHAPTER I2 Collateralized Mortgage Obligations and Stripped Mortgage-Backed Secu

tes Thus, whereas PAC bonds are said to have two-sided prepayment protection, TAC

bonds have one-sided prepayment protection Such a bond is acceptable to institu

tional investors who are not overly concerned with some extension risk but greatly

concerned with contraction risk

Some institutional investors are interested in protection against extension risk but

are willing to accept contraction risk This is the opposite protection from that sought

by the buyers of TAC bonds The structures created to provide such protection are re

Very Accurately Determined Maturity Bonds

Accrual or Z bonds have been used in CMO structures as support for bonds called

very accurately determined maturity (VADM) or guaranteed final maturity bonds, In

this case the interest accruing (i.e., not being paid out) on a Z bond is used to pay the

interest and principal on.a VADM bond This effectively provides protection against

extension risk even if prepayments slow down, because the interest accruing on the Z

bond will be sufficient to pay off the scheduled principal and interest on the VADM

bond Thus, the maximum final maturity can be determined with a high degree of cer-

tainty If prepayments are high, resulting in the supporting Z bond being paid off

faster, however, a VADM bond can shorten

A VADM is similar in character to a reverse TAC For structures with similar

collateral, however, a VADM bond offers greater protection against extension risk

Moreover, most VADMs will not shorten significantly if prepayments speed up

Thus, they offer greater protection against contraction risk compared with a reverse

TAC with the same underlying collateral Compared with PACs, VADM bonds

have greater absolute protection against extension risk, and though VADM bonds

do not have as much protection against contraction risk, as noted previously, the

structures that have included these bonds are such that contraction risk is generally

not significant

Interest-Only and Principal-Only Tranches

As we explain later in this chapter, stripped mortgage-backed securities are created

by paying all the principal to one bond class and all the interest to another bond

class These two classes are referred to as the principal-only (PO) bond class and the

interest-only (10) bond class We discuss the investment characteristics of these se- ©

curities later

CMO structures can be created so that a tranche can receive only the principal or

only the interest Fox,example, consider FJF-01 Tranche B in this structure can be di-

vided into two tranches, a principal-only tranche and an interest-only tranche

Notional lOs

In our previous illustrations, we used a CMO structure in which all the tranches have

the same coupon rate (7.5%) and that coupon rate is the same as the collateral In

practice, the same coupon rate would not be given to each tranche Instead, the

coupon rate would depend on the term structure of intefast rates and the average life

of the tranche, among other things

In the earlier CMO deals, all of the excess interest between the coupon rate on

the tranches and the coupon interest on the collateral was paid to an equity class re-

‘alized HN Obligations and Stripped Mortgage-Backed Securities ferred to as the CMO residual This is no longer the practice today Instead, a tranche

is created that receives the excess coupon interest This tranche is called a notional in-

terest-only (IO) class and also referred to as a structured 10

To see how a notional IO is created, consider the CMO structure shown in Ex- hibit 12-15, FJF-06 This is the same structure as FJF-02 except that the coupon rate varies by tranche and there is a class denoted IO, which is the class of inter- est to us,

Notice that for this structure the par amount for the IO class is shown as

$52,566,667 and the coupon rate is 7.5% This is an IO class, so there is no par

amount The amount shown is the amount on which the interest payments will be de- termined, not the amount that will be paid to the holder of this bond Therefore, it is

called a notional amount

Let’s look at how the notional amount is determined Consider first tranche A

The par value is $194.5 million and the coupon rate is 6% Because the collateral’s coupon rate is 7.5%, the excess interest is 150 basis points (1.5%) Therefore, an IO with a 1.5% coupon rate and a notional amount of $194.5 million can be created from tranche A But this is equivalent to an IO with a notional amount of $38.9 million and

a coupon rate of 7.5% Mathematically, this notional amount is found as follows:

tranche’s par value X excess interest

0.075 notional amount for 7.5% IO =

1 For payment öƒ periodic coupon interest: Disburse periodic coupon

interest to tranches A, B, and C on the basis of the amount of principal

outstanding at the beginning of the period For tranche Z, accrue the interest based on the principal plus accrued interest in the preceding period The interest for tranche Z is to be paid to the earlier tranches as a principal pay down Disburse periodic interest to the IO tranche based on the notional amount at the beginning of the period

2 For disbursement of principal payments: Disburse principal payments to tranche A until it is paid off completely After tranche A is paid off completely, disburse principal payments to tranche B until it is paid off completely After tranche B is paid off completely, disburse principal payments to tranche C until it is paid off completely After tranche C is paid off completely, disburse principal payments to tranche Z until the

original principal balance plus accrued interest is paid off completely

" 282 CHAPTER 12 Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities

= $38,900,000

Similarly, from tranche B with a par value of $36 million, the excess inkerest is v00

basis points (1%), and therefore an IO with a coupon rate of 1 % an a ae fona

amount of $36 million can be created But this is equivalent to creating an ° Me là

notional amount of $4.8 million and a coupon rate of 7.5% This procedure own

in the following table for all four tranches

The support bonds—or bodyguards—are the bonds that provide prepayment prov „

tion for the PAC tranches Consequently, they are exposed to the Màn ies nong

prepayment risk Because “of this, investors must be particularly careful in

the cash flow characteristics of support bonds to reduce the likelihood of adverse port- '

i uences due to prepayments

re the support bond typically is divided into different bond classes All the bond

classes we have discussed earlier in this section are available, including sequent

support bond classes, floater and inverse floater support bond classes, and accrua

pe The support bond can even be partitioned so as to create support bond oc

with a schedule of principal repayments That is, support bond classes tat a ith ;

bonds 2an be created In a structure with a PAC bond and a support bon

bonds have greater prepayment protection than the support bond tO

schedule of principal repayments, the prepayment protection is less than that

vided PAC I bonds

me “TZ” Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities 283

be satisfied

Credit risk exposure depends on who has issued the CMO An issuer is either (1) Freddie Mac, Fannie Mae, or Ginnie Mae, or (2) a private entity Those CMOs is- sued by the former are referred to as agency CMOs Those issued by a private entity are called nonagency CMOs and can be divided into two types A private entity that issues a CMO but whose underlying collateral is a pool of pass-throughs guaranteed

by an agency is called a private-label CMO If the collateral for a CMO is a poot of unsecuritized mortgages loans, the structure is referred to as a whole loan CMO

