how resilient are mortgage backed securities to collateralized debt obligation market disruptions
Download
Skip this Video
Download Presentation
How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?

Loading in 2 Seconds...

play fullscreen
1 / 44

How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions? - PowerPoint PPT Presentation


  • 897 Views
  • Uploaded on

How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions? Joseph R. Mason, Associate Professor of Finance, Drexel University Joshua Rosner, Managing Director, Graham Fisher & Co. Figure 1: U.S. Home Ownership 1965-2006 Source : Bureau of Census

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?' - oshin


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
how resilient are mortgage backed securities to collateralized debt obligation market disruptions

How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?

Joseph R. Mason, Associate Professor of Finance, Drexel University

Joshua Rosner, Managing Director, Graham Fisher & Co.

Criterion Economics L.L.C.

figure 1 u s home ownership 1965 2006
Figure 1: U.S. Home Ownership 1965-2006

Source: Bureau of Census

Criterion Economics L.L.C.

figure 2 home equity extracted and available for extraction 1995 2005
Figure 2: Home Equity Extracted and Available for Extraction 1995-2005

Source: Joint Center for Housing Studies of Harvard University (2006).

Criterion Economics L.L.C.

figure 3 refinancing behavior 1995 2005
Figure 3: Refinancing Behavior 1995-2005

Sources: Joint Center for Housing Studies of Harvard University (2006).

Criterion Economics L.L.C.

figure 4 piggyback lending for home purchase 2001 2004
Figure 4: Piggyback Lending for Home Purchase 2001-2004

Source: SMR Research Corporation (2004).

Criterion Economics L.L.C.

figure 5a investment homes share of total homes purchased
Figure 5A: Investment Homes Share of Total Homes Purchased

Source: National Association of Realtors

Criterion Economics L.L.C.

figure 5b prime market investor shares
Figure 5B: Prime Market Investor Shares

Source: Harvard’s Joint Center for Housing Studies (2006)

Criterion Economics L.L.C.

figure 6 five year bbb floating home equity spread to one month
Figure 6: Five Year BBB- Floating Home Equity Spread to One-Month

Source: Bureau of Census

Criterion Economics L.L.C.

the complexity of securitization
The Complexity of Securitization
  • Mortgages and Mortgage-backed Securities Are Complex and Difficult to Value
    • Complexity of Default vs Prepay Risk
    • Additional Complexity in MBS
      • Deep Tranching
      • Unique Securities
    • Examples

Criterion Economics L.L.C.

the complexity of securitization10
The Complexity of Securitization
  • Mortgages and Mortgage-backed Securities Are Complex and Difficult to Value
    • Complexity of Default vs Prepay Risk
    • Additional Complexity in MBS
      • Deep Tranching
      • Unique Securities
    • Examples

Criterion Economics L.L.C.

figure 7 prepayment and default rates as a function of mortgage duration
Figure 7: Prepayment and Default Rates as a Function of Mortgage Duration

Source: Calomiris and Mason (2007).

Criterion Economics L.L.C.

typically adjust for prepayment speeds with psa models
Typically Adjust for Prepayment Speeds with PSA Models

Prepayment and Principal and Interest Cash flows arising from Selected Prepayment Scenarios

Source: Mathworks.com

Criterion Economics L.L.C.

table 1 regression results dependent variable is prepayments
Table 1: Regression Results (Dependent Variable Is Prepayments)

Source: Calomiris and Mason (2007)

Criterion Economics L.L.C.

the complexity of securitization15
The Complexity of Securitization
  • Mortgages and Mortgage-backed Securities Are Complex and Difficult to Value
    • Complexity of Default vs Prepay Risk
    • Additional Complexity in MBS
      • Deep Tranching
      • Unique Securities
    • Examples

Criterion Economics L.L.C.

figure 8 tranches issued in european securitizations 1987 2003
Figure 8: Tranches Issued in European Securitizations 1987-2003

Source: Firla-Cuchra and Jenkinson (2005)

Criterion Economics L.L.C.

slide17
Table 2: Issues with the Given Number of Tranches as a Percentage of All Issues Per Type (Mean Number of Tranches Per Issue)

Source: Firla-Cuchra and Jenkinson (2005)

Criterion Economics L.L.C.

