Weighted Average Coupon

Core Description

• Weighted Average Coupon (WAC) is the mortgage pool’s “headline coupon” for an MBS: a fast way to summarize the average borrower note rate, weighted by outstanding principal.
• Weighted Average Coupon is not a return forecast, because realized performance can move away from WAC due to prepayments, defaults, fees/servicing, and tranche structure.
• In practice, investors use Weighted Average Coupon together with WAL, OAS, and scenario cash-flow analysis to understand reinvestment risk, negative convexity, and how the MBS fits within a risk budget.

Definition and Background

Weighted Average Coupon (WAC) describes the average interest rate of the mortgages inside a mortgage-backed security (MBS), weighted by each loan’s current outstanding principal balance. In plain language: larger remaining loans “count more” in the average than smaller remaining loans.

What WAC is (and what it isn’t)

• What it is: a collateral statistic that summarizes the pool’s gross borrower coupon level.
• What it isn’t: the investor’s yield, IRR, or total return. Even with the same Weighted Average Coupon, two MBS positions can deliver different results if prices, fees, and prepayment speeds differ.

Why the market uses WAC

Modern MBS markets expanded in the 1970s–1980s as agency mortgage pooling became standardized. Investors needed a single, comparable number to summarize pools that contained thousands of loans with different note rates and balances. Weighted Average Coupon became a widely quoted metric because it is simple, intuitive, and available in standard deal disclosures.

Why WAC becomes “context-dependent” over time

Weighted Average Coupon can drift after issuance because the pool is not static:

• Refinancing and prepayments remove loans from the pool, changing the weights.
• Amortization reduces balances over time, also changing the weights.
• Defaults and liquidations can remove principal and alter composition.

A key takeaway is to always check whether a source is showing original WAC (at issuance) or current WAC (as of a reporting cutoff date). In volatile rate cycles, the two can diverge meaningfully.

Calculation Methods and Applications

Weighted Average Coupon is computed by weighting each loan’s note rate by its outstanding balance, then dividing by total outstanding balance. This is the standard principal-weighted average used in MBS disclosure and analytics.

WAC formula (principal-weighted average)

\[\text{WAC}=\frac{\sum_{i=1}^{n}(\text{Rate}_i\times \text{Balance}_i)}{\sum_{i=1}^{n}\text{Balance}_i}\]

Step-by-step calculation workflow

1. Gather loan-level (or cohort-level) data: note rate and current outstanding principal.
2. Multiply each loan’s rate by its balance to get Rate × Balance.
3. Sum all Rate × Balance.
4. Sum all balances.
5. Divide and express the result as a percentage.

Simple example (hypothetical numbers for illustration)

Assume two loans in a pool:

Weighted Average Coupon:

• Numerator = 8,000 + 5,000 = 13,000
• Denominator = 300,000
• WAC = 13,000 / 300,000 = 4.33%

Where WAC is used in real analysis

Weighted Average Coupon is most useful as a starting input in MBS workflows.

Screening and comparison

Traders and portfolio managers often use Weighted Average Coupon to quickly compare coupon profiles across similar pools. When two pools share similar collateral type and seasoning, WAC can help explain why one might have a different prepayment profile than another.

Prepayment incentive “first pass”

A pool with a higher Weighted Average Coupon can have a larger incentive to refinance when market mortgage rates fall, which may accelerate prepayments and shorten expected cash flows. This is not a full prepayment model, but it is a practical first filter.

Context for cash-flow modeling

In scenario analysis, Weighted Average Coupon helps estimate gross interest generation before:

• servicing and guaranty fees,
• prepayment assumptions (e.g., CPR/PSA),
• default and loss assumptions (for credit-sensitive MBS),
• tranche allocation rules.

Comparison, Advantages, and Common Misconceptions

Weighted Average Coupon is popular because it is simple. That simplicity can also create common mistakes, especially when readers treat WAC as if it were yield.

WAC compared with related metrics

WAC vs. pass-through / net coupon

• Weighted Average Coupon: gross borrower note rate average in the pool.
• Pass-through (net) coupon: what investors receive on the security after deductions (servicing, guaranty/administrative fees, trust expenses).

As a result, the security’s net coupon is typically lower than Weighted Average Coupon.

WAC vs. WAL (Weighted Average Life)

• Weighted Average Coupon is about the level of rates in the collateral.
• WAL is about the timing of principal return under a prepayment assumption.

Two pools can share the same Weighted Average Coupon but have very different WAL if borrower behavior differs or if the structure reallocates principal differently.

