About Freddie Mac (FHLMC)

About Freddie Mac (FHLMC)


In 1970, Congress created Freddie Mac with a few important goals in mind:

    * Make sure that financial institutions have mortgage money to lend

    * Make it easier for consumers to afford a decent house or apartment

    * Stabilize residential mortgage markets in times of financial crisis (reduce foreclosures)

    

To fulfill this mission, Freddie Mac conducts business in the U.S. secondary mortgage market – meaning we do not originate loans – and works with a national network of mortgage lending customers. We provide access to funding for mortgage originators and, indirectly, for mortgage borrowers. We have three business lines: a Single Family Credit Guarantee business for home loans; a Multifamily business for apartment financing; and an investment portfolio.


Our participation in the secondary mortgage market includes

    * Providing our credit guarantee for residential mortgages originated by mortgage lenders

    * Investing in mortgage loans and mortgage securities


Freddie Mac is operating under a conservatorship that began on September 6, 2008, conducting our business under the direction of the Federal Housing Finance Agency (FHFA).


Business Lines

a) Single-Family Credit Guarantee Business

In our Single-Family business, we use mortgage securitization to fund millions of home loans every year. Securitization is a process by which we purchase home loans that lenders originate, put these loans into mortgage securities that are sold in global capital markets, and recycle the proceeds back to lenders. This recycling is designed to ensure that lenders have mortgage money to lend. During 2009, Freddie Mac guaranteed $475 billion in home loans, representing 2.2 million families who purchased or refinanced their homes. And at year-end 2009, our total outstanding obligations of mortgage-backed securities stood at $1.9 trillion.

What makes the securitization process work? Families paying their mortgages every month. Because once a family moves into their home, their monthly payments of mortgage principal and interest are transferred ultimately to securities investors. When a family stops making payments – often due to loss of income – Freddie Mac steps in and makes those payments to securities investors. Managing this risk, known as credit risk, is how we generate revenue. Each time we fund a loan, we collect a credit guarantee fee from the lender selling us the loan. This fee is intended to protect us in case of loan default.

Other features of this business line:

    * We guarantee mortgages exclusively in the conventional conforming market, where we purchase loans only up to a certain dollar amount [PDF] (for 2010, $417,000 for most of the nation and $729,750 in high-cost areas)

    * The vast majority of the loans we fund are long term, fixed rate mortgages

    * We generally require third-party mortgage insurance on loans with low downpayments

    * We have loan servicing operations that work with lenders to avoid foreclosure, where possible, for families in financial difficulty


b) Multifamily Business

Since not everyone owns their own home, Freddie Mac supports renters, too. Through our Multifamily business, we work with a network of lenders to finance apartment buildings around the country. Like single-family loans, these lenders originate and close loans that Freddie Mac later purchases; lenders then use the proceeds to originate additional loans.

Unlike single-family loans, which are relatively small in dollar amount and standardized in their composition and underwriting, multifamily loans typically are several million dollars in size, have underwriting characteristics that vary from property to property, and require custom examination such as on-site property inspections and verification of income cash flows (i.e., rents). One other difference: while single-family borrowers are individual consumers, multifamily borrowers are property developers and/or managers.

In this business line, Freddie Mac finances most of its loan acquisitions by issuing corporate debt securities. We generate revenue by producing what is known as net interest income; that is, the difference between the interest payments we collect on the multifamily loans we own and the yields we pay securities investors for investing in our debt. Freddie Mac also funds some multifamily loans through securitization. And, market conditions permitting, we invest in certain commercial mortgage-backed securities that contain multifamily loans.

During 2009, Freddie Mac funded $16.6 billion in multifamily loans, which helped provide rental units for 250,000 families. At year-end 2009, the portfolio of multifamily loans outstanding was $99 billion.


c) Investment Business

The investment portfolio invests in mortgage-related securities that are guaranteed by Freddie Mac and other financial institutions. The portfolio also invests in individual loans that are guaranteed by Freddie Mac but not immediately securitized. As a bidder in the market, the investment portfolio helps to make mortgage-related securities more liquid and mortgage funding more available.

