Lecture 24
Loan Securitization – Market Risk
Chap 26, Chap 17 -19, Chap 10
1
You are responsible for all the material presented in class
and in the book since the previous exam.
This is a review of some elements of that information. It is
not a comprehensive review of all the information you will
be responsible for on the Exam!
2

Loan Securitization

Liquidity Risk

Liability and Liquidity Management

Depository Insurance

Market Risk
3
Loan Securitization
4

Securitization Process

Pass-Through Securities

Agencies

Costs and benefits of securitization

Cash flows

Other Securitizations
◦ Vehicles: SPV, SIV, similarities/differences, Procedure Advantages &
Disadvantages
◦ What are they, how are they created, payments, ownership
◦ GNMA, FNMA, FHLMC – what do they do, how are they similar/different
◦ Payments, value, pre-payment risk
◦ CMOs, CDOs, RMBS
5
Bank of America purchased 6000 mortgages with an average principal of $143,000 each. BoA intends to
finance the purchase by raising deposits and want to maintain its current risk profile. Currently BoA has a
Tier I risk-based capital ratio of 5.8%, The Federal Reserve requires 10% of deposits to be held in reserve,
and the FDIC charges 27 bps annual premium to insure deposits. Find the total regulatory tax BoA is
exposed to from these mortgages. If the risk weight on residential mortgages is 50%, they currently have a
20% default rate and pay an aggregate coupon of 4.3%.
6
$119,950,020.67
Deutsche Bank purchases a pool of 1000 mortgages with an average principal value of $323,500
each. The mortgage pool has an aggregate mortgage coupon rate of 4.3% and the average time to
maturity is 30 years. Deutsche Bank sells the pool to an SPV who collects a 38bp annual servicing
fee. GNMA Charges an 18bp annual fee to insure the pass-through security payments.
a) Find the aggregate monthly payment to GNMA bondholders assuming no pre-payment risk.
b) Find the value of the issue after 12 years have past if a similar pool of mortgages yields a 2.3%
mortgage coupon
7
$1,496,343.87
How much should Carlyle Capital expect to get for the sale of a newly originated GNMA
securitization with $703M of residential mortgage principal. The pool of mortgages has
30 years left to maturity. Currently, a 30-year Treasury note with face value of $1,000
sells for $98.23. A 30-year BBB rated corporate bond with $1,000 sells for $56.23 and the
OAS for a 30-year GNMA pass-through bond is $0.002 per dollar of face value.
8
$67,649,690.00
UBS originates a CMO backed by interest only GNMA bonds with $20M of Class A principal,
$150M of Class B principal and $200M of Class C principal. The Class A, Class B and Class
C bonds pay an annual coupon of 12%, 5% and 3% respectively. Find the payments to the
Class A, B and C bond holders at the end of month 3 if: (assume all payments are made in arrears)
a) $5M of principal is pre-paid each month
b) $5M of residential mortgage principal defaults each month
c) $5M is prepaid each month but $500,000 of the interest payment is delinquent in month 3
A) Class A = 5,100,000
Class B = 625,000
Class C = 500,000
B. No Change
9
C. No Change
1.
Regulatory tax – cost of holding mortgages on balance sheet
2.
Pass Though bond payments – No prepayment risk
a)
b)
No Fees
With GNMA & Servicing Fees
3.
Pass Through bond value – No prepayment risk
4.
Pass through bond payments – with prepayment risk (interest only)
5.
Option Adjusted Spread (OAS)
6.
CMO Payments – interest only loan pool
10
Liquidity Risk
11

Types of liquidity
◦ Asset-side Liquidity
◦ Liability-side Liquidity

Managing Liquidity
◦ Stored Liquidity – sell assets
◦ Purchased Liquidity – borrow funds

Measuring Liquidity
12
Suppose a customer of a bank takes down $100 million of a loan commitment. How would the
banks balance sheet, shown below, change if the DI:
(i) Uses stored liquidity to meet its commitment
(ii) Uses purchased liquidity to meet its commitment
Assets
Cash
Loans
Marketable Securities
Total assets
$50
50
200
$300
Liabilities and Equity
Deposits
$168
Borrowed Funds
125
Equity
7
Total liabilities and equity
$300
(i) Cash = 0, Loans = 150, MS = 150
(ii) Loans = 150, Borrowed = 225 13
Suppose a bank with the following balance sheet experiences a $100 million net deposit drain,
how would the balance sheet change if the DI:
(i) Uses stored liquidity to meet its commitment
(ii) Uses purchased liquidity to meet its commitment
Assets
Cash
Loans
Securities
Total assets
$50
50
200
$300
Liabilities and Equity
Deposits
$168
Borrowed Funds
125
Equity
7
Total liabilities and equity
$300
(i) Cash = 0, MS = 150, Deposits = 68
(ii) Deposits = 68 Borrowed = 225 14
1.
Sources and uses of liquidity
2.
Peer Group Comparison
3.
Liquidity Index
15
Example: use the following ratios to determine which bank is more exposed to liquidity
risk (from external markets)
Borrowed funds to Total assets
Core deposits to total assets
Loans to deposits
Loan Commitments to total assets
Bank A
31.22%
26.28%
22.63%
19.87%
Bank B
21.43%
45.82%
15.23%
17.52%
16
The table shows estimates of fundamental asset value and the value that could be
recovered for immediate sale. Use this information to calculate the liquidity index of
the bank.
Asset
Face Value
True Value
Market collapse
T-Bill
10M
$9
$9
C&I
144M
$8.5
$3.5
Real Estate
360M
$58
$10
17
L=25.6%
1.
Asset/Liability side liquidity risk management
2.
Peer Group Comparison
3.
Liquidity Index
18
Liquidity & Liability Management
19