WAC vs. WAM (Weighted Average Maturity)

• WAM summarizes remaining term to maturity (timing/extension exposure).
• WAC summarizes coupon level (income profile).

Using both helps reduce false comparisons (for example, a high WAC pool with long WAM can behave very differently from a high WAC pool with shorter WAM).

WAC vs. yield (YTM/IRR/OAS)

• Yield/IRR depends on price paid, timing of cash flows, and reinvestment assumptions.
• OAS (Option-Adjusted Spread) attempts to adjust spread for embedded prepayment option behavior using a model and interest-rate paths.

Weighted Average Coupon is not a replacement for these measures. It is an input that helps describe the collateral’s coupon profile.

Advantages and limitations (quick reference)

Common misconceptions and how to avoid them

Treating WAC as “expected yield”

Weighted Average Coupon does not include:

• the purchase price (premium/discount),
• fee deductions,
• changes in cash-flow timing from prepayments,
• credit losses (where relevant).

A high Weighted Average Coupon can still be associated with weaker realized outcomes if the security is purchased at a premium and prepays quickly, which can increase reinvestment risk.

Using original balances instead of current balances

WAC should be weighted by current outstanding principal, because prepaid or amortized loans no longer generate interest in the same way. Using original balances can overstate the influence of loans that have already paid down.

Ignoring ARM resets or teaser structures

For adjustable-rate mortgages (ARMs) or loans with resets, caps, and floors, a single Weighted Average Coupon snapshot may not represent future coupon behavior. Investors often supplement WAC with reset schedules and rate-path scenarios.

Assuming WAC stays constant

If higher-coupon borrowers refinance faster, the remaining pool may skew to lower coupons, reducing current Weighted Average Coupon. The reverse can also happen in certain environments. Always confirm the “as of” date.

Practical Guide

This section turns Weighted Average Coupon from a definition into a repeatable checklist you can apply when reading an MBS term sheet, servicer report, or analytics screen. The goal is not to select securities based on the highest WAC, but to understand what could cause performance to differ from Weighted Average Coupon.

A practical checklist for using WAC in MBS analysis

Clarify what the WAC number refers to

• Is it pool WAC (a collateral statistic) or a security-level field displayed in an analytics system?
• Is it original WAC or current WAC? Record the cutoff date.

Reconcile WAC with net coupon and fees

Identify what sits between borrower coupons and investor cash flows:

• servicing fee,
• guaranty/administrative fee,
• trust expenses,
• any other structural deductions.

Even if Weighted Average Coupon is stable, changes in fee treatment or servicing transfers can change net cash received.

Link WAC to prepayment risk (refinancing incentive)

As a working habit, compare Weighted Average Coupon to prevailing mortgage rates and your prepayment assumptions:

• If WAC is well above prevailing rates, refinance incentive may be higher, which can shorten WAL and increase reinvestment risk.
• If WAC is near or below prevailing rates, prepayments may slow, which can extend WAL.

This is not a prediction. It is a structured way to frame scenarios.

Use WAC with WAL and OAS, not instead of them

A practical trio used by many investors:

• Weighted Average Coupon: “headline coupon” of the pool
• WAL: expected principal timing under a prepayment assumption
• OAS: model-based spread adjusted for prepayment option behavior

Together, they help assess negative convexity and reinvestment risk, which Weighted Average Coupon alone cannot measure.

Data hygiene checks that help avoid errors

• Confirm balances are current and consistent across sources.
• Watch for rounding and missing fields in loan tapes.
• Keep an audit trail of “as of” dates when comparing pools.

Case study: why WAC alone can mislead (hypothetical scenario, not investment advice)

Assume two pass-through MBS pools, each with \$ 100 million current collateral balance and similar collateral type. Both show the same Weighted Average Coupon of 5.00%, but they trade at different prices and face different prepayment outcomes.

Pool X (premium price, faster prepayment scenario)

• Weighted Average Coupon: 5.00%
• Price: 104 (paying a premium)
• Scenario A: refinancing activity increases prepayments; principal returns sooner than expected

Pool Y (closer to par, slower prepayment scenario)

• Weighted Average Coupon: 5.00%
• Price: 100 (near par)
• Scenario B: prepayments slow; principal returns later than expected

What the example illustrates:

• Even though Weighted Average Coupon is identical, Pool X can have more premium-at-risk if prepayments accelerate, because more principal returns at par while the investor paid above par.
• Pool Y may have less premium risk but can carry more extension risk if rates rise and prepayments slow, pushing cash flows further out.

