This document provides information about mortgage-backed securities and the securitization process. It defines key terms like mortgages, MBS, and special purpose vehicles. It describes the major players in securitization like borrowers, originators, trustees, servicers, issuers, investors, and rating agencies. It explains how MBS are issued through an SPV and the types of MBS like pass-through, stripped, and collateralized mortgage obligations. Finally, it outlines regulations and guidelines from the SECP and SBP for entities involved in securitization.

1. GROUP MEMBERS:
Qandeel Basharat(F11ba148)
Fizza Karamat(F11ba139)
Maria Ahmad(F11ba156)
Aqsa Attiq(F11ba149)
Rimsha Naeem(F11ba150)

2. Mortgage-backed Securities

3. WHAT IS A MORTGAGE?
 An agreement under which a person borrows money to buy
property, and the lender may take possession of the property if
the borrower fails to repay the money.

4. MBS DEFINED:
 Mortgage-backed securities, called MBS, are bonds secured by
mortgage loans. They are created when a number of these
loans, are pooled together.
 Mortgage bonds characteristics:
 Coupon is interest and principal on monthly basis.
 Collect principal each month not at the maturity.

5. SECURITIZATION:
 Securitization is the process of taking an illiquid asset, or
group of assets, transforming them into a security.
 A typical example of securitization is a mortgage-backed
security (MBS), that is secured by a collection of
mortgages.
 Securitization will not takes place without the SPV/SPE.

6. MAJOR PLAYERS IN
SECURITIZATION.
 Borrowers: The borrowers are responsible for payment
of interest and principal to the loan originator.
 Originators: Institution that lends mortgage to
borrowers. And also transfer the pool of assets to the
issuer(SPV).
 Trustee: The trustee is a third party retained for a fee to
administer the trust/SPV that holds the underlying assets
supporting a mortgage-backed security.

7.  Servicer: Company that receives payments from
borrowers.
 Issuer: usually SPV/SPE that handles securitization.
 Investors: Trade in MBS.
 Rating agencies: Rate the securities issued by special
purpose entity.

9. HOW MBSS ARE ISSUED:
1. Seller (typically a mortgage lender) extends mortgage
loans to borrowers.
2. Seller and a trustee creates an entity called
(SPE/SPV).
3. Seller then sells a group, or "pool" of assets (mortgage
loans) to the SPE. The payment it receives in exchange
for the loans replenishes the funds used to make the
original loans. Those funds now are available to the
lender for other uses, including making loans to other
potential homeowners.

10. 4. Based on the income stream expected from the
mortgages held in the SPE, the SPE issues securities.
The securities that the SPE issues are called
"mortgage-backed securities" ("MBS") because they
are backed by the pool of mortgage loans that the SPE
holds.
 The monthly principal and interest to be received from
the mortgage borrowers will be used to make monthly
principal and interest payments to investors in the issued
securities.

11.  These securitization SPEs are considered “bankruptcy
remote” .The SPV makes its obligations secure even if
the parent company goes bankrupt.
 An SPV, or a special purpose entity (SPE), is a legal
entity created by a firm (known as the sponsor or
originator) by transferring assets to the SPV, to carry out
some specific purpose. SPVs have no purpose other than
the transaction(s) for which they were created, and they
can make no substantive decisions; the rules governing
them are set down in advance and carefully circumscribe
their activities.

12. Types of MBS

13. PASS-THROUGH MBS
A pool of fixed-income securities backed by a
package of assets. A servicing intermediary collects the
monthly payments from issuers, and, after deducting a
fee, remits or passes them through to the holders of the
pass-through security.
There are two subtypes of pass-through mortgage backed
securities
 Residential MBS
 Commercial MBS

14. RESIDENTIAL MBS
A residential mortgage-backed security (RMBS) is
a pass-through mortgage-backed security backed by
mortgages on residential property such as mortgages &
home loans.
COMMERCIAL MBS
A commercial mortgage-backed security (CMBS)
is a type of mortgage-backed security backed
by commercial mortgages rather than residential real
estate. CMBS tend to be more complex and volatile
than residential mortgage-backed securities due to the
unique nature of the underlying property assets.

