1 課程 5: Secondary Mortgage Market

2 Definition of Secondary Mortgage Market (SMM) A collection of institutions and individuals involved in the trading of mortgages either in their primitive forms or in transformed forms called Mortgage Passthrough Securities (MPTS) What are MPTS? –bonds, notes or certificates -- issued against and collateralized by a pool of mortgages where the issuer passes mortgage payment from borrowers to investors who purchased the securities. Hence the name “passthroughs”

3 Function of the SMM –To provide liquidity to the primary market. –To correct geographical mismatch in mortgage markets. –To correct institutional mismatch in the flow of funds in the primary mortgage –Management of interest rate risk

4 Facilitators of the Market or Market Makers Broker no risk Dealers exposed to interest rate risk Conduits transformation standardization

5 Role of Conduits Transform mortgages into more liquid mortgage pass through securities Standardize whole mortgages to create sufficient volume Examples –Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), Government National Mortgage Association (Ginnie Mae), commercial banks, S&Ls, mortgage banks, investment banks

6 GNMA or Ginnie Mae Guarantees the timely payment of interest and principal on MPTs backed by FHA, VA loans Has backing of the full faith and credit of the US government Enables mortgage originators to package mortgages and issue securities backed by these mortgages The buyer of the security is charged a fee which provides GNMA with operating funds.

7 FNMA or Fannie Mae Corporate instrumentality of the US government whose stocks are traded on the NYSE Primary function is to purchase and sell FHA, VA and Conventional mortgages Issues its own security collateralized by mortgages called Mortgage- Backed Securities (MBSs) cash program and swap program Sources for capital for FNMA non-voting preferred non-voting common notes and debentures

8 Fannie Mae (Contd). The ACT setting up FNMA allows the agency to borrow from the Treasury up to $ 2.5 billion. In practice investors do not see the difference between Ginnie Mae and Fannie Mae guarantee. Should there be a yield differential between a Ginnie Mae and Fannie Mae security of similar maturity? Think about this !!!!!

9 FHLMC/ Freddie Mac Established to provide liquidity in conventional mortgages Currently its portfolio includes both conventional, FHA and VA loans Sells the mortgages either in whole, or in the form of MPTs called Participation Certificates (PCs) –Cash program –Swap program (1984)

10 Outstanding Passthrough As of September 1994 Agency outstanding ($ billions) Ginnie Mae$426.4 Freddie Mac$461.5 Fannie Mae$505.7 Private$179.5 Total$1,573.1

11 FACT About 49% of the estimated $3.2 trillion of single family mortgages outstanding have been securitized. From 1989 Fannie Mae and Freddie Mac issues outstripped Ginnie Maes. Roughly 88% of securitized residential mortgages have agency labels. In 1984 Fannie Mae created first MBS collateralized by multifamily mortgages

12 Types of Mortgage Related Securities Mortgage pass-through securities (MPTs) –Mortgage-backed security (MBS): FNMA –Participation Certificates (PCs): FHLMC –Ginnie Maes –Private Pass-throughs Mortgage Backed Bonds (MBBs) Other Mortgage Derivative Securities –Collateralized Mortgage Obligations (CMOs) –Interest Only (IOs) and Principal Only (POs) Commercial Mortgage Backed Securities (CMBS)

Borrowers Originating lenders and services Swaps Brokers Dealers Government Guarantee GSEs, Private conduits, HFA GSEs Mortgage Backed Security Notes Bonds Security Dealers Investors Insurance Operations in the Secondary Mortgage Market 12 3a3b 4 5

Mortgage Pass Through Structure Collateral Whole mortgages Trustee/Custodian owns mortgages in pool no overcollateralization Pass through issuer sale of assets not obligation of issuer debt obligation of original borrower MPT Investor :Owns the right to receive cash flow from morgages in pool