Today, the most common type of nonagency CMO is a whole loan CMO Conse- quently, market participants use the terms nonagency CMO and whole loan CMO interchangeably

As we noted in Chapter 11, the guarantee of a government-sponsored enterprise depends on the financial capacity of the agency CMOs issued by private entities are rated by commercial rating agencies There are various ways that such issues can be credit enhanced, as described in Chapter 13 when we discuss asset-backed securities,

Tax Considerations

The issuer of a CMO wants to be sure that the trust created to pass through the interest and principal payments is not treated as a taxable entity A provision of the Tax Reform Act of 1986, called the Real Estate Mortgage Investment Conduit (REMIC), specifies the requirements that an issuer must fulfill so that the legal entity created to issue a CMO is not taxable Most CMOs today are created as REMICs Although it is common

to hear market participants refer to a CMO as a REMIC, not all CMOs are REMICs

STRIPPED MORTGAGE-BACKED SECURITIES

Stripped mortgage-backed securities (MBSs), introduced by Fannie Mae in 1986, are another example of derivative mortgage products A pass-through divides the cash flow from the underlying pool of mortgages on a pro rata basis across the security holders A stripped MBS is created by altering the distribution of principal and interest from a pro rata distribution to an unequal distribution Some of the securities thus created will have

a price/yield relationship that is different from the price/yield relationship of the under- lying mortgage pool There are three types of stripped MBS: (1) synthetic-coupon pass- throughs, (2) interest-only/principal-only securities, and (3) CMO strips

Synthetic-Coupon Pass-Throughs

The first generation of stripped mortgage-backed securities is called synthetic-coupon pass-throughs This is because the unequal distribution of coupon and principal re- sults in a synthetic coupon rate that is different from that of the underlying collateral

284 CHAPTER 12 Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities

Interest-Only/Principal-Only Strips

In early 1987, stripped MBS began to be issued where all the interest is allocated to

one class (the IO class) and all the principal to the other class (the PO class) The IO

class receives no principal payments IOs and POs are referred to as mortgage strips,

The PO security is purchased at a substantial discount from par value The yield

an investor will realize depends on the speed at which prepayments are made The

faster the prepayments, the higher the yield the investor will realize For example,

suppose that there is a pass-through backed by 30-year mortgages with $400 million in

par value and that investors can purchase POs backed by this pass-through for $175

million The dollar return on this investment will be $225 million How quickly that

dollar return is recovered by PO investors determines the yield that will be realized,

In the extreme case, if all the homeowners in the underlying mortgage pool decide to

prepay their mortgage loans immediately, PO investors will realize the $225 million

immediately At the other extreme, if all homeowners decide to keep their houses for

30 years and make no prepayments, the $225 million will be spread out over 30 years,

which will result in a lower yield for PO investors

Let’s look at how the price of the PO can be expected to change as mortgage rates

in the market change When mortgage rates decline below the coupon rate, prepay-

ments are expected to speed up, accelerating payments to the PO holder Thus, the

cash flow of a PO improves (in the sense that principal repayments are received ear-

lier) The cash flow will be discounted at a lower interest rate because the mortgage

rate in the market has declined The result is that the price of a PO will increase when

mortgage rates decline When mortgage rates rise above the coupon rate, prepay-

ments are expected to slow down The cash flow deteriorates (in the sense of its taking

longer to recover principal repayments) Coupled with a higher discount rate, the

price of a PO will fall when mortgage rates rise

When an IO is purchased there is no par value In contrast to the PO investor,

the IO investor wants prepayments to be slow The reason is that the IO investor

receives only interest on the amount of the principal outstanding As prepayments

are made, the outstanding principal declines, and less dollar interest is received In

fact, if prepayments are too fast, the IO investor may not recover the amount paid

for the IO

Let’s look at the expected price response of an IO to changes in mortgage rates If

mortgage rates decline below the coupon rate, prepayments are expected to acceler-

ate This results in a deterioration of the expected cash flow for an IO Although the

cash flow will be discounted at a lower rate, the net effect is typically a decline in the

price of an IO If mortgage rates rise above the coupon rate, the’expected cash fiow

improves but the cash flow is discounted at a higher interest rate The net effect may

be either a rise or a fall for the 10 Thus, we see an interesting characteristic of an 10:

Its price tends to move in the same direction as the change in mortgage rates This ef-

fect occurs (1) when mortgage rates fall below the coupon rate, and (2) for some

An example of this effect can be seen in Exhibit 12-16, which shows for various

mortgage rates the price of (1) a 9% pass-through, (2) 4.PO created from this pass-

through, and (3) an IO created from this pass-through Notice that as mortgage rates

decline below 9%, the price of the pass-through does not respond much This is the

c

S022

HAP! a lộ Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities 285

(Current) Mortgage Rate

Source: Adapted from Steven J Carlson arid Timothy D Sears,

“Stripped Mortgage Pass-Throughs: New Tools for Investors,”

in Frank J Fabozzi, ed., The Handbook of Mortgage-Backed Securities, rev ed (Chicago: Probus Publishing, 1988), p 564

negative convexity (or price compression) property of pass-throughs For the PO se- curity, the price falls monotonically as mortgage rates rise For the IO security, at mortgage rates above approximately 11%, the price declines as mortgage rates rise; as mortgage rates fall below about 11%, the price of an IO falls as mortgage rates de- cline Both POs and IOs exhibit substantial price volatility when mortgage rates change The greater price volatility of the IO and PO compared with the pass-through from which they were created can be seen by the steepness of a tangent line to the

curves at any given mortgage rate

CMOs that are backed by POs are referred to as PO-collateralized CMOs

CMO Strips One of the classes in a CMO structure can be a principal-only or an interest-only class These are called CMO strips Earlier we discussed how CMO strip tranches can be created ‘

