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Slide 1, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Residential Mortgage Finance: Products, Markets, Risk Assessment, Pricing, and Securitization
Andrew WidmanSVP, Enterprise Risk ManagementCountrywide Financial Corporation
Slide 2, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
A foreword on the significance of housing finance
Housing is a basic human necessity and a critical component of every economy in all parts of the world
Home ownership builds social stability, serves as a store of value, and provides a source of income
Along with governmental, monetary, and property rights stability, a reliable system of housing finance is argued by some as a major aid to sustainable economic development
The US model with long-term financing and broad accessibility is a luxury not available in many countries
This document and today’s discussion reflect my views alone and not those of Countrywide Financial
Slide 3, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
About Countrywide Financial, NYSE Ticker = CFC
Key Facts:
Mortgage-centered, diversified financial services company with rapid business growth during the 2000s, especially in non-traditional loans
Growth in PayOption and Sub Prime mortgages – more on these later
Servicer of nearly $1.5 Trillion in mortgage assetsPayment processing for 1 in 8 loans – #2 industry wide
Set to be acquired by Bank of America following precipitous 80+% decline in market value during 2007
http://finance.yahoo.com/q/bc?s=CFC&t=2y&l=on&z=m&q=l&c=
January announcement with July consummation target- 100% stock transaction priced at 0.1822 shares of BAC per share of CFC
What’s the implication of CFC’s current stock price compared to the deal-implied price?
Slide 4, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
What’s your favorite angle on the real estate debacle?
Toxicity?http://www.google.com/search?hl=en&q=toxic+mortgage
Victims and predators?http://www.google.com/search?hl=en&q=mortgage+predators+and+victims
Industry doomsayers?http://ml-implode.com/
Cash infusions?http://www.google.com/search?hl=en&q=mortgage+cash+infusion
Humor? (warning: explicit!)
Slide 5, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Agenda
US residential real estate finance market Real estate as an investment asset
Home financing basics and loan instruments
Primary and secondary markets, loan origination and disposition
Risk assessment and loan pricingDefault, loss severity, and prepayment risks
Option-embedded fixed income valuation
Mortgage securitizationRationale, relation to other assets
GSEs, other credit enhancement, rating agencies,
Structures and issuer/investor considerations
Slide 6, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Residential real estate from an in investment perspective
Home ownership is encouraged by our governmentTax advantages on interest costs and capital gainsPost-depression “agencies” were created to bear risk
Provides diversification benefits as an asset classImperfect correlation improves risk-adjusted portfolio returnsBut for many, real estate concentration is arguably too high
- Mean/variance optimization would allocate a lower amount
Highly leveraged financing is now the norm10% house price change on 10% down = 100% return
- Actual return depends on treatment of borrowing costs/expenses- Like buying stock on margin – without the margin call
Liquidity can be poor and markets inefficientThin markets, few transactions, no natural short positionLimited availability of hedges – note recent rise of CME futures
Slide 7, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
House prices and the early 2000s experience
In the early 2000s, house prices offset losses in equities as cheap credit, investor interest, and loose underwriting standards prevailed
For most homeowners, their gains were unrealized
Local House Prices vs. Equities, The Aught Years
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Sources: Yahoo Finance, Off ice of Federal Housing Enterprise Oversight
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Slide 8, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
House prices and the late 90s experience
In the mid-late 90s, housing stagnated as equities tripled
Assuming you were omniscient and bought at the bottoms and sold at the end, where did you make your best returns – S&P during the 1990s or on a house in DC in the 2000s?
