Mortgage backed securities are asset backed and secured through a pool of mortgages and as an investment will pay regular payments. The original mortgaged in the pool must have been arranged by a recognised lender and adhere to mortgage regulations and guidelines. Mortgage backed securities can also be known as mortgage-related security or mortgage pass through.
Securitisation is a fairly low risk way of investors to invest in the financial services market, whilst giving lenders the opportunity to release capital to carry on lending. Residential first mortgages are pooled together by the lenders and the loan is sold on as mortgage backed securities. The interest and capital on the loan are repaid back to the investors, giving them a fairly risk free investment.
So why would lenders issue mortgage backed securities to the market?
- Such long term debt ties up millions of pounds of capital and cash flow from these assets is a slow trickle. By issuing a mortgage backed security realises the capital and allows the lenders to liquidise the cash tied up.
- This liquidised cash can then be used to further potential business development opportunities, it can be lent out to new or existing customers or can be used to buy further assets.
- It diversifies the lenders portfolio for the shareholders, giving a wider spread of risk across the business.
- It is cheaper to raise finance through the issue of mortgage backed securities than to go to an external force and pay for further lending.
- By getting the assets off the balance sheet will improve the financial ratios of the company and make them appear more stable in times of economic difficulty.
- The issuing of mortgage backed securities can help improve the economy of the country as it will encourage lenders to lend as they liquidise past debts.
The rating of a mortgage backed security is imperative. Usually mortgages are issued after the likelihood of repayment has been looked into by the borrower. Some mortgage backed security issuers will guarantee against the original borrower not repaying, known as prepayment risk, in the US this guarantee is even backed up by the Federal Government in some cases.