The takeaway is that Weighted Average Coupon should be evaluated alongside drivers that can cause realized results to differ from WAC:

• prepayments (timing changes),
• defaults and losses (for credit-sensitive deals),
• fees/servicing (net coupon differences),
• tranche structure (principal allocation, triggers, and cash-flow rules).

Platform workflow note (research context)

If you use a brokerage or analytics platform (for example, Longbridge) to review MBS data fields, treat Weighted Average Coupon as a screening variable and document:

• which WAC field is shown (pool vs. security vs. tranche),
• whether it is original or current,
• which report date it corresponds to.

Then evaluate how that Weighted Average Coupon exposure fits within your portfolio’s risk budget, rather than using WAC as a standalone decision metric.

Resources for Learning and Improvement

A practical way to improve your understanding of Weighted Average Coupon is to study it in the same sequence often used in professional workflows: official disclosures, market primers, and then textbooks.

Official disclosure and agency materials

• Agency disclosure templates and MBS reporting glossaries (pool factors, coupon fields, collateral summaries)
• Pass-through structure guides that explain servicing and fee mechanics

These materials can help clarify where Weighted Average Coupon appears, how it is defined in reporting, and how it relates to other pool statistics.

Market primers and professional curricula

• Fixed-income and securitization primers from major market associations
• CFA Program fixed-income readings on MBS cash-flow behavior, prepayment risk, and how coupon metrics differ from yield metrics

These sources often explain the conceptual link between Weighted Average Coupon and option-adjusted measures such as OAS.

Practitioner and academic references

• Frank J. Fabozzi’s mortgage-backed securities references for detailed discussion of prepayment modeling, cash-flow waterfalls, and pool statistics
• Central bank and securities regulator publications discussing mortgage markets, prepayment dynamics, and reporting conventions

These can help connect “what WAC is” with “how WAC behaves under scenarios.”

FAQs

What is Weighted Average Coupon (WAC) in an MBS?

Weighted Average Coupon (WAC) is the principal-weighted average of the borrower note rates in the mortgage pool backing an MBS. It summarizes the pool’s coupon profile as a single number.

How do you calculate Weighted Average Coupon?

You multiply each loan’s note rate by its current outstanding balance, sum those products, and divide by the total outstanding balance. This produces a balance-weighted average coupon.

Is Weighted Average Coupon the same as yield or IRR?

No. Weighted Average Coupon is a collateral coupon statistic, while yield or IRR depends on the security’s price, timing of cash flows, fees, and prepayments. Two securities can share the same Weighted Average Coupon and have different realized outcomes.

Why can Weighted Average Coupon change after issuance?

As borrowers prepay, refinance, amortize, or default, the remaining balances (the weights) change. If higher-coupon loans exit faster, current Weighted Average Coupon may drift downward.

Does a higher Weighted Average Coupon always mean a better investment?

Not necessarily. A higher Weighted Average Coupon can also be associated with higher refinance incentive and faster prepayments, which may reduce the time an investor earns that coupon and increase reinvestment risk. Price paid and structure also matter.

What is the relationship between WAC and the pass-through (net) coupon?

Weighted Average Coupon reflects gross borrower coupons. The pass-through coupon is typically lower because servicing and guaranty/administrative fees are deducted before interest is paid to investors.

What should I pair with Weighted Average Coupon for decision-making?

Common companion measures include WAL (timing), OAS (option-adjusted compensation), and cash-flow scenarios that vary prepayment and rate environments. This combination helps address reinvestment and convexity risk that Weighted Average Coupon cannot measure by itself.

What are the most common mistakes when reading WAC on a platform screen?

Common mistakes include mixing up original vs. current Weighted Average Coupon, using original balances instead of current balances, confusing pool WAC with tranche-level metrics, and treating WAC as if it were the investor’s yield.

Conclusion

Weighted Average Coupon (WAC) is best understood as the mortgage pool’s “headline coupon”: a widely used statistic that summarizes the average borrower note rate in an MBS, weighted by outstanding principal. Its primary value is speed and comparability, especially for a first-pass view of coupon profile and potential refinance incentive.

At the same time, Weighted Average Coupon is not a return forecast. Realized performance can differ from WAC due to prepayments, defaults, fees and servicing, and tranche structure. A more complete approach is to use Weighted Average Coupon as an initial anchor, then pair it with WAL, OAS, and scenario-based cash-flow analysis to evaluate reinvestment risk and convexity risk with clearer assumptions.