We fund acquisition of mortgage securities by issuing debt securities, generating net interest income. During 2009, the investment portfolio acquired a net of $255 billion in mortgage-related securities. At year-end 2009, the investment portfolio had an outstanding balance of $755 billion. Roughly one-half of this balance includes Freddie Mac mortgage-backed securities, known as Participation Certificates, guaranteed by the Single-Family and Multifamily businesses. During 2010, the investment portfolio can be no larger than $810 billion, per our regulator.


Benefits

1) First, we have been a consistent market presence, providing mortgage liquidity in a wide range of economic environments. This has become significant during the credit crunch that began in mid-2007 and resulted in the exit of most other mortgage funders from the market. Indeed, in 2009 Freddie Mac and Fannie Mae funded 72 percent of all new home loans and an even higher percentage of multifamily loans.

2) Second, consumers have enjoyed uninterrupted access to long term, fixed rate mortgages. Banks and other depositories tend to hold shorter term, floating rate assets in their loan portfolios. These institutions finance long-term, fixed-rate mortgages (i.e., 15-, 20- and 30-year terms) largely by selling them into the secondary market, where Freddie Mac and Fannie Mae securitize and guarantee the loans. In 2009, long term, fixed-rate mortgages comprised 97 of new home loans.

3) Third, consumers have typically paid less on home loans funded by Freddie Mac or Fannie Mae. Because investors usually place a greater value on our mortgage securities, we have been able to pass this premium ultimately along to homebuyers in the form of lower mortgage rates. During normal or flush markets, where there are many sources of mortgage funds, homebuyer savings on our loans have averaged about 0.30 percent (or 30 basis points) compared to loans that exceed our loan limits. During the credit crunch that began in 2007, however, mortgage rate savings have been high as 1.84 percent (or 184 basis points). At year-end 2009, consumers were paying 0.91 percent (or 91 basis points) less on loans backed by Freddie Mac and Fannie Mae.

4) Fourth, consumers are able to refinance their loans when mortgage rates decline. Because of the nature of long-term, fixed-rate mortgages, homeowners are protected against rising interest rates but are able to take advantage of declining rates through refinancing. In 2009, Freddie Mac refinanced $379 billion in home loans for 1.7 million families who reduced their annual mortgage payments by $2,600 on average. In other words, mortgage refinanced enabled by Freddie Mac in 2009 created $4.5 billion in homeowner savings.

5) Fifth, all these benefits accrue the most to families of modest financial means. The majority of home loans that we fund support low- and moderate-income families, reflecting affordable housing goals set forth by the federal government. Further, more than four in five multifamily loans support renters earn at or below the area median income where they live.


Foreclosure Prevention

Since the beginning of 2005, we have provided foreclosure alternatives to more than 525,000 distressed borrowers. We do everything we can to keep borrowers in their homes, using a variety of workout options including loan modifications (including HAMP), repayment plans and forbearance agreements depending on each borrower's individual situation. However, sometimes it is not financially feasible for the borrower to remain in the home. In those cases, we help facilitate pre-foreclosure sales (short sales and deed-in-lieu).

About Federal Housing Administration (FHA)

About Federal Housing Administration (FHA)

The Federal Housing Administration, generally known as "FHA", provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories. FHA insures mortgages on single family and multifamily homes including manufactured homes and hospitals. It is the largest insurer of mortgages in the world, insuring over 34 million properties and 47,205 multifamily project mortgages since its inception in 1934. FHA currently has 4.8 million insured single family mortgages and 13,000 insured multifamily projects in its portfolio.

FHA mortgage insurance provides lenders with protection against losses as the result of homeowners defaulting on their mortgage loans. The lenders bear less risk because FHA will pay a claim to the lender in the event of a homeowner's default. Loans must meet certain requirements established by FHA to qualify for insurance.

