Secured Mortgage Obligations and Secured Debt Obligations

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A mortgage-backed security (or an asset-backed security) can be divided into different tranches so that investors can invest according to their appetite for risk. When this is done with mortgages, it is called a secured mortgage obligation (CMO). When this is done with other types of debt (student loans, corporate debt, auto loans, etc.) it is called collateralized debt obligation (CDO). Each tranche has different schedules for the repayment of the principal, the coupon rates and the prepayment allocation. If you are concerned about default, you would invest in a tranche with a higher repayment priority. The Z tranche (or Z bond) is the riskiest because it receives the cash flows last. The CMO / CDO structure generally results in more predictable cash flows for investors because they can choose a tranche based on their desired level of risk. Here’s an example of how this works: 1. A loan originator, such as a bank, makes loans 2. The loan originator sells the loans to a special purpose entity (SPE), which is a separate entity ( the SPE is generally established as a trust) 3. The SPE then sells debt securities (notes or bonds, called “investor certificates”) to investors. The cash inflows that these investors will receive from the debt securities come from the cash inflows of the underlying assets (in this case, loans) 4. The debt securities are classified in several tranches according to (a) the priority of repayment and (b) credit risk (a senior tranche has a higher repayment priority and less risk). A tranche structured security is a “multi-class” ABS (as opposed to a “single class” ABS in which all investors have equal rights to the underlying pool of assets). 5. A rating agency assigns a rating to the notes / bonds based on (a) the quality of the underlying assets, (b) the securitization structure and (c) the result of stress tests 6. The loans they are generally administered by a subsidiary of the loan originator. The subsidiary collects payments from borrowers on behalf of the SPE in exchange for a fee: Edspira is the brainchild of Michael McLaughlin, an award-winning professor who went from a homeless teenager to a Ph.D. Edspira’s mission is to make high-quality business education accessible to all. – SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO FINANCIAL STATEMENTS, PLUS: • A 23-PAGE GUIDE TO ADMINISTRATIVE ACCOUNTING • A 44-PAGE GUIDE TO US TAXES * http://eepurl.com/dIaa5z
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Viralrook: Secured Mortgage Obligations and Secured Debt Obligations
Secured Mortgage Obligations and Secured Debt Obligations
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