Description
It explains what are mortgage backed bonds, mortgage pass through securities, collaterized mortgage obligations.
The Secondary Mortgage Market for Real Estate Loans
• • • • History of the market The residential agencies Types of mortgage pools CMBS
Market History
• Market for publicly traded mortgage securities originated with federal gov involvement in the residential market • Government created a series of “alphabet soup” agencies to:
• Facilitate flows of capital nationwide by creating liquidity in the market • Promote home ownership broadly, specifically among middle class
Federal National Mortgage Association – “Fannie Mae”
• Founded in 1938 • Initial federal agency designed to broaden the residential marketplace
• Initial Objectives of the agency:
• Create a secondary market for loans – A source of loan repayment besides amortization of outstanding mortgage loans • Manage outstanding loans • Provide special assistance programs for homeowners
How Fannie Mae Works
• FNMA actually issues its own debt in the public markets
• Debt has a very low coupon • Even though private today, it is perceived as a quasi public/private entity – assumed to enjoy the full faith and credit backing of the U.S. government
• Uses proceeds from these offering to purchase loans from loan originators
• FNMA’s low issuance cost allows it to earn a spread between the interest expense on its debt and the yield on purchased mortgage loans
Government National Mortgage Association – “Ginnie Mae”
• Established in 1968 when FNMA was spun off as a private entity • Objectives:
• Manage and liquidate mortgages previously acquired by FNMA • Offer federally subsidized housing programs • Private a federal guarantee for FHA and VA mortgage loans
How Ginnie Mae Works
• GNMA offers a guarantee of timely payment of principal and interest on FHA, VA and Farmer Mac residential loans • Guarantee allows these loans to be pooled into “passthrough” securities
• The original collateralized mortgage obligations ? “CMOs”
What is a CMO?
• A collateralized mortgage obligation is a separate security backed by a pool of mortgage loans • Allows investors to acquire an undivided interest in an underlying pool of mortgages
• Creates a takeout for “whole” loans
• Interest and principal payments on the underlying mortgages provide the cash to pay the P&I on the CMO
GNMA’s role
• When the pass through securities are issued, the purchasers pay a guarantee fee to GNMA • GNMA uses these fees to conduct its operations
• GNMA takes timing and collection risk on the mortgages backing the CMO’s
• FHA, VA and Farmer Mac provide guarantees against mortgage default on those loans • Guarantees are priced on the historical experience with default rates
Distinction between FNMA and GNMA
• FNMA actually purchases mortgages
• Uses its own balance sheet to issue debt • Used proceeds of that debt to buy loans
• GNMA is only issuing a guarantee
• The guarantee backs a pooled mortgage security that allows the other agencies to raise capital so that they can effectively recycle their capital into new loans
The Secondary Market for Conventional Loans
• Federal Home Loan Mortgage Corporation – “Freddie Mac” • Freddie Mac mimics Fannie Mae
• Issues debt to acquire conventional mortgage loans • Conventional loans are larger loans that do not qualify for FHA, VA status
Value-Add of the Agencies
• The agencies keep funds flowing into the residential mortgage market regardless of the level of interest rates • The public markets continually re-price these loans as the yield curve changes • Since lenders are passing long term interest rate, prepayment and default risks to the public markets, they can use their balance sheets over and over to originate new loans at current underwriting levels
What Risks do Lenders Continue to Face?
• Standard underwriting risk
– Market and property conditions, borrower financial status, etc.