Unlike conventional loans that adhere to strict underwriting guidelines, FHA-insured loans require very little cash investment to close a loan. There is more flexibility in calculating household income and payment ratios. The cost of the mortgage insurance is passed along to the homeowner and typically is included in the monthly payment. In most cases, the insurance cost to the homeowner will drop off after five years or when the remaining balance on the loan is 78 percent of the value of the property -whichever is longer.

Funding - FHA is the only government agency that operates entirely from its self-generated income and costs the taxpayers nothing. The proceeds from the mortgage insurance paid by the homeowners are captured in an account that is used to operate the program entirely. FHA provides a huge economic stimulation to the country in the form of home and community development, which trickles down to local communities in the form of jobs, building suppliers, tax bases, schools, and other forms of revenue.

History -  created in 1934. The FHA became a part of the Department of Housing and Urban Development's (HUD) Office of Housing in 1965.
When the FHA was created, the housing industry was flat on its back:
    * Two million construction workers had lost their jobs.
    * Mortgage loan terms were limited to 50 percent of the property's market value, with a repayment schedule spread over three to five years and ending with a balloon payment.
    * America was primarily a nation of renters. Only four in 10 households owned homes.
During the 1940s, FHA programs helped finance military housing and homes for returning veterans and their families after the war.
By 2001, the nation's homeownership rate had soared to an all time high of 68.1 percent as of the third quarter that year.

About Fannie Mae

About Fannie Mae

Fannie Mae is a government-sponsored enterprise (GSE) chartered by Congress with a mission to provide liquidity, stability and affordability to the U.S. housing and mortgage markets.

Fannie Mae operates in the U.S. secondary mortgage market. Rather than making home loans directly to consumers, we work with mortgage bankers, brokers and other primary mortgage market partners to help ensure they have funds to lend to home buyers at affordable rates. We fund our mortgage investments primarily by issuing debt securities in the domestic and international capital markets.

Fannie Mae was established as a federal agency in 1938, and was chartered by Congress in 1968 as a private shareholder-owned company. On September 6, 2008, Director James Lockhart of the Federal Housing Finance Agency (FHFA) appointed FHFA as conservator of Fannie Mae. In September 2008, we also entered into an agreement with the U.S. Department of Treasury that was most recently amended in December 2009. Under the agreement, Treasury will provide us with capital as needed to correct any net worth deficiencies that we record in any quarter through 2012. After 2012, Treasury's remaining funding commitment under the Agreement to correct any net worth deficits will be  $124.8 billion ($200 billion less the $75.2 billion we have drawn for net worth deficits through December 31, 2009), less any positive net worth we may have as of December 31, 2012. The agreement is intended to ensure that we are able to continue providing liquidity and stability to the housing and mortgage markets.

Fannie Mae has three lines of business - Single-Family, Multifamily and Capital Markets - that provide services and products to lenders and a broad range of housing partners. Together, these businesses contribute to the company's chartered mission to increase the amount of funds available in order to make homeownership and rental housing more available and affordable.

About Ginnie Mae

About Ginnie Mae

Ginnie Mae does not buy or sell loans or issue mortgage-backed securities (MBS). Therefore, Ginnie Mae's balance sheet doesn't use derivatives to hedge or carry long term debt. What Ginnie Mae does is guarantee investors the timely payment of principal and interest on MBS backed by federally insured or guaranteed loans — mainly loans insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) or RHS or PIH.

Ginnie Mae MBS are created when eligible mortgage loans (those insured or guaranteed by FHA, the VA, RHS or PIH) are pooled by approved issuers and securitized. Ginnie Mae MBS investors receive a pro rata share of the resulting cash flows (again, net of servicing and guaranty fees).

a) Ginnie Mae I MBS requires all mortgages in a pool to be the same type (e.g. single-family). Each mortgage must be, and must remain, insured or guaranteed by FHA, VA, RHS or PIH. In addition, the mortgage interest rates must all be the same and the mortgages must be issued by the same issuer. The minimum pool size is $1 million; payments on Ginnie Mae I MBS have a stated 14-day delay (payment is made on the 15th day of each month).

b) Ginnie Mae II MBS allows multiple-issuer pools to be assembled, which in turn allows for larger and more geographically dispersed pools as well as the securitization of smaller portfolios. A wider range of coupons is permitted in a Ginnie Mae II MBS pool, and issuers are permitted to take greater servicing fees — ranging from 25 to 75 basis points. The minimum pool size is $250,000 for multi-lender pools and $1 million for single-lender pools. Ginnie Mae II MBS have an additional five-day payment delay because issuer payments are consolidated by a central paying agent (payment is made on the 20th day of each month).

c) Real Estate Mortgage Investment Conduits (REMICs) direct principal and interest payments from underlying mortgage-backed securities to classes with different principal balances, interest rates, average lives, prepayment characteristics and final maturities.
Unlike traditional pass-throughs, the principal and interest payments in REMICs are not passed through to investors pro rata; instead, they are divided into varying payment streams to create classes with different expected maturities, different levels of seniority or subordination or other differing characteristics. The assets underlying REMIC securities can be either other MBS or whole mortgage loans.
REMICs allow issuers to create securities with short, intermediate and long-term maturities — flexibility that allows issuers to expand the MBS market to fit the needs of a variety of investors.

d) Ginnie Mae Platinum Securities provide investors with greater operating efficiency, allowing holders of multiple MBS to combine them into a single platinum certificate. Ginnie Mae Platinum Securities can be used in structured finance transactions, repurchased transactions as well as general trading. --

Finding a Lender
If you have already used the Affordability Calculator to obtain an estimate of the maximum loan amount, house price, and the types of loan programs for which you may qualify, the next step is to find prospective lenders in your area that may formally approve the loan. This is also the time for you to ask your local lenders about opportunities in the following programs:
* Government Loan Programs: FHA and VA offer loan programs particularly beneficial to low- and moderate-income individuals. Contact your local FHA and VA lenders to learn more about these government loan opportunities. Additionally, you may want to find out about opportunities through the Native American Programs and the Rural Housing Service (RHS).
* State and Local Housing Programs: Potential home buyers can familiarize themselves with the variety of state and local housing programs that offer additional benefits in their local area.
* Ginnie Mae's Targeted Lending Initiative (TLI): A government initiative offering increased mortgage loan availability in designated areas that have been traditionally underserved. These service offerings are especially beneficial for low-income and moderate-income home buyers.

Securitization

Securitization

The process of securitization is complicated, and is highly dependent on the jurisdiction upon which the process is conducted.
First, mortgage loans are purchased from banks, mortgage companies, and other "originators".
Secondly, these loans are assembled into collections, or "pools". While a residential mortgage-backed security (RMBS) is secured by primarily single-family real estate, a commercial mortgage-backed security (CMBS) is secured by commercial and multifamily properties, such as apartment buildings, retail or office properties, hotels, schools, industrial properties and other commercial sites. A CMBS is usually structured differently than a RMBS.
Thirdly, these pools are securitized through various legal methods dependent on the type of MBS and jurisdiction. This securitization is done by government agencies, government-sponsored enterprises, and private entities which may offer credit enhancement features to mitigate the risk of prepayment and default associated with these mortgages. Since residential mortgages in the United States have the option to pay more than the required monthly payment (curtailment) or to pay off the loan in its entirety (prepayment), the monthly cash flow of an MBS is not known in advance, and therefore presents risk to MBS investors. These securities are usually sold as bonds, but financial innovation has created a variety of securities that derive their ultimate value from mortgage pools. In the United States, most MBS's are issued by the Federal National Mortgage Association (FNMA, colloquially called Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), U.S. government-sponsored enterprises. Ginnie Mae, backed by the full faith and credit of the U.S. government, guarantees that investors receive timely payments. Some private institutions, such as brokerage firms, banks, and homebuilders, also securitize mortgages, known as "private-label" mortgage securities.

