The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

COMMERCIAL MORTGAGE-BACKED SECURITIES

Commercial mortgage-backed securities (CMBSs) are backed by a pool of commercial mortgage loans on income-producing property—multifamily properties (i.e., apartment buildings), office buildings, industrial properties (including warehouses), shopping centers, hotels, and health care facilities (i.e., senior housing care facilities). The basic building block of the CMBS transaction is a commercial loan that was originated either to finance a commercial purchase or to refinance a prior mortgage obligation.

Commercial mortgage loans are nonrecourse loans. This means that the lender can only look to the income-producing property backing the loan for interest and principal repayment. If there is a default, the lender looks to the proceeds from the sale of the property for repayment and has no recourse to the borrower for any unpaid balance. Basically, this means that the lender must view each property as a stand-alone business and evaluate each property using measures that have been found to be useful in assessing credit risk.

Regardless of the property type, the two measures that have been found to be key indicators of the potential credit performance are the debt-to-service coverage (DSC) ratio and the loan-to-value (LTV) ratio. The DSC ratio is the ratio of the property’s net operating income (NOI) divided by the debt service. The NOI is defined as the rental income reduced by cash operating expenses (adjusted for a replacement reserve). ...