Borrowers Lenders (Securities issuers) Insurance/guarantee (Government or PMI) Mortgage Pool Investors Securities Dealer Custodian of mortgage documents Mortgages Monthly payments Securities Mortgages Guarantee Seeks guarantee Mortgage documents The Mortgage Passthrough Security with Government Guarantee (Ginnie Mae) Government Agency Whole loans

16 Creation of Ginnie Maes Mr./Ms. Smith Mr./Ms. Jones Mr./Ms. Miller Lenders Thrift or Bank GNMA Investors Thrifts, Banks, Others GNMA $ Mortgages $ Fee Guarantee

17 Creation of other Agency Mortgage Pass-Through (MPTs) Mr./Ms. Smith Mr./Ms. Jones Mr./Ms. Miller Lenders Thrift or Bank Agencies FNMA FHLMC Investors Thrifts, Banks, Others MBS $ Mortgages $ Sell $

18 Advantages of MPTs over Whole Mortgages Diversification of prepayment risk Investment is made more liquid More efficient way to invest in mortgages than purchasing the primitive instrument Efficient management of interest rate risk Cheaper source of financing housing Guarantees eliminates default risk

19 Features of MPT Prepayment risk –Systematic risk –Unsystematic risk Default risk

20 Nature of Cash Flow from MPT Monthly payments consisting of –Interest on the mortgage –Scheduled principal repayments. –Unscheduled principal repayments. The cash flow is reduced by servicing fee and guarantee fee of 50 basis points Cash flow and value of MPT security depends on the cash flow from underlying mortgage

Mortgage Cash Flows Principal Interest MONTHS Cash Flow No Prepayments

Pass-Through Cash Flows Principal Interest MONTHS Cash Flow No Prepayments Servicing

23 Timing of Cash Flow The first mortgage payment is always made in arrears There is another delay after receipt of cash flow from mortgage pool before the cash flow is passed on to the investor –Real or actual delay –Stated delay = normal delay + actual delay

24 Payment Delay Illustration AB CD Month 1Month 2 Stated Delay = 45 days Real Delay = 14 days A: Investor Buys Security B: First Record Date C: First Payment Due D: First Payment Actually Made AB C D Stated Delay = 50 days Real Delay = 19 days GNMA-I GNMA-II

25 Payment Delay Illustration AB C D Month 1Month 2 Stated Delay = 55 days Real Delay = 24 days A: Investor Buys Security B: First Record Date C: First Payment Due D: First Payment Actually Made AB C D Stated Delay = 75 days Real Delay = 44 days FNMA MBS FHLMC PC

26 Nature of Promise on MPT cashflow Fully Modified e.g. Fannie Mae Mortgage Backed Security (MBS) –timely payment of both P and I Modified e.g. Freddie Mac Participation Certificate (PC) –timely payment of interest only

27 Some salient Characteristics of MPTs affecting pricing Characteristics of Pool, e.g. FHA/VA, conventional mortgage Maximum size of Loan e.g. conforming loan versus jumbo Amount of Seasoning Assumability Maturity e.g. 15, 20, 30 years Net Interest Spread Payment Procedure e.g. stated delay Minimum Pool Size

28 Private Passthroughs Issued by thrifts, commercial banks and investment banks Large-size loans Registered with SEC Rated by Moody’s and S&P FRM’s or ARM’s Market size around 6% of all MPTs

29 Credit Enhancement on Private MPTs Corporate guarantee -- Letters of credit -- issued by financial institutions. Bond insurance -- rating of insurance co. Senior/subordinate certificate --A/B passthrough –A has priority over B in terms of cash flow –A certificates are the once rated Additional safeguards to protect against shortfall in payment –reserve fund divert principal from B to A –shifting interest prepayment meant for B goes to A

30 Differences between MBS and Traditional Bonds MBS pay-off monthly. Bonds typically pay-off semi- annually MBS payments consists of principal and interest, bond payments typical consists of interest only MBS have payment delays, Treasury bonds have no payment delay MBS has call risk due to borrower prepayment. Some bond have no call options Some MBS have default risk. Treasury bonds have no default risk