THE NON-PARAMETRIC VALUATION OF THE COMMERCIAL MORTGAGE BACKED BOND (MBB)

Abstract

Abstract

Purpose – This paper introduces a comprehensive framework to enable an active secondary mortgage market in Singapore. The paper examines the determinants of the underlying mortgage affecting securitization in the form of the mortgage backed bond (MBB).

Design/methodology/approach – A theoretical model is formulated in conjunction with a structured Monte Carlo simulation. Scenario and sensitivity analyses form the meaningful dynamic aspect.

Findings – Results demonstrate that the prepayment rate, the default rate and the prevailing mortgage interest rate significantly impact the MBB total returns and the MBB viability in Singapore. Prepayments cause the NPVEQ (i.e. net present value of the residual of the mortgages pool maturity date), for the MBB issuer to fall, and to be targeted at a most favorable point to maximize benefit to the MBB issuer and investor. Defaults are important to the sinking fund balance because if defaults get too big, the fund is unable to pay back the face value to investors, and the MBB issuer suffers a loss. The holding period returns (HPR) are at a reasonable level in comparison to direct and indirect real estate investment assets. Holding period returns (HPR) are at a reasonable level in comparison to direct and indirect real estate investment assets.

Research limitations/implications – As the MBB promises periodic payments similar to a traditional debt security, changes in the market interest rates affect the MBB value. MBB investors are concerned with the return of the MBB face value at maturity. Whether or not the MBB issuers can address such a concern is largely dependent on the sinking fund balance at maturity. Adequate and appropriate credit enhancement lead to the potential of favorable credit ratings. The MBB can be so sold at a premium.

Practical implications – Traditional financing sources private for real estate developments are bank loans. The alternative of securitization raises funds against a designated pool of private real estate assets or income streams. Several financial and economic crises over the years prompted the search for securitization. It is imperative to take a close look at the nature of the MBBS total returns in the steady state.

Social implications – This paper closely looks at the MBB performance in the steady state via scenario generation and sensitivity analysis. It is meaningful for MBB issuers, investors and policy makers to enhance their MBB in-depth understanding.

Originality/value – This paper fulfils the need to closely look at the MBB performance in the steady state via scenario generation and sensitivity analysis, utilizing reasonable, meaningful, reliable and authoritative information and data. The MBB optimal performance is attained when the MBB sector is a complete market with many transactions, an established and long enough history.

Keywords: Securitization; mortgage backed bonds; structured Monte Carlo simulation; scenario analysis; sensitivity analysis; prepayment rate; default rate; mortgage interest rate.