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1.
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Definition
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In
finance, a mortgage-backed security (MBS) is an asset-backed
security whose cash flows are backed by the principal and interest
payments of a set of mortgage loans. Payments are typically made
monthly over the lifetime of the underlying loans.
Residential mortgagors in the United States have the option to pay
more than the required monthly payment (curtailment) or pay off the
loan in its entirety (prepayment). Because curtailment and
prepayment affect the remaining loan principal, the monthly cash
flow of a MBS is not known in advance, and therefore presents an
additional risk to MBS investors.
The yield on mortgage-backed securities
is typically higher than that on comparable Treasury notes or bonds,
in large part as a result of the premium associated with the
prepayment risk imbedded in pass-through mortgage securities.
Mortgage arbitrage Portfolio Managers typically take long
mortgage-backed positions and attempt to hedge interest-rate,
prepayment and other risks. Substantial profits may be realized if
the Portfolio Manager is able to purchase undervalued securities and
hedge properly against interest rate prepayment and other risks.
Other Resources:
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The Investment Funds
Institute of Canada:
Certificates that represent ownership in a pool of mortgages.
The holders of these securities receive regular payments of
principal and interest.
More…
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Georgia Real Estate:
Securities purchased by investors that are secured by mortgages.
Such securities are also known as pass-through securities since
the debt service paid by the borrower is passed through to the
purchaser of the security.
More…
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Home Mortgage of North
Carolina:
Bond-type investment securities representing an undivided
interest in a pool of mortgages or trust deeds.
More…
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ABN AMRO Asset Management:
Securities backed by Ginnie Mae, Fannie Mae and the Federal Home
Loan Mortgage Corporation (Freddie Mac).
More…
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Options Learning Center:
An investment that is backed by a share of a pool of home
mortgages. Mortgage-backed securities pay monthly income, which
is a combination of interest and a portion of the principal of
the underlying mortgages.
More…
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Mortgage Trust Group, Inc.:
Bond-type investment securities representing an undivided
interest in a pool of mortgages or trust deeds.
More…
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Encyclopedia of Finance:
are securities issued by federal agencies to help fund their
projects.
More…
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SEC.gov:
Mortgage-backed securities (MBS) are debt obligations that
represent claims to the cash flows from pools of mortgage loans,
most commonly on residential property.
More…
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2.
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Examples, Types, or
Variations
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Mortgage-backed security sub-types include:
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Pass-through mortgage-backed security is the simplest MBS,
as described in the sections above. Essentially, a
securitization of the mortgage payments to the
mortgage originators. These can be subdivided into:
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Residential mortgage-backed security (RMBS) is a
pass-through MBS backed by mortgages on
residential property
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Commercial mortgage-backed security (CMBS) is a
pass-through MBS backed by mortgages on
commercial property
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Collateralized mortgage obligation (CMO) is a
more complex MBS in which the mortgages are ordered into
tranches by some quality (such as repayment
time), with each
tranche sold as a separate security.
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Stripped
mortgage-backed securities (SMBS): Each mortgage payment is
partly used to pay down the loan's
principal and partly used to pay the interest on
it. These two components can be separated to create SMBS's,
of which there are two subtypes:
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Interest-only stripped mortgage-backed securities (IO
SMBS) is a bond with cash flows backed by the interest
component of property owner's mortgage payments.
Principal-only stripped mortgage-backed securities (PO SMBS) is
a bond with cash flows backed by the principal repayment
component of property owner's mortgage payments.
Commercial mortgage-backed securities (CMBS) are secured by
commercial and multifamily properties (such as apartment buildings,
retail or office properties, hotels, industrial properties and other
commercial sites). The properties of these loans vary, with
longer-term loans (5 years or longer) often being at fixed interest
rates and having restrictions on prepayment, while shorter-term
loans (1-3 years) are usually at variable rates and freely
prepayable.
