THE SECONDARY MORTGAGE MARKET: PASS THROUGH SECURITIES CHAPTER NINETEEN THE SECONDARY MORTGAGE MARKET: PASS THROUGH SECURITIES

Chapter Objectives Evaluation of secondary mortgage market and FNMA and GNMA Mortgage backed bonds and pass through securities Implications of borrower prepayment

Mortgage Markets Primary mortgage market Secondary mortgage market Lenders and borrowers Secondary mortgage market Conduits, investment bankers and investors Mortgage-backed securities

Real Estate Debt and Equity Markets Private Public Equity Individuals, Pension Funds Equity REITS, Real Estate Corporations Mortgage Debt Banks, Insurance Companies Mortgage-backed Securities, Mortgage REITs

Mortgage Markets Primary mortgage market Secondary mortgage market Lenders and borrowers Secondary mortgage market Federal National Mortgage Assoc. “Fannie Mae” Federal Home Loan Mortgage Corporation “Freddie Mac”

Depository Lenders in the Primary Market Commercial Banks Savings Institutions

Nondepository Lenders in the Primary Market Mortgage bankers Mortgage brokers Others

Government-Sponsored Mortgage Programs FHA-Insured Loans VA-Guaranteed Loans

FHA- Insured Loans FHA loans are made by private lenders through various programs (e.g. section203 loans) FHA insurance protects the lender from losses due to default and foreclosure FHA borrowers pay an up front premium, plus a monthly premium for FHA insurance Maximum FHA loan amounts vary depending on an area’s median house price Minimum down payment of three percent

VA-Guaranteed Loans VA loans are made by private lenders (available to U.S. Veterans) VA guarantees the lender against loss up to 100% of a property’s value VA charges a funding fee based on the size of the LTVR Maximum VA loan amounts exist No down payment is required and no discount points can be paid by the borrower

The Secondary Market Federal National MTG. Assoc., FNMA (Fannie Mac) Federal Home Loan Mtg. Assoc., FHLMC (Freddie Mac) Government National Mtg. Assoc., GNMA (Ginnie Mae) Life insurance companies and other purchases

Fannie Mae, FNMA FNMA was organized in 1938 to purchase FHA loans FNMA reorganized in 1968 and authorized to purchase conventional mtgs. in 1970 FNMA obtains funds from the sale of its stock, its MBS, by issuing bonds, and from its earnings The MBSs issued by FNMA and the mortgages they own account for 23 percent of the residential mortgage market

Freddie Mac, FHLMC FHLMC was created in 1970 to provide a secondary market for S&L associations FHLMC currently buys both government- underwritten and conventional loans Freddie Mac and Fannie Mae are now operationally similar The MBSs issued by Freddie Mac and the mortgages they own represent 16 percent of the residential mortgage market

Ginnie Mae, GNMA GNMA was created in 1968 GNMA guarantees the timely payment of principal and interest on MBSs (primarily FHA and VA pools) GNMA also purchases mortgages designed by the FHA for low and moderate- income buyers

GNMA Payment Guarantee GNMA was empowered to guarantee timely payment of PI, on Securities backed by FHA, VA, and FmHA GNMA resulted in an expansion of secondary market Pass-through securities Default risk minimized

Operation of Secondary Market Direct sale programs Mortgage-related security pools

Direct Sale Programs Originators Buyers Mortgage companies Thrifts Commercial Banks others Buyers Life insurance companies Eastern thrifts FNMA FHLMC

Mortgage Related Security Pools MBBs MPTs (pass through) MPTBs (pay through) CMOs

Mortgage- Backed Bonds Fixed coupon rate Specific maturities Issuer retains ownership of mortgages Mortgages pledged as security Over collateralization

Mortgage- Backed Bonds Continued Investment Rating Quality Diversification Rates Prepayment Appraised value DCR

Pricing- Calculator Solution n= semi annual periods I= required rate PV= present value of bond pmt= semi annual interest payment (stated rate) FV= par value Requires 4 variables to solve for yield or PV inverse relationships between interest rates and bond prices

Mortgage Pass-Through Securities Mortgage originations are pooled by lenders or FNMA or FHLMC Originators use a securities underwriter Securities represent an individual interest in pool Large or small investors

Characteristics of Mortgage Pools Security issuers and guarantors Pass through Participation certificates MBS Default insurance PMI- conventional Guarantee- VA Insured- FHA

Characteristics of Mortgage Pools Continued Payment patterns Coupon rates and interest rates Geographic distributions Borrower characteristics Pool size Prepayment considerations All of the above can effect pricing