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Reading 56: Mortgage-Backed Sector of the Bond Market Los l~Q

 

LOS l: Distinguish credit risk analysis of commercial mortgage-backed securities from credit risk analysis of residential nonagency mortgage-backed securities.

Q1. When assessing credit risk for a Commercial Mortgage-Backed Security (CMBS), the underwriter will complete which of the following financial analysis?

A)   Both of the answer choices are correct.

B)   Compute a weighted debt service coverage ratio (DSC ratio) for the overall portfolio.

C)   Compute the DSC ratio for each property in the CMBS.

Correct answer is A)

Financial analysis of the DSC ratio for each property in the CMBS and analysis of the DSC ratio for the overall portfolio are both completed by the underwriter when assessing credit risk for a CMBS.

Q2. Which of the following is the primary difference between residential Mortgage-Backed Securities (MBS) and Commercial Mortgage-Backed Securities (CMBS) credit risk?

A)   Residential credit risk is difficult to quantify because of the nature of the residential borrower.

B)   Residential credit risk does not use financial ratio analysis for the determination of borrower credit worthiness.

C)   In residential MBS securities, the lender has the ability to seek repayment from the borrower beyond the value of the collateral.

Correct answer is C)

All CMBS mortgages are non-recourse loans; however, the residential mortgage lender can go back to the borrower personally in an attempt to repay a delinquent mortgage loan.

LOS m: Describe the basic structure of a CMBS, and illustrate the ways in which a CMBS investor may realize call protection at the loan level and by means of the CMBS structure.

Q1. 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)   increases the quality of a CMBS loan pool by reinvesting any prepayments in Treasury securities.

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

 

Q2. Commercial Mortgage-Backed Securities (CMBS) provide structural call protection through which of the following key repayment terms?

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

B)   Sequential repayment of the CMBS tranches.

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

 

Q3. Which of the following regarding key credit enhancement features of defeasance as prepayment protection is least accurate?

A)   The duration of the defeasance funds reduces the credit risk of the commercial mortgage-backed securities (CMBS).

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

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

 

Q4. Commercial mortgage-backed securities (CMBS) provide call protection through loan-level and individual mortgage call protection. Which of the following are least likely forms of call protection?

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

B)   If borrowers prepay their loan, proceeds are distributed to investors.

C)   Penalty fees assessed against the borrower for prepayment.

 

Q5. The strongest form of prepayment protection is:

A)   yield maintenance charges.

B)   a one year prepayment lockout.

C)   defeasance.

[2009]Session15-Reading 56: Mortgage-Backed Sector of the Bond Market Los l~Q

 

LOS l: Distinguish credit risk analysis of commercial mortgage-backed securities from credit risk analysis of residential nonagency mortgage-backed securities. fficeffice" />

Q1. When assessing credit risk for a Commercial Mortgage-Backed Security (CMBS), the underwriter will complete which of the following financial analysis?

A)   Both of the answer choices are correct.

B)   Compute a weighted debt service coverage ratio (DSC ratio) for the overall portfolio.

C)   Compute the DSC ratio for each property in the CMBS.

Correct answer is A)

Financial analysis of the DSC ratio for each property in the CMBS and analysis of the DSC ratio for the overall portfolio are both completed by the underwriter when assessing credit risk for a CMBS.

Q2. Which of the following is the primary difference between residential Mortgage-Backed Securities (MBS) and Commercial Mortgage-Backed Securities (CMBS) credit risk?

A)   Residential credit risk is difficult to quantify because of the nature of the residential borrower.

B)   Residential credit risk does not use financial ratio analysis for the determination of borrower credit worthiness.

C)   In residential MBS securities, the lender has the ability to seek repayment from the borrower beyond the value of the collateral.

Correct answer is C)

All CMBS mortgages are non-recourse loans; however, the residential mortgage lender can go back to the borrower personally in an attempt to repay a delinquent mortgage loan.

LOS m: Describe the basic structure of a CMBS, and illustrate the ways in which a CMBS investor may realize call protection at the loan level and by means of the CMBS structure.

Q1. 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)   increases the quality of a CMBS loan pool by reinvesting any prepayments in Treasury securities.

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

Correct answer is B)

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

 

Q2. Commercial Mortgage-Backed Securities (CMBS) provide structural call protection through which of the following key repayment terms?

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

B)   Sequential repayment of the CMBS tranches.

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

Correct answer is C)       

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.

 

Q3. Which of the following regarding key credit enhancement features of defeasance as prepayment protection is least accurate?

A)   The duration of the defeasance funds reduces the credit risk of the commercial mortgage-backed securities (CMBS).

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

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

Correct answer is A)

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

 

Q4. Commercial mortgage-backed securities (CMBS) provide call protection through loan-level and individual mortgage call protection. Which of the following are least likely forms of call protection?

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

B)   If borrowers prepay their loan, proceeds are distributed to investors.

C)   Penalty fees assessed against the borrower for prepayment.

Correct answer is B)

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.

 

Q5. The strongest form of prepayment protection is:

A)   yield maintenance charges.

B)   a one year prepayment lockout.

C)   defeasance.

Correct answer is C)

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.

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