• “Pricing” the original loan
– Lenders must price into their spread the timing risk of holding the loans from the time of origination to sale
• If rates rise in that time period, the market value of outstanding loans in the fixed income markets will fall
Types of Mortgage Backed Pools
• Mortgage backed bonds • Mortgage pass-through securities
• Mortgage pay-through bonds
• CMO’s
Mortgage Backed Bonds
• Issuer originates commercial loans • Issuer also issues a fixed rate bond on its balance sheet
– Retains ownership of the mortgages – Pledges them as collateral for payment of the new bonds
• New bonds have fixed coupon rates and maturities
– Coupons are lower than the original mortgage rates, so the lender earns the spread – Lender uses the bond proceeds to create new loans to individual borrowers
Mortgage Pass-Through Securities
• Commercial mortgage equivalents of the GNMA guaranteed securities • The newly issued securities represent an undivided “equity” interest in a pool of mortgages • Payments of P&I on the pool are “passed through” directly to the holders
Mortgage Pay-Through Bonds
• Function similar to pass-throughs, but purchaser actually owns a bond, not an interest in a pool • Payment obligation is on the bond issuer, not the underlying mortgages
– Even though the underlying mortgages are the issuer’s source of payment
Collateralized Mortgage Obligations – CMO’s
• Combine features of the mortgage backed bond and the pass through • Issuer retains ownerships of the mortgages, as in the mortgage-backed bond • But the underlying mortgage payments are passed directly through to investors
• Investor assumes the prepayment risk
Securitized Mortgage Market Today
• Federally funded mortgage pools
• > $70 billion • 4% of total mortgages outstanding
• Non-government Commercial Mortgage Backed Securities ? “CMBS”
• > $250 billion today • Approximately 20% of total outstanding debt
• Overall secondary market is still relatively small but growing in importance as a benchmark for the underwriting and pricing of all real estate debt
Secondary Market for Commercial Mortgages
• Market is less than 20 years old • Created to replicate the success of the secondary market for residential loans
• Consists primarily of mortgage backed pools
• One of three key drivers of the recovery from the late 1980, early 1990 real estate depression
• The others? The RTC and the change in the REIT ownership rules
Structure of CMBS
• CMBS are issued in “tranches”
• Tranches are called ‘A’, ‘B’, ‘C’, and so on • The “spread” is the difference between the value of the assets pledged and the size of the tranches
• To help insure that payments are made, CMBS issues are typically “overcollateralized”
• A $100 million issue will be backed by $125 - $240 million of par value mortgages • This is the public market equivalent of the DCR
How Do the Tranches Work?
• Tranches create a tier of claims on the cash flow from the mortgage payments • Tranche ‘A’ will have first claim
• Effective collateral value and DCR ratio is much higher than average of the pool • Will have lowest coupon and minimal default risk
• Tranche ‘B’ will be less secure
• Higher coupon, lower debt coverage, higher risk
• Tranche ‘C’ is effectively a junk bond
• Highest coupon, first in line of default
Rating CMBS
• Bonds are underwritten and rated by Moody’s and S&P • Investment banks work with issuers to structure and price the tranches • Issuance and pricing will be based on the ratings assigned to each piece of the CMBS pool
Basis for CMBS Ratings
• • • • • • Quality of issuer’s underwriting Mortgage insurance Geographic diversification Interest rate Size of collateral pool Appraised value and underlying, blended mortgage debt coverage ratio
Pricing the Bonds
• Bonds may or may not be issued at par
• i.e. may not be issued exactly at the average interest rate of the pool
• Why would they priced differently?
• Market rate has moved away from the original underwriting levels • Issuer wants to establish a certain pay rate – Will take more or less proceeds in exchange for the desired payment obligation
CMBS example
• $100 million issue, 8% stated interest rate, 10 year term • However, the market requires a 9% current yield, even though the issuer wants the 8% pay rate
• The bonds will be priced at less than par to compensate for the higher yield requirement of prospective buyers
CMBS example (cont.)
• Step 1: Find the payments that will be made the stated interest rate
• • • • • PV = - $100,000,000 N = 10 I = 8 (simple interest) FV = $100,000,000 (bonds do not amortize) PMT = $8,000,000
CMBS Example (cont.)
• Step 2: Discount those payments and the par value at maturity by the actual market rate
• • • • • FV = $100,000,000 N = 10 I = 9% PMT = $8,000,000 PV = $93,582,342 = proceeds at issue
Zero Coupon Bonds
• Means that there are no interest payments made during the life of the bond • The entire yield is based on the residual par value of the bond
• • • • • FV = $100,000,000 I = 8% N = 10 years PMT = 0 PV = -$46,319,350 = proceeds of the issue
MALAYSIAN MORTGAGE MARKET
Cagamas Berhad…
• Established in 1986
• National mortgage corporation ?leader in securitization
• Issues debt securities to finance the purchase of housing loans from financial and non financial institutions • Provision of liquidity at a reasonable cost to the primary lenders of housing loans encourages further financing of houses at an affordable cost
Cagamas Berhad…
• Regarded by the World Bank as the most successful secondary mortgage liquidity facility • Cagamas debt securities– unsecured obligations – issued scripless – tradeable electronically in book-entry form (through an electronic clearing house known as the Scripless Securities Trading Systems, operated by Bank Negara Malaysia)
Islamic Mortgages in Malaysia…
In March 1983 Bank Islam Malaysia (BIMB) was established to offer Islamic products and services to cater to the demand of Muslims. The financing facilities granted by BIMB included the financing of Islamic mortgages. Today, Islamic mortgages in Malaysia have broadened their appeal to not only devoted Muslims, but also to non-Muslims, due to their competitive pricing as compared to conventional, interest-based financing.
