Mortgage-backed Security


1. What is it?

Mortgage-backed Securities (MBS) or simply Mortgage Bonds are fixed income bonds issued by financial institutions authorized to make mortgage loans. They are issued based on mortgages from real estate property. Currently, the biggest issuer of this type of bond, in Brazil, is Caixa Economica Federal (the Brazilian Federal Savings and Loan Bank). Financial institutions use the MBS to raise money with which to finance certain real estate credit lines.

Not too many banks issue MBSs, because most of them don’t need to raise resources to help finance real estate credit lines – this is already done with the help of the common savings account.

The minimum investment period is 180 days (6 months). The maximum period may vary, but usually is around 24 months. It’s possible to redeem the bond in advanced, but that will necessarily harm the bottom line. The longer the investment period, the larger the potential earnings.

The minimum investment value is high: in the olden days, this was bond exclusively focused on highly qualified and experienced investors. Nowadays one can find more accessible starting levels, however high for the average Joe. As a practical example, the minimum investment for some Caixa Economica Federal MBSs is R$ 20 thousand.

If the investor wishes – and the offering institution agrees – a linked swap contract is also a possibility. This means one would have the opportunity of switching the profitability option on the contract half way through the preset period. A practical example would be swapping a MBS paying interest plus the prime rate (in Brazil, the TR) with an MBS earning a percentage of the Interbank Deposit Rate. This type of swap may guarantee greater security for the investor, considering the return can be maximized.

2. Profitability

Profitability on this type of investment may be prefixed or post-fixed, or tied to some specific index – such as the Interbank Deposit Rate, the prime rate (TR) or the long-term interest rate (TJLP, in Portuguese).

The longer the investment period, the greater the profitability. For instance, some MBSs may pay larger interest rates for higher and/or longer investments than the shorter or lower investment options. Some examples:

Investment – R$ 20 thousand

  • Redemption on the 10th month – fixed 7.5% + TR
  • Redemption on the due date – fixed 9.5% + TR;

Investment – R$ 50 thousand

  • Redemption on the 7th month – fixed 8% + TR
  • Redemption on the due date – fixed 10% + TR

Some banks may also offer an option paying a percentage of the Interbank Deposit Rate. Example: 92% of CDI

  • Resgate feito no 7º mês: 8% fixo + TR
  • Resgate feito no vencimento: 10% fixo + TR

3. Risks

The only risk for the MBS is having the issuing institution go bankrupt before the end of the contract. Noncompliance, however, is not a risk to the bond holder – only to the issuing bank. To guarantee backing that would further mitigate any investor risks, the Brazilian Central Bank issued local regulations on the subject (circular nº 1.393, de 7/12/1988).

Furthermore, Caixa Economica Federal, the larger MBS issuer in Brazil, is a governmental bank – and consequently very solid. So bankruptcy represents no real concern. In addition, MBSs are backed not only by the real estate property to which their tied, but also guaranteed by the Credit Guarantee Fund (FGC, in Portuguese).

4. Taxation

MBSs are not burdened by income tax or tax on financial transactions (IOF, in Portuguese).

However, if the investor opts for a swap (thus changing the MBS’ earning model) income tax shall be due on the difference between the Interbank Deposit Rate percentage and the bond’s interest rate.

Custody, service or other operational fees may also be charged by the issuing bank.

5. How it works

To invest on MBSs one should hold an account with the issuer of choice. Account managers and internet bank services should hold a detailed investment portfolio. All MBSs are registered with CETIP (Central de Custódia de Títulos Privados or Private Bond Custody Center, in loose translation. This is an open society company that offers services to the financial market in Brazil). Notably, MBSs are bonds with a unitary issuing value of R$ 1,000 (one thousand Reais). Minimum investment usually varies between R$ 20 – 50 thousand (meaning 20 – 50 units) and minimum redemption is R$ 5,000 (five thousand). Minimum investment term is usually 6 months – which means no redemptions can be made prior to that. Once the contract comes to its term, money is paid back into the bank account (if a swap was made, income tax will be withheld by the bank and destined to the IRS).

6. Advantages

  • Not burdened by income tax (except for swap options)
  • Allows for swap options;
  • Guaranteed by the Credit Guarantee Fund (FGC, in Portuguese).

7. Disadvantages

  • High minimum investment (roughly R$ 20 thousand);
  • Low liquidity;
  • Medium to long term investment.

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