Mortgage-backed securities

[ghotib]

I've been trying to get my head around how securitized debt works, and so far I'm failing, so I'm hoping someone here can help. My big question at the moment is: where do the repayments go?

That is, assuming most borrowers are making payments under a contract with a particular lender, what happens to that money if the lender securitizes the mortgages?

Hope the question makes sense.

Thanks

Ghoti

 

[robots]

hello,

great question, always remember Gerry Harvey (harvey norman) talk about "securitization" around a year ago,

but to the death of me could not find any good information describing this subject and technique (ha ha)

his wife is an investment banker and wonder if this is some secret structure

any info greatly appreciated

thankyou

robots

 

[Kimosabi]

I've been trying to get my head around how securitized debt works, and so far I'm failing, so I'm hoping someone here can help. My big question at the moment is: where do the repayments go?

That is, assuming most borrowers are making payments under a contract with a particular lender, what happens to that money if the lender securitizes the mortgages?

Hope the question makes sense.

Thanks

Ghoti

Try watching this for starters...

I already know one guy who has lost +$20K from his Super from exposure to US Mortgage Backed Securities

Subprime Derivatives

 

[Kimosabi]

hello,

great question, always remember Gerry Harvey (harvey norman) talk about "securitization" around a year ago,

but to the death of me could not find any good information describing this subject and technique (ha ha)

his wife is an investment banker and wonder if this is some secret structure

any info greatly appreciated

thankyou

robots

You spout your crap about Real Estate ALWAYS being a great investment, blah, blah, blah, but you don't even understand the toxic waste that is funding the Real Estate Bubble...

I really hope you don't actually work in the Real Estate/Financial Advice Industry!

 

[Judd]

Bugger. File too big. Need to split

These doco's should explain it in detail.

 

[robots]

hello,

gee kimo, feeling okay today?

thankyou

robots

 

[Mofra]

I've been trying to get my head around how securitized debt works, and so far I'm failing, so I'm hoping someone here can help. My big question at the moment is: where do the repayments go?

That is, assuming most borrowers are making payments under a contract with a particular lender, what happens to that money if the lender securitizes the mortgages?

Hi ghotib,

Securitisation is a process used by a fairly high proportion of the Australian mortgage market. The video posted by Kimosabi does provide a fairly good run down, but it is worth noting some differences for the Australian market.

In a nutshell, it is a vehicle lenders use to borrow money at a cheaper rate than they sell the debt to the consumer for.

For example, Mofra Mortgages is offering a home loan at 7.5%
ghotib likes this mortgage, and takes $500k at 60% LVR.
Mofra Mortgages covers the loan with mortgage insurance, and because of the low LVR pays it on ghotib's behalf.

Mofra Mortgages pools ghotib's funds with a multitude of other funds, and creates a mortgage backed debenture sold on market for 6%

Out of the 1.5% margin comes a referral fee to the broker, costs of setting up mortgage, compliance costs etc. Lets say that amounts to 1%.

This process is repeated with a book value of billions of dollars, all creating a tiny, wafer thin profit margin. However unlike the US markets, Australian conforming lenders do not offer mortgages that are not MI covered under the mortgage backed security banner, and the proportion of sub prime mortgages is far less.

Back to the crux of your question, the repayments go directly to the lender as basic cashflow to covers the costs of running the operation; if the repayments stop, the lender can call recovery action like a normal lender, however unlike a bank, they run screaming to the MI first to recover their mortgage. The MI will then "recover their loss" + any associated fees (not forgetting they write the fees).
If you are in a situation of negative equity, they will continue chasing you for every last cent until you are in your grave.... then they sell your grave.

Hope this clarifies things somewhat. The important part to note is it is really just a complex funding mechanism for non-deposit holding organisations.

 

[ghotib]

Thanks so far everyone.

Kimo, I've printed that document (both parts) off for bedtime reading. Also breakfast reading I note that the latest reference it cites is dated November 1997; do you know when it was written and do you think anything has changed since?

Judd, that presentation was crystal clear until he got into bond yields and prices, a subject I've been boggling at for about 20 years. The slice and dice explanation was really helpful.

Mofra thanks, that's very clear. Except:

1) Nothing personal, but where did Mofra Mortgages get the funds it lent to ghotib in the first place?

