This repository has been archived by the owner on Nov 14, 2023. It is now read-only.
-
Notifications
You must be signed in to change notification settings - Fork 1
/
Copy pathCRMM-1-understanding-the-securitization-of-subprime-mortgage-credit.html
190 lines (157 loc) · 8.64 KB
/
CRMM-1-understanding-the-securitization-of-subprime-mortgage-credit.html
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
188
189
190
<!doctype html>
<html lang="en">
<head>
<meta charset="utf-8">
<title>Credit Risk Measurement and Management | Chapter 1 | Understanding the Securitization of Subprime Mortgage Credit</title>
<meta name="description" content="Financial Risk Manager Part 2 Study Materials">
<meta name="author" content="MacLane Wilkison">
<meta name="apple-mobile-web-app-capable" content="yes" />
<meta name="apple-mobile-web-app-status-bar-style" content="black-translucent" />
<meta name="viewport" content="width=device-width, initial-scale=1.0, maximum-scale=1.0, user-scalable=no">
<link rel="stylesheet" href="css/reveal.min.css">
<link rel="stylesheet" href="css/theme/default.css" id="theme">
<!-- For syntax highlighting -->
<link rel="stylesheet" href="lib/css/zenburn.css">
<!-- If the query includes 'print-pdf', use the PDF print sheet -->
<script>
document.write( '<link rel="stylesheet" href="css/print/' + ( window.location.search.match( /print-pdf/gi ) ? 'pdf' : 'paper' ) + '.css" type="text/css" media="print">' );
</script>
<!--[if lt IE 9]>
<script src="lib/js/html5shiv.js"></script>
<![endif]-->
</head>
<body>
<div class="reveal">
<!-- Any section element inside of this container is displayed as a slide -->
<div class="slides">
<section>
<h1>Chapter 1</h1>
<h3>Understanding the Securitization of Subprime Mortgage Credit</h3>
<p>
<small>Created for <a href="http://alchemistsacademy.com">Alchemists Academy</a> by <a href="http://alchemistsacademy.com/about">MacLane Wilkison</a></small>
</p>
</section>
<section>
<section>
<h2>Overview</h2>
<img src="images/CRMM1/key-players-and-frictions.png" alt="illustration of the key players and frictions in subprime mortgage credit securitizations" />
<aside class="notes">
Securitization is the process by which loans are removed from the balance sheet of lenders and transformed into debt securities purchased by investors. The above diagram outlines the players involved in the securitization process and the various frictions that exist between them. Additionally, information asymmetry is a universal friction that exists throughout the securitization process. **KEY** 1. Predatory lending; 2. Mortgage fraud; 3. Adverse selection; 4. Moral hazard; 5. Moral hazard; 6. Principal-agent; 7. Model error
</aside>
</section>
<section>
<h2>1. Predatory Lending</h2>
<p>Frictions between the mortgagor and the originator</p>
<ul>
<li>Subprime borrowers often financially unsophisticated</li>
<li><em>Resolution: </em>laws prohibiting certain lending practices</li>
</ul>
</section>
<section>
<h2>2. Mortgage Fraud</h2>
<p>Frictions between the originator and the arranger</p>
<ul>
<li>Originator has information advantage over arranger regarding quality of borrower</li>
<li><em>Resolution: </em>arranger due diligence and representations and warranties (R&W) from originator about borrower and underwriting process</li>
</ul>
</section>
<section>
<h2>3. Adverse Selection</h2>
<p>Frictions between the arranger and third-parties</p>
<ul>
<li>Arranger has more information about quality of loans</li>
<li><em>Resolution: </em>haircuts on collateral imposed by warehouse lender; due diligence conducted by portfolio manager on arranger and originator</li>
</ul>
</section>
<section>
<h2>4. Moral Hazard</h2>
<p>Frictions between the servicer and the mortgagor</p>
<ul>
<li>Mortgagor has little incentive to maintain value of underlying asset and pay insurance and taxes when in delinquency</li>
<li><em>Resolution: </em>Require mortgagor to escrow funds for both insurance and property taxes</li>
</ul>
</section>
<section>
<h2>5. Moral Hazard</h2>
<p>Frictions between the servicer and third-parties</p>
<ul>
<li>Servicer's income increases the longer the loan is serviced; in event of delinqency, servicer has incentive to inflate expenses</li>
<li><em>Resolution: </em>servicer quality ratings and a master servicer</li>
</ul>
</section>
<section>
<h2>6. Principal-Agent</h2>
<p>Frictions between the asset manager and investor</p>
<ul>
<li>Investor defers formulation of investment strategy, due diligence, and trading to asset manager who may not exert sufficient effort on his or her behalf</li>
<li><em>Resolution: </em>investment mandates and evaluation of manager performance relative to appropriate benchmark</li>
</ul>
</section>
<section>
<h2>7. Model Error</h2>
<p>Frictions between the investor and the credit rating agencies</p>
<ul>
<li>Rating agencies compensated by arrangers, not investors which creates a potential conflict of interest; models are susceptible to both honest and dishonest errors</li>
<li><em>Resolution: </em>reputation of rating agencies and public disclosure of ratings criteria</li>
</ul>
</section>
</section>
<section>
<h2>Credit Enhancements</h2>
<ul>
<li>Subordination</li>
<li>Excess spread</li>
<li>Shifting interest</li>
<li>Performance triggers</li>
<li>Interest rate swaps</li>
</ul>
<aside class="notes">
Subordination: the distribution of losses on the mortgage pool is typically tranched into different classes. The overcollateralization portion and all junior tranches are subordinated. Excess spread: the difference between the weighted average coupon from the mortgage loan and the sum of fees to the servicer, net payments to the swap counterparty, and the weighted average coupon on debt securities issued by the trust. Shifting interest: requirement that all principal payments be applied to senior notes over a specified time period before being paid to mezzanine bondholders. Performance triggers: after the lockout period, the overcollateralization is released and principal is applied to mezzanine notes subject to passing prespecified performance tests. Interest rate swaps: the trust may enter a swap agreement to ensure a fixed cost of funding.
</aside>
</section>
<section>
<h2>Ratings Overview</h2>
<ul>
<li>Credit rating - an overall assessment and opinion of a debtor's creditworthiness</li>
<li>Rating Process</li>
<ol>
<li>Estimation of loss distribution</li>
<li>Simulation of cash flows</li>
</ol>
</ul>
<aside class="notes">
In estimating a loss distribution, rating agencies construct a baseline frequency of foreclosure and loss severity for each loan that depends on the characteristics of the loan and local area economic conditions. In simulating cash flows, the following key inputs are considered: the credit enhancement for a given credit rating, the timing of losses, prepayment rates, interest rates and index mismatches, trigger events, weighted average loan rate decrease, prepayment penalties, pre-funding of accounts, and swaps, caps, and other derivatives.
</aside>
</section>
<section>
<h1>THE END</h1>
<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
</section>
</div>
</div>
<script src="lib/js/head.min.js"></script>
<script src="js/reveal.min.js"></script>
<script>
// Full list of configuration options available here:
// https://github.com/hakimel/reveal.js#configuration
Reveal.initialize({
controls: true,
progress: true,
history: true,
center: true,
theme: Reveal.getQueryHash().theme, // available themes are in /css/theme
transition: Reveal.getQueryHash().transition || 'default', // default/cube/page/concave/zoom/linear/fade/none
// Optional libraries used to extend on reveal.js
dependencies: [
{ src: 'lib/js/classList.js', condition: function() { return !document.body.classList; } },
{ src: 'plugin/markdown/showdown.js', condition: function() { return !!document.querySelector( '[data-markdown]' ); } },
{ src: 'plugin/markdown/markdown.js', condition: function() { return !!document.querySelector( '[data-markdown]' ); } },
{ src: 'plugin/highlight/highlight.js', async: true, callback: function() { hljs.initHighlightingOnLoad(); } },
{ src: 'plugin/zoom-js/zoom.js', async: true, condition: function() { return !!document.body.classList; } },
{ src: 'plugin/notes/notes.js', async: true, condition: function() { return !!document.body.classList; } }
// { src: 'plugin/remotes/remotes.js', async: true, condition: function() { return !!document.body.classList; } }
]
});
</script>
</body>
</html>