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Mortgage Financing &
Mortgage - Backed Securities
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Mortgages
WHAT IS A MORTGAGE ?
A pledge of property (a house) to secure payment of
a debt (a bank loan).
If a homeowner (the mortgagor) fail to pay the lender (the
mortgagee), the lender has the right to foreclose the loan
and seize the property in order to ensure that it is repaid.
The form that a mortgage loan takes could technically
be anything the borrower and lender agree upon.
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Mortgages
WHAT TYPE OF PROPERTY ARE MORTGAGED?
Property
(and the mortgage on it)
Residential
-housing
-apartments
-condominiums
-cooperatives
Single (1-4)
Family
Multi-Family
Nonresidential
-office buildings
-shopping centers
-hospital
-industrial plants
Commercial
Farm
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Traditional Mortgage Loan
Mortgages
A fixed rate of interest on the loan for its entire term, and the
loan was repaid in monthly installments of principal and interest.
Each loan was structured in such a way that the total payment
each month (the sum of the principal and interest) was equal, or
level.
The terms to be negotiated are the interest and the period to
maturities
- interest rate vary with the general economic climate
- maturities range from 12 to 40,depending on the type of property
involved
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Traditional Mortgage Loan
Mortgages
The principal portion increases over time until, at maturity, the payment is
almost entirely principal.
The principal portion of each monthly payment is used to reduce the
amount of the loan outstanding.
In mortgage term, the loan is amortized over the maturies and the
principal payments each month known as amortization payments.
The amount of the loan that is outstanding at any time is known the
mortgage balance.
Sometimes a mortgagor may want to make monthly payment that is
greater than the amount actually due, with the idea of applying the
excess payment to further reducing the loan – such are called
prepayments.
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Nontraditional Mortgages
Mortgages
Unlike traditional mortgages, most of these alternative mortgage
instruments (AMIs) do not have level monthly payments, but employ
some other (often complicated) scheme.
What was the impetus for the creation of AMIs, and in what ways are
they superior to traditional mortgage ?
-High interest rate combined with the rapid inflation in housing
prices to make home financing difficult in general and all but impossible
for the first-time buyer. AMIs were created as a way of coping with these
problem.
There are literally dozens of different types of AMIs, each with its own
peculiar twist.
Ex. VRMs (Variable-Rate Mortgages), GPMs (Graduated-Payment
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Mortgages), RRMs (Renegotiated-Rate Mortgages)
Process
Example of a Mortgage
Property value; $55,000
seller
$50,000
home
$50,000
($5,000 down)
Mortgage for $50,000
mortgagee
mortgagor
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History
-These early mortgage banks obtained lending
capital by issuing debenture bonds that were bought by
insurance companies.
-In 1914 The Farm Mortgage Bankers Association was
formed.
-By the 1920s , the lending activities of these mortgage
banks were increasingly extending into urban areas.
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History
-The 1920s brought a real estate boom and high profits
to both institutional and individual investors of mortgage.
-In 1929, the real estate boom crashed with the stock
market.
-Mortgage companies foreclosed on property. Mortgage
guarantee companies were unable to pay on their mortgage
bonds, and the loss to individual investors was crushing. In
1933 the federal government established the Home Owners’ Loan
Corporation (HOLC), Which used the proceeds of government
– guaranteed bond sales to refinance homeowners’ indebtedness.
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History
-In 1933 the federal government established the
Home Owners’ Loan Corporation (HOLC), Which used the
proceeds of government – guaranteed bond sales to
refinance homeowners’ indebtedness.
-In 1934 the government created the Federal
Housing Administration (FHA) to insure long – term, fixed-rate
loans to provide homeowners with viable financing.
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FHA
To encourage the improvement of the nation’s housing
standards and conditions.
To provide an adequate home financing system.
To exert a stabilizing influence on mortgage and
residential real estate market.
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FNMA
Federal National Mortgage Association
In 1938, the Federal National Mortgage Association (FNMA,
or Fannie Mae) was formed by an act of Congress for the purpose of
providing a secondary mortgage market for FHA-insured loans.
In secondary the post-World War II era, mutual savings banks
were the most active purchasers of loans. Fannie Mae’s first
purchases of VA mortgages in 1948 may mark the beginning of the
market.
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FNMA
Federal National Mortgage Association
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Fannie Mae is a private, shareholder-owned company that
works to make sure mortgage money is available for people
in communities all across America. We do not lend money
directly to home buyers.
Fannie Mae stock (FNM) is actively traded on the New York
Stock Exchange and other exchanges and is part of the
Standard & Poor's 500 Composite Stock Price Index.
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GNMA
Government National Mortgage Association
-In 1968, congressional legislation spun off Fannie Mae as a
government-chartered private corporation. The Government National
Mortgage Association (GNMA, or Ginnie Mae) was also created to
assume Fannie Mae’s special-assistance functions of overseeing loan
subsidies and below-market purchase programs.
-Ginnie Mae was also given the guaranty authority that resulted
in the introduction of the Ginnie Mae guaranteed mortgage-backed
securities (MBSs) program.
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FHLMC
Federal Home Loan Mortgage Corporation
-The Federal Home Loan Mortgage Corporation (FHLMC,
or Freddie Mac) followed shortly with its PC program in 1971.
-A few years later, in 1981, Fannie Mae introduce its own
MBSs program.
-Today, the mortgage banking community includes-in
addition to the many still-independent mortgage bankers–savings
institutions, commercial banks, and other lender ;even some
insurance companies are engaged in originating and servicing
home mortgages.
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Mortgages
Most of the money for home loans comes three major institutions:
• Fannie Mae (FNMA-Federal National Mortgage Association)
• Freddie Mac (FHLMC-Federal Home Loan Mortgage
Corporation)
• Gennie Mae (GNMA-Government National Mortgage
Association)
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Mortgages
This is how it works now:
You talk to practically any lender and apply for a loan. They
do all the processing and verifications and finally, you own the house
and now you have a home loan and you make mortgage
payments. You might be making payments to the company who
originated your loan, or your loan might have been transferred to
another institution.
The company you make your payments to very rarely owns
your loan. They are the "servicer" of your mortgage. They are called
the servicer because they are simply "servicing" your loan for the
institution that does own it.
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Mortgages
This is how it works now:
In fact, mortgage servicing is where lenders make the real
money. The entire system of originating mortgages, including
wholesale lenders, mortgage brokers and mortgage bankers is
designed so that servicers get loans into their portfolio -- hopefully
at a "break even" level -- but often at a loss. Mortgage servicing is
where they make their profit.
Once your loan has been packaged into a pool and sold to
Fannie Mae, Freddie Mac, or Ginnie Mae, the lender gets
additional funds so they can make more loans (to service in their
portfolio) and sell to those institutions, so they can get more
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money, and so on....
Mortgage Backed Securities
Mortgages
Once Freddie Mac, Ginnie Mae, and Fannie purchase the
pools, they break them down into smaller ownership parcels. These
are called "mortgage backed securities“. Each security represents a
small ownership interest, not in your specific loan, but in the pool of
which your loan is only one part. The risk is therefore diversified and it
is a very safe investment.
The mortgage backed securities are sold on Wall Street to
institutions or individuals looking for a safe investment, but one that
earns a higher interest rate than treasury bonds. You may even own
some as part of your retirement fund or investment portfolio. Those
are securities backed by the mortgages on FHA and VA loans.
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Mortgages
Mortgage Backed Securities
By selling the bonds, Ginnie Mae, Freddie Mac, and
Fannie Mae obtain new funds to buy new pools so lenders
can get more money to lend to new borrowers.
This buying and selling of mortgages and mortgage
backed securities is called "mortgage banking" , and it is the
backbone of the mortgage business.
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Securitization
securitization
Securitization is how to convert “ Non Marketable Asset ” to
“ Marketable Asset ”
 Asset definition
- Any asset that provides cash flow stream
- It can be : a pool of residential mortgage, pools of credit card,
pools of car leasing, income stream from office buildings or
even income stream from records copy rights.
- However, in our study , we will focus on Residential Mortgage
pool

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Risk to Lender
securitization
Risk of delayed payment of principle and interest
 Default Risk
 Interest risk
 Prepayment Risk
 Other Risks
- Liquidity and Marketability of asset
- Legislative risk

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Lender Perspective
securitization
Cost of lending
- Deposit rate (Cost of Fund) + Inflation Rate + Risk Premium
 Capital requirement
- If lender is consider to lend borrower, this loan will be counted
as 100% risk asset that will required 8% capital base according
to BIS standard
- The lender will need to have 8% for this loan
- While for the same transaction amount, Lender might choose to
lend to individuals home mortgage borrower which are counted
for 50% risk asset, in this case lender will need to reserve only
4% of the transaction
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
securitization
Problem with Non securitization Flow
High Cost of Fund
- since residential mortgage is a low risk asset. There are many investors that
required lower yield than the normal depositor ( such as insurance fund, fixed
income fund ) who are willing to invest in the residential mortgage pool
 Capital Base Requirement
- Financial institution has to comply with BIS ratio that require 8 % of capital per
risk asset issued.
 Interest Rate Risk
- Financial institution has to deal with volatility in financial market that might
effect its mortgage fix rated offered to the market
 Fund Mismatching
- Normally mortgage required long term funding ( 10 to 15 years ) while it is
difficult for financial institution to obtain such funds from its short term
depositor.
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
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Parties
in
Securitization
Loan originator
securitization
- financial institution who issue loan to borrower
Special Vehicle Purpose
- Entity who bys loan from financial institution
- Entity who sells securities to investor
Trustee
- Representatives who supervise collection and distribution of payment
Credit Enhancer
- Third party who guarantees cash flow generated from assets
Credit Rating Agency
- Third party who audits and rates risks of securities
Underwriter
- investment banker who sells the securities to investor
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Investor : party who invests in securities
securitization
MBS Process
Principle & Interest
Trustee
Individual borrower
Mortgage
repayment
Mortgage repayment
after servicing fees
Sell pool of loan
Financial inc
Investors
Investment /
Finance
SPV
Pay for loan purchase
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MBS
Type of Mortgage Back Securities
Mortgage Pass – Through Securities (MPT)
Mortgage Backed Bonds ( MBB )
Mortgage Pay – Through Bond ( MPTB )
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Type of MBS
Mortgage Pass – Through Securities (MPT)
-
-
Investor invests directly in SPV and will receive entirely principle
and interest generated from the asset investor had invested
Investor will have the direct risk of default, Prepayment and
interest risk
U.S. Gov’t has created three agencies to support (Funding as the
buyer or guarantor) the market development which are
FHLMC ( federal home loan mortgage corporation )
FNMA ( federal national mortgage association )
GNMA ( gov’t national mortgage association )
Prepayment rate is an important valuation factor for this type of
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securities
Type of MBS
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Mortgage Backed Bonds ( MBB ) or
Asset backed bonds ( ABB )
Investor invests in bonds issued by SPV, therefore investor will receive fixed
coupon rates and specific maturities
Investor will not share any default, prepayment and interest risk.Therefore, to
assure investor for the quality of bonds, the issuer usually “ over collateralizes”
the bond issue.
By using the “over collateralizes”method,issuer will replace the prepayment
mortgage with the new spare one that were earlier defined in the over
collateralizes portion
Therefore,Trustee has the duty to “Mark Mortgage Collateral to market “
periodically to ensure investor that the level of over collateralization are
maintained at the level agreed upon at the time of issue ( generally 125% to
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240% )
Type of MBS
Mortgage Pay – Through Bond ( MPTB )
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A hybrid between two earlier types
Investor don’t directly own SPV, Originator is the owner of the
asset.
Originator issue a bond with coupon rate for interest payment
while principal is pass through as it received from normal
amortization and prepayment of loan in the pool.
Investor receives interest per coupon stated but receive
principle payment as actual
MPTB will require less over collateralization than MBB since all
interest of Principle repayment is paid directly to investor and
no need to mark over collateral to market
MPTB will also help investor receive constant coupon as MBB 30
securitization
Benefits of Securitization
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For Borrower
- Competitive Rate
- Increase Supply of Credit
For Lender
- Reduce capital base requirement for business expansion
- Provide pricing competitiveness for small player
- Reduce fund mismatching problems
- Hedge interest rate risk
For Investor
- New attractive investment instruments
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