R42: INTRODUCTION TO ASSET-BACKED SECURITIES

Structure of Mortgage-Backed Securities

Prepayment Risk & Non-Mortgage Backed Securities

Securitized Assets: Pool of assets (ABS):
• Residential and commercial mortgage loans (MBS)
• Automobile (auto) loans, student loans, bank loans
• Credit card debt

Originator (Owner)
Được paid cash ≈ Move asset to SPE

Special legal entity (SPE)
Using the securitized assets as guarantees to back a bond issue

Investors
Take the bond (Bond hold by investors is ABS)
≈ Funding cash

Explain Benefits of ABS

Problems before securitization

Ngân hàng là người cấp vốn cho các khoản vay, investors chỉ tham gia vào hoạt động deposits, debt hoặc equity cho cả port của bank => Bank đại diện thêm 1 layer giữa borrowers và investors.

Investors were only able to gain exposure to the bank’s entire portfolio of assets; that is, they were unable to pick and choose the types of assets they desired exposure to. (Không giải quyết được sở thích rủi ro của từng người)

BENEFITS for market (giảm chi phí)

Cắt bớt layer người trung gian => Chi phí giảm => Return tăng

Tổng số vốn vay tăng lên theo nhu cầu

Lower liquidity risk (Vì tạo ra một thị trường có nhu cầu)
=> Thị trường hiệu quả hơn

Stronger legal claim on the collateral
(Khả năng claim ts thế chấp cao hơn)

BENEFITS for investors
(Nói chung là diversify danh mục)

Offer assets that match their risk, return, and maturity profiles.

Would not be required to originate, monitor, and collect payments from the underlying loans themselves

More types to choose and pick

BENEFITS for security issuers (Banks, IB)

Originate more loans than themselves
=> Improve profitability

Diversify the product (Other than bond and equity)
=> diversification and risk reduction

Typical structures of securitizations

Credit tranching

Time tranching

The SPV is a bankruptcy-remote entity, its obligations remain secure even if the parent company goes bankrupt

Structure of the securitization can also be structured with multiple classes of securities, each with a different claim to the cash flows of the underlying assets. The different classes are often referred to as tranches.


With this structure, a particular risk of the ABS securities is redistributed across the tranches.

Credit risk ≈ failing to make full and
timely payments ≈ waterfall structure

Prepayment risk ≈ the cash flows will be different from the scheduled cash flows

  • Allow investors to choose the level of credit risk that they prefer to bear.
  • Senior được bảo vệ tốt nhất => Higher credit rating => Lower yield => Default thì sẽ được trả trước

  • The first tranche receives all principal payments until it is paid off => more contraction risk


  • The second tranche receives no prepayments until the first tranche is paid in full, then receives all principal payments until the entire issue is paid off => more extension risk + less contraction risk

TYPE OF ASSET BACKED SECURITIES
(Các khoản loan thực sự sẽ secured cho MBS, sau đó diversified pool thành 1 cục => biến nó thành CDO hỗn hợp)

Commercial mortgage-backed securities (CMBS)

Non-mortgage asset- backed securities

Residential mortgage-backed securities (RMBS)

Covered bonds

Collateralized debt obligations (CDO)

Residential mortgage loans
(Secured for RMBS)

Characteristics

Mortgage design

Amortization Schedule (R39)

Prepayment Options and Prepayment Penalties (cmt)

Interest Rate

Rights of Foreclosure (Tịch thu TS)

Maturity

Phân loại based on Credit quality

Loan-to-value ratio

Amount of loan and collateralized assets’s price

Subprime loans

Prime loans

The borrower’s equity changes because:
• Changes in market value of the property
• Borrower trả nợ

= Mortgage loan value/Asset's purchase price

• High credit quality
• Income sufficient

• Lower credit quality
• Without a first lien on the property (Ko có quyền nắm TS thế chấp)

Adjustable-rate mortgage (FLOAT)

Initial period fixed rate (Fix 1 thời gian, rồi float)

Fixed rate

Convertible (Tới 1 thời điểm, cho chọn float hay fix)

Recourse Loan (Truy đòi)

Non-recourse Loan (Miễn truy đòi)

Agency RMBS
(issued by Federal agencies => no credit risk
OR Quasi-gov entities => Minimal credit risk)

Non-Agency RMBS
(issued by private entities)

Mortgage pass-through securities
represents a claim on the cash flows from a pool of mortgages (Investor)

Weighted average maturity ≈ weighted average of the final maturities of all the mortgages in the pool

Weighted average coupon ≈ weighted average of the interest rates of all the mortgages in the pool

Criteria on MBS pool:

  1. maximum size
  2. maximum LTV ratio
  3. minimum percentage down payment
  4. minimum documentation required
  5. insurance purchased by the borrower

Prepayment Risk

Nó có 2 loại risk:
Risk trả sớm (Contraction risk)
Risk trả chậm (Extension risk)
(Chữ C đứng trước chữ E)

Prepayment Rate Measures:
Theo tháng: the single monthly mortality rate (SMM)
Theo năm: the conditional prepayment rate (CPR) (PSA)

Weighted Average Life
Higher prepayment rate assumed → Shorter the average life of MBS
Lower prepayment rate assumed → Longer the average life of MBS

CMO are securities that are collateralized by RMBS (they are securities secured by other securities, RMBS, mortgage pass-through)

Mục đích làm ra CMO là tạo thêm các tranches khác nhau để exposure risk từ các MBS giống nhau về risk
=> Each CMO tranche has a different mixture of contraction and extension risk


IMPORTANT COMMENTS

Planned amortization class (PAC) + Support tranches

Sequential pay CMO

Floating-rate tranches

Backed by Income-producing property

Office buildings, industrial properties

Shopping centers, hotels, and health care facilities

Multifamily properties

Lock-out period

Ratio for analysis

LTV

Debt-service-coverage ratio (DSC)

Bởi vì CMBS lấy tiền từ hoạt động cho thuê, hoặc là sử dụng bđs đó để trả lãi và gốc => net operating income / debt service càng cao sẽ càng giảm rủi ro.

Synthetic CDOs (credit default swaps được backed)

Structured Finance CDOs

Collateralized loan obligations (CLO)

Pass through rate

Structure

Credit tranching