Mortgage backed Securities

Mortgage-backed Securities (MBS) are Asset-backed Securities (ABS). The cash flows of Mortgage-backed Securities are supported by the interest payments and the principal of a collection or group of mortgage loans. Usually, monthly payments are made over the lifespan of the underlying loan.
In the United States, the residential mortgagors can avail the choice to make payments higher than the requisite monthly payment (Curtailment) or repay the loan completely (Prepayment).

As Prepayment and Curtailment impact the remainder of loan principal, it is not possible to know the monthly cash flow of an MBS in advance. It carries an extra risk for the MBS investors.

Issue of Mortgage-backed Securities carry the following advantages:
High liquidity and tradeablity
Portfolio Diversification
Wall Street Banks can implement Mortgage-backed Securities for monetizing the credit spread between the inception of an underlying mortgage (private market dealings) and the rate of return or yield asked by the Bond investors by the issue of Bonds (a public market dealing)
Highly effective and cheaper source of financing
Highly effective capital utilization and improvement of different financial ratios
The mortgage originators are able to do replenishment of their funds, which can later be implemented for further inception processes

The price of Mortgage-backed Securities are dependent on three uncertainty factors.

They are:
Default Risk (Credit Risk)
Interest Rate (IR) Risk
Risk of early redemption (Prepayment)

Mortgage-backed Securities can be categorized into the following types:

Pass-Through Mortgage-backed Security or Participation Certificates (PC) is the most basic form of MBS.

This can be categorized into two subtypes:
Residential Mortgage-backed Security (RMBS)
Commercial Mortgage-backed Security (CMBS) Collateralized Mortgage Obligation (CMO) or REMIC (Real Estate Mortgage Investment Conduits)

Stripped Mortgage-backed Securities (SMBS).

These can be categorized into two subtypes:
Interest-Only Stripped Mortgage-backed Securities (IO)
Principal-Only Stripped Mortgage-backed Securities (PO)
Callable Pass-Throughs
Callable Pass-Throughs in CMOs

Mortgage-backed Securities have a quite high credit rating. In the United States, the leading issuers of Mortgage-backed Securities include Fannie Mae, Ginni Mae, and Freddie Mac. Mortgage-backed Securities are available in minimum amounts ranging from $1,000 to $25,000 depending on the security issuer.


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Last Updated on : 26th June 2013

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