Mortgage-backed Security - Uses

Uses

There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Mortgage-backed securities:

1. Transform relatively illiquid, individual financial assets into liquid and tradable capital market instruments.
2. Allow mortgage originators to replenish their funds, which can then be used for additional origination activities.
3. Can be used by Wall Street banks to monetize the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance (typically, a public market transaction).
4. Are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives.
5. Allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing.
6. Allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilise capital more efficiently and achieve compliance with risk-based capital standards.

The high liquidity of most mortgage-backed securities means that an investor wishing to take a position need not deal with the difficulties of theoretical pricing described below; the price of any bond is essentially quoted at fair value, with a very narrow bid/offer spread.

Reasons (other than investment or speculation) for entering the market include the desire to hedge against a drop in prepayment rates (a critical business risk for any company specializing in refinancing).