Mortgage Financing Mortgage - Backed Securities

Mortgage Financing & Mortgage - Backed Securities กรพินธ์ ศรีอาพลชาญ 434 56251 29 บุญเกิด เฉลียวไว อุรุพงษ์ พุ่มจาปา 434 55462 29 434 56348 29 ศรัณยา ไชยาศิรินทร์โรจน์ 434 55995 29 1 Mortgages WHAT IS A MORTGAGE ? A pledge of property (a house) to secure payment of a debt (a bank loan). If a homeowner (the mortgagor) fail to pay the lender (the mortgagee), the lender has the right to foreclose the loan and seize the property in order to ensure that it is repaid. The form that a mortgage loan takes could technically be anything the borrower and lender agree upon. 2 Mortgages WHAT TYPE OF PROPERTY ARE MORTGAGED? Property (and the mortgage on it) Residential -housing -apartments -condominiums -cooperatives Single (1-4) Family Multi-Family Nonresidential -office buildings -shopping centers -hospital -industrial plants Commercial Farm 3 Traditional Mortgage Loan Mortgages A fixed rate of interest on the loan for its entire term, and the loan was repaid in monthly installments of principal and interest. Each loan was structured in such a way that the total payment each month (the sum of the principal and interest) was equal, or level. The terms to be negotiated are the interest and the period to maturities - interest rate vary with the general economic climate - maturities range from 12 to 40,depending on the type of property involved 4 Traditional Mortgage Loan Mortgages The principal portion increases over time until, at maturity, the payment is almost entirely principal. The principal portion of each monthly payment is used to reduce the amount of the loan outstanding. In mortgage term, the loan is amortized over the maturies and the principal payments each month known as amortization payments. The amount of the loan that is outstanding at any time is known the mortgage balance. Sometimes a mortgagor may want to make monthly payment that is greater than the amount actually due, with the idea of applying the excess payment to further reducing the loan – such are called prepayments. 5 Nontraditional Mortgages Mortgages Unlike traditional mortgages, most of these alternative mortgage instruments (AMIs) do not have level monthly payments, but employ some other (often complicated) scheme. What was the impetus for the creation of AMIs, and in what ways are they superior to traditional mortgage ? -High interest rate combined with the rapid inflation in housing prices to make home financing difficult in general and all but impossible for the first-time buyer. AMIs were created as a way of coping with these problem. There are literally dozens of different types of AMIs, each with its own peculiar twist. Ex. VRMs (Variable-Rate Mortgages), GPMs (Graduated-Payment 6 Mortgages), RRMs (Renegotiated-Rate Mortgages) Example of a Mortgage Property value; $55,000 seller $50,000 Mortgage for $50,000 Process home $50,000 ($5,000 down) mortgagee mortgagor 7 History -These early mortgage banks obtained lending capital by issuing debenture bonds that were bought by insurance companies. -In 1914 The Farm Mortgage Bankers Association was formed. -By the 1920s , the lending activities of these mortgage banks were increasingly extending into urban areas. 8 History -The 1920s brought a real estate boom and high profits to both institutional and individual investors of mortgage. -In 1929, the real estate boom crashed with the stock market. -Mortgage companies foreclosed on property. Mortgage guarantee companies were unable to pay on their mortgage bonds, and the loss to individual investors was crushing. In 1933 the federal government established the Home Owners’ Loan Corporation (HOLC), Which used the proceeds of government – guaranteed bond sales to refinance homeowners’ indebtedness. 9 History -In 1933 the federal government established the Home Owners’ Loan Corporation (HOLC), Which used the proceeds of government – guaranteed bond sales to refinance homeowners’ indebtedness. -In 1934 the government created the Federal Housing Administration (FHA) to insure long – term, fixed-rate loans to provide homeowners with viable financing. 10 FHA To encourage the improvement of the nation’s housing standards and conditions. To provide an adequate home financing system. To exert a stabilizing influence on mortgage and residential real estate market. 11 FNMA Federal National Mortgage Association In 1938, the Federal National Mortgage Association (FNMA, or Fannie Mae) was formed by an act of Congress for the purpose of providing a secondary mortgage market for FHA-insured loans. In secondary the post-World War II era, mutual savings banks were the most active purchasers of loans. Fannie Mae’s first purchases of VA mortgages in 1948 may mark the beginning of the market. 