Collateralized mortgage obligations are bond classes created by redirecting the cash flows of mortgage-related products (pass-throughs and whole loans) The creation of a CMO cannot eliminate prepayment risk; it can only redistribute the various forms of this risk among different classes of bonds called tranches

In a CMO there are rules for the distribution of interest and principal from the collateral The first CMOs were structured so that each class of bond would be retired

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286 CHAPTER 12 Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities

sequentially, and hence such structures are referred to as sequential-pay Mos The:

average life of the tranches differs from that of the collateral An accrual tranc ¢ al-

lows the creation of even shorter-term and longer-term average life tranches than in a

sequential-pay CMO without the inclusion of an accrual tranche From any of the

fixed-rate tranches, a floater and an inverse can be created Also, an interest-only and

a principal-only tranche can be created from a tranche A notional IO is a tranche cre-

ated from the difference between the collateral’s coupon interest and the total coupon

Despite the redistribution of prepayment risk with sequential-pay and accrual

CMOs, there is still considerable prepayment risk That is, there is still considerable

average life variability for a given tranche This problem has been mitigated by the

creation of a planned amortization class tranche This type of CMO tranche reduces

average life variability The bonds included in a CMO structure that provide the bet-

ter protection for PAC tranches are the support or companion tranches There are

various ways in which greater prepayment protection can be provided for some or all

of the PAC bonds within a CMO structure These include a lockout and a reverse

Targeted amortization class bonds are created so as to provide protection

against contraction risk but not against extension risk A reverse TAC also provides

one-sided protection: protection against extension risk but not against contraction

tisk A very accurately determined maturity bond also provides protection against

nsion risk

oe Support bonds are the riskiest tranche within a CMO structure From support

bonds other types of bonds can be created For example, a part of the support bonds

can be carved up to create support bonds with a principal repayment schedule Such

bonds are referred to as PAC II or level II PAC bonds ; ;

The credit risk exposure depends on whether the issuer is an agency (i.e., the is-

suer is Ginnie Mae, Fannie Mae, or Freddie Mac) or a nonagency CMO Agency

CMOs are perceived to have no credit risk Nonagency CMOs can be divided into pri-

vate-label CMOs in which the underlying collateral is a pool of agency pass-throughs,

and whole loan CMOs, in which the underlying collateral is a pool of whole loans

agency-CMOs expose investors to credit risk

Noms stripped MBS is created by assigning distribution of principal and interest

of the underlying pass-through security in unequal portions to two classes 0

bonds The result is that the two bonds will have a different price/yield Tọa pm

ship from that of the underlying pass-through There are three types of strippe

MBS: (1) synthetic-coupon pass-throughs, (2) interest-only/principal-only securities,

and (3) CMO strips

Questions

1 How does a CMO alter the cash flow from mortgages so as to shift the prepay-

ment risk across various classes of bondholders? tụ

2 Why is a CMO called a pay-through structure? ; -

3 a “By creating a CMO, an issuer eliminates the prepayment risk associated with

the underlying mortgages.” Do you agree with this statement? ;

b Wall Street often refers to CMOs as “customized securities.” Explain why

Collateralized Mortgage Obligations and Stripped Mortgage-Backed Securities

What types of investors would be attracted to an accrual bond?

Suppose that a tranche from which an inverse floater is created has an average life

of five years What will the average life of the inverse floater be?

This quotation is taken from a 1991 issue of BondWeek:

First Interstate Bank of Texas will look into buying several different types of collateralized mortgage obligation tranches when it starts up its buy program sometime after the second quarter of 1991, according to Jules Pollard, v.p Pollard said he will consider replacing maturing ad- justable-rate mortgage pass-throughs with short companion tranches and planned amortization classes because the ARMS have become rich Pollard did not provide a dollar figure on the planned investments, which will be made to match fund the bank’s liabilities When -he does invest he said he prefers government-guaranteed securities or those with implied

guarantees

a Explain the types of securities that Pollard is buying and selling

_ b Given the preference stated in the last sentence of the quotation, what issuers

is he likely to prefer? What issuers would he reject?

Describe how the schedule for a PAC tranche is created

Explain the role of a support bond in a CMO structure

What was the motivation for the creation of PAC bonds?

Suppose that a savings and loan association has decided to invest in mortgage- backed securities and is considering the following two securities: (i) a Freddie Mac pass-through security with a WAM of 340 months or (ii) a PAC tranche of a Freddie Mac CMO issue with an average life of two years Which mortgage- backed security would probably be better from an asset/liability perspective?

Suppose that a PAC bond is created assuming prepayments speeds of 80 PSA and

350 PSA If the collateral pays at 100 PSA over its life, what will this PAC tranche’s average life be?

Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million and a support bond with a par value of

Suppose that the $1 billion of collateral in Question 14 was divided into a PAC

bond with a par value of $800;million and a support bond with a par value of $200

million Will the PAC bond in this CMO structure have more or less protection than the PAC bond in Question 14?

Suppose that $1 billion of pass-throughs is used to create a CMO structure with a PAC bond with a par value of $700 million (PAC 1), a support bond with a sched- ule (PAC II) with a par value of $100 million, and a support bond without a schedule with a par value of $200 million

a Will the PAC I or PAC II have the smaller average life variability? Why?

b Will the support bond without a schedule or the PAC II have the greater aver-

te Fh og cr TL NT go Thế hưippÊổ Motgage Meee secuft ˆ

a How many classes are there in this CMO structure?

b (1) Which class is the floating-rate class?

(2) What benchmark interest rate is used for the floating-rate, and what is the spread to the benchmark?

