Mortgage Backed Securities

Below are a few typical questions asked about Mortgage Backed Securities. If your question isn't answered here please write to us at mbs@cmhc-schl.gc.ca and we'll respond promptly.

1. What is an NHA Mortgage-Backed Security?
2. What is CMHC?
3. What is the National Housing Act?
4. What is Mortgage Insurance?
5. Who is involved in the NHA MBS program?
6. What is the role of the Central Payor and Transfer Agent (CPTA)?
7. How is an NHA MBS created?
8. What constitutes an eligible mortgage?
9. Who can issue the securities?
10. How are the securities issued?
11. What fees are involved?
12. Does a prospectus have to be filed with securities commissions?
13. What types of pools are available?
14. What happens in the default of…
15. What makes NHA MBS unique as an investment?
16. What does timely payment mean?
17. Can any insured mortgage be pooled?
18. Is there a minimum investment?
19. Are NHA MBS available for RRSP, RRIF?
20. Can foreign investors buy an NHA MBS?
21. What kind of return does it offer
22. How do they compare with Government of Canada bonds and financial institution's guaranteed investment certificates (GICs)?
23. Can they be sold before maturity?
24. Can I buy an NHA MBS that has been in existence for some time?
25. How does NHA MBS benefit investors?
26. How does NHA MBS benefit issuers?
27. How does it benefit the economy?
28. When is the monthly payment made?
29. How soon does payment start?
30. How is the payment calculated?
31. Is the monthly payment always the same?
32. When is final payment made?
33. What information statements are available?
34. Where are NHA MBS available?

1. What is an NHA Mortgage-Backed Security?

The NHA MBS represents an undivided interest in a pool of NHA-insured residential mortgages. As mortgages, these financial instruments are secured by the value of the underlying real estate.

CMHC provides Mortgage Loan Insurance on all pooled mortgages and an unconditional guarantee under the National Housing Act (NHA) of timely payment to NHA MBS investors.

These securities, as investments, combine the investment qualities inherent in both real estate mortgages and Canadian Government bonds.

2. What is CMHC?

CMHC, established in 1945, is the Canada Mortgage and Housing Corporation, a Crown corporation wholly owned by the federal government.

Through CMHC, the federal government is committed to helping house Canadians across the country at an affordable price. In general terms, CMHC’s mandate, as outlined in the National Housing Act, is "to promote the construction of new houses, the repair and modernization of existing houses, and the improvement of housing and living conditions."

CMHC has provided Mortgage Loan Insurance to protect NHA Approved Lenders in both urban and rural communities from borrower default, and by doing so has helped support a private housing market that now meets the needs of some 80 per cent of Canadians.

3. What is the National Housing Act?

The National Housing Act (NHA) is the federal government legislation that was introduced in 1944 to improve housing and living conditions for Canadians.

4. What is Mortgage Insurance?

The legislation governing CMHC authorizes a system of mortgage loan insurance as a key mechanism in mobilizing funds for housing. CMHC insures Approved Lenders of mortgages against default on principal and interest of residential housing mortgages.

CMHC Mortgage Loan Insurance supported the provision of more than 3 million dwelling units — one out of every three built in Canada over 52 years. At year-end 1997, there were over $164 billion of insurance policies in force and approximately $190 billion by year-end 1998. A portion of these mortgages and new mortgage loans that are approved and insured by CMHC provide the mortgage product for NHA Mortgage-Backed Securities.

NHA-insured mortgage loans are made by lenders that are approved by CMHC — a select list of Canadian financial institutions.

For purposes of NHA MBS, CMHC’s role was expanded through an amendment to the National Housing Act (NHA) to include the provision of the unconditional guarantee of timely payment when pools of these insured mortgages are created. This CMHC guarantee is in effect a guarantee of the Government of Canada. The NHA MBS is the only mortgage-backed security with such a guarantee.

5. Who is involved in the NHA MBS program?

CMHC, the administrator of the NHA MBS program and the guarantor of timely payment on behalf of the federal government — This Government of Canada agency approves all NHA MBS issues.

Investors — Individuals and institutions, such as pension funds and corporations — both Canadian and foreign — purchase NHA MBS issues.

MBS Issuers — These include financial institutions that are already operating as Approved Lenders of NHA-insured mortgages: banks, trust companies, insurance companies, loan companies, credit unions and caisses populaires. Other financial institutions that are not originators of the underlying mortgages, such as investment dealers, may become issuers. All issuers must be approved by CMHC.

