Risk Considerations

Credit and Default Risk

Private Label Mortgaged-backed Securities derive their credit protection from within the structure or rules of cash flow disbursement in the trust. Therefore, Private Label Mortgaged-backed Securities credit and default risk should be evaluated based the characteristics and performance of the underlying mortgage pool and the remaining credit support within the CMO trust.

Cash Flow

MBS passthroughs provide monthly payment of principal and interest until the bond is retired. Most CMOs deliver monthly cash flow of either interest only and ultimately principal, or interest and principal until the bond is retired. Accrual bonds, which is a type of tranche within a CMO, offer monthly compounding of interest until a conversion date, at which time monthly cash flow is paid to the investor.

Minimum Investments, Transaction Costs & Liquidity

The degree of liquidity can vary widely between a MBS passthrough and some CMO tranches. The unique characteristics of some individual CMO tranches place limitations on the potential liquidity of the product. As with all debt securities, if these investments are sold in the secondary market prior to maturity or a call date, they may be worth less than their original cost.

MBS Settlement Dates and Payment Dates

MBS passthroughs have scheduled settlement dates established each month by the Securities Industry and Financial Markets Association (SIFMA) although some securities may be available for other settlement dates as well. Investors who purchase newly issued CMOs may find that their transaction takes up to a month to settle because of the time required to assemble the collateral, deposit it with the trustee, and complete other legal and reporting requirements. In the secondary market, CMO transactions typically settle in three business days.

Payment dates for MBS passthroughs and CMOs variy based on the guaranteeing GSE. GNMA and most FHLMC securities pay monthly interest and principal on the 15th of the month. FNMA securities pay monthly interest and principal on the 25th of the month. Depending on when a new issue CMO transaction settles, the investor may have to wait up to two months for the first payment, but this delay is factored into the yield quoted at the time of purchase. Once the first payment is received, future payments will be made monthly.

Tax Considerations

Investors should be aware that interest income on MBS is subject to federal, state and local income tax, while Treasury securities are exempt from state and local income tax.

MBS payments that represent the return of principal are not taxable. However, similar to corporate bonds and other taxable fixed-income investments, MBS purchased at a discount to par may be subject to Original Issue Discount (OID) tax. Investors should have a comprehensive understanding of all tax related matters associated with MBS investing and should contact their tax advisor, if applicable, prior to any MBS (or other security) investment.

Coupon Features

MBS securities are issued with a wide variety of coupons. MBS with higher coupons typically have shorter average lives while issues with lower coupons typically have longer lives. Please see the respective offering documents for additional considerations.