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mgraham224
925 Posts |
 Posted - 07/11/2008 : 3:30:49 PM
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ToddBlue mentioned something in another post about how it would be nice to have the flow of money, start to finish, in the market explicated in minute and blunt detail.
I wasn't feeling 100% up to the task, so I'll let you know that there may well be things that I'm not aware of with respect to this question. Nonetheless, the below is what I do know (or at least what I think I know :-). If you respond with questions or corrections, I'll update it so we can have something accurate and as definitive as possible. If anyone else wants to take the reigns, go for it! Just because I write about MBS doesn't make me think I know everything about it. In fact the more I learn the "bigger" the picture gets. Long story short, I'm not writing this to be cocky or hear myself talk. It's here if you need it. Don't read it if you don't care...
here goes (forgive the grammatical errors, I wrote this in notepad and copied it over without proofreading):
Here's my understanding of the flow of cash and where it can fall out.
End User gets a loan
Loan is funded by a lender ranging from ma and pa with correspondent line on up to a big financial like CITI, CHASE, WAMU, etc...
This is phase one, and for the sake of simplicity, let's say there is 1 point of spread existing above what the capital market investor is expecting to be paid back on the deal. For instance if the loan rate is 6.5%, the investor may only be planning on a 6.0% return. Then let's assume that the other .5% in rate = 1.0% in price (not usually the case, but it keeps the example more simple)
This 1.0% in price, aka 100bps, will now be chopped up and divided among interested parties.
This 100bps to be divided accounts for THREE key profit streams on the secondary market, with the third profit stream being compensated by the actual yield of the security. They are:
1) Service Release Premium - or SRP, basically the profit that the originator gets from selling the loan.
2) servicing fees (customer service, call centers, records, collections, payment processing, etc..,
3)Guarantor Fees (In this case, let's assume it's a Fannie loan, so fannie [the guarantor]takes a cut as a form of insurance against some or all of the credit risk of the deal),
And finally the actual investor [might be CITI itself, might be a credit union, might be a pension fund, might be chinese billionaire, might be saudi oil money, might be a hedge fund, might be a japanese bond fund, etc..) collects their profit as payments are made on the 6% note. Of course due to prepayments (sales and refis) and default, that 6% turns into something less, but the investor hopes at the end of the day that it's higher than a treasury, or other less risky bond.
In fact, in most cases they will have a certain floor of insurance provided by the 50bps they coughed up to have Fannie securitize (process of turning mortgage paper into MBS) and guarantee the loan. Fannie doesn't insure against less profit, they simply insure against loss. This brings up one of the main areas where money can fall through the cracks. If the investor was planning on collecting 100 dollars based on historical average yields, and now all of the sudden a mortgage meltdown happens, now the principle, interest, and foreclosure sale (or other loan mod, such as balance reduction, etc..) of the home only generates 60 bucks, NOW what happens?
Depending on Fannie's agreements with the originator (ma and pa perhaps) from whom they "bought" (they didn't really buy it. They just securitized it) the loan, and with the investor to whom they "sold" the loan, they are both entitled to and obligated for some of this loss. As far as the entitlement, this is what we have heard about in when we hear "buybacks." If the loan is audited post-trauma and a speck of dust is out of place, Fannie can force the originator to buy back the loan. Fannie will then wish "ma and pa" good luck foreclosing, modding, and collecting, assuming ma and pa don't immediately file bankruptcy as so many did. But say that agreement only brings the profit up to 80 bucks. And now say Fannie's agreement with the investor was to insure them for any loss resulting in profit under 90 bucks, Fannie owes the investor 10 bucks. Fannie loses money there.
The investor loses the final 10 bucks. This is what occurs when we hear about "write downs." Because federal regulations allow the investment instition (in most cases) to show this anticipated profit on their balance sheet, their balance sheets were figured based on 100 bucks of profit. mind you, the 100 bucks is not the maximum the loan could pay, it is the average anticipated yield based on current statistics of prepayment and default. If the loan performs better, the investor gets more, but since this meltdown made the loan perform worse, they're getting less. So they have to write down assets accounting for the 10% overshoot on their MBS portfolio estimate.
Now! Imagine the all too common occurrence where Citibank is not only the originator of the loan, but is also the investor on the loan! In that case they take the hit on the front end and on the back end. Of course it doesn't happen in quite the same way, but basically, in those cases, Fannie's arrangement would insure a slightly lower amount of loss because Citi would be keeping the profit normally paid to release servicing (ever heard of SRP?!) to themselves. Whatever the case, the net effect is roughtly the same, in that Citi would lose whatever Ma and Pa would have lost but also whatever they would lose as the end investor. And since Citi was accounting for that profit on their balance sheet as well, this is how the write downs can get so huge so quickly.
Moving BACK to the flow of dollars. The SPREAD (remember the 100bps or .5% of interest rate we talked about), will be divided--not always evenly--between the whoever originated the loan and whoever guarantees the loan (fannie, freddie, ginnie, other...). The first chunk that goes to the originator is something they get in exchange for giving up the servicing rights, AKA Service release premium or SRP. I don't know what it's sitting at right now, but it depends on the relationship, let's just say it's 33.3 bps. You see where this is going now?
