Business Glossary

mortgage-backed bond that separates mortgage pools into different maturity classes, called tranches. This is accomplished by applying income (payments and prepayments of principal and interest) from mortgages in the pool in the order that the CMOs pay out. Tranches pay different rates of interest and can mature in a few months, or as long as 20 years. Issued by the Federal Home Loan Mortgage Corporation (Freddie Mac) and private issuers, CMOs are usually backed by government- guaranteed or other top-grade mortgages and have AAA ratings. In return for a lower yield, CMOs provide investors with increased security about the life of their investment compared to purchasing a whole mortgage-backed security. Even so, if mortgage rates drop sharply, causing a flood of refinancings, prepayment rates will soar and CMO tranches will be repaid before their expected maturity. CMOs are broken into different classes, called companion bonds or planned amortization class (PAC) bonds.

acronym for real estate mortgage investment conduit, a passthrough vehicle created under the tax reform act of 1986 to issue multiclass mortgage-backed securities. REMICs may be organized as corporations, partnerships, or trusts, and those meeting qualifications are not subject to double taxation. Interests in REMICs may be senior or junior, regular (debt instruments) or residual (equity interests). The practical meaning of REMICs has been that issuers have more flexibility than is afforded by the Collateralized Mortgage Obligation (CMO) vehicle. Issuers can thus separate mortgage pools not only into different maturity classes but into different risk classes as well. Whereas CMOs normally have AAA bond ratings, REMICs represent a range of risk levels.