Popular Asset 
Class - MBS

A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments.

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Mortgage-backed security (MBS) is a variation of an asset-backed security but one that is formed by pooling together mortgages exclusively. The investor who buys a mortgage-backed security is essentially lending money to home buyers. An MBS can be bought and sold through a broker. The minimum investment varies between issuers.

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As became glaringly obvious in the subprime mortgage meltdown of 2007-2008, a mortgage-backed security is only as sound as the mortgages that back it up. An MBS may also be called a mortgage-related security or a mortgage pass-through.

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Essentially, the mortgage-backed security turns the bank into an intermediary between the homebuyer and the investment industry. A bank can grant mortgages to its customers and then sell them at a discount for inclusion in an MBS. The bank records the sale as a plus on its balance sheet and loses nothing if the homebuyer defaults sometime down the road.

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This process works for all concerned as everyone does what they're supposed to do. That is, the bank keeps to reasonable standards for granting mortgages; the homeowner keeps paying on time, and the credit rating agencies that review MBS perform due diligence.

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In order to be sold on the markets today, an MBS must be issued by a government-sponsored enterprise (GSE) or a private financial company. The mortgages must have originated from a regulated and authorized financial institution. And the MBS must have received one of the top two ratings issued by an accredited credit rating agency.

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There are two common types of MBSs: pass-throughs and collateralized mortgage obligations (CMO).

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• Pass-Throughs: Pass-throughs are structured as trusts in which mortgage payments are collected and passed through to investors. They typically have stated maturities of five, 15, or 30 years. The life of a pass-through may be less than the stated maturity depending on the principal payments on the mortgages that make up the pass-through.

• Collateralized Mortgage Obligations (CMO): CMOs consist of multiple pools of securities which are known as slices, or tranches. The tranches are given credit ratings which determine the rates that are returned to investors.