Description
This is a presentation explaining about Types of mortgage; advantage of mortgage; Modern methods of mortgage; Securitization of Mortgages; Pass Through Securities; Collateralized Mortgage Obligation
Housing Finance or Mortgages
• Conventional loan format – Fixed interest, EMI (level repayment), self liquidating, borrower’s home as collateral – Floating rate loans are being introduced • Most common practice – housing finance company – Originate – Get a customer, make the loan – Hold it in own books till maturity – Service the loan – collect payments, provide tax certificates and documents to borrower – Raise money to finance the loan • HFC assumes all the risks – Credit risk – Liquidity risk (illiquid secondary markets) – Price risk – Cash flow risk – prepayment
Disadvantages – One firm does all format
• Acute asset liability mismatch problem – Less investors with long horizon – More borrowers with long maturity loans • Most HFCs – Reluctant to make 30 year loans (5-15 yr normal) – Prefer big ticket borrowers (5 L plus not < 2L) – Credit standards get rather stringent (PTI) – LTV ratios get smaller (70% rather than 85%) • Funds locked for a long period • Size of the market often constrained by supply of funds rather than demand for loans • Customers who may need loans most may not get them – exclusion • Bank credit to housing as on March 09 – Rs.2.77 L Cr, increased by Rs.47,000 Cr over March 07 • Housing finance by dedicated HFCs – Rs.60,000 cr approx • Capital formation in the household sector – Rs.6 L cr in 07-08
Mortgage market – Modern methods
• All functions need not be done by the same firm • Different players doing different things – Originator – can be a bank – Pool several loans, have a combined collateral, Create a security with that backing – investment bank or a specialized institution – Sell the security in the market • Credit risk insurance – get a firm to insure the security • Loan service firm – collect payments etc • Risks are spread but this requires – Standardization of mortgages – Loan aggregators and sellers – Mortgage backing framework/institutions – Credit rating – Credit insurance/guarantee firms
Securitization of Mortgages – Pass Thru
• Creation of pass through securities formed the first step in securitization of mortgages • An institutional framework that provides for creation, credit assessment, guarantees, selling and trading of such securities is at the heart of this innovation • It essentially involves creating securities with the cash flows of the underlying mortgages • Called Mortgage Backed Pass-Through Securities • An investor is merely participating in the cash flows generated by the collective pool of mortgages • This process involves costs – insurance and guarantees, rating, servicing, legal & Admin etc. • The investor will thus receive a return that is less than the home loan rate • The timing of receipt may be with some time lag
Pass-Thru Securities
• Investor in Pass-thru securities – Cash flow depends on repayments and prepayments – Interest and principal are scheduled – Pre-payments are not • When interest rates decline borrowers tend to prepay and refinance at lower rates – PTS holders receive money earlier than anticipated – Loose out on the earlier high rate – Possibility of this loss is called Contraction risk • When interest rates rise borrowers do not prepay – This is precisely the time PTS holders would want early payments – So that they can benefit from the rising rates – This lost opportunity is called extension risk
Factoring in Prepayments
• A prepayment rate can be built into the cash flow of PTS • CPR – conditional prepayment rate – that a fraction of remaining principal in pool is prepaid each year • If CPR is 8% p.a then monthly prepayment rate, called SMM = 1 – ( 1 – 0.08) ^ (1/12) or 0.69% • Or 0.69% of the remaining mortgage balance at the beginning less scheduled principal will prepay that month • PSA (Public Securities Association) prepayment benchmark • 0.2% for the first month rising up to 6% for month 30 in identical steps, remaining at 6% for remaining years • 100 PSA means 6% CPR, 0 PSA means zero prepayment, 150 PSA means 9% CPR • Given a PSA ? CPR ? SMM ? prepayment amount
Factoring in Prepayments
• With prepayment, life of a pass thru is much lower than the stated term of the pool – Higher the rate of prepayment (PSA speed) lower the average life of PTS (15 to 3 years) – Factoring in prepayments does not eliminate risks • Investors can however choose between pools with different PSA speeds that suit their term appetite • Further innovation – better management of these risks – Redirect the cash flows from pools of PTSs – tranches – Create new securities (bonds) using the redirected cash flows of PTSs as collateral – The redirection creates different exposures to prepayment for different tranches – Effectively different risk/return profiles get created
Collateralized Mortgage Obligation
• The process of creation of different securities with varying risk/return profiles from an underlying pool of cash flows – collateralized mortgage obligation • CMO securities or bonds do not eliminate prepayment risk • It distributes the same between different classes of bonds (Sequential Pay CMO, Accrual Bonds, Planned amortization class, Stripped Securities etc) • In the process several classes of bonds with maturities varying from , say 3 to 25 years get created from an underlying pool with maturity of, say 15 years • It is also possible to create securities that resemble ZCBs from an underlying coupon based cash flow • A standardized plain mortgage thus enables creation of different types of securities with different features
doc_756521760.ppt
