page 1 international housing finance services © 2000 fannie mae – all rights reserved...

International Housing Finance Services© 2000 Fannie Mae – All Rights Reserved

Possibilities for Capital Market Transactions

Mortgage-Backed Securities

IDB Business Seminar

Capital Markets for Development

The Role of the Private Sector

June 04, 2004

Washington, D.C.



• Residential mortgage debt is the largest credit market in the world, outpacing nominal GDP growth for the last decade

As of 12/31/03…

U.S. residential mortgage debt outstanding was an estimated $7.6 trillion.

Growth in primary mortgage market

• Fueled by population growth, rising homeownership rates, home price appreciation, stable interest rate environment, and technology advances

Growth in secondary mortgage market

• Fueled by high purchase and refinance activity, high securitization rates and industry consolidation



• Types of mortgage securities issued in the U.S. capital markets :

Non-Derivative Products

• Mortgage-Backed Bonds (MBB)

• Mortgage-Backed Securities (MBS) (also referred to as Pass-Through Securities)

Derivative Products

• Collateralized Mortgage Obligations (CMO)

• Real Estate Mortgage Investment Conduit (REMIC)

• Stripped Mortgage-Backed Securities (SMBS)


Features of MBS

General Description

• MBS is a basic mortgage security

– Fixed income investment instrument that represents ownership of an undivided interest in a group of mortgages

– Pooling loans of one or more mortgage originators to form the underlying assets for the security

– Selling shares in the pool to investors to create pass-through security

• Entire stream of cash flows received from the collateral is passed on to investors in an undivided manner

– Principal and interest from the individual mortgages are used to pay principal and interest on the MBS

– Payment based upon the percentage of ownership of the pool balance

• MBS represents a true sale of assets for the issuer

– Treated as Off-balance sheet financing


Features of MBS

General Description

Interest and Scheduled PrincipalLoan #1

Interest and Scheduled Principal

Loan #2


Loan #3


Loan #4

Pooled Monthly Cashflow:• Interest• Scheduled Principal• Prepayments

Passthrough: $1 million parEach loan: $250,000

Rule for distribution of cash flow: pro rata basis

$250,000

$250,000

$250,000

$250,000

Each loan is $250,000Total Pool Amount: $1 Million


Features of MBS

Cash Flow Characteristics

$$Monthly P&I

Payment

LessServicing Fee

Borrower IssuerConduit or Financial Guarantor

Capital Market Investor

$$Monthly P&I

Payment

LessGuaranty Fee

$$Monthly P&I

Payment

Gross Mortgage Coupon (Note Rate)

Servicing Fee to Issuer (Servicer)

Mortgage Coupon to Conduit

Guaranty Fee (Conduit)

Pass-Through Coupon to Investor

7.00%

(.25%)

6.75%

(.25%)

6.50%

• Cash flows generated by mortgage pool are passed on to the investor net the servicing spread

Pass-Through Coupon =Gross Mortgage Note Rate - Guaranty Fee - Servicing Fee

Cash flows include:

• Scheduled interest

• Scheduled principal repayments

• Unscheduled payments (including partial prepayments and prepayment of the entire outstanding balance of the loan)


Features of MBS


• Servicing fee provides compensation to the issuer (and/or servicer) for assuming loan administration responsibilities:– Collection, remittance, and reconciliation of payments– Document custody– Cash management and accounting– Delinquency management– Investor reporting (as required)

Servicing Fees in U.S. Market

Agency Conduits( Fannie Mae & Freddie Mac )

Government Conduit( Ginnie Mae )

• Typically range between 25 and 37 basis points

• Higher fee for adjustable rate loans due to increased complexity

• Negotiable with agency -- high servicing standards may benefit from reduced guaranty fees

• Typically around 44 basis points


Features of MBS


• Guaranty fee is compensation provided to the financial guarantor for:

– Guaranty of timely payment of principal and interest to investors

– Used to cover issuer credit risk in the event of default

– Assumption of some or all of the credit risk associated with underlying assets

Guaranty Fees in U.S. Market

Agency Conduits( Fannie Mae & Freddie Mac )