In 1993, conventional banking institutions were permitted to offer Islamic banking products and services through Islamic windows, subject to the specific guidelines issued by Bank Negara Malaysia (BNM), the Central Bank. In 1994, the secondary mortgage market for Islamic mortgages was created by Cagamas, the national mortgage corporation, when it purchased Islamic mortgages from Islamic banking institutions (IBIs). This has resulted in the growth of Islamic mortgages over the years
Islamic Mortgages in Malaysia…
The primary market for Islamic mortgages: The financing of Islamic mortgages in Malaysia was first made available to individuals under the principle of Bai Bithaman Ajil (deferred payment sale). Today, Islamic finance is moving towards the floating rate market. BNM has allowed a floating rate Bai Bithaman Ajil where customers are required to make higher monthly payments and are given rebates depending on the prevailing market rate.
The secondary market for Islamic mortgages:
The secondary mortgage market in Malaysia became a reality with the establishment of Cagamas in 1986 to perform the function of an intermediary between the originators of housing loans and the investors of long-term funds
Islamic Mortgages in Malaysia…
The secondary market for Islamic mortgages:The secondary mortgage market in Malaysia became a reality with the establishment of Cagamas in 1986 to perform the function of an intermediary between the originators of housing loans and the investors of longterm funds
In March 1994, Cagamas introduced a scheme to purchase Islamic mortgages granted on the basis of Bai Bithaman Ajil on with recourse basis, in accordance with the principle of Bai Dayn (debt trading). The recourse relates to the obligation of the seller to bear any losses arising from default by its customer. The debt securities issued to finance the purchase are the general obligation of Cagamas and are not strictly backed by the cashflows from the Islamic mortgages purchased.
Securitization of Islamic Mortgages…
The IBI (Islamic Banking Institution) sells its Islamic mortgages to a special purpose vehicle (SPV) that is owned by Cagamas
The SPV then issues asset-backed securities (ABS) – i.e. Islamic residential mortgage-backed securities (RMBS) – to investors
Cashflows from the purchased Islamic mortgages are utilized to meet the Islamic RMBS obligations. The securitization process therefore unlocks the illiquid assets of the IBI into tradable securities
CAGAMAS Bonds and Notes
• Cagamas Fixed Rate Bonds
– Tenures -1.5 to 10 years – Fixed coupon rate - determined at the point of issuance, based on the tenders submitted by the Principal Dealers. – Interest paid half-yearly – Redemption at nominal value with interest due on maturity
• Cagamas Floating Rate Bonds
– Tenure of up to 10 years – Adjustable interest rate - pegged to the 3-month or 6-month KLIBOR. The interest rate is reset every 3 or 6 months – Interest is paid at 3 or 6 monthly intervals. – Redeemed at face value with interest due upon maturity.
CAGAMAS Bonds and Notes
• Cagamas Notes
– Short-term instruments with maturities between 1 to 12 months issued at a discount from the face value – Redeemable at their nominal value upon maturity.
• Sanadat Mudharabah Cagamas
– Islamic bonds issued under the Islamic principle of Mudharabah (profit-sharing) – Dividend based on a pre-determined profit sharing ratio - payable semi-annually – Redeemable at par on maturity date unless there is principal diminution – Tenure of up to 10 years
CAGAMAS Bonds and Notes
• Sanadat Cagamas
– – – – Islamic bonds issued under the Islamic principle of Bai Bithaman Ajil Dividend payable semi-annually Redeemable at par together with the dividend on maturity Tenure of up to 10 years
doc_338516493.pptx
It explains what are mortgage backed bonds, mortgage pass through securities, collaterized mortgage obligations.
