Types of Bonds
Agency vs. Privately Issued CMOs
Many mortgage pass-through securities are guaranteed by the Government National Mortgage Association (GNMA, or Ginnie Mae), an agency of the U.S. government, or by U.S. government-sponsored enterprises (GSE) such as the Federal National Mortgage Association (FNMA, or Fannie Mae) or the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac). Ginnie Mae is a government-owned corporation within the Department of Housing and Urban Development. Fannie Mae and Freddie Mac have federal charters and are subject to some oversight by the federal government, but are publicly owned by their stockholders. (The term “agency” is commonly used to refer to Fannie Mae and Freddie Mac as well as to GNMA. This discussion follows that usage, but readers should bear in mind that Fannie Mae and Freddie Mac are federally chartered and privately owned companies.)
Fannie Mae and Freddie Mac issue and guarantee pass-through securities; Ginnie Mae only adds its guarantee to privately issued pass-throughs backed by government-insured (FHA and VA) mortgages. Fannie Mae and Freddie Mac have issued CMOs for some time; the Department of Veterans Affairs (VA) began to issue CMOs in 1992; and Ginnie Mae initiated its own CMO program in 1994. Securities guaranteed, or guaranteed and issued by these entities are known generically as “agency” mortgage securities. The agency guarantees enhance their credit quality for investors. In addition, the mortgages backing Fannie Mae and Freddie Mac mortgage securities must meet strict quality criteria. Those backing GNMA pass-throughs are underwritten in accordance with the rules and regulations of the FHA and the VA, which insure them against default.
The extent of the agency guarantee depends on the entity making it. Ginnie Mae, for example, guarantees the timely payment of principal and interest on all of its mortgage securities, and its guarantee is backed by the “full faith and credit” of the U.S. government. Holders of Ginnie Mae mortgage securities are therefore assured of receiving payments promptly each month, regardless of whether the underlying homeowners make their payments. They are guaranteed to receive the full return of face-value principal even if the underlying borrowers default on their loans. Mortgage securities issued by the VA carry the same “full faith and credit” U.S. government guarantee.
Fannie Mae guarantees timely payment of both principal and interest on its mortgage securities whether or not the payments have been collected from the borrowers. Freddie Mac also guarantees timely payment of both principal and interest on its Gold PCs and CMOs. Some older series of Freddie Mac PCs guarantee timely payment of interest, but only the eventual payment of principal. Although neither Fannie Mae nor Freddie Mac securities carry the additional “full faith and credit” U.S. government guarantee, the credit markets consider the credit on these securities to be equivalent to that of securities rated triple-A or better.
Some private institutions, such as subsidiaries of investment banks, financial institutions, and home builders, also issue mortgage securities. When issuing CMOs, they often use agency mortgage pass-through securities as “collateral”; however, their collateral may also include different or specialized types of mortgage loans or mortgage loan pools, letters of credit, or other types of credit enhancements. These so-called “private label” CMOs are the sole obligation of their issuer. To the extent that private-label CMOs use agency mortgage pass-through securities as collateral, their agency collateral carries the respective agency’s guarantees. Private-label CMOs are assigned credit ratings by independent credit agencies based on their structure, issuer, collateral, and any guarantees or outside factors.
As an additional investor protection, the CMO issuer typically segregates the CMO collateral or deposits it in the care of a “trustee,” who holds it for the exclusive benefit of the CMO bondholders.
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.