BUS307 Topic 7 - Topic 7 Of Balance Sheet Banking I Securitization and Loan Sales BUS307 Commercial Banking DECOMPOSITION OF THE LENDING FUNCTION

BUS307 Topic 7 - Topic 7 Of Balance Sheet Banking I...

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Topic 7 Off Balance Sheet Banking I Securitization and Loan Sales BUS307 Commercial Banking
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DECOMPOSITION OF THE LENDING FUNCTION Origination (including underwriting) Guaranteeing. Servicing Funding
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DIFFERENT TYPES OF SECURITISATION CONTRACTS (continued)
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PASS-THROUGHS (Mortgage-backed securities) Bank places a pool of homogenous mortgaged loans in a trust. Removed from the balance sheet as an asset. Bank seeks ‘credit enhancement’ – timing insurance of cash flows to bondholders – from insurance company or government. Trust sells debt securities (‘pass-through’ bonds) to outside investors. Bank receives proceeds from the sale of the bonds (thus replaces the mortgaged loans with cash on the balance sheet).
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PASS-THROUGHS (Mortgage-backed securities) On an ongoing basis: bank collects payments from mortgages and charges a service fee (eg. 40bpts). credit enhancer charges insurance fee (eg. 60 bpts). trustee pays a share of these payments minus fees to the bank and enhancer to each bondholder The cash flows from the mortgages are dedicated to paying the bondholders. These payments include interest and principal, including prepayments of principal. Thus payments to bondholders increase if prepayments increase.
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PASS-THROUGHS (Mortgage-backed securities) Consider impact of Y on bond value where Y is the market interest rate. Low Y first two effects dominate, high Y latter two effects dominate. If current mortgage rate Y decreases then this implies that: Remaining cash flows have a higher Present Value (PV) Principal received earlier Prepayments reinvested at lower rates, and Future cash flows will decrease
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PASS-THROUGHS (Mortgage-backed securities) Static Pool Pass-Throughs loans in pool are long-term pool is fixed – prepayments passed through to investors immediately Dynamic Pool Pass-Throughs loans in pool usually short term when a loan matures, the proceeds are reinvested for a fixed period of time (the “revolving period”) only interest is paid to bondholders during the revolving period principal amortisation occurs after the revolving period, and usually recovered rapidly
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COLLATERALISED MORTGAGE OBLIGATION (CMO) A mortgage-loan originating bank places the loans off-balance sheet, in either a trust or third-party bank. Alternatively, mortgage-backed pass- through bonds created from these mortgages are placed in the trust or third-party bank.
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