BlackRock MBS Primer

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  ALTERNATIVESBLACKROCK SOLUTIONSEQUITIESFIXED INCOMELIQUIDITY Mortgage-Backed SecuritiesA BlackRock Primer NOT FDIC INSUREDMAY LOSE VALUENO BANK GUARANTEE  What are MBS? Generally speaking, MBS are bonds representing an ownership interest in apool of residential mortgage loans. Residential homeowners make mortgagepayments which are ultimately pooled each month. These pooled payments arethen “passed through” to MBS holders in the form of principal and interestcash flows. How are MBS Created? To create a MBS, a lending bank first pools together a group of mortgage loansthat it has issued. The bank then presents this pool of mortgages to agovernment-sponsored agency designated to issue and guarantee MBS. Theseagencies may include the Government National Mortgage Association (GNMAor “Ginnie Mae”), the Federal National Mortgage Association (FNMA or “FannieMae”), or the Federal Home Loan Mortgage Corporation (FHLMC or “FreddieMac”). Alternatively, private issuers of whole loan MBS may assemble mortgagepools with credit enhancements through a combination of insurance andsenior/subordinate structuring.The agency issuing the MBS guarantees the timely payment of principal andinterest to MBS investors. The principal and interest payments the mortgageborrowers pay to the bank are “passed through” to MBS investors each month. Investors can purchase individual MBS securities, or mutual funds comprisedof MBS holdings from firms like BlackRock. Who Issues MBS? In order to facilitate the flow of funds to the housing industry, the U.S.Government created three major housing agencies to support the mortgagemarket. Ginnie Mae —The first MBS was issued in 1970 by the Government NationalMortgage Association (GNMA). Ginnie Mae is a government-owned corporationthat issues MBS backed by the full faith and credit of the U.S. Government. As a direct obligation, the timely payment of principal and interest is guaranteed,regardless of mortgage payments or default. Fannie Mae —The Federal National Mortgage Association (FNMA) is astockholder-owned, government-sponsored corporation subject to Treasuryregulations, and has a line-of-credit with the U.S. Government. Fannie MaeMBS are considered a moral obligation of the U.S. Government, providingFederal agency credit quality. Freddie Mac —The Federal Home Loan Mortgage Association (FHLMC) is astockholder-owned, government-sponsored corporation established toincrease mortgage credit and provide liquidity. Like Fannie Mae, Freddie Machas a line-of-credit with the U.S. Government. Freddie Mac MBS are considereda moral obligation of the U.S. Government, offering Federal agency credit quality.Both Fannie Mae and Freddie Mac MBS generally offer higher current yieldsthan Ginnie Mae MBS in order to compensate for their slightly lower perceivedcredit quality. Mortgage-backed securities(MBS) have become anincreasingly important partof some investors’ assetallocation strategy. Today,MBS offer the opportunity todiversify a portfolio with ahigher yielding, high-qualityfixed income investmentalternative.  What are the Effects of InterestRate Changes on MBS? When interest rates fall , principal prepayments typically accelerate, due toincreased refinancing and new homebuying. As a result, the size of theprincipal prepayments to MBS investorsincreases and the estimated maturity ofthe MBS shortens. This occurs as principalis paid back sooner than expected. When interest rates rise , principalprepayments tend to decelerate, asrefinancing and home buying typicallydecrease in a higher interest rateenvironment. Typically, the size of principalprepayments lessens and the estimatedmaturity of the MBS lengthens. Giventhese possibilities, MBS investors mustrely on statistical information to anticipatethe rate of principal prepayments, as wellas the estimated maturity of the security. What are the Benefits of These Agencies? Together, these agencies help to effectively lower lending rates on residentialmortgage loans. They also facilitate the flow of funds to the U.S. housingindustry by providing lending institutions with the money they need to offeradditional mortgages. How are MBS Different from Other Fixed Income Securities? Unlike other fixed income investments, which typically pay periodic interestand return principal in one lump sum at maturity, MBS make interest andprincipal payments to investors on a monthly basis. As such, MBS investorsreceive their principal back over the life of the investment, instead of only atmaturity. This occurs as the monthly loan payments made by homeowners(which consist of both interest and principal) are passed through to MBS holders. Because homeowners can prepay their mortgage loans in advance, the size ofMBS monthly payments and the bond’s maturity are only estimated and canvary. In exchange for their estimated payment and maturity characteristics,MBS generally offer a yield advantage over other comparable-quality fixedincome securities. How Do Prepayments Affect MBS? Principal prepayments can affect both the monthly income stream and thematurity of a MBS. In theory, if every homeowner in a pool of mortgages madetheir monthly payments on time and held their mortgages for the full term (for example, 30 years), MBS investors could expect to receive equal monthlypayments of