After their origination in the primary market, mortgages serve as collateral for mortgage backed securities – mortgage-backed securities (MBS) and collateralized debt obligations (CDO) and covered bonds – that are sold in the secondary market. By selling the mortgages they originate, lenders convert mortgages into cash used to fund new mortgages. The volume of mortgages that an originator can fund is determined by its capacity to hold mortgages on its own books and its ability to sell the mortgages in the secondary market.
A mortgage-backed security (MBS) marketable pass-through asset-backed security created through the true-sale of a pool of mortgages to a bankruptcy-remote special purpose vehicle (SPV) that are used to back and service the securities the SPV sells to investors, with the sale proceeds used by the SPV to pay the originator for the mortgages. The pooled assets serve both as collateral and to generate the cash flows used to make regular interest payments and the repayment of principal to the investors. Mortgage-backed securities can be subdivided into:
- Residential mortgage-backed security (RMBS) – An MBS backed by residential mortgages; and
- Commercial mortgage-backed security (CMBS) – An MBS secured by commercial mortgages.
Rather than through securitization, European banks typically obtain the refinancing of their mortgage loans through the issuance of covered bonds. A covered bond is a generally fixed-rate bond issued directly by a financial institution that is liable for the security’s repayment and backed by a segregated pool of mortgage loans and other qualifying collateral to which investors have a priority claim, mostly high-grade mortgages or loans to the public sector.