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I. MORTGAGE ORIGINATION PROCESS
Borrower Mortgage Originator
Housing Market
Down Payment
Mortgage Loan
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Mortgage Origination Example
500,000 = Property Value
(20%)100,000 = Down Payment400,000 = Mortgage Loan @ 7.5%Term = 30 yr fixed
Mortgage Loans are secured by a lien on the property. The homeserves as collateral for the loan made by the originator.Mortgage rate is a fee paid on borrowed money. This fee isdetermined by an evaluation of the borrowers credit worthiness.
The level of this rate is dependent on the perceived amount of riskassociated with the loan.Failure to pay the loan will result in foreclosure of the mortgageand ultimately repossession of the property by the lien holder.
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Measure of RiskHigher coupon = Higher Risk
MotivesBorrower Motives - To own a homeOriginator Motives -
1. Profits made on closing costs and coupon (Volume driven).
2. To provide buyers with liquidity based on risk
parameters.
Loan Type Rate Risk Characteristics
Prime Low Rate Low RiskHigh Fico - 720+,Flawless credit history
AltA MediumRate
MediumRisk
Med Fico -
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II. MBS TRADING
Originator wants to lend more to make more money through increasing
volumes.In order to make more loans the originator needs to clean up warehouselines through loan sales.This liquidity is provided by: 1. Investment Banks
2. FNMA FHLMC Govt agencies
3. Hedge Funds Buy across sectors
Borrowers OriginatorsPrincipal& Interest
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Origination Liquidity Cycle
Originator puts whole loan package out for bid to street firms.
Street firms put bid on loan package and winner will eventually receiveprincipal and interest payments.Motive : Originators can now originate more loans and make more money.Investment banks use loans as collateral for securitizations and receiveinterest payments.
Originators
WallStreetFirms
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III. Wall Street ProfitsSecuritizationLoans are sold to a special purpose vehicle (SPV) which allows cash flowsto be redirected to create several tranches of bonds.The tranches make up collateralized mortgage obligations (CMOs) Tranches turn a profit on the spread between the loans bought and the pointwhere bonds trade + excess interest.Motives : Hold on to loans - make a profit by collecting interest payments.
Securitize Loans are given off balance sheet treatment, andusually turns a larger profit.Securitization Lifecycle:
SPV
Cash Flowto
Bond Holders
Raw
Loans
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Example:
A Wall Street firm buys 119mm of 7.5% 30 year fixed rate loans @ 95.00%
Cost basis = 119mm * .95 = 114mm
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Bond Ratings
http://www2.standardandpoors.com/portal/site/sp/en/us/page.siteselection/home.jsphttp://www.fitchratings.com/corporate/index.cfm8/10/2019 Villanova Mbs Presentation
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IV. Subprime MeltdownHousing Market
Borrowers
Originators
Wall Street
Investors
Rating Agencies
Market begins to depreciate, increase indelinquencies
Borrowers locking loans they cannot afford usingnew exotic lending instruments.
Originating based on volume rather than
fundamentals. Using loose underwriting toensure high volumes.
Providing liquidity to originators with looseunderwriting guidelines. Holding loans andsecurities that are declining in value.
Investing in securities backed by questionablecollateral. Holding on to securities that aredeclining in value.Giving too much credit to securitization. Dealsshould have been rated more strictly with a
closer eye on the credit worthiness of thecollateral.
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