Mortgage Pass-through Securities: Characteristics and Risks

  • Mortgage Pass-through Security: shares in a pool of mortgages sold by a financial institution or government agency, where mortgage payments less fees are passed through to the security investors.

  • A mortgage pass-through security is a type of MBS.

  • Following issuance, pass-throughs can be resold by investors on the secondary market.

Pass-through Rate = Mortgage Rate - Service Fee

  • Note that while mortgage payments are due on the first of the month, investors do not receive the pass-through payment for several days thereafter, enabling the servicing institution to collect several days worth of interest (which is called the "float").

  • WAC = weighted average coupon rate of the mortgages in the security pool

  • WAM = weighted average of maturity of the mortgage in the security pool

Pass-through Types

  • Agency Pass-throughs: Guaranteed by U.S. government agencies (Fannie Mae, Freddie Mac, and Ginnie Mae).

  • Technically, Fannie Mae and Freddie Mac pass-throughs are corporate and do not carry the full faith and credit of the U.S. government, but there has been considerable debate over the "implied backing" of these securities.

  • Mortgage Pass-throughs: Issued by Ginnie Mae and Fannie Mae

  • Participation Certificates: Issued by Freddie Mac

  • Conforming Mortgages: Meet standards to obtain agency backing

  • Jumbo Mortgages: Mortgages that do not qualify for agency backing because of their size (too large)

  • Non-agency Pass-throughs: Are issued by private financial institutions and do not have the backing of a government agency; the mortgages in a non-agency pass-through are usually non-conforming.

Risks of Mortgage Pass-through Securities

  • Interest Rate Risk: As rates rise, the security's value will fall.

  • Prepayment Risk: Because mortgages can usually be prepaid at any time without penalty, mortgages essentially take the form of a callable bond that has a strike price at par.

  • Prepayments are unpredictable, but directionally they increase as interest rates fall and decrease as interest rates rise.

  • Prepayment risk is form of reinvestment risk, as the investor will be forced to re-invest at lower interest rates.

  • MBS securities exhibit negative convexity as a result of the ability to prepay.

  • Credit Risk: Agency securities tend to have low credit risk.

Membership
Learn the skills required to excel in data science and data analytics covering R, Python, machine learning, and AI.
I WANT TO JOIN
JOIN 30,000 DATA PROFESSIONALS

Free Guides - Getting Started with R and Python

Enter your name and email address below and we will email you the guides for R programming and Python.

Saylient AI Logo

Take the Next Step in Your Data Career

Join our membership for lifetime unlimited access to all our data analytics and data science learning content and resources.