Mortgage-backed Securities

1
Mortgage-backed Securities

• Business 4039

2
Securitization

• 30 years ago, investors could not invest in
  mortgagestoday, however, almost anyone can
  invest in a portfolio of mortgage loans
• A mortgage-backed security (MBS) is either an
  ownership claim in a pool of mortgages or an
  obligation that is secured by such a pool.
• These claims represent securitization of mortgage
  loans.

3
Securitization Defined

• Pooling of loans for various purposes into
  standardized securities backed by those loans,
  which can then be traded like any other security.
• This is a technique that causes previously
  illiquid assets to become liquid investments
  around which a secondary market can develop.
• This tradeability and market valuation, a wider
  range of investors become interested in making
  the investment, thereby increasing the pool of
  funds in society available to support the primary
  purpose of a mortgage.

4
Home Mortgages

• Home mortgages are usually written with a
  long-term (25- to 30- year maturity) amortization
  of the principal.
• Until the 1970s, almost all such mortgages had a
  fixed interest rate over the life of the loan
  with equal fixed monthly payments.
• Since then these so-called conventional mortgages
  have become renewable at one-to-five year
  intervals, at which point their interest rates
  may be renegotiated.

5
Fixed-rate Mortgages and Banks

• Fixed-rate mortgages pose difficulties to banks
  in years of increasing interest rates because of
  the mismatching of maturities of assets and
  liabilities.
• Banks commonly issue short-term liabilities (the
  deposits of their customers) and hold long-term
  assets such as fixed-rate mortgages.
• Hence, they suffer losses when interest rates
  increase the rates they pay on deposits increase
  while their mortgage income remains fixed.
• The five-year renewal period helps to alleviate
  this problem.
• Variable rate mortgages transfer the interest
  rate risk from the financial institution to the
  borrower.

6
Mortgage-Backed Securities

• A MBS is an instrument whose cash flow depends on
  the cash flow from an underlying pool of
  mortgages.
• There are four types
• Mortgage pass-through securities
• Collateralized mortgage obligations
• Mortgage-backed bonds, and
• Stripped mortgage-backed securities.

7
Mortgage

• A mortgage is a pledge of real estate to secure
  the loan originated for the purchase of that real
  property.
• The mortgage gives the lender (mortgagee) the
  right to foreclose on the loan and seize the
  property in order to ensure that the loan is paid
  off if the borrower (mortgager) fails to make the
  contracted payments.
• The types of real estate properties that can be
  mortgaged are divided into two broad categories
  residential and nonresidential (ie., commercial
  and farm)
• The mortgage loan specifies the interest rate of
  the loan, the frequency of payment, and the
  number of years to maturity.

8
Mortgage Cash Flows

• Each monthly mortgage payment consists of the
  monthly interest, a scheduled amount in excess of
  the monthly interest that is applied to reduce
  the outstanding loan balance (this is called the
  scheduled repayment of principal), and any
  payments in excess of the mortgage payment.

9
Mortgage Pass-Through Securities
10
Collateralized Mortgage Obligations
11
Mortgage-Backed Bonds
12
Stripped Mortgage-Backed Securities