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What is Commercial Mortgage-Backed Security?

A commercial mortgage-backed security is a form of bond security that is often issued in security markets based in the United States.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 01 November 2014
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A commercial mortgage-backed security is a form of bond security that is often issued in security markets based in the United States. The security makes use of mortgages that are taken out on commercial properties rather than on real estate holdings that are classified as residential. In most cases, the issue of a commercial mortgage-backed security are configured as a component in multiple tranches.

One of the advantages to the American type of commercial mortgage-backed security is that the bond tends to present less of a prepayment risk than other types of commercial mortgage backed strategies. This is due to several elements that tend to define the structure of commercial mortgages in the United States. Notable elements of a commercial mortgage-backed security would be a mortgage that includes lockout provisions, penalties for early repayment, and yield maintenance. All these elements work together to protect investors who choose to purchase the bonds.

With a commercial mortgage-backed security, the issuer of the bonds may choose to pool a number of commercial mortgages and place them into a trust. The trust functions as the issuer for a series of bonds that may vary in factors such as duration, payment priority, and rate and size of yield. Rating agencies help potential investors to evaluate the terms related to the bonds, with a AAA rating indicating the most favorable options.

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A commercial mortgage-backed security that is left unrated is often considered to be a risky venture and devoid of many of the benefits that would be of interest to an investor. However, it should be noted that an unrated commercial mortgage-backed security may still be a good investment, since the purchase price would tend to be lower. While the low return may not be attractive to some investors, even the unrated commercial mortgage-backed security has a place in commercial lending and can yield a small return. For investors who are willing to assume a greater risk for a smaller return on what is sometimes a short term, this approach may be acceptable.

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