2) I still don't quite get how the cash is working. Somebody somewhere is expecting regular payments on each of the loans that make up the security. I presume that somebody is whoever has bought the security. So when ghotib reluctantly sends a payment to Mofra Mortgages, does MM forward most of it (i.e. the part representing the 6% rate that was sold) to the security holder and keep the balance?

3) I also don't see what's happening to the title in the property. Does MM still hold the mortgage, or MM's insurer (surely not), or... who?

4) Australian banks securitise loans and they do have deposits. Am I right that for them the securitisation increases the funds available to lend?

5) Are you saying that the mortgage originators falling like flies in the US either couldn't get or didn't take insurance? Does that suggest that mortgage insurers are at greater risk than lenders in Oz? Errr... who offers mortgage insurance in Oz anyway?

I think the paper Judd has attached offers information about 1, 2 and 3. The more the better though.

Thanks again.

Ghoti

 

[reece55]

Thanks so far everyone.

Kimo, I've printed that document (both parts) off for bedtime reading. Also breakfast reading I note that the latest reference it cites is dated November 1997; do you know when it was written and do you think anything has changed since?

Judd, that presentation was crystal clear until he got into bond yields and prices, a subject I've been boggling at for about 20 years. The slice and dice explanation was really helpful.

Mofra thanks, that's very clear. Except:

1) Nothing personal, but where did Mofra Mortgages get the funds it lent to ghotib in the first place?



2) I still don't quite get how the cash is working. Somebody somewhere is expecting regular payments on each of the loans that make up the security. I presume that somebody is whoever has bought the security. So when ghotib reluctantly sends a payment to Mofra Mortgages, does MM forward most of it (i.e. the part representing the 6% rate that was sold) to the security holder and keep the balance?

3) I also don't see what's happening to the title in the property. Does MM still hold the mortgage, or MM's insurer (surely not), or... who?

4) Australian banks securitise loans and they do have deposits. Am I right that for them the securitisation increases the funds available to lend?

5) Are you saying that the mortgage originators falling like flies in the US either couldn't get or didn't take insurance? Does that suggest that mortgage insurers are at greater risk than lenders in Oz? Errr... who offers mortgage insurance in Oz anyway?

I think the paper Judd has attached offers information about 1, 2 and 3. The more the better though.

Thanks again.

Ghoti

In answer to your question Ghoti:
1). Depends on how the securitisation process took place. Often the bank will initially fund the loans themselves, this could either be on their balance sheet or in the form of a note in a trust. Realistically it doesn't matter, once it's securitised, it's no longer the banks problem (in the case of a RMBS).

2). Could be coordinated via a sweep of the bank account. I.e. say I'm Commonwealth Bank, everyone thinks that they are paying money to CBA rigth? Well, not all the time. Your loan could actually belong to a mortgage trust. You don't know the difference, because there is an equitable assignment of the future cash flow payments. What's going to confuse you even more is that depending on the delinquency rate of the loan, it could be swapped in or out of the trust.

3). The bank/institutional originator will still retain right to the title. The security to the trust is assigned by way of an equitable assignment. It's like CBA saying well we have the title, but if the loan goes bad, the RMBS trust can use the title to get back their cash flow.

4). Absolutely this increases there funding availability, provided they aren't investing in the trust themselves. There are some accounting issues about whether it's consolidated or not, but principally what happens is the RMBS will be structured financially. So, the trust will issue say 85% of the nominal value of the loans in a class A note that will be rate AAA by S&P and will yield only slightly above BBSW (this will be taken up by the super funds chasing risk free yield), perhaps 10% in perhaps a BBB, with the balance unrated. Say the loans are low doc, and investors really aren't sure. No problems - we will just subordinate the unrated and BBB notes above the AAA. Have a good look on subordination topics.

5). LMI is actually required in Australia (from memory) if the LVR is less than 80%. The US has a completely different financial sector than Australia - lots of little banks that run off no dough. And it's not the originator that's in trouble here - the originator just sells the loan, it's the funder we are concerned about.

Hope this helps, I worked with ADB in structured finance for a couple of months but didn't really like it. However, I learnt a few things on the way...

All the best...

 

[saichuen]

Got this from the internet. It is a simplified visual representation of the subprime mortgage market - how it works and why it is failing now.

