How Do You Sell A Debt?

[danlightbulb]

Hi all,

Just wondering how a mortgage debt can be sold on?

If I borrow £100k from the rock, for example, how do they go about selling it on?

Thanks

[South Lorne]

Hi all,

Just wondering how a mortgage debt can be sold on?

If I borrow £100k from the rock, for example, how do they go about selling it on?

Thanks

...it's all here ...

http://en.wikipedia.org/wiki/Life_Insurance_Securitization

[padders]

Well, right now they don't.

But otherwise they just sell the IOU, debt has a value, if you owe me £10 to be paid in a year's time then that is worth, say, £9 now - so to sell the debt they just find someone who has £9 to buy it.

[Leonard Hatred]

If I borrow £100k from the rock, for example, how do they go about selling it on?

By preying on the terminally stupid. Other bankers, basically.

[Broken Fan]

Well, right now they don't.

But otherwise they just sell the IOU, debt has a value, if you owe me £10 to be paid in a year's time then that is worth, say, £9 now - so to sell the debt they just find someone who has £9 to buy it.

It pays well, in fact its worth borrowing money to buy these debts.

[fluffy666]

Hi all,

Just wondering how a mortgage debt can be sold on?

If I borrow £100k from the rock, for example, how do they go about selling it on?

Thanks

My understanding is this:

Basically, you 'repackage' the debt as a series of bonds yielding a certain percentage, which must be less than the rate you pay on the mortgage.

So your 100k @ 6% mortgage becomes £120k of bonds yielding 5%. The lender can then take the difference (£20k in this case) as pure profit and has passed the risk on to the bondholders if anything goes wrong. (Hence the 'does it have a pulse' lending criteria).

The problem happens when the Mortgage company (i.e. Northern Rock) can't find a buyer for the bonds it has created - it initially makes the loan from short term funds which are paid back when the bonds are sold. If it can't sell the bonds, it has to refinance, probably at a higher rate than the mortgage interest coming in. This erodes capital - and gets worse as it goes on and it looks a riskier and riskier bet, until the bank runs out of capital and collapses.

[Nelly]

My understanding is this:

- and gets worse as it goes on and it looks a riskier and riskier bet, until the bank runs out of capital and collapses.

you mean

untill the bank runs out of capital and gets us to fund it via the tax man

[fluffy666]

My understanding is this:

- and gets worse as it goes on and it looks a riskier and riskier bet, until the bank runs out of capital and collapses.

you mean

untill the bank runs out of capital and gets us to fund it via the tax man

Oh, yes, I forgot: And is rescued by the state at great expense.

Unlike companies that actually make stuff, banks must be saved by state intervantion during market downturns. They must also be immune from state intervention during market upturns.

[ockham]

Hi all,

Just wondering how a mortgage debt can be sold on?

If I borrow £100k from the rock, for example, how do they go about selling it on?

Thanks

Quite a few ways. The simplest way is just to sell the 'book'. You legally transfer ownership of the mortgages to anyone who want to buy them, which gives them rights to the income from the mortgages, as well as the risk of them defaulting. Sometimes the seller retains the 'administration', i.e. collecting payments, sending out statements, that sort of thing. There is also 'collection', i.e. sending in people with tattoos to enforce payments.

Another method is 'securitisation'. The simplest form is to set up a special vehicle which contains two 'tranches' (French for 'slice'), an 'equity tranche' and a 'senior tranche'. The senior tranche has a defined coupon, to which it has 'seniority' i.e. it can claim all income on the mortgages, up to the defined amount. Anything left over goes to the owners of the equity tranche. There is usually considerably more left over, and the equity tranche holders get a good return compared to the senior note holders. The catch is that the equity holders absorb all the losses from default, up to the amount of equity. Thus, high return, high risk.

Actually, with senior to equity ratios of sometimes 80-20, it turns out that senior holders may have more risk than they thought. If losses due to default > 20%, they will lose money as well. I.e. if loan to value ratio greater than 100%, and 'value' is realised at auction or a fire sale of some kind, then there could be considerable losses.

Fortunately, British banks have been maintaining strong LTV ratios and there is no risk of a HPC here because of the buoyant economy.