So Fannie, in conjunction with Citi would give Ma and Pa 33.3 bucks in exchange for the loan + the 66.6 bucks of spread still left on there. Now who's going to collect the payments and speak my favorite words on their auto-dialers: "Mr. Gray-Ham! This is Miss Lathosha Johnson calling on a personal business matter, it is very impo-tant dat we speak two you right away!" that's right! It's the servicing company! Sometimes it will be Citi, sometimes it will be a separate (and sometimes wholly owned) subsidiary (for instance America's Servicing Company/ASC is simply Wells Fargo). Some servicing companies service debt for more than one investor as well. Whatever the case, they gots to gets paid. Latosha likely couldn't muster the fervor to hound me 10 days before my grace period if she wasn't pulling down a solid 7.25 an hour. But multiply LaTosha by a couple hundred (depending on lender size), pay for the lights, computers, phones, bill-pay system, etc... and another 33.3 bucks, whether it's an internal money shuffle from Wells to ASC, or a distinct transaction from Citi to XYZ servicing company, will cover it.
Finally, Fannie gots to gets paid. 33.3 will go to them for their role in the process. A very small amount of this 33.3 may actually go to maintaining DU, purchasing, etc... The vast majority goes to fund their insurance policy for the investor. If prices drop far enough, and foreclosures sell cheap enough, and originators are insolvent enough, this is what can leave Fannie holding a bigger piece of the bill than they wanted, and ultimately lead talking heads on CNBC and bloomberg to speculate about Fannie's fiscal solvency.
Whew... That's a TON of info, I know. And it doesn't even get into to some of the more complicated particulars, not to mention the aspects that I may not even be aware of. Nonetheless, I think it provides better than a good basic framework for Mortgage Originators to understand where all this money goes. Oh yeah, of course there is one more phase of profit that happens before all else, and that would be where the loan originator pays you your YSP for brokering the loan to them (or a portion of the SRP if you are a bank). Tons of cooks in this kitchen!
Please shoot me some additional questions ASAP on this so I can flesh this "article" out to cover broader questions. I'm kind of lost as to what else to include, so I'm just going to stop and let you guys tell me what else you want to know about it. If I don't know, I'll research it.
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racerx
11048 Posts |
Posted - 07/11/2008 : 3:49:40 PM
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Yes, you type too much and didn't Todd ask for a flow chart?
Personally, I like books with pictures. |
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mgraham224
925 Posts |
Posted - 07/11/2008 : 3:58:12 PM
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quote:
Originally posted by racerx
Yes, you type too much and didn't Todd ask for a flow chart?
Personally, I like books with pictures.
hmmm... books... seems like i'm missing one I thought I would have... |
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KHufford
4866 Posts |
Posted - 07/11/2008 : 3:59:41 PM
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Maybe if you spent less time on typing so much MBS info you would have time to email me back!
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racerx
11048 Posts |
Posted - 07/11/2008 : 4:00:51 PM
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quote:
Originally posted by mgraham224
quote:
Originally posted by racerx
Yes, you type too much and didn't Todd ask for a flow chart?
Personally, I like books with pictures.
hmmm... books... seems like i'm missing one I thought I would have...
Oops!!! I'm in trouble now!! But you did tell me that you are too busy to read. =) |
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mgraham224
925 Posts |
Posted - 07/11/2008 : 4:01:34 PM
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| Damn! I knew i was forgetting something! Ah Hell, just call me... |
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KHufford
4866 Posts |
Posted - 07/11/2008 : 4:02:31 PM
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quote:
Originally posted by mgraham224
Damn! I knew i was forgetting something! Ah Hell, just call me...
JK, all is good. Im on top of it.
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mgraham224
925 Posts |
Posted - 07/11/2008 : 4:04:18 PM
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quote:
Originally posted by racerx
quote:
Originally posted by mgraham224
quote:
Originally posted by racerx
Yes, you type too much and didn't Todd ask for a flow chart?
Personally, I like books with pictures.
hmmm... books... seems like i'm missing one I thought I would have...
Oops!!! I'm in trouble now!! But you did tell me that you are too busy to read. =)
yeah, but i can still read the writing on the wall Saliwan! lol! |
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toddblue
1737 Posts |
Posted - 07/11/2008 : 5:32:01 PM
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| Top Notch Work! Thanks for the help. I'm saving this one. |
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mgraham224
925 Posts |
Posted - 07/11/2008 : 5:35:23 PM
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quote:
Originally posted by toddblue
Top Notch Work! Thanks for the help. I'm saving this one.
Honored! |
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Nico
2933 Posts |
Posted - 07/11/2008 : 7:08:24 PM
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| Now we need a thread talking about Non-Agency MBS. We can get into credit enhancements, pool insurance, and dirty servicing tactics. |
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mgraham224
925 Posts |
Posted - 07/11/2008 : 8:06:04 PM
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You'll have to carry the flag for non-agency Nico...
My next stop on the MBS tour bus will probably be the broader interconnection of swap spreads, dollar rolls, debs, CMBS, etc... I don't even think I'm up to speed enough on non-agency to be much of a participant. Now where did I put my Fabozzi? |
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darkstar
15606 Posts |
Posted - 07/12/2008 : 07:14:32 AM
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| Where do I send the bill for the therapy?...That stuff aint cheap!!!!! |
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neversaynever
1005 Posts |
Posted - 07/12/2008 : 10:39:41 AM
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Another great contribution, shows that there still is a bright side to BO! I guess the obvious question is, what needs to change, or what change is being forced?
BTW- Thank you I got your e-mail, gf got me sick with strep, I will call you Monday! Enjoy the weekend :D |
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