Collateralized Mortgage Obligation

Business, Legal & Accounting Glossary

Definition: Collateralized Mortgage Obligation


Quick Summary of Collateralized Mortgage Obligation


A type of MBS with cash flows segregated into bonds offering different maturity and risk characteristics.




What is the dictionary definition of Collateralized Mortgage Obligation?

Dictionary Definition


CMO or Collateralized Mortgage Obligation is a specific kind of mortgage-backed security. CMO is an investment-grade bond.

It is a bond, which represents an investor’s claims on a specific cash flow arising out of big home mortgage pools. The Federal Home Loan Mortgage Corporation in the USA issues CMO bonds. Other government-sponsored bodies and some private issuers also issue CMOs. Freddie Macs and Ginnie Mae are some other types of mortgage-backed securities in the USA. Mortgage pools are separated into different maturity classes, which are paid off in specific order.

The flow of interest payments and principal amount on mortgages are divided among different sections of CMO interests, called tranches. Each tranche may possess a variety of principal balances, maturity dates, coupon rates and prepayment risks. (CMO investors are classified into three broad groups; A, B and C class of investors). Collateralized Mortgage Obligations are extremely sensitive to interest rate variations. Interest rate variations in their turn lead to a change in key factors like property sale price, refinancing terms and terms of loan prepayment.

CMOs are low risk and low return ventures, at times supported by government securities. Collateralized mortgage obligations can sometimes be low on liquidity.


Full Definition of Collateralized Mortgage Obligation


A collateralized mortgage obligation (CMO) is a type of mortgage-backed security (MBS). Unlike a mortgage pass-through, in which all investors participate proportionately in the net cash flows from the mortgage collateral, with a CMO, different bond classes are issued, which participate in different components, called tranches, of the net cash flows. A CMO is any one of those bonds. The tranches are structured to each have their own risk characteristics and maturity range. In this way, investors can select a bond offering the characteristics which most closely meet their needs. Collateral for the securitization may represent a pool of mortgages, but it is often a mortgage pass-through.

Many arrangements are possible. One of the simplest is a sequential pay structure comprising three or four tranches that mature sequentially. All tranches participate in interest payments from the mortgage collateral, but initially, only the first tranch receives principal payments. It receives all principal payments until it is retired. Next, all principal payments are paid to the second tranch until it is retired, and so on.

CMOs entail the same prepayment risk as mortgage pass-throughs. The riskiness of a specific bond depends upon how that tranch is structured and on the underlying collateral. Many different structures are used in practice, including stable PAC bonds or risky IOs and POs. There are floaters and inverse floaters. There are also Z-bonds, which are analogous to zero-coupon bonds.

Like mortgage pass-throughs, CMOs typically have minimal credit risk. Either they have a high-quality mortgage pass-through or similar MBS as collateral, or the collateral is bundled with suitable credit enhancement.

CMOs are issued by various organizations, including Fannie Mae, Freddie Mac, investment banks, mortgage originators, insurance companies, etc.

Mortgage-Backed Securities

These are asset-backed securities, where security offered is either a mortgage or a pool of mortgages. These securities are rated by accredited credit rating agencies. Mortgage-Backed Securities normally make periodic payments to investors (much like coupon payments). Investors who invest in mortgage-backed securities primarily lend money to home buyers.

Mortgage loans are bought from entities like mortgage companies and banks and collected into pools by either a quasi-governmental or governmental authority or a private entity. Most of MBS (mortgage-backed securities) are issued by US governmental bodies like Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae).


Synonyms For Collateralized Mortgage Obligation


CMO

Cite Term


To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.

Page URL
https://payrollheaven.com/define/collateralized-mortgage-obligation/
Modern Language Association (MLA):
Collateralized Mortgage Obligation. PayrollHeaven.com. Payroll & Accounting Heaven Ltd. September 22, 2021 https://payrollheaven.com/define/collateralized-mortgage-obligation/.
Chicago Manual of Style (CMS):
Collateralized Mortgage Obligation. PayrollHeaven.com. Payroll & Accounting Heaven Ltd. https://payrollheaven.com/define/collateralized-mortgage-obligation/ (accessed: September 22, 2021).
American Psychological Association (APA):
Collateralized Mortgage Obligation. PayrollHeaven.com. Retrieved September 22, 2021, from PayrollHeaven.com website: https://payrollheaven.com/define/collateralized-mortgage-obligation/

Definition Sources


Definitions for Collateralized Mortgage Obligation are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 17th April, 2020 | 2 Views.