History
After the Great Depression, the federal government of the United States created the Federal Housing Administration (FHA) with the National Housing Act of 1934 to assist in the construction, acquirement, and/or rehabilitation of residential properties. The FHA helped develop and standardize the fixed rate mortgage as an alternative to the balloon payment mortgage by insuring them, and helped the mortgage design garner usage.
In 1938, the government also created the government-sponsored corporation Federal National Mortgage Association (FNMA), colloquially known as Fannie Mae, to create a liquid secondary market in these mortgages and thereby free the loan originators to originate more loans, primarily by buying FHA-insured mortgages.
In 1968 Fannie Mae was split into the current Fannie Mae and the Government National Mortgage Association (GNMA), colloquially known as Ginnie Mae, to support the FHA-insured mortgages, as well as Veterans Administration (VA) and Farmers Home Administration (FmHA) insured mortgages, with the full faith and credit of the United States government.
In 1970, the federal government authorized Fannie Mae to purchase private mortgages, i.e. those not insured by the FHA, VA, or FmHA, and created the Federal Home Loan Mortgage Corporation (FHLMC), colloquially known as Freddie Mac, to do much the same thing as Fannie Mae. Ginnie Mae does not invest in private mortgages.

Securitization
Ginnie Mae guaranteed the first mortgage passthrough security of an approved lender in 1968. In 1971 Freddie Mac issued its first mortgage passthrough, called a participation certificate, composed primarily of private mortgages. In 1981 Fannie Mae issued its first mortgage passthrough, called a mortgage-backed security. In 1983 Freddie Mac issued the first collateralized mortgage obligation.
In 1960 the government enacted the Real Estate Investment Trust Act of 1960 to allow the creation of the real estate investment trust (REIT) to encourage real estate investment. In 1977 Bank of America issued the first private label passthrough, and in 1984 the government passed the Secondary Mortgage Market Enhancement Act (SMMEA) to improve the marketability of such securities. The Tax Reform Act of 1986 allowed the creation of the tax-free Real Estate Mortgage Investment Conduit (REMIC) special purpose vehicle for the express purpose of issuing passthroughs.

Types
Most bonds backed by mortgages are classified as an MBS. This can be confusing, because a security derived from an MBS is also called an MBS. To distinguish the basic MBS bond from other mortgage-backed instruments the qualifier pass-through is used, in the same way that "vanilla" designates an option with no special features.

Mortgage-backed security sub-types include:
a) * A pass-through mortgage-backed security is the simplest MBS, as described in the sections above. Essentially, it is a securitization of the mortgage payments to the mortgage originators. These can be subdivided into:
          o A residential mortgage-backed security (RMBS) is a pass-through MBS backed by mortgages on residential property.
          o A commercial mortgage-backed security (CMBS) is a pass-through MBS backed by mortgages on commercial property.
b) * A 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.
c) * A stripped mortgage-backed security (SMBS) where 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:
          o An interest-only stripped mortgage-backed security (IO) is a bond with cash flows backed by the interest component of property owner's mortgage payments.
                + A net interest margin security (NIMS) is resecuritized residual interest of a mortgage-backed security
          o A principal-only stripped mortgage-backed security (PO) is a bond with cash flows backed by the principal repayment component of property owner's mortgage payments.

There are a variety of underlying mortgage classifications in the pool:
    * Prime mortgages are conforming mortgages with prime borrowers, full documentation (such as verification of income and assets), strong credit scores, etc.
    * Alt-A mortgages are an ill-defined category, generally prime borrowers but non-conforming in some way, often lower documentation (or in some other way: vacation home, etc.)
    * Subprime mortgages have weaker credit scores, no verification of income or assets, etc.
    * Jumbo mortgages when the size of the loan is bigger than the "conforming loan amount" as set by Fannie Mae.

