The Mortgage-Backed Securities Market in the United States - Essay Example

DISCUSS THE MBS MARKET IN THE US Executive Summary The paper is going to discuss majorly on the Mortgage backed securities (MBS) market in the United States. The research in the journal is carried out using the five journal articles. They include; The US mortgage market: A model of duelling charters. It is a Journal of Housing Research, The concept of credit OAS in valuation of MBS. The Journal of Portfolio Management, The other journal is what Moves the Mortgage‐Backed Securities Market? Real Estate Economics journal and GSEs, mortgage rates, and secondary market activities. The Journal of Economics and Real Estate Finance, Finally is Reforming the US mortgage market through private market incentives. Fisher Centre for the Economics and Real Estate Journal (Van Order, 2000). The paper also shows a little history about the mortgaged based securities market in the US. It also displays the subtypes of the mortgage-backed security. For instance, it indicates mortgages that have collateral especially those that are secured using bond. It also shows stripped mortgages that are acquired using the relationships. The paper also that there is also the secondary mortgage market where a network of lenders does sell, and the investors buy the existing MBS. The issue of market size and liquidity is. The paper also shows how the Mortgage-backed security is where the weighted average coupon (WAC) and the weighted average maturity are in the valuation of a pass-through MBS (Van Order, 2000). The paper also talks about the issue of credit risk where the credit risk of the mortgage-backed securities will depend on the susceptibility of the borrowers in honouring their credit obligations at the required time. It also shows that the MBS’ credit rating is usually high (Van Order, 2000). Table of Contents Introduction…...............................................................................................................................1 Literature Review………………………………………………………………………………..2 Application/Discussions…………………………………………………………………............3 The MBS market in the US……………………………………………………………………....4 Securitization……………………………………………………………………………..............5 Market size and liquidity…………………………………………………………………………6 Pricing……………………………………………………………………………………………7 Valuation…………………………………………………………………………………………8 Weighted Average Maturity……………………………………………………………………...9 Weighted Average Coupon……………………………………………………………………...10 Credit Risk………………………………………………………………………………………11 Conclusion……………………………………………………………………………………….12 Reference List……………………………………………………………………………………13 Introduction The Mortgage backed securities (MBS) entails a debt responsibility that act as a representative of the claims to the cash flows from various loan mortgages brought together. It commonly witnessed in the real estate properties. Mortgage loans are from mortgage companies, banks, and other originators, and they are into pools by the private entity, governmental or quasi-governmental entity. The entity will then issue securities that represent claims on the principal and payments of interest made by investors on the loans in the pool. The process is as securitization (Levin and Davidson, 2008). Most Mortgaged Backed Securities originate from government-based institutions especially those that deals with mortgages. Some of such institutions are NMA and FAM. It also involves other corporation in the United States such as Federal Home Loan Mortgage Corporation. Further, the United States supported business is. Mortgage-backed securities have a variety of structures. The most fundamental types are the pass-through participation certificates that entitle the holder to a pro-rata share of all principal and payments of interest made on the pool of loan assets. More complicated MBSs known as the collateralized mortgage obligations or mortgage derivatives may be done to expose investors to or protect investors from various types of risk. An essential risk concerning residential mortgages involves prepayments. The reason is that homeowners refinance when there is a fall in interest rates. Lack of security, some prepayments may not be in a position to give the investors the anticipated returns on their investment as anticipated. The total face value of an MBS reduces over time. The rates of interest on MBS may fail to be paid back in a single payment to the bondholder at expiry period. The effect is attributable to the interest payments in every pay period (Levin and Davidson, 2008). Literature review The research was one by the use of journal articles. One of the journal article used was The US mortgage market: A model of duelling charters. It is a Journal of Housing Research; The Journal develops a framework for understanding the basic structure and evolution of the American mortgage markets. In the article, the author shows that a mortgage can be backed by selling it in the security market or via utilization of MBS. In addition, the MBS may be organized such that it appear as a combination of various security derivatives that have a separate interest rates and risk attributable to different risk takers. The author also shows that there is the secondary mortgage market where a network of lenders does sell, and the investors buy the existing MBS. The originators into the liquid and large market where they are packaged into MBS and sold to private and public investors sell an enormous percentage of the newly originated mortgages. It also includes; hedge funds, mutual funds, insurance companies, pension funds, Freddie Mac and Fannie Mae (Van Order, 2000). The other journal article used focuses on