15. STRIPPED MORTGAGE-BACKED SECURITIES
A stripped mortgage-backed security (SMBS)
derive their cash flows either from principal payments or
interest payments on the underlying mortgages. These
two components can be separated to create SMBS's, of
which there are two subtypes:
 Principal-only (PO)
 Interest-only (IO)

16. PRINCIPAL-ONLY:
A principal-only stripped mortgage-backed security
is a bond with cash flows backed by the principal
component of property owner's mortgage payments.
INTEREST-ONLY:
An interest-only stripped mortgage-backed security
is a bond with cash flows backed by the interest
component of property owner's mortgage payments.

17. COLLATERALIZED MORTGAGE
OBLIGATIONS
A type of mortgage-backed security in which
principal repayments are organized according to their
maturities and into different classes based on risk.
Payments received from the mortgages is passed to
investors based on a predetermined set of rules, and
investors receive money based on the specific mortgages
invested in.

18. CONVENTIONAL MORTGAGE
A loan that is not guaranteed is a conventional
mortgage. i.e. the mortgage that does not have to be
insured against default and usually requires private
mortgage insurance. It is a loan that does not exceed 80%
of the purchase price or value of the home. It usually
requires 5% to 20% down payment.

19. INSURED MORTGAGE
A loan that is secured against any asset is insured
mortgage. When the borrower defaults in this event the
Federal and private insurance guarantees repayment of
the loan. To get backup line of credit, borrowers have to
pay insurance premium.

20. FIXED RATE MORTGAGE
A fixed rate mortgage is a loan for which the
interest remains the same through out the life of the
mortgage. They usually come in terms of 10, 15 or 30
years. The biggest benefit of having a fixed rate
mortgage is that the homeowner knows exactly when the
interest payments will be for the length of loan.
Homeowner knows that the rate will never change for
the duration of the loan this allows the homeowner to
budget easier. Cost of funds increases when the interest
rates are high in the market. When the rates go down the
homeowner is able to refinance.

21. ADJUSTABLE-RATE MORTGAGE (ARM)
Interest rate in adjusted rate mortgage is tied to
some other security and is adjusted periodically. A large
discount is given on the rate as a welcoming offer for the
first three months of the mortgage and the rate can be
adjusted monthly to reflect current rates.
The ratio between principal and interest
fluctuates but the mortgage payments remains
constant.You pay less interest and more principal when t
he interest rates are falling. If the rates are rising, less
principal and more interest is paid.

22.  THE COMPANIES(SECURITIZATION
RULES),1999.
PROVIDED BY SECP

23. PROHIBITION TO COMMENCE BUSINESS
WITHOUT REGISTRATION.--
No person shall commence business as a Special Purpose
Vehicle unless it is registered with the Commission under
these rules.

24. ELIGIBILITY FOR REGISTRATION
A person proposing to commence business as a special
purpose vehicle shall be eligible for registration under
this law:
(a) (i) it is registered as a public limited company under the
Ordinance having a paid up capital of not less than one
hundred thousand rupees; or
(ii) it is a trust duly formed under the Trusts Act, 1882
(II of 1882); or
(iii) it is a body corporate formed under any law for the
time being in force and owned or controlled, whether
directly or through a company or corporation, by the
Federal Government or a Provincial Government;

25. CONT…
(b) no director, officer or employee of such person has
been adjudged as insolvent or has suspended
payment or has compounded with his creditors or
has been convicted of fraud or breach of trust or of
an offence involving moral turpitude; and
(c) the promoters, directors and trustees of such person
are, in the opinion of the Commission, persons of
means and integrity and have special knowledge and
experience of matters to be dealt with by a Special
Purpose Vehicle.

