Publications

- September 1, 2020: Vol. 32, Number 8

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A match not made in heaven: Securitization and the commercial mortgage industry

by Andrew Stewart

Commercial mortgages and securitization have always made for an uneasy alliance. The secret sauce of all forms of debt securitization is to take highly idiosyncratic nonrated credit risk and turn it into a form that allows the cash flows to be carved up, separately rated and then sold to investors with varying risk tolerances. It is difficult to quantify the probability of a single borrower defaulting on their loan, but over a large pool of borrowers one can more easily estimate default rates across many metrics. In essence, pooling borrowers creates diversification that lowers risk to those who are to be paid back first out of cash flows. The various ratings — AAA, AA, BBB, etc. — simply reflect different probabilities of default. Rating these cash flows for bond buyers results in less debt financing, which is what induces people to borrow in a format where the debt is destined to be sold. Commercial mortgages were late to the securitization party because it was thought the het

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