Dynamics of mortgage-backed securities


By Baljeet Grewal

IN an increasingly deepening capital market, contemporary investors often seek assortments of investment instruments which are not only profitable, but also marketable and innovative.  

Of the array of creative financing techniques that are coming of age, one that is beginning to gain credence is mortgage-backed securitisation (MBS).  

At its core, the technique of MBS involves the “pooling” or packaging of mortgage loans by issuers for sale to investors. MBS differs from collateralised debt or traditional asset-based lending in that the pooled mortgage loans are assigned or sold to a third party, typically a special-purpose company or trust.  

This special-purpose vehicle (SPV), in turn, issues one or more debt instruments – the mortgage-backed securities – whose interest and principal payments depend on the cashflows from the underlying mortgage loans repayment. The crux of the MBS structure is the severance of good assets (i.e. mortgage loans) and the use of these assets as backing for high-quality securities that appeal to investors. 

By channelling funds from domestic bond markets to domestic housing markets, MBS link the wholesale and retail credit markets hence, reasonably efficient bond and housing markets are crucial for the efficient operation of domestic MBS markets. The process also benefits the economy by bridging financial and capital markets together. Financial assets are created in the financial markets, e.g., banks or mortgage financing companies. The process of securitisation then connects the capital markets and financial markets by converting these financial assets into capital market commodities, thereby reducing agency and intermediation costs.  

Advantages arising from MBS include the transformation of relatively illiquid mortgage loans into liquid and tradeable assets, enabling mortgage lenders and bankers to access larger reservoirs of capital. Following this, the diversification of funding sources from the off-balance sheet treatment of debt results in improved gearing thus encouraging the more efficient use of regulatory capital.  

In more developed capital markets like the US, the first MBS was issued in 1970, by the US Government National Mortgage Association (Ginnie Mae). Soon after, other governmental mortgage agencies/ associations, i.e. Freddie Mac and Fannie Mae, followed suit. 

These agencies buy qualified mortgage loans or guaranteed pools of such loans originated by financial institutions, securitise the loans and distribute the securities through the dealer community. As a result of increasing investor interest in these investments, the mortgage securities market is one of the largest financial markets in the US. As at June 2004, total volume of outstanding mortgage securities stood at US$5.4bil or 23.7% of total outstanding bonds in the US.  

In Asia, the financial crisis underscored the need to further develop long-term domestic bond markets in the region. Despite generally high rates of savings, long-term savings were not efficiently mobilised. 

In most markets, mortgage credit as a proportion of the GDP is still small and displays potential for future growth – in particular, China, Indonesia, Pakistan, and India, all very populous countries, each having mortgage-to-GDP ratios of less than 7%, which implies room for growth.  

However, traditional aversion to mortgage borrowing in India and Pakistan may limit the potential for mortgage credit growth. Also, the concentration of liquidity in Asia’s short-term bond market is to the detriment of long-term bond market activities, such as housing and infrastructure. 

Mortgage-backed securities are increasingly seen as a tool for mobilising long-term savings, while at the same time stimulating domestic housing markets. In Malaysia’s instance, the capital market will soon witness the issuance of the country’s inaugural residential mortgage-backed securities (RMBS), pioneered by Cagamas MBS Bhd (CMBS), a wholly-owned subsidiary of Cagamas Bhd.  

The RM1.8bil bond issue, backed by civil servants' housing loans purchased from the Malaysian government represents the strategic initiative of broadening the domestic bond market while simultaneously extracting a benchmark yield curve for long-term bonds. 

The serial RMBS have been accorded the highest rating of AAA, reflecting the superior quality of the underlying assets. The result is that the domestic securitisation market is now no longer a peripheral bond market, but an increasingly important component of the Malaysian capital market.  

The introduction of the RMBS will not only add variety to the range of asset-backed securitisation (ABS) products available, but could also spur similar issues from the private sector, notably in industry property loans. The paper is anticipated to drive demand from a large base of investors, given its strong credit quality.  

The Malaysian debt market has displayed exemplary growth and has been underscored by a series of notable highlights, namely, regulatory consolidation, the unveiling of the Capital Market Masterplan, the advent of ABS and the broadening of the Islamic debt market.  

The issuance of the country’s first RMBS issue adds to this list of accomplishments for further enhancing competitiveness and diversity in the market place and contributing towards the resilience of the overall financial architecture.  

l The author is chief economist and head (fixed income research) with Aseambankers Malaysia Bhd, the investment banking arm of Malayan Banking Bhd. Aseambankers possesses a notable fixed income research initiative with the primary task of undertaking comprehensive and proficient research in the area of Malaysia’s debt capital market.  

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