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of loans (e.g., LICs vs. CMBS vs. bank loans) may have different default characteristics owing to
the relative risk appetites, investment horizons, etc., of the respective lenders.
Analysis of Commercial Mortgage Portfolios
Because of the specialized knowledge necessary for effective, cost-efficient commercial
mortgage lending, commercial mortgage investors, to include LICs, generally invest in portfolios
of commercial mortgages, which may range from hundreds to thousands of individual
mortgages, and in value amount from the tens of millions to billions of dollars. These portfolios
are ongoing enterprises with portions of the portfolios continually maturing and being paid off
and new originations being added to the portfolio. As this process takes place, the investor is
adjusting the investment program to achieve an optimal return vs. risk profile.
The commercial mortgage investment portfolio is generally composed of a variety of property
types in different geographic areas, and the mortgages may be of fixed or variable rate, of
varying maturities, senior or subordinate position, etc. Accordingly, the portfolio may be
analyzed in terms of the aggregate metrics outlined above (debt service coverage ratio [DSCR],
LTV, DY, EL, PD, LGD) for each component of the portfolio, i.e., property type (multifamily,
office, retail, industrial, hotel and other); geographic area (central business district vs.
suburban); metropolitan area (New York, Los Angeles, etc.); primary vs. secondary vs. tertiary
markets; by maturity; etc. By calculating the average (typically, value weighted) coupon vs. the
DSC, or LTV, or other risk characteristic, the investor can gain insight into the types of new
originations to be targeted in order to achieve the optimal risk/return tradeoff.
A further consideration is the beneficial effect on the overall risk of the portfolio of the
diversification of the various investments. A full discussion of diversification is beyond the
scope of this primer, but it is shown by Modern Portfolio Theory and well recognized in the
investment community that investments in multiple assets whose return series are less than
perfectly correlated results in a reduction of portfolio risk at no loss of aggregate return.
Accordingly, the commercial mortgage investor may conduct an analysis of the portfolio
holdings by type, location, etc., with respect to overall portfolio returns and risk to determine
the effect of an increased focus on a particular property type and/or location on portfolio risks
and returns. For instance, many large LICs have particular concentrations in commercial
mortgages secured by office and retail properties, portfolios that may benefit by risk reduction
from additions of multifamily and industrial properties. Also, research has shown that portfolios
that are concentrated in major metropolitan areas may benefit from addition of investments in
secondary and tertiary markets. However, as all commercial mortgage investors discover these
benefits and focus on these investments, the benefits tend to evaporate as the prices of these
assets are bid up.