MORTGAGE-BACKED SECURITIES MARKET

1
Chapter 24

• MORTGAGE-BACKED SECURITIES MARKET

2
Mortgage-Backed Securities

• Mortgage Pass-Through Securities
• Derivative Mortgage-Backed Securities
• Collateralized Mortgage Obligations
• Stripped Mortgage-Backed Securities

3
Asset Securitization

• Originate mortgage
• Sell mortgage to investment banking firm
• Insure pool of mortgages
• Sell right to service loans
• Sell securities collateralized by mortgages to
  investors

4
Foundations of the Mortgage Market

• Federal Home Loan Banks (FHLBs)
• Federal Housing Administration (FHA)
• Federal National Mortgage Association (FNMA)
• Fannie Mae
• Ginnie Mae

5
Mortgage Pass-Through Securities

• Created when one or more holders of mortgages
  form a pool of mortgages and sell shares in the
  pool.
• Features
• more liquid
• securitized

6
Cash Flow Characteristics

• Monthly mortgage payments
• interest
• principal repayment
• Timing of monthly mortgage payments and payments
  made to investors is not identical
• Magnitude of monthly mortgage payments is greater
  than payments for pass-through securities
• servicing fee
• other fees

7
Issuers of Mortgage Pass-Through Securities

• Government National Mortgage Association
• Federal Home Loan Mortgage Corporation
• Federal National Mortgage Association

8
Nonagency Pass-Through Securities

• Conforming mortgages
• Nonconforming mortgages
• Jumbo loans
• Nonagency pass-throughs

9
Issuers of Nonagency Pass-Throughs

• Commercial Banks
• Investment Banking Firms
• Others

10
Credit Enhancements

• Corporate Guarantees
• Pool insurance from a mortgage insurance company
• Bank letter of credit
• Senior/subordinated interests

11
Prepayment Risk and Prepayment Conventions

• Prepayment risk is the risk associated with
  prepayments
• Contraction risk
• Extension risk
• Prepayment Conventions
• Prepayment speed
• Conditional prepayment rates
• Single-monthly mortality rate

12
Average Life

• It is the average time to receipts of principal
  payments weighted by the amount of principal
  expected.
• The average life of a pass-through depends on the
  PSA prepayment assumption.

13
Collateralized Mortgage Obligations

• Tranches
• Collateralized Mortgage Obligations
• Types of Tranches
• Sequential-Pay CMOs
• Accrual Bonds
• Planned Amortization Class Tranches
• Floating-Rate Tranche
• Inverse Floating-Rate Tranche

14
Stripped Mortgage-Backed Securities

• Created by distributing principal and interest
  from pool of underlying mortgages on a pro rata
  basis to security holders.
• Features
• Derivative mortgage security
• Hedges prepayment risk
• Types
• Partially stripped securities
• Interest-only/principal-only securities

15
Yields on Mortgage-Backed Securities

• Yields are a function of prepayment risk
• Yield calculation requires
• determination of cash flow
• projections of prepayment
• The PSA convention is used