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The University of Sydney Page 1
Mortgage Debt and US Capital Markets
Presented byProfessor Daniel Quan
Powell Visiting FacultyFinance Department, University of SydneyandRobert C. Baker Professor in Real EstateCornell University
The University of Sydney Page 2
Residential Mortgage Markets
Securitization – the process by which illiquid financial assets and liabilities are transformed into capital market instruments.
The University of Sydney Page 3
Aircraft-lease receivables
Airline-ticket receivables
Auto Leases
Auto loans
Boat loans
Bank loans (CLOs)
Catastrophic risk
Collateralized bond obligation
Credit risk
Consumer loans, unsecured
Credit cards
Delinquent receivables
Delinquent taxes
Equipment loans
Equipment leases
Export receivables
Factoring receivables
Miscellaneous fees
Franchise fees
Franchise loans
Health-club dues
Healthcare receivables
Home-equity loans
Home-improvement loans
Home-equity lines of credit
Insurance-premium loans
Loans (bank-to-bank)
Multi-family (apt. leases)
Manufactured-housing loans
Non-U.S. residential loans
Motorcycle loans
Mutual fund (12b-1) fees
High-LTV (“no-equity”) loans
Natural resources
Project finance
Repackaged ABS
Residential mortgages
Rent receipts
Royalties
Unsecured REIT bonds
Railcar
Retail sales
Recreational-vehicle loans
Small-business loans
Stock
Legal settlements
Ship leases
State-lottery winnings
Sub-prime home loans
Shipping receivables
Student loans
Tax-exempt lease contracts
Tax liens
Timeshare loans
Toll-road receivables
Trade receivables
Truck loans
Utility receivables
Weather
Thompkins CountyTobacco Settlements
What Has Been Securitized?
What mortgage products are available to households ?
Sources: Research Institute for Housing America, RBA, CHMC, KHFC, EMF,GPG, MBA and S&P
Mortgage Product Interest-Rate Variability
Long term, fixed-rate mortgages dominate US, and ARMs elsewhere
4
What investors buy mortgages ?
Sources: Research Institute for Housing America, ABS, CMHC, EMF, ESF, FRB, Merrill Lynch Europe, AU, CA, U.S. 2008, Japan 2006
Developed Country Mortgage Funding
Securitization funds most mortgages in U.S., deposits elsewhere.
5
The University of Sydney Page 6
Do product mix, funding sources and risk allocation affect homeownership rates ?
Sources: Research Institute for Housing America, ABS, CMHC, Delft University, EMF, Bureau of the Census
Homeownership rates are broadly similar in developed countries.
6
The University of Sydney Page 7
Mortgage Debt Outstanding in U.S. is Greater Than Next 10 Countries Combined
Sources: Peoples Bank of China, Australian Bureau of Statistics, Swiss National Bank, Bank of Japan, Statistics Canada, European Mortgage Federation; Currency conversions based on 10-year average exchange rates
$9,418,397$96,608$137,464$162,967$196,043$263,258$284,776$340,399$422,414$477,504
$704,790$750,500$754,984$816,250$870,944$955,920$973,649
$1,382,634$1,731,222
$10,060,547
$0 $2,000,000 $4,000,000 $6,000,000 $8,000,000 $10,000,000 $12,000,000
Top 10 non-USGreece
PortugalIreland
BelgiumNorway
DenmarkSweden
ItalySwitzerland
ChinaCanada
NetherlandsSpain
AustraliaFranceJapan
GermanyUK
USA
Estimated value of mortgage debt outstanding, millions USD, 2010
7
The University of Sydney Page 8
US Experience
What have we learned?
