MMP321 Lecture Notes - Lecture 8: Securitization, Commercial Mortgage, Weighted Arithmetic Mean

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31 May 2021
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MMP321 Topic 8 Seminar Solutions
1
Topic 8: Property Debt Securitisation
Question 1:
Define the difference between RMBS and CMBS.
SOLUTIONS:
RMBS are residential mortgage backed securities. The pool of loans in these
securities come from residential mortgages.
CMBS are commercial mortgage backed securities. The pool of loans in CMBS come
from commercial mortgages.
Question 2:
What is the role of the Special Purpose Vehicle in the debt securitisation process?
SOLUTIONS:
The Special Purpose Vehicle (SPV) issues securities to investors, the securities are
backed by the pool of loans that are securitised into a mortgage backed security.
Investors receive returns back by the repayment of the loan and interest payments.
The SPV is set up as a trust and is ‘bankruptcy remote’ in two ways. First, if the SPV
cannot pay entitlements to all the investors, the mortgage originator is not
responsible for the losses. Second, the securities are independent of the mortgage
originator. The SPV generally splits the income from the loans into different classes
of securities, known as tranches.
Question 3:
The income from a mortgage backed security is sometimes split into different
classes of security, known as tranches. Define the role tranches in a mortgage
backed security.
SOLUTIONS:
Tranches are different credit levels of securities that can be issued through the debt
securitisation process. They have different entitlements and priorities. Tranches
stratify the default risk of the loans. Tranches levels can range from one to even
four, depending on the size of the pool of loans and their value. For example, a MBS
with 2 tranches can be split into senior and subordinate levels. The senior tranches
earn a lower rate of return, but are paid before the subordinate holders. In the case
of default by some of the loans, subordinate holders have a higher probability of
not receiving payments, however, to compensate them for this higher risk they will
be offered a higher rate of return.
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MMP321 Topic 8 Seminar Solutions
Question 4:
What is the purpose of credit enhancement in the debt securitisation process? List
two ways credit enhancement can be done.
SOLUTIONS:
Credit enhancement is designed to minimise the consequences of default. Credit
enhancement can be done via:
a) Loan insurance taken out by individual borrowers (i.e. mortgage insurance)
or on all of the loans within a tranche
b) Credit ratings provided by credit agencies such as Standard & Poor’s.
c) Credit default swaps which are a financial instrument that provide a form of
insurance to cover losses from loan defaults. The originator pays a premium
for these swaps.
Question 5:
Describe the two groups of lenders that issue Residential Mortgage Back Securities.
SOLUTIONS:
First group are called Mortgage Managers. They are independent mortgage
providers (e.g. RAMS).
The second group are banks and other traditional lenders (e.g. ANZ).
Question 6:
What is the major advantage for retail banks to use Residential Mortgage Back
Securities?
SOLUTIONS:
The securitisation of loans by retail banks removes the loan liabilities from the
bank’s balance sheets. Once the loans are ‘off the books’ they have less impact on
their capital adequacy requirements. This results in the bank being able to grant
more loans.
Question 7:
Identify and describe the four main types of Mortgage Funds.
SOLUTIONS:
Pooled Mortgage Funds:
Managed investment schemes that hold portfolios of mortgages in unit trusts. Unit
holders receive their portion of mortgage interest & capital repayments. They are
mortgage pass-through funds, unit holders are entitled to amounts received
proportionate to the number of units they own.
Contributory Mortgage Schemes:
These funds let investors choose one or more mortgages from a number that have
been sourced by the fund manager. Investors contribute capital to the selected
mortgages and receive their proportion of the loan payments. They are also
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