Residential Mortgage
In the residential mortgagebacked securities (RMBS) sector. In a second stage, we focus on the more advanced modeling techniques that have emerged among the most active market participants.
From an historical perspective, the structured finance market began with the issuance of the first mortgage-backed security in the U.S. by the Government National Mortgage Association (Ginnie Mae) in 1968. Soon after, the Federal Home Loan Mortgage Corporation (Freddie Mac) introduced its mortgage participation certificates in 1970, and, by 1977, the Federal National Mortgage Association (Fannie Mae) was in the game.
Loans eligible for sale to one of these agencies must satisfy specific criteria; such loans are conforming mortgages. Loans not eligible for sale to the agencies, or nonconforming mortgages, needed another way to the capital markets. Around that time, Standard & Poor’s rated the first U.S. private issue mortgage-backed bond. This was the beginning of one of the fastest growing and most innovative sectors of the global capital markets.
Today, Standard & Poor’s rates transactions are backed by a wide variety of assets, including residential and commercial mortgages, credit cards, auto loans, and small business loans, to name a few. While historically the RMBS sector has dominated with respect to overall issuance volume, the collateral debt obligation (CDO) market currently is the fastest growing sector.
All structured finance securities are either cash flow or synthetic securitizations. Simply put, in a cash flow structured finance transaction, an issuer conveys ownership of the assets to a special-purpose entity (SPE), which then issues the rated debt. Principal and interest related to those assets are conveyed along with the risks.
The U.S. RMBS sector has evolved quite a bit from those early days from the typical nonconforming prime mortgage pool to over a dozen different types of underlying assets. One of the fastest growing RMBS sectors is the sub-prime market. Sub-prime RMBS represent about a third to a half of the volume of Standard & Poor’s-rated RMBS, and prime is about 20 percent.
Lastly, the banking industry has considerably developed the modeling techniques applicable to the RMBS sector and more generally to the asset-backed securities (ABS) sector. Talking about mortgage risk without describing the modeling of the broad prepayment and credit risks of underlying assets backing structured finance bonds is not possible any more. Cash flow statistical modeling is another area of focus for market participants.