I am still confused about defaul risk on those mortgage backed securities. If an underlying mortgage defaults or the house is foreclosed, who will take the loss? The loan originator looks lucky since he might sell those mortgages to others. If the mortgages have been securitized and sold as MBS/ABS, it seems to me that the bond issuer shall take the loss (default risk?). What about the bond investor? What is the usual pratice when only a small part of mortgages are default, will the bond issuer takes the house and keep paying the interest/principal? If the bond issuer defaults, will the investor take the house? Thnaks a lot.
FI investors would take the loss, that’s part of the investment risk they have to accept when investing in MBS or ABS type of securities. The securities sellers could also take a loss if their securities got downgraded. (But that would be a downgrade risk, not a default risk.)
Thanks. If the underlying mortgages default, will the MBS investors take the preceeds from the foreclosed house sale? What loss will the mortgage lender take(the mortage has been packaged in an MBS) in this case?
Of course the owner of the bad tranche takes the loss. What do you think is happening in the world right now. Servicer might take some hit depending on the servicing agreement. Also depends on how the bond is structured and which tranche gets hit first. But the investor who owns the bond takes the hit.
this isn’t really default risk. Default risk is the risk that you either wont get your interest payments or principal back. Just because one mortgage or underlying asset in the pool defaults it does not mean you wont get your money back. It all depends on where you are in the structure. In all deals there will be some form of credit enhancement to absorb the first losses. This may be in the form of subordination, letters of credits, excess spread, or some insurance from other parties etc etc. Subordination works in that lower tranches (which will also be lower credit rated) will absorb all the losses before your tranche takes any. Excess spread is where the interest the securitisation recieves from the mortgages or credit card loan or whatever the asset is, is higher than the interest paid to the investors/bond holders. Ultimately if all the mortgages in the pool defaulted the top tranches may still get their money back if enough of the monies are recovered. But the lower tranches wouldn’t.