This is a presentation explaining about Types of mortgage; advantage of mortgage; Modern methods of mortgage; Securitization of Mortgages; Pass Through Securities; Collateralized Mortgage Obligation
Housing Finance or Mortgages
• Conventional loan format – Fixed interest, EMI (level repayment), self liquidating, borrower’s home as collateral – Floating rate loans are being introduced • Most common practice – housing finance company – Originate – Get a customer, make the loan – Hold it in own books till maturity – Service the loan – collect payments, provide tax certificates and documents to borrower – Raise money to finance the loan • HFC assumes all the risks – Credit risk – Liquidity risk (illiquid secondary markets) – Price risk – Cash flow risk – prepayment
Disadvantages – One firm does all format
• Acute asset liability mismatch problem – Less investors with long horizon – More borrowers with long maturity loans • Most HFCs – Reluctant to make 30 year loans (5-15 yr normal) – Prefer big ticket borrowers (5 L plus not < 2L) – Credit standards get rather stringent (PTI) – LTV ratios get smaller (70% rather than 85%) • Funds locked for a long period • Size of the market often constrained by supply of funds rather than demand for loans • Customers who may need loans most may not get them – exclusion • Bank credit to housing as on March 09 – Rs.2.77 L Cr, increased by Rs.47,000 Cr over March 07 • Housing finance by dedicated HFCs – Rs.60,000 cr approx • Capital formation in the household sector – Rs.6 L cr in 07-08
Mortgage market – Modern methods
• All functions need not be done by the same firm • Different players doing different things – Originator – can be a bank – Pool several loans, have a combined collateral, Create a security with that backing – investment bank or a specialized institution – Sell the security in the market • Credit risk insurance – get a firm to insure the security • Loan service firm – collect payments etc • Risks are spread but this requires – Standardization of mortgages – Loan aggregators and sellers – Mortgage backing framework/institutions – Credit rating – Credit insurance/guarantee firms
Securitization of Mortgages – Pass Thru
• Creation of pass through securities formed the first step in securitization of mortgages • An institutional framework that provides for creation, credit assessment, guarantees, selling and trading of such securities is at the heart of this innovation • It essentially involves creating securities with the cash flows of the underlying mortgages • Called Mortgage Backed Pass-Through Securities • An investor is merely participating in the cash flows generated by the collective pool of mortgages • This process involves costs – insurance and guarantees, rating, servicing, legal & Admin etc. • The investor will thus receive a return that is less than the home loan rate • The timing of receipt may be with some time lag
Pass-Thru Securities
• Investor in Pass-thru securities – Cash flow depends on repayments and prepayments – Interest and principal are scheduled – Pre-payments are not • When interest rates decline borrowers tend to prepay and refinance at lower rates – PTS holders receive money earlier than anticipated – Loose out on the earlier high rate – Possibility of this loss is called Contraction risk • When interest rates rise borrowers do not prepay – This is precisely the time PTS holders would want early payments – So that they can benefit from the rising rates – This lost opportunity is called extension risk
Factoring in Prepayments
• A prepayment rate can be built into the cash flow of PTS • CPR – conditional prepayment rate – that a fraction of remaining principal in pool is prepaid each year • If CPR is 8% p.a then monthly prepayment rate, called SMM = 1 – ( 1 – 0.08) ^ (1/12) or 0.69% • Or 0.69% of the remaining mortgage balance at the beginning less scheduled principal will prepay that month • PSA (Public Securities Association) prepayment benchmark • 0.2% for the first month rising up to 6% for month 30 in identical steps, remaining at 6% for remaining years • 100 PSA means 6% CPR, 0 PSA means zero prepayment, 150 PSA means 9% CPR • Given a PSA ? CPR ? SMM ? prepayment amount
Factoring in Prepayments
• With prepayment, life of a pass thru is much lower than the stated term of the pool – Higher the rate of prepayment (PSA speed) lower the average life of PTS (15 to 3 years) – Factoring in prepayments does not eliminate risks • Investors can however choose between pools with different PSA speeds that suit their term appetite • Further innovation – better management of these risks – Redirect the cash flows from pools of PTSs – tranches – Create new securities (bonds) using the redirected cash flows of PTSs as collateral – The redirection creates different exposures to prepayment for different tranches – Effectively different risk/return profiles get created
Collateralized Mortgage Obligation
• The process of creation of different securities with varying risk/return profiles from an underlying pool of cash flows – collateralized mortgage obligation • CMO securities or bonds do not eliminate prepayment risk • It distributes the same between different classes of bonds (Sequential Pay CMO, Accrual Bonds, Planned amortization class, Stripped Securities etc) • In the process several classes of bonds with maturities varying from , say 3 to 25 years get created from an underlying pool with maturity of, say 15 years • It is also possible to create securities that resemble ZCBs from an underlying coupon based cash flow • A standardized plain mortgage thus enables creation of different types of securities with different features
doc_756521760.ppt