What Is a Mortgage Participation Certificate?

A mortgage participation certificate is a type of security that groups together mortgages held by the Federal Home Loan Mortgage Corporation (Freddie Mac), a government-sponsored enterprise. The certificates are guaranteed by Freddie Mac but not the federal government itself. They are taxable by federal, state, and local governments.

Mortgage participation certificates, which Freddie Mac calls PCs, are also referred to as “pass-through securities” because the interest and principal payments are periodically passed through to investors from debtors after service fee deductions.

Key Takeaways

  • A mortgage participation certificate is a security made up of a group of mortgages held by Freddie Mac, a government-sponsored entity.
  • The certificates are guaranteed by Freddie Mac, rather than the federal government itself, and are considered to be fairly safe investments.
  • These certificates are known as pass-through securities as the interest and principal payments get passed to investors from debtors, minus any deductions for service fees.
  • Mortgage participation certificates are taxable at the local, state, and federal levels.

Understanding Mortgage Participation Certificates

Mortgage participation certificates in one form or another have been an essential part of Freddie Mac’s operation since its founding by Congress in 1970. The original goal of Freddie Mac was to increase liquidity for thrift banks, which at the time issued most mortgages. Freddie Mac bought mortgages from the thrifts, providing the banks with cash to lend out as new mortgages, then packaged and resold them on the secondary market.

Until 1990, Freddie Mac paid PC investors under a system known as a “modified guarantee,” meaning the payment was delayed until the 75th day after the mortgage payment was due from the original borrower.

Payment delays changed after the 1989 Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), when Freddie Mac was restructured as a market-oriented corporate entity that was placed under the regulatory control of the Department of Housing and Urban Development (HUD). Shortly thereafter, Freddie Mac introduced its so-called Gold program, which pays PC investors on the 45th day.

Conventional Mortgages Underlie Most Participation Certificates

The vast majority of mortgage participation certificates are for pools of conventional 15- and 30-year mortgages on single-family homes. However, Freddie Mac also issues certificates for groups of adjustable-rate mortgages (ARMs). The minimum pool size is generally $1 million. In the past, Freddie Mac sold most PCs for cash, but today most PCs are swapped for new mortgages from banks.

Liquidity and Regulatory Risk

Because they are guaranteed by Freddie Mac, mortgage participation certificates are considered fairly safe investments, but they do carry some risk. For example, while HUD remains Freddie Mac’s regulator with regard to fair lending issues, since the 2008 subprime housing crisis the organization’s financial operations are now under the conservatorship of the new Federal Housing Finance Agency (FHFA).

It is possible, though unlikely, that the FHFA could revoke Freddie Mac’s guarantees. Another risk is liquidity, since Freddie Mac PCs are not traded on any exchange. Should Freddie Mac curtail its own mortgage investment portfolio, the secondary market for its PCs could be impacted.