Mortgages hedging

Collateral cover is now calculated with reference to market value as well as nominal value, enabling greater transparency and precision in the calculation of cover. Both these amendments benefit the Pfandbrief investor in the event of the insolvency of a mortgage bank, there would be no netting of derivatives, which would therefore continue to protect the cover pools and allow the banks to hedge against adverse market conditions that could cause their paper to suffer credit deterioration. 

There is a loan-to-value limit imposed of 60% for residential mortgages and 100% for public sector loans and hedging contracts against interest rate risk are permitted in the collateral pool. 

Pricing and hedging mortgage-backed securities are complex subjects. The following sections present a brief introduction. Readers interested in more-in-depth discussions should consult the Reference section for appropriate texts. 

Much of this activity took place out of public view in the closed and largely unregulated world of hedge funds and investment banks. The investment banks were subject to modest debt-to-equity requirements that SEC promulgated to protect shareholders from fraud. At the urging of the big five investment banks, however, SEC in April 2004 relaxed the requirements to allow investment banks to use their models to set their own minimum capital reserves. As the banks poured more and more resources into mortgage-backed securities, leverage rose dramatically from debt-to-equity ratios of 12 1 to ratios of 30-40 1. With capital reserves at historic lows, the investment banks were in no position to survive the crisis of confidence that hit the industry in the late summer of 2008. ... 

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