(3) What are the cap and the floor on the floating rate after August 24, 1990?

How is the floor determined?

c (1) Which class is the inverse-floating-rate class?

(2) What formula is used to determine the coupon rate for the inverse floater?

(3) What is the coupon leverage?

(4) What are the cap and the floor on the inverse floater after August 24, 1990?

(5) How was the cap on the inverse floater determined?

(6) How was the cap on the floating-rate class determined?

d Assuming the initial principal outstanding of both the floating-rate and in- verse-floating-rate classes and LIBOR of 9%:

(1) What dollar coupon interest will be paid to the floating-rate class?

(2) What dollar coupon interest will be paid to the inverse floater?

(3) What is the total dollar coupon interest to both classes?

(4) What is the total dollar coupon interest on the underlying pass-through as- suming a coupon rate of 10.125%?

e Based on your answer to part (d) what is the weighted-average coupon paid to the sum of the floating- and inverse-floating-rate classes?

f Are the floating-rate and inverse-floating-rate classes in this structure PAC or support classes?

g (1) How many PAC bonds are in this CMO structure?

(2) What is the initiakPAC collar?

h Based on the planned principal balances shown on pages S-16 to S-24:

(1) When is Class 89-A scheduled to make its first principal payment?

(2) When is Class 89-A scheduled to make its final principal payment?

(3) What is the window for Class 89-A? , (4) When is Class 89-G scheduled to make its first principal payment?

(5) When is Class 89-G scheduled to make its final principal payment?

(6) What is the window for Class 89-G?

i Which bond is an accrual PAC bond? How did you determine which PAC bond was an accrual PAC bond?

j What are the support bonds in this CMO structure?

k Based on the percent of original principal balance outstanding reported on

(1) To what extent is Class 89-A subject to extension risk?

(2) To what extent is Class 89-B subject to contraction risk? - (3) Explain why the support classes are subject to substantial prepayment risk

fateralized Mortgage Obligations and Stripped Mortgage-Backed Securities

(4) For the PAC bonds, why is the weighted-average lif t

20 Consider the following CMO structure backed by 8% collateral:

Par Amount Coupon Rate

Par Amount Coupon Rate

Par Amount Coupon Rate

Tranches A to E are a sequence of PAC Is, Fisa PAC IL, and Gi

a In structure II, tranche’G is created from tranche F in structure I, What is the coupon rate for tranche G assuming that the combined coupon rate for

b tranches F and G in structure I should be 8.5%?

What is the effect on the value and average life of tranches A to E by i i

¢ What is the difference in the average life variability of tranche G in structure II and tranche F in structure II?

a What is the role of a lockout in a CMO structure?

b Explain why in a reverse PAC bond structure, the longest average life bond can turn out to be effectively a support bond if all the support bonds in the structure.are paid off?

What type of prepayment protection is afforded each of the following: (a a TAC

ran IS sọ PP E ized Mortgage lguỄn TỔ su

What types of CMO issues require a credit rating?

What is a whole loan CMO?

Indicate why you agree or disagree with the following statement: “All CMOs are

a What is a principal-only security? What is an interest-only security?

b How is the price of an interest-only security expected to change when interest

Suppose that 8% coupon pass-throughs are stripped into two classes Class X-1

receives 75% of the principal and 10% of the interest Class X-2 receives 25% of

the principal and 90% of the interest

(1) What type of stripped MBS would this be?

(2) What is the effective coupon rate on Class X-1?

(3) What is the effective coupon rate on Class X-2?

CHAPTER T2 C liäterlized Mortgage Ob

Prospectus Supplement to Prospectus Dated January 4, 1990

$500,000,000 Federal National Mortgage Association

FannieMae

Guaranteed REMIC Pass-Through Certificates Fannie Mae REMIC Trust 1990-89 The Guaranteed REMIC Pass-Through Certificates offered hereby (the “REMIC Certificates”)

tepresent beneficial ownership interests in one of two trust funds The REMIC Certificates, other than

the Class 89-RL REMIC Certificates, Tepresent beneficial ownership interests in Fannie Mae REMIC Trust 1990-89 (the “Trust”) The assets of the Trust consist of the “regular interests” in a separate trust fund (the “Lower Tier REMIC"), consisting of Fannie Mae Guaranteed Mortgage Pass-Through Certificates (the “MBS Certificates”), each of which represents a beneficial interest in a pool (the

“Pool”) of first lien, single-family, fixed-rate residential mortgage loans (the “Mortgage Loans”) having the characteristics described in this Prospectus Supplement The Class 89-RL REMIC Certificates will be the “residual interest” in the Lower Tier REMIC The general characteristics of the REMIC Certificates, including the terms of Fannie Mae’s guaranty thereof, are described in the attached Prospectus dated January 4, 1990 (the “REMIC Prospectus”), The general characteristics of the MBS Certificates, including the terms of Fannie Mae’s guaranty thereof, are described in the attached MBS Prospectus dated April 1,1990 (the “MBS Prospectus”),

:

(Continued on page 292) THE OBLIGATIONS OF FANNIE MAE UNDER ITS GUARANTY OF THE REMIC CERTIFICATES ARE OBLIGATIONS OF FANNIE MAE ONLY AND ARE NOT BACKED BY THE FULL FAITH AND CREDIT OF THE UNITED STATES, THE REMIC CERTIFICATES ARE EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURI- TIES ACT OF 1933 AND ARE “EXEMPTED SECURITIES” WITHIN THE MEANING OF THE SECURITIES EXCHANGE ACT OF 1934