Local House Prices vs. Equities, 1993 - 1999
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Sources: Yahoo Finance, Office of Federal Housing Enterprise Oversight
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Slide 9, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
House prices and future prognostications
Economists across the board are bearish on housing activity and prices in the near-to-mid term
Few are as negative as Mark Zandi of Moody’s Economy.com
House Price Forecasts - Economy.com Mild Recession Series
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Slide 10, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Residential mortgage basics in the US
A residential mortgage is a long-term loan used to finance a home which serves as collateral
Traditionally, repayment is made through level monthly installments comprising both interest and principal
Until the recent housing boom, the most common loan was a fixed rate, 30-year, level-pay, fully amortizing mortgage
Useful Excel function for monthly, level, amortizing payment:= pmt(rate/12, #months, loan amount)
= pmt(6%/12, 360, $250,000) = $1,499
In this example, a $250k loan at a fixed rate of 6% has a monthly payment of $1,499 and will be paid off after 30 years
Slide 11, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Time profile of a $250k, fixed rate 30-year mortgage at 6%
Interest due dominates the early payments as it takes more than 20 years to cut the balance in half
Most borrowers will have long since pre-paid by then
Average holding period for a fixed rate 30-year mortgage < 7yrs
Mortgage Payment Time Profile
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Total payment = $1,499
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Slide 12, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Non-traditional features grew during the boom in home prices
Down paymentTraditionally 20% covered by borrower funds and/or mortgage insuranceIncreasingly secondary financing (aka piggyback lending) up to 100%
Income and asset documentationTraditionally full verification of employment and financial assetsIncreasingly no-income-no-asset (NINA)
Amortization featuresTraditionally fully amortizing until maturityIncreasingly initial interest-only or negative amortization periods
Term to maturityTraditionally 15 or 30 years – increasingly up to 40 years
Interest rate variabilityTraditionally fixed – increasingly adjustable with teasers and resets
Prepayment optionTraditionally permissible to prepay the remaining balance any timeIncreasingly penalized for early payment in exchange for “better” terms
Slide 13, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Adjustable rate mortgages (ARMs) allow lower initial payments
Common products: 1-yr, 3/1-yr, 5/1-yr, 7/1-yr, 10/1-yrLoans with fixed periods >1yr commonly called “hybrid” ARMsRate typically offered at a discount to the 30-year fixed rate
- Discount amount depends on shape of the yield curve- With a flat yield curve, the rate benefit is minimal
Interest rate and payment are fixed for the initial periodRate reset is based on a reference rate plus a margin constrained by maximum periodic adjustment and ceilingFor example, a borrower with good credit and 20% down could get a 5/1-yr ARM with following terms as of April 2008
- Initial rate: 5.75%- Margin over 1-yr constant maturity treasury: 2.75%- Maximum lifetime adjustment: 5.00%
The same lender offers a 30-year fixed rate loan at 5.875%- Are the borrower’s savings worth the added risk?
Slide 14, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Other popular loans with lower initial payments
Interest-only (IO) mortgagesEasy to think of as an add-on feature to ARMs
- Increasingly popular feature now attached to >50% of new ARMs- The initial period specifies a fixed payment with no principal- At reset, the rate adjusts and an amortizing payment is required- If held to reset the new payment may rise by 30% or more
Negatively amortizing mortgagesMarketed as PayOptions, OptionARMs, and Pick-a-Payments
- A low payment is permitted which causes the loan balance to rise- Let’s review the glossy literature
http://www.countrywide.com/pdf/050850_POA_brochure_70.06.pdf
- In this instrument the actual accrual rate adjusts monthlyThis feature makes it a popular bank investment product
- Payment shock after the fifth year can be devastatingly large
Bank of America plans to discontinue after the CFC acquisition
Payment Profiles
Slide 15, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Even more ways loan payments were reduced
3-2-1 buydowns, often offered by home buildersThe builder effectively subsidizes the mortgage for 3 years
- A 3% rate discount in year 1, followed by 2%, then 1%
Maybe a good deal for the borrower but more likely a signal that the borrower paid too much for the house
40-year or greater terms-to-maturityLonger terms require lower payments of principal
Not very common yet due to limited investor interest
All of the above products grew in popularity during the boom and almost certainly contributed to escalating prices
In many cases, interest rate risks more capably managed by financial institutions are now borne by private citizens
Slide 16, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
The Primary Mortgage Market
Institutions/individuals who market, originate loans to borrowers comprise the primary mortgage marketLoan providers include
Traditional depositories- Banks, Savings & Loans, Credit Unions- Have the capacity to fund and portfolio loans (but may not)- May also perform loan servicing
Mortgage bankers- Generally mono-line companies that make, fund, and sell loans- May also perform loan servicing
Mortgage brokers- Independent agents who generally act as intermediaries- Generally don’t underwrite or put capital at risk
For the typical borrower, there is no universal, material advantage to any one type of loan provider
Slide 17, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
