interest only, typically with an endowment policy, or straight repay-
ment mortgages, also common are capped and ﬁxed rate.
The capital markets, obviously, are not interested in individual debt
obligations. However if all of these obligations are pooled together then
the characteristics of the collection are often attractive. Such then is
the motive behind MBSs. In the US certain MBSs enjoy government
sponsorship; in which case the credit rating will be AAA. There are three
agencies which are either owned by, or have government association.
These are the Government National Mortgage Association (GNMA), the
Federal Home Loan Mortgage Corporation (FHLMC) and the Federal
National Mortgage Association (FNMA). The overwhelming majority of
mortgages will be ﬁnanced by these agencies. Do not think however
that the consumer goes directly to the agency. They lend to intermedi-
aries. Table 4.1 illustrates the development of this phenomenon.
MBSs are issued both as ‘pass through’ and ‘pay through’ securities,
often referred to as CMOs. The latter formed by pooling ‘pass throughs’,
and redistributing the principal and interest according to a pre-set
‘Pass throughs’ represent an undiluted claim on the asset base. Cash
received by the vehicle (no distinction is made between interest and
principal) is passed directly on to the underlying securities. These all
have a single class structure, that is no holder has rights to the cash
ﬂow that are senior or subordinated to the other holders (Figure 4.5).
There are a number of varieties of pass through which can be categor-
ized as ‘straight pass through’ whereby interest and principal is paid
directly to investors as it is received in the pool. ‘Partially modiﬁed pass
through’, where some payments may be delayed but ultimately covered
by the guarantee
and then the ‘modiﬁed pass through’ whereby all pay-
ments are made regardless of whether there is money in the pool. There
is also a type of pass through which categorizes the investors into two
groups the ‘callable’ and the ‘call class’. The latter receive nothing but
hold the right to call the security at a certain price and date in the future.
Table 4.1 Issuance of MBSs ($ billion).
2003* 2002 2001 2000 1999
FHLMC 198 531 379 159 226
FNMA 410 727 524 213 299
GNMA1 51 111 109 59 108
GNMA2 19 63 67 46 46
Source: Bloomberg LP. *Until April 2003.
The guarantee must supply the extra funds.