MORTGAGE-BACKED SECURITIES | CAIIB FREE SHORT NOTES
Meaning of securitization: It is the process of conversion of existing or future cash inflows to any person into securities that are tradable and can be sold in the market.
Different market players have different characteristics which relate to:
- Risk Appetite
- Return Expectations
- Liquidity of Instruments
The securitization process which is backed by a mortgage is unique and supposedly depends on the following factors:
- The quality of receivables, home loans (mortgages), and the value of the security.
- The collection history as well as any delinquencies if any.
- The credit rating system of home loan lender
- The probable greeting will be given to the proposed theory by a rating agency.
- Cost of issue which also includes the credit enhancement cost and trust management costs etc.
SECURITISATION – CONCEPT & RATIONALE
Conversion of mortgage loans with the futures into securities that can be traded/transferred or assigned is known as the securitization process.
In other words, it is a process in which a selected pool of homogeneous and credit assets (quality loans) taken from lending institutions are sold to the investors via intermediaries or trust funds by bundling them in the securities. These then can be transferred by way of pass-through or Pay through certificates status (PTC).
STRUCTURING OF ASSET-BACKED SECURITIES
Securities that are backed by assets can be structured in the following two ways:
For loans that have a tenure of more than one year for example car or housing loans, in a Pass-Through Structure, a bunch of these loans get converted into ABS (asset-backed securities). The maturity of asset-backed securities can be compared with the tenure of loans. Any returns which are received on the asset-backed securities are paid directly from the loan installments.
This type of structure is used for loans that have short maturity. For Example Credit Card receivables.
MORTGAGE-BACKED SECURITISATION (MBS)
When some home loan assets are bundled together and then converted into securities to be sold to the investors, these are known as mortgage-backed securities because of they reason that it is made up of the pool of receivables sold to SPV (Special Purpose Vehicle) and are supported by the mortgaged home-loans.
Although these Mortgage-Backed Securities are not popular in India because of the underwritten reasons:
- There are no or not enough laws relating to stringent foreclosures
- High stamp duty is applicable on the conversion of assets into securities
In the case of the National Housing Bank, the process of securitization of receivables (home loan products) works as a two-stage process.
First stage: In this first stage, the mortgaged debt is transferred from the primary lending institution to a special purpose vehicle which is set by NHB through declaration whether with or without any underlying security.
Second stage: The acquired debt is being converted into debt instruments (which are mostly in the form of pass-through certificates) without going through the originator or the special purpose vehicle.
Securitization of Mortgage Debt: Special purpose vehicle of the National Housing Board might purchase and convert the loan into securities or pass-through certificates which are then issued in the capital market to be invested by the investing institutions.
Execution of Memorandum of Agreement with National Housing Board: Primary lending institutions, depending on their willingness to sell or securitize their portfolio of housing loans, are needed to enter into an umbrella agreement National Housing Board.
This umbrella agreement is known as a memorandum of agreement & it captures the entire transaction of MBS and enables National Housing Board to take the needed action to purchase or securitize the housing loan that has been identified for the purpose. This also includes circulating the information memorandum and collecting the subscription amount from investors.
Selection of Pool of Housing Loans: Primary lending Institutions will select popular functions known from their existing housing loans which will be based on a ‘pool selection criteria as per their institution’s policy.
VALUATION OF THE POOL & CONSIDERATION OF ASSIGNMENT
National Housing Board while making payment o for the purchase consideration to the primary landing agency or institution will take into account the following methodologies:
Per Pricing Methodology
- Premium Pricing Methodology
- Discount Pricing Methodology
The credit enhancement can be in the form of a cash Collateral account (i.e. Setting aside a cash pool), limited corporate guarantees, over-collateralization (i.e setting aside an additional mortgage pool), guarantees by third parties, and investment in subordinated MBS papers if securitization happens.
CUSTODY OF MORTGAGE DOCUMENTS
Even though after the MBS transaction, the mortgage debt or the receivables which pertains to the transaction itself, gets transferred to NHB/SPV, the primary lending agency (originator) continues to hold the physical title documents of house properties which has been received as a priority on the loans issued. These house properties are held in the capacity of the custodian to NHB/SPV Trust.
HIERARCHY OR APPROPRIATION OF COLLECTION MOUNTS (PAYMENT “WATERFALL”)
The payment in relation to securitization follows the below hierarchy:
|PAYMENT OF||PAYMENT TO||CLASSIFICATION|
|Service Providers||Trustee, Servicing Agent, Rating Agency, & other service providers|
|Interest||Senior Class RMBS holders||Class A PTC|
|Principal||Senior Class RMBS holders||Class A PTC|
|Replenishment of Cash Collateral/Guarantee/such other form of credit enhancement|
|Principal||Subordinate RMBS||Class B PTC|
|Residual income||Subordinate RMBS||Class B PTC|