In 1983, the introduction of Collateralized Mortgage Obligations (CMO's) by the Federal Home Loan Mortgage Corporation established a new investment vehicle for investors not traditionally involved in the mortgage market. The Tax Reform Act of 1986 authorized the establishment of Real Estate Mortgage Investment Conduit (REMIC's) which provided monthly pay possibilities to investors and a tax advantage to issuers. For investment purposes, REMIC securities are indistinguishable from CMO's. Today, virtually all CMO's issued are actually REMICs. The CMO market has grown to hundreds of billions of dollars in size since its inception in 1983 and today accounts for an ever increasing and important segment of the overall mortgage market. Please contact us for information on CMO'S and how they react to different market conditions.


CMO's are multi-class bonds that are collateralized by mortgage backed securities such as Ginnie Maes (Government National Mortgage Association), Fannie Maes (Federal National Mortgage Association), Freddie Macs (Federal Home Loan Mortgage Corporation), or by whole loan mortgages. The cash flows generated by the collateral are used to pay principal and interest to the CMO bondholder.


CMO's are most often issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC), both government sponsored corporations. While FHLMC and FNMA dominate the new issue market, many private issuers regularly bring CMO's to market also.


CMO's may offer substantially higher yield than other securities with comparable credit quality. Each CMO issue offers a variety of different maturities, allowing investors to choose the class that best meets their investment objectives. CMO'S also have market risk and a risk of pre-payment.



Deferred coupon tranche of a CMO. An accrual bond receives cash payments of neither principal nor interest until all tranches preceding it are retired. In effect, an accrual bond is a deferred interest obligation, resembling a zero coupon bond prior to the time that the preceding tranches are retired, except that accrual bonds carry an explicit coupon rate. The accrual bond then receives cash payments representing interest and principal on the accrued amount outstanding. Accrual bonds are purchased most frequently by investors who require the greatest degree of protection against reinvestment and call risk, or who seek the greater price leverage afforded by these classes. Also called Z bond.


The weighted average retirement date of a bond; the average amount of time each dollar of principal amount will be outstanding.


Corporate Bond Equivalent Yield. An internal rate of return on an investment, calculated as if coupon payments were made semi-annually as on a corporate or Treasury security. Yields computed for monthly or quarterly pay securities are often converted to a CBE basis to facilitate comparisons.


The mortgages underlying a mortgage-backed pass-through security or bond; the mortgages and/or pass-through securities underlying a CMO.


A corporate bond backed by a pool of mortgages in which the principal cash flows of the pool are channeled sequentially into one or more classes, or tranches, of bonds. Interest payments are made on all tranches except, in some CMO's, the accrual bond or Z bond.


The annual rate at which each tranche of a CMO will pay interest while the tranche is outstanding. On an accrual tranche, the coupon interest accrues and is added to the principal amount outstanding to be paid when the Z bond begins to make payments.


The date from which a newly issued CMO begins to accrue interest, typically about a month prior to the closing date.


The time between the record date and the payment date. A bond that pays interest on the record date has zero delay.


The date when the final principal payment of a CMO tranche is anticipated, assuming the prepayment speed used when the deal was priced.


The ratio of the outstanding principal amount of a pass-through pool or CMO tranche to its original principal amount.


The date on which principal and/or interest payments commence on applicable tranches within a CMO.


Net Weighted Average Coupon. The average pass-through rate on the mortgage securities backing a CMO.


Predictive model of prepayment rates. Models include the 12-year life assumption, FHA experience. Single Monthly Mortality (SMM), Constant Prepayment Rate (CPR), and the Public Securities Association Standard Prepayment (PSA). The pre-payment rate is based on assumptions which can and do change, and which will affect realized yield. Therfore, this yield will vary with changes in market conditions and in pre-payment rate.


The prepayment assumption used to project the cash flows on the underlying collateral of a given CMO when initially priced and offered to investors. These cash flows in turn determine the expected maturities and average lives of each tranche in the CMO.


PSA specifies a standard percentage for each month, and annualizes that percentage. 100% PSA calls for prepayment at annual rates of .2% in the first month, .4% in the second month, .6% in the third month, and so on until month 30 and beyond, the mortgage (or mortgage pool) will prepay at an annual rate of 6%.


The date on which a bondholder must officially own the bond in order to be entitled to a principal and interest payment. For CMO's, it is generally a month prior to the payment date.


Real Estate Mortgage Investment Conduit. A mortgage securities vehicle, authorized by the Tax Reform Act of 1986, that holds residential or commercial mortgages and issues securities representing interests in those mortgages. For investment purposes, REMIC securities are virtually indistinguishable from CMO's.


A floating rate CMO whose coupon resets inversely to the index, typically the LIBOR.


Indenture provision providing for the orderly amortization of a CMO tranche over the life of the tranche within a broad range of prepayment speeds. The amortization schedule mandates a fixed principal payment on each payment date covered by the schedule.


The date when the final principal payment of a CMO tranche will be made, assuming no prepayments on the underlying collateral.


One of the individual bonds within the sequential pay structure of a CMO. Each tranche within a given CMO deal can have a different coupon and maturity.


An institution, usually a commercial bank, that holds CMO collateral for the benefit of CMO bond holders. The trustee collects principal and interest payments on the collateral, invests the cash between payment dates, and makes funds available to pay principal and interest on the CMO bonds.


Weighted Average Maturity. WAM is calculated by multiplying the maturity of each mortgage in a given pool by its remaining balance, summing the products, and dividing the result by the total remaining balance.


The effective annual rate of return expressed as a percentage; the discount rate which, if applied to each cash flow, sets the sum of the present values of the cash flows equal to the price (internal rate of return).


See Accrual Bond.