Interest Only Strip

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Interest Only Strip

A derivative security whose cash flow derives exclusively from interest payments on various debt securities. That is, the underlying asset of an interest-only strip is interest paid on debt securities, rather than the debt securities themselves. Many interest only strips are backed by mortgage interest, but some are also backed by Treasury securities and other debt securities. Interest-only strips are derived from bonds whose coupons are legally separated, or "stripped", from the bonds themselves.
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IO strips are precisely the same instrument as excess servicing.
First, IO strips represent less than 2% of total assets at March 31, 1998.
The underlying securities remaining in Structured Asset Securities Corporation 2007-5R consist of Lehman Mortgage Trust 2007-3 class 2A1 (rated 'CC/RR3' by Fitch), Structured Asset Securities Corporation 2004-20 class AP (rated 'A/LS1'; Outlook Stable by Fitch), Structured Asset Securities Corporation 2005-1 class AP (rated 'B/LS1; Outlook Negative by Fitch), Structured Asset Securities Corporation 2005-5 class AP (rated 'CCC/RR3' by Fitch), several Fannie Mae and Freddie Mac Principal Only bonds, and two Freddie Mac IO strips.
According to the complaint, the true facts, which were known by each of the defendants but concealed from the investing public during the Class Period, were as follows: (a) the Company was using overly aggressive and unrealistic assumptions to value its derivative portfolio of IO Strips used to hedge its mortgage portfolio against interest rate fluctuations; (b) the Company was using fraudulent accounting practices and materially overstated its net income, net gain on mortgage loan sales and net capital; and (c) the Company was using ineffective risk management and hedging strategies against the increasing risk of rising interest rates.
In fact, I was puzzled a while ago over the seeming dichotomy of servicing trading at lower yields than interest-only (IO) strips even though I know, and the market knows, that servicing has the same prepayment risks as IO strips plus credit risk, regulatory risk and operational risk.