The University of Sydney Page 9
Dedicated Mortgage Banks – Savings and Loans (S&Ls) or Thrifts
– Promote homeownership after the Great Depression (1929-1939)
– Dedicated to home mortgage origination– Perks
• Government guaranteed deposits• Local monopoly• Deposit ceilings higher for thrifts
– Must only engage in home mortgage lending– Funded by deposits– Worked under the 3-6-3 rule
– Creation of Government Sponsored Enterprises (GSE)– Government National Mortgage Association (Ginnie Mae – 1968)– Federal National Mortgage Association (Fannie Mae – 1938)– Federal Home Lone Mortgage Corporation (Freddie Mac – 1970)
The University of Sydney Page 10
Dedicated Mortgage Banks – Savings and Loans (S&Ls) or Thrifts
– S&Ls retain all mortgage loans
– Inflation (1979 - 1981)– Inflation premiums and uncertainty increased mortgage rates– Fed policy inverted yield curve– Traditional lending model does not work – Duration mismatching – duration of mortgages much longer than on
deposits– Exposed interest rate risk of holding mortgages
– Massive S&L insolvency– Estimate two-thirds (475) of all thrifts were insolvent – negative net
worth of $109 billion
The University of Sydney Page 11
1-Year and 10-Year Treasury Yields
-4
1
6
11
16Ap
r-53
Apr-5
6
Apr-5
9
Apr-6
2
Apr-6
5
Apr-6
8
Apr-7
1
Apr-7
4
Apr-7
7
Apr-8
0
Apr-8
3
Apr-8
6
Apr-8
9
Apr-9
2
Apr-9
5
Apr-9
8
Apr-0
1
Apr-0
4
1 Year 10 Year Term Premium
The University of Sydney Page 13
Dedicated Mortgage Banks – Savings and Loans (S&Ls) or Thrifts
– Deregulation– Eliminate deposit ceilings– Increase competition– Relax restrictions on lending
– Suggested factors leading to insolvency– Duration mismatching– Excessive risk taken by insolvent thrifts– Overspecialization in mortgages– Deposit insurance
– Lesson – risky for financial institutions to retain mortgages– Need a secondary market for mortgages - securitization
The University of Sydney Page 14
MortgageOrigination
Conforming“Agency”Mortgages
GSEFannie MaeFreddie MacGinnie Mae
Non-ConformingMortgages
Jumbo•700+ FICO
•Conforming exceptby size
•65%-80%LTV
Alt-A•640-730 FICO
•No Doc/Lo Doc•70-100%LTV
Subprime•500-660 FICO
•Poor credit history•Poor documentation
US Secondary Mortgage Market
The University of Sydney Page 15
Conforming Borrower
Originating Lenders
and Servicers
GNMAguarantee
Mortgage-backed
Securities
Investment Banks
Investors
FNMA, FHLMC Brokers or dealers
Conforming Market
The University of Sydney Page 16
Secondary Mortgage Market
– Conforming or Agency Market– GSEs provide guarantee again default risk – no default risk– Primary risk is prepayment – premature return of mortgage principal– Loan originators retain servicing role
– Financial Engineering• Collateralized Mortgage Obligation (CMO)• Strips – high coupon and deep discount• IO, PO Strips• Floater and Inverse Floaters• Planned Amortization Class (PAC)
The University of Sydney Page 17
Secondary Mortgage Markets
– Nonconforming market– Private sector securitizations – no GSEs involved– Default risk– Subordination as credit support– Products sold in the Asset-Backed Securities (ABS) market
– Subprime was only a small part of the market
Securitization Has Replaced Depositories as the Predominant Source of Mortgage Money
Source: Federal Reserve Board; Data as of 3Q 2011
Depository Institution Holdings of Mortgages
(whole loans)
Life Insurers (whole loans)
Ginnie Mae MBS Investors
FRE & FNM Mortgage-Backed Security Investors
FRE & FNM Retained Portfolios
Private-Label MBS Investors
Other
0
10
20
30
40
50
60
70
80
90
100
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Total Residential Mortgage Debt Outstanding by HolderPercent
18
The University of Sydney Page 19
0
20
40
60
80
100
120
140
160
180
200
198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013
S&LCrisis
1990-91Recession Black
Wednesday PesoDevaluation
CurrencyCrisis
2001Recession
TechBubble
IraqWar
SubprimeCrisis
21-year Average: 30 bps
19
Source: HSH Associates (last data: week ending April 19, 2013)Note: Effective spread adds fees and points to the interest rate; 20-year average computed over April 1986 to July 2007.
