The Securitization Markets Handbook

Structures and Dynamics of Mortgage - and Asset-Backed Securities

Charles Austin Stone, Anne Zissu

• Publisher: Bloomberg Press
• Year: 2010
• Print ISBN: 9781576601389
• eBook ISBN: 9780470884843
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

In this long-awaited handbook, noted experts Charles Stone and Anne Zissu provide an enlightening overview of how securitization works and explain how future cash flows from various asset classes—from credit card receipts to mortgage payments—can be packaged into bond-like products and sold to investors. Once a marginal source of funds, securitization is now an essential corporate funding technique widely adopted by financial and industrial companies throughout the world to finance both working capital and capital budgets. It is also used as a risk-management tool and a source of liquidity. Securitization has been adapted to fund corporate acquisitions, to capitalize future streams of revenue, and to liquidate pools of nonperforming loans. With examples from companies such as GE Capital, Ford Motor Credit, Countrywide Home Loans, and D&K Healthcare, The Securitization Markets Handbook provides descriptions of all major classes of asset-backed securities and offers a practice-oriented commentary on trends in securitization and the value of asset- and mortgage-backed securities across industries and throughout the global markets. The authors approach the topic from both sides of the market: the supply side, where assets are securitized and mortgage- and asset-backed securities are issued, and the demand side, where investors choose which classes of mortgage and asset-backed securities will enhance their portfolios or serve as efficient hedges. The book's detailed explanations and practical examples make it a valuable guide both for experienced money managers trying to put a securitization strategy into place and for those new to securitization looking to acquire a broad and strong foundation in the subject.

PART ONE

Key Structures and Cash Flow Dynamics

Chapter One

Mortgage-Backed Securities

IN THE UNITED STATES mortgage-backed securities (MBSs), created by securitizing mortgages, form the core of the secondary mortgage market. Securitization, the process of pooling loans and converting them into packages of securities, integrates the banking market with the securities markets.

The process occurs as follows. Financial institutions (originators) sell pools of mortgages to government-sponsored enterprises (GSEs)—the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac), the Federal National Mortgage Association (FNMA, or Fannie Mae), or the Government National Mortgage Association (GNMA, or Ginnie Mae)—for cash or in exchange for MBSs, or they sell pools of mortgages for cash to private-conduit-type customers. The GSEs and private conduits finance their purchases of the mortgage pools via vehicles called real estate mortgage investment conduits (REMICs) that then issue multiple short-, medium-, and long-term positions (called tranches) of securities. The design of these tranches of collateralized mortgage obligations (CMOs), which are set up to pay different rates of interest depending on their maturity, depends on the demand for the various elements within the mortgage pool. Proceeds from the issues of CMOs are used to finance the purchase of the mortgage pool from the conduit.

Mortgage-backed securities received in exchange for pools of mortgages are either retained by the originator or refinanced through REMICs. There is also an active forward market for mortgage loans in the United States. Originators sell their production of mortgage pools forward to conduits that warehouse the loans until the pool is large enough to be securitized. Conduits and originators hedge their risk exposures in the MBS and Treasury markets.

Origins of the Market

THE U.S. MBS market was kick-started and has been sustained by the activities of GNMA, FNMA, and Freddie Mac. The first GNMA-GUARANTEED MBS was issued in 1970. FNMA securitized its first pool in 1981, and Freddie Mac issued the first CMO, backed by thirty-year fixed-rate mortgages, in 1983. The pool was refinanced with the issue of three classes of securities that matured sequentially.

National mortgage conduits such as FNMA and Freddie Mac do not exist in Europe. Without the depth and liquidity of the mortgage- and asset-backed securities markets, securitization is not as valuable there nor as popular, especially where banks have alternative techniques of refinancing their mortgage portfolios. In the United Kingdom, the largest market in Europe for both mortgage- and asset-backed securities, only 6 percent of U.K. mortgages are securitized, according to the Council of Mortgage Lenders, while in the United States securitized mortgages constitute 60 percent of the market.¹

Originating mortgage pools with the intent of liquidating them through whole loan sales or securitizations net of mortgage servicing is characteristic of the U.S. mortgage market. It is a model that has become ingrained in the housing finance system and is supported by the large mortgage conduits, such as General Motors Acceptance Corp. (GMAC), General Electric Capital Corporation (GE Capital), FNMA, Freddie Mac, and Countrywide Financial Corp., among others. It is a model that relies on a deep and liquid secondary mortgage market.

From the Primary to the Secondary Mortgage Market

THE PRIMARY mortgage market encompasses transactions between mortgagors and mortgagees. The secondary mortgage market is where mortgages are refinanced and distributed in the capital and money markets in the form of mortgage-backed securities. Multifamily and single-family, fixed- and variable-rate, and level-pay and balloon mortgages are all securitized in the agency and private-label markets.

The Agency Market

Mortgage-backed securities issued by FNMA and Freddie Mac and guaranteed by GNMA are at the core of the secondary market for conforming mortgage loans. GNMA is a wholly owned corporate instrument of the United States within the Department of Housing and Urban Development. GNMA guarantees the full and timely payment of principal and interest on MBSs. The quality of the guarantee is that of “the full faith and credit of the United States.”

A mortgage lender qualified to do business with GNMA originates a pool of mortgages and submits the mortgages to GNMA to create guaranteed MBSs. An institution acting as central paying and transfer agent registers the securities secured by a mortgage pool with a clearing agency registered with the Securities and Exchange Commission (the depository), which issues the MBSs through the book entry system. GNMA-guaranteed MBSs are backed by mortgages that are guaranteed by the following U.S. government agencies: the Federal Housing Administration (FHA), the Department of Agriculture’s department of Rural Housing Service (RHS), the Department of Veterans Affairs (VA), and the Office of Public and Indian Housing (PIH).

As was noted earlier, FNMA and Freddie Mac are GSEs, chartered by the United States Congress. The equity of FNMA and Freddie Mac is owned by private investors. Shares of FNMA and Freddie Mac are listed on the New York Stock Exchange. Their congressional charters define their mission, which is to lower the cost of mortgage capital to low-, moderate-, and middle-income Americans by creating and sustaining a deep, liquid, and stable secondary mortgage market. They accomplish their mission by providing mortgage originators with an efficient way of liquidating their mortgage portfolios.

FNMA and Freddie Mac are able to offer continuous bid prices for mortgages at favorable rates because the market for agency MBSs and agency debt are efficiently priced. The market for agency-guaranteed MBSs is standard, deep, and liquid. In 2002 $721.2 billion of single-family residential mortgages were o...

Table of contents

• About the Authors
• Title Page
• Copyright Page
• Dedication
• Table of Exhibits
• Acknowledgements
• Introduction
• PART ONE - Key Structures and Cash Flow Dynamics
• PART TWO - Corporate Debt and the Securitization Markets
• PART THREE - Securitization of Revolving Credit
• PART FOUR - Searching for Value in the Mortgage- and Asset-Backed Markets
• Index
• About Bloomberg