Wed, Nov 5, 2008Mortgage Backed Securities BasicsBY JAY DROZD chammond Certified Mortgage[Part 1] [Part 2] [Part 3] [Part 4] [Return to the blog] Planning Specialist Mortgage Network, IncDeciphering the Greek clint-hammond.comNow that there are graphs and MBS prices posted periodically, chammond@mortgagenetwork...weve received numerous questions about the significance of the Phone: (803) 771-6933data. This is intended to be a brief companion to the daily mortgage Mobile: (803) 422-6797rate analysis that will "get you by" until we release more Fax: (803) 771-6944comprehensive literature on the topic. To some of you this will be Facebookold hat, but Ill start completely at the beginning so it is accessible Twittereven to the first timer. Keep in mind this will be brutallyoversimplified due to the fact that a more detailed version will be Linked Inreleased at a later date.What is MBS?Any time you see me write MBS in this blog, or anywhere else for that matter, I am always going tobe referring to Mortgage Backed Securities. These are bonds that have a PRICE and a YIELD justlike treasuries. The PRICE always refers to the cost of buying $100 of that particular bond. Forinstance, if the price of a bond is 101.00, then an investor would pay $101.00, and in exchange,would then own only $100.00 worth of that bond. So why pay more or less?In a word: YIELD. Yield is the rate of return paid on that bond over time. There are multiple differenttypes of bonds, and each bond has a certain yield that it pays. You will sometimes hear me refer toyield as "coupon" or "issue." As you might guess, the higher the yield, the more the buyer will makeover time, so the more the buyer is willing to pay. For instance, at the very moment this tutorial isbeing typed, a certain class of MBS (a bond) with a 5% yield costs $97.25. So for every $97.25 youspend, you get $100 dollars of bond, paying you back at a 5% rate of return. Another bond in thesame class with a yield of 6.5% is currently costing $103.10. So youd have to pay over the facevalue to get the $100 dollars to pay you back at 6.5%. So hopefully this illustrates as we move fromcoupon to coupon (i.e. 5% to 5.5% to 6.0% to 6.5%) that the cost of ownership will get higher, butso will the yield.Now it gets confusing because all this time Ive been telling you that "as PRICE goes up, YIELDgoes down." Well, it does, but only when were talking about one coupon at a time. Talking about thefull spectrum of coupon rates means that naturally the price will be higher when were talking abouthigher yields. But that concept is not central to bond analysis. We are only ever interest in PriceVS. Yield as it relates to supply and demand, and even if we are considering several coupon rates,we will only analyze one at a time.
Wed, Nov 5, 2008Mortgage Backed Bonds and SecuritizationBY JAY DROZD chammond Certified Mortgage[Part 1] [Part 2] [Part 3] [Part 4] [Return to the blog] Planning Specialist Mortgage Network, IncSo MBSs are bonds! Where do they come from? clint-hammond.comGrossly oversimplified and leaving out numerous items that are not chammond@mortgagenetwork...germane to rate analysis, MBS are the bonds that mortgage loans Phone: (803) 771-6933are turned into when they are bought or sold. Thats a tough one to Mobile: (803) 422-6797grasp your first time around. I know it was for me. Fax: (803) 771-6944 FacebookBasically, Big Bank will write a check for your mortgage, say its Twitter$100,000. Big Bank A then has a promissory note saying that you Linked Inwill pay them a certain interest rate over time (sound familiar?). ButBig Bank A needs some more money to lend other people... Whereto get it? I know! They can sell your mortgage note to someone elsein the form of a bond! Hopefully, that investor is willing to pay something like $102,000 for the right tocollect interest on your $100,000 loan. Big Bank A just made $2000, and the investor has somethingthat will hopefully pay them interest over time. Remember price vs. yield? The higher your interestrate, the more the investor would be willing to pay Big Bank A. Thats YSP Baby! And if the investoris only going to pay $97,000 for the loan, that means Big Bank has to pay them a discount to buy it,which was probably passed on to you on line 802 of the GFE! Now YSP starts to become clear Ihope!But theres a big problem! The investor doesnt want all of their risk riding on one loan, so we have tofind a way to spread out the risk. Because even if you only have a 3% chance of defaulting, in theevent that you do, the investor would lose his hat. So to spread out the risk, Big Bank A combinesyour loan with 10s to hundreds of other similar loans with similar rates and similar credit quality.Then either by selling them directly to Fannie Mae and Freddie Mac or by utilizing Fannie andFreddies Protocols and doing it themselves, Big Bank A accomplished what is known asSECURITIZATION. Now the "pool" (collective of all the bundled loans which will now be in themillions of dollars) can be broken up into bond-sized chunks. Now instead of buying one loan for$100,000 dollars (give or take), and investor can buy a portion of 10s to hundreds of loans for thesame amount of money, with the same rate of return, with the same risk of default. BUT NOW, if youapply the 3% rate of default, the investor only loses 3%! Brilliant! And its a concept that has alloweda significantly larger amount of money to be available for home loans than ever before.[Part 1] [Part 2] [Part 3] [Part 4] [Return to the blog]
Wed, Nov 5, 2008Why do MBSs matter to mortgage rates?BY JAY DROZD chammond Certified Mortgage[Part 1] [Part 2] [Part 3] [Part 4] [Return to the blog] Planning Specialist Mortgage Network, IncWe just said that investors are paying 102% of the face value of abond in certain cases right? So what happens if they are not clint-hammond.cominterested at that price any more? No more liquidity for the chammond@mortgagenetwork...mortgage market. So how do you combat this? In a nutshell, the Phone: (803) 771-6933market forces of supply and demand take care of it. If demand for a Mobile: (803) 422-6797bond is low when the price is 102.00, then the sellers of the bonds Fax: (803) 771-6944may lower the price to 101.50 to ENTICE investors to start buyingagain. And what did we already say would happen to the YIELD Facebookwhen the price got lower for a particular issue? It goes UP because Twitterthe same money the investor was going to spend, now buys more Linked Inshares. So their rate of return per dollar spent (yield) goes up.Those pricing adjustments from 102.00 to 101.50 should look familiar. They move in exactly thesame proportion to YSP. Although Big Bank A has to pull profit off that for themselves, THE PRICESOF MBS ALWAYS MOVE IN DIRECT PROPORTION TO THE PRICES (YSP IF POSITIVE,DISCOUNT IF NEGATIVE) OF THE MORTGAGES FROM WHICH THEY ARE DERIVED.That is why we want to follow MBS instead of any other treasury or index in order to gauge thedirection of the market. If investors are wanting to buy more MBS, then the prices are going to go up(Price vs. Demand function). Higher prices mean that Big Bank A makes more on a given coupon,which means they can originate a loan for your clients with either a slightly lower interest rate or aslightly higher YSP. Your choice!So that is the theme of any mortgage market analysis. We want to assess the movements of MBSprices (which change by the second), in conjunction with the macroeconomic climate, in order todetermine which way they might be headed and what future events can have an impact.For instance, inflation data being negative hurts bonds because bonds return a fixed income. So ifinflation has devalued the dollar over time, the bond is not really worth as much as when it first waspurchased. So high inflation makes investors seek higher yields in order to get on that boat. Anotherpopular correlation is that a booming economy draws money out of bonds and into more rapidlyappreciating stocks. This causes bond owners to lower the price to entice buyers which raisesmortgage rates. That is why, if you look at a historical chart of recessions and interest rates, you willalmost always see recessions coincide with low rates.Beyond that, theres only a little more you need to know when reading my analysis.