Benefits to Homeowners: Conforming Mortgage Interest Rates Below Jumbo Rates
Effective Interest Rate Spread Between Jumbo and Conforming 30-Year Fixed-Rate Mortgages (Basis Points)
Record: 184 bps12/19/08
Current: 33 bps
The University of Sydney Page 20
The University of Sydney Page 21
Was It A Global Contagion? The Housing Bubble Was Larger in Other Countries
Source: Federal Reserve Bank of Dallas21
The University of Sydney Page 22
Commercial Mortgages
Source: Commercial Mortgage Alert
US CMBS ISSUANCE( $ M I L L I O N S )
•COPYRIGHT 2016 - PROF. DANIEL QUAN
The University of Sydney Page 24
$1B Pool of Commercial
MortgageLoans
5yr AAA10yr AAA
AA
B-First Loss
AA-
BBB
BBB
BBB-
LOSSES
5.7 yr9.8 yr
14.9 yr15.8 yr16.0 yr
12.9 yr10.0 yr9.9 yr9.9 yr9.9 yr9.9 yr
AvgLife
CMBS Senior Subordinate Tranching - JPMCC-CIB5
PREPAYS
1.75%2.00%3.88%7.00%8.63%11.50%12.88%17.00%20.63%
Credit Support
Credit R
isk
•COPYRIGHT 2016 - PROF. DANIEL QUAN
CollateralMortgage
Rate6%
AAA Bonds2%
AA Bonds3%
A Bonds5%
BBB Bonds8%
BB Bonds11%
B Bonds18%
NR (Non-Rated) Bonds – 22%
Weighted Average Coupon
4.5%
Capital Markets Analytics
10-Year CMBS Spread over Treasury
700
600
500
400
300
200
100
0
bps
Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00
Key Axis Name Last Minimum Maximum MeanSD SD Change
Left CMBS Fixed AAA 10Yr 38.800 21.500 02/13/1998 102.500 10/16/1998 41.649 12.951 5.528
Left CMBS Fixed AA 10Yr 55.800 36.000 05/15/1998 117.500 10/16/1998 58.365 16.436 5.901
Left CMBS Fixed A 10Yr 73.800 49.500 02/13/1998 137.500 10/16/1998 75.161 18.686 6.129
Left CMBS Fixed BB 10Yr 540.000 240.000 02/13/1998 700.000 10/30/1998 472.126 1
38.900 21.201
Left CMBS Fixed BBB 10Yr 129.800 74.500 02/13/1998 230.800 10/30/1998 128.483 32.243 8.438
Left CMBS Fixed BBB- 10Yr 164.800 104.500 02/13/1998 327.200 11/06/1998 194.074 54.955 11.683
This page was produced on December 2, 2014 12:08:37 PM ESTThis document is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy the products mentioned in it. No representation is made that any returns will be achieved. Past performance is not necessarily indicative of future results; any information derived herein is not intended to predict future results. This information has been obtained from various sources, including where applicable, entered by the user; we do not represent it is complete or accurate. Users of these calculators are hereby advised that Barclays Capital takes no responsibility for improper, inaccurate or other erroneous assumptions to the extent such data is entered by the user hereof. Opinions expressed herein are subject to change without notice. The securities mentioned in this documentmay not be eligible for sale in some states or countries, nor suitable for all types of investors.
Time Series Plotter Page 1 of 1
Key Axis Name Last Minimum Maximum Mean SD SD ChangeLeft CMBS Fixed AAA 10Yr 0.000 0.000 10/01/2008 319.000 09/18/2008 47.017 53.739 8.978
Left CMBS Fixed AA 10Yr 4663.176 29.000 02/15/2005 4849.971 02/13/2009 566.060 286.409 30.236
Left CMBS Fixed A 10Yr 5740.206 38.000 02/15/2005 5819.941 04/23/2009 721.404 577.674 32.797
Left CMBS Fixed BB 10Yr 7200.000 240.000 02/13/1998 7200.000 04/23/2009 1292.080 971.194 36.302
Left CMBS Fixed BBB 10Yr 6958.164 68.000 02/22/2007 7021.647 04/23/2009 989.782 941.988 35.422
Left CMBS Fixed BBB- 10Yr 7235.284 87.000 02/23/2007 7287.147 04/23/2009 1094.654 027.736
Capital Markets Analytics
10-Year CMBS Spread over Treasury
7K
6K
5K
4K
3K
2K
1K
0K
36.797
bps
2000 2002 2004 2006 2008
This page was produced on December 2, 2014 12:10:16 PM ESTThis document is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy the products mentioned in it. No representation is made that any returns will be achieved. Past performance is not necessarily indicative of future results; any information derived herein is not intended to predict future results. This information has been obtained from various sources, including where applicable, entered by the user; we do not represent it is complete or accurate. Users of these calculators are hereby advised that Barclays Capital takes no responsibility for improper, inaccurate or other erroneous assumptions to the extent such data is entered by the user hereof. Opinions expressed herein are subject to change without notice. The securities mentioned in this documentmay not be eligible for sale in some states or countries, nor suitable for all types of investors.
Time Series Plotter Page 1 of 1
The University of Sydney Page 28
Source: Wachovia Securities
$500 MillionValued Office
Tower
$400 MillionLarge Loan
A-Note 1$100 Million
A-Note 2$100 Million
Investment-GradeCMBS
Conduit Loans,Other A-Notes,
etc.
