abstract finance: lending and investing in a dissembled, automated world james b. heian, accounting...
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![Page 1: Abstract Finance: Lending and Investing in a Dissembled, Automated World James B. Heian, Accounting February 20, 2008 Copyright James B. Hein 2008](https://reader035.vdocuments.us/reader035/viewer/2022072010/56649da95503460f94a96c45/html5/thumbnails/1.jpg)
Abstract Finance: Lending and Investing in a Dissembled, Automated World
James B. Heian, AccountingFebruary 20, 2008
Copyright James B. Hein 2008
![Page 2: Abstract Finance: Lending and Investing in a Dissembled, Automated World James B. Heian, Accounting February 20, 2008 Copyright James B. Hein 2008](https://reader035.vdocuments.us/reader035/viewer/2022072010/56649da95503460f94a96c45/html5/thumbnails/2.jpg)
A Giant Abstraction Old-bank/s&l at risk-three c’s
(collateral, credit-worthiness, character) Many banks/s&ls, local focus
New-technology puts space and time between those at risk (investors-lenders) and customers-borrowers Few giant players, global focus
Losses-$120 todate; $400 possible
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Major Lenders/Originators
Fannie Mae-FNM
FreddieMac-FRE Citicorp-C
Bank of America-BAC
Country-wide-CFC
Founded 1938 1970 1813 1874 1969
Assets 843 813 1,884 1,460 200
Liabilities 802 785 1,764 1,325 186
Equity 41 28 120 135 14
Equity/assets 4.9% 3.4% 6.4% 9.2% 7.0%
Revenue 43.6 43.1 147.6 117.0 24.8
Expenses\ 39.5 40.9 126.1 95.9 22.1
Net income 4.1 2.2 21.5 21.1 2.7
Revenue/assets 5.2% 5.3% 7.8% 8.0% 12.4%
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Loan Origination
Good Old Days!
Customer-Bank/S&L
Loan application-30 yr; 80% loan/value
Credit assmnt
Wild West Today! Customer-Loan
broker Loan application-
ARM, Fixed rate Credit assmnt-
FICO
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Technology: Loan Characteristics Loans can be written with various
cash flow characteristics: Standard fixed rate fully amortizing Variable rate Interest only for period Increasing cash payment Balloon payments
Computer calculations enable variety
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Risk Assessment-Borrower
Nationwide credit reporting agencies- Experian, Equifax, TransUnion Giant databases--errors and omissions
common FICO score (Fair Isaac-late 1950’s)
Appropriate for short-term consumer credit--less reliable for mortgage lending
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Loan Origination
Good Old Days!
Appraisal-local/MAI
Loan committee
Abstract/title insnce
Wild West Today! Appraisal-drive
by; database Financing
commitment Title insurance
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Risk Assessment-Property Value Property Valuation-appraisal factors
Highest and best use; Location; Size; Cost; Condition; Income from; Assessment
Comparable values-recent sales Appraisal Institute (MAI) Values inflated in contrast with history
Current studies indicate property values 25% too high in selected areas
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Risk Assessment-Property Rights Title to property-fee simple Real property rights
Water Mineral, timber, farming, grazing, hunting,
air, etc. Easements Development
Liens against property-taxes, assessments
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Risk Abatement: Property Title Insurance
Title insurance--guarantees title as specified in the purchase/sale contract
Firms tied to major lenders Four major title insurance firms >
80% of market Giant databases of ALL county
records—mirror image
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Risk Abatement-Private Mortgage Insurance for Non-conforming Loans
PMI-Private Mortgage Insurance-for loan/value > 80%
Primary insurers (Mortgage Insurance Company-MIC) AIG United Guaranty, Genworth MC,
Mortgage Guaranty Insurance Corporation (MGIC), PMI MICo., Republic MIC, and Triad Guaranty IC.
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Loan Origination
Good Old Days!
Funding Closing-Bank/S&L
Wild West Today! Funding from afar Closing-attorney
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Sale and Servicing
Good Old Days!
Bank sold % Bank serviced
loan
Foreclosures rare
Wild West Today! Loans sold 100% Servicing by
major entity Foreclosures
common
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Securitization
Packagers clump loans owned by Countrywide, major banks, and others,
Packages underwritten by major investment banking houses and sold to investors Citicorp, Merrill Lynch, Bear Stearns,
hedge funds, municipalities
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Risk Assessment-Agencies Assess Overall Default Risk
Credit rating agencies for corporations: Moody’s, Standard and Poor’s, Fitch
Assess probability of loan default with respect to clump of loans (CDO)
Market concentrated! (Three firms)
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Risk Abatement-Insurance for CDO Investors
Two major firms and others provide insurance against defaults for CDO’s AMBAC (ABK) MBIA Inc (MBI) Security Capital Assurance (SCA)
$2.3 Trillion at risk
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Technology: Systems for Payment Processing (Servicing)
Major banks/financial institutions service or bookkeep loans—collect payments from borrowers; split into principal, interest, fees, etc; remit to owners Countrywide-$1.2 trillion; fee 1-25
basis points for efforts
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Incentives to Over-lendThose who win: Loan originators (Banks and others)-earn fees
based on volume of $ lent Underwriters forming portfolios for sale-earn
fees to package and sell based on volume of $ offered
Rating agencies-considered loans to be low risk; earn fees based on packages sold
Those who lose: Investors (Including Banks that hold loans) CDO insurers--earn fees based on amount
insured Taxpayers??!!
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Conclusion Sophisticated, complex industries grown up to
support Lending Investing in debt instruments
Including risk assessment and risk abatement firms
Conflicts of interest and mis-pricing of risk common!
Highly concentrated industries—brokers, lenders, credit ratings, title insurers, etc.
ABSTRACTIONS of those at risk from those assuming risks!