1.The strongest form of prepayment protection is:

A)   prepayment penalty points.

B)   a one year prepayment lockout.

C)   yield maintenance charges.

D)   defeasance.

The correct answer was D)

Defeasance occurs when prepayment loan proceeds received by the loan servicer are invested in U.S. Treasury securities. When the defeasance period ends, the U.S. Treasuries are liquidated and the proceeds are used to repay the mortgage. The collateral provided by the U.S. Treasuries is of higher quality than the underlying asset; therefore, defeasance represents the greatest level of prepayment protection for an investor.

2.Commercial mortgage-backed securities (CMBS) provide call protection through loan-level and individual mortgage call protection. All of the following are forms of call protection EXCEPT:

A)   penalty fees assessed against the borrower for prepayment.

B)   borrowers are charged the amount of interest lost by the lender had the loan not been prepaid.

C)   borrowers are prohibited from prepaying their loans within a specified period of time.

D)   if borrowers prepay their loan, proceeds are distributed to investors.

The correct answer was D)

Loan-level call protection includes: defeasance, prepayment penalty charges, prepayment lock out period, and yield maintenance charges. Prepayment proceeds should not be distributed to investors. When borrowers prepay, the mortgage loan can be “defeased” – the loan proceeds are received by the loan servicer and invested in U.S. Treasuries to create cash collateral against the loan.

3.Which of the following regarding key credit enhancement features of defeasance as prepayment protection is least accurate?

A)   No distributions are made when the defeasance takes place, so there is no issue concerning how prepayment penalties will be disbursed.

B)   The cash flow from the defeasance funds is substituted for payments made by the borrower.

C)   The duration of the defeasance funds reduces the credit risk of the Commercial Mortgage-Backed Securities.

D)   By using U.S. Treasury securities as funding for the defeasance, the overall credit quality of the collateral improves with each payment.

The correct answer was C)

Duration is related to interest rate risk; it is not related to credit risk.

4.Commercial Mortgage-Backed Securities (CMBS) provide structural call protection through which of the following key repayment terms?

A)   Sequential repayment of the CMBS tranches and the allocation of losses of principal to specific tranches, rather than to the CMBS overall.

B)   Losses of principal are allocated to specific tranches, rather than to the CMBS overall.

C)   The contribution of additional collateral is required should property values decline below a specified level.

D)   Sequential repayment of the CMBS tranches.

The correct answer was A)

CMBS securities provide structural call protection through sequential repayment of the CMBS tranches, as well as the allocation of losses of principal to specific tranches rather than to the overall CMBS.

5.Which of the following statements is most accurate concerning the effect of defeasance on the quality of a Commercial mortgage-backed securities (CMBS) loan pool? Defeasance:

A)   increases the quality of a CMBS loan pool by requiring fees for late payments.

B)   decreases the quality of a CMBS loan pool by refusing any prepayments.

C)   increases the quality of a CMBS loan pool by reinvesting any prepayments in Treasury securities.

D)   decreases the quality of a CMBS loan pool by selling some of the pool as payments come due.

The correct answer was C)     

Defeasance increases the quality of a CMBS loan pool by reinvesting any prepayments in Treasury securities.