Investment dealers, stock brokers and financial advisors — Canada`s investment industry and other financial organizations are active participants in the program.

Central Payor and Transfer Agent (CPTA), Computershare.

Custodians — Organizations authorized by CMHC to hold the mortgage assignments (the security for the NHA MBS pools) on behalf of the investors and CMHC.

6. What is the role of the Central Payor and Transfer Agent (CPTA)?

The main tasks of the CPTA are to collect payments of principal and interest monthly from the issuers and forward these on to the registered NHA MBS investors. The CPTA also maintains ownership records, replaces certificates when sold or lost, maintains information to support secondary market pricing and assists CMHC in monitoring issuer performance. The CPTA has offices across Canada.

7. How is an NHA MBS created?

An NHA Mortgage-Backed Security is created by a CMHC Approved Issuer. The Approved Issuer brings together a pool of mortgage loans insured under the National Housing Act, which must meet specific eligibility requirements. Then CMHC obtains an assignment of the residual interest in the mortgages. All mortgage papers and supporting documentation are given to an arm's length custodian acceptable to CMHC. The investor buys an undivided interest in this pool. The issuer also establishes a CMHC approved P & I trust account for monthly payments from the pooled mortgages. The issuer then carries out its plan to sell and deliver the securities to investors. NHA MBS issues are sold to investors by investment dealers or may be sold directly by the issuer.

8. What constitutes an eligible mortgage?

CMHC will guarantee timely payment only on mortgages that meet certain requirements. Social Housing Pools, consisting exclusively of qualified Social Housing mortgages, can be made up of any number of mortgages, including a single loan. The issuer then carries out its plan to sell and deliver the securities to investors. NHA MBS issues are sold to investors by investment dealers or may be sold directly by the issuer.

All mortgages in the pool are based on blended equal payments. The interest rate range from low to high on individual mortgages in the pool is not to exceed two per cent.

• The minimum mortgage term is 6 months.
• The minimum mortgage pool size is $2 million.

The range of remaining amortization periods for all mortgages must be within the short-term range band pools of fifteen years or less, or the longer term band pools of fifteen years or more.

9. Who can issue the securities?

To be approved by CMHC to issue NHA MBS investments, a participant must be a Canadian chartered bank, insurance company, trust company, loan company, caisse populaire, credit union or other company or corporation that is authorized to issue mortgage-backed securities.
The institution must have the experience, management capability and facilities necessary to assure CMHC of its ability to issue and service mortgage-backed securities. As well, the issuer must have a net worth (as defined by CMHC) of at least $3 million, plus 2 per cent of the aggregate principal amount of NHA MBS issued, plus amounts approved for a proposed issue but not yet issued.

10. How are the securities issued?

Like government bonds and other securities, NHA MBS can be issued in two ways — registered in the name of the owner-investor or in the name of a securities firm rather than the individual owner of the certificates — this latter method is commonly referred to as being registered in "street name". (This procedure is often followed, because like a bond in bearer form, an NHA MBS certificate in "street name" is negotiable, allowing it to be readily bought or sold). If issued in "street name", the financial institution maintains records of individual ownership.

11. What fees are involved?

Issuers pay a non-refundable application fee plus a guarantee premium, in respect of the timely payment guarantee, that is based on the principal amount of the pool at the date of issue.

12. Does a prospectus have to be filed with securities commissions?

A prescribed information circular, for each new NHA MBS issue, containing information of interest to investors is prepared and available upon request from your investment dealer. NHA MBS are exempt from normal requirements of an extensive and complex prospectus applicable to other issues of securities. NHA MBS are treated by the provincial securities commissions in the same manner as government bonds, which are also exempt from prospectus requirements.

13. What types of pools are available?

a) Homeowner:

964 — exclusive homeowner mortgage pools which are classified as prepayable because the borrowers within this type of pool have the option to prepay their mortgage (often at a penalty) in accordance with the specific terms of the mortgage. The appropriate Penalty Interest Payment (PIP) is passed through to the investors.

967 — exclusive homeowner mortgage pools which are classified as prepayable because the borrowers within this type of pool have the option to prepay their mortgage. However, the PIP is not passed through to the investor.