The Secondary Mortgage Market
The secondary mortgage market is comprised of funding, buying, selling, servicing, and securitizing closed loans
This activity replenishes funds for making new loans
Secondary market mortgage participants include Primary market participants
- When they sell their loans and/or servicing rights
Fannie Mae and Freddie Mac (the GSEs)- When they guarantee and securitize loans (discussed later)
Investment banks- When they buy, structure, and securitize loans
Prior to the 1930s depression, loan sales were uncommon
Fannie Mae was the first institution created to ensure lenders funds for loans other than their own locally-based deposits
Slide 18, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Drawbacks and benefits of the Secondary Mortgage Market
The growth and robustness of the secondary market has improved the pricing and availability of mortgage credit
Risks can be allocated more optimally- Borrowers aren’t hindered by local economic weakness
Uniform performance data can be collected and analyzed- Models can be improved so the right borrowers are approved
International funds can flow more readily to mortgages- Increased supply of funds reduces borrowing costs
Innovation in mortgages and securitization is encouraged- Structures can be developed for borrowers and investors
The secondary market and structured securitization in particular have been criticized as primary to the housing bust
Critics say originators were too far removed from risks
Slide 19, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Interaction of primary and secondary markets
Participants are engaged in a relatively efficient marketBorrowers enjoy certain regulatory protections and transparency
- RESPA, good faith estimates, HUD-1 - The internet is a good source for finding the best loan terms- http://www.amerisave.com/index.cfm, http://www.borrow123.com
Originators have multiple choices for loan placement- Hold for portfolio investment to profit from net interest margin (NIM)- Sell to a GSE or to an aggregator/issuer – a bigger institution
Sell the future stream of payments for their present value
“Best execution” is the process for determining where to place different loans to achieve optimal value on a pool of loans
The aggregator may re-sell to a GSE or issue its own security
Parties typically engage in forward agreements to originate and fund/sell loans with specified terms/pricing at future dates
- A borrower’s rate lock-in is a type of forward agreement
Slide 20, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Mortgages are grouped into several categories for secondary marketing
Conventional/Conforming (C/C)Meets standards for loan features, credit quality, approval guidelines and size limits specified by the GSEs
- C/C loans can be both fixed rate or ARMs- Interest-only loans were approved as C/C in the early 2000s
Many lenders have 12-month term agreements with GSEs to sell a representative mix of their C/C production for the coming year
- Agreements are often dimensioned by relative share and loan/pool credit quality stipulations or loan/credit price adjustments
- Lenders retain the ability to conduct best execution subject to the constraints of the GSE sales agreements
- The GSEs closely monitor lenders’ selling behavior to watch for population skewness, a.k.a. adverse selection
Slide 21, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Other major mortgage categories
Conventional/JumboConsistent in most respects with GSE guidelines with the major exception of loan size (currently > $417k)
- Typically sold to an institution with security issuance capabilities (for later discussion); interest rates are usually 0.25% higher
- Cannot be sold to GSEs
Alt-A (the label is hotly debated and often changing)Generally represents loans made to prime quality “A” borrowers (typically defined by FICO score) but outside standard guidelines
- e.g., 90% financing with cash out, investor occupancy, no-income-no-asset documentation (NINA), or other layered risk
- Separate from the forward agreements GSEs may be willing to buy Alt-A loans on a pool-by-pool basis after close consideration
- Otherwise Alt-A is portfolio-ed or sold to an aggregator/issuer
Slide 22, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Even more major categories of mortgage loans
Government guaranteedFederal Housing Administration (FHA), Veterans Administration (VA), Rural Housing Service (RHS)
- Primarily designated to finance modest housing for certain borrower segments, e.g., first time buyers, lower income, veterans, etc.
Manufactured housing (MH) loansMH residing on leased land is not considered real estate
- More like personal property lending, e.g. car loans, than housing
Sub prime mortgages Typically outside guidelines due to ineligible borrower quality
- Low FICO, recent bankruptcy, unpaid collection accounts, etc.- Formerly primarily home equity lending, i.e., poor credit quality but
with reasonable equity in the property- More recently evolved into first time buyers and high LTV lending- Typically sold to an issuer of mortgage-backed securities
Slide 23, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Risk assessment and loan pricing – e.g., corporate debt
In the world of corporate lending, unsecured debt is commonly graded and priced according to risk
source: Vanguard
Lower grade corporate borrowers pay higher interest rates to account for a higher perceived probability of default and loss
Rat
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Maturity
Slide 24, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Risk assessment and loan pricing in mortgage lending
Mortgages are also priced according to risk, though rate responsiveness is fairly minor among prime FICO borrowers
Like secured corporate debt, the mortgage collateral, i.e., house has a stabilizing effect on the interest rates offered
Credit quality below certain thresholds triggers sub prime rates
source: myfico.com
