Understanding Pass-through Mortgage Securities

By Brian Zwerner

Introduction

As the senior vice president of FIG Partners, LLC, Brian Zwerner engages with U.S. financial institutions in optimizing securities investment performance. Brian Zwerner has extensive knowledge of fixed-income sales and trading, including holdings involving diverse types of mortgage securities.

Pass Through Security

One common mortgage instrument is the pass-through security. The issuer collects money each month from borrowers, and the loans are held within a specific pool. Investors are then are paid out their allocated cash, after guarantee and servicing fees from the issuer have been deducted. The majority of pass-throughs are backed by fixed-rate mortgage loans. A minority are constructed from adjustable rate loans. Another variety of mortgage security is the Collateralized Mortgage Obligation (CMO).

Conclusion

A CMO is created by grouping together mortgage pools with similar characteristics. The principal and interest payments on the underlying pools are then allocated to different tranches issued by the CMO structure. Typically one or more tranches with more stable cash flows are balanced by tranches with more volatile cash flows. The stable cash flow securities, often called Planned Amortization Classes (PAC) or Sequentials, are sold to banks and insurance companies. The more volatile cash flow securities, often called support bonds, are sold to investment firms and hedge funds targeting a higher yield potential.