What is Subordination About? Credit Risk and Subordination Levels in Commercial Mortgage-backed Securities (CMBS)

What is Subordination About? Credit Risk and Subordination Levels in Commercial Mortgage-backed... Subordination is designed to provide credit risk protection for senior CMBS tranches by allocating the initial credit losses to the more junior tranches. Subordination level should in theory reflect the underlying credit risk of the CMBS pool. In this paper, we test the hypothesis that subordination is purely about credit risk as intended. We find a very weak relation between subordination levels and both the ex post and ex ante measures of credit risk, rejecting our null-hypothesis. Alternatively, we find that subordination levels were driven by non-credit risk factors, including supply and demand factors, deal complexity, issuer incentive and a general time trend. We conclude that contrary to the traditional view, the subordination level is not just a function of credit risk. Instead it also reflects the market need of a certain deal structure and is influenced by the balance of power among issuers, CRAs and investors. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Real Estate Finance and Economics Springer Journals

What is Subordination About? Credit Risk and Subordination Levels in Commercial Mortgage-backed Securities (CMBS)

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Publisher
Springer US
Copyright
Copyright © 2014 by Springer Science+Business Media New York
Subject
Economics / Management Science; Regional/Spatial Science; Finance/Investment/Banking
ISSN
0895-5638
eISSN
1573-045X
D.O.I.
10.1007/s11146-014-9480-1
Publisher site
See Article on Publisher Site

Abstract

Subordination is designed to provide credit risk protection for senior CMBS tranches by allocating the initial credit losses to the more junior tranches. Subordination level should in theory reflect the underlying credit risk of the CMBS pool. In this paper, we test the hypothesis that subordination is purely about credit risk as intended. We find a very weak relation between subordination levels and both the ex post and ex ante measures of credit risk, rejecting our null-hypothesis. Alternatively, we find that subordination levels were driven by non-credit risk factors, including supply and demand factors, deal complexity, issuer incentive and a general time trend. We conclude that contrary to the traditional view, the subordination level is not just a function of credit risk. Instead it also reflects the market need of a certain deal structure and is influenced by the balance of power among issuers, CRAs and investors.

Journal

The Journal of Real Estate Finance and EconomicsSpringer Journals

Published: Jul 27, 2014

References

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