I’m a little confused. Let’s say Bank A creates 40 mortgages, sells them to Investment Bank B, who securitizes them, and sells these securities to private investor C.
Question 1 - Who do the mortgage payers pay? B? Or A who in turn pays B? Or directly to C?
Some of the mortgages go to default, and the lower tranches of the security divisions dry up.
Question 2 - Does B still have to pay out to C on those securities/tranches? Or is B just a middle man, who is not obligated to pay C if the homebuyers fail to pay B.
Question 3 - How does the foreclosure process work? Who forecloses? When the collateral (home) is sold at auction, where do these proceeds go?
The borrowers pay the owner of the mortgage notes or the owers representative. In this case that would be C unlesst the term securitize in this context has has more meaning. In this case C purchased the mortgage so C would now have to manage the mortgage or pay someone else to do so. In any case the someone else (May very well be B would only have interest in processing transactions and not in the value of the mortgage.)
Depends on the purchase agreement between B and C.
Foreclosure processes are determined by the state. The owner in this case: C would take back the property and hire an auctioneer to sell it. All proceeds would go to C.
You are confused as to what the term securitize means. It can mean a lot. Clearly B buys the mortgage from A. So B owns the mortgage and any proceeds from it. If B simply bundles it into blob of other mortgages and sells them to C but contracts to process the mortgage. C is the owner who will ultimately be responsible for the proceeds and the risk in the mortgages. B may collect the money but B no longer owns the mortgages.
The more famous process is actually much worse than this as it involves government agencies buying mortgages and selling them to other investors who buy insurance contracts on the mortgages themselves. So in this scenario you would have: A originates mortgage and sells to government sponsored enterprises Fannie or Freddie who combine this mortgage with thousands of others. They purchased the default risk in the mortgages. They bundle them together and sell to B. B now holds all the risk. B then buys insurance a Credit Default Swap on this bundle of mortgages from C. So Fannie and Freddie own the mortgages but C ultimates holds the risk.
Thanks for the answer, Bogart. That’s how I figured it worked, but sometimes I’ll read something that makes me wonder.
I still have a little confusion, and perhaps someone can help me clarify this. It seemed like the securities were mostly divided into tranches based upon risk tolerance, with the lowest tranches carrying the highest potential profits or losses.
In your case above, it seems easy that one party could buy the entire security, which represents hundreds to thousands of mortgages. But weren’t the Wall St. banks especially slicing these things up and selling the pieces individually?
In the case of clear, complete ownership of the whole security, the process seems obvious. When you only own a piece of the lowest tranche, things get dirty. It seems for this kind of thing, maybe the bank still owns the mortgages and security and is only selling part of their cash flow. In such case, a foreclosure and auction would simply be represented in the cash flow. The non-payments would effect the lower tranche’s payout until foreclosure and auction - then you’d get a lump payment that would extend the cash paid into the lower tranche, but only at that one time.
But in the above case, the bank might make out like bandits from widespread foreclosures…unless the principle depreciates heavily.
On the other hand, if hundreds of people each own a piece of a mortgage, the mortgage-payer doesn’t write hundreds of cheques each month. And if he defaults, they don’t all have to organize to foreclose. I would guess in such cases, the bank that created or sliced up and sold pieces of the security also administrate it.