SECURITISATION RESEARCH Residential Credit Strategy | 18 September 2009


Non-agency derivatives are a class of bonds created by stripping out part or whole of the
interest or principal cash flow paid to a collateral group and diverting the cash flows to a
bond. Within this rather simplistic definition lies an entire gamut of structures, ranging
from fixed rate IOs paying an annual interest rate of 50bp to principal + inverse IO
structures that could pay out coupons north of 30% if Libor remains low. In this piece, we
provide an introduction to common non-agency derivatives and examine factors that
drive their valuation. In addition to providing ways to hedge risks in other non-agency
bonds, they remain one of the very few securities with high double-digit yields.