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 The
Money Management Newsletter: Choosing
Financial Services
Mortgage Backed Securities overview
By Rob Whipp
Money Management Newsletter
In the United States, mortgage
backed securities account for a much larger proportion of the investment
market than in Canada. The relatively small size of the market for these
guaranteed securities
has a lot to do with a limited understanding of the securities themselves.
Mortgage Backed Securities (MBS) fulfill two important investment objectives.
First, MBS are completely guaranteed by the federal government through
the auspices of the National Housing Act. In fact, these securities are
backed by the Canada Mortgage and Housing Corporation (CMHC). Secondly,
the yields
are often better for these securities than for comparable Government of
Canada securities.
MBS are Canada 's answer to the American "Freddie Macs." In
Canada, for ease of reference to these securities, traders refer to MBS
as "Cannie Maes."
CMHC insures lenders against defaults on residential mortgages so that
lenders can safely issue high-ratio
mortgages without the concern of defaults.
Currently, CMHC insures mortgages where 90% of the mortgage is institutionally
financed with the borrower coming up with 10% of the first $100,000 in
equity for the purchase of a home (other CMHC insurance is available beyond
the first $100,000).
The borrower pays a percentage of the financed portion of the purchase
price of the home to CMHC for this insurance. About 1 in every 3 houses
built in Canada in the last 44 years has a mortgage insured by CMHC.
These insured mortgages are pooled by an issuer ( i.e., a mortgage lender)
that in turn sells the pool to the purchasers of MBS. The income for the
purchasers of the securities comes from the principal
and interest payments made by the mortgagors in the pooled fund. However,
the guarantee of timely payment for the income from MBS is made by the
federal government agency assuring investors of timely payments.
According to Robert Whipp of Fiscal Agents Investment Division, "institutional
investors are by far the largest investors in MBS at present, but the
product is becoming increasingly popular with retail investors."
"They offer excellent guaranteed returns and are backed by a strong
covenant - the Government of Canada, " Whipp says.
A word of caution for MBS investors. With residential mortgages, lenders
typically offer up to a 15% annual prepayment option on the principal
mortgage amount. What this means is that lump-sum payouts from the fund
are the norm. The payouts can happen at any time meaning that the investor
will occasionally get money back to pursue other investment opportunities.
"For a constant monthly return, I recommend that investors in MBS
consider the purchase of closed (as opposed to open) pool MBS funds as
themselves with the pre-payment issue," Whipp says.
Other reference: MBS...
Look Before You Leap
This article first appeared in
Today's Seniors newspaper
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