26. REGISTRATION
(1) A person eligible for registration as Special
Purpose Vehicle may make an application to the
Commission for registration under these rules in
such form and with such documents, as the
Commission may notify.
(2) The Commission, if it is satisfied after making
such inquiry and after obtaining such information as
may be considered necessary, may grant a certificate
of registration to such person on such conditions as
may be deemed necessary.

27. CANCELLATION OF REGISTRATION
 (1) Where the Commission is of the opinion that--
(a) a Special Purpose Vehicle has contravened or
failed to comply with any provisions of the
Ordinance, or has otherwise neglected or failed to
comply with any requirement of these rules or has
failed or neglected to carry out its duties in
accordance with law; or
(b) if a Special Purpose Vehicle fails to make a public
offering within such time frame and in such
manner as may be specified by the Commission
while granting the certificate of registration,

28. CONT…..
(2) If a Special Purpose Vehicle fails to make a public
offering within such time frame as may be specified
by the Commission while granting the certificate of
registration, the Commission may, after affording a
reasonable opportunity of be heard by the such
Special Purpose Vehicle, cancel its registration.
(3) If the registration of a Special Purpose Vehicle is
cancelled under sub-rule (1), or, as the case may be,
under sub-rule (2), the Commission shall appoint an
administrator to manage the business of the Special
Purpose Vehicle.

29. CONDITION OF OPERATION
No Special Purpose Vehicle shall, --
(a) merge with, acquire or take over any other company or
business, unless it has obtained the prior approval of the
Commission in writing to the scheme of such merger,
acquisition or take-over;
(b) pledge any of the assets held or beneficially owned by
such Special Purpose Vehicle except for the benefit of
the investors;
(c) make a loan or advance money to any person except in
connection with its normal business;

30. (d) participate in a joint account with others in any
transaction;
(e) apply any part of its assets to real estate except property
for its own use;
(f) make any investment with the purpose of having the
effect of vesting the management, or control, in the
Special Purpose Vehicle; and
(g) give guarantee, indemnity or security for any liability of
a third party;

31. OBLIGATIONS OF SPECIAL PURPOSE
VEHICLE
A Special Purpose Vehicle shall --
(a) be obliged to manage its assets in the interest of the
investors in good faith and to the best of its ability and
without gaining any undue advantage for itself or any of
its related parties, connected persons or its officers;
(b) be responsible for the acts and omissions of all persons
to whom it may delegate any of its functions as manager
as if they were its own acts and omissions;
(c) keep at its registered office, proper books of accounts
and records to enable a complete and accurate view to be
formed of its assets, liabilities, income and expenditure;

32. (d) prepare and transmit its annual report, together with a
copy of the balance sheet and profit and loss account,
prepared in compliance with the requirements set out in
the Ordinance and the Schedules thereto, and the
auditor's report within three months of closing of the
accounting period to the investors;
(e) within two months of the close of the first half of its
year of account, prepare and transmit to the investors and
the Commission a profit and loss account for, and
balance sheet as at the end of that half year, whether
audited or otherwise;
(f) keep a register of investors at its registered office;

33. ADVERTISEMENT AND INVITATIONS
(1) Advertisements and other invitations to the public to
invest in a scheme, including public announcements,
shall be submitted to the Commission for approval prior
to their issue.
(2) The approval so granted may be varied or withdrawn by
the Commission after giving an opportunity of being
heard to the Special Purpose Vehicle.

34. Special Purpose Vehicle and the Originator to be
independent:
Originator shall not be a connected person to the
Special Purpose Vehicle.

35. STATE BANK OF PAKISTAN GUIDELINES
circular issued @
November 14, 2002
Assets Securitization
through
Special Purpose Vehicle (SPV)

36. GENERAL GUIDELINES
The guidelines say that the banks and DFIs participating
in securitization deals shall ensure that:
 They do not own any share capital in SPV
 The SPV and ABS (assets backed securities) issued by it
do not carry the same or similar name as that of the
bank/DFI.
 All transactions between them and SPV are conducted at
arms length and are market based.

