FIN 4170 Ch 10 Secondary Mortgage Markets

What does secondary mortgage market provide?

Boosts liquidity, which lowers borrowing costs for the consumer

Mortgage Backed Secuities

• Multiple mortgage loans in a single pool or fund

• Security entitles investor to pro rata share of all cash flows

Loans in a given pool will be similar:

• FHA/VA; conventional

• Same vintage (new or recent loans)

• Similar interest rates

Between Fannie Mae, Freddie Mac, and Ginnie Mae which does not buy mortgage loans and issue MBS?

Ginnie Mae (basically just an insurance company)

Which type of mortgage pools does Ginnie Mae insure?

FHA and VA loans, provide insurance on passthrough payments, no disruption on the cash flow, investors still receive principal and interest payments

What does credit enhancement mean/protect?

Principal, it increases the likelihood that you will get all of your invested money back.

What are the five types of credit enhancement

1. Credit tranching

2. Excess spread

3. Overcollateralization

4. Reserve account

5. Guarantees

4 types of mortgage backed securities

1. Mortgage passthrough securities (MPT)

2. Mortgage backed bonds (MBB)

3. Mortgage pay through bonds (MPTB)

4. Collateralized mortgage obligations (CMO)

Mortgage passthrough securities (MPT)

Aggregation of loan cash flows, and then we distribute those to bond investors on a pro rata basis. No rearrangement of cash flows (pro rata)

Mortgage backed bonds (MBB)

Essentially, a corporate bond, but it's backed by residential loans. You get interest only until maturity and then full face value back at maturity.

Collateralized mortgage obligations (CMO)

Rearrange cash flows from the pool of mortgages into several different bond-like securities with different maturities (tranching up the cash flows). so principal, and interest gets paid in a sequential order. Losses flow through in reverse sequential order in the bottom up

Real Estate Mortgage Investment Conduit (REMIC)

Is the structure that allows principal and interest to be passed through to bond investors without being taxed.

the trustee that's taking in the cash flow from the loans isn't going to get taxed on that interest income because that interest income is being passed along to bond investors.

Commercial Mortgage-Backed Securities (CMBS)

• Started with S&L crisis of 1980s when Resolution Trust Corp. packaged

commercial loans of failed thrifts and sold CMBS

• Senior tranche(s) received all principal payments including prepayments

• Subordinated tranche(s) bore all losses from defaults

• Securitization process is similar to CMO with different tranches, except there is typically a “first-loss” or “B-piece” tranche for CMBS instead of the Z tranche for a traditional CMO

• Most common CMBS pool involves many mortgages on many properties, but sometimes a CMBS may only involve a single loan on a very large property or a single loan on many properties

Which are government sponsored enterprises?

Fannie Mae and Freddie Mac

What are known as the “agencies”?

Fannie Mae, Freddie Mac, and Ginnie Mae

What do the non agencies do?

The private sector issues MBS for "non-conforming" loans

• A mortgage can be non-conforming for a variety of reasons:

• Jumbo loans: loan amounts above the conforming loan limit (currently $417,000 in most states)

• Investor loans: 1-to-4 family property mortgages for non-owner-occupied homes; single-family properties held for investment

• Inadequate documentation (e.g. self-employed)

• Subprime: "B" and "C" rated borrowers (FICO < 620)

• Home equity loans

• Second mortgages

• Manufactured housing mortgages

Characteristics of Mortgage-Backed Securities

• Have some form of credit enhancement

• Avoid double taxation

• Tailor cash flows of MBS to appeal to investors