Assignment on

Mortgage Backed Security

Submitted to:

Nusrat Khan
Assistant Professor
Department of Finance
University of Dhaka

Submitted by:

Md. Alfaz Shaikh

ID: 21-815
Batch: 21st MBA

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Introduction:
A Mortgage-backed Security (MBS) is a debt security that is collateralized by a mortgage or a
collection of mortgages. An MBS is an asset-backed security that is traded on the secondary
market, and that enables investors to profit from the mortgage business without the need to
directly buy or sell home loans. Mortgages are sold to institutions such as an investment
bank or government institution, which then package it into an MBS that can be sold to
individual investors. A mortgage contained in an MBS must have originated from authorized
financial institutions.

Features of MBS:
 ƒ Absolute sale of assets to an SPV with narrowly defined purposes and activities
 ƒ Issuance of securities collateralised by the underlying assets by the SPV to investors
 ƒ Reliance by the investors on the performance of the assets for repayment - rather than
the credit of their Originator (the seller) or the issuer (the SPV)
 ƒ Consequent to the above, “Bankruptcy Remoteness” from the Originator and the Issuer
Apart from the above, the following additional characteristics may generally be noticed:
 ƒ Administration of the assets by the Originator, including continuation of relationships
with Obligors (the Borrowers of the original loans)
 ƒ Support for timely interest payments and principal repayments in the form of suitable
credit enhancements
 ƒ Formal rating from one or more rating agencies. For achieving a target rating may
require offering the required level of credit enhancements.

How does MBS work?

The mortgage-backed security turns the bank into a middleman between the homebuyer and the
investment industry. A bank can grant mortgages to its customers and then sell them on at a
discount for inclusion in an MBS. The bank records the sale as a plus on its balance sheet and
loses nothing if the homebuyer defaults sometime down the road.

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The investor who buys a mortgage-backed security is essentially lending money to home buyers.
An MBS can be bought and sold through a broker. The minimum investment varies between
issuers.

This process works for all concerned as everyone does what they're supposed to do. That is, the
bank keeps to reasonable standards for granting mortgages; the homeowner keeps paying on
time, and the credit rating agencies that review MBS perform due diligence.

In order to be sold on the markets today, an MBS must be issued by a government-sponsored

enterprise (GSE) or a private financial company. The mortgages must have originated from a
regulated and authorized financial institution. And the MBS must have received one of the top
two ratings issued by an accredited credit rating agency.

Types of MBS
Pass-through: In a pass-through MBS, the issuer collects monthly payments from a pool of
mortgages and then passes on a proportionate share of the collected principal and interest to
bondholders. A pass-through MBS generate cash flow through three sources:

1. Scheduled principal (usually fixed)

2. Scheduled interest (usually fixed)
3. Prepaid principal (usually variable depending on the actions of homeowners, as governed
by prevailing interest rates)

Collateralized mortgage obligations (CMOs):

CMOs are repackaged pass-through mortgage-backed securities with the cash flows directed in a
prioritized order based on the structure of the bond. A CMO's objective is to provide some
protection against prepayment risk—above and beyond the protection offered by pass-throughs
—while still offering credit quality and high yields.

CMOs take the cash flow from pass-throughs and segregate it into different bond classes known
as tranches, which provide a time frame, or window, during which repayment is expected. This
gives investors some level of payment predictability. The tranches prioritize the distribution of
principal payments among various classes and serve as a series of maturities over the life of the
mortgage pool.

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MBS in Bangladesh:
A vibrant secondary mortgages market in Bangladesh will benefit all the stakeholders in the
mortgage chain. This includes issuers, investors, borrowers and mortgage finance industry as a
whole. It will also improve the housing situation and socio-economic situation in the country.
The introduction of MBS can improve housing affordability, increase the flow of funds to the
housing sector and better allocate the risks inherent in housing finance. It will also benefit lot of
other industries that depend upon housing sector in one way or the other. In recent years,
mortgage-financing market in the Bangladesh has been growing significantly. Four specialized
financial institutions and a quite a good number of commercial banks have either started their
mortgage financing business or contemplating to commence near soon. However, the major
challenge for this operation remains with the availability of long term funding. A developed
MBS market can really play a catalytic role in the development of overall economic scenario of
the country.

Conclusion
The major issue for issuance of MBS would be absence of appetite of investor, particularly for
long term securities. Ideally MBS would for 10-15 years tenure and if there is not sufficient
buyer, it might take some time to be a successful issue in Bangladesh. Even government
Treasury bond for long term is not widely invested. All major commercial banks and financial
institutions may form one housing finance company which will buy the housing loans from the
originators and can arrange issuance of MBS. Thus good originator of housing loans can
concentrate only on quality asset booking and servicing of the same.