What are subprime mortgage-backed securities?

Question

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Answer 1

First, let us look at what a mortgage-backed security. A mortgage-backed security (MBS) is an asset-backed asset whose cash flows are backed by the principal and interest payments of a set of mortgage loans. A mortgage pass-through security, or simply pass-through security, is a type of MBS created by pooling mortgage loans and issuing certificates entitling the investor to receive a pro rata share in the cash flows of the specific pool of mortgage loans that serves as the collateral for the security. All principal and interest payments (less a servicing fee) from the pool of mortgages are "passed through" directly to investors each month. Because there is only one class of bondholders, these securities are sometimes referred to as single-class MBS.

Now let us incorporate "subprime." The subprime mortgage sector is the market for loans providedto borrowers with an impaired credit rating or where the loan is a second lien; theseloans are nonconforming loans.All of these loans can be securitized in different sectors of the RMBS market. Loans thatsatisfy the underwriting standard of the agencies are typically used to create RMBS that arereferred to as agency mortgage-backed securities (MBS). All other loans are included inwhat is referred to generically as nonagency MBS. In turn, this subsector is classified intoprivate label MBS, where prime loans are the collateral, and subprime MBS, where subprimeloans are the collateral. The names given to the nonagency MBS are arbitrarilyassigned. Some market participants refer to private label MBS as "residential deals" or"prime deals." Subprime MBS are also referred to as "mortgage-related asset-backed securities."In fact, market participants often classify agency MBS and private label MBS as partof the RMBS market and subprime MBS as part of the market for asset-backed securities. This classification is somewhat arbitrary.