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CHAPTER 20

CHAPTER 20. The Secondary Mortgage Market: CMOs and Derivative Securities. Secondary Mortgage Market. Mortgage Pay-Through Bonds Bond, not an equity ownership interest Debt obligation of issuer Interest paid a coupon rate of interest Pass-through of principal Over collateralized

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CHAPTER 20

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  1. CHAPTER20 The Secondary Mortgage Market: CMOs and Derivative Securities

  2. Secondary Mortgage Market • Mortgage Pay-Through Bonds • Bond, not an equity ownership interest • Debt obligation of issuer • Interest paid a coupon rate of interest • Pass-through of principal • Over collateralized • Credit rating

  3. Secondary Mortgage Market • Collateralized Mortgage Obligations • Debt instrument • Mortgage pool owned by issuer • Pass-through of principal & interest • Multiple classes of securities issued • Different maturity classes • Different priority for payment of principal and interest • Tranches

  4. Secondary Mortgage Market • Collateralized Mortgage Obligations • Over collateralization • Represents equity interest of issuer • Residual cash flow is return to issuer • Cash flow = Interest earned – Interest paid • Prepayment problem • Reinvestment problem • Calamity call

  5. Secondary Mortgage Market • Collateralized Mortgage Obligations • Sequential Payout Tranche Structure • Tranche Z: Paid Last • Tranche A: Principal, Prepayments, & Interest Received First • Tranche B: Interest Only Until Tranche A is Paid • Etc. for any additional tranches

  6. Secondary Mortgage Market • Collateralized Mortgage Obligations • Expected Maturities • Pricing & Prepayment • Tranche Variations • Sinking Fund Structure • Planned amortization class tranche • Targeted amortization class • pricing speed • Companion tranche

  7. Secondary Mortgage Market • Collateralized Mortgage Obligations • Floating Rate Tranches • Floater Tranche • Coupon rates adjust periodically • Inverted Floating Rate Tranche • Coupon rate adjusts opposite to its index • Scaling • Used as a Hedge • Yield Enhancement

  8. Secondary Mortgage Market • Collateralized Mortgage Obligations • Principal Only Tranches • Similar to a Zero-Coupon Bond • Interest Only Tranches • Convexity

  9. Secondary Mortgage Market • Commercial Mortgage-Backed Securities • Similar in form to residential MBSs • Default risk differs significantly • Assets in mortgage pool • Interest-only • Lump sum principal payment

  10. Secondary Mortgage Market • Commercial Mortgage-Backed Securities • Senior Tranche (A piece) • Subordinate Tranche (B piece) • Prepayment is less likely than residential mortgages • Lockouts • Extension Risk

  11. Secondary Mortgage Market • Commercial Mortgage-Backed Securities • First Loss Position • Credit Ratings • Credit Enhancements • Issuer or 3rd party guarantee • Surety bonds • Letters of credit • Advance payment agreements

  12. Secondary Mortgage Market • Commercial Mortgage-Backed Securities • Credit Enhancements • Loan substitutions & repos • Lease assignments • Over collateralization • Cross-collateralization • Cross-default

  13. Secondary Mortgage Market • Collateralized Debt Obligations • Broader range of collateral • B notes • Commercial Mortgage-Backed Securities Class B • Mezzanine Loans • Preferred Equity • Managed Collateralized Debt Obligations

  14. Secondary Mortgage Market • Real Estate Mortgage Investment Conduits (REMICS) • Tax Reform Act of 1986 • Qualified Mortgages • Foreclosed Property • Interest Bearing Assets • Qualified Reserve Fund

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