principal and interest for 30 years. However, homeowners can choose to prepay all or part of their mortgagesprior to maturity. This is known as “principal prepayment.” Types of Principal Prepayments One type of prepayment is known as refinancing . Refinancing typically occurswhen interest rates decline, providing mortgage borrowers with the opportunityto take advantage of lower mortgage rates. When this refinancing occurs, theprepaid principal is returned to the lending bank, and then passed through toMBS investors. Prepayments also occur through home sales . When homeowners relocate orsimply want to buy another home, the sale results in the prepayment of theprincipal amount due on the existing mortgage. Again, this principal prepaymentis then passed through to MBS investors.Another type of prepayment occurs when mortgage borrowers add to theminimum principal amount due each month on their mortgage statements. In this way, they accelerate the payment of principal, effectively paying off theloan before it’s due.When MBS are prepaid during periods of declining interest rates, investors willgenerally be forced to re-invest the proceeds at a lower rate of return. InterestRatesPrincipalPrepaymentsShorterEstimatedMaturity = InterestRatesPrincipalPrepaymentsLongerEstimatedMaturity =  FOR MORE INFORMATION © 2004 BlackRock. All Rights Reserved.MBS-BRO 1Q05 What are the Investment Advantages of MBS? High Credit Quality —MBS issued by Ginnie Mae are direct obligations backedby the full faith and credit of the U.S. Government, guaranteeing timelyrepayment of principal and interest. MBS issued by Fannie Mae and FreddieMac provide Federal agency credit quality. Whole loan MBS afford “AAA” creditquality through a combination of insurance and senior/subordinate structuring. Attractive Current Yields —MBS offer attractive current yields that are typicallyhigher than those of other comparable-quality fixed income securities. Thiscompensates investors for the variable maturity and payment characteristics of their MBS holdings. Monthly Income —Unlike other fixed income securities, MBS make monthlyincome payments (of principal and interest), rather than semi-annual payments.This provides investors with reinvestment opportunities as well as regularincome for meeting current expenses. A Variety of Estimated Maturities —MBS are available in a wide range ofestimated maturities in order to meet investors’ different financial planningtime horizons. Why Invest in MBS Funds Versus Individual MBS Securities? Active Management —The primary benefit of investing in MBS funds versus anindividual MBS security is active management. By owning actively managedfunds, investors can benefit from fund managers’ depth of experience, as wellas their access to research resources. Diversification —Another important benefit of owning MBS funds is diversification.By owning funds that contain a variety of MBS securities, investors canconveniently diversify their risk across such factors as credit quality, sensitivityto interest rates, and prepayment risk. Low Minimum Investment —MBS funds offer individual investors greateraffordability in achieving diversification due to their low minimum investmentcompared to individual bonds. What MBS Funds Does BlackRock Offer? BlackRock’s primary MBS offering is its BlackRock GNMA Fund. The Fundinvests primarily in securities issued by Ginnie Mae, as well as other U.S.Government securities in the five- to ten-year maturity range. The Fundnormally invests at least 80% of its assets in GNMA securities. Securitiespurchased by the Fund are rated in the highest rating category (AAA or Aaa) atthe time of purchase by at least one major rating agency, or are determined tobe of similar quality by the portfolio management team. The Fund measures itsperformance against the Lehman Brothers GNMA MBS Index.Investors can also gain exposure to the MBS sector through several otherBlackRock funds, including our Core Bond Total Return Portfolio, our CorePLUS Total Return Portfolio, and our Government Income Portfolio. TheseFunds offer exposure to GNMA and other MBS securities, as well as a broaderarray of fixed income instruments. MBSFunds at BlackRock FundShare ClassTickerGNMA Class ABGPAXClass BBGPBXClass C BGPCXInstitutional BGNIX Core Bond Class ABCBAXClass BBCIBXClass C BCBCXInstitutional BFMCX Core PLUS Class ABRTAXClass BBRTBXClass C BRTCXInstitutional BCRIX Gov’t Income Class ACCGAXClass BPNGBXClass C BGICXInstitutional N/A You should consider the investment objectives,risks, charges and expenses of the fund(s)carefully before investing. For completeinformation about any of the BlackRock funds,including objectives, risks, charges and expenses, you may obtain a prospectus from BlackRockDistributors, Inc., 760 Moore Road, King of Prussia, PA 19406. 800-882-0052. Please read the prospectus carefully before you invest or send money.  Affiliates of PNC Bank receive compensationfrom BlackRock funds for providing investmentadvisory and other services. Mutual fund shares are not deposits or obligationsof, or guaranteed or endorsed by, any bank, andare not federally insured by the Federal DepositInsurance Corporation, the Federal ReserveBoard or any other agency. An investment inmutual fund shares involves certain risks,including the possible loss of principal.
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