the complexity of securitization18
The Complexity of Securitization
  • Mortgages and Mortgage-backed Securities Are Complex and Difficult to Value
    • Complexity of Default vs Prepay Risk
    • Additional Complexity in MBS
      • Deep Tranching
      • Unique Securities
    • Examples

Criterion Economics L.L.C.

the complexity of securitization19
The Complexity of Securitization
  • Mortgages and Mortgage-backed Securities Are Complex and Difficult to Value
    • Complexity of Default vs Prepay Risk
    • Additional Complexity in MBS
      • Deep Tranching
      • Unique Securities
    • Examples

Criterion Economics L.L.C.

figure 9 examples of actual mbs funding structures
Figure 9: Examples of Actual MBS Funding Structures

Source: ABSnet

Criterion Economics L.L.C.

the complexity of securitization21
The Complexity of Securitization
  • Point: Mortgages are complex and difficult to value, and MBS are built upon that complexity.
  • Fundamental changes to underwriting and servicing standards are not easily identifiable in the inherent complexity of mortgages and MBS, posing risk to mortgage funding.

Criterion Economics L.L.C.

cdos add complexity to mbs and other constituent credit instruments
CDOs Add Complexity to MBS and Other Constituent Credit Instruments
  • Complexity of CDO Structures
  • Growth of the CDO Market

Criterion Economics L.L.C.

figure 10 basic cdo security structure
Figure 10: Basic CDO Security Structure

Source: JP Morgan, CDO Handbook 5 (2001).

Criterion Economics L.L.C.

figure 11 typical tranche sizes and coupon rates
Figure 11: Typical Tranche Sizes and Coupon Rates

Source: Lucas, Goodman and Fabozzi (2005)

Criterion Economics L.L.C.

key differences between mbs and cdos
Key Differences between MBS and CDOs
  • CDO pools are actively managed.
  • CDO transactions close before the pool of underlying assets is fully formed.
  • CDOs are heterogeneous with respect to granularity.
  • CDOs illustrate more ratings volatility than ABS or MBS.
  • CDO collateral heterogeneity increases opacity.
  • Secondary market trading (liquidity) is limited.

Criterion Economics L.L.C.

figure 12 examples of actual cdo funding structures
Figure 12: Examples of Actual CDO Funding Structures

Source: Bennett and Mason (forthcoming 2007)

Criterion Economics L.L.C.

cdos add complexity to mbs and other constituent credit instruments27
CDOs Add Complexity to MBS and Other Constituent Credit Instruments
  • Complexity of CDO Structures
  • Growth of the CDO Market

Criterion Economics L.L.C.

figure 13 annual cash cdo issuance
Figure 13: Annual Cash CDO Issuance

Source: Lucas, Goodman, and Fabozzi (2006)

Criterion Economics L.L.C.

fast growth lessons from 1999 2003
Fast Growth: Lessons from 1999-2003

The CDO market is opportunistic in the way it drops collateral types that are out of favor with investors and picks up collateral types that are in favor with investors. The best example of this is the switch out of poor-performing high-yield bonds and into well-performing high yield loans between 2001 and 2003. Also, certain types of ABS present in SF CDOs from 1999 through 2001 disappeared from later vintages: manufactured housing loans, aircraft leases, franchise business loans, and 12b-1 mutual fund fees. All of these assets had horrible performance in older SF CDOs. In their place, SF CDOs have recently focused more on RMBS and CMBS. (Lucas, Goodman and Fabozzi 2006, at 5).

Criterion Economics L.L.C.

the link from mortgages to mortgage backed securities to collateralized debt obligations
The Link from Mortgages to Mortgage-Backed Securities to Collateralized Debt Obligations
  • CDO rating changes follow other ratings changes.
  • An extremely high proportion of current CDO collateral is MBS.
  • 1999-2003 redux?

Criterion Economics L.L.C.

figure 14 number of cdo rmbs and abs ratings changes three month ma
Figure 14: Number of CDO, RMBS, and ABS Ratings Changes, Three-month MA

Criterion Economics L.L.C.

the link from mortgages to mortgage backed securities to collateralized debt obligations32
The Link from Mortgages to Mortgage-Backed Securities to Collateralized Debt Obligations
  • CDO rating changes follow other ratings changes.
  • An extremely high proportion of current CDO collateral is MBS.
  • 1999-2003 redux?

