Intro to Asset-backed securities Flashcards
Benefits to securitization
- Cost savings: Securitization reduces intermediation costs, which results in lower funding costs for borrowers and higher risk-adjusted returns for lenders (investors).
- Access to liquid investments and payment streams otherwise unavailable.
- Increased loan origination (loan creation): When a loan portfolio is securitized, the bank receives the proceeds, which can then be used to make more loans.
- Diversification/risk reduction: Securitization provides diversification and risk reduction compared to purchasing individual loans (whole loans).
residential mortgage loan
A residential mortgage loan is a loan that is collateralized by residential real estate. In other words, if the borrower defaults on the loan, the lender has legal claim to the collateral property
loan to value ratio (LTV)
Loan to value (LTV) ratio = mortgage/property value
One key characteristic of a mortgage loan is its loan-to-value ratio (LTV), the percentage of the value of the collateral real estate that is loaned to the borrower.
The lower the LTV ratio, the higher the borrower’s equity in the property
For a lender, loans with lower LTVs are less risky because the borrower has more to lose in the event of default (so is less likely to default). Also, if the property value is high compared to the loan amount, the lender is more likely to recover the amount loaned if the borrower defaults and the lender repossesses and sells the property.
Prepayments
A partial or full repayment of principal in excess of the scheduled principal repayments required by the mortgage is referred to as a prepayment. Basically, payments made in excess of regular payments
Could be payment in full: E.g. a homeowner sells her home during the mortgage term and repays the remaining principal required. Or, a homeowner refinances her mortgage prepays the remaining principal amount using the proceeds of a new, lower interest rate loan.
Could be partial payments: Some homeowners prepay by paying more than their scheduled payments in order to reduce the principal outstanding, reduce their interest charges, and eventually pay off their loans prior to maturity.
non-recourse loans
Favors the borrowers. Basically, if the borrower defaults on the non-recourse mortgage loan, the lender is obviously entitled to the collateral real estate. But, if the lender liquidates the collateral and still has balance from the loan then he’s out of luck. In short, borrowers like non-recourse loans b/c if you default, all you have to do is give up the collateral property and you can walk away (pretty much why 2007 happened)
recourse loans
Favors lenders. Basically, if borrower defaults on recourse loans, lenders are entitled not only to the collateral but also any of the borrower’s assets if liquidating the collateral doesn’t pay off the loans.
agency residential mortgage-backed securities (RMBS)
agency RMBS are issued by Ginnie Mae, Fannie Mae or Freddie Mac and have no credit risks b/c they’re backed by the US government. Basically, MBS issued by federal and government sponsored agencies
Minimal to no credit risk but have some prepayment risk
non-agency RMBS
non-agency RMBS are issued by private entities such as banks
passthrough rate (residential mortgage-backed securities)
passthrough rate = mortgage rate - fees (servicing e.g.)
Agency RMBS are mortgage pass-through securities. Each mortgage pass-through security represents a claim on the cash flows from a pool of mortgages. The mortgages in the pool typically have different maturities and different mortgage rates.
if interest rates drop…(ABS)
refinancing increases, prepayments increase, PSA speed increases, avg life decreases
Which means, contraction risk: lower reinvestment on cash flow
if interest rates increase (ABS)…
refinancing decreases, prepayment decreases, PSA speed declines, avg life increases
Therefore, there’s an extension risk: lower cash flow for reinvestment
collateralized mortgage obligations (CMOs)
collateralized mortage obligations (CMOs) are securities that are collateralized by RMBS
Each CMO has multiple bond classes (CMO tranches) that have different exposures to prepayment risk.
collateralized debt obligations (CDOs)
A collateralized debt obligation (CDO) is a structured security issued by an SPE for which the collateral is a pool of debt obligations.
Think the Big Short -> what happens to bonds w/shitty credit rating? They’re repackaged until eventually they’re deemed high creditworthiness by ratings agency