August 2003 Class 89-X 18,984,000 9.50%

July 2011 Class 89-C 40,000,000 9.50%

March 2014 Class 89-D 40,000,000 9.50%

March 2016 Class 89-E 16,168,000

9.50% December 2016 Class 89-G 22,028,000 _

8.75% October 2017 Class 89-H 15,856,000 8.75%

May 2018 Class 89-J 35,884,000 8.50%

July 2019 Class 89-K 36,683,000 6.50%

July 2020 Class 89-L 209,000 1009.00%

July 2020 Class 89-M , 88,649,000 9.50%

Juty 2020 Class 89-F 9,120,000 (D

November 2017 Class 89-S 11,400,000 (2) November 2057

July 2020 Class 89-RL 10,000 9.50%

July 2020

(1) During their initial Interest Accrual Period of July 25, 1990 through August 24, 1990, the Class 89-F REMIC Certificates will bear interest at a rate of 8.8125% per annum During each Interest Accrual Period thereafter, the Class 89-F REMIC Certificates will bear interest, subject to a maximum rate of 11.00% per annum and a minimum rate of 0.50% per annum, at a rate per annum equal to 50 basis points in excess of the London interbank offered rate for one-month U.S doilar deposits (“LIBOR"), as more fully described herein

| I, CVAPTER fa ee

(2) During their initial Interest Accrual Period of July 25, 1990 through August 24, 1990, the Class 89-S REMIC

Certificates will bear interest at a rate of 10.05% per annum During each Interest Accrual Period thereafter, the

Class 89-S REMIC Certificates will bear interest, subject to a maximum rate of 16.7% per annum and a minimum

rate of 8.3% per annum, at a per annum rate equal to 16.7% - (0.8 K LIBOR)

(3) Holders of the Class 89-R REMIC Certificates will be entitled on each Distribution Date to receive all Surplus

Cash See “Description of the REMIC Certificates Additional Characteristics of the Class 89-R and Class 89-

RL REMIC Certificates” herein

This Prosp Suppl does not plete information regarding this offering and

should be read only in conjunction with the REMIC Prospectus and the MBS Prospectus

Interest on each Class of REMIC Certificates, other than the Class 89-R REMIC Certificates,

at the applicable per annum interest rate described on the cover hereof will be distributed on the 25th day of each month (or, if such 25th day is not a business day, on the first business day next succeeding such 25th day), commencing in August 1990 (each, a “Distribution Date”), except for interest distributions on the Class 89-X, Class 89-Y and Class 89-Z REMIC Certificates, which are Accrual

Certificates Interest will accrue on the Accrual Certificates as described under “Description of the

REMIC Certificates—Distributions of Interest” herein Interest to be distributed or added to principal

with respect to each REMIC Certificate on a Distribution Date will consist of one month’s interest on

the outstanding principal amount of such REMIC Certificate immediately prior to such Distribution Date

The principal distribution on each Distribution Date will be in an amount equal to the sum of the aggregate distributions of principal concurrently made on the MBS Certificates and interest that accrues and is unpaid on the Accrual Certificates On each Distribution Date, distributions of principal

of the REMIC Certificates will be allocated among the Classes of REMIC Certificates in accordance with the priorities described herein

The Final Distribution Dates of the respective Classes of REMIC Certificates have been

determined so that distributions on the underlying MBS Certificates will be sufficient to make timely

distributions of interest on the REMIC Certificates and to retire each such Class on or before its Final Distribution Date without the necessity of any call on Fannie Mae under its guaranty of the REMIC Certificates The rate of distribution of principal of the REMIC Certificates will depend on the rate of payment (including prepayments) of the principal of the Mortgage Loans underlying the MBS Certificates Both the Trust and the Lower Tier REMIC are subject to early termination only under the limited circumstances described in the REMIC Prospectus under “The Trust Agreement—

Termination.”

The yields on the REMIC Certificates will be sensitive in varying degrees to the rate of principal payments (including prepayments) of the Mortgage Loans, which generally can be prepaid at any time An extremely rapid rate of principal payments (including prepayments) may have a negative effect on the yield on the Class 89-L REMIC Certificates, which initially will be offered at a substantial premium to their original principal amount and could result in a

failure by investors in the Class 89-L REMIC Certificates to recoup their initial investment In

addition, the Class 89-F and Class 89-S REMIC Certificates will be sensitive to fluctuations in the level of LIBOR Furthermore, the weighted average life of the Class 89-Y REMIC Certificates may decrease significantly, and the weighted average lives of the Class 89-M, Class

89-F, Class 89-S, Class 89-N, Class 89-0, Class 89-P and Class 89-Z REMIC Certificates may

increase in varying degrees, if the prepayment rates of the Mortgage Loans exceed approximately 169% PSA (as defined herein) for any Distribution Date Such changes in weighted average lives may have a significant effect on the yields on the REMIC Certificates, The Class 89-R and Class 89-RL REMIC Certificates will be subject to certain transfer restrictions See “Description of the REMIC Certificates—-Additional Characteristics of the Class 89-

R and Class 89-RL REMIC Certificates” herein In addition, any transferee of a Class 89-R or Class 89-RL REMIC Certificate will be required to execute and deliver an affidavit as provided in the REMIC Prospectus See “Description of the REMIC Certificates—Additional Characteristics of Residual Certificates” and “Certain Federal Income Tax Consequences—Sales of Certificates—

Residual Certificates Transferred to or Held by Disqualified Organizations” in the REMIC Prospectus

Elections will be made to treat the Lower Tier REMIC and the Trust as “real estate mortgage investment conduits” (“REMICs”) pursuant to the Internal Revenue Code of 1986, as amended (the

“Code”) The REMIC Certificates, other than the Class 89-R and Class 89-RL REMIC Certificates, will be designated as “regular interests” in the REMIC constituted by the Trust, and the Class 89-R REMIC Certificates will be designated as the “residual interest” in such REMIC The interests in the Lower Tier REMIC, with the exception of the Class 89-RL REMIC Certificates (the “Lower Tier Interests”), will be designated as the “regular interests,” and the Class 89-RL REMIC Certificates will

be designated as the “residual interest,” in the Lower Tier REMIC See “Certain Federal Income Tax Consequences” in the REMIC Prospectus

