RMBS: Residential Mortgage Backed Security
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Investor interest in US residential mortgage backed security (RMBS) has waned after the 2007 housing crisis. An RMBS represents claims on cash flows from residential property mortgage and home loans. Returns from an RMBS are, thus, solely dependent on the performance of the housing market and the level of interest rates.[br]
Traditionally, the market for RMBS was fairly large in the US and attracted significant investments from both retail and institutional investors. However, the housing and mortgage crisis triggered by massive investments in sub prime mortgages has dampened the demand for RMBS in the recent years. A sharp increase in mortgage defaults was attributed to home buyers resorting to non-traditional loan forms, such as interest only loans and adjustable rate mortgages. In a bid to restore investor confidence in the mortgage securities segment, the US authorities have decided to tighten the lending standards besides working on improving the origination standards of the RMBS.
Availability of RMBS: Residential Mortgage Backed Security
RMBS can be bought directly from agency originators and securities firms. These securities are issued by the Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Mortgage Association (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae), and some private agencies. While all securities issued by government agencies are guaranteed, those issued by private agencies are rated by credit rating agencies, such as Fitch, Standard & Poor’s and Moody’s.
These agencies purchase mortgage loans from various sources, guarantee them against the risk of default and issue securities or bonds representing claims on cash flows pertaining to such loans. Investment in an RMBS is recommended by most investment experts. However, it is recommended that all individual mortgages in an RMBS be studied and evaluated for the risk they carry.[br]
Risk in RMBS: Residential Mortgage Backed Security
Private agency-issued RMBS are considered riskier than those issued by government agencies. However, securities issued by government agencies also face the risk of prepayments and refinancing. In times of declining interest rates, borrowers prefer to refinance their loans for cheaper rates and this leads to the RMBS getting paid off early. Besides, any fresh investments in securities will also have to be at lower interest rates.