Criterion Economics L.L.C.

how much and what kind of mbs are in cdos
How much and what kind of MBS are in CDOs?
  • The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006)

Criterion Economics L.L.C.

how much and what kind of mbs are in cdos34
How much and what kind of MBS are in CDOs?
  • The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006)
  • Moody’s reports that among RMBS, 70%-75% below AAA-rated

Table 3: Top Collateral Types in Resecuritization CDOs, 2005 (All Vintages)

Criterion Economics L.L.C.

how much and what kind of mbs are in cdos35
How much and what kind of MBS are in CDOs?
  • The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006)
  • Moody’s reports that among RMBS in CDOs, 70%-75% below AAA-rated. (Moody’s CDO Asset Exposure Report, October 2006)
  • $200 billion of RMBS in CDOs x 70% below AAA = $140 billion of lower-tranche RMBS in CDOs

Criterion Economics L.L.C.

how much and what kind of mbs are in cdos36
How much and what kind of MBS are in CDOs?
  • The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006)
  • Moody’s reports that among RMBS in CDOs, 70%-75% below AAA-rated. (Moody’s CDO Asset Exposure Report, October 2006)
  • $200 billion of RMBS in CDOs x 70% below AAA = $140 billion of lower-tranche RMBS in CDOs
  • SIFMA puts total RMBS issued in 2005 at $1,326 billion.

Criterion Economics L.L.C.

how much and what kind of mbs are in cdos37
How much and what kind of MBS are in CDOs?
  • The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006)
  • Moody’s reports that among RMBS in CDOs, 70%-75% below AAA-rated. (Moody’s CDO Asset Exposure Report, October 2006)
  • $200 billion of RMBS in CDOs x 70% below AAA = $140 billion of lower-tranche RMBS in CDOs
  • SIFMA puts total RMBS issued in 2005 at $1,326 billion.
  • Assuming 90% AAA in all 2005 RMBS, that leaves a total of $133 billion in lower-tranche RMBS issued in 2005

Criterion Economics L.L.C.

the link from mortgages to mortgage backed securities to collateralized debt obligations38
The Link from Mortgages to Mortgage-Backed Securities to Collateralized Debt Obligations
  • CDO rating changes follow other ratings changes.
  • An extremely high proportion of current CDO collateral is MBS.
  • 1999-2003 redux?

Criterion Economics L.L.C.

1999 2003 redux but with mbs
1999-2003 Redux (but with MBS)?
  • Point: CDOs are buying a lot of lower-tranche RMBS
  • Point Point: The 10% of lower-tranche RMBS provide crucial credit support for the 90% of AAA securities.
    • If you can’t sell the 10%, can’t sell the other 90%!
  • Point Point Point: If CDOs exit RMBS as they did with other collateral after 1999-2003, that will leave a substantial hole in the market for crucial lower-tranche RMBS.

Criterion Economics L.L.C.

table 5 cdo risk premiums and credit spreads and macroeconomic performance
Table 5: CDO Risk Premiums and Credit Spreads and Macroeconomic Performance

Source: D’Amato (2005)

Criterion Economics L.L.C.

figure 16 cdo issuance and u s home equity abs indices
Figure 16: CDO Issuance and U.S. Home Equity ABS Indices

Source: BIS Quarterly Review, Dec. 2006

Criterion Economics L.L.C.

slide42
Overview of Public Policy Implications: Information Problems across Financial Markets and Institutions

CDO Market is here

Want to move it this way

Adapted from Merton, “A Functional Perspective of Financial Intermediation,” Financial Management, Summer 1995.

Criterion Economics L.L.C.

policy implications
Policy Implications
  • Transparency
  • Stability
  • Continued Innovation

Criterion Economics L.L.C.

policy implications44
Policy Implications

MBS Pioneer Lewis S. Ranieri, in an interview published in the American Banker last June, said:

"When you start divorcing the creator of the risk from the ultimate holder of the risk, it becomes an issue of, 'Does the ultimate holder truly understand the nature of the risk that you've redistributed?' " Mr. Ranieri said. "By cutting it up in so many ways or complicating it by so many levels, do you still have clarity ... on the nature of the underlying risk?"

"It's not clear that we haven't gone, in some ways, too far -- that we have not gone beyond the ability to have true transparency," he said. "That is a fair question many of us in the business and people in the regulatory regime are wrestling with."

Criterion Economics L.L.C.

ad