970 — offers investors an indemnity where mortgages are renegotiated during the closed period of the loan. Penalty Interest Payments (PIP) are retained by the issuer. For all prepayments in circumstances other than those permitted in the Information Circular, an indemnity is passed through.

b) Multiples:

966 — multi-family pool type which is comprised exclusively of multiple family loans, and are not prepayable.

c) Social housing:

These NHA-insured mortgages are issued to finance low-cost housing for senior citizens, the disabled and the economically disadvantaged. Typically, such housing is sponsored by government housing agencies, other social service organizations and private non-profit organizations.

99 — special category of NHA MBS pool created to allow exclusive pools of "Social Housing mortgages". The key feature of Social Housing pools is the absence of prepayment at the option of the borrower on the underlying mortgages; this makes them more attractive to investors who seek predictable cash flow.

d) Mixed

965 — mixed pools which are comprised of a combination of homeowner, multiple or social housing mortgages. These also consist of prepayable multifamily pools.

14. What happens in the default of…

— a mortgage?

In situations where mortgagors haven't made their regular payments, as required under the terms of their respective mortgages, the issuer MUST make these scheduled payments to the CPTA for credit to the NHA MBS investors, as if they had been made. CMHC mortgage insurance protects the lender/issuer against mortgage default, assuring payment of principal and interest in accordance with the terms of the mortgage insurance policy.

— an NHA MBS issuer?

CMHC guarantees full and timely payment of principal and interest to the NHA MBS investor in case of issuer default. The investor is fully protected by this guarantee. CMHC will make the timely payment, if there is a default by the issuer.

15. What makes NHA MBS unique as an investment?

CMHC guarantees, on behalf of the Government of Canada, the timely payment of principal and interest on securities. This is the key innovation in the NHA MBS. Regular monthly payments are made to the NHA MBS investors whether or not payments from mortgagors are actually received by the issuing financial institution.

Principal and interest payable by the mortgagors of houses and apartment buildings on which insured mortgages are issued are passed through to the registered NHA MBS investors by the CPTA (Central Payor and Transfer Agent). The principal is distributed based on an expected actual pass through approach, while interest payments are calculated and credited at the coupon rate of the securities. Similarly, any lump sum prepayments, including any applicable interest bonus payable by the mortgagors in the case of some pool types, pass through to the investors. Since each NHA MBS pool may have different prepayment conditions, a review by the investor of the Information Circular relative to each pool should be standard practice.

This guarantee of timely payment is the essential feature that makes NHA MBS an important part of the range of investments available in Canada for financial planning.

While there are other investments based on a pooling of mortgages, NHA MBS issues are the only such investments that CMHC guarantees on behalf of the Government of Canada.

16. What does timely payment mean?

Payment on Time — An investor receives monthly payments from the CPTA according to the terms specified in the offering circular available for each individual NHA MBS pool.

17. Can any insured mortgage be pooled?

NHA-insured mortgages are the only residential mortgages that can be pooled to create an NHA MBS. These are mortgages insured by CMHC.

18. Is there a minimum investment?

Certificates are available in multiples of $1,000.

19. Are NHA MBS available for RRSP, RRIF?

They may be included in any RRSP fund portfolio or as part of a self-directed RRSP.

Available for RRIFs, deferred profit sharing plans and revoked plans.

For further clarification contact an investment dealer, counselor or Revenue Canada.

20. Can foreign investors buy an NHA MBS?

Foreign investors and Canadians living outside Canada can also purchase these securities. Like government bonds, NHA MBS are exempt from withholding taxes that investors living outside Canada must normally pay on interest. This is a significant incentive.

21. What kind of return does it offer?

As interest-rate-sensitive securities, MBS' return is determined by prevailing market conditions. Yields are higher than for other Government of Canada securities of comparable maturities.

Note: For current yield quotations and product availability, please contact an investment dealer.

22. How do they compare with Government of Canada bonds and financial institution's guaranteed investment certificates (GICs)?

There are significant differences between NHA MBS issues and Guaranteed Investment Certificates (GICs) issued by banks and trust companies. GICs do not have the government guarantee through CMHC that is standard on an NHA MBS issue. Also, the underlying mortgages in an NHA MBS are fully insured by CMHC. The timely payment guarantee of all principal and interest, regardless of the amount, compares with a maximum of $60,000 of Federal Deposit Insurance on GIC investments. In addition, GICs are not tradable on the secondary market, limiting their liquidity in comparison to NHA MBS. In 1998, average yields over comparable Government of Canada bonds were approximately 60 basis points (0.60%) for prepayable issues and 30 basis points (0.30%) for non-prepayable issues.

