Monday, November 7, 2011

MBS is a separate PnL from Mortgage lending

MBS is a completely separate PnL from Mortgage lending business. As explained in http://bigblog.tanbin.com/2011/11/buy-sidesell-side-business-units-in.html, a universal bank has commercial banking + security dealing business units. Such a bank often has a mortgage business and a MBS business. Citigroup is an example, where MBS is probably part of Institutional Client Group. It's important to realize the mortgage and MBS businesses have different books and don't necessarily depend on each other.

The mortgage lending business is older and simpler, much like a loan with collateral. The business starts with initial capital and profits by lending at an interest.
- It has realized PnL
- It has a lot of unrealized PnL
- It has significant risk in terms of default
- When housing prices tumble, all hell breaks loose. Borrowers default. Collateral devalues...

MBS business is more like a dealing desk in corp bonds. MBS business starts with its own capital, and profits by buying/selling "assets". Holding a mortgage "asset" is like holding a coupon-bearing bond with collateral. We need to very clear about the meaning of "asset" before we understand the MBS securitization process, which I will not discuss.
- MBS business can create MBS security from regular mortgage assets (raw material), and sell them
- MBS business can use as raw material mortgage assets by other mortgage lenders, and therefore decoupled from the mortgage department of the parent bank.
- MBS business can buy or sell existing MBS securities, possibly created by other MBS houses.
** Any trader can buy or sell existing MBS securities, but the MBS business probably does it with more purpose.
- MBS business probably should never create a mortgage by lending directly. That's the responsibility of the mortgage department of the parent bank.

MBS can profit while Mortgage business loses money - if the MBS trader is smart
MBS can lose while Mortgage business profits - if the mortgage lending officer is prudent.


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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin