Collateralized Mortgage Obligations: Advertisements & Disclosures

Instructor: Brad Yeckley

Brad has taught at the university level, has an MBA, and is currently finishing his PhD.

This lesson covers the advertisement and communication of information to investors regarding collateralized mortgage obligations. Specifically, FINRA Rule 2216 is discussed.

What is a CMO?

At its most basic level, a collateralized mortgage obligation (CMO) is a bundle of mortgages that have been pooled together and then sold as an investment. As the borrowers of the underlying mortgages repay their loans, the monies collected are distributed to the CMO investors based on preset terms.

Most CMO's are issued by a government-backed agency like Fannie Mae or Freddie Mac. However, there are still private label firms that will sell these securities. Mr. Jones is a communications director for a private label firm that markets and sells CMO's to the public. Mr. Jones must be sure to abide by the provisions and conditions outlined in FINRA Rule 2216, which sets forth the standards when producing any outgoing communications. He reviews the rule to refresh his memory.

Educational Materials and Disclosures

When a CMO is going to be offered, there are requirements set forth by FINRA regarding what must be fully disclosed and what educational materials are required to be given to any potential investor not classified as an institutional investor.

Mr. Jones fully understands these requirements, so when he and his team produce outgoing communications, they follow the following guidelines:

Education Materials

When providing educational materials, Mr. Jones must be sure to include verbiage regarding:

  • The risks of CMO investments including credit quality, prepayment risk, interest rate risk, tax risk, liquidity risk, etc.
  • A glossary of related terms.
  • Questions for investors to ask.
  • How the CMO is structured and the relationship between a mortgage loan, mortgage security, and tranches.

Tranches are selections of securities that have been split up and repackaged according to predetermined investment outcomes. For example, a CMO may be constructed into maturity, interest rate, or cash flow tranches. Mr. Jones must fully inform potential clients of the different tranches and their specific risks.

Disclosure Materials

When Mr. Jones and his team are communicating about potential CMO investments to clients, they must cover and include the following disclosures:

  • The term 'Collateralized Mortgage Obligation' must be used in the name of the investment product
  • The CMO cannot be compared to any other investment product
  • It must include the disclosure that both the life cycle and yield of the investment are wholly dependent on the repayment rate of the mortgage holders and current interest rates.

When Mr. Jones covers all of the above-referenced education and disclosure standards for his firm's CMO offerings, the work is not entirely done. There are also provisions as to how specific offerings are to be promoted.

Endorsing CMO'S and Promotion

Mr. Jones is now creating some advertising promotions for his firm's CMO product. He is not allowed to market in just any way he wishes, though. FINRA Rule 2216 outlines what must be included and how it is to be presented. Below is a summary of the template that Mr. Jones must follow. In addition to the template, there are conditions on font size, assumptions used, and prominence of particular sections in relation to each other.

  • Section 1: Title -- Collateralized Mortgage Obligations
    • Coupon Rate
    • Anticipated Yield/Average Life
    • Specific Tranche -- Number & Class
    • Final Maturity Date
    • Underlying Collateral
  • Section 2: Disclosure Statement
    • ''The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions.''
  • Section 3: Product Features (optional)
    • Minimum Denominations
    • Rating Disclosure
    • Agency/Government Backing
    • Income Payment Structure
    • Generic Description of Tranche
    • Yield to Maturity of CMO
  • Section 4: Company Information
    • Name, Memberships
    • Address
    • Telephone Number
    • Representative's Name

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