Subordinate CMBSor "B-Pieces"
A-Note 3$100 Million
B-Note$50 Million
C-Note $50 Million
$25 MillionMezzanine Loan
$25 MillionPreferred Equity
$50 MillionCommon Equity
Commercial RealEstate
Investment Bank
$100 MillionEquity
Mezzanine Loan
PreferredEquity
Managed CRE CDO
B-Note Subordinate CMBSor "B-Pieces"
Real EstateCompany or Other
Entity Owning, Operating orControlling
Property
Deconstructing the Real Estate Finance Tower
The University of Sydney Page 29
Interest Rate Increase
Which ones?
Fed Undertakes QE3 With $40 Billion Monthly MBS Purchases
The University of Sydney Page 31
Interest Rates – Long versus Short
– Term Structure of Interest Rate– http://stockcharts.com/freecharts/yieldcurve.php
– Traditionally, open market operations impact short term rates– Long term rates driven by economy’s fundamentals and not
subjected to monetary policy
– QE3 targeted long term rates
– Possible only because of MBS
The University of Sydney Page 32
Quantitative Easing 3 (9/12 – 10/14)
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
Weekly Fed MBS Purchase
30Y MBS 15Y MBS
The University of Sydney Page 33
Interest Rate Increase
Impact on commercial mortgage market.
The University of Sydney Page 34
How Does Rate Increases Affect Commercial Lending?
– 10Y Treasury yields increased 55bp since Dec. 1, 2017. Committee voted to raise rates by 25bp today.
– Lenders require target DCR (2017Q4 – 2.2)
– To offset higher rates (and higher debt service) lenders will reduce loan size
– Borrowers will seek additional financing
The University of Sydney Page 35
Example of Funding Needs
– Borrow $10 mill on a property that generates $900,000 NOI– 4.5% senior loan– Annual Debt Service $450,000– DCR 2.0– If rates increase to 5%– Loan reduced to $9 mil to maintain DCR of 2.0
– Borrower will need to seek additional $1 mill loan (mezzanine)
– Will lead to a short term boost in loan demand
The University of Sydney Page 36
Interest Rate Increase
Affect on Commercial Mortgage Prepayment
The University of Sydney Page 37
Balloon Due Dates
The University of Sydney Page 38
CMBS Defeasance
– Defeasance – substitution of a coupon-matching portfolio of Treasury securities for mortgage
– Factors leading to defeasance– Property appreciation– Past lock-out period– Increasing interest rates
Annual Defeasance ($Bil.)32.425.9
20.9 22.4
17.213.2 12.2
4.9
4.9
5.91.
32.8
’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17Source: Moody’s
The University of Sydney Page 39
Debt Funds – the new lending force?
The University of Sydney Page 40
CMBS Performance
The University of Sydney Page 41
Debt Funds
- Debt Funds raised over $50.7 billion, 21% over last year
- More than double from three years ago
- Targeting bridge and mezzanine loans – returns of 10%
- Fill void by banks pulling back from lending due to regulatory concerns
- Funds possibly used to acquire CMBS retention slice
The University of Sydney Page 42
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http://www.wsj.com/articles/china-becomes-asias-biggest-securitization-market-1443082192
MARKETS | CREDIT MARKETS
China Becomes Asia’s BiggestSecuritization MarketChina’s issuance of asset-backed securities rose by a quarter in the first eight months of 2015
By FIONA LAWUpdated Sept. 24, 2015 10:18 p.m. ET
The University of Sydney Page 43
MARKETS February 28, 2013, 1:38 p.m. ET
China Bank Securitizing U.S. LoansArticle Stock Quotes Comments
By LINGLING WEI And AL YOON
Add one more item to the list of products "made in China": debt backed by commercial mortgages.
Bank of China Ltd. is already one of the largest foreign lenders to commercial realestate in the U.S., helping finance prestige properties. Now, it is staking a claim inthe red-hot market for bonds backed by packages of commercial-real-estate loans.
In November, Bank of China became the first Chinese lender to participate in the sale of U.S. commercial-mortgage-backed securities, known as CMBS. Bank of China joined a group of banks in a $950 million loan to finance a 43-story building at 1290 Avenue of the Americas in midtown Manhattan that was then packaged into bonds.
The Chinese bank is planning loans that would end up in to two or three
more CMBS deals, a person with knowledge of the bank said. State-controlled Bank of China earns a profit from selling loans via CMBS. It also frees up its balance sheet to make more loans.
Bloomberg News
The Bank of China Tower, center, in the central business district of Hong Kong.
Enlarge Image
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