What are Mortgage Backed Obligations (MBO)?

Published by Thomas Herold in Economics, Investments, Real Estate

'Mortgage Backed Obligations (MBO)' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Mortgage Backed Obligations are also called mortgage backed securities, or MBS. These are real estate-based financial instruments. They represent an ownership stake in a pool of mortgages. They can also be called a financial security or obligation for which mortgages underlie the instrument.

Such a security offers one of three different means for the investor getting paid. It might be that the loan becomes paid back utilizing principal and interest payments that come in on the pool of mortgages which back the instrument. This would make them pass through securities. A second option is that the security issuer could provide payments to the investing party independently of the incoming cash flow off of the borrowers. This would then be a non-pass through security. The third type of security is sometimes referred to as a modified-pass through security. These securities provide the security owners with a guaranteed interest payment each month. This happens whether or not the underlying incoming principal and interest payments prove to be sufficient to cover them or not.

Pass-through securities are not like non-pass through securities in key ways. The pass through ones do not stay on the issuer of the securities’ or originators’ balance sheets. Non-pass through securities do stay on the relevant balance sheet. With these non pass through variants, the securities are most frequently bonds. These became mortgage backed bonds. Investors in the non-pass through types often receive extra collateral as a letter of credit, guarantees, or more equity capital. This type of credit enhancement is delivered by the insurer of the mortgage backed obligation. The holder of the MBO will be able to count on the security which underlies the instruments in the event that the repayments the pools of mortgages make are not enough to cover the payments (or fail altogether) for the bond holder investors.

These offerings of Mortgage Backed Obligations, Mortgage Backed Bonds, or Mortgage Backed Securities are all ultimately backed up by mortgage pools. Analysts and investors usually call these securitized mortgage offerings. When such types of investments are instead backed up by different kinds of assets and collateral then they have another name. An example of this is the Asset Backed Securities or Asset Backed Bonds. They are backed up with such collateral as car loans, credit card receivables, or even mobile home loans. Sometimes they are referred to as Asset Backed Commercial Paper when the loans that underlie them are short term loan pools.

With these Mortgage Backed Obligations, they are often grouped together by both risk level and maturity dates. Issuers, investors, and analysts refer to this grouping as tranches, which are the risk profile-organized groups of mortgages. These complicated financial instrument tranches come with various interest rates, mortgage principle balances, dates of maturity, and possibilities of defaulting on their repayments. They are also highly sensitive to any changes in the market interest rates. Other economic scenarios can dramatically impact them as well. This is particularly true of refinance rates, rates of foreclosure, and the home selling rates.

It helps to look at a real world example to understand the complexity of Mortgage Backed Obligations and Collateralized Mortgage Obligations like these. If John buys an MBO or CMO that is comprised of literally thousands of different mortgages, then he has real potential for profit. This comes down to whether or not the various mortgage holders pay back their mortgages. If just a couple of the mortgage-paying homeowners do not pay their mortgages while the rest cover their payments as expected, then John will recover not only his principal but also interest. On the other hand, if hundreds or even thousands of mortgage holders default on their payments and then fall into foreclosure, the MBO will sustain heavy losses and will be unable to pay out the promised returns of interest and even the original principal to John.

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The term 'Mortgage Backed Obligations (MBO)' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.