NonAgency Mortgages

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Non-Agency Mortgages Asset-Backed
Securities(not the latest version, Wed.)
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U.S. Fixed Income Markets by Sector Current
Snapshot
The Mortgage and Asset-Backed Securities with 7
trillion total outstanding debt make up the
largest of the U.S. fixed income securities
market.
Source The Bond Market Association
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U.S. Fixed Income Markets by Sector Historical
Trend
The Mortgage and Asset-Backed market has also
been the fastest growing segment of the U.S.
fixed income securities market.
Source The Bond Market Association
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Asset Backed and Mortgage Securities Basic
Definitions

• (A) Broadly defined, Asset-Backed Securities
  (ABS) are backed by any type
• of loans or other securities
• (B) Mortgage Backed Securities are backed by a
  pool of real estate loans
• residential or commercial
• (C) Narrowly defined, Asset-Backed Securities
  (also ABS) are backed by any type of loans or
  securities other than real estate (e.g. credit
  card loans, automobile loans, etc.)
• (D) Home Equity Securities are backed by second
  mortgage and other similar types of loans

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Non-Agency Mortgage Securities

• Mortgage securities which are backed by loans on
  single family but NOT issued by a U.S. Agency
  (e.g., issued by a mortgage bank) are called
  non-agency residential mortgage backed securities
  (RMBS).
• Commercial Mortgage-Backed Securities (CMBS)
  are collateralized by multi-family real estate
  loans or other commercial real estate loans.

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U.S. Asset-Backed Securities Market
There are a total of 1.7 trillion Asset-Backed
Securities outstanding in the U.S. fixed income
market. The three largest sub-sectors are auto,
credit cards, and home equity which together make
up 58 of the ABS market.
Source The Bond Market Association
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U.S. ABS Market Size by Sector Historical Trend
While Credit Card has historically been the
largest of the ABS sectors, the most rapidly
growing in recent years has been the Home Equity
sector.
Includes franchise loans, trade receivables,
etc.
Source The Bond Market Association
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U.S. ABS New Issuance by Sector Historical Trend
The rapid growth of Home Equity versus other ABS
sectors becomes more apparent when seen through
the new issuance volume.
Includes equipment leases, MH, CDOs, franchise
loans and other receivables
Source Thompson Financial
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Home Equity Loans

• The largest sector by volume in the ABS and the
  second largest in total outstanding after credit
  card deals.
• 46 of the ABS issued in 2003 were HEL deals.
• The term is increasingly used to encompass all of
  the subprime or otherwise highly leveraged home
  loans
• Subprime mortgages (loans made to borrowers of
  B and C qualities)
• Second lien loans (traditional home equity
  loans)
• High LTV loans (loans made to prime borrowers at
  LTV from 100 to 125).
• HELOC (revolving home equity lines of credit)
• HIL (home improvement loans)
• Scratch Dent (sub, non or re-performing
  mortgage loans)

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Non-Agency Residential Mortgage Backed Securities
(RMBS)

• Defined to be any single family mortgage products
  that are not issued or guaranteed by one of the
  U.S. government agencies.
• Non-Agency RMBS broadly fall into 3 categories,
  being backed by
• Jumbo (prime borrowers but the loan size exceeds
  the conforming loan balance limit currently
  330k)
• Alt-A (also prime borrowers but falls out of the
  Agency underwriting guidelines due to
  documentation, occupancy reasons)
• Home Equity (sub-prime borrowers or high
  leveraged loans)
• Generally, residential mortgages can be paid off,
  without a penalty, at any time.

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Loans Backing a Commercial Mortgage Backed
Security (CMBS)

• CMBS are backed by cashflows from commercial or
  multi-family residential real estate loans.
• The property types collateralizing the real
  estate loans include Office, Retail, Multifamily,
  Hotels, Industrial, and Healthcare.
• As the loans are made on a non-recourse basis,
  the investors typically look to the cashflow
  generated from the property for the P I
  payments and not to the borrowers credit.

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Annual CMBS Issuance

• The CMBS issuance volume has grown significantly
  over the past decade with the record over 80
  billion issued during 2003.

Source RBSGC CMBS Research
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CMBS vs. RMBS

• Both are backed by loans on real estate
• CMBS credit depends on income generated by the
  property while residential MBS depend on the
  borrowers credit
• CMBS are backed by relatively fewer but much
  larger loans than residential MBS.
• Commercial loans generally restrict prepayments
  through lockouts (and other features) while
  residential loans can be paid off at any time.
• Commercial loans tend to have maturities of 10
  yrs. or less (fixed rate - 10 yrs., floating rate
  - 5 yrs. or less). Many residential loans have
  maturities of 30 yrs.

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Credit Ratings of RMBS, CMBS, and ABS

• RMBS, CMBS and ABS differ from corporate bonds in
  that the credit of the bond is drawn from the
  structure of the deal rather than the issuers
  creditworthiness.
• RMBS, CMBS, and ABS are generally rated by one or
  more of the 3 major rating agencies.
• They determine the amount of credit enhancement
  (C.E.) required to produce a credit quality
  comparable to that of a same-rated corporate.

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An Example of Credit Enhancement
Senior/Subordinated Structure
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A Hypothetical Example of a Senior/Sub Structure
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How Does a Non-Agency RMBS/ABS Business Make
Money?

• Advising mortgage banks on the liquidation of
  their assets earn advisory fees
• Purchase loans and then structure/securitize
  underwrite and sell the securities
• earn underwriting fee plus the profit from
  selling the pieces for more than the whole
• Fund a client loan origination, then
  structure/securitize, underwriting, and sell the
  securities
• earn warehouse line revenue plus underwriting
  fees
• Secondary trading of securities (bid/offer
  spread)
• Trading strategies
• ABS/Non-Agency mortgage vs. interest rate
  swaps/treasuries
• Owning selected tranches of particular deals
  based on loss expectations
• Restructuring deals
• Some of the above activities bear certain risks

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How Does a CMBS Business Make Money?

• Originate commercial loans earn origination fee
• Structure/securitize, underwrite, and sell CMBS
• earn underwriting fees plus profit from selling
  the pieces for more than the whole
• Secondary trading of securities (bid/offer
  spread)
• Trading strategies
• CMBS vs. interest rate swaps/treasuries
• Owning selected tranches of particular deals
• Owning junior loans (B-notes)
• Some of the above activities bear certain risks

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