What Is a Super Sinker?

The term super sinker refers to a type of bond with a long-term coupon but a potentially short maturity. If the principal balance of the bond is paid out before maturity, bondholders receive the value of the principal back quickly. Super sinker bonds typically attract investors who want a brief maturity period while taking advantage of longer-term interest rates. Super sinker bonds, for the most part, are collateralized by mortgages and are used to reduce prepayment risk.

Key Takeaways

  • A super sinker refers is a bond that has a long-term coupon but a potentially short maturity.
  • If the bond's principal is paid before it matures, bondholders receive the value of the principal back quickly.
  • These bonds are primarily collateralized by mortgages and are used to reduce prepayment risk.
  • Super sinkers are generally sold at par or at a discount to par.

How Super Sinkers Work

As noted above, a super sinker bond is characterized by a short maturity and a long-term coupon. Super sinker bonds are normally collateralized by mortgages and are used to reduce any associated prepayment risks. Mortgages and housing bonds carry a level of prepayment risk. That's because the homeowner may repay the value of the mortgage in full before the mortgage’s maturity date has been reached. This can happen in several situations whether the homeowner sells the home or if the homeowner refinances the mortgage at a lower rate.

When a super sinker is attached to a mortgage, it receives special treatment. A specifically-identified bond maturity is selected to receive the prepayments, so all mortgage prepayments are applied to the super sinker first before any other mortgage-related investment vehicles. This allows the bond to be retired faster than other mortgage bonds. This way, even though super sinker bonds may have an actual lifespan that lasts only three to five years, their yields are usually similar to bonds with much longer maturities.

Super sinkers are typically sold at par or at a discount to par since their short duration makes paying a premium for the bonds a relatively great risk. But investors should take a few things into considerations before investing in these kinds of bonds. They should carefully estimate the securities’ yield to call—the total return that would be received if the bond purchased was held until its call date instead of full maturity. Because it is impossible to know when a bond's issuer may recall it, investors can only estimate this calculation based on the bond’s coupon rate, the time until the first or second call date, as well as the market price.

The reason why super soakers are sold at par or at a discount to par is that their short duration makes paying a premium for the bonds a relatively great risk.

While a super sinker's actual maturity date may not be exactly known, investors can estimate the bond's yield to maturity (YTM). This is the total return an investor may receive if the bond was held through its maturity date based on past prepayments for similar mortgage profiles.

Special Considerations

A super sinker fund is most likely to be used in home financing, where there is a greater risk of bond prepayment. Super sinker funds are specifically associated with single-family mortgage revenue bonds, which have allowed many home buyers with low- and moderate-incomes to purchase their first home. Funds that are gathered through the prepayment of mortgages go into the super sinker. Otherwise, a super sinker operates likes a normal sinking fund.