[beefheart]

My understanding is this:

Basically, you 'repackage' the debt as a series of bonds yielding a certain percentage, which must be less than the rate you pay on the mortgage.

So your 100k @ 6% mortgage becomes £120k of bonds yielding 5%. The lender can then take the difference (£20k in this case) as pure profit and has passed the risk on to the bondholders if anything goes wrong. (Hence the 'does it have a pulse' lending criteria).

The problem happens when the Mortgage company (i.e. Northern Rock) can't find a buyer for the bonds it has created - it initially makes the loan from short term funds which are paid back when the bonds are sold. If it can't sell the bonds, it has to refinance, probably at a higher rate than the mortgage interest coming in. This erodes capital - and gets worse as it goes on and it looks a riskier and riskier bet, until the bank runs out of capital and collapses.

So why are the banks in trouble if all the sh1t3 debts have been farmed out?

[AteMoose]

Selling debt is very similar to saving money in a bank account. You have given money to a bank and they give you interest every month/year, they take your money and give it to other people who pay a little more interest each year to the bank. If you are in debt and put money in a savings account your essentially selling your debt onto a bank.

[ockham]

My understanding is this:

Basically, you 'repackage' the debt as a series of bonds yielding a certain percentage, which must be less than the rate you pay on the mortgage.

So your 100k @ 6% mortgage becomes £120k of bonds yielding 5%. The lender can then take the difference (£20k in this case) as pure profit and has passed the risk on to the bondholders if anything goes wrong. (Hence the 'does it have a pulse' lending criteria).

The problem happens when the Mortgage company (i.e. Northern Rock) can't find a buyer for the bonds it has created - it initially makes the loan from short term funds which are paid back when the bonds are sold. If it can't sell the bonds, it has to refinance, probably at a higher rate than the mortgage interest coming in. This erodes capital - and gets worse as it goes on and it looks a riskier and riskier bet, until the bank runs out of capital and collapses.

This is not correct. Assume the senior tranche is 80% or 80k. Then the senior notes, assuming 5% coupon, will receive 4k in any year. That leaves 2k difference, divided among the 20% of the equity holders. Thus the equity holders get 10% return. However, as noted above, any losses up to 20k have to be paid by the equity holders as well.

[ockham]

You don't.

At first, it's confusing, isnt it? It is not the debt obligation that gets sold, it is the debt payments.

Whomever lent you the money owns the right to receive the payments that you will make,

and it is the right to receive those payments that gets sold on.

So you cannot sell it. It is whomever you will pay the money to, who owns something to sell.

This is also not correct (if I understand you). You can sell the rights to the income, the rights to administration, and also the risk of default. Pretty much anything can be bought and sold.

[ockham]

So why are the banks in trouble if all the sh1t3 debts have been farmed out?

Banks 'warehouse' the debts in a big, well 'warehouse' waiting to be packaged up and sold on. The huge losses we are seeing at the moment correspond to the securities they were unable to sell on. Any other losses will be taken by the purchasers.

[fluffy666]

This is not correct. Assume the senior tranche is 80% or 80k. Then the senior notes, assuming 5% coupon, will receive 4k in any year. That leaves 2k difference, divided among the 20% of the equity holders. Thus the equity holders get 10% return. However, as noted above, any losses up to 20k have to be paid by the equity holders as well.

I was simplifying for sake of well.. simplicity.

Ultimately, if we assume that the original borrower is paying a realistic market rate taking full account of the risk of default, none of the tranche holders are actually getting an acceptable return for the risk involved, because otherwise the middleman could not possibly make a profit...

[ockham]

I was simplifying for sake of well.. simplicity.

Ultimately, if we assume that the original borrower is paying a realistic market rate taking full account of the risk of default, none of the tranche holders are actually getting an acceptable return for the risk involved, because otherwise the middleman could not possibly make a profit...

The reason for selling the debts off is not necessarily for profit. The fundamental reason is to get the stuff of the balance sheet, and reduce capital costs.

[Lone_Twin]

Banks 'warehouse' the debts in a big, well 'warehouse' waiting to be packaged up and sold on. The huge losses we are seeing at the moment correspond to the securities they were unable to sell on. Any other losses will be taken by the purchasers.

