Page 84 - FINAL CFA SLIDES DECEMBER 2018 DAY 14

Session Unit 15:
53. Introduction To Asset-Backed Securities

• Prepayment penalty points. A penalty fee expressed in points may be charged to borrowers

who prepay mortgage principal. Each point is 1% of the principal amount prepaid.

• Yield maintenance charges. The borrower is charged the amount of interest lost by the lender

should the loan be prepaid. This make whole charge is designed to make lenders indifferent to
prepayment, as cash flows are equivalent (at current market rates) whether the loan is prepaid

or not.

tanties
With all loan call protection programs, any prepayment penalties received are distributed to the

CMBS investors in a manner determined by the structure of the CMBS issue.

To create CMBS-level call protection, CMBS loan pools are segregated into tranches with a specific

sequence of repayment (higher priority will have a higher credit rating and a wide variety of
features can be used to provide call protection to the more senior tranches of the CMBS.

Commercial mortgages are typically amortized over a period longer; say a 20-year commercial
mortgage may be determined based on a 30-year amortization schedule. At the end of the loan

term, there will be a principal outstanding (this amount is called a balloon payment). Failure to
arrange refinancing to make this payment, the borrower is in default (this is called balloon risk).

Because balloon risk entails extending the term of the loan, during which workout period, the
borrower will be charged a higher interest rate, it is also referred to as extension risk for CMBS.