Mortgage backed securities: liquidation of the mortgage book.

AuthorStone, Charles A.
PositionLetter from the Editors - Editorial
  1. MORE THAN ONE EUROPEAN PATH TO THE SECONDARY MORTGAGE MARKET

  1. MBS in the U.S.

    In the U.S. mortgage backed securities created by securitizing mortgages are the core of the secondary mortgage market. Securitization integrates the bank market with the securities markets. Originators sell mortgages to the Government Sponsored Enterprises, the GSEs (the Federal Home Loan Mortgage Corporation, Freddie Mac and The Federal National Mortgage Association, FNMA) for cash or in exchange for MBS or to the private conduits for cash. The GSEs and private conduits finance purchases of mortgage pools via real estate investment mortgage conduits (REMICS) which issue multiple tranches of securities (collateralized mortgage obligations) the design of which depends on the demand for various elements of the mortgage pool. Proceeds from the issues of collateralized mortgage obligations are used to finance the purchase of the mortgage pool from the conduit.

    "GE Capital Mortgage Services, Inc. ("GECMSI"), a wholly-owned affiliate of GE Capital Mortgage Corporation, is engaged primarily in the business of originating, purchasing, selling and servicing residential mortgage loans collateralized by one to-four family homes located throughout the United States. GECMSI obtains servicing through the origination and purchase of mortgage loans and servicing rights, and primarily packages the loans it originates and purchases into mortgage-backed securities which it sells to investors. GECMSI also originates and services home equity loans." (1) (10-K, 2000).

    Bank of America Funding Corporation recently securitized $1.8 billion of mortgages it purchased from Fleet Financial Corporation via a REMIC BAFC 2000-1. The pool of mortgages was financed with 28 different classes of securities. Fleet Financial continues to service the mortgages. (2)

    Mortgage backed securities received in exchange for pools of mortgages are either retained by the originator or refinanced through REMICS. There is also an active forward market for mortgage loans in the U.S. Originators sell their production forward to conduits that warehouse the loans until the pool is large enough to be securitized. Conduits and originators hedge their exposures in the MBS and treasury markets.

    In the U.S. the MBS market was kick started and has been sustained by the activities of GNMA, FNMA, and Freddie Mac. The first GNMA guaranteed MBS was issued in 1970. FNMA securitized its first pool in 1981 and Freddie Mac issued the first CMO, backed by 30 year fixed rate mortgages in 1983. The pool was refinanced with the issue of three classes of securities that matured sequentially.

    National mortgage conduits such as FNMA and Freddie Mac do not exist in Europe. Without depth and liquidity of MBS/ABS markets, securitization is not as valuable and cannot be as popular especially when banks have alternative techniques of refinancing their mortgage portfolios. In the U.K. which is the largest market in Europe for both mortgage and asset backed securities, only 6% of U.K. mortgages are securitized while in the U.S. it is 60% (Council of Mortgage Lenders). (3)

  2. MBS in the U.K.

    Woolwich, a U.K. bank, originates mortgages in France and Italy through its banking subsidiaries. For now Woolwich funds these mortgages on balance sheet through its Euro MTN, CD, CP programs, its U.S. CP program, and its deposit base. Woolwich has a long term unsecured rating of A1 by Moody's and a short term rating of P-1.

    In 1999 Woolwich established a "fee based mortgage services" joint venture with Countrywide Credit Industries, a U.S. finance company that specializes in the origination and servicing of mortgage assets. Countrywide relies heavily on the use of securitization to liquidate its mortgage assets net of servicing. It appears that Woolwhich and Countrywide are going to apply Countrywide's model in the U.K. and across Europe. "Our proposed joint venture with Countrywide Credit Industries Inc. is expected to streamline mortgage services to securitisation standards and increase our efficiency. Scale economies are available and the size of the Woolwich portfolio will allow the partnership to achieve such economies" (4)

    Abbey National the largest U.K. mortgage lender with about a 10% share of the net mortgage lending securitized its first pool of mortgages in 1998 and then followed in 1999 with two transactions. Abbey National securitizes its mortgages through its Holmes securitization program. Currently Abbey National funds 80% of its U.K. mortgage book with retail savings. It has also established an U.S. asset backed commercial paper program.

    "In February 1998, we launched a pilot securitisation followed by another in February this year. This has enabled us to test our systems capability in what could become an increasingly important capital management tool in the UK. We are actively exploring the possibility of adopting more effective capital structures, including tax efficient tier 1 capital. In December 1998, ANTS sponsored a US$ 5 billion asset-backed commercial paper programme which invests in a wide range of asset-backed securities. This adds flexibility to the ANTS balance sheet and represents an attractive capital management instrument for the future". (5)

    Abbey National Treasury Services (ANTS) is sponsoring an ABCP program to earn fees and spread income via an off balance sheet vehicle. The vehicle is set up as a so called "arbitrage driven" program. In this type of program the conduit purchases rated liquid asset backed securities and fends them in the CP market. Sounds a bit like traditional financial intermediation with the difference that the assets that can be funded are restricted to liquid asset backed securities and the intermediary is not a bank.

    In the U.K. the mortgage market has been characterized by on balance sheet funding and has been dominated by building societies and banks with centralized mortgage lenders such as Paragon (Formerly National Home loans) filling gaps left by the traditional lenders. Most of the centralized lenders are now owned by the banks. Paragon remains independent.

    The first foray into securitization in the U.K. was by centralized mortgage lenders (finance companies) in the late 1980 and early 1990s. Without access to a deposit base they relied on continuous access to the wholesale financial markets. Centralized lenders intended to originate mortgages, warehouse the mortgages until the pool was large enough, and then securitize the mortgages. Fees were earned from servicing and originating the loans, and interest earned on the subordinate loans they made to the securitization vehicles.

    This excerpt form National Home Loans 1996 annual report offers a summary of what centralized lenders expect from securitization and how a typical U.K. securitization of mortgage works. (6)

    "NHL is a market leader in the securitisation of mortgage and other financial assets. Since 1987, the Group has issued approximately 5 billion [pounds sterling] of asset backed securities, including some 813 million [pounds sterling] in the past twelve months alone.

    Securitisation remains the Group's primary source of funding and, as such, represents a fundamental part of our strategy for the future. It provides limited recourse finance from the capital markets which is attractive to us for a number of reasons:

    1. Investors in the capital markets will accept maturities anywhere between one month and forty years. This enables us to structure the maturity of our funding to match the profile of the assets being funded. There is no obligation to repay these bonds until the...

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