Like all securitized assets tied to US real estate, these bonds often get a bad rap. That’s understandable—but not entirely fair.
During the financial crisis, the plunge in the value of many mortgage-backed bonds was traumatic for investors. Holders of the lower-rated or equity tranches sustained big losses. To be fair, that’s the way structured products are supposed to work. The highest-quality tranches enjoy the most credit protection, while the lower ones offer higher yields but are first to absorb losses when underlying loans default.
NOT LAST DECADE’S LOANS
But the commercial loans originated after the CMBS market hit bottom in 2010 are very different from those that were made between 2006 and 2008. That’s because large and regional US banks got stricter and overhauled their lending practices. At the same time, credit enhancement levels for the non-AAA-rated CMBS have approximately doubled, which creates a deeper cushion against loan losses.
As the display below illustrates, the loan-to-value (LTV) ratios, which compare the size of the loan to the value of the property, came down sharply between 2010 and 2014. At the same time, property values rose, making the effective LTVs of these loan pools even lower. For instance, the BBB-rated tranche of CMBS issued between 2012 and 2014 offer strong credit fundamentals and yields of up to 7.5%.
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