Mortgage-backed securities - MBS - Fixed Income Investing

Money Digest, Jan, 2003

Higher yields are also offered by mortgage-backed securities, often referred to as MBS or "Cannie Maes."

When you buy an MBS, your money is invested in residential first mortgages. MBS certificates are sold by banks, trust companies, and brokerage houses.

The minimum investment is $5,000. You earn monthly interest based on prevailing mortgage rates at the time of investing. The market has been growing steadily since MBS were first introduced a few years ago.

Advantages of MBS

* Safety. Your principal and interest are insured by the Canada Mortgage and Housing Corporation, a federal Crown agency.

* Diversification. The properties on which mortgages are taken are distributed across Canada and possible bad risks are counter-balanced by sound mortgages.

* Higher yields. Yields on MBS are generally higher than yields on five-year GICs.

* Monthly income. You get monthly income. In other types of income investments, such as dividend-paying stocks, bonds, and GICs, you may have to wait for longer periods.

Disadvantages of MBS

* Interest rate risk. If you want to sell your MBS, you may find that you are not able to sell at the price you paid. MBS operate like bonds. The price you can get when you sell depends on current interest rates. If the interest rate moves higher, the price of MBS falls in the secondary market. If rates fall, the price of MBS rises.

* Reinvestment risk. Your monthly income includes some principal and some interest. This is fine if you are using MBS to generate current income. But if you have to reinvest the monthly cheques, you should take into consideration that these monthly payments are relatively small amounts. If you are going to reinvest, ask yourself if MBS are suitable for you.

High-yield and government backing make MBS suitable for the conservative, income-seeking investor.

Prepayable MBS

There are two types of MBS: prepayable and non-prepayable. As the name implies, prepayable MBS hold mortgages that can be paid (with penalty) before the maturity date. The accompanying table gives examples of high-yielding MBS.

How to find out more

Almost any stock broker should be able to provide you with more information on these securities. The Monday Globe and Mail and National Post provide a listing on MBS. So does Money Digest.

Examples of high-yielding mortgage-backed securities

Prepayable           Yield  Nonprepayable  Yield

Royal Bank '07       4.35   TD Bank '07    4.35
Equitable Trust '08  4.75   Peoples '08    4.80
MRS Trust '08        4.68   BMO '09        4.83
MRS Trust '09        4.77   BNS '11        5.21