What Is a Generic Security?
A generic security is a new security that is less than one year old and is usually backed by recently issued loans or mortgages. Generic securities cost less than established securities because they are newer and, therefore, do not have a long trading history to establish their qualities. As such, they are considered riskier. Securities over a year old are called seasoned securities.
- A generic security is a new security that is less than one year old and whose qualities are not yet established.
- Because a generic security is mostly unknown it is considered riskier and as a result, it is priced lower than longer, more established securities.
- Generic securities are most commonly backed by recently issued loans or mortgages.
- Information about a generic security that is not known is primarily its liquidity, volatility, and trading volume.
- One common generic security is a mortgage-backed security (MBS).
Understanding Generic Securities
A generic security does not yet have a history that potential investors can look to for a past performance rating as a seasoned security does. They have not established common metrics as established securities have, such as liquidity, volatility, and trading volume.
These metrics are important because they allow an investor to know how quickly they can sell the asset if they are in need of cash or if they see the value of the security fall. It also provides an indicator of how predictable the income stream is from the security.
However, as generic securities are valued less by investors, they are less expensive to purchase. While their value is lower than the older investment options, their pricing may make them more attractive to some types of investors, particularly to those with a higher risk tolerance.
Investing in Generic Securities
One reason for the lower rates on generic securities is that the underlying mortgages or loans backing the security are too new to be considered stable. The incidence of default on these types of debt obligations is traditionally understood to be higher during the first twelve months after issuance. Once payments on the debts have remained current during the first year, confidence increases. This will turn a generic security into a seasoned security.
It's important for investors to look closely at the nature of the debt obligations that provide the support for any generic security. Once someone understands the nature of those loans and mortgages and gets an idea of the risks one way or another that those debts would be settled in a timely manner, it will be easier to focus attention on investments that are more likely to earn a return.
At the same time, this type of activity will also increase the chances of identifying generic securities that carry a higher degree of risk than is comfortable for the investor. Assuming the investor is correct, the effort to carefully evaluate the viability of an investment can prevent losses while also allowing an investor to move on to a more promising investment.
Example of Generic Securities
One of the most common generic securities is a mortgage-backed security (MBS). A mortgage-backed security (MBS) is secured by a mortgage or a collection of mortgages. The mortgages are sold to a group of individuals (a government agency or investment bank) that packages the loans together into a security that investors can buy.
The mortgages of an MBS may be residential or commercial, depending on whether it is an agency MBS or a non-agency MBS. In the United States, they may be issued by structures set up by government-sponsored enterprises like Fannie Mae or Freddie Mac, or they can be "private-label," issued by structures set up by investment banks.
When an MBS is issued it is new and some of its specific qualities are unknown to the investor. For example, the quality of the underlying mortgages that make up an MBS will vary, therefore the default rate will vary. This default rate will affect an investor's income stream, depending on the tranche they have invested in. This can change over time, but after a year has passed, it will generally be known how the underlying mortgages perform and, therefore, how the MBS will perform.