hard · Asset-Backed Securities
An investor is evaluating a CMBS IO (Interest-Only) tranche from a pool with a $1B notional. The pool exhibits a high rate of defeasance (50% of the pool over 7 years).
How does this trend specifically affect the IO holder compared to a scenario with high voluntary prepayments?
- Defeasance is more favorable because the notional balance remains in the trust and credit risk is replaced by Treasury collateral.
- Defeasance is less favorable because the yield maintenance penalties are paid to principal bondholders, not the IO holder.
- Both scenarios are identical because the weighted average life (WAL) of the IO is shortened by any exit from the mortgage pool.
- The IO yield increases because the Treasury securities have higher coupons than the original commercial mortgages.
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