What is Weighted Average Coupon ?

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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 repaid at different lengths of time, so the WAC represents its return at the time it was issued and may differ from its WAC later.

Definition

The Weighted Average Coupon (WAC) measures the return rate of a pool of mortgages sold to investors in the form of Mortgage-Backed Securities (MBS). WAC reflects the return rate at the time of issuance, although these underlying mortgages are repaid over different time periods, and the coupon may vary.

Origin

The concept of WAC originated with the development of the mortgage-backed securities market. As MBS gained popularity in the 1970s, investors needed a way to assess the potential yield of these securities, leading to the introduction of WAC as a standardized measurement tool.

Categories and Features

WAC is calculated based on the coupon of each mortgage and its weight in the entire loan pool. It is characterized by providing a comprehensive yield indicator, helping investors assess the overall return potential of MBS. The advantage of WAC is its ability to simplify complex loan portfolio analysis, but its disadvantage is that it may not accurately reflect the risk of individual loans.

Case Studies

Case 1: During the 2008 financial crisis, many MBS had a high WAC, but the actual yield significantly decreased due to increased default risk of the underlying loans. Case 2: In 2015, an investment firm purchased a set of MBS with a WAC of 4.5%. Despite market interest rate fluctuations, the firm predicted relatively stable returns by analyzing the WAC.

Common Issues

Investors often misunderstand WAC as representing the actual yield, overlooking the impact of market interest rate changes and loan default risks on actual returns. Additionally, WAC should not be used alone to assess the risk of MBS; it should be combined with other indicators for a comprehensive analysis.

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