MBS MODULE MODULE 7

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MBS MODULEMODULE 7

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Mortgage-Backed Security Markets-- Secondary
Mortgage Markets

• Mortgage Related Securities
• Mortgage Collateral
• Why Should There Be a Secondary Market?

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Buys
Sells
Secondary Mortgage Market
Mortgages
MRS
Investor
Originator
Cash
Cash
Originator
Agency
Investor
Mortgage (-)
Mortgage ()
MRS ()
MRS ()
Cash ()
Cash (-)
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MRS Basic Characteristics

• Credit Enhancement
• Avoid Double Taxation and Bankruptcy
• Tailor Cash Flows from Mortgages to Investors

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MRS Phylum -- Flora Fauna

• Mortgage Pass-Through Securities
• Mortgage-Backed Bonds
• Mortgage Pay-through Bonds
• Collateralized Mortgage Obligations

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Credit Enhancement Techniques

• Pass-Through -- FHA/VA Loans
• Mortgage-Backed Bonds -- Agency Equity
  or Pool Revenue
• Mortgage Pay- -- Agency Equity Through
  Bonds Pool Insurance
• Collateralized -- Agency Equity
  Pool
• Mortgage Obligations Insurance
  Letter of
• Credit
• Debts of Agency -- FHA/VA Loans in
  Pool

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Mortgage-Backed Bond Cash-flows
Buys
Sells
Originator
Mortgages
Firm
MBB
Investor
Cash
Cash 125
100
Firm
MBB 100 Equity 25
125 Mortgages
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CMO Structure

• Maturity Coupon
  Total
• Assets
• Mortgages 30 10.0 106
• Total Assets
  106
• Liabilities
• A 5-9 9.25
  30
• B 9-14 9.50
  30
• C 12-17 10.0
  25
• Z 28-30 10.5
  15
• Liabilities
  100
• Equity
  6
• Total
  106

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Tax and Accounting for MRS

• - Guarantor Trust -- Avoids Double Taxation
• 1. Limited Life
• 2. Self-Liquidating
• 3. No Asset Management

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REMIC Cash Flow Structure
Buys
Sells
Secondary Market Agency
REMIC
Originator
Mortgages
Investor
Cash
Cash
Transfers or Sells Mortgages off balance Sheet
Trust or Separate Accounting Activity
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Secondary Market Players

• - FNMA
• - GNMA
• - FHLMC

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Secondary Market Players

• - Federal Credit Agencies
• Farm Credit system
• Farm Credit Assistance Financial Corp.
• Federal Agricultural Mortgage Corp.
• (Farmer Mae)
• Farmers Home Administration
• (FmHA)
• Financing Corp.
• (FICO)
• Federal Financing Bank
• (FFB)
• State and Local Credit Agencies
• - HFAs
• - Private Sector Firms
• - First Boston, et. al.
• - RTC Paper

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Regulation of GSEs

• FNMA/FHLMC Capital Requirements
• - Interest Risks
• - Default Risks
• - Management and Operating Risks

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Valuation of MRS

• Mortgage Derivative Securities
• Interest Rates Affect both Amounts of Cash Flows
  and Time Value of Cash Flows
• MRS are Interest-Contingent Securities

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MRS Fundamentals

• 1. Principal of Pool is Fixed in Total (No
• Defaults)
• 2. Interest Payments Depend Upon Past
• Amortization
• 3. Changes in Interest Rates Affect Timing of
• Prepayments

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Pass-Throughs and Prepayment Rates

• 1. Twelve Year Prepaid Life
• 2. Constant Prepayment Rate (CPR)
• 3. FHA Experience
• 4. Public Securities Association (PSA)
• 5. Econometric Prepayment Models

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PSA Model

6
100 PSA
Time
30
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Econometric Models

• Age of Mortgage
• Seasonal
• Current and Projected Interest Rate Relative to
  Mortgage Coupon
• Geography
• Borrower Characteristics
• - Age
• - Income
• - Wealth

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Interest Rates and Prepay Behavior
100
.
o

-
Differential Between
Market and Coupon
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SWAPS

• - Mortgage Pools for MRS
• - Used by SLs Because of Liquidity