CH. 9 part 2- Asset Backed Securities

Investor risk of pass-throughs

- Contraction risk (When mortgage rates decline, prepayments speed up ) - Extension risk (When mortgage rates increase, prepayments slow down)

Types of Mortgage-Backed Securities

- GNMA (Ginnie Mae) mortgage-backed securities (gov) - Private label pass-through securities - FNMA (Fannie Mae) mortgage-backed securities - FHMLC (Freddie Mac) participation certificates - Collateralized mortgage obligations (CMOs)

FHLMC (Freddie Mac) Participation Certificates

- The Federal Home Loan Mortgage Association was chartered as a corporation in 1970 to ensure that sufficient funds flow into the mortgage market. - Sells participation certificates and uses the proceeds to finance the origination of conventional mortgages from financial institutions - Fannie Mae and Freddie Mac enhance liquidity in the mortgage market.

FNMA (Fannie Mae) mortgage-backed securities

- The Federal National Mortgage Association was created in 1938 to develop a more liquid secondary market for mortgages - Channels funds from institutional investors to financial institutions that desire to sell their mortgages.

GNMA (Ginnie Mae) mortgage-backed securities

- The Government National Mortgage Association (called GNMA, or Ginnie Mae) was created in 1968 as a corporation that is wholly owned by the federal government. -Guarantees timely payment of principal and interest to investors who purchase securities backed by FHA and VA mortgages.

Private label pass-through securities (conventional mortgages without gov guarantees)

-Backed by conventional rather than FHA or VA mortgages. - Insured through private insurance companies

Securitization process

1) A financial institution such as a securities firm or commercial bank combine individual mortgages together into packages. 2) The issuer of the MBS assigns a trustee to hold the mortgages as collateral for the investors who purchase the securities. 3) After the securities are sold, the financial institution that issued the MBS receives interest and principal payments on the mortgages and then transfers (passes through) the payments to investors that purchased the securities.

Collateralized debt obligation (CDO)

A package of debt securities backed by collateral that is sold to investors.

Collateralized mortgage obligations (CMOs)

CMOs consist of several tranches, or groups of mortgages, organized by their risk profile; separating risks for investors

How Fannie Mae and Freddie Mac enhance liquidity in the mortgage market?

Lubricate entire (most) mortgage market

Securitization

The pooling and repackaging of loans into securities.

What is a "Jumbo" mortgage?

Too big of a mortgage

Yields on MBS

Yields are largely a function of prepayment risk. Yield calculation requires: - Determination of cash flow. - Projections of prepayment

Nonconforming mortgages

do not meet agency underwriting standards (too big of loans- ex. $2 million paradise valley home) - Can still be held in issuer's portfolio. - Can still be securitized.

The Public Securities Association (PSA)

is used - Assumes low prepayment rates in newly created mortgages. - Assumes prepayment rates speed up as mortgages become seasoned.

Conforming mortgages

meet agency underwriting standards: - Maximum PTI. - Maximum LTV. - Maximum loan amount (over 400k= not conforming)

"Pass though"

securitization