These types are not limited to Mortgage Backed Securities. Bonds backed by mortgages, but are not MBS can also have these subtypes.

Market size and liquidity
There is about $14.2 trillion in total U.S. mortgage debt outstanding. There are about $8.9 trillion in total U.S. mortgage-related securities. The volume of pooled mortgages stands at about $7.5 trillion. About $5 trillion of that is securitized or guaranteed by government sponsored enterprises (GSEs) or government agencies, the remaining $2.5 trillion pooled by private mortgage conduits. Mortgage backed securities can be considered to have been in the tens of trillions, if Credit Default Swaps are taken into account.

Uses
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 tradable capital market instruments.
   2. allow mortgage originators to replenish their funds, which can then be used for additional origination activities.
   3. can be used by Wall Street banks to monetize the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance (typically, a public market transaction).
   4. are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives.
   5. allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing.
   6. allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilise capital more efficiently and achieve compliance with risk-based capital standards.
The high liquidity of most mortgage-backed securities means that an investor wishing to take a position need not deal with the difficulties of theoretical pricing; the price of any bond is essentially quoted at fair value, with a very narrow bid/offer spread.[citation needed]


Real-world pricing
Most traders and money managers use Bloomberg and Intex to analyze MBS pools and more esoteric products such as CMOs, although tools such as Citi's The Yield Book and Barclays POINT are also prevalent across Wall Street, especially for multi-asset class managers. 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 3.5% - 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.
The price of an MBS pool is influenced by prepayment speed, usually measured in units of CPR or PSA. When a mortgage refinances or the borrower prepays during the month, the prepayment measurement increases.
If the buyer acquired a pool at a premium (>100), as is common for higher coupons then they are at risk for prepayment. If the purchase price was 105, the investor loses 5 cents for every dollar that's prepaid, possibly significantly decreasing the yield. This is likely to happen as holders of higher-coupon MBS have good incentive to refinance.
Conversely, it may be advantageous to the bondholder for the borrower to prepay if the low-coupon MBS pool was bought at a discount. This is due to the fact that when the borrower pays back the mortgage he does so at "par". So if the investor bought a bond at 95 cents on the dollar, as the borrower prepays he gets the full dollar back and his yield increases. This is unlikely to happen as holders of low-coupon MBS have very little incentive to refinance.

The price of an MBS pool is also influenced by the loan balance. Common specifications for MBS pools are loan amount ranges that each mortgage in the pool must pass. Typically, high premium (high coupon) MBS backed by mortgages no larger than 85k in original loan balance command the largest pay-ups. Even though the borrower is paying an above market yield, they are dissuaded to refinance a small loan balance due to the high fixed cost involved.

Low Loan Balance: < 85k
Mid Loan Balance: Between 85k - 110k
High Loan Balance: Between 110k - 150k
Super High Loan Balance: Between 150k - 175k
TBA: > 175k

The plurality of factors makes it difficult to calculate the value of an MBS security. Quite often, market participants do not concur resulting in large differences in quoted prices for the same instrument. Practitioners constantly try to improve prepayment models and hope to measure values for input variables implied by the market. Varying liquidity premiums for related instruments as well as changing liquidity over time, makes this a devilishly difficult task.

