Mortgage Bond

Glossary

Banking

Mortgage Bond

Mortgage bonds a.k.a. mortgage-backed securities (MBS) or mortgage covered bonds, are bonds whose coupon payments derive from the cash flows of pools of underlying mortgages that the mortgage originator either sells to third-party institutional investors (in the case of MBS) or grants preferential claims on (in the case of covered bonds). In the case of MBS, the mortgages are sold in a process known as securitisation. Lenders securitise mortgages and other assets and remove them from their balance sheets. By doing this, they gain regulatory capital relief, which frees up capacity so they can make or buy additional loans. MBS are split into several tranches offering different risk characteristics. The most senior tranche is the least risky since it is first in line to be paid from the cash flows from underlying mortgages. Mortgage covered bonds are bonds secured by mortgage pools (known as the cover pool). Covered bond investors have preferential claims on the underlying collateral (the cover pool assets) in the event of default. Unlike MBS, covered bonds remain on the balance sheet of the mortgage originators.

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