a. Whole Loan Sales: Although not a security, the sale of whole loans can be an important way for primary lenders to raise funds and manage risk. Whole loan sales involve the sale of mortgages, either individually or more commonly in pools, to other lenders or investors. Examples of whole loan sales include the sale of pools in their entirety, participation or recourse basis, by savings and loan institutions in the US in the 1960s and 1970s.[1] Whole loans may be sold through brokers, relationships (e.g., the seller delivers loans on a regular basis to the buyer)) or wholesalers who aggregate loans from a variety of sources and sell them to investors.
b. Agency Bonds: These are bonds issued by agencies
specialized in mortgage finance at a secondary (i.e., not the loan origination) level. Issuers include liquidity facilities which refinance primary market lenders (discussed below) and [the retained portfolio activities of] the mortgage GSEs in the US.[2] Their bonds are not specifically backed by mortgage loans but the assets of the issuers are almost entirely mortgages or loans backed by mortgages. The bonds are obligations of the issuers and can be straight or callable.c. Mortgage Bonds: These are bonds that are issuer obligations and issued against a mortgage collateral pool. Investors have a priority claim against the collateral in the event of issuer bankruptcy. The issuer may be a specialized mortgage bank, as is the case in Denmark, Germany and Sweden, a commercial bank as is the case of Chile, Czech Republic or Spain, or a centralized issuer as is the case of France or Switzerland. The collateral pool may consist of all of the qualified assets of the issuer, as is the case with the German Pfandbriefe, a specified pool as in the case of US savings and loans and the recent issue by Halifax Bank of Scotland in the UK, or individual loans as in Chile and Denmark (the individual bonds are aggregated into large series). The bonds may be straight (non-amortizing) or pass-through (in which mortgage principal is “passed through” to investors as received from borrowers).
d. Mortgage Pass-through Securities: Pass-throughs (PTs) are securities issued against a specific collateral pool subject to cash flow matching. The balance on the PT is always equal to the balance on the mortgages in the pool and the cash flows received from borrowers are passed through to investors, with a delay and deduction for servicing and guarantee fees. Pass-throughs are typically not the liability of the issuer and feature credit enhancement through a variety of techniques described below. They may be issued by lenders or conduit institutions.[3] The best known PTs are the securities guaranteed by Ginnie Mae and those issued by Fannie Mae and Freddie Mac in the US.[4]
e. Mortgage Pay-through Securities: Pay throughs are multiple securities issued against a single collateral pool. They may be closed end, wherein there is a fixed collateral pool and all securities are issued at the outset of the transaction, or open end in which the collateral pool and securities can be increased over time (subject to constraints). These securities modify cash flows between borrowers and investors to meet the needs or requirements of investors. Examples of pay through securities include mortgage strips in which separate securities that are backed from either the principal and interest from a mortgage pool are sold, and collateralized mortgage obligations (CMOs) in which a number of securities that repay principal sequentially are issued. Most mortgage security issuance by banks in developed and emerging markets are pay-through structures.
[1] In participation agreements, the seller retains a portion of the pool and thus shares the risk with the purchaser on a pari-pasu basis. In recourse transactions, the seller retains some or all of the risk of default by agreeing to repurchase loans in default. The recourse may be limited to a certain amount or percentage of the pool balance.
[2] GSE stands for Government Sponsored Enterprise, a special class of institutions in the US. The GSEs are government chartered, limited purpose corporations that are owned by either their members or the general public. They enjoy a number of tax and regulatory privileges that translate into lower funding costs. The best known enterprises, Fannie Mae and Freddie Mac and the Federal Home Loan Banks are described in Lea, 1999.
[3] Conduits are centralized institutions that purchase loans from lenders and issue mortgage securities. Fannie Mae and Freddie Mac have conduit functions and there are over 20 major private conduits in the US as well.
[4] For more detail on mortgage security characteristics, see Fabozzi 1997, 2001.
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