Commercial mortgages

The comparatively low risk that a portfolio of both residential and commercial mortgages entails is also expressed in the equity weighting of 50% for mortgage loans with a lending limit of up to 60%. 

Commercial mortgage-backed securities (CMBS) represent an important and growing sector of the European securitisation market. However, in many cases there are significant differences between transactions, even those backed by collateral from the same originator, and it is these differences, in both collateral types and structural features, that make European CMBS such an interesting asset class. This chapter focuses on some of the more important aspects that investors should consider when analysing the collateral supporting these transactions and briefly looks at the key features of the common transaction structures. 

There are two basic forms of pooled commercial mortgage transactions the true sale and the synthetic structures. The true sale mechanism, as its name suggests, involves the sale of assets from the originator s balance sheet to an SPV, which are then used as security for the issue of notes to investors. Synthetic structures, by contrast, involve the creation of a credit derivative linked to the performance of a pool of loans. The loans themselves remain on the balance sheet of the originator but the credit risks associated with these loans are transferred through the credit derivative to investors. Synthetic structures can simplify the issuance process and avoid many of the complexities (and costs) associated with the sale of assets in many jurisdictions. 

Double credit risk is a particular feature of such synthetic transaction structures. Not only are investors exposed to the performance of the reference pool of commercial mortgages, but also to the performance of the collateral the issuer is holding. If this includes notes issued by the originator itself then this will also include exposure to the credit rating of the originator. 

An ABS is a bond issued by a single purpose vehicle (SPV) that is secured with a large number of assets (the Assets ) of one same type pooled in a portfolio. These Assets are usually the sole recourse the investors will have for repayment of the bonds. Examples of Assets are residential mortgages, commercial mortgages, credit card receivables, aircraft leases, and the like. 

Some lending institutions penalize borrowers who retire their loans early. In the United States, prepayment penalties are levied only for commercial mortgages, not for residential ones (both are penalized in the United Kingdom). Residential lenders, therefore, cannot be certain of the cash flows they will receive. This is known as prepayment risk. The uncertainty of mortgages cash flows, and the risk associated with it, is passed on to the securities backed by the loans. In this way, an MBS is similar to a callable bond, with the call exercisable at the discretion of the borrowers, and, as will be explained later, it can be valued using a similar pricing model. 

The loans underlying commercial mortgage-backed securities are, as the name implies, for commercial, as opposed to residential, properties. CMBSs trade like other mortgage securities but differ in structure. 

Commercial mortgages are loans made against commercial property. A CMBS is created from a pool, or trust, of commercial mortgages, whose interest and principal payments back the bond s cash. It is rated in the same way as a residential mortgage security and usually includes a credit... 

In addition to their early-retirement protection, commercial mortgages differ from residential ones in that many of them are balloon loans. As explained above, a large part of the principal of a balloon loan is paid off on a single date. This makes CMBSs similar to plain vanilla, or buUet, bonds, an attraction for investors who prefer more certainty about terms to maturity. 

Fabozzi, E, and D. Jacob. 1996. The Handbook of Commercial Mortgage-Backed Securities. New Hope, PA FJF Associates. 

Debt Service Coverage Ratio (DSCR) Net Operating Income/ Debt Payments commercial mortgages... 

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