Mortgage-Backed Securities

Mortgage-Backed Securities

Product Overview
Mortgage-backed securities (MBS) represent an investment in mortgage loans. An MBS investor owns an interest in a pool of mortgages, which serves as the underlying assets and source of cash flow for the security. The loans backing the MBS are issued by a national network of lenders consisting of mortgage bankers, savings and loan associations, commercial banks, and other lending institutions.
MBS may be backed by entities such as Government National Mortgage Association (GNMA or colloquially as Ginnie Mae) and backed / issued by Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), and Federal National Mortgage Association (FNMA or Fannie Mae). Ginnie Mae guarantees investors the timely payment of principal and interest on loans originated through the Federal Housing Association (FHA), the Department of Veterans Affairs (VA), the Rural Housing Service (RHS) and Public and Indian Housing (PIH). Freddie Mac and Fannie Mae purchase mortgages forming pools and issue MBS that carry a guarantee of timely payment of principal and interest to the investor. Unlike GNMA, their obligation is not backed by the full faith and credit of the U.S. government.
All MBS are subject to federal, state and local taxes and various securities have different minimum investment amounts. Settlement for MBS depends on the issue and is confirmed on an individual trade basis, but settlement usually occurs within the last two weeks of each month.

Features
a)Attractive yields
•Typically higher yields than government bonds.
•Varies by coupon and term-typically, MBS with higher coupons produce higher yields but carry a greater prepayment risk.
b) Credit quality
•Credit risk is affected by homeowners or borrowers defaulting on their loans. Credit risk is considered minimal for mortgages backed by federal agencies or federally sponsored agencies.
c) High current income
•Investors may receive high payments compared to the income generated by investment grade corporate issues.
•A portion of these payments may represent return of principal, not just interest payments.
d) Liquidity
•The secondary market can be large and relatively liquid, with active trading by dealers and investors.
•Characteristics and risks of a particular security, such as the presence or lack of GSE backing, may affect its liquidity relative to other mortgage backed securities.

Risks
•MBS with higher coupons typically have shorter average lives (defined below) while issues with lower coupons have lengthier average lives.
•Lower interest rates, relative to the rate obtained by the mortgage borrower, may lead some borrowers to refinance their mortgage, while those holding loans with fairly current coupons may not refinance their mortgage.
a) Credit/Default risk
•MBS backed by Ginnie Mae carry no risk of default. There is some default risk for Freddie Mac and Fannie Mae MBS. MBS not backed by any of these agencies generally carry a higher risk of default.
•Pooling mortgages helps mitigate some of this risk.
•Investors considering mortgage backed securities, particularly those not backed by one of these entities, should consider the characteristics of the underlying mortgage pool carefully (e.g. terms of the pooled mortgages, underwriting standards, etc.).
•Credit risk of the MBS issuer may also be a factor depending on the legal structure and entity that retains ownership of the underlying mortgages.
b) Interest Rate risk
•In general, bond prices in the secondary market rise when interest rates fall and visa versa.
•Because of the prepayment risk and extension risk (see below), the secondary market price of MBS will sometimes rise less than a typical bond when interest rates decline, but may drop more when interest rates rise. Thus, there may be greater interest rate risk with MBS than with other bonds.
c) Prepayment risk
•Prepayment risk is the risk that homeowners will pay off more than their required monthly mortgage payments.
•Prepayment is usually precipitated by a decline in interest rates.
•As prepayments occur, the amount of principal retained in the bond declines faster than what otherwise may be expected-thereby shortening the average life of the bond by returning principal prematurely to the bondholder, potentially at a time when interest rates are low.
d) Extension risk
•Extension risk is the risk that homeowners will decide not to make prepayments on their mortgages to the extent initially expected-instead they make only the required monthly payment.
•Extension can be the result of an increase in interest rates. As rates rise, there is little incentive to refinance fixed rate mortgages.
•As the prepayments that were expected do not materialize, the average length of term (average life) originally estimated begins to creep out further along the curve, resulting in a security that is lengthier in term.

