1. Mortgage Securitization Basics
Karin Good, CFA
President kmg consulting

2. Class discussion Securitization Structures and Mechanics
Mortgage Cashflows for securitizations
Securitization waterfalls
Losses and how they impact securitization cashflows
Conflict of Interest or Something else?

3. Types of Securitizations- Two Segments of the market
GSE eligible, Fannie Mae, Freddie Mac and Ginnie Mae eligible loans.
Eligibility based on loan size and underwriting guidelines
Securitization had Implicit guaranty by the government for Fannie Mae and Freddie Mac. Government guarantee for Ginnie Mae (FHA and VA loans). AAA rating
Guidelines expanded significantly during the early 2000’s as initiatives for home ownership became popular.
Private Label or Non – Agency loans
Loan sizes larger and / or loans that had underwriting guidelines wider than the GSE’s.
Securitizations were structured and rated by the rating agencies. No guarantee, ratings of bonds obtained by structure.
When GSE’s expanded guidelines, some loans were eligible for both private label and GSE executions. Decision made by best price obtained.

4. Types of Structures Participation Agreements - 144A
Passthrough – GSE fixed security
CMO (Collateral Mortgage Obligation)
WAC (weighted average coupon) Pass through – hybrids, arms
Fixed coupon with supporting bonds – fixed rate loans
Both structures have supporting bonds that create a AAA security
CMO private label securities are done with a Special Purpose Vehicle (SPV). This is a special off balance sheet structure that is arms length to the issuer.

5. Types of collateral
Loans were separated into collateral types and put on separate shelf’s. These are shelf registrations with the SEC for a specificate amounts. Each shelf had it’s own name so investors could identify what kind of loans were in the pool
Jumbo A (CHASE )- Best credit quality, higher loan amounts
Fixed rate loans
Hybrids
Alt A (CFLEX )expanded criteria and reduced docs
Fixed
Subprime (JPMAC ) Lower fico scores and credits
All pools were derived from data files provided by the originator
Rating Agency models to determine subordination levels could be run by the issuer prior to rating agency review

6. CMO Structure AAA Bond fixed pass-through 95%
IO (interest only )- the interest above the fixed coupon
PO (Principal only) – the principal below the fixed coupon
Subordinate bonds 5%
AA, A, BBB above investment grade
BB, B, UR are the below investment grade
Residual account with is excess interest in alternative structure, mostly for subprime deals.

7. Pricing of CMO - Assume a 4.125 WAC
Bond
Percentage
coupon
Price
AAA bonds
95%
4.0
104.0
IO ( 4.0 multiple)
.125
0.5
Total AAA
104.5
Subordinate bonds(AA,A,BBB,BB,B,UR) 5%
65.0
Total Proceeds from bonds
102.55

8. Implications of Pricing
The example above is how mortgage companies would price a loan to the loan officers less margins = par rate
Increasing demand for AAA bonds reduced the rate offered to consumers
The Subordinated bond demand also helps the price. However the lower the % of subordinated bonds needed to support the AAA bonds, the better the economics.
Most investors required 2 rating agencies to rate the bonds. There were 3 prominent rating agencies Moody’s, S&P, and fitch.
Issuers and dealers would decide on the 2 agencies that they would use to rate the bonds. The Issuer / dealers pay the rating agency fees.

9. Securitization Waterfall
AAA bonds
Pro rata portion of the principal paydown
100% prepayments go to the AAA bonds
0% of the defaults go to the AAA bonds
Subordinate Bonds
100% of the loan defaults go the subordinates starting with the UR, then B,BB,BBB,A,AA
0% of the prepayments go to the subordinate bonds
Shifting Interest
After 5 years or overcollateralization triggers, shifting interest starts to take place.
20% of prepays will shift to the subordinate bonds each year for 5 years
20% of the defaults will shift to the AAA for 5 years.
After 5 years or the trigger, the bonds become pro rata pay for all cashflows.
Clean up call at 10% or 5% depending on the shelf

10. How Investors Got Paid- HPA Increasing, prepayments high
Issuance
AAA- 95% $ px 104.5
Subordinates 5%
$ px 65
Prepayments- reducing AAA
AAA – 90%
Px stable or increase due to more subordination – proceeds to reinvest
10%
Px increase up to 100

11. How Investors Got Paid- HPA declining and loans defaulting
Issuance
AAA- 95% $ px 104.5
Subordinates 5%
$ px 65
Credit losses decreasing subordinate bonds
AAA – 100%
Px declines quickly and rating falls so liquidity drops 0%
Px declines to 0

12. Issues occurring with the financial Meltdown
HPA went down for the entire country. The theory of rating agencies, etc. was that any changing in housing value would be regional. Portfolio theory.
Reps and warrants in the securitization documents stated issuers and underwriters can only buy back loans that had a breach. This was typically an underwriting of the loan that was flawed of inaccurate data. Due diligence review was negotiated down to about 10% of deal.
Issuers, rating agencies and investors relied on data in a file!
Reduced documentation and high LTV loans, where originators expanded guidelines were the worst performing loans.

13. Parties Involved- conflict of interest or something else?
Investors – Used leverage to increase returns increasing demand
AAA – banks, insurance companies and other portfolios
Subordinates
AA, A,BBB (investment grade tranches) – CDO’s
BB, B and UR – Specialty finance firms
Originators to consumer- Improved pricing from investors and demand expanding underwriting guidelines.
Issuers / Underwriters – Driving and fulfilling demand created unprecedented profits.
Rating Agencies – competition for deals made them more aggressive
GSE’s – initiative for home ownership and entering some of the private label space reduced g-fees and expanded guidelines.
Fair Value Accounting – Must see a trade to mark loans in pipeline. Lack of liquidity and tiering of shelf names in the market made this very difficult.

14. State of the Non Agency Market today
Private label securities are back for Jumbo A fixed loans only. No liquidity vs the past.
Most issuers are REITs or specialty finance companies or dealers with origination businesses
Rating agency levels are not as predictable and much higher
Most non agency loans go into bank portfolios, that by far still has the best pricing
There are QM (Qualified Mortgage ) vs Non QM mortgages. Non QM have rep and warrant restrictions and are not currently securitizable
By far, the largest part of the securitization market today are the GSEs