Slide 25, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Risk assessment and pricing models have evolved in the last decade
The practice of charging higher rates to compensate for higher risk has existed since the dawn of lending
Statistical performance models to determine mortgage pricing have become increasingly prominent in the last decade
Growth of the secondary market, creation of FICO scores, and increased data collection have enabled statistical sophistication
The modern-day application of the risk assessment entails supplying application data into models that predict:
Probability of borrower default, a.k.a. default rates
Loss given default, a.k.a. severity rates
Expected loan life, a.k.a. prepayment rates
Slide 26, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
It’s helpful to think about loan performance intuitively
Why do borrowers default? A borrower is likely to default on a mortgage if s/he
- Can no longer afford the payments and - Cannot sell the property without a loss
Why do borrowers prepay?Early payoff may be made for the following reasons
- Rate incentive: a better rate becomes available- Mobility: the owner sells the home and moves- Cash out: the owner extracts home equity as cash
What losses are sustained in the event of default?Severity rates are generally a function of
- Property value deficiency relative to loan amount- Lost interest prior to property liquidation
Slide 27, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Significant origination predictors of default and severity in credit models
FICO: measure of borrower credit line performanceMost significant indicator of default rate along with LTV
Loan-to-value: ratio of loan amount to property valueImportant to both default and severity rates
Loan purpose: purchase, refinance, or cash-out refinanceCash-out usually considered riskier for default and severity
Occupancy: owner, investment, or second/vacation homeInvestment considered a higher risk for default and severity
Documentation: full income/asset verification, or reducedReduced documentation may signal increased default risk
Payment-to-income: ratio of loan payment to income levelHigh ratio suggests increased default risk
Slide 28, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Significant origination predictors of mortgage prepayments
Among prime mortgages, in general, origination loan attributes that suggest higher credit risk also suggest slower prepayment or longer average life
Alternately stated, a borrower with a good credit profile and low-risk origination attributes may more readily relocate to another home or refinance when financially advantageous
Within the sub prime space, borrowers with weak loan attributes and commensurately high note rates generally prepay faster with a shorter average life
The phenomenon is referred to as “credit curing” whereby a borrower can lower her monthly payment by refinancing when her credit score improves
Slide 29, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Major macroeconomic predictors of mortgage performance
By and large, the most important factors that affect mortgage performance are house prices and interest rates
Favorable house prices - Reduce default and severity rates- Increase prepayment rates by increasing housing mobility
Stagnant or declining house prices - Increase default and severity rates - Reduce prepayment rates by lowering mobility
Low or declining interest rates - Create the incentive for borrowers to refinance (prepay)- Increase housing mobility by improving affordability
High or increasing interest rates - Reduce prepayment rates- Increase pay shock default risk with ARM borrowers
Inferences from origination loan attributes are excellent for determining ordinal pool performance; poor for cardinal
Slide 30, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
House price and interest rate models
Monte Carlo simulation employs a multi-scenario approach Single scenario assumptions fail to capture risk asymmetries
Variations in prices are dimensioned by volatility and random shocks
Interest rate models typically employ mean-reversion features- Volatility exists but invisible forces pull rates toward their long run averages
Each “path” produces a different level of defaults and losses
Monte Carlo Simulation Example - Sample House Price Paths
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Slide 31, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Considering mortgages in a valuation framework
Mortgage cash flows can be valued similar to other assetsThe value of a risk-free vanilla bond or annuity is equivalent to its PV of future cash flows; in this way a mortgage is no different
The key differentiating feature of mortgage valuation is uncertainty due to embedded options
The right to prepay is equivalent to a call option
The right to default is equivalent to a put option
In simple terms, a mortgage rate (or IRR) should be the sum of:The underlying rate of a risk free annuity of the same maturity
The value of the embedded call option
The value of the embedded put option
Valuing these options is difficult in reality due to inefficient exercise
Slide 32, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
The price-yield relationship and negative convexity
A plain vanilla bond possesses:
An inverse relationship between price and yield
Convexity properties thataccelerate increases in value in response to declining rates
Decelerate declines in value when rates increase
A mortgage loan possesses:
Negative convexity whichConstrains value increases in response to declining rates
As rates decline, prepayment incentives increase the value of the call option for the borrower
Plain Vanilla Bond
Mortgage Loan
Slide 33, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Asset securitization
“Securitization is the packaging of designated pools of loans or receivables with an appropriate level of credit enhancement and the redistribution of these packages to investors.”
