mortgages week 7. what is it? mortgage – the charging of real (or personal) property by a debtor,...
TRANSCRIPT
S
MORTGAGESWEEK 7
What is it?
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
Investment Value
Two components
Loan to Value
Loan to Value = Mortgage Amount / Appraised Value of Property
Banks typically require 75% LTV
Prevention of sale
Underwater Mortgage
Underwater Mortgages
1 2 3 4 5 6 7 8 9 10 110
20,000
40,000
60,000
80,000
100,000
120,000
Loan Real Estate Value
Components of a Mortgage
Components (APR and Amortization)
Amortized depending on amount borrowed
Typically amortized monthly
Types of Mortgages (and others)
Fixed Rate
ARM
Convertible ARM
Fixed Period ARM
Hybrid Option ARM
Option Arm
Other
BuydownGPM
Fixed Rate Mortgages
Interest rate and your monthly payments remain fixed for the period of the loan
Term is fixed
Example
Adjustable Rate Mortgages
Interest rate / monthly payments change overtime (period of loan)
Changes based on defined index
Index established at application
New Interest Rate
Margin
Why adjustable rate?
Indices
Negatively Amortizing Loans
Different payment structure
Allows for smaller payments
Deferred interest
Contractual limit
Recalculation
Fixed Period ARMs
Same as ARM
Fixed + Adjustable period
After fixed period, adjusts based on index plus margin
Subject to IR cap structure after fixed period
Convertible ARMs
Similar to ARM
Option to convert
Usually charged fee
Beneficial in certain circumstances
Option ARM
No set payment
Begin with initial payment
4 options after (hence the name…)
Buydown Mortgages
Initial discount
Builder or seller
Lowers qualification
GPM
Initial low rate
Gradual increase
Usually 7-12% annually
Until desired rate reached
Structured Products
What is a structured product?
Highly Customized
Returns derived from underlying not issuer’s cash flow
Similar to other derivatives that we have discussed
Types of Securities
ABS – Asset backed securities
CMBS – Commercial mortgage backed security
RMBS – Residential mortgage backed security
MSR – Mortgage servicing rights
Benefits to Structured Products
Diversification
Liquidity
More efficient markets (Lower Mortgage Rates)
U.S. Debt Market
Size of Securitized Products
Securitization
Mortgage
Originator
Investors
Mortgage
Aggregator
Securities
Dealer
Originator
Mortgage originators
Different types of originators
Operational differences
Originator Continued
Banks
Internal aggregation
Risk
Mitigation
Liability Transfer / Legality
Originator Continued
Hedging
Best efforts trade
Smaller originators
Aggregator
What is an aggregator?
Next in line
Close ties with WS
Aggregator Continued
Re-origination
Two Options
Mortgage Backed Securities (MBS) [GSE’s]
Securitize into private label MBS [WS]
Aggregator Continued
Hedging
Timeline of hedging
Entire pipeline
Profiting
Mortgage Fallout
Loans that do not close
Why is this important?
Fallout = Loans that do not close / Total Loans
Fallout Continued
Hedge until mortgage closes
Many loans do not end up closing
Variety of reasons..
Selling into secondary market
Prepayment Risk
Returning principal on loan early
In bundle, accelerates cash flows of MBS
Front-loads the mortgage cash flows (Principal and Interest)
Front Loading of Prepayments
Tranches
Divided into different tranches
Many different ways mortgages can be divided
Interest rate, risk, maturity, etc.
Tranche Division
Risk and Hedging
How are MBS’s hedged?
IR Future
MBS Option
TBAs (Fallout)
Securities Dealers
MBS sold to securities dealer
Most WS firms have a desk for MBS
Dealers wrap and bundle MBS
Eventual outcome…
Mortgage to Security
MSR (Mortgage Servicing Rights)
Servicing Rights
Sold by lender
Usually specializes in servicing
Investors
End users of mortgages
Types of investors
Diverse yields
GSE’s largest portfolio
Investor Breakdown
Refinancing
Replaces older loan with new loan
New payment scheme
Usually involves a penalty fee
Subprime
Low credit ratings (Below 600; 850 FICO is perfect)
Not given conventional loan
Higher IR
Much higher risk
Predatory Lending
Enticing borrower
High fees
High IR
Strips equities
Places borrower in lower credit rating (Charge higher IR)
Foreclosing Strategies
Thank you !