18. Mortgage Backed Security (MBS) Source: http://www.urbandigs.com/2007/08/how_mortgage_backed_securities.html STEP 1 - A pool of mortgages are owned by a bank or lender. They are grouped into categories by credit risk including subprime, alt-a (between subprime and prime), and prime. STEP 2 - The pool of mortgages are packaged into a mortgage backed security. STEP 3 - The mortgage backed security is then sliced and diced into different classes with varying maturities (called tranches). Each tranche offers varying degrees of risk to the investor. The first loan to default will be placed into the Junk tranche while the strongest loans receive the highest credit rating of 'AAA' and are placed at the top of the tranche division. As with any asset associated with risk, the highest risk tranche receives the highest rate of return or yield while the lowest risk (AAA rated) will receive the lowest yield. STEP 4 - The tranches are then resold to investors who are willing to take on the varying degrees of risk and maturities.
26. Details : Private Sub-prime mortgage process 1. Brokers identify borrowers 2. Originator and broker identify a loan for borrower after looking at his credit rating 3. Formal application for loan by borrower 4. Originator transfers the loan to the subsidiary of an investment banking firm ( Seller) 5. Seller(Investment bank) collects a pool of loans and call it as SPE/SIV/SPV. Off balance sheet instrument 6. SPV can be a corporation, partnership or limited liability company. Most often a Trust. It has nothing else except mortgage loans 7. Underwriter purchases all the securities (derivative income streams) 8. In designing SPV and its tranches underwriter works with credit rating agencies 9. Underwriter then sells the securities to the investors 10. High rated tranches might be guaranteed by a 3rd party insurance company 11. Seller also arranges to sell the rights to service the loan pool to a company or sometimes Originator takes these rights 12. MERS – document custodian. Company to keep track of mountains of paper work on loans in the pool. At National level. Source : Subprime Mortgage Market Turmoil , testimony by Christopher L. Peterson
27. Possible inter linkage in the US subprime mortgage market Source: http://www.norges-bank.no/templates/article____66901.aspx
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