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CMBS 101
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CMBS 101An Introduction To Commercial Mortgage Backed Securities (CMBS)
Prepared by
The Education/Research Committee of the Commercial Mortgage Securities AssociationCMBS 101
Joseph Franzetti, Citigroup Global MarketsGale Scott Standard & Poors 2
The CMBS Process
The Participants in a SecuritizationSecurities2 months (Loan Funding) + 2 months (Bond Issuance)577764123334
The Participants in a Securitization5
1Borrower:Owns the property, has repayment and performance obligations2Mortgage Banker:Intermediary between borrower and loan originators/loan sellers3Loan Originators/Loan Sellers:Lends money to the borrower, secured by a first priority lien, enters into a mortgage loan purchase agreement (MLPA) to sell the loan to the securitization depositor4Depositor:An entity set up by the investment bank sponsoring the securitization purchases commercial mortgage loans and immediately sells loans to a trust. 4Investment Banker:Overall responsibility for structuring the securitization, selling the bonds/certificates to investors, helps maintain a liquid secondary market for trading the bonds/certificates.4Issuer:The trust is the record owner of the commercial mortgage loans, formed by the depositor pursuant to a pooling and servicing agreement (PSA).5Trustee:Responsible for administering the trust on behalf of and making payments to the investors. 6Investors:Different investors with varying risk appetites purchase certificates rated from AAA/Aaa to B/B to and unrated certificates.
The Participants in a Securitization6
7Master Servicer:Responsible for servicing all mortgage loans owned by the trust. 7Primary or Sub Servicer:May be the originating mortgage bankers, often the initial point of contact for the borrower. 7 Special Servicer:Named at the issuance of the CMBS to be responsible for servicing any mortgage loans that may default in the future.8Rating Agencies:Assigns risk of loss ratings on certain bonds/certificates issued for a securitization transaction, monitors performance after securitization funds.
The Participants after the Securitization is Completed
7
Where the Money GoesAssignments of Rents and LeasesLoan ProceedsDebt Service& EscrowsDebt ServiceLess Servicer FeePlus AdvancesMortgageNotesMonthly BondCoupon& PrincipalSecurities SaleProceeds at ClosingSecurities SaleProceeds at Closing8
Transaction TimetableActivity9
12345678910111213141516
Build-A-Bond
Hypothetical Structure: Credit TranchingLast LossFirst LossLowest RiskHighest RiskLoss PositionCredