Mortgage drought, Mark to market and the frozen market for mortgage securitisation

michaels

(Oops, meant to post this here )

I was wondering exactly how the mark to market accounting standard works with mortgages.

Currently I believe mortgage backed securities can only be sold at an extreme discount to their face value. Do banks have to value mortgage assets on their books at these market values? If this is the case, imagine the scenario where a bank provides a borrower with a new mortgage - suppose it is a sound decision, the ltv and employment status of the borrower is fine, the rate is above the banks funding costs etc; the bank advances 100k.

Now at the end of the quarter the bank must value this mortgage on its books at mark to market. The market is weak so the mortgage could only be sold for say 75% of face value - the bank immediately has to write off £25k ie even though there is no indication that over the life of the mortgage it will be anything but profitable.

Net result, advancing mortgages for the bank is an apparently loss making activity that burns valuable capital (over and above the use of tier 1 capital). No wonder the banks don't want to lend to house buyers.

Have I got this right or is there a way the bank can provide its own valuation of the mortgage?

GDB2222

You have hit the nail on the head, and this is one reason why the mark to market rules are being (have been?) suspended.

Generali

michaels wrote: »

(Oops, meant to post this here )

I was wondering exactly how the mark to market accounting standard works with mortgages.

Currently I believe mortgage backed securities can only be sold at an extreme discount to their face value. Do banks have to value mortgage assets on their books at these market values? If this is the case, imagine the scenario where a bank provides a borrower with a new mortgage - suppose it is a sound decision, the ltv and employment status of the borrower is fine, the rate is above the banks funding costs etc; the bank advances 100k.

Now at the end of the quarter the bank must value this mortgage on its books at mark to market. The market is weak so the mortgage could only be sold for say 75% of face value - the bank immediately has to write off £25k ie even though there is no indication that over the life of the mortgage it will be anything but profitable.

Net result, advancing mortgages for the bank is an apparently loss making activity that burns valuable capital (over and above the use of tier 1 capital). No wonder the banks don't want to lend to house buyers.

Have I got this right or is there a way the bank can provide its own valuation of the mortgage?

It is very hard to value a RMBS and all the associated CDOs and so on as they are not the same.

If you want to value some shares in BP it's easy. You go to the LSE website or look on Bloomberg for the last trade that was struck in those shares. That's their value.

If yo want to value a bunch of mortgages that have been bundled together you can't do that. They are sold Over The Counter (OTC) rather than on an exchange so you can't just look up a price. Also they are all different - would you pay more for a CDO backed by Northern Rock 125% mortgages or one backed by 50% LTV mortgages made to dentists?

Generally a bank will have a model that they use for pricing these things, usually created along with a chat with the auditors to ensure that they will be happy with the valuations provided.

kennyboy66_2

Do you think my bank would let me buy my mortgage off them for 75% of the remaining amount ?

Thought not.

beingjdc

michaels wrote: »

Now at the end of the quarter the bank must value this mortgage on its books at mark to market. The market is weak so the mortgage could only be sold for say 75% of face value

The market is weak because these things have been overvalued.

If it was definitely 'worth' face value, it would be snapped up at 75%, and probably fetch more.

But right now, there's no way of being sure - even if it's a sensible multiple and LTV compared to open market price, the borrower might lose their job, and auction prices are way down - up to 50% off Summer 2007 market prices.

Generali

kennyboy66 wrote: »

Do you think my bank would let me buy my mortgage off them for 75% of the remaining amount ?

Thought not.

In the US when the Savings and Loans were going bust during the 80s, people were buying up loan books, calling the debtor and offering them precisely that.

michaels

And there were reports on BBC (and I think on here) of people being offered the chance to redeem their self-certs for 95% of face value - I guess it makes sense if that is more than the lender values the mortgage at. I would very happily pay HSBC 95p on the pound for my mortgage