Important Updates for Investors
Carla Pasternak's Premiere Issue of High-Yield International Just
Released
Income expert Carla Pasternak's debut issue of High-Yield
International covers a Taiwanese manufacturer yielding 9.5%... a
rare Mexican monopoly yielding 13.4%... and other top-performing
investments yielding up to 19.0%.
Government's Biofuel Timetable Could Spell +15,900% Growth
+15,900% growth might seem far-fetched... but it's not. In fact, it
is mandated by law. And I've identified the ONLY stock positioned to
capture this growth.
The
Silver Lining to a Falling Dollar
Despite the U.S. national debt, there is a silver lining for income
investors. This massive spending, combined with movement out of U.S.
Treasuries, is going to take its toll on the dollar, and
international income investors could reap the rewards in the form of
higher dividends. |
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| Mortgage-Backed
Securities (MBS) |
What It Is:
Mortgage-backed securities (MBS) are securities that represent an interest in a
pool of mortgage loans.
How It Works/Example:
To understand how MBS work, it's important to understand how they're created.
Let's assume you want to buy a house, so you get a mortgage from XYZ Bank. XYZ
Bank transfers money into your account, and you agree to repay the money
according to a set schedule. XYZ Bank may then choose to hold the mortgage in
its portfolio (i.e., simply collect the interest and principal payments over the
next several years) or sell it.
If XYZ Bank sells the mortgage, it gets cash to make other loans. So let's
assume that XYZ Bank sells your mortgage to ABC Company, which could be a
governmental, quasi-governmental, or private entity. ABC Company groups your
mortgage with similar mortgages it has already purchased (referred to as pooling
the mortgages). The mortgages in the pool have common characteristics (i.e.,
similar interest rates, maturities, etc.).
ABC Company then sells securities that represent an interest in the pool of
mortgages, of which your mortgage is a small part (called securitizing
the pool). It sells these MBS to investors in the open market. With the funds
from the sale of the MBS, ABC Company can purchase more mortgages and create
more MBS.
When you make your monthly mortgage payment to XYZ Bank, they keep a fee or
spread and send the rest of the payment to ABC Company. ABC Company in turn
takes a fee and passes what's left of your principal and interest payment along
to the investors who hold the MBS.
There are two kinds of MBS. The first, called pass-throughs or participation
certificates (PCs), represent a direct claim on the pool of mortgage loans.
The second kind, called collateralized mortgage obligations (CMOs) or real
estate mortgage investment conduits (REMICs) are more complicated. These
securities essentially take the interest and principal payments from several MBS
and create additional securities with varying maturities and coupons.
For investors, an MBS is much like a bond. Most offer semi-annual or monthly
income, and this payment frequency enhances the compounding effects of
reinvestment. Prepayment risk is a large concern for MBS investors. When people
move, for example, they sell their houses, payoff their mortgages with the
proceeds, and buy new houses with new mortgages. When interest rates fall, many
homeowners refinance their mortgages, meaning they obtain new, lower-rate
mortgages and pay off their higher-rate mortgages with the proceeds. Like bonds,
changes in interest rates affect MBS prices, but the change is exacerbated by
the fact that MBS investors are more likely to get their principal back early.
They might have to reinvest that principal at rates below what their MBS were
yielding.
The Role of the Government in MBS
Although several private institutions (brokerage firms, financial institutions,
and even construction companies) create and sell MBS, the Federal National
Mortgage Association (FNMA, or "Fannie Mae") and the Federal Home Loan
Mortgage Corporation (FHLMC, or "Freddie Mac") purchase a very large
portion of mortgages. Freddie Mac and Fannie Mae (both government- sponsored
entities) guarantee the timely payment of interest and principal on the MBS they
issue -- that is, if the borrowers do not make their mortgage payments on time,
Freddie Mac and Fannie Mae will still make their payments to their MBS
investors. It is important to note that the U.S. government does not guarantee
Freddie Mac or Fannie Mae. That is, if these entities cannot fulfill their
obligations to their MBS investors, the federal government has no responsibility
to rescue them. However, both entities have lines of credit with the government,
and investors generally believe that the government would not actually let them
default on any of their securities.
The Government National Mortgage Association (GNMA, or "Ginnie Mae"),
on the other hand, is a governmental entity that does not purchase mortgages but
does guarantee (with the full faith and credit of the U.S. government) the
mortgage-backed securities of certain MBS issuers. GNMA MBS have the lowest risk
of the three, because they carry an explicit guarantee from the federal
government.
Why It Matters:
Ultimately, the MBS industry provides lenders with more cash to make more
mortgage loans. This steady supply of mortgage funds keeps mortgage rates
competitive and mortgages readily available. Also, banks that are averse to
mortgage lending or are worried about losing money if borrowers prepay their
mortgages can mitigate these risks by selling their mortgages, and thus
transferring these risks, to MBS issuers. Fannie Mae, Freddie Mac, and Ginnie
Mae purchase mortgages and issue and/or guarantee MBS as part of their efforts
to support the MBS industry and make homeownership possible for more people.
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