I memorised that “Collateral for secured amortizing assets does not change in composition, but the composition of collateral for secured non-amortizing assets does change.” but could some smart gig explain this to me esp the collateral loan bit. For example if the mortgages (colletaral) are $100m and the securitised amortized loans are $100m. After a few years, say $80m principal is paid back and only $20m is outstanding, is the statement saying that the collateral of $100m remains the same?? Is this the right intepretation??
Amortizing Assets which act as collateral are those with scheduled principle and interest repayments (Think some mortgages, Auto-Loans etc).
Non-Amortizing Assets do not typically have scheduled principle repayments (Think credit card balances).
Therefore when these scheduled P+I payments come down for amortizing loans , they get passed on to the security holders. There is no reinvestment in new Collateral with those payments; the collateral composition doesn’t change (aside from defaults/prepayments).
On the other hand, when P+I payments come in on Non-Amortizing assets, they can be used to reinvest in more, example, credit card receivables. Therefore the collateral composition does change. Whether or not they are reinvested is based on the time since inception of the security. There is a lockout/revolving period where all proceeds are reinvested.
Does that help?
Thanks Kman2001. But i still cant understand why the colleral wont change for amortizing loans I have re-worded my question and included an example. Could you please assist ?
Let’s say you have an MBS and it’s backed by 100 loans to individual homeowners, for $100 each. In 5 years, each of those 100 borrowers has paid off their mortgage by $20. Your MBS is now backed by the same exact 100 borrowers, but has amortized down by 20%. This is what “collateral not changing for amortizing loans” means. It simply means the loans in the pool are the same as at original issuance of the MBS (just with a lower balance due to payments).
Thanks once again. So for non-amortizing loans what would happen to the 100 loans,if we are to use the same example above? I understand no payment of principal before lock-out period. Would the principal payments received be invested in new collatel say instead of 100 loans backing the securitization, the loans are now 115??
No, you’d just have 100 loans to different people, with the same original balance. As opposed to 100 loans to the same people, with different balances.