the OAS credit concepts in valuing of the MBS. On the other hand, Portfolio Management Journal, the authors shows how the MBS is. The authors show that the weighted average coupon (WAC) and the weighted average maturity are in the valuation of a pass-through MBS. They also try to put on the concept of credit. They explain that the severity of borrowing of the MBS is based the likelihood of the borrower to pay the promised cash flows within the stipulated time (Levin and Davidson, 2008). The other journal used focuses on factors that make the MBS move. The facts may be from the journal of economic real estate. It can be observed that the evaluation of Mac Freddie, as well as Mae Fannie on MBS, indicate that the risk that the MBS guarantor have. Such risk is a crucial determinant of the returns on investments (Mae Xu, and Fung, 2005).The other journal task of GSEs rates of mortgages and functions in the secondary market. The Economics and Finance Journal on real estate shows that Freddie Mac and Fannie Mae are government-sponsored enterprises that scrutinize mortgages and give mortgage-backed securities. The article also shows that a trade based mortgage security is a pass-through MBS on the property that is for trading purposes. A residential backed security mortgage is a pass-through for property mortgage that is residential (Lehnert, Passmore, and Sherlund, 2008). The other journal that is reforming the US mortgage market through private market incentives. Fisher Centre for Economics and Real Estate Journal. The journal has an assumption that the government-sponsored enterprises (GSE’s, Freddie Max, and Fannie Mae) are unsustainable. The assumption is in that the expected costs they establish for the United States, the taxpayers far exceed their expected benefits. The journal also gives a passing certificate that is taxable under the trust policies of the grantor of the Internal Revenue Code. Under the rules, the holder of the pass-through certificate is taxed as the direct owner of a section of the trust given to the license (Jaffee, 2011). Applications/Discussion: The MBS market in the US One of the early examples of mortgage-backed security backed mortgage in the America was the farm railroad mortgage for farm rail on bonds in the mid-19th century. There was also an extensive tradable MBS in the year nineteen twenties. Low-value securities backed mortgage supported the Supreme mortgages that played a significant role in the 2007 to 2012 global financial crisis. By 2012, the markets for high quality mortgaged backed securities had already recovered and were a profit centre for the United States banks. Most bonds supported by mortgages are as an MBS. The distinction between the MBS bond and other security-backed mortgages is made using pass through quantifiers. The other sub-division category of the mortgages that are supported by safety is as follows; securities pass-through that are provided by the trust and are cash flows based on the holders assembled collateral. A trust that provides pass-through certificates is under the trust rules of the grantor of the Internal Revenue Code. Under the rules, the pass-through certificate holder is taxed as a direct owner of the portion of the trust given to the license. For the issue to be as a trust for tax purposes there can be a significant power under the agreement of confidence. The agreement may help to change the composition of the pool of asset. On the contrary, it can contribute to ensuring that a second and a third investment exercise obtains their earnings from the venture. The trust should some few exceptions and interest rates for individual ownership class owners. A commercial mortgage-backed security is a pass-through MBS backed by mortgages on the property that is commercial. A residential backed security mortgage involved an MBS that is via by residential property based mortgages. A mortgage with collateral obligation or pay through bond carries a duty of a debt of the entity that is legal that covered using various possessed assets. The payment through bonds is into classes that have different priorities and different maturities for the receipt of the principal and in some cases of interest. They often contain a pay structure that is sequential with at least two classes of mortgage-backed securities issued, with one class getting principal payments that are and payments before any other category. The pay through securities is as debt for the purposes of income tax. A stripped security backed mortgage-backed where every mortgage payment is used to pay down the loan’s principal, and some of it used to pay the interest on it. The elements may be put apart to create SMBS’s. It includes some rates of interest on mortgaged backed security that is as well as a bond with cash flows that are by the interest component of the owner’s property mortgage payments. A net interest margin is the security is a residual interest that is re-securitized of a mortgage-backed security. There is also the only stripped mortgage-backed security that is a bond with cash flows that is by the principal repayment component of the owners of property mortgage payments. There is also the secondary mortgage market where a network of lenders does sell, and the investors buy the existing MBS. The originators into the liquid and large market where they are packaged into MBS and sold to private and public investors sell a significant percentage of the newly originated mortgages. It also includes; hedge funds, mutual funds, insurance companies, pension funds, Freddie Mac and Fannie (Mae Xu, and Fung, 2005). Securitization The process depends greatly on the jurisdiction through