The Secondary Mortgage Market for Real Estate Loans
• • • • History of the market The residential agencies Types of mortgage pools CMBS
Market History
• Market for publicly traded mortgage securities originated with federal gov involvement in the residential market • Government created a series of “alphabet soup” agencies to:
• Facilitate flows of capital nationwide by creating liquidity in the market • Promote home ownership broadly, specifically among middle class
Federal National Mortgage Association – “Fannie Mae”
• Founded in 1938 • Initial federal agency designed to broaden the residential marketplace
• Initial Objectives of the agency:
• Create a secondary market for loans – A source of loan repayment besides amortization of outstanding mortgage loans • Manage outstanding loans • Provide special assistance programs for homeowners
How Fannie Mae Works
• FNMA actually issues its own debt in the public markets
• Debt has a very low coupon • Even though private today, it is perceived as a quasi public/private entity – assumed to enjoy the full faith and credit backing of the U.S. government
• Uses proceeds from these offering to purchase loans from loan originators
• FNMA’s low issuance cost allows it to earn a spread between the interest expense on its debt and the yield on purchased mortgage loans
Government National Mortgage Association – “Ginnie Mae”
• Established in 1968 when FNMA was spun off as a private entity • Objectives:
• Manage and liquidate mortgages previously acquired by FNMA • Offer federally subsidized housing programs • Private a federal guarantee for FHA and VA mortgage loans
How Ginnie Mae Works
• GNMA offers a guarantee of timely payment of principal and interest on FHA, VA and Farmer Mac residential loans • Guarantee allows these loans to be pooled into “passthrough” securities
• The original collateralized mortgage obligations ? “CMOs”
What is a CMO?
• A collateralized mortgage obligation is a separate security backed by a pool of mortgage loans • Allows investors to acquire an undivided interest in an underlying pool of mortgages
• Creates a takeout for “whole” loans
• Interest and principal payments on the underlying mortgages provide the cash to pay the P&I on the CMO
GNMA’s role
• When the pass through securities are issued, the purchasers pay a guarantee fee to GNMA • GNMA uses these fees to conduct its operations
• GNMA takes timing and collection risk on the mortgages backing the CMO’s
• FHA, VA and Farmer Mac provide guarantees against mortgage default on those loans • Guarantees are priced on the historical experience with default rates
Distinction between FNMA and GNMA
• FNMA actually purchases mortgages
• Uses its own balance sheet to issue debt • Used proceeds of that debt to buy loans
• GNMA is only issuing a guarantee
• The guarantee backs a pooled mortgage security that allows the other agencies to raise capital so that they can effectively recycle their capital into new loans
The Secondary Market for Conventional Loans
• Federal Home Loan Mortgage Corporation – “Freddie Mac” • Freddie Mac mimics Fannie Mae
• Issues debt to acquire conventional mortgage loans • Conventional loans are larger loans that do not qualify for FHA, VA status
Value-Add of the Agencies
• The agencies keep funds flowing into the residential mortgage market regardless of the level of interest rates • The public markets continually re-price these loans as the yield curve changes • Since lenders are passing long term interest rate, prepayment and default risks to the public markets, they can use their balance sheets over and over to originate new loans at current underwriting levels
What Risks do Lenders Continue to Face?
• Standard underwriting risk
– Market and property conditions, borrower financial status, etc.