 

[robots]

hello,

mortgage-backed securities have been around for a while before the sub-prime issue in US so hope the facts can be presented on MBS and how they work

so the securities (collateral/asset) and their supposed income stream have been "packaged" and sold to investors (ie. a fund manager, private investor, investment bank)

for instance, basis capital "invested" somehow in MBS which were involved in the US sub-prime mortgage market(risk?),

is it true the total risk is transferred to the "investor" who bought the packaged security?

still dont get the finer details

thankyou

robots

 

[CanOz]

Great thread folks! Great input there Reese.

Cheers,

 

[Mofra]

Mofra thanks, that's very clear. Except:

1) Nothing personal, but where did Mofra Mortgages get the funds it lent to ghotib in the first place?

2) I still don't quite get how the cash is working. Somebody somewhere is expecting regular payments on each of the loans that make up the security. I presume that somebody is whoever has bought the security. So when ghotib reluctantly sends a payment to Mofra Mortgages, does MM forward most of it (i.e. the part representing the 6% rate that was sold) to the security holder and keep the balance?

3) I also don't see what's happening to the title in the property. Does MM still hold the mortgage, or MM's insurer (surely not), or... who?

4) Australian banks securitise loans and they do have deposits. Am I right that for them the securitisation increases the funds available to lend?

5) Are you saying that the mortgage originators falling like flies in the US either couldn't get or didn't take insurance? Does that suggest that mortgage insurers are at greater risk than lenders in Oz? Errr... who offers mortgage insurance in Oz anyway?

Hi ghotib,

Reece has basically answered very well, I'll just elaborate on a couple of points:

1. Are you doubting my treasury skills?
Securitised lenders have a variety of methods of starting capital - smaller players often originate from Credit Unions or have raisined starting/venture capital, others have arisen from boutique fundies, others are formed via a JV for eg. Virgin & Macquarie, Aussie & Macquarie, BMW & Macquarie, Macquarie themselves (yes they do actually own some percentage of bruddy everything in Australia).

2. The payment of loans & the payment are interest on the MBS are completely seperate - Think of a deposit holding organisation paying interest on a CMT. Fees are paid monthly, yet the CMT interst is generally only paid quarterly. The lenders coordinates payments via a treasury department who spend their waking hours trying to save a fraction off a basis point for every transaction put to market.

3. The lender can hold the title, normally it is also outsourced to a third party (Perpetual Trustees get alot of this business).
A securitised lender will often outsource to a third party:
- Loan selling process via a mortgage broker / accountant / financial planner
- Majority of risk via LMI
- Preparation of settlement docs & funding via solicitors
- Depending on their size, client relations department / callcentre operations
- Security holder

Much like an LPT can transfer effective ownership of property assets and manage the property themselves for fee income, so a securitised lender
outsources the majority of operations to sit in the middle & collect margin

4. Can't add anything to Reece's answer

5. In Australia, the LMI providers are GE & PMI (recently a third LMI provider has commenced operations, however they are completely manual so are still establishing themselves in the market place). Over 80% LMI charges are passed onto the customer anyway.

Another point to add is securitised Fixed rates are often not competive compared to major banks - most majors offer Fixed rates as loss leaders, and knowing a client is unlikely to refi due to the fixed rate break costs, then try & cross sell profitable products (credit cards, insurance, consumer loans etc.)

 

[ghotib]

Well, this is all getting rather exciting isn't it.

Mofra, how can you think I would ever doubt you? After all, I'm the one who owes you the hypothetical money. I might, however, be re-checking your capital-raising resume rather closely right now if it was my money that you'd been lending. I might as well admit that I'm feeling a little queasy about my current investment in a mortgage trust, even though its name is more widely known than the Mighty Moff's Miracle Mortgage Machine.

Kimo's paper is very informative, if slightly eye-glazing at times. I'd recommend it to anyone else who's struggling to understand how securitised debt has appeared to work and why it's been attractive for so long. Interestingly, it doesn't say much about how things might go seriously wrong; I guess that's harder to see until hindsight becomes available. It talks about credit, liquidity, financial, and interest rate risks, but not about the risk that appears to be emerging now: that no one really knows where or what the risks actually are. The whole system is starting to look to me like a super Ponzi scheme.

The general reporting of mortgage and other debt problems doesn't give any sense of the proportion of loans that are actually defaulting. Clearly the numbers are rising and the personal cost of every one of them is awful, but the vast majority of home-purchasers will be able to either hold on or get out cleanly, as they have through other difficult times. Won't they?

Ghoti - wondering if I'll ever understand what's going on before it isn't any more