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Senior-subordinated structures are referred to as self-insuring structures because they rely on internally generated credit support to protect the investor from losses. Typically, senior-subordinated bonds employ a combination of excess spread, overcollateralization and subordination. Losses are absorbed in reverse priority through the capital structure, first by excess spread, then overcollateralization (OC) and finally via the principal writedown of the subordinated bonds.

As mentioned previously, collateral may be either all fixed or adjustable rate or consist of both fixed and adjustable rate. Credit enhancement structures may be designed to accommodate the different collateral groups. These structures are referred to as I-, H-, or Y-structures.

Type I credit enhancement structures accommodate a single collateral group of either fixed rate, adjustable rate, or mixed loan types.

Both the H and Y credit enhancement structures may be used with multiple collateral groups. The H-structure allows two collateral groups and two distinct subordinated bond groups.

The H-structure can be thought of as two distinct transactions, except that excess interest may be shared between collateral groups to maintain target OC levels and cross coverage of subordinate bonds for triple-A support. Because excess interest is shared between groups, the Hstructure is said to be cross collateralized.

For example, if Group 2’s excess interest is insufficient to cover losses and maintain target OC levels and Group 1 has sufficient excess interest to cover its losses and maintain excess interest, then Group 1’s excess interest may be used to bring Group 2’s OC to the target level.

The Y-structure also allows two distinct collateral groups. However, unlike the H-structure, the Y-structure employs a single subordination group to support both the Group 1 and the Group 2 senior tranches.

Excess interest represents the difference between the collateral weighted average mortgage rates and the weighted average cost of the liabilities, net of fees and expenses. Generally, the mortgage loans are expected to generate more interest than required to pay the liabilities.

To the extent that excess interest (net of fees, expenses or derivative payments) is positive, it is used to absorb losses on the mortgage loans. After the financial obligations of the trust are covered, excess interest is used to maintain overcollateralization at the target level.

Several factors could affect the extent to which excess interest is available to maintain overcollateralization:
Full or partial repayments and defaults may reduce the amount of excess interest. This is because borrowers with mortgage loans carrying higher WACs have a greater tendency to repay. This, in turn, reduces the weighted average rate of the underlying mortgage loan pool (this is commonly referred to as WAC drift).

If the rates of delinquencies, defaults or losses turn out to be higher than expected, excess interest will be reduced by the amount necessary to compensate for any shortfalls in the cash available to make required distributions to the senior and mezzanine certificates.

The following four property types constitute the majority of CMBS collateral—apartment buildings, shopping or strip malls, office properties and industrial properties. Other asset types included in CMBS pools are hotels, manufactured housing, self-storage, and healthcare properties.

One appealing factor for borrowers is that the loans are nonrecourse (or limited recourse) to the borrower. Ultimate repayment comes solely from the collateral and not the borrower. There are exceptions for fraudulent borrower activities or representations, and the like. Borrowers typically make their borrowing decisions either on price (which conduit or other lender is offering the cheapest financing) and/or proceeds (which lender is willing to lend the largest amount of proceeds—that is, allowing the borrower the greatest leverage).

In exchange for nonrecourse and favorable rates, the loans come with prepayment restrictions, making it possible to create bonds that have excellent call protection and average life stability. Most loans amortize over a 25-to 30-year period. However, most loans also balloon at 10 years and must be paid in full. Since 2004, the amount of loans with IO periods (where no amortization is taking place) has been increasing. For many years, IO periods as a percentage of a loan’s term has hovered around 5%. This percentage has grown to nearly 70%.

‘Property’ is a term used to describe a legal real property interest in real estate. In economic terms a property can have a value-in-use and a value-inexchange, the latter is an estimate of exchange price.

A property valuation is the process of forming an opinion of value-inexchange under certain assumptions and a market valuation requires those assumptions to establish an open market scenario.

Valuations are required in connection with many activities, chiefly development appraisal, transfer of ownership, monitoring of property investment performance, reporting the value of property assets held by companies, loan security, tax matters and insurance risk assessment.

The diversity of property makes valuation a difficult task, no two properties are ever the same, yet valuation relies on the comparison of properties to give an indication of value. To do this the valuer must be aware of, and be able to quantify, differences in type, location, legal interest, quality and the state of the market.