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Government Agencies and Related Securities

 - The Main Issuers

 - Background of the main GSE

 - Types of Securities

 

 


Types of Securities

These government agencies offer a wide range of equity and debt securities. Most of these investment instruments are boiler plate investments. The mortgage backed securities, however, have unique features that deserve extra attention.   

Mortgage-Backed Securities (MBS)

Mortgage-backed securities are debt obligations collateralized by mortgages and issued by the housing agencies and various mortgage lenders. The main issuers are Fannie Mae and Freddie Mac. (Ginnie Mae insures certain mortgage-like FHA & VA loans, to ensure housing availability throughout the country.) MBS have attractive yields, solid credit ratings, and fluid liquidity.

Bonds are normally sold for a minimum investment of $10,000 with $5,000 increments. Ginnie Mae requires a minimum investment of $25,000.

Types of MBS

Pass-throughs – A pass-through security is created when an originating company pools a group of assets, in this case mortgages, and converts them to debt securities. Some sort of credit enhancement is needed, and an investment grade rating is obtained. The securities are then sold to income-oriented investors. When the mortgage payments are received, they are passed along to the bondholders. Monthly, the bondholders receive a combination of interest, principal and prepayments, if any. Pass-through bonds are usually investment grade securities and are ideal for investors looking for a steady cash flow stream and an attractive yield. The downside with pass-through bonds is that the prepayments are uncertain and are thereby considered to be a risk. Normally, prepayments occur when interest rates decline. Thus, the bondholders are receiving their funds early, but in a lower interest rate environment, reducing their income on a going forward basis. The monthly payment received consists of interest and principal.

Collateralized Mortgage Obligations (CMOS)

CMOs are similar to pass-through securities, except that the composite of the principal repayments reimbursed to the bondholders is restructured. The cash flows are segregated into different classes, called tranches, and sold separately to investors. The tranches are determined by the types of cash flows, rates (yields), average life (terms), credit ratings and projected prepayment rates that bond investors require. Interest is normally paid on all the classes first.  The priority of the principal repayment portion of the cash flows is what makes a CMO unique, and it also determines the rating and yield of the security. For example: some investors may need an average life of 2 years, some 10 years, and some 20 years. Naturally, the first tranche to be paid off is more secure than subsequent ones; usually the longer the average life of the security, the higher the yield. There are all sorts of “slicing and dicing” of the cash flow streams, including interest only tranches (IO strips), principal only tranches (PO strips), and zero-coupon bonds (tranche Z); the possibilities are unlimited. They also convert fixed rate mortgages to floating rate bonds, and have inverse floaters. The MBA’s really do some “wild things” with these bonds. Insurance companies are good examples of MBS investors; they need to match the maturity dates on their investments with expected benefit payments. Insurers time cash inflows from their investments, to their projected cash outflows. The discipline of matching the runoff of assets with liabilities is called asset and liability management. Since many of these products are customized for particular customers or industries, it is preferred that they are held to maturity. CMOs are also known as REMICs - Real Estate Mortgage Conduits

For young adults, all of these agency securities have solid credit ratings and pay competitive rates. The best strategy, however, may be to use the money that these agencies provide in terms of mortgages and loans. Their rates and credit terms are usually extremely competitive. Many of these agencies offer funds that can truly improve the quality and richness of one’s life.

 

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