12 FNMA Federal National Mortgage Association   Fannie Mae is a private, shareholder-owned company that works to make sure mortgage money is available for people in communities all across America. We do not lend money directly to home buyers. Fannie Mae stock (FNM) is actively traded on the New York Stock Exchange and other exchanges and is part of the Standard & Poor's 500 Composite Stock Price Index. 13 GNMA Government National Mortgage Association -In 1968, congressional legislation spun off Fannie Mae as a government-chartered private corporation. The Government National Mortgage Association (GNMA, or Ginnie Mae) was also created to assume Fannie Mae’s special-assistance functions of overseeing loan subsidies and below-market purchase programs. -Ginnie Mae was also given the guaranty authority that resulted in the introduction of the Ginnie Mae guaranteed mortgage-backed securities (MBSs) program. 14 FHLMC Federal Home Loan Mortgage Corporation -The Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac) followed shortly with its PC program in 1971. -A few years later, in 1981, Fannie Mae introduce its own MBSs program. -Today, the mortgage banking community includes-in addition to the many still-independent mortgage bankers–savings institutions, commercial banks, and other lender ;even some insurance companies are engaged in originating and servicing home mortgages. 15 Mortgages Most of the money for home loans comes three major institutions: • Fannie Mae (FNMA-Federal National Mortgage Association) • Freddie Mac (FHLMC-Federal Home Loan Mortgage Corporation) • Gennie Mae (GNMA-Government National Mortgage Association) 16 Mortgages This is how it works now: You talk to practically any lender and apply for a loan. They do all the processing and verifications and finally, you own the house and now you have a home loan and you make mortgage payments. You might be making payments to the company who originated your loan, or your loan might have been transferred to another institution. The company you make your payments to very rarely owns your loan. They are the "servicer" of your mortgage. They are called the servicer because they are simply "servicing" your loan for the institution that does own it. 17 Mortgages This is how it works now: In fact, mortgage servicing is where lenders make the real money. The entire system of originating mortgages, including wholesale lenders, mortgage brokers and mortgage bankers is designed so that servicers get loans into their portfolio -- hopefully at a "break even" level -- but often at a loss. Mortgage servicing is where they make their profit. Once your loan has been packaged into a pool and sold to Fannie Mae, Freddie Mac, or Ginnie Mae, the lender gets additional funds so they can make more loans (to service in their portfolio) and sell to those institutions, so they can get more 18 money, and so on.... Mortgage Backed Securities Mortgages Once Freddie Mac, Ginnie Mae, and Fannie purchase the pools, they break them down into smaller ownership parcels. These are called "mortgage backed securities“. Each security represents a small ownership interest, not in your specific loan, but in the pool of which your loan is only one part. The risk is therefore diversified and it is a very safe investment. The mortgage backed securities are sold on Wall Street to institutions or individuals looking for a safe investment, but one that earns a higher interest rate than treasury bonds. You may even own some as part of your retirement fund or investment portfolio. Those are securities backed by the mortgages on FHA and VA loans. 19 Mortgages Mortgage Backed Securities By selling the bonds, Ginnie Mae, Freddie Mac, and Fannie Mae obtain new funds to buy new pools so lenders can get more money to lend to new borrowers. This buying and selling of mortgages and mortgage backed securities is called "mortgage banking" , and it is the backbone of the mortgage business. 