The following is the example discussed in the class. The solution is the next worksheet.
The rationale is indicated in the com
Consider a bank XYZ that was not in the business of originating residential mortgages in 2007, but plans to do so in 2008. As of
December 31, 2007, bank XYZ had a balance sheet as shown in Table 1. Among the few assets, the bank held consumer loans
totalling $500,000 and a cash position of $25,000. To finance its assets worth $525,000 the bank relies on traditional funding
sources of Deposits and Debentures totalling $483,[Link] is, of course, an additional source of funds: the shareholders
equity of $42,000.
Balace sheet of Bank XYZ, as of December 31, 2007
Cash $25,000 Deposits @1% $433,000
Consumer loans @8% $500,000 Debentures @ 9% $50,000
Capital $42,000
Total Assets $525,000 Total liabilities $525,000
For the 2008 operation this bank decides to originate $4,000,000 worth of mortgages with interest 6% and
origination fee of $80,000 and fund the operations entirely by attracting deposits and some additional capital. The
bank does not engage in any other lending activities. The lending also increases by $3,700,000 in addition to the
existing deposits of $433,000. Debentures remain same, while bank puts in additional capital of $300,000.
Now, consider a scenario that the bank decides to go for securitization. Suppose that the pace of origination is
smooth; that it originates $1,000,000 worth of new mortgages every three months. That is, the bank originates and
securitizes the newly originated mortgages four times a year. To facilitate the securitization process the bank
secures a warehousing line of credit from another financial institution. This line of credit is revolving @4% p.a. As
the bank originates the mortgages, it draws down the credit line. However, once the loans have been originated,
the bank sells the loans, only to replenish it again with the proceeds of selling the newly originated loans. In this
case the interest rate on mortgages remains the same and the Bank earns the same origination fees. The interest on
consumer loans also remains same. Additionally the Bank receives a servicing fee of 50 basis points on the principal
amount of mortgages. The interest on debentures and deposits remain same.
rationale is indicated in the comments inserted therefof.
but plans to do so in 2008. As of
s, the bank held consumer loans
ank relies on traditional funding
urce of funds: the shareholders'
with interest 6% and
additional capital. The
000 in addition to the
of $300,000.
pace of origination is
e bank originates and
on process the bank
evolving @4% p.a. As
have been originated,
iginated loans. In this
n fees. The interest on
points on the principal
Balace sheet of Bank XYZ, as of December 31, 2007
Cash $25,000
Consumer loans $500,000
Total Assets $525,000
Without Securitization
Balace sheet of Bank XYZ, as of December 31, 2008 w/o securitization
Cash $25,000
Consumer loans $500,000
Mortgage $4,000,000
Total Assets $4,525,000
Income
Interest on Mortgages - half of 6%interest on $5000,000
Interest on consumer loans - 8% on $600,000
Originantion fees -
Gross Income
Expense
Interest cost on Deposits - 1% interest on $433,000 and half of 1% on $3,700,000
Interest on debentures - 9% on $50000
Nett Income
With Securitization
Balace sheet of Bank XYZ, as of December 31, 2008 with securitization
Cash $25,000
Consumer loans $500,000
Total Assets $525,000
Income
Interest on Mortgages - 6%on $100000 for 6 months
Interest on consumer loans - 8% on $600,000
Originantion fees -
Servicing Income
Gross Income
Expense
Interest cost on credit lines - 4 times half of 1% on $100000
Interest cost on Deposits - 1% interest on $433,000
Interest on debentures - 9% on $50000
Nett Income
Deposits $433,000
Debentures $50,000
Capital $42,000
Total liabilities $525,000
Deposits $4,133,000
Debentures $50,000
Capital $342,000
Total liabilities $4,525,000
$120,000.0
$40,000
$80,000
$240,000
$22,830
$4,500 ROIC ROE
$212,670 4.7% 62.2%
Deposits $433,000
Debentures $50,000
Capital $42,000
Total liabilities $525,000
$30,000.0
$40,000
$80,000
$7,500
$157,500
($20,000)
($4,330)
($4,500) ROIC ROE
$128,670 24.5% 306.4%