37. ADMINISTRATOR/TRUSTEE/SERVICING
AGENT
According to the guidelines the banks/DFIs playing the
role of administrator/trustee/serving agent will be
responsible for collection of the assigned/purchased
receivables, defraying them to investors and taking
appropriate enforcement action when necessary to ensure
their payment.
 The bank/DFI should have clearly defined process flow
and roles and responsibilities of personnel needed to
carry out these activities.
 There should be a written contract/agreement between
the bank/DFI, originator and SPV specifying the services
to be provided.

38. ADMINISTRATOR/TRUSTEE/SERVICING
AGENT
 The bank/DFI shall place in record the written opinions
from its legal advisers that the terms of agreement
protect it from any liability to investors in the
securitization transaction or the SPV.
 The bank/DFI may receive a performance-related
payment, or benefit from any surplus income generated,
in addition to its base fee.

39. INVESTORS
The banks/DFIs acting as investors will have to comply with the following
guidelines:
 The banks/DFIs holding asset backed securities (ABS) have risk exposure to
these underlying ABS assets.
 The banks/DFIs shall invest in only those ABS which are listed on the stock
exchange and have a minimum credit rating of A or equivalent.
 Total exposure of a bank/DFI towards ABS issued by a SPV shall not exceed
5 per cent of its own paid-up capital or 15 per cent of the total value of the
ABS issued by a SPV — whichever is less. Further, the aggregate exposure
on account of ABS shall not exceed 20pc of the total paid-up capital of the
bank/DF I.
 For capital adequacy purposes, the banks holding ABS shall treat them at par
with investment in TFCs.
 The banks/DFIs will not invest in ABS in cases where originator/the
company setting up the SPV is defaulter of any financial institution.

40. ORIGINATOR
The banks/ DFIs under this role would act as supplier of the
assets/receivables that are securitized.
 The banks/DFIs can securitize their assets relating to lease financing (with
acknowledged assignment of lease rental proceeds), mortgage financing and
toll financing (for infrastructure developmental projects).
 The securitizing bank/DFI shall ensure that there are no impediments that
prevent the transfer of the assets or the rights in relation to such assets to an
SPV.
 The securitizing bank/DFI must have legal and accounting opinions on
record to the effect that it has retained no liability for the loans so securitized.
 The securitizing bank/DFI must ensure that it is not obliged to support any
losses suffered by investors in the ABS issued by the SPV.
 The assets should be transferred at fair value. A fixed amount of
consideration for the securitized assets must be received not later than the
time of the transfer of the assets.
 The securitizing bank/DFI shall have no obligation to purchase any
securitized assets at any time.

41. ORIGINATOR
 The securitizing bank/DFI shall not support any loss arising from the
securitization transaction or by investors involved in it. It will also
not bear any of the recurring expenses of the transaction.
 The securitizing bank/DFI shall not underwrite or invest in the ABS
issued by the SPV.
 the originator must effectively transfer all rights and obligations in
the underlying assets to the SPV and should not retain any residual
beneficial interest in the underlying assets
 The originator thus should not have any director, officer or employee
on the board of the SPV
 An SPV must have no recourse to an originator for losses arising
from those assets.
 Investors must be informed that their holdings of ABS are subject to
investment risk, including repayments or interest rate risks, possible
delays in repayments and loss of income, principal invested, etc.

42. UNDERWRITER
 Banks/DFIs can underwrite the ABS issued by an SPV.
However, its share should not exceed 5 per cent of its
own paid-up capital or 15 per cent of total value of the
ABS — whichever is less.

43. BENEFITS OF MORTGAGE
SECURITIZATION
 Attracts new capital to the market, improves overall
liquidity and keeps rates low.
 Transforms relatively illiquid, individual financial assets
into liquid and tradable capital market instruments.
 Allow mortgage originators to replenish their funds,
which can then be used for additional origination
activities.
 Frequently a more efficient and lower cost source of
financing in comparison with other bank and capital
markets financing alternatives.