which t is. It permits investors to choose from different levels of investment, and it distributed risk. While single-family, multi-family and properties secure residential MBS, secure the commercial MBS. In the United States, the most known securitization trusts are typically sponsored by Freddie Mac and Fannie Mae, Us government sponsored enterprises (Mae Xu, and Fung,2005). Market size and liquidity In the second quarter of 2011, there was about $ 13.7 trillion outstanding United States mortgage debt. There was an existence of about $ 8.5 trillion U.S mortgage-related securities. Government sponsored enterprises guaranteed almost $ 7 trillion, government agencies or securitized. Private mortgage conduits pooled the remaining $ 1.5 trillion. According to Bond Market Association, gross US issuance of agency MBS Was; • 2005: USD was 0.967 trillion • 2004: USD was 1.019 trillion • 2003: USD was 2.131 trillion • 2002: USD was 1.444 trillion 2001: USD 1.093 trillion (Mae Xu, and Fung, 2005). Pricing Valuation the weighted average coupon (WAC) and the weighted average maturity are in the valuation of a pass-through MBS. They provide the basis for computing cash flows that mortgage pass-through. A $ 3 billion pass-through MBS could be considered with a pass-through rate of 6 %, a 6.5 % WAC and a 340- month WAM. The pass-through rate is usually different from WAC. It is the rate that an investor would get if he held the pass-through MBS and the pass-through rate is usually less than the WAC. The difference is in servicing costs (Lehnert, Passmore, and Sherlund, 2008). To illustrate the concepts, a mortgage pool will be which has three mortgage loans that have the following mortgage balances, months remaining to maturity and mortgage rates. Loan Outstanding mortgage balance Mortgage rate Remaining months to maturity Percentage of pools total $900,000 balance (the loans "weighting") Loan 1 $300,000 6.00% 300 33.22% Loan 2 $400,000 6.25% 260 44.44% Loan 3 $200,000 6.50% 280 22.33% Overall pool $900,000 WAC: 6.16% WAM: 275.55 100% (Lehnert, Passmore and Sherlund, 2008). The weighted maturity average The weighted average coupon of a pass-through MBS is simply the average of the coupons of the mortgages in the pool that are weighted by their original balances at the initiation of the MBS. Therefore the WAC of the above example is; WAC= (33.33%* 6.00%) + (44.44%* 6.25%) + (22.22% * 6.50%) =6.16% (Lehnert, Passmore and Sherlund, 2008). Credit risk The severity of risk credit on mortgages that are backed by securities relies on the ability of borrowers in paying the necessary cash within the stipulated duration. The MBS’ credit rating is usually high due to the following reasons; most originations of the Mortgage include a research on the ability of the mortgage borrower in honouring payments. It may also attempt to advanced credit based on credit worth assessment. A notable provision has been established and focuses on lower loan docs. Some of the providers of MBS provide a risk warranty to the owners of homes. The art of creating a shared pool of numerous mortgages that do not have related default likelihood may help in creating a bond that has no defaulters. In such a situation, the owners can honour their credit obligations. However, the risk neutral credit spread is identical between an ensemble mortgage and the average mortgage in it, the chance of loss is. If the owner of the defaults, the property remains as collateral. However, the prices of the real estate can move the value of the original loan that enhances the validity of the payment guarantees and prevents borrower default (Lehnert, Passmore and Sherlund, 2008). If the original real estate and the guarantee of the issuer underwrote the MBS, the bond rating would emerge to be significantly lower. The effect is due to the adverse selection of loanees who have credit improvements rating (Morgage backed securities on the original loan quantity). It is also vital to those who would have an incentive to refinance (Lehnert, Passmore, and Sherlund, 2008). Conclusion Mortgage backed securities (MBS) are obligations of debt that do represent claims to the cash flows from the pools of mortgage loans, most commonly on the residential property. Most Mortgaged Backed Securities are by the Government National Mortgage Association, the Federal National Mortgage Association, an agency of the government of U.S and the Federal Home Loan Mortgage Corporation, U.S sponsored enterprises. The weighted average coupon (WAC) and the weighted average maturity are in the valuation of a pass-through MBS. The weighted average maturity of a pass-through MBS is the average of the maturities of the mortgages in the pool that are weighted by their balances at the issue of the MBS. The weighted average coupon of a pass-through MBS is simply the average of the coupons of the mortgages in the pool that are weighted by their original balances at the initiation of the MBS (Jaffee, 2011). Reference List Jaffee, D. M. (2011). Reformation of the US mortgage market by utilizing the incentives of the Private Market. Fisher Centre for Economics and Real Estate. Lehnert, A., Passmore, W., and Sherlund, S. M. (2008). GSEs, mortgage rates, and secondary market activities. Finance and Economics Real Estate Journal, 36(3), Levin, A., and Davidson, A. (2008). The OAS concept in valuation Concept for Morgage Backed Securities. The Journal of Portfolio Management, 34(3), Van Order, R. (2000). The US mortgage market: A model of duelling charters. Journal of Housing Research, 11(2), Xu, X. E., and Fung, H. G. (2005). What Moves the Mortgage‐Backed Securities Market? Real Estate Economics, 33(2), Read More