2. Mortgage-Backed Security
Mortgage-backed securities also known as MBS is an asset-
backed security issued by larger financial corporations (bond
issuers) representing a pool of mortgages into a single financial
instrument.
The MBS undergoes a securitization process, which is a
financial exercise that involves pooling of various contractual
debts like commercial mortgages, residential mortgages, credit
card debt commitments or auto loans and trading those
securities as bonds, Collateralized mortgage obligation
(CMOs), pass-through securities to its stockholders in
secondary markets.
The various investors are provided with periodic payments on
principal and interest similar to coupon payments.
3. Mortgage-Backed Security
RMBS is an Instrument whose cash flow depends upon
the cash flows of an Underlying pool of mortgages in US.
RMBS are classified into two groups,
Agency MBSs are MBSs created by one of the agencies;
they are collectively referred to as agency MBSs,
Nonagenecy MBS are MBS created by private conduits;
also called private labels.
Agency
RMBS
1 Non-
Agency
RMBS
2
4. Residential Mortgage-Backed Security
(RMBS)
In US, majority of the MBSs are issued by the Government Sponsored
Enterprises like the Federal National Mortgage Association (Fannie
Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac)
and Government National Mortgage Association (Ginnie Mae). There
are few private investment banks as well
The MBS traded by government agencies are more attractive as there
are guaranteed returns backed by the Federal government itself. There
are few factors that affect the MBS.
Economic Growth : Greater economic growth accentuates the need
of large capital and it indirectly reduces the MBS prices
Inflation: Increasing inflation can have an impact over the MBS
pricing. Inflation causes the dollar value to erode, lender demand for
more interest rate.
5. Residential Mortgage-Backed Security
(RMBS)
Residential mortgages can be divided into prime and subprime
mortgages.
Prime mortgages include those that are both conforming
(meet the agency’s underwriting standards) and
nonconforming but still meeting credit quality standards.
Subprime mortgages include those with low credit ratings.
6. Mortgage securitization
Wht is Mortgage Securitization?
It is a process combining individual mortgages of similar
characteristics in a pool and selling debt securities.
Securitization turns illiquid assets of individual mortgage
loans into marketable securities that can be bought. sold
and traded on the secondary markets.
Mortgage securitization allows lenders to continue to
recycle loan money to home owners without retaining the
loan assets on their books.
7. Players
The major players in the MBS market could be categorized
into MBS issuers, MBS investors and Regulators.
MBS Issuers: MBS Issuers are further categorized
into GSE and non-GSE.
GSE ( Government Sponsored Enterprises)
Non – GSE ( Non- Government Sponsored Enterprises)
Non – GSE includes large homebuilders, banks and
financial institutions.
8. MBS investors
Traditional primary investors of MBS finance instruments
were used to be insurance companies, pension funds, thrift
institutions, commercial banks, charitable endowments.
There is gradual increase in individual investors.
Investors invest in MBS for either to diverse their long
term portfolios or for short term trading purposes.
9. Regulators.
Regulatory framework plays a pivotal role in growth of a
countries economy.
1. Securities and Exchange Commission (SEC)
In US the MBS market is regulated by the SEC, it is the
primary overseer and regulator. It enforces the regulatory
framework for issuance of Residential MBS through
Regulation AB issued in 2005.
2. Financial Industry Regulatory Authority (FINRA)
All the security firms operating in US market are obligated to
this largest independent regulator. FINRA amended the
TRACE rules to facilitate the dissemination of the securities.
10. Conti…
3. Office of Federal Housing Enterprise Oversight ( OFHEO)
Its main function is to oversee the financial safety and capital
adequacy of the two GSEs (Freddie Mac and Fannie Mae)
4. Federal Housing Finance Agency
This was established as a merger of OHHEO and the Federal
Housing Finance Board (FHFB) post the subprime crisis loss.
This new regulator would oversee the functioning of the GSEs
and the 12 Federal Home Loan Banks.
11. Ginnie Mae Mortgage-Backed Securities
Ginnie Mae (Government National Mortgage Association's (GNMA)) is a
true federal agency.
As such, the MBSs that it guarantees are backed by the full faith and credit
of the U.S. government.
Creation
Ginnie Mae MBSs are put together by a lender/originator (bank, thrift, or
mortgage banker), who presents a block of mortgages that meets Ginnie
Mae’s underwriting standards.
If Ginnie Mae finds them in order, it will issue a guarantee and assign a pool
number that identifies the MBS that is to be issued.
The lender will then transfer the mortgages to a trustee, and then issue the
pass-through securities as a Ginnie Mae pass-through security.
12. Ginnie Mae Mortgage-Backed Securities
Features
Ginnie Mae provides the guarantee, but does not issue the
Ginnie Mae MBS.
Thus, different from the standard MBS that is issued by
the other agencies or a conduit, Ginnie Mae MBSs are
issued by the lenders.
The minimum denomination on a Ginnie Mae pass-
through is $25,000 and the minimum pool is $1 million
13. Fannie Mae and Freddie Mac
Mortgage-Backed Securities
Fannie Mae and Freddie Mac are Government-sponsored enterprises
(GSE) initially created to provide a secondary market for mortgages.
Today, there activities include not only the buying and selling of
mortgages, but also creating and guaranteeing mortgage-backed
pass-through securities, as well as buying MBSs.
Unlike Ginnie Mae, Fannie Mae’s and Freddie Mac's MBSs are
formed with more heterogeneous mortgages.
The minimum denomination on a Freddie Mac and Fannie Mae
pass-through is $100,000 and their mortgage pools range up to
several hundred million dollars.
14. Non agency MBS
Nonagency pass-throughs or private labels are sold by
commercial banks, investment banks, other thrifts,
and mortgage bankers.
As noted, nonagency pass-throughs are often formed
with prime or subprime nonconforming mortgages.
Larger issuers of nonagency MBSs include Citigroup,
Bank of America, and G.E. Capital Mortgage.
15. Conti…
Features
Nonagency MBSs are often guaranteed against default through
external credit enhancements, such as the guarantee of a
corporation or a bank letter of credit or by private insurance
from a monocline insurer.
Many are also guaranteed internally through the creation of
senior and subordinate classes of bonds with different
priority claims on the pool's cash flows in the case some of the
mortgages in the pool default.
The more subordinate claims sold relative to the senior
claims, the more secure the senior claims.