Are the ones the banks hold.

.

1. The Good ones they thought would pay a a good income and not default?

1. The Crap they have never been able to sell?

1. Ones based on recently made loans that people arent buying due to increased percieved risk in these products?

.

And the really big question. WHo has been the biggest buyer of all this rubbish, going on past performance

I am going to say pensions but am I right?

.

ST

[ockham]

And the really big question. WHo has been the biggest buyer of all this rubbish, going on past performance

I am going to say pensions but am I right?

That's the million dollar question. Or should I say the trillion dollar ... The problem is that no one knows. As I've commented before, if you look at the publicly available information on the annual statement, it says something like 'debt securities' held as assets. It almost never says what the 'true' investment grade is. Indeed, why should it? A lot of institutions have mandates of 'governance' that dictates they should only invest in safe AAA low-risk securities, so as long as they have fulfilled the mandate, why should they report any different? So we only know when one of these is downgraded.

I'm not sure anyone in the industry knows either.

[gavp]

So why are the banks in trouble if all the sh1t3 debts have been farmed out?

Twofold:

1) Many of thbese bad debts have been bought be investment funds owned by the major banks which is why the likes of Citibank are having to write off billions of dollars.

2) Smaller mortgage banks like Northern Rock do business by issuing mortagages and then selling the debt on. If no-one wants to buy these debts then they don't have much of a business left.

[ockham]

1) Many of thbese bad debts have been bought be investment funds owned by the major banks which is why the likes of Citibank are having to write off billions of dollars.

Wrong. An investment fund holds none of those funds on its balance sheet. The fund is just the manager. It has 'discretion' or power of attorney for the fund vehicle, but doesn't own any of the assets itself.

The main owners of investment funds are pension holders, you and me. I'm not sure if pension funds actually hold any of the toxic stuff.

[danlightbulb]

Thanks for all replies so far. Obviously a complicated issue.

I'm still a bit confused though.

Lets say i borrow £100k from the rock at 6%. Over 25 years I would pay back about double that, £200k.

So the rock sell my loan to citibank for £120k and makes £20k straight profit.

Citibank makes £80k profit (ultimately, over the full 25 years). £200k - £120k.

How does citibank recieve my monthly payments (which are still being paid to the rock)?

What happens in 5 years when I remortgage and pay off the original loan - no where near £200k paid up to that point.

Futhermore, the 'package' sold to citibank is probably 100's of loans packaged up. How does citibank know which houses these loans are secured on? Everytime the issue of selling on loans is mentioned it is always said that the buyer doesn't know what 'bad debts' are in the package. But to be recieving the payments there must be a trace back to the original mortgagee, somewhere?

And how are the monthly payments collected when the debt is sold again, and again and again. The debt may be owned by someone in Dubai, packaged into god knows how many loan combinations, but how do they receive my monthly payment?

Thanks

[ockham]

Thanks for all replies so far. Obviously a complicated issue.

No, it's not particularly complicated. The problem is that a lot of people on this forum don't know what the f--k they are talking about. (Sorry, it had to be said).

I'm still a bit confused though.

Lets say i borrow £100k from the rock at 6%. Over 25 years I would pay back about double that, £200k.

So the rock sell my loan to citibank for £120k and makes £20k straight profit.

As I explained above, whoever told you that had no clue what s/he was talking about.

How does citibank recieve my monthly payments (which are still being paid to the rock)?

If the administration rights have not been sold (see my post above) then everything is as before. You don't know that your debt has been sold on. If it has, then you will get a letter of some kind telling you about this. It would not normally affect the details of your payments, because these will be to a service company of some kind, which now has a new owner.

What happens in 5 years when I remortgage and pay off the original loan - no where near £200k paid up to that point.

The economic details of your mortgage will be identical, unless you have opted to change. Legally, no one can change the terms of your original contract (which is a legal contract, of course).

Everytime the issue of selling on loans is mentioned it is always said that the buyer doesn't know what 'bad debts' are in the package. But to be recieving the payments there must be a trace back to the original mortgagee, somewhere?

Of course the buyer knows what is in the packate, or at least will have that information. A loan book contains every single detail of every single mortgage.

Hope this is helpful. Sorry for any rudeness.