RE Secondary Market

Effects of a mortgage secondary market

encourages firms to enter the mortgage origination business (lower mortgage rates and higher home ownership), liquid market grants loan originators the ability the quickly sell portfolios to balance their mortgage holdings with deposit funds, introduce new funding source, promote integration of mortgage market with overall capital market

Mortgage pass through

simplest form of mortgage backed security, created by pooling mortgage loan and issuing certificates that entitle the investor to a pro rata share of pools cash flows

Agency Pass throughs

pooled and sold (securitized) by FNMA and GNMA, those by FHLMC are called participation certificates

Non-agency pass throughts (private label)

pooled and sold by gov agency of GSE

10 Loans at $100,000 each are pooled in a mortgage pass through. An investor can choose to invest in 1) a single mortgage loan of $100,000 or 2) a 10% share of the pass through security. In scenario ONE

The investor is entitled to all principal and interest payments but it the borrower of the mortgage in scenario 1 prepays, the investor is subject to 100% prepayment risks

10 Loans at $100,000 each are pooled in a mortgage pass through. An investor can choose to invest in 1) a single mortgage loan of $100,000 or 2) a 10% share of the pass through security. In scenario TWO

The investor is entitled to 10% of principal and interest payments of the entire pool which equals to scenario 1 but if the borrower of one of the pooled mortgages in scenario 2 prepays, the investor is subject to 10% prepayment risks

Benefits of pass through security compared to holding individual loans

MINIMAL LIQUIDITY RISK (investment of varying sizes and active secondary market) and MITIGATE DEFAULT RISK (loan level diversification decrease risk, agency pass through are guaranteed no default risk, private label pass through= manageable risk)

Pool Issue date

Date of issuance of pass through, not the date of mortgage origination

Pool maturity date

date of the last maturing mortgage in the pool

Pool factor

% of original principal that is still outstanding (PF= 1 @ origination)

Pass through rate

the net interest rate based of which investors recieve payment (after deducting servicing, management, and guarantee fees)

Pass through rate=

Weighted average mortgage coupon rate- servicing fee- guarantee fee

Weighted average coupon

average of the gross interest rate of pooled mortgages weighted by the remaining balance of each mortgage (WAC- Servicing Spread= pass through rate)

Weighted average maturity (WAM)

Average remaining terms of the underlying mortgages of the pool weighted by the remaining balance of each mortgage

RMBS

pass through security, tranching (dividing large pool of assets into smaller portions), smaller homogenous loans, less risky, borrower can generally prepay

CMBS

consists of fewer, larger, heterogenous loans, riskier, prepayment penalties

CMBS investors

institutional investors interested in fixed income securitires but do not want to directly invest in commercial real estate (life money managers, insurance companies, pension funds, mutual funds, and commercial banks,) investment grade bonds. RE high yield investors (hedge funds managers

Benefits of CMBS: Borrower

Match term financing, easy access, lower origination costs

Benefits of CMBS: banks

moving, not a warehouse business, risk off

Benefits of CMBS: Bond investors

Liquidity and diversification

Benefits of CMBS: B-piece investors

attractive risk adjusted returns

Tranching=

Waterfall structure