Mortgage-Backed Security Issuers
a) Government National Mortgage Association (GNMA or Ginnie Mae)
•A wholly owned government corporation backed by the full faith and credit of the U.S. government.
•Purpose is to ensure that mortgage funds are available throughout the U.S.
•Guarantees certain privately issued mortgage-backed securities.
•Instrumental in eliminating regional differences in the availability of mortgage credit.
•Available in a variety of maturities.
•Minimum denomination for new issue securities is $25,000 with additional increments of $1,000.
•Investments for less than $25,000 may be available by purchasing bonds that are either selling at a discount or have paid back a portion of their principal.
b) Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)
•A publicly-owned government-sponsored enterprise not explicitly guaranteed by the U.S. government (see Agency/GSE Product Overview).
•Purpose is to increase the availability of mortgage credit for residential financing.
•Raises most of its funds by developing and maintaining an active secondary market for residential mortgages.
•Issues both mortgage-backed securities and standard corporate coupon bonds, referred to as Government-Sponsored Enterprise (GSE) bonds.
•Securities available in $1,000 increments.
c) Federal National Mortgage Association (FNMA or Fannie Mae)
•A publicly-owned government-sponsored enterprise (see Agency/GSE Product Overview) not explicitly guaranteed by the U.S. government.
•Purpose is to maintain an active secondary market for mortgages.
•Issues both mortgage-backed securities and standard corporate coupon bonds.
•Securities available in $1,000 increments.

Types of MBS
a) Pass-throughs
•In a pass-through MBS, an issuer collects monthly payments from homeowners and then passes on a proportionate share of the collected principal and interest to the investor.
Pass-through MBS have three components of cash-flow:
•Scheduled principal (usually fixed).
•Scheduled interest (usually fixed).
•Prepaid principal (usually variable depending on the actions of homeowners, as governed by prevailing interest rates).
Pass-throughs represent a share of an investment pool consisting of multiple mortgages. Prepayment risk is reduced when the investment is subject to increasingly larger numbers of mortgages because each mortgage prepayment would then have a reduced effect on the total pool. Pass-through securities allow investors to reduce their prepayment risk through diversification rather than a single mortgage investment.
b)Collateralized Mortgage Obligations (CMOs)
•CMOs represent repackaged pass-through mortgage-backed securities, but with the cash-flows directed in a prioritized order based on the structure of the bond. A CMO's objective is to provide some protection against the prepayment risk associated with mortgage investments, above and beyond the protection offered by pass-throughs, while still offering credit quality and high yields.
•CMOs take the cash-flows from pass-throughs and segregate them into different bond classes known as tranches, to provide the investor some level of payment predictability. Tranches are created in an attempt to provide a time frame, or window, during which repayment is expected. The tranches prioritize the distribution of principal payments among various classes and serve as a series of maturities over the life of the mortgage pool.

Average life
•Mortgage securities are often discussed in terms of average life rather than their stated maturity date. The average life is the average time that each principal dollar in the pool is expected to be outstanding, based upon certain assumptions about prepayment speeds. When prepayment speeds are faster than expected, the average life of the CMO is shorter than the original estimate. While some CMO tranches are specifically designed to minimize the effects of variable prepayment rates, the average life is always a best estimate, contingent on how closely the actual prepayment speeds of the underlying mortgage loans match the assumption.

Liquidity
•CMOs can be less liquid than other mortgage - backed securities due to the individuality of each tranche. Investors need a high level of expertise to understand the implications of tranche-specification. In addition, investors may receive more or less than the original investment upon selling a CMO.

Interest rate risks
•Movements in market interest rates generally have a greater effect on CMOs than other fixed interest obligations because rate movements affect the underlying mortgage loan prepayment rates, and consequently the CMO's average life and yield. Prepayment speeds tend to accelerate in a declining interest rate environment. When rates are rising, prepayments tend to slow down.

CMOs versus traditional mortgage-backed securities
The key difference between traditional mortgage pass-throughs and CMOs is in the principal payment process:
•With Traditional MBS each investor receives a monthly pro rata distribution of any principal and interest payments made by homeowners; a pass-through holder receives some return of principal until the final maturity of a pass-through, when homeowners pay the mortgage in the pool in full. This process results in uncertainty in the timing of principal return because part or all of the debt can be retired early by the borrower.
•CMOs substitute a principal pay-down priority schedule among tranches for the pro rata process found in pass-throughs, which ensures a more predictable rate of principal pay-down.