Mortgage Backed Securities
Mortgage backed securities (MBS) are debt obligations that represent claims to the cash flows from pools of mortgage loans. Mortgage loans are purchased from banks, mortgage companies, and other originators and then assembled into pools by the issuer. A MBS represent claims on the principal and interest payments made by borrowers on the loans in the pool.
Mortgage backed security pools can be made up of pools of either residential or commercial mortgages. An important risk with regard to residential mortgages involves prepayments, typically because homeowners refinance when interest rates fall. Absent protection, such prepayments would return principal to investors precisely when their options for reinvesting those funds may be relatively unattractive.
Commercial mortgage backed securities are generally considered the safer bet because such loans often contain lockout provisions after which they can be subject to defeasance, yield maintenance and prepayment penalties to protect bondholders.
According to the SEC, MBSs 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 complicated MBSs, known as collaterized mortgage obligations or mortgage derivatives, may be designed to protect investors from or expose investors to various types of risk.