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THE MBS CERTIFICATES

General The MBS Certificates underlying the REMIC Certificates are Fannie Mae Guaranteed

Mortgage Pass-Through Certificates, which will have an aggregate unpaid principal amount of

$500,000,000, Pass-Through Rates of 9.50% and the general characteristics described in the attached MBS Prospectus The Mortgage Loans that underlie the MBS Certificates are conventional Level Payment Mortgage Loans, each secured by a first mortgage or deed of trust on a one- to four-family (“single-family”) residential property, and all of which have an original maturity of up to 30 years, as described under “The Mortgage Pools” and “Yield Considerations” in the MBS Prospectus The weighted average coupon of the Mortgage Loans in each Pool at the Issue Date of the related MBS Certificate (“WAC”) was within the range of 9.75% to 12.00% per annum The weighted average remaining term to maturity, in months, of the Mortgage Loans in each Pool at the Issue Date of the related MBS Certificate (“WAM”), less the number of months elapsed from such Issue Date through the July 1, 1990 REMIC Issue Date (“Adjusted WAM”), or the current WAM, if available, will not be less than 180 or greater than 360 The weighted average of the Adjusted WAMs (or current WAMs, to the extent available) of all the MBS Certificates underlying the REMIC Certificates is expected to be approximately 356 months Following the issuance of the REMIC Certificates, Fannie Mae will prepare a Final Data Statement setting forth the Pool number, the WAC at the Issue Date (or current WAC, to the extent available) and the Adjusted WAM (or current WAM, to the extent available) of each MBS Certificate underlying the REMIC Certificates, along with the weighted average of all the WACSs (or of any available current WACs) and the weighted average of all the Adjusted WAMs (or of any available current WAMs) based on the current unpaid principal balances of the MBS Certificates

as of the REMIC Issue Date The Final Data Statement will also include the MBS Percentage Schedule as further described herein, Final Data Statements will not accompany Prospectus Supplements but will be made available by Fannie Mae To request Final Data Statements, telephone Fannie Mae at (202) 752-7585 The contents of the Final Data Statement and other data specific to the REMIC Certificates are available in electronic form by calling Fannie Mae at (202) 782-6000

Prepayment Considerations and Risks The rate of principal payments of the MBS Certificates, and therefore of distributions on the REMIC Certificates, is related directly to the rate of payments of principal of the underlying Mortgage Loans, which may be in the form of scheduled amortization or prepayments (for this purpose, the term

“prepayment” includes prepayments and liquidations resulting from default, casualty, condemnation and payments made pursuant to any guaranty of payment by, or option to repurchase of, Fannie Mae)

In general, when the level of prevailing interest rates declines significantly below the interest rates on fixed-rate mortgage loans, the rate of prepayment is likely to increase, although the prepayment rate is influenced by a number of other factors, including general economic conditions and homeowner mobility See “Maturity and Prepayment Assumptions” in the MBS Prospectus

Acceleration of mortgage payments as a result of transfers of the mortgaged property is another factor affecting prepayment rates The Mortgage Loans underlying the MBS Certificates will generally provide by their terms that, in the event of the transfer or prospective transfer of title to the underlying mortgaged property, the full unpaid principal balance of the Mortgage Loan is due and payable at the option of the holder As set forth under “Description of Certificates—Collection and Other Servicing Procedures” in the MBS Prospectus, Fannie Mae is required to exercise its right to accelerate the maturity of’Mortgage Loans containing enforceable “due-on-sale” provisions upon certain transfers of the mortgaged property

Prepayments of mortgage loans commonly are measured relative to a prepayment standard or model The mode! used in this Prospectus Supplement, the Public Securities Association's standard prepayment model (“PSA”), represents an assumed rate of prepayment each month of the then outstanding principal balance of a pool of new mortgage loans PSA does not purport to be either a historical description of the prepayment experience of any pool of mortgage loans or a prediction of the anticipated rate of prepayment of any pool of mortgage loans, including the Mortgage Loans underlying the MBS Certificates backing the PEMIC Certificates 100% PSA assumes prepayment

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rates of 0.2% per annum of the then unpaid principal balance of such mort i

of the life of the mortgage loans and an additional 0.2% per annum inch eth theeater tục example, 0.4% per annum in the second month) until the 30th month Beginning in the 30th month and

in each month thereafter during the life of the mortgage loans, 100% PSA assumes a constant prepayment rate of 6% per annum Multiples will be calculated from this prepayment rate series; for example, 165% PSA assumes prepayment rates will be 0.33% per annum in month one, 0.66% per annum in month two, reaching 9.9% per annum in month 30 and remaini

annum thereafter 0% PSA assumes no prepayments - mun Constant of 9.9% per

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DESCRIPTION OF THE REMIC CERTIFICATES The following summaries describing certain provisions of the REMIC Certificates do not purport to be complete and are subject to, and are qualified in their entirety by reference to, the REMIC Prospectus and the provisions of the Trust Agreement

General

Two separate trust funds will be created pursuant to the Trust Agreement, and elections will

be made to treat each trust fund as a REMIC for federal income tax purposes

One trust fund (the “Lower Tier REMIC”) will consist of the MBS Certificates The entire beneficial ownership interest in the Lower Tier REMIC will be evidenced by the Lower Tier Interests and the Class 89-RL REMIC Certificates Each of the Lower Tier Interests will be designated as a

“regular interest” in the REMIC constituted by the Lower Tier REMIC and will bear interest at the rate

of 9.50% per annum The initial aggregate principal amount of the Lower Tier Interests, together with the initial principal amount of the Class 89-RL REMIC Certificates, equals the initial aggregate principal amount of the REMIC Certificates The Lower Tier Interests, together with the Class 89-RL REMIC Certificates, in the aggregate, will evidence the entire beneficial ownership interest in the distributions of principal and interest on the MBS Certificates The Class 89-RL REMIC Certificates will be designated as the “residual interest” in the REMIC constituted by the Lower Tier REMIC and will have the characteristics described herein,