Mark Fisher & Zoe Shaw, eds., Euromoney Books, London 2003
Securitization was first developed for US mortgages, but the basic principles are now applied worldwide to various assets such as
Credit card receivables
Car loans
Student loans
Tax liens
Gambling revenues
Royalties
Slide 34, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Mortgage securitization practices
US mortgage loans are securitized in two primary waysGSE guarantor execution
- Conventional/conforming loans sold to the GSEs are typically pooled together and issued as mortgage-backed securities (MBS)
- MBS are guaranteed against credit losses and rated ‘AAA’ based on the perception of US Government backing of the GSEs
- This form of credit enhancement, i.e., provided by corporate guarantee, is referred to as external enhancement
Private label execution- In private label MBS, enhancement is typically achieved internally
Subordination assigns sequential payment priority to senior classesOvercollateralization describes the practice of absorbing losses by issuing securities with total value smaller than the underlying loansExcess spread describes the reliance on excess interest payments to form a reserve to provide for coverage for pool losses
- Credit rating agencies assign ratings based on the level of supportEnhancement structures are engineered to achieve desired ratings
Slide 35, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
MBS cash flows – GSE execution example
• Make monthly payments to servicers of Principal, Interest, Taxes, Insurance (PITI)
• Retain servicing fees to cover costs
• Escrow and pay property taxes and insurance to third parties
• Remit principal and remaining interest portion to next party
• Earn ancillary income – interest on escrows, product cross-sales, late fees
• Keep guarantee fees (g-fees) in exchange for protecting investors against default
• Remit to MBS investor at pass-through rate
• Receive guaranteed principal and interest at pass-through rate
• Seller-Servicers and GSE portfolios are major MBS investors
Borrowers Servicers Fannie/Freddie MBS Investors
Slide 36, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
MBS cash flows – numeric GSE example
• Pay PITI to servicer at 6% note rate
• Retain 0.25% as servicing revenue
• Remit P&I at 5.75% to Fannie or Freddie
• Keep 0.25% as g-fee revenue
• Remit to MBS investor at 5.5% pass-through rate
• Receive guaranteed principal and interest at 5.5%
Borrowers Servicers Fannie/Freddie MBS Investors
To illustrate, assume... - 6% note rate - ¼% guaranty fee - ¼% servicing fee - 5½% pass-through rate
Slide 37, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Internal credit enhancement mechanics – further detail
In the most basic form, internal enhancement is achieved through sequential pay, senior/subordinate structures
The subordinates take on losses until their balances dry up
Because the subordinates are riskier, they pay higher yields
The bigger the subordinates, the more protected the seniors
The smaller the subordinates, the more profitable to the issuer
Credit rating agenciesStandard & Poors (S&P) and Moody’s exist to rate securities
- they specify the required subordinate security sizings for the issuer to achieve certain ratings on the senior securities
In the process of preparing for securitization, an issuer will send to the rating agencies the underlying loan details for “sizing”
- The riskier the loans the bigger the subordinate class required
Slide 38, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Basic Senior/Subordinate Two-Tranche Structure
Subordinate10%
Senior90%
Internal credit enhancement mechanics – simplified example
Assume $100M pool of risky mortgages with an average rate of 6% (post servicing)
The rating agency specifies that 10% of potential losses must be covered to achieve the desired senior rating
Issue $90M senior security and $10M risky subordinate
Investors require 5% yield on the senior, 15% on the sub
The weighted average rate stays the same but the losses are redistributed
90%*5% + 10%*15% = 6%
Slide 39, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Other practices in mortgage securitization
The three types of cash flows within mortgage pools, interest, scheduled principal, and prepayments can be assigned to different classes or tranches and subjected to different rules and triggers through timeIn practice, collateralized mortgage obligations (CMOs) can strip-out and structure many types of instruments from highly predictable to highly unpredictable and riskySome examples
Interest only (IO) bonds- On a separate note, loan servicing fees are a natural form of IO
Servicing can be retained or released (sold) upon loan dispositionMarket standards regulate a minimum servicing fee“Excess” servicing beyond the minimum can be securitized
Principal only (PO) bondsPlanned Amortization Class (PAC) bondsNon-Accelerating Senior (NAS) bonds
Slide 40, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Major advantages securitizing mortgages – issuer perspective
LiquidityUniform, well-understood securities are easier to value and trade than individual loans
Risk managementCredit risks and balance sheet issues, such as asset-liability matching can be more readily optimized per tolerance levels
PricingCash flows can be restructured to suit investor demand and yield better all-in pricing – though arbitrage arguments disagree
Profit takingProfits can be realized upon the sale of the assets rather than incrementally over the life of the mortgages
Slide 41, BUFN700, Spring 2008, Professor Doron Avramov
Residential Mortgage Finance
Major advantages to securitization – investor perspectives
Improve diversification and risk-adjusted returnsSecuritization can make ordinarily un-traded, weakly correlated assets available for investment managers as rated securities
- Many managers are restricted to investment grade assets only
Risk management or speculationSome instruments can serve as effective hedges for other investment or business activities (negatively correlated asset)
The same instruments, absent an offsetting position, can allow investors to make highly leveraged bets on prepayment rates, interest rates, or loss levels
Investment repackagingCollateralized debt obligations (CDOs) can pool and re-securitize securities to provide yet another form of investment
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