Government Conduit( Ginnie Mae )

• Typically under 25 basis points

• Negotiable with agency -- high underwriting standards and low delinquency history may negotiate a guaranty fee under 25 basis points

• Typically around 13 basis points

• Both the underlying loans and the securities are backed by the full faith and credit of the U.S. government


Features of MBS

Additional Features

• Generally issued in a single class with each investor having a pro-rata interest in the mortgage pool:

Investor receives principal and interest on a monthly basis in an amount equal to his proportionate share of the security

• Typically requires some type of credit support to protect the investors against delinquencies of payment and defaults on the underlying mortgage collateral

– Agency securities include financial guaranty of corporation (e.g. Fannie Mae, Freddie Mac) or government (e.g., Ginnie Mae)

– Private issuance securities include some form of internal or external credit enhancement

Example:

If 1,000 certificates are issued relative to a mortgage pool, each certificate would represent the right to 1/1000 of each payment of

principal and interest on each mortgage in the pool.


Benefits of Mortgage Securitization

Industry Benefits

• Enables borrowers to receive lower rates• Allows lenders to sell loans into capital markets• Attracts funds from capital markets • Promotes standardization and specialization in the industry --

creating lending and investment efficiencies• Assists in management of portfolio risk and liquidity imbalances

Borrower

Lender

Investor

Mortgage

Funds

• Pool of Loans• Monthly P&I

Payment1

Issuer• Security• Monthly P&I

Payment2

Funds



Issuer Benefits Borrower

Lender

Investor

Issuer

• Reduced level of credit risk over holding individual loans in portfolio

• Credit risk transferred or from lender to third-party guarantor -- in exchange for guaranty fee

• Availability of credit enhancements

• Risk especially acute with longer-term fixed-rate mortgages

• Cost of hedging interest rate risk can be extremely high relative to return

• Interest rate risk transferred to ultimate investor in MBS security

• Greater liquidity over whole loan mortgages

• Agency MBS is highly liquid in fixed income markets

• Increased borrowing capability using MBS as collateral

• Reliable source of off-balance sheet financing

• Reduce capital risk resulting from investor sale

• Provide regulatory relief through reduced risk-based capital requirements

• Increase company’s return on capital / equity through efficient allocation

• Enhance company’s ability to raise funds in the capital markets

Potential Benefit IReduced Credit Risk

Potential Benefit IIReduced Interest Risk

Potential Benefit IIISource of Liquidity

Potential Benefit IVEnhanced Capital



Investor Benefits Borrower

Lender

Investor

Issuer

• Represents thousands of loans of varying amounts, seasoning and geographic locales

• Provides vehicle for diversification of overall retained portfolio and assets

• Greater liquidity over whole loan mortgages

• Agency MBS are AAA rated

• Standardization yielding reduced capital, funding and expenses

• Favorable accounting and tax treatment

Potential Benefit IIDiversified Security

Potential Benefit IIIImproved Execution

• Reduced level of credit risk over holding individual loans in portfolio

• Repays principal throughout life of investment

• Pays monthly versus semi-annual payments, such as bonds

• May receive above market rate payments in declining rate market

• Long duration assets to match longer term liabilities

Potential Benefit IAttractive Return on Investment



MBS Transaction

Issuer

Primary Market Lender 1

MBS in Portfolio

Primary MarketLender 2

MBS in Portfolio

Primary Market Lender 3

MBS in Portfolio

Loans

P&IPayment

Funds

MBS Security Ownership: Capital Market Investor

Servicing Rights: Primary Market Lender/Servicer

Credit Risk Allocation: Financial Guarantor or Credit Enhancement

Interest Rate Risk Allocation: Capital Market Investor

Swap & Sell Transaction

Funds

FundsFinancial Guarantor

Credit Guaranty Fee

Capital Market Investor

MBS

Funds

InvestorPayment

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