Covered bonds: In Europe exists a type of asset-backed bonds
called "covered bonds" (commonly known by the German term
Pfandbriefe). Pfandbriefe were first created in 19th century Germany
when Frankfurter Hypo began issuing mortgage covered bonds. The
market has been regulated since the creation of a law governing the
securities in Germany in 1900. The key difference between
Pfandbriefe and mortgage-backed or asset-backed securities is that
banks that make loans and package them into Pfandbriefe keep those
loans on their books. This means that when a company with mortgage
assets on its books issue the covered bond its balance sheet grows,
which it wouldn't do if it issued an MBS, although it may still
guarantee the securities payments.
Other Resources:
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TheStreet.com:
The first thing you should know about mortgage-backed securities
funds is that there are three types.
More…
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SEC.gov:
Mortgage-backed securities exhibit a variety of structures. The
most basic types are pass-through participation certificates,
which entitle the holder to a pro-rata share of all principal
and interest payments made on the pool of loan assets.
More…
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3.
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Formula
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4.
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Related Terms
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Mortgage Pass-Through
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Mortgage Backed Certificate
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Fannie Mae
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Ginnie Mae
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Freddie Mac
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Mortgage
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Pass-Through Security
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REIT
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5.
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As
Used in the Hedge Fund World
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Reasons for issuing mortgage-backed securities:
There
are many reasons for mortgage originators to finance their
activities by issuing mortgage-backed securities.
Mortgage-backed securities...
1. transform
relatively illiquid, individual financial assets into liquid and
tradeable capital market instruments.
2. allow
mortgage originators to replenish their funds, which can then be
used for additional origination activities.
3. are
frequently a more efficient and lower cost source of financing
in comparison with other bank and capital markets financing
alternatives.
4. allow
issuers to diversify their financing sources, by offering
alternatives to more traditional forms of debt and equity
financing.
allow issuers
to remove assets from their balance sheet, which can help to
improve various financial ratios, utilize capital more
efficiently and achieve compliance with risk-based capital
standards.
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6.
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Applications
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Most
traders and money managers use Bloomberg and Intex to analyze MBS
pools. Intex is also used to analyze more esoteric products. Some
institutions have also developed their own proprietary software.
TradeWeb is used by the largest bond dealers ("primaries") to
transact round lots ($1 Million+).
For "vanilla" or "generic" 30-year pools (FN/FG/GN) with coupons of
4.5% - 7% one can see the prices posted on a TradeWeb screen by the
primaries called To Be Announced (TBA). This is due to the actual
pools not being shown. These are forward prices for the next 3
delivery months since pools haven't been cut . - only the issuing
agency, coupon and dollar amount are revealed. A specific pool whose
characteristics are known would usually trade "TBA plus {x} ticks"
or a "pay-up" depending on characteristics. These are called
"specified pools" since the buyer specifies the pool characteristic
he/she is willing to "pay up" for.
A
mortgage-backed security (MBS) is similar to a
bond
whose cash flows are backed by
mortgage
payments. In the United States, mortgages may usually be prepaid
in their entirety at any time. This is called
prepayment. This means that the duration of the cash
flows is unknown, which makes an MBS more interesting than plain
vanilla bonds. An MBS is an
asset-backed security where the assets are mortgages.
The
MBS market:
The high
liquidity
of most mortgage-backed securities means that any investor
wishing to take a
position
need not deal with the difficulties of theoretical pricing
described above; the price of any bond is essentially quoted at
fair value, with a very narrow
bid/offer
spread.
Reasons (other than
speculation) for entering the market include the
desire to hedge against a drop in
prepayment rates. (This is a critical business risk
for any company specializing in refinancing.)
Total market value of all outstanding MBS at the beginning of
2004 was reported to the National Secondary Market Conference ([1])
at over USD 2.75 trillion. This is much larger than the market
value of outstanding
asset-backed securities The MBS market overtook the
market for
US
Treasury notes and
bonds
in 2000.
According to
Thomson
Financial League Tables, US issuance was:
·
2004:
USD 729 billion (1,121 issues)
·
2003:
USD 904 billion (1,203 issues)
·
2002:
USD 767 billion (980 issues)
·
2001:
USD 586 billion (837 issues)
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7.
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Misused & Abused
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Other Resources:
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TheStreet.com:
Rising interest rates can also hurt the mortgage-backed
investor, as they have this year. Mortgage-backed securities are
valued based on an assumption about the rate at which homeowners
will prepay.
More…
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
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