Eagle Accounting takes an approach based on a level yield amortization method to recognize amortization and Interest income for MBS interest-only securities. Because Eagle Accounting takes a level yield amortization approach to processing income and amortization for MBS/ABS IO securities, Eagle Accounting treats each lot as an identified lot, regardless of whether the portfolio is set up with an Average Cost Basis where Cost Method (tag 22) is set to A in the entity and accounting basis.
Paydowns of a MBS Interest-only security do not produce a loss because Eagle Accounting brings down the proportional amount of cost and amortization to produce zero gain/loss. The amount of cost that a tax lot is being reduced by is equal to the amount of close amortization being brought down. The amount of close amortization is calculated based off the percentage of current face being reduced, with regard to the current face of the tax lot prior to processing the paydown.
Eagle Accounting uses this formula to recognize Interest Receivable:
IO Interest Receivable = (Original Face * Current Factor * Coupon / Day Count Basis)
Eagle Accounting uses this formula to recognize Interest Income:
Interest Income = (Cost of Investments * YTM) / Day Count Basis
Eagle Accounting uses this formula to calculate Total Daily Cost Adjustment (amortization):
(Cost Adjustment) = Interest Receivable - Interest Income
Eagle Accounting uses this formula to calculate Cost & Close Amortization as the result of Paydown:
% of Paydown = Current Amount of Paydown / Previous Current Face
Close Amortization = % of Paydown * Amortization Life to Date on the open Tax Lot
Close Amortization = Cost
Eagle Accounting uses this formula to recognize deferred IO:
Deferred IO = (Total Income PTD ) / Accr PTD) * Deferred Income
MBS IO Purchased Interest Example
Option | Value |
|---|---|
Trade Date | 4/28/00 |
Settle Date | 4/29/00 |
Purchase Price | 6.25 |
Original Face | 83,617,800 |
Current Face | 78,017,054.67 |
Current Factor | .9330197 |
Day Count | 30/360 |
Purchase YTM (user defined) | 20% |
Coupon Rate | 5.05% |
Initial Purchase
DR Investments (Tax Cost) | 4,876,065.92 | ||
DR Interest Receivable (purchased interest) | 306,433.65 | ||
CR Payable for Investments Purchased | 5,182,499.570 | ||
Purchased Interest = Current Face (78,017,054.67) * Coupon Rate (5.05% * Days in Accrual Period (28/360) = 306,433.65
MBS IO Daily Recognition of Daily Income Accrual
Option | Value |
|---|---|
Trade Date | 4/28/00 |
Settle Date | 4/29/00 |
Purchase Price | 6.25 |
Original Face | 83,617,800 |
Current Face | 78,017,054.67 |
Current Factor | .9330197 |
Day Count | 30/360 |
Purchase YTM | 20% (annualized) |
Coupon Rate | 5.05% (adjusted monthly) |
Daily Income Accrual
DR Interest Receivable | 10,944.05 | ||
CR Interest Income | 2,709.92 | ||
CR Cost of Investments | 8,235.13 | ||
Total Daily Income Accrual
(Original Face (83,617,800) * Current Factor (.9330197) * Coupon (5.05%)) / 360 = 10,944.05 (IO Interest Receivable)
Total Daily Interest Income
(Cost of Investments (4,876,066) * YTM (20%)) / 360 = 2,709.92 (Interest Income)
Total Daily Cost Adjustment
(Interest Receivable (10,944) - Interest Income (2,709)) = 8,235.13 (Cost Adjustment)
MBS IO Paydown Example
Option | Value |
|---|---|
Trade Date | 4/28/00 |
Settle Date | 4/29/00 |
Purchase Price | 6.25 |
Original Face | 83,617,800 |
Current Face | 78,017,054 |
Current Factor | .9330197 |
Day Count | 30/360 |
Purchase YTM | 20% (annualized) |
Coupon Rate | 5.05% (adjusted monthly) |
Factor Payment to 20000501 for .90 | |
Current Face | 78,017,054.67 |
Current Amortize | 4,859,595.66 |
No general Ledger entries are created for the paydown of an IO as the principal is reduced by the close amortization amount.
Par Reduction = Original Face * (Current Month Factor - Previous Month Factor), or 2,761,034.67 = 83,617,800 * (.90 - 0.9330197)
% of Paydown = Current amount of Paydown / Previous Current Face .035390142 = 2,761,034.67 / 78,017,054.67
Cost Reduction & Close Amortization = (% of Paydown * Amortization Life to Date) 582.88 = (0.035390142 * -16,470.26)
The paydown for a MBS/ABS Interest Only security is posted against zero cash, but because equal amounts of cost and amortization are reduced as a result of the paydown, no gain loss occurs. The amount of cost and amortization offset each other and therefore there are no general ledger entries when a paydown is processed for an MBS Interest Only security.
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