• “Pricing” the original loan
– Lenders must price into their spread the timing risk of holding the loans from the time of origination to sale
• If rates rise in that time period, the market value of outstanding loans in the fixed income markets will fall
Types of Mortgage Backed Pools
• Mortgage backed bonds • Mortgage pass-through securities
• Mortgage pay-through bonds
• CMO’s
Mortgage Backed Bonds
• Issuer originates commercial loans • Issuer also issues a fixed rate bond on its balance sheet
– Retains ownership of the mortgages – Pledges them as collateral for payment of the new bonds
• New bonds have fixed coupon rates and maturities
– Coupons are lower than the original mortgage rates, so the lender earns the spread – Lender uses the bond proceeds to create new loans to individual borrowers
Mortgage Pass-Through Securities
• Commercial mortgage equivalents of the GNMA guaranteed securities • The newly issued securities represent an undivided “equity” interest in a pool of mortgages • Payments of P&I on the pool are “passed through” directly to the holders
Mortgage Pay-Through Bonds
• Function similar to pass-throughs, but purchaser actually owns a bond, not an interest in a pool • Payment obligation is on the bond issuer, not the underlying mortgages
– Even though the underlying mortgages are the issuer’s source of payment
Collateralized Mortgage Obligations – CMO’s
• Combine features of the mortgage backed bond and the pass through • Issuer retains ownerships of the mortgages, as in the mortgage-backed bond • But the underlying mortgage payments are passed directly through to investors
• Investor assumes the prepayment risk
Securitized Mortgage Market Today
• Federally funded mortgage pools
• > $70 billion • 4% of total mortgages outstanding
• Non-government Commercial Mortgage Backed Securities ? “CMBS”
• > $250 billion today • Approximately 20% of total outstanding debt
• Overall secondary market is still relatively small but growing in importance as a benchmark for the underwriting and pricing of all real estate debt
Secondary Market for Commercial Mortgages
• Market is less than 20 years old • Created to replicate the success of the secondary market for residential loans
• Consists primarily of mortgage backed pools
• One of three key drivers of the recovery from the late 1980, early 1990 real estate depression
• The others? The RTC and the change in the REIT ownership rules
Structure of CMBS
• CMBS are issued in “tranches”
• Tranches are called ‘A’, ‘B’, ‘C’, and so on • The “spread” is the difference between the value of the assets pledged and the size of the tranches
• To help insure that payments are made, CMBS issues are typically “overcollateralized”
• A $100 million issue will be backed by $125 - $240 million of par value mortgages • This is the public market equivalent of the DCR
How Do the Tranches Work?
• Tranches create a tier of claims on the cash flow from the mortgage payments • Tranche ‘A’ will have first claim
• Effective collateral value and DCR ratio is much higher than average of the pool • Will have lowest coupon and minimal default risk
• Tranche ‘B’ will be less secure
• Higher coupon, lower debt coverage, higher risk
• Tranche ‘C’ is effectively a junk bond
• Highest coupon, first in line of default
Rating CMBS
• Bonds are underwritten and rated by Moody’s and S&P • Investment banks work with issuers to structure and price the tranches • Issuance and pricing will be based on the ratings assigned to each piece of the CMBS pool
Basis for CMBS Ratings
• • • • • • Quality of issuer’s underwriting Mortgage insurance Geographic diversification Interest rate Size of collateral pool Appraised value and underlying, blended mortgage debt coverage ratio
Pricing the Bonds
• Bonds may or may not be issued at par
• i.e. may not be issued exactly at the average interest rate of the pool
• Why would they priced differently?
• Market rate has moved away from the original underwriting levels • Issuer wants to establish a certain pay rate – Will take more or less proceeds in exchange for the desired payment obligation
CMBS example
• $100 million issue, 8% stated interest rate, 10 year term • However, the market requires a 9% current yield, even though the issuer wants the 8% pay rate
• The bonds will be priced at less than par to compensate for the higher yield requirement of prospective buyers
CMBS example (cont.)
• Step 1: Find the payments that will be made the stated interest rate
• • • • • PV = - $100,000,000 N = 10 I = 8 (simple interest) FV = $100,000,000 (bonds do not amortize) PMT = $8,000,000
CMBS Example (cont.)
• Step 2: Discount those payments and the par value at maturity by the actual market rate
• • • • • FV = $100,000,000 N = 10 I = 9% PMT = $8,000,000 PV = $93,582,342 = proceeds at issue
Zero Coupon Bonds
• Means that there are no interest payments made during the life of the bond • The entire yield is based on the residual par value of the bond
• • • • • FV = $100,000,000 I = 8% N = 10 years PMT = 0 PV = -$46,319,350 = proceeds of the issue
MALAYSIAN MORTGAGE MARKET
Cagamas Berhad…
• Established in 1986
• National mortgage corporation ?leader in securitization
• Issues debt securities to finance the purchase of housing loans from financial and non financial institutions • Provision of liquidity at a reasonable cost to the primary lenders of housing loans encourages further financing of houses at an affordable cost
Cagamas Berhad…
• Regarded by the World Bank as the most successful secondary mortgage liquidity facility • Cagamas debt securities– unsecured obligations – issued scripless – tradeable electronically in book-entry form (through an electronic clearing house known as the Scripless Securities Trading Systems, operated by Bank Negara Malaysia)
Islamic Mortgages in Malaysia…
In March 1983 Bank Islam Malaysia (BIMB) was established to offer Islamic products and services to cater to the demand of Muslims. The financing facilities granted by BIMB included the financing of Islamic mortgages. Today, Islamic mortgages in Malaysia have broadened their appeal to not only devoted Muslims, but also to non-Muslims, due to their competitive pricing as compared to conventional, interest-based financing.