23. Can they be sold before maturity?

Yes, NHA MBS can be sold before maturity. The Canadian financial industry has established a secondary market where NHA MBS can be traded. This liquidity is an important feature that helps make NHA MBS an attractive investment for individuals and institutions.

Like Government of Canada bonds, NHA MBS prices in this secondary market tend to fluctuate with changing interest rates, declining as interest rates rise and rising as interest rates fall.

To facilitate determination of buying and selling prices, the CPTA provides an 8-decimal place number that shows the proportionof principal still to be repaid for a specific pool. This Remaining Principal Balance, (RPB) factor is reported monthly for each NHA MBS mortgage pool.

The following formula is used by investment firms to calculate the amount of money for purchase or sale of an NHA MBS in the secondary market:
RPB factor multiplied by original face value = Proceeds multiplied by the buying or selling price (depending on market) divided by 100, plus any accrued interest

Here is a specific example of how this formula works. An investor wants to sell $10,000 worth of a 9% NHA MBS, where $45.01 of principal has been repaid and there is no accrued interest owing. This $10,000 block of NHA MBS is sold at $101.85, which is determined on the secondary market.

Substitute the numbers in the formula:

Proceeds to investor =
(Original face value x RPB factor x selling price/100 + accrued interest)

=($10,000 x 0.9954990) x 101.85/100 + 0

=$10,139.16

This example describes the sale of an NHA MBS at a premium, which provides the investor with a capital gain. An example could also have been used to describe the sale at discount, which would have had the opposite effect for the investor by producing a capital loss position. You may wish to go through the same calculations substituting the price of $101.85 for a price of $98.15. The sale proceeds would be reduced to $9,770.82.

24. Can I buy an NHA MBS that has been in existence for some time?

Because NHA MBS are a liquid investment and trade regularly in the secondary market, it is possible to buy a portion of an older pool that may have a higher coupon rate. In such cases, it is important to understand that even though NHA MBS certificates trade based on their face value, the principal balance will have begun to decline subsequent to the first payment. It is the remaining principal balance (RPB) that is the basis for calculation of the purchase price.

Therefore, as of the date that you wish to purchase a particular portion of a pool that has been in existence for some time, the actual principal balance outstanding may have already been reduced substantially. This current remaining principal balance will depend on the number of payments already made from the issue date as well as any unscheduled principal prepayments that have already been passed through to previous investors of the particular issue. Also, if the coupon rate is higher, normally the seller will wish to receive more for that particular issue, and will charge a premium to the purchaser.

The following calculation may be of assistance. Individual clarification can also be obtained by contacting your investment dealer:

PURCHASE PRICE*=
Face Value x RPB Factor** x Market Price + Accrued Interest
*Excludes commissions (normally built into the purchase price)
**Remaining Principal Balance Factor (available from the investment dealer)

25. How does NHA MBS benefit investors?

• guaranteed timely payment of all principal and interest
• monthly cash flow
• attractive yield
• highly tradable
• an additional personal financial planning tool
• an investment that is fully government guaranteed to any maximum

26. How does NHA MBS benefit issuers?

• new source of off-balance sheet financing, which reduces capital requirements and improves both the return on equity and return on capital ratios
• interest rate protection
• source of funds
• continuing fees from mortgage servicing and pooling
• reduced loan losses through NHA mortgage insurance
• reduction of specific costs associated with traditional mortgage funding (i.e. capital taxes, liquidity costs).

27. How does it benefit the economy?

NHA MBS provide new sources of funds for residential mortgage financing that have demonstrated lower interest rates. Homebuyers have more mortgage financing available to them. The housing and construction industries will, in turn, benefit. In addition, the NHA MBS add greater stability to the mortgage market by providing longer term mortgages and flexible prepayment privileges.

Also, the securitization of Social Housing mortgages under the NHA Mortgage-Backed Securities Program has been instrumental in reducing the associated financing costs of these projects, which ultimately results in savings for Canadian taxpayers.

28. When is the monthly payment made?

Cheques are normally mailed, postdated, by the CPTA three business days prior to the "payment date", which is typically the 15th of each month.

