Mortgage-Based Bonds Offer Good Yield - Risk

By Guy Halverson, writer of The Christian Science Monitor | The Christian Science Monitor, January 16, 1996 | Go to article overview

Mortgage-Based Bonds Offer Good Yield - Risk


Guy Halverson, writer of The Christian Science Monitor, The Christian Science Monitor


IF you think Ginnie, Fannie, and Freddie sound like members of a family, you are right.

They are all bond-like investments that draw their income from the home-mortgage market. The family names - Ginnie Mae, Fannie Mae, and Freddie Mac - were created out of sheer necessity - so that we don't need to use lumbering acronyms for these government-created investments. They're complicated enough as it is!

These mortgage-derived instruments offer relative safety - based on their implicit or explicit government backing - and potentially high rates of return. That makes them popular with some conservative, older investors as well as big institutional money managers.

If interest rates fall further, issues from Ginnie, Fannie, and Freddie might gain in value along with bonds, because their current yields would appear more attractive.

But beware the risks.

Those gains could be negated if declining interest rates prompt another wave of mortgage prepayment and refinancing. When homeowners refinance some of the mortgages standing behind such a security, the yield on the investment drops.

"We're very cautious" about buying mortgaged-backed securities right now, says Jacob Navon, co-director of fixed-income products at Columbus Circle Investors, Stamford, Conn. Interest rates are now at levels where "the next wave of refinancing is ready to come."

A Ginnie Mae security, the most common of the three sibling products, is a share in a pool of home mortgages guaranteed by the Government National Mortgage Association (GNMA), a quasi-federal agency set up in 1968 to promote home ownership. Each month you receive a check that represents both interest and principal. Ginnie Maes are backed by the full credit of the US government. That guarantee covers payment of principal and interest earned by the pool, but does not guarantee a specific yield over time - and thus, the amount of cumulative interest you will receive.

Fannie Mae and Freddie Mac securities are also assembled by quasi-federal agencies, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp. But they are not formally guaranteed by Uncle Sam. They also return a combination of interest and principal.

Yields on all three products typically run one to three percentage points higher than yields on comparable US Treasury issues. The higher rate stems from the greater risk. Unlike Treasury issues, they are subject to state and local taxes as well as federal taxes. (Treasury issues are exempt from state and local taxes.)

There are three ways to buy these investments: One can buy the individual securities through a broker, buy into a "unit investment trust" that holds such instruments, or buy mutual funds that invest in mortgage-backed issues. …

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