MORTGAGES
WEEK 7
S
What is it?
S Mortgage – The charging of real (or personal) property by a
debtor, to a creditor as security for a debt (especially
incurred by the purchase of property) on the condition that
it shall be returned on payment of the debt within a certain
period
S Investment Value
S Two components
Loan to Value
S Loan to Value = Mortgage Amount / Appraised Value of
Property
S Banks typically require 75% LTV
S Prevention of sale
S Underwater Mortgage
Underwater Mortgages
120,000
100,000
80,000
Loan
Real Estate Value
60,000
40,000
20,000
0
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10
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Components of a Mortgage
S Components (APR and Amortization)
S Amortized depending on amount borrowed
S Typically amortized monthly
Types of Mortgages (and
others)
Fixed Rate Mortgages
S Interest rate and your monthly payments remain fixed for the
period of the loan
S Term is fixed
S Example
Adjustable Rate Mortgages
S Interest rate / monthly payments change overtime (period of loan)
S Changes based on defined index
S Index established at application
S New Interest Rate
S Margin
S Why adjustable rate?
Indices
Negatively Amortizing Loans
S Different payment structure
S Allows for smaller payments
S Deferred interest
S Contractual limit
S Recalculation
Fixed Period ARMs
S Same as ARM
S Fixed + Adjustable period
S After fixed period, adjusts based on index plus margin
S Subject to IR cap structure after fixed period
Convertible ARMs
S Similar to ARM
S Option to convert
S Usually charged fee
S Beneficial in certain circumstances
Option ARM
S No set payment
S Begin with initial payment
S 4 options after (hence the name…)
Buydown Mortgages
S Initial discount
S Builder or seller
S Lowers qualification
GPM
S Initial low rate
S Gradual increase
S Usually 7-12% annually
S Until desired rate reached
Structured Products
S What is a structured product?
S Highly Customized
S Returns derived from underlying not issuer’s cash flow
S Similar to other derivatives that we have discussed
Types of Securities
S ABS – Asset backed securities
S CMBS – Commercial mortgage backed security
S RMBS – Residential mortgage backed security
S MSR – Mortgage servicing rights
Benefits to Structured Products
S Diversification
S Liquidity
S More efficient markets (Lower Mortgage Rates)
U.S. Debt Market
Size of Securitized Products
Securitization
Originator
S Mortgage originators
S Different types of originators
S Operational differences
Originator Continued
S Banks
S Internal aggregation
S Risk
S Mitigation
S Liability Transfer / Legality
Originator Continued
S Hedging
S Best efforts trade
S Smaller originators
Aggregator
S What is an aggregator?
S Next in line
S Close ties with WS
Aggregator Continued
S Re-origination
S Two Options
S Mortgage Backed Securities (MBS) [GSE’s]
S Securitize into private label MBS [WS]
Aggregator Continued
S Hedging
S Timeline of hedging
S Entire pipeline
S Profiting
Mortgage Fallout
S Loans that do not close
S Why is this important?
S Fallout = Loans that do not close / Total Loans
Fallout Continued
S Hedge until mortgage closes
S Many loans do not end up closing
S Variety of reasons..
S Selling into secondary market
Prepayment Risk
S Returning principal on loan early
S In bundle, accelerates cash flows of MBS
S Front-loads the mortgage cash flows (Principal and Interest)
Front Loading of Prepayments
Tranches
S Divided into different tranches
S Many different ways mortgages can be divided
S Interest rate, risk, maturity, etc.
Tranche Division
Risk and Hedging
S How are MBS’s hedged?
S IR Future
S MBS Option
S TBAs (Fallout)
Securities Dealers
S MBS sold to securities dealer
S Most WS firms have a desk for MBS
S Dealers wrap and bundle MBS
S Eventual outcome…
Mortgage to Security
MSR (Mortgage Servicing
Rights)
S Servicing Rights
S Sold by lender
S Usually specializes in servicing
Investors
S End users of mortgages
S Types of investors
S Diverse yields
S GSE’s largest portfolio
Investor Breakdown
Refinancing
S Replaces older loan with new loan
S New payment scheme
S Usually involves a penalty fee
Subprime
S Low credit ratings (Below 600; 850 FICO is perfect)
S Not given conventional loan
S Higher IR
S Much higher risk
Predatory Lending
S Enticing borrower
S High fees
S High IR
S Strips equities
S Places borrower in lower credit rating (Charge higher IR)
S Foreclosing Strategies
Thank you !