The second trust fund (the “Trust”) will consist of the Lower Tier Interests The entire beneficial ownership interest in the Trust will be evidenced by the REMIC Certificates, other than the

Class 89-RL REMIC Certificates, as described herein

Distributions of Interest

The REMIC Certificates, other than the Class 89-R REMIC Certificates, will bear interest at

the respective per annum interest rates described on the cover hereof Interest on the REMIC Certificates is calculated on the basis of a 360-day year consisting of twelve 30-day months and is payable monthly on each Distribution Date, commencing (except in the case of the Class 89-X, Class 89-Y and Class 89-Z REMIC Certificates, which are Accrual Certificates) in August 1990 Interest to

be distributed or added to principal of each REMIC Certificate on a Distribution Date will consist of one month’s interest on the outstanding principal amount of such REMIC Certificate immediately prior to such Distribution Date Interest to be distributed or added to principal on a Distribution Date will accrue on the REMIC Certificates, other than the Class 89-F, Class 89-S and Class 89-R REMIC Certificates, during the calendar month preceding the month in which such Distribution Date occurs

In the case of the Class 89-F and Class 89-S REMIC Certificates, such interest will accrue during the one-month period beginning on the 25th day of such preceding month and ending on the 24th day of the month of such Distribution Date (each, an “Interest Accrual Period”)

Interest will accrue on the Accrual Certificates at the per annum interest rate of 9.50%;

however, such interest will not be distributed to Holders of the Accrual Certificates but rather will be added to the principal balances thereof on each Distribution Date (i) until after the principal balance of the Class 89-B REMIC Certificates has been reduced to zero, in the case of the Class 89-X REMIC Certificates, and (ii) in the case of the Class 89-Y and Class 89-Z REMIC Certificates, for so long as the Class 89-Y and Class 89-Z REMIC Certificates, respectively, are outstanding Interest so accrued and unpaid on theAccural Certificates will be added to the principal amounts thereof on the applicable

Interest will accrue on the Class 89-F REMIC Certificates at the per annum rate of 8.8125%

during the initial Interest Accrual Period, and will accrue during each Interest Accrual Period

thereafter, subject to a maximum per annum interest rate of 11.00% and a minimum per annum rate of 0.50%, at a variable per annum rate equal to 50 basis points in excess of the London interbank offered rate for one-month U.S dollar deposits (“LIBOR”) Interest will accrue on the Class 89-S REMIC Certificates at the per annum rate of 10.05% during the initial Interest Accrual Period, and will accrue during each Interest Accrual Period thereafter, subject to a maximum per annum interest rate of 16.7%

and a minimum per annum interest rate of 8.3%, at a variable per annum rate equal to 16.7%— (0.8 X LIBOR) in each case, the applicable rate will be determined monthly on the second business day prior

to the first day of the related Interest Accrual Period (the “LIBOR Determination Date”) The yields

with respect to the Class 89-F and Class 89-S REMIC Certificates will be affected by changes in LIBOR, which may not correlate with changes in mortgage interest rates It is possible that lower mortgage interest rates could occur concurrently with an increase in the level of LIBOR Conversely, higher mortgage interest rates could occur concurrently with a decrease in the level of LIBOR

The effective yield on the REMIC Certificates, other than the Class 89-F, Class 89-S and Class 89-R REMIC Certificates, will be reduced below the yield otherwise produced because interest payable with respect to an Interest Accrual Period will not be distributed until the 25th day following the end of such Interest Accrual Period and will not bear interest during such delay

Calculation of LIBOR Commencing on August 23, 1990 and thereafter on each LIBOR Determination Date, until the principal amounts of the Class 89-F and Class 89-S REMIC Certificates have been reduced to zero, Fannie Mae or its agent (initially State Street Bank and Trust Company in Boston, Massachusetts, hereinafter referred to as “State Street”) will request each of the designated reference banks meeting

the criteria set forth herein (the “Reference Banks”) to inform State Street of the quotation offered by

its principal London office for making one-month United States dollar deposits in leading banks in the London interbank market, as of 11:00 a.m (London time) on such LIBOR Determination Date (For purposes of calculating LIBOR, “business day” means a day on which banks are open for dealing in foreign currency and exchange in London, Boston and New York City.) In lieu of making a request of the Reference Banks, State Street may rely on the quotations for those Reference Banks that appear at such time on the Reuters Screen LIBO Page (as defined in the International Swap Dealers Association, Inc Code of Standard Wording, Assumptions and Provisions for Swaps, 1986 Edition), to the extent available

LIBOR will be established by State Street on each LIBOR Determination Date as follows:

(a) If on any LIBOR Determination Date two or more Reference Banks provide such offered quotations, LIBOR for the next Interest Accrual Period shail be the arithmetic mean

of such offered quotations (rounded upwards if necessary to the nearest whole multiple of

1/32%)

(b) If on any LIBOR Determination Date only one or none of the Reference Banks

provides such offered quotations, LIBOR for the next Interest Accrual Period shall be

whichever is the higher of (i) LIBOR as determined on the previous LIBOR Determination Date or (ii) the Reserve Interest Rate The “Reserve Interest Rate” shall be the rate per annum

which State Street determines to be either (i) the arithmetic mean (rounded upwards if

necessary to the nearest whole multiple of 1/32%) of the one-month United States dollar lending rates that New York City banks selected by State Street are quoting, on the relevant LIBOR Determination Date, to the principal London offices of at least two of the Reference Banks to which such quotations are, in the opinion of State Street being so made, or (ii) in the event that State Street can determine no such arithmetic mean, the lowest one-month United States dollar lending rate which Néw York City banks selected by State Street are quoting on such LIBOR Determination Date to leading European banks

(c) If on the August 23, 1990, LIBOR Determination Date, State Street is required but is unable to determine the Reserve Interest Rate in the manner provided in paragraph (b) above,

