Module 26
CMBS & commercial mortgage credit
CMBS — commercial mortgage-backed securities — are pools of mortgages on commercial property: office towers, shopping centers, apartment buildings, warehouses. Structurally they look like the agency MBS from the MBS module, but the risk profile is the exact opposite. Agency MBS is all about prepayment and has no credit risk; CMBS has almost no prepayment risk and is all about credit.
Why no prepayment risk? Commercial mortgages are written with lockouts, yield maintenance, and defeasance — contract terms that make it prohibitively expensive for the borrower to repay early. That call protection means CMBS keeps the positive convexity that agency MBS gives up: when rates fall, your bond just gets more valuable, because nobody can refinance away from you. The trade is that you now carry the risk the borrower can't pay.
So CMBS analysis is property credit analysis, built on a few measures:
- DSCR (debt service coverage ratio) — the property's net operating income divided by its debt service. A DSCR of 1.5x means the building earns 50% more than its mortgage bill; below 1.0x the rent doesn't cover the loan.
- LTV (loan-to-value) — the loan divided by the property's value. It's the equity cushion: at 60% LTV the property can lose 40% of its value before the lender loses a dollar.
- Property type and market — a full warehouse in a logistics hub and a half-empty downtown office are different worlds, even at the same DSCR today.
The distinctive CMBS danger is balloon risk. Most commercial mortgages don't amortize down to zero — they pay mostly interest for five to ten years and then owe a large balloon payment that the borrower expects to refinance. That works until it doesn't: if rates have spiked, or the property sector has died, no new lender will advance enough to take out the old loan. A wave of loans hitting maturity into that environment is a maturity wall — and the post-pandemic office sector, with empty floors and repricing buildings, is the live stress case playing out right now.
Deals come in two flavors. Conduit deals pool dozens of loans across property types and cities — diversified, so you underwrite averages. SASB (single-asset, single-borrower) deals finance one trophy property or one borrower — no diversification at all, so you underwrite that one building like a bond issuer.
Dial in a property below and stress the refinancing.
🎛 DSCR / LTV / balloon lab
Implied property value
$153.8M
NOI ÷ cap rate
DSCR
1.82x
NOI ÷ debt service
LTV
65%
loan ÷ property value
Balloon shortfall
$0
loan − refi proceeds
Refi test passed. At a 7% refinancing rate a lender holding out for 1.20x DSCR and 70% LTV would advance $107.7M — enough to take out the $100M balloon. DSCR at the new rate would be 1.43x.
DSCRis the property's income cushion over its interest bill (interest-only for simplicity); LTV is leverage against the value implied by the cap rate. The balloon testasks whether a new lender — demanding 1.20x coverage and 70% leverage at today's rates — would lend enough to repay the maturing loan. Educational tool — not investment advice.
How the lab computes it
Commercial property is valued by capitalizing its income: divide the net operating income by the cap rate the market demands for that property type. Everything else follows:
property value = NOI / cap rate LTV = loan / property value DSCR = NOI / (loan × interest rate) (interest-only)
The balloon test asks what a new lender would advance at maturity. Lenders typically require both a minimum coverage (say 1.20x DSCR) and a maximum leverage (say 70% LTV) at the new, possibly higher rate:
refi proceeds = min( NOI / (1.20 × refi rate), 0.70 × value ) shortfall = loan − refi proceeds (if > 0 → gap)
If the maturing loan exceeds what a new lender will provide, the borrower must inject fresh equity or default at maturity — that shortfall, multiplied across every loan maturing into the same market, is the maturity wall.
Sibling topic: non-agency RMBS
Residential mortgages without a government guarantee trade on the same logic. Non-agency RMBS layers credit modeling — default rates, severity (loss-given-default), and delinquency roll-rates — on top of the prepayment modeling you already know, and tranches the pool into senior and subordinate bonds so losses hit the bottom first. The post-2008 market comes in a few flavors: prime jumbo (loans too big for the agencies), non-QM (borrowers outside the standard underwriting box), and CRT— credit-risk transfer, where Fannie and Freddie sell investors the credit risk they guarantee. In practice it's modeled loan by loan, with every assumption run through a cashflow engine.
The takeaway:CMBS flips the MBS problem on its head. Prepayment is locked out, so there's nothing to model there — it's pure credit: the DSCR, the LTV, and whether the balloon can refinance at maturity.
Things to try
- • Push the refinancing rate up while leaving everything else alone — watch a healthy loan develop a maturity-wall gap purely because rates moved.
- • Raise the cap rate (the market repricing a sector, like office). Property value falls, LTV blows out, and the 70% LTV leg of the refi test starts to bind.
- • Set up a marginal loan — DSCR just above 1.2x — then trim NOI slightly. Small income declines flip both the coverage color and the refi test.
- • Find the combination where DSCR looks fine today but the balloon still fails — that's why maturity schedules matter as much as current coverage.