MORTGAGE BACKED BOND

Topics: Asset, Credit rating, Interest rate risk Pages: 3 (699 words) Published: April 19, 2015
MORTGAGE BACKED BOND (MBB)

WHAT IS IT
MBBs are the third asset securitization vehicles.
They differ from pass-thru and CMOs in 2 key dimensions:

1. Pass thru’ and CMOs remove mortgages
from bank’s balance sheets as forms of offbalance sheet securitization.

1. MBBs normally remain on the balance
sheet

2. Pass thru’ and CMOs have a direct link
between the cash flows on the underlying
mortgages and the cash flows on the bond
vehicles

2. For MBBs, there is no direct link between
the cash flow on the mortgages backing the
bond and the interest and principal payments
on the MBB

HOW IT WORKS

An FI issues an MBB to reduce risk to the MBB bondholders.
MBB bondholders have the first claim to a segment of the FI’s mortgage assets. In practical terms, the FI segregates a group of mortgage assets on its balance sheet and pledges this group as collateral against the MBB issue.

A trustee normally monitors the segregation of assets and makes sure that the market value of the collateral exceeds the principal owed to MBB holders. That is, FIs back most MBB issues by excess collateral.

This excess collateral backing of the bond and in addition to the priority rights of the bondholders generally ensures that the bond can be sold with a high credit rating such as AAA.
In contrast, the FI, when evaluated as a whole, could be rated BBB or even lower. A high credit rating results in lower coupon payments than would be required if significant default risk had lowered the credit rating.

Example:
Consider an FI with $20 in LT mortgages as assets.
It is financing these mortgages with $10m in ST uninsured deposits (wholesale deposits) and $10m in insured deposits (retail deposits).
We ignore the issues of capital and reserve requirements.

Assets
LT Mortgages

$20m
Total:

Liabilities
Insured deposits
ST uninsured deposits

$20m

$10m
$10m
Total: $20m

Looking at this balance sheet, there are a few issues.
❶The FI has a positive...
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