Costs and benefits of regulating reserve requirements

Monetary policy and RR

Costs and benefits of holding liquid vs illiquid assets

Calculating reserve requirements

Managing & manipulating reserve requirements
20
Example: Over the period from February 14-27 a bank has:
 Cumulative transaction account balance of $12,430M
 They are owed 800M from other US DIs (cumulative)
 They have $500M of cash in the process of being delivered (cumulative)
 Cumulative vault cash of $200M.
(i) Calculate the reserve requirement to be maintained at the fed
Total = 76.083M
At the Fed = 61.793M
21
1.
Find computation & maintenance period
2.
Calculate Reserve Requirements
◦
◦
◦
3.
Total
At the Fed
In the vault
Over/under shoot reserve requirements & carry forwards
22
Deposit Insurance
23

Depository Insurance history and structure
◦ Agencies, Limits, Structure

Purpose of depository insurance

Costs and benefits of depository insurance

Problems and proposed solutions with depository insurance
24
By how much will the premium for depository insurance change if the bank is forced
to write down a loss of $15M on its mortgage portfolio. The Bank is classified as
supervisory concerned
Assets
Liabilities & Equity
Cash
Mortgages
Consumer loans
C&I Loans
Securities
37
245
145
164
40
631
Deposits
Short-term borrowing
Perpetual preferred stock (Qualified)
Common stock
Retained earnings
458
135
3
15
20
631
25
Change = 1,099,200-137,400=961,800
Total risk based capital ratio ≥ 10% and Tier I risk-based capital ratio ≥ 6% and Tier I Leverage ratio ≥ 5%
Total risk-based capital ratio ≥ 8% and Tier I risk-based capital ratio ≥ 4% and Tier I Leverage ratio ≥ 4%
26
First Boston Bank has total assets of $398M total deposits of $345M all of which are
insured. They have estimated the volatility of returns on assets to be 0.12 pa. Suppose
the one-year risk free rate is 1.6%. Find the depository insurance premium that First
Boston should be charged.
P(t) = 1,890,183.4627
Find Φ(X1) = -1.38 on the table:
1.0000
- 0.9162
0.0838
Find Φ(X2) = -1.26 on the table:
1.0000
- 0.8962
0.1038
1.
Find the deposit insurance premium using the table
2.
Find the deposit insurance premium using options pricing
30
Market Risk
31

RiskMetrics – Variance Covariance

Estimates the risk of individual trading books using VaR

Combines the risk of all trading books accounting for
diversification

Produces a daily earnings at risk (DEAR) that estimates
the potential loss from the full trading book that occurs
with a certain probability (1%, 5% ...)
32
Example: Calculate the 99% DEAR for a bank with: (i) a $5M equity portfolio with beta equal to .8 (ii) a
BBB portfolio of zero coupon bonds with maturity of 12.5 years, total face value of $20M and average YTM
of 10.2%. Assume that the daily expected return and volatility of the market are 0.00012 and 0.0005
respectively. The risk free rate is 0.00001 per day. The mean and standard deviation of the daily changes in
the yield on BBB bonds is 0.00 and 0.00082 respectively. Assume that the correlation between YTM
changes and market returns is .23
33
128,253.05
1.
Calculate DEAR
34
More Examples
35
Securitization
36
Allied Bank originates a GNMA securitization backed by $12M in residential mortgage
principal. The pool of mortgages generates a 4.1% aggregate mortgage coupon pa. Find the
interest payment to GNMA bond holders, the SPV and GNMA after the 4th month. The
servicing fee is 28bp pa. and GNMA insurance costs 14bp pa. Assume 325% PSA.
Service fee
= 2,692.10
GNMA insurance = 1,346.05
Bond Holders
= 35,381.8437
IDBI Money Market Mutual fund purchased a newly originated GNMA pass-through bond 7
years ago. The bond pays $1.2M per month. There is a 45bp annual servicing fee on the pool
and GNMA insurance costs 12bps pa. The current mortgage rate is 3.9%. Find the current value
of the GNMA bond if there is 23 years left to maturity. Assume no prepayment risk.
$231,174,604.3310 38