week 8 Flashcards
Define the difference between RMBS and CMBS.
RMBS are residential mortgage backed securities. The pool of loans in these securities come from residential mortgages.
CMBS are commercial mortgage backed securities. The pool of loans in CMBS come from commercial mortgages.
What is the role of the Special Purpose Vehicle in the debt securitisation process?
The Special Purpose Vehicle (SPV) issues securities to investors, the securities are backed by the pool of loans that are securitised into a mortgage backed security. Investors receive returns back by the repayment of the loan and interest payments.
The SPV is set up as a trust and is ‘bankruptcy remote’ in two ways.
First, if the SPV cannot pay entitlements to all the investors, the mortgage originator is not responsible for the losses.
Second, the securities are independent of the mortgage originator. The SPV generally splits the income from the loans into different classes of securities, known as tranches.
The income from a mortgage backed security is sometimes split into different classes of security, known as tranches. Define the role tranches in a mortgage backed security.
Tranches are different credit levels of securities that can be issued through the debt securitisation process. They have different entitlements and priorities. Tranches stratify the default risk of the loans. Tranches levels can range from one to even four, depending on the size of the pool of loans and their value. For example, a MBS with 2 tranches can be split into senior and subordinate levels. The senior tranches earn a lower rate of return, but are paid before the subordinate holders. In the case of default by some of the loans, subordinate holders have a higher probability of not receiving payments, however, to compensate them for this higher risk they will be offered a higher rate of return
What is the purpose of credit enhancement in the debt securitisation process? List two ways credit enhancement can be done
Credit enhancement is designed to minimise the consequences of default. Credit enhancement can be done via:
a) Loan insurance taken out by individual borrowers (i.e. mortgage insurance) or on all of the loans within a tranche
b) Credit ratings provided by credit agencies such as Standard & Poor’s.
c) Credit default swaps which are a financial instrument that provide a form of insurance to cover losses from loan defaults. The originator pays a premium for these swaps
Describe the two groups of lenders that issue Residential Mortgage Back Securities.
First group are called Mortgage Managers. They are independent mortgage providers (e.g. RAMS).
The second group are banks and other traditional lenders (e.g. ANZ).
What is the major advantage for retail banks to use Residential Mortgage Back Securities
The securitisation of loans by retail banks removes the loan liabilities from the bank’s balance sheets. Once the loans are ‘off the books’ they have less impact on their “capital adequacy requirements”.
This results in the bank being able to grant more loans.
Identify and describe the four main types of Mortgage Funds
Pooled Mortgage Funds:
Managed investment schemes that hold portfolios of mortgages in unit trusts. Unit holders receive their portion of mortgage interest & capital repayments. They are mortgage pass-through funds, unit holders are entitled to amounts received proportionate to the number of units they own.
Contributory Mortgage Schemes:
These funds let investors choose one or more mortgages from a number that have been sourced by the fund manager. Investors contribute capital to the selected mortgages and receive their proportion of the loan payments. They are also mortgage pass-through securities. Mortgage pool typically interest only loans for shorter periods (1 to 3 years).
Mezzanine Mortgage Funds:
Mezzanine refers to subordinate (junior) debt or second mortgages. Holders of these securities receive loan interest and repayment of capital after all the entitlements of senior debt holders (fist mortgages) have been paid. They are akin to the lower tranches of RMBS & CMBS. Because they are higher risk they offer higher rates of return. These funds raise capital to lend as second mortgages, predominantly property development.
Property-Based Debentures and Notes:
Debentures are debt securities issued by companies to raise capital or issued to financial institutions for them to lend to other businesses. They range from relatively safe loans to finance companies (e.g. Esanda) through to unsecured loans to unlisted companies for property development. Due to the variability of their risk profile, the returns offered vary greatly. Debentures & notes differ from pass-through mortgage funds in that they offer a fixed rate until maturity
explain pooled mortgage funds
Managed investment schemes that hold portfolios of mortgages in unit trusts. Unit holders receive their portion of mortgage interest & capital repayments. They are mortgage pass-through funds, unit holders are entitled to amounts received proportionate to the number of units they own.
explain contributitoutionary mortgage schemes
These funds let investors choose one or more mortgages from a number that have been sourced by the fund manager. Investors contribute capital to the selected mortgages and receive their proportion of the loan payments. They are also mortgage pass-through securities. Mortgage pool typically interest only loans for shorter periods (1 to 3 years).
explain mezzainine mortgage funds (junior)
Mezzanine refers to subordinate (junior) debt or second mortgages. Holders of these securities receive loan interest and repayment of capital after all the entitlements of senior debt holders (fist mortgages) have been paid. They are akin to the lower tranches of RMBS & CMBS. Because they are higher risk they offer higher rates of return. These funds raise capital to lend as second mortgages, predominantly property development.
explain Property-Based Debentures and Notes
Debentures are debt securities issued by companies to raise capital or issued to financial institutions for them to lend to other businesses. They range from relatively safe loans to finance companies (e.g. Esanda) through to unsecured loans to unlisted companies for property development. Due to the variability of their risk profile, the returns offered vary greatly. Debentures & notes differ from pass-through mortgage funds in that they offer a fixed rate until maturity.
Why would an investor be concerned about the saleability of the properties within a pool of properties that have been securitised?
In the case of default an investor wants to be confident that the properties within the pool can be sold quickly and at the prevailing market value. Difficulties in achieving a sale can increase the investor’s possible losses. For example, unusual properties are generally harder and slower to sell, particularly is a depressed market.
For non-traded debt securities how, in theory, would we estimate the value of the security?
In theory the value of any asset/security should be the present value of the future cash flows, discounted at a rate that reflects the risks of the security.
define par value
The amount the issuer will pay the holder at maturity.
define maturity date
The date at which the issuer re-pays the par value. The amount of time remaining until the maturity date is called the term to maturity.