In 1993, conventional banking institutions were permitted to offer Islamic banking products and services through Islamic windows, subject to the specific guidelines issued by Bank Negara Malaysia (BNM), the Central Bank. In 1994, the secondary mortgage market for Islamic mortgages was created by Cagamas, the national mortgage corporation, when it purchased Islamic mortgages from Islamic banking institutions (IBIs). This has resulted in the growth of Islamic mortgages over the years
Islamic Mortgages in Malaysia…
The primary market for Islamic mortgages: The financing of Islamic mortgages in Malaysia was first made available to individuals under the principle of Bai Bithaman Ajil (deferred payment sale). Today, Islamic finance is moving towards the floating rate market. BNM has allowed a floating rate Bai Bithaman Ajil where customers are required to make higher monthly payments and are given rebates depending on the prevailing market rate.
The secondary market for Islamic mortgages:
The secondary mortgage market in Malaysia became a reality with the establishment of Cagamas in 1986 to perform the function of an intermediary between the originators of housing loans and the investors of long-term funds
Islamic Mortgages in Malaysia…
The secondary market for Islamic mortgages:The secondary mortgage market in Malaysia became a reality with the establishment of Cagamas in 1986 to perform the function of an intermediary between the originators of housing loans and the investors of longterm funds
In March 1994, Cagamas introduced a scheme to purchase Islamic mortgages granted on the basis of Bai Bithaman Ajil on with recourse basis, in accordance with the principle of Bai Dayn (debt trading). The recourse relates to the obligation of the seller to bear any losses arising from default by its customer. The debt securities issued to finance the purchase are the general obligation of Cagamas and are not strictly backed by the cashflows from the Islamic mortgages purchased.
Securitization of Islamic Mortgages…
The IBI (Islamic Banking Institution) sells its Islamic mortgages to a special purpose vehicle (SPV) that is owned by Cagamas
The SPV then issues asset-backed securities (ABS) – i.e. Islamic residential mortgage-backed securities (RMBS) – to investors
Cashflows from the purchased Islamic mortgages are utilized to meet the Islamic RMBS obligations. The securitization process therefore unlocks the illiquid assets of the IBI into tradable securities
CAGAMAS Bonds and Notes
• Cagamas Fixed Rate Bonds
– Tenures -1.5 to 10 years – Fixed coupon rate - determined at the point of issuance, based on the tenders submitted by the Principal Dealers. – Interest paid half-yearly – Redemption at nominal value with interest due on maturity
• Cagamas Floating Rate Bonds
– Tenure of up to 10 years – Adjustable interest rate - pegged to the 3-month or 6-month KLIBOR. The interest rate is reset every 3 or 6 months – Interest is paid at 3 or 6 monthly intervals. – Redeemed at face value with interest due upon maturity.
CAGAMAS Bonds and Notes
• Cagamas Notes
– Short-term instruments with maturities between 1 to 12 months issued at a discount from the face value – Redeemable at their nominal value upon maturity.
• Sanadat Mudharabah Cagamas
– Islamic bonds issued under the Islamic principle of Mudharabah (profit-sharing) – Dividend based on a pre-determined profit sharing ratio - payable semi-annually – Redeemable at par on maturity date unless there is principal diminution – Tenure of up to 10 years
CAGAMAS Bonds and Notes
• Sanadat Cagamas
– – – – Islamic bonds issued under the Islamic principle of Bai Bithaman Ajil Dividend payable semi-annually Redeemable at par together with the dividend on maturity Tenure of up to 10 years
doc_338516493.pptx