Mortgage Backed Securities

7 Key excerpts on "Mortgage Backed Securities"

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  eBook - ePub

  The Capital Markets

  Evolution of the Financial Ecosystem

  • Gary Strumeyer(Author)
  • 2017(Publication Date)
  • Wiley

    (Publisher)

  The importance of MBSs to the domestic investment‐grade fixed‐income universe (i.e., U.S. Treasury, government agency, investment‐grade corporate, asset‐backed, commercial mortgage–backed, and residential mortgage–backed securities) cannot be overstated. The MBS market is second only in size to the U.S. Treasury market and currently represents the second largest sector of the Barclay Aggregate Index at roughly 29%. Adding in asset‐backed securities and commercial mortgage‐backed securities, we see that securitized instruments make up nearly 32% of the index. This is quite remarkable when considering that many investors know little, if anything, about this sector.

  MORTGAGES: THE BUILDING BLOCKS OF MBSs

  Homeowner mortgage loans are the building blocks of the mortgage‐backed securities market. Mortgage bonds are backed by the cash flows generated by pools of individual mortgage loans. Sixty‐five percent of American households have secured mortgage loans to purchase a home. Before venturing into the complex world of securitization, it is necessary to understand the concept of mortgage lending.

  A mortgage is the pledge of property to a creditor as security for the payment of a debt. The borrower (mortgagor) is obliged to make a preset series of payments, representing repayment of principal, interest, and fees. If the borrower fails to make these payments, the lender (mortgagee) has the right to foreclose on the property. In other words, if you don't pay the loan back along with all the associated fees and interest, the lender can take your house and sell it to recoup his investment. Mortgages are usually paid off over time in incremental payments that steadily reduce the principal of the loan. This is called amortization

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  eBook - ePub

  Investing in Fixed Income Securities

  Understanding the Bond Market

  • Gary Strumeyer(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  Should the retail investor then avoid this market at all costs? Not necessarily. The investor who spends the time (lots of time) learning about this marketplace may be compensated with higher yields than would be received on other fixed income securities. The mortgage-backed security investor is rewarded with a high credit quality investment and great value relative to Treasury or agency securities with essentially no added credit risk. Essentially, the mortgage investor has chosen to get paid to take on interest rate or prepayment risk rather than credit risk.

  The mortgage-backed securities market has seen momentous growth over the past two decades. Total volume of outstanding mortgage securities exceeded $4.1 trillion at the end of 2001, according to An Investors Guide to Mortgage Securities , New York: Bond Market Association, 1997–2002.

  The importance of MBS as a percentage of the domestic investment grade fixed income universe (i.e., U.S. Treasury, government agency, investment grade corporate, asset-backed, commercial mortgage-backed, and residential mortgage-backed securities) continues to grow, surpassing the size of the U.S. Treasury market and currently representing the largest sector of the Lehman Aggregate Index (the most popular fixed income index: see Chapter 19) at roughly 34 percent. Adding in asset-backed securities (Chapter 15) and commercial mortgage-backed securities, we see that securitized instruments make up nearly 40 percent of the index. This is quite remarkable when considering that many investors know little, if anything, about this sector. This is about to change!

  BUILDING BLOCKS OF MBS—MORTGAGES

  Before venturing into the complex world of securitization, it is first necessary to understand the basic workings of a mortgage. Mortgages are the building blocks of the mortgage-backed securities market, since mortgage loans are the instruments that comprise the pools backing the securities. While the concept of a mortgage is popular in the United States, as over 65 percent of American households have a mortgage and the average person most likely understands what a mortgage loan is, how a mortgage loan actually works may be confusing at times. For this reason, it is necessary to give a basic lesson of how mortgages work. For those of you already expert on this subject, feel free to skip ahead.

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  eBook - ePub

  Real Estate Valuation

  A Subjective Approach

  • G. Jason Goddard(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  Chapter 9 Mortgage-backed securities and subjectivity

  DOI: 10.4324/9781003083672-9

  Chapter highlights

  • Types of mortgage-backed securities (MBS)
  • Residential MBS and subjectivity
  • Commercial MBS and subjectivity
  • MBS and investor preference

  It is not when the truth is dirty, but when it is shallow, that the lover of knowledge is reluctant to step into its waters. Friedrich Nietzsche

  9.1 Types of mortgage-backed securities

  In this chapter, we turn our attention to the valuation subjectivities associated with groupings of mortgages secured with real estate. While the preceding chapters have focused on the valuation inflection points for single properties, this chapter will concern mortgage-backed securities. When a property owner seeks a loan secured with their property, there are typically two avenues for lender support: traditional lenders who keep the loans on their balance sheets, and lenders who package up and sell loans to investors.