Should the 14th or 15th day of a month fall on a weekend or statutory holiday, the payment is made on the 2nd business day following the 14th. If the 14th happens to be a Friday, payment will be made on the next business day which is Monday of the following week.

The registered owner of an NHA MBS certificate can make arrangements with the CPTA for the automatic deposit of monthly payments into his/her account at a selected financial institution. Where the NHA MBS certificate is in "street name" (registered in the name of a securities firm rather than that of the owner of the certificate), arrangements can be made for automatic deposit and reinvestment through a financial institution, following the investors' instructions.

29. How soon does payment start?

First payment is sent to investors approximately 45 days from the date of NHA MBS issue. This payment consists of principal (together with any unscheduled principal repayment) received during the preceding month and one month's interest on the original balance at the coupon rate.

30. How is the payment calculated?

There is a formula for the calculation of the NHA MBS payment to investors. The interest rate is compounded semi-annually, not in advance, and is applied to the outstanding principal balance at the end of the previous month. This is the same method used to calculate interest on all NHA-insured mortgages.

The monthly payment is calculated by adding the following:

• stated interest payment (based on the coupon rate of the issue)
• scheduled principal payment
• additional principal for partial repayments, if made, and
• repayment penalties, if applicable.

The sum is the TOTAL MONTHLY PAYMENT

31. Is the monthly payment always the same?

Payments would be similar each month since NHA MBS schedules blend principal and interest repayment in the same way as NHA-insured first mortgages.

However, increased payments might be received by investors in an NHA MBS prepayable issue. This occurs when unscheduled payments are made by the borrower and then automatically passed through to the investors. Unscheduled payments that might be made before maturity of an NHA MBS include advance payments of principal on a mortgage and may include bonuses or penalties (refer to the applicable pool information circular). It should also be noted that investors may receive the full payment of principal of a mortgage loan before the scheduled maturity date, should the mortgaged property become damaged beyond repair, or should the mortgage loan go into default, warranting legal action which results in the liquidation of the loan from the NHA MBS pool.

The statement sent to investors sets out the remaining principal value of the investor's share of the mortgage pool.

Generally, monthly payments remain the same throughout the term of the NHA MBS if NHA MBS pools consist exclusively of NHA-insured Social Housing mortgages. Social Housing mortgages eligible for NHA MBS are classified as non-prepayable because prepayment of principal is not permitted at the option of the borrower.

32. When is final payment made?

Final payment date is 15 days after the maturity date of the NHA MBS. This final payment is normally substantial because it includes not only the interest due on the outstanding principal balance at the coupon rate of the issue for the preceding month, but also the payment of the entire amount of the outstanding principal balance of the pool.

For example:

On a new 25-year 10 per cent amortized mortgage, blended monthly payments of principal and interest are $8.94488 for every $1,000.
Over 5 years (60 months) a total of $536.69 of principal and interest would have been paid. Of this, only $60 represents principal.

Thus, a balance of $940 per $1,000 of principal would remain after 5 years (less any unscheduled principal repayment received during the term of the NHA MBS).

It is important to realize that the final payment of principal shall be remitted only upon the surrender of the outstanding NHA MBS certificate. If you are a registered certificate holder and have lost your certificate, arrangements can be made to allow for the replacement of the certificate by completing a bond of indemnity. There is a fee for this service and investors are advised to contact the CPTA, NHA MBS Issuers:

c/o Computershare
Corporate Trust Services
100 University Avenue, 12th Floor
Toronto, Ontario M5J 2Y1
Phone: 416-263-9701
Fax: 416-981-9788

33. What information statements are available?

The monthly payment is accompanied by a statement showing the amount of principal outstanding as well as the amount of principal and interest making up the payment.

Investors are provided with appropriate records for income tax purposes.

34. Where are NHA MBS available?

NHA Mortgage-Backed Securities are bought and sold through the Canadian financial system. NHA MBS are available through investment dealers and often through banks, trust companies and other financial institutions.

As in Government Canada bonds, there is an active secondary over-the-counter market for the buying and selling of already issued NHA MBS among financial organizations, providing investors with liquidity.

Information circulars, available from your investment dealer, are produced for each individual NHA MBS pool and contain all the relevant pool information and prepayment provisions necessary to make an informed investment decision (available on the Internet).