Chapter 24

MORTGAGE-BACKED SECURITIES MARKET

Mortgage-Backed Securities

Mortgage Pass-Through SecuritiesDerivative Mortgage-Backed

Securities Collateralized Mortgage Obligations Stripped Mortgage-Backed Securities

Asset Securitization

Originate mortgageSell mortgage to investment banking

firmInsure pool of mortgagesSell right to service loansSell securities collateralized by

mortgages to investors

Foundations of the Mortgage Market

Federal Home Loan Banks (FHLBs)Federal Housing Administration

(FHA)Federal National Mortgage

Association (FNMA) Fannie Mae Ginnie Mae

Mortgage Pass-Through Securities

Created when one or more holders of mortgages form a pool of mortgages and sell shares in the pool.

Features more liquid securitized

Cash Flow Characteristics

Monthly mortgage payments interest principal repayment

Timing of monthly mortgage payments and payments made to investors is not identical

Magnitude of monthly mortgage payments is greater than payments for pass-through securities servicing fee other fees

Issuers of Mortgage Pass-Through Securities

Government National Mortgage Association

Federal Home Loan Mortgage Corporation

Federal National Mortgage Association

Nonagency Pass-Through Securities

Conforming mortgagesNonconforming mortgagesJumbo loansNonagency pass-throughs

Issuers of Nonagency Pass-Throughs

Commercial Banks

Investment Banking Firms

Others

Credit Enhancements

Corporate GuaranteesPool insurance from a mortgage

insurance companyBank letter of creditSenior/subordinated interests

Prepayment Risk and Prepayment Conventions

Prepayment risk is the risk associated with prepayments Contraction risk Extension risk

Prepayment Conventions Prepayment speed Conditional prepayment rates Single-monthly mortality rate

Average Life

It is the average time to receipts of principal payments weighted by the amount of principal expected.

The average life of a pass-through depends on the PSA prepayment assumption.

T

1t

principal) (Total 12

tat time received Principalt life Average

Collateralized Mortgage Obligations

TranchesCollateralized Mortgage ObligationsTypes of Tranches

Sequential-Pay CMOs Accrual Bonds Planned Amortization Class Tranches Floating-Rate Tranche Inverse Floating-Rate Tranche

Stripped Mortgage-Backed Securities

Created by distributing principal and interest from pool of underlying mortgages on a pro rata basis to security holders.

Features Derivative mortgage security Hedges prepayment risk

Types: Partially stripped securities Interest-only/principal-only securities

Yields on Mortgage-Backed Securities

Yields are a function of prepayment risk

Yield calculation requires determination of cash flow projections of prepayment

The PSA convention is used