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FMI week 8 The Mortgage market and Securitisation - Coggle Diagram
FMI week 8 The Mortgage market and Securitisation
The mortgage market
Mortgage
Mortgage is a
secured loan,
typically with
property as collateral
obliges borrower to make predetermined payments.
if fails to pay the lender, lender has right to foreclose on the loan and take the collateral.
puropose
Early consumptions/investments
Tax subsidy. Residential in US, Rental in AU.
Mortgage process
Borrower submit
Mortgage application
mortgage underwriter evaluate
credit risks and property appraisal
with
credit score, loan to value ratio and Payment to income ratio.
offer
commitment letter
as approval
settlement of the property
borrower make
regular repayments
until
redemption
.
if
fail
to make loan repayment, mortgage will be
foreclosed
.
Mortgage repayments
provide lender the
contractual interest
and
amount borrowed
at the end.
use to be only interest payment throughout and principle at the end. now is
amortised
to reduce credit risks.
There are
fixed rate mortgage
(US) and
adjustable-rate mortgage
(AU).
Institutional features
Offset account:
at call deposit account links to mortgage loan. interest generated offset with mortgage interest, provide incentives through high offset interest rate and tax implications.
Redraw facilities:
borrowers have access to early excess repayments. Encourage people to save with open options.
Post mortgage origination
lenders use to originate and hold as assets
expose to 4 risks
Credit risk:
borrower may default
Liquidity risk
:mortgage are less liquid, hard to trade
Price risk:
mortgage value inversely related to market interest rate
Prepayment risk:
borrower has unrestricted call provision to repay early without penalty. banks need to invest in low interest rate.
since 1970, start selling them on
secondary market
.
sources of income
Origination fees
Servicing fees
if continue collect repayments
Secondary market profit
if sell
Pooling as a solution to diversify risks. securitization.
Securitisation
take
illiquid assets
and turn into liquid securities sold to investors in the capital markets.
process
create a
special purpose vehicle(SPV)
trustee of SPV create securities and sell them into investors
securities are funded with interest and principal repayments of the underlying loans.
Benefits
transfer risks
loan underwriters remove value of underlying assets from BS
improve banks credit rating and capital it needed
allow bank to invest more capital in new loans
SPV benefiting from difference between income on loans and payments for investors
Mortgage backed securities(MBS)
asset backed securities by the cash flow of a pool of mortgages
Pass-through
principle&interest payments from borrowers pass through to MBS holder each month.
SPV(issuer) buys up mortgages, pool them and assign cash flow pro rata to new bondholders
monthly mortgage payment > payments for pass through due to fees
Collateralised Mortgage Obligations(CMO)
use pass-through as collateral and issue new security
CMO features
different payment streams and risks
depending on investor
preferences
.
Tranches
Sequential-Pay Tranches
top-most tranches:
first dip, high credit, low return, hold by insurance, pension risk-averses.
bottom-most tranche:
first hit, lower rating, high return, hold by hedge funds and risk lovers.
Collateralised debt obligations(CDO)
buy different tranches, group them together and sell to others
still the same collateral, share the same risk
Risk management
overcollateralization:
excess mortgage over CMO to absorb shocks
lender
retain a high share
of securitised portfolio to reduce asymmetric information and moral hazzard.
normally need to hedge with financial instruments, but forgot in GFC
Securitisation and GFC
difference between US and Australia
AU RMBS were
backed by prime, full-doc loans
. Legal systems allow to
recourse to all borrower's assets.