20 Securitization  securitization Securitization is how to convert “ Non Marketable Asset ” to “ Marketable Asset ”  Asset definition - Any asset that provides cash flow stream - It can be : a pool of residential mortgage, pools of credit card, pools of car leasing, income stream from office buildings or even income stream from records copy rights. - However, in our study , we will focus on Residential Mortgage pool 21 Risk to Lender Risk of delayed payment of principle and interest  Default Risk  Interest risk  Prepayment Risk  Other Risks - Liquidity and Marketability of asset - Legislative risk  securitization 22 Cost of lending - Deposit rate (Cost of Fund) + Inflation Rate + Risk Premium  Capital requirement - If lender is consider to lend borrower, this loan will be counted as 100% risk asset that will required 8% capital base according to BIS standard - The lender will need to have 8% for this loan - While for the same transaction amount, Lender might choose to lend to individuals home mortgage borrower which are counted for 50% risk asset, in this case lender will need to reserve only 4% of the transaction 23  Lender Perspective securitization Problem with Non securitization Flow  securitization High Cost of Fund - since residential mortgage is a low risk asset. There are many investors that required lower yield than the normal depositor ( such as insurance fund, fixed income fund ) who are willing to invest in the residential mortgage pool  Capital Base Requirement - Financial institution has to comply with BIS ratio that require 8 % of capital per risk asset issued.  Interest Rate Risk - Financial institution has to deal with volatility in financial market that might effect its mortgage fix rated offered to the market  Fund Mismatching - Normally mortgage required long term funding ( 10 to 15 years ) while it is difficult for financial institution to obtain such funds from its short term depositor. 24   Parties in Securitization Loan originator securitization      - financial institution who issue loan to borrower Special Vehicle Purpose - Entity who bys loan from financial institution - Entity who sells securities to investor Trustee - Representatives who supervise collection and distribution of payment Credit Enhancer - Third party who guarantees cash flow generated from assets Credit Rating Agency - Third party who audits and rates risks of securities Underwriter - investment banker who sells the securities to investor 25 Investor : party who invests in securities MBS Process Trustee Individual borrower Mortgage repayment Principle & Interest securitization Investors Investment / Mortgage repayment after servicing fees Sell pool of loan Finance Financial inc Pay for loan purchase SPV 26 MBS Type of Mortgage Back Securities Mortgage Pass – Through Securities (MPT) Mortgage Backed Bonds ( MBB ) Mortgage Pay – Through Bond ( MPTB ) 27 Type of MBS Mortgage Pass – Through Securities (MPT) - - - Investor invests directly in SPV and will receive entirely principle and interest generated from the asset investor had invested Investor will have the direct risk of default, Prepayment and interest risk U.S. Gov’t has created three agencies to support (Funding as the buyer or guarantor) the market development which are FHLMC ( federal home loan mortgage corporation ) FNMA ( federal national mortgage association ) GNMA ( gov’t national mortgage association ) Prepayment rate is an important valuation factor for this type of 28 securities Type of MBS     Investor invests in bonds issued by SPV, therefore investor will receive fixed coupon rates and specific maturities Investor will not share any default, prepayment and interest risk.Therefore, to assure investor for the quality of bonds, the issuer usually “ over collateralizes” the bond issue. By using the “over collateralizes”method,issuer will replace the prepayment mortgage with the new spare one that were earlier defined in the over collateralizes portion Therefore,Trustee has the duty to “Mark Mortgage Collateral to market “ periodically to ensure investor that the level of over collateralization are maintained at the level agreed upon at the time of issue ( generally 125% to 29 240% ) Mortgage Backed Bonds ( MBB ) or Asset backed bonds ( ABB ) Mortgage Pay – Through Bond ( MPTB )    Type of MBS    A hybrid between two earlier types Investor don’t directly own SPV, Originator is the owner of the asset. Originator issue a bond with coupon rate for interest payment while principal is pass through as it received from normal amortization and prepayment of loan in the pool. Investor receives interest per coupon stated but receive principle payment as actual MPTB will require less over collateralization than MBB since all interest of Principle repayment is paid directly to investor and no need to mark over collateral to market MPTB will also help investor receive constant coupon as MBB 30 securitization    For Borrower - Competitive Rate - Increase Supply of Credit For Lender - Reduce capital base requirement for business expansion - Provide pricing competitiveness for small player - Reduce fund mismatching problems - Hedge interest rate risk For Investor - New attractive investment instruments 31 Benefits of Securitization