44. ISSUES OF MORTGAGE SECURITIZATION
 Increased Risk Taking When banks hold the mortgages they write,
there is a good chance those banks will be very careful about to
whom they loan money, because if those mortgages go bad, the
banks are responsible for them. But when mortgages are securitized
and sold, the risk inherent in those mortgages is shifted to the buyers
of the mortgage-backed securities. This can entice some banks to
take more risks than they should, since they no longer have to suffer
the default if the mortgage goes bad.
 Potential for Fraud Packaging dozens or even hundreds of
mortgages into a mortgage-backed security can come with the
potential for fraud. The end buyers of these securities might have
trouble working out exactly what they own, and if the mortgages
used to build the security are not quality instruments, the security
itself could be next to worthless. In addition, the value of mortgage-
backed securities could vary wildly along with the quality of the
mortgages held.

45. Role of PACRA in MBS

46. THE MBS RATING CRITERIA
CONCENTRATES ON THREE MAIN AREAS
 The credit quality of the loans and related security, which
reflects the experience and competency of the
underwriter as well as the loan characteristics.
 Structural features of the transaction, including the
transaction’s cash flows, tranching.
 Legal aspects of the transaction.

47. ORIGINATOR EVALUATION
PACRA conducts an on-site visit in our underwriting
evaluation where we run through the processes of the
origination of a mortgage (from submission of
application through to loan disbursement). PACRA
conduct interviews and discussions with key
management personnel and operations staff at critical
levels.

48. PACRAASSESSES DATA ON THE
FOLLOWING:
 Staffing such as levels of experience
 ongoing training and productivity incentives
 appraisal procedures are evaluated
 quality control issues are discussed to find out how well
an originator adheres to its own guidelines and
procedures

49. SERVICING
A key part of analysis is to determine the effectiveness of
servicer in managing portfolio delinquencies and
defaults.
Some of the key areas examined are:
 ƒMonitoring and Collection procedures
 ƒHistorical repossession and recovery rates
 ƒHistorical delinquency and default rates
 ƒPrepayments

50. FINANCIAL PERFORMANCE
CASH FLOW ANALYSIS
Collateral cash flow analysis considers the financial
structure and determines credit enhancement. PACRA
develops a base-case portfolio performance expectation,
which represents the anticipated performance of a
portfolio under a non-stressed economic scenario.
PREPAYMENT SCENARIOS
Prepayment plays an important role in determining how
much excess spread is generated within a transaction.
High prepayment levels reduce the available excess
spread, as interest income is no longer available from
prepaid loans.

51. INTEREST RATE SCENARIOS
Residential mortgages in Pakistan typically have
floating rates and are referenced to the KIBOR. RMBS
transactions, on the other hand, can be issued either on a
fixed-rate or floating-rate basis, and may be exposed to
interest-rate and/or basis risk. Floating-rate liabilities in
the meantime are typically referenced to inter-bank rates
e.g. the 6-month Karachi Interbank Offer Rate (6-m
KIBOR).

52. POOL CHARACTERISTICS ANALYSIS
Pool selection criteria play a very important role in
determining the quality of the pool.
Characteristics
 Loan-to-Value Ratio (LTV Ratio)
 Geographical Distribution
 Seasoning
 Borrower Profile and Diversification
 Original Tenure
 Loan Amount
 Loan Purpose

53. LEGAL STRUCTURE AND
DOCUMENTATION REVIEW
The purpose of this review is to assess the credit and
legal implications of the transaction structure. As part of
this review, issues considered include transferability of
assets, taxation issues including transfer tax, with
holding tax. When rating a securitization transaction,
particularly in an industry with no previous securitization
transactions or examples in the proposed asset class, an
understanding of the legal environment is vital.

54. PERFORMANCE ANALYTICS
Once a transaction has been closed, PACRA continues to
play a role in the securitization throughout the life of the
transaction.