  Mortgage-backed security (MBS) investors seek cash flow from a pool of properties which make up the specific bond of which they are investing. MBS investors can receive financial benefit from the mortgage industry without having to own real estate property directly. In this chapter, when we speak of investors, we are concerned with those who are buying shares in securitized products that will be itemized in this section.

  9.1.1 Collateralized mortgage obligations (CMOs)

  Collateralized mortgage obligations (CMOs) are the category header within the overall securitization market nomenclature for mortgage loan pools. The wider net of securitized products would include loan pools secured with business loans (collateralized loan obligations or CLOs), various forms of debt (collateralized debt obligations or CDOs), and specific loans secured with vehicles or other collateral (asset-backed securities or ABS). Exhibit 9.1

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  eBook - ePub

  The Financialization of Latin American Real Estate Markets

  New Frontiers

  • Alfonso Valenzuela Aguilera(Author)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  For instance, a banking institution could take on those risks, but once the assets are securitized, those liabilities are transferred to investors according to their underlying assets, through financial instruments such as mortgage-backed securities (MBSs) and asset-backed securities (ABSs) which can be sold to institutional funds such as private pensions, retirement funds, money market funds, international and domestic commercial banks, real estate investment trusts (REITs), private investment partnerships, insurance companies, corporate treasures, individual investors, and fixed-income mutual funds. These securities allow financial institutions to trade their whole portfolios to MBSs in order to reduce their exposure to risk as well as diminishing capital investments required to hold complete mortgages loans, adding with it more liquidity to their balance sheet and enabling them to increase their fee income by writing more mortgages. In this way, banks were able to secure segments of the portfolios in the secondary market acting as sellers or buyers, transforming them into liquid securities that complied with their asset location priorities, as well as meeting their risk-management standards. To this end, whenever the mortgages did not meet the standards set by the government-sponsored entities (GSEs), the private-label market provided an alternative source of funds, in which MBSs offered a wide range of possible risk profiles depending on maturity, prepayment, duration, coupon, and liquidity spectrums (divided into floating, fixed, inverse-floating, zero, and inflation-indexed coupons). In such cases, MBSs yielded less profit than the loans underlying the securities because of the hedging cost and credit-enhancement mechanisms that can be used to reduce credit risk to investors

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  eBook - ePub

  Encyclopedia of Financial Models, Volume III

  • Frank J. Fabozzi(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  Abstract: The valuation of residential mortgage-backed securities begins with a projection of a subject security's cash flow. The monthly cash flow from the underlying pool of mortgage loans includes three components: (1) scheduled principal payments (also referred to as amortization), (2) interest payments, and (3) any prepayments. Prepayments are any payments made by borrowers that are in excess of the scheduled principal payment. Consequently, the cash flow depends on the prepayment behavior of the borrowers in the mortgage pool. In addition to prepayments, the expected credit performance of the underlying loans must be projected to estimate a residential mortgage-backed securities cash flow. The sharp deterioration in mortgage performance that emerged in late 2006 led to the realization that prepayments and defaults often had related effects on the performance of these securities, even though they represent very different phenomena. As a result, new terminology has emerged to clarify the different circumstances that result in the early return of principal to investors. Understanding the terms used in the market to define prepayments and default experience, as well as the methodologies used to generate these metrics, is important for the following reasons: efficient risk-based pricing at the origination level; evaluation of relative value within the residential mortgage-backed securities sector (as well as across the fixed income universe); effective hedging and management of prepayment and credit risk exposure; and ex post performance attribution.

  Securities backed by a pool of residential mortgage loans, referred to as mortgage-backed securities (MBS) or mortgage-related securities, have complex cash flow characteristics compared to the traditional government, corporate or municipal security. Residential MBS are classified as agency MBS and nonagency MBS . The former include MBS issued by Ginnie Mae (a federally-related government entity) and two government-sponsored enterprises (Fannie Mae and Freddie Mac). Residential MBS not issued by agency MBS are called nonagency or private label MBS . In turn nonagency MBS are categorized based on the credit quality of the underlying borrower or lien. There are nonagency MBS backed by prime loans, along with those backed by borrowers with blemished credit histories or an inferior lien on the mortgaged property (e.g., a second mortgage lien). The latter nonagency MBS are generically referred to as subprime MBS.1

