What Is a Pass-Through Security?

A pass-through security is a pool of fixed-income securities backed by a package of assets. A servicing intermediary collects the monthly payments from issuers and, after deducting a fee, remits or passes them through to the holders of t💟he pass-through security (that is, people or𒐪 entitities who have invested in it).

A pass-through security is also known as a "pay-through security" or a "澳洲幸运5官方开奖结果体彩网:pass-through certificate"—tho🦹ugh technically the certificate is the evidence of interest or participation in a pool of assets that signifies the transfer of payments to investors; it's not the security itself.

Understanding Pass-Through Security

A pass-through secur♍ity is a derivative based on certain debt receivables that provides the investor a right to a portion of those profits. Often, the debt receivables are from underlying assets, which can include things ꦡsuch as mortgages on homes or loans on vehicles. Each security represents a large number of debts, such as hundreds of home mortgages or thousands of car loans.

The term "pass-through" relates to the transaction process itself, whether it involves a mortgage or other loan product. It originates with the debtor payment, which passes through an 澳洲幸运5官方开奖结果体彩网:intermediary before being released to the investor.

Payments are made to investors on a monthly basis, corresponding with the standard payment schedules for debt repayment. The payments include a portion of the 澳洲幸运5官方开奖结果体彩网:accrued interest on the unpaid principal, and another portion that goes toward the 澳洲幸运5官方开奖结果体彩网:principal itself.

Risks of Pass-Through Securities

The risk of default on the debts associated with the securities is an ever-present factor, as failure to pay on the debtor’s part results in lower returns. Sh♛ould enough debtors default, the securities can💦 essentially lose all value.

Another risk is tied directly to current interest rates. If interest rates fall, there is a higher likelihood that current debts may be refinanced to take advantage of the low-interest rates. This results in smaller interest payments, which mean lower returns for the investors of ꧒pass-through securities.

Prepayment on the part of the debtor can also affect return. Should a large number of debtors pay more than minimum payments, the amount of interest accrued on the debt is lower—and of course, it becomes non-existent if the debtor entirely repays the loan ahead of schedule. Ultimately, these prepayments result in lower returns for securities investors. In some instances, loans will have 澳洲幸运5官方开奖结果体彩网:prepayment penalties t🍃hat may offset some of the interest-based losses a pre🍒payment will cause.

Example of Pass-Through Securities

The most common type of pass-through is a mortgage-backed certificate or a 澳洲幸运5官方开奖结果体彩网:mortgage-backed security (MBS), in which a homeowner's payment passes from the original bank through ꦉa governmentꦜ agency or investment bank before reaching investors.

These types of pass-throughs derive their value from unpaid mortgages, in which the owner of the security receives payments based on a partial claim to the payments being made by the va🧜rious debtors. Multiple mortgages are packaged together, forming a pool, which spreads the risk across multiple loans.

These securities are generally 澳洲幸运5官方开奖结果体彩网:self-amortizing, meaning the entire mortgage principal is paid off in a specified period of time with regular interest and principal paཧyments.

The Bottom Line

Pass-through securities are securities that pay income from a pool of assets, usually collected by an intermediary. The intermediary subtracts a portion of the payment for its own costs and expenses, and passes on the remainder to investors. Mortgage-backed securities are a typical example.