LIBOR shall be 8.3 125%,

Each Reference Bank (i) shall be a leading bank engaged in transactions in Eurodollar deposits in the international Eurocurrency market; (ii) shall not control, be controlled by, or be under

WA FAs

The establishment of LIBOR on each LIBOR Determination Date by State Street and State Street’s calculation of the rate of interest applicable to the Class 89-F and Class 89-S REMIC Certificates for the related Interest Accrual Period shall (in the absence of manifest error) be final and binding Each such rate of interest may be obtained by telephoning State Street at (617) 654-4067 or

Fannie Mae at (202) 752-6547 `

Distributions of Principal Principal will be distributed monthly on the Lower Tier Interests and the Class 89-RL REMIC Certificates in an amount equal to the aggregate distributions of principal concurrently made

on the MBS Certificates (the “Cash Flow Distribution Amount”), On each Distribution Date, the Class

89-RL REMIC Certificates will receive approximately 002% of the Cash Flow Distribution Amount, which percentage is equal to the proportion that the original principal amount of such Class bears to the aggregate original principal amount of the Lower Tier Interests plus the Class 89-RL REMIC Certificates The balance of the Cash Flow Distribution Amount (the “Lower Tier Regular

Distribution Amount”) will be distributed as principal of the Lower Tier Interests held by the Trust

The principal distribution on the REMIC Certificates, other than the Class 89-RL REMIC Certificates, on each Distribution Date (the “Principal Distribution Amount”) will be in an amount equal to the sum of (i) the Lower Tier Regular Distribution Amount and (ii) any interest accrued and added on such Distribution Date to the principal amounts of the Accrual Certificates

The Class 89-A, Class 89-B, Class 89-X, Class 89-C, Class 89-D, Class 89-E, Class 89-G, Class 89-H, Class 89-J, Class 89-K, Class 89-L and Class 89-R REMIC Certificates are “Planned Principal REMIC Certificates” and the amount necessary to reduce the outstanding principal balances

of the Planned Principal REMIC Certificates to their respective Planned Principal Balances on any

Distribution Date is referred to herein as the “Planned Principal Amount.”

On each Distribution Date, the Principal Distribution Amount will be applied to the

distribution of principal of the Classes of REMIC Certificates in the following order of priority:

(i) to the Classes of Planned Principal REMIC Certificates, in the following order and in

the proportions set forth below, in an amount up to the amount necessary to reduce their outstanding principal balances to their respective Planned Principal Balances as set forth in the table beginning on page S-16 for such Distribution Date (which amount will be zero, except in the case of the Class 89-L and Class 89-R REMIC Certificates, until the Distribution Date in June 1992):

Allocated to Class listed in

preceding Column Class 89-L

ii) on each and every Distribution Date, beginning on the Distribution Date, if any, for

which the Cash Flow Distribution Amount is greater than the related MBS Payment Amount

(as defined below), to the Class 89-Y REMIC Certificates (the “Class 89-Y Priority Amount”), until the principal balance thereof has been reduced to zero;

(iv) concurrently, to the Class 89-F, Class 89-S and Class 89-N REMIC Certificates, in

the proportions of 22.2227637126%, 27.7784546407% and 49.9987816467%, respectively,

until the principal balance of the Class 89-N REMIC Certificates has been reduced to zero;

(v) concurrently, to the Class 89-F, Class 89-S and Class 89-0 REMIC Certificates, in the proportions of 22.2227637126%, 27.7784546407% and 49,99878 16467%, respectively, until

the principal balances thereof have been reduced to zero;

(vi) to the Class 89-P REMIC Certificates, until the principal balance thereof has been

reduced to zero;

(vii) if the Class 89-Y REMIC Certificates are then outstanding, concurrently, to the Class 89-Y and Class 89-Z REMIC Certificates, in proportion to their original principal balances (or approximately 50.6% and 49.4%, respectively), until the principal balance of the Class

89-Y REMIC Certificates has been reduced to zero;

(viii) if the Class 89-Z REMIC Certificates are then outstanding, to the Class 89-Z REMIC Certificates, until the principal balance thereof has been reduced to zero;

(ix) to the Class 89-M REMIC Certificates, without regard to their Targeted Principal Balance and until the principal balance thereof has been reduced to zero; and

(x) to the Planned Principal REMIC Certificates, in the order and in the Proportions set forth in clause (i) above, without regard to their respective Planned Principal Balances and until their respective principal balances have been reduced to zero

Because the timing and amount of distributions of principal of the REMIC Certificates will depend on the rate of principal payments (including prepayments) of the Mortgage Loans underlying

the MBS Certificates, there can be no assurance as to the timing of distributions of principal of the

The MBS Payment Amount will equal the product of the corresponding MBS percentage on the MBS Percentage Schedule (as described below) for each Distribution Date multiplied by the aggregate unpaid principal amount of the MBS Certificates (the “MBS Balance”) immediately preceding such Distribution Date An MBS Balance Schedule will be calculated by Fannie Mae based upon the actual characteristics of the MBS Certificates delivered to the Trust (which characteristics will vary from the characteristics assumed herein) Such MBS Balance Schedule will reflect the MBS Balance for each Distribution Date assuming that the Mortgage Loans underlying the MBS Certificates prepay at a constant rate of approximately 169% PSA and that all of the Mortgage Loans underlying each Pool have the same interest rate and remaining term as the WAC (or current WAC, if available) and Adjusted WAM (or current WAM, if available) of the respective Pool The MBS

Pe ge Schedule will rep the p ge decrease from one Distribution Date to the next in the MBS Balance Schedule Consequently, at prepayment levels higher than approximately 169%

PSA, the Cash Flow Distribution Amount for each Distribution Date will be greater than the related MBS Payment Amount The determination by Fannie Mae of the MBS Percentage Schedule will be final and binding and will be included in the Final Data Statement referred to herein under “The MBS Certificates—General.” The MBS Balance Schedule will not be included in the Final Data Statement