CMBS: The basics
Commercial mortgage-backed securities are divided into tranches that pay off only when the tranche above has been paid. As issues do not have borrower recourse, the market is characterized by detailed rating agency analysis and investor due diligence. The main criterion used to evaluate deals are the loan-to-value (LTV) ratio. In addition, debt service ratio and interest coverage ratio are also frequently used.
The tranching of a deal is an indication of the quality of the assets underlying it. Typically, between 70% and 80% of the deal forms the triple-A tranche and this will usually have a maturity of five to 10 years. Subordinated tranches below this – from double-A to below investment grade – will usually have a longer maturity than the triple-A tranche in order to fully protect it. The buyers of CMBS are typically banks and institutional investors although hedge funds do take an interest in the market at the lower end of the credit spectrum.