Lesson 5 of 5 · 15 min
Commercial mortgage-backed securities (CMBS)
CMBS are backed by a small number of loans on income-producing property, so they have little contraction risk thanks to call protection, but more concentration and balloon (extension) risk, judged with the DSC and LTV ratios.
In short
- CMBS are backed by commercial mortgages on income-producing property: apartments, offices, warehouses, shopping centres, hotels, health care facilities.
- Call protection makes CMBS trade more like corporate bonds: structural (sequential-pay tranches) or loan-level (prepayment lockout, prepayment penalty points, defeasance).
- Commercial loans are usually balloon loans. Balloon risk (failing to repay the balloon at maturity, leading to an extended workout) is a form of extension risk.
- A CMBS pool may hold only a few loans, so one default can hurt a lot: concentration risk. Analyse loans, properties and owners as well as the structure.
- Key credit metrics: LTV and debt service coverage (DSC) = NOI / debt service. DSC above 1.0× means the property's cash flow covers the debt.
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