What is the weighted average remaining term (WART)?
The weighted average remaining term (WART) statistic determines the average duration till maturity of an asset-backed securities (ABS) portfolio. The average maturity period of the portfolio’s assets increases with a longer WART.
WART, sometimes referred to as the weighted average maturity (WAM), is a term that is frequently used in connection with mortgage-backed securities (MBS) but may be used for any fixed-income security portfolio.
The inverse of WART, weighted average loan age (WALA), is strongly associated with WART.
The Calculation of the Weighted Average Remaining Term (WART)
An investor may determine if the assets in a portfolio have a relatively short or lengthy time to maturity by looking at the portfolio’s weighted average rate of return (WART). An MBS with mortgages that have just been launched would have a higher WART overall than one whose underlying mortgages are all incredibly close to the conclusion of their periods. Confident investors may want to be exposed to assets with a certain maturity period, depending on their financing sources and risk tolerance.
The investor first totals the outstanding amount of the underlying assets and determines the size of each asset in proportion to that total to assess the WART of the portfolio. Next, the investor would use each asset’s relative size to calculate how long it would take to mature. Lastly, they would total the weighted times to maturity of all the assets in the portfolio to get a WART.
WART is frequently present in MBS disclosure documents, including those that Freddie Mac provides. WART is used in this context to show how external factors, like prepayment, affect a security’s WART rather than to compare two securities. When evaluating a Freddie Mac asset, an investor may consider these WART computations to compare it to other investments or to build a portfolio with varying WARTs.
An instance of WART
Consider an MBS with four mortgage loans: loan 1 has a remaining principal balance of $150,000 due in five years; loan 2 has a principal balance of $200,000 due in seven years; loan 3 has a principal balance of $50,000 due in ten years; and loan 4 has a principal balance of $100,000 due in twenty years. Therefore, the total remaining loan value is $500,000.
Our next step would be determining how much of the total residual value is owed to each mortgage to compute the WART. We would determine that loan 1 represents 30% of the total, loan 2 represents 40%, loan 3 represents 10%, and loan 4 represents 20% by dividing the remaining principal from each mortgage by the total amount of $500,000.
The weighted remaining term of each mortgage may then be determined by multiplying its time to maturity by its portion of the $500,000 total. Upon doing so, we discover the following weighted residual terms:
- Loan 1: 1.5 weighted years x 5 years x 30%
- Loan 2: 2.8 weighted years x 7 years x 40%
- Loan 3: 1 weighted year (10 years x 10%).
- Loan 4: Four weighted years (20 years x 20%).
The last thing we need to do is add up these weighted years to obtain the WART for the whole portfolio. Our WART, in this instance, is 1.5 + 2.8 + 1 + 4 = 9.3 years.
Interest rate risk and WART
Longer-term bonds and other fixed-income instruments are often more sensitive to changes in interest rates in terms of price than shorter-term securities (sometimes referred to as the tenure of the asset). As a result, bonds held by MBS and ABS with higher WARTs often have a higher interest rate risk than those with lower WARTs.
Laddering is one method of lowering this kind of risk. Buying bonds with varying maturity dates is known as bond laddering, and it is an investing technique that allows the investor to get their money back from the portfolio at various intervals throughout time. By gradually allowing the owner to reinvest bond maturity proceeds at current interest rates, a laddering technique lowers the risk of reinvesting the whole portfolio during a period of low interest rates.
Income-oriented investors use WART to evaluate their bond portfolios and bond laddering to help them maintain a reasonable interest rate.
WALA versus WART
Fixed-income portfolios can be evaluated for credit risk, interest rate sensitivity, and potential profitability using the weighted average remaining term (WART) and average loan age (WALA). Mortgage-backed securities (MBS) pools’ maturity is typically gauged using weighted average maturity (WAM). It calculates the duration, weighted according to the amount invested, until the securities in a fixed-income portfolio mature. Changes in interest rates are more likely to affect portfolios with higher WARTs.
In essence, WALA is the opposite of WART: the weighted average maturity of the bonds in the portfolio equals the sum of the subtotals multiplied by each percentage, the number of months or years until the bond’s maturity.
Prepayment Risk: What Is It?
Prepayment risk, which affects MBS and ABS, is the decrease in the fund’s weighted average ratio of debt (WART) brought on by homeowners or other debtors refinancing their loans or making early, irregular payments. These repayments shorten the average maturity of a portfolio while also changing its risk profile. This poses a risk, in particular when interest rates are dropping.
For instance, when a mortgage is refinanced, the initial debt is entirely repaid and replaced with a new loan with a lower interest rate. Funds holding MBS with the original mortgage will no longer receive cash flows from that homeowner.
What Does a Mortgage-Backed Security (MBS) Serve as?
In essence, mortgage-backed securities (MBS) combine several individual mortgages into a single security. The idea is that while any single home loan may have the idiosyncratic risk that the borrower will default, a portfolio of many mortgages would mute the effect of any single bad loan.
What Is the Difference Between Weighted Average Maturity (WAM) and Weighted Average Life (WAL)?
WAM and WAL are mainly used when evaluating money market funds. The difference between WAM and WAL is that WAM considers interest rate resets, and WAL does not. The SEC limits the WAL for money market mutual funds to 120 days.
The weighted average remaining term (WART) measures a fixed-income portfolio’s average time to maturity.
Conclusion
- WART is also known as weighted average maturity or WAM.
- It is often used for mortgage-backed securities (MBS) and other asset-backed securities (ABS), although it can be applied to any fixed-income portfolio.
- Some investors may prefer having exposure to investments with particular maturity profiles, making WART a helpful tool for comparing alternative investments.
- WART is particularly important in assessing a portfolio’s interest rate and prepayment risk exposures.