  Complicating the cash flows projection of a residential MBS is that borrowers can prepay their loans and will in fact do so for a variety of reasons. Such prepayments

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  eBook - ePub

  Handbook of Fixed-Income Securities

  • Pietro Veronesi(Author)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  4 Mortgage-Related Securities (MRSs) Jefferson Duartea and Douglas A. McManusb *

  a Rice University, Jones Graduate School of Business, Houston, TX, United States

  b Freddie Mac, Office of the Chief Economist, McLean, VA, United States

  4.1 Purpose of the Chapter

  Mortgage-related securities (MRSs) comprise one of the largest segments of the American fixed income market. Figure 4.1 shows the amount of debt outstanding for three different sectors of the U.S. bond market. This figure reveals that between 1999 and 2010, MRS comprised the largest sector of the American bond market. As of December 2013, there are around $8.7 trillion of outstanding MRSs, making the MRS sector the third largest segment of the American fixed income market, following only the Treasury sector ($11.9 trillion outstanding) and the corporate sector (at around $9.5 trillion outstanding). Of the $8.7 trillion of MRS outstanding, around $7 trillion are agency MRSs; that is, they are created through government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac or government backed such as FHA/VA loans securitized through Ginnie Mae. The remainder, $1.7 trillion, is non-agency MRSs, such as private-label residential mortgage-backed securities (RMBSs) and securities backed by mortgages on commercial properties (commercial mortgage-backed securities, or CMBSs).

  Figure 4.1

  The amount outstanding for three different sectors of the U.S. bond market. The amounts are in billions of dollars. Source: Securities Industry and Financial Markets Association (SIFMA).

  It is of course impossible to describe all the issues related to a market of the size of the MRS market in a book, let alone in a chapter. We therefore focus on three objectives: first, we provide a very brief description of the MRS market. Second, we describe an important new class of MRS introduced in 2013. The GSEs, responding to supervisory requests, created instruments to achieve risk sharing with private capital through Freddie Mac’s STACR deals and Fannie Mae’s C-deals. We provide a textbook description of this type of MRS.a Third, we give an example of the evaluation of MRSs with emphasis on the modeling of prepayment and default and their resulting impact on mortgage cash flows. This example would be a good starting place for the more technical reader wishing to better understand a competing risk model of default and prepayment. Throughout the chapter, we focus on the agency MRSs and provide citations for the reader interested in delving further into the MRS literature.b

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  eBook - ePub

  An Introduction to Financial Markets and Institutions

  • Maureen Burton, Reynold F. Nesiba, Bruce Brown(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  In recent decades, the government has become much more active in the mortgage market by guaranteeing the repayment of some mortgages and encouraging the development of a secondary market in mortgages. Most mortgages today are made in accordance with lending guidelines that allow them to be packaged and sold as mortgage-backed securities. Fannie Mae and Freddie Mac are GSEs that issue mortgage-backed securities and use the proceeds to purchase mortgages. Fannie Mae and Freddie Mac securities have no explicit government guarantee. However, when they collapsed in September 2008 and were put into conservatorship by the U.S. government, the stockholders in Fannie Mae and Freddie Mac lost but the government made good on the securities the corporations had issued. Ginnie Mae guarantees the timely payment of principal and interest on mortgage-backed securities put together by private lenders. Ginnie Mae securities do have an explicit government guarantee. Other private groups issue mortgage-backed securities without government involvement. Secondary markets trade previously issued mortgage-backed securities and are similar to the secondary markets in bonds. Collateralized mortgage obligations redirect the cash flows (principal and interest) of mortgage-backed securities to various classes of bondholders, thus creating financial instruments with varying prepayment risks and varying returns.

  The Determinants of the Price of Mortgages in Secondary Markets

  Up until the financial crisis of 2008, a large and active secondary market existed for mortgages and mortgage-backed securities. The collapse of this market brought on the financial crisis of 2008. Because so many bad mortgages were made that would never be repaid, lenders did not know which securities were good and which were bad. Hence borrowing and lending in the secondary markets froze up. We expect this market to return to normal once financial markets are stabilized and the economy works its way out of this financial crisis. In this section, we discuss determination of prices of previously issued mortgages and the related Mortgage Backed Securities in secondary markets.

  Like bonds, the price of a previously issued mortgage is simply the present value of the future stream of income from the ownership of the security. This consists of the monthly payment stream that includes both an interest and a principal payment, as depicted in Equation (14-1)

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