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Page 1 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Possibilities for Capital Market Transactions Mortgage-Backed Securities IDB Business Seminar Capital Markets for Development The Role of the Private Sector June 04, 2004 Washington, D.C.
Page 2 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Mortgage-Backed Securities Residential mortgage debt is the largest credit market in the world, outpacing nominal GDP growth for the last decade As of 12/31/03… U.S. residential mortgage debt outstanding was an estimated $7.6 trillion. Growth in primary mortgage market Fueled by population growth, rising homeownership rates, home price appreciation, stable interest rate environment, and technology advances Growth in secondary mortgage market Fueled by high purchase and refinance activity, high securitization rates and industry consolidation
Page 3 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Mortgage-Backed Securities Types of mortgage securities issued in the U.S. capital markets : Non-Derivative Products Mortgage-Backed Bonds (MBB) Mortgage-Backed Securities (MBS) (also referred to as Pass- Through Securities) Derivative Products Collateralized Mortgage Obligations (CMO) Real Estate Mortgage Investment Conduit (REMIC) Stripped Mortgage-Backed Securities (SMBS)
Page 4 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS General Description MBS is a basic mortgage security –Fixed income investment instrument that represents ownership of an undivided interest in a group of mortgages –Pooling loans of one or more mortgage originators to form the underlying assets for the security –Selling shares in the pool to investors to create pass-through security Entire stream of cash flows received from the collateral is passed on to investors in an undivided manner –Principal and interest from the individual mortgages are used to pay principal and interest on the MBS –Payment based upon the percentage of ownership of the pool balance MBS represents a true sale of assets for the issuer –Treated as Off-balance sheet financing
Page 5 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS General Description Interest and Scheduled Principal Loan #1 Interest and Scheduled Principal Loan #2 Interest and Scheduled Principal Loan #3 Interest and Scheduled Principal Loan #4 Pooled Monthly Cashflow: Interest Scheduled Principal Prepayments Passthrough: $1 million par Each loan: $250,000 Rule for distribution of cash flow: pro rata basis $250,000 Each loan is $250,000 Total Pool Amount: $1 Million
Page 6 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS Cash Flow Characteristics $$ Monthly P&I Payment Less Servicing Fee BorrowerIssuer Conduit or Financial Guarantor Capital Market Investor $$ Monthly P&I Payment Less Guaranty Fee $$ Monthly P&I Payment Gross Mortgage Coupon (Note Rate) Servicing Fee to Issuer (Servicer) Mortgage Coupon to Conduit Guaranty Fee (Conduit) Pass-Through Coupon to Investor 7.00% (.25%) 6.75% (.25%) 6.50% Cash flows generated by mortgage pool are passed on to the investor net the servicing spread Pass-Through Coupon = Gross Mortgage Note Rate - Guaranty Fee - Servicing Fee Cash flows include: Scheduled interest Scheduled principal repayments Unscheduled payments (including partial prepayments and prepayment of the entire outstanding balance of the loan)
Page 7 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS Cash Flow Characteristics Servicing fee provides compensation to the issuer (and/or servicer) for assuming loan administration responsibilities: –Collection, remittance, and reconciliation of payments –Document custody –Cash management and accounting –Delinquency management –Investor reporting (as required) Servicing Fees in U.S. Market Agency Conduits ( Fannie Mae & Freddie Mac ) Government Conduit ( Ginnie Mae ) Typically range between 25 and 37 basis points Higher fee for adjustable rate loans due to increased complexity Negotiable with agency -- high servicing standards may benefit from reduced guaranty fees Typically around 44 basis points
Page 8 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS Cash Flow Characteristics Guaranty fee is compensation provided to the financial guarantor for: –Guaranty of timely payment of principal and interest to investors –Used to cover issuer credit risk in the event of default –Assumption of some or all of the credit risk associated with underlying assets Guaranty Fees in U.S. Market Agency Conduits ( Fannie Mae & Freddie Mac ) Government Conduit ( Ginnie Mae ) Typically under 25 basis points Negotiable with agency -- high underwriting standards and low delinquency history may negotiate a guaranty fee under 25 basis points Typically around 13 basis points Both the underlying loans and the securities are backed by the full faith and credit of the U.S. government
Page 9 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Features of MBS Additional Features Generally issued in a single class with each investor having a pro-rata interest in the mortgage pool: Investor receives principal and interest on a monthly basis in an amount equal to his proportionate share of the security Typically requires some type of credit support to protect the investors against delinquencies of payment and defaults on the underlying mortgage collateral –Agency securities include financial guaranty of corporation (e.g. Fannie Mae, Freddie Mac) or government (e.g., Ginnie Mae) –Private issuance securities include some form of internal or external credit enhancement Example: If 1,000 certificates are issued relative to a mortgage pool, each certificate would represent the right to 1/1000 of each payment of principal and interest on each mortgage in the pool.
Page 10 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Benefits of Mortgage Securitization Industry Benefits Enables borrowers to receive lower rates Allows lenders to sell loans into capital markets Attracts funds from capital markets Promotes standardization and specialization in the industry -- creating lending and investment efficiencies Assists in management of portfolio risk and liquidity imbalances Borrower Lender Investor Mortgage Funds Pool of Loans Monthly P&I Payment 1 Issuer Security Monthly P&I Payment 2 Funds
Page 11 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Benefits of Mortgage Securitization Issuer Benefits Borrower Lender Investor Issuer Reduced level of credit risk over holding individual loans in portfolio Credit risk transferred or from lender to third- party guarantor -- in exchange for guaranty fee Availability of credit enhancements Risk especially acute with longer-term fixed- rate mortgages Cost of hedging interest rate risk can be extremely high relative to return Interest rate risk transferred to ultimate investor in MBS security Greater liquidity over whole loan mortgages Agency MBS is highly liquid in fixed income markets Increased borrowing capability using MBS as collateral Reliable source of off- balance sheet financing Reduce capital risk resulting from investor sale Provide regulatory relief through reduced risk-based capital requirements Increase company’s return on capital / equity through efficient allocation Enhance company’s ability to raise funds in the capital markets Potential Benefit I Reduced Credit Risk Potential Benefit II Reduced Interest Risk Potential Benefit III Source of Liquidity Potential Benefit IV Enhanced Capital
Page 12 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Benefits of Mortgage Securitization Investor Benefits Borrower Lender Investor Issuer Represents thousands of loans of varying amounts, seasoning and geographic locales Provides vehicle for diversification of overall retained portfolio and assets Greater liquidity over whole loan mortgages Agency MBS are AAA rated Standardization yielding reduced capital, funding and expenses Favorable accounting and tax treatment Potential Benefit II Diversified Security Potential Benefit III Improved Execution Reduced level of credit risk over holding individual loans in portfolio Repays principal throughout life of investment Pays monthly versus semi- annual payments, such as bonds May receive above market rate payments in declining rate market Long duration assets to match longer term liabilities Potential Benefit I Attractive Return on Investment
Page 13 International Housing Finance Services © 2000 Fannie Mae – All Rights Reserved Benefits of Mortgage Securitization MBS Transaction Issuer Primary Market Lender 1 MBS in Portfolio Primary Market Lender 2 MBS in Portfolio Primary Market Lender 3 MBS in Portfolio Loans P&I Payment Funds MBS Security Ownership:Capital Market Investor Servicing Rights:Primary Market Lender/Servicer Credit Risk Allocation: Financial Guarantor or Credit Enhancement Interest Rate Risk Allocation:Capital Market Investor Swap & Sell Transaction Funds Financial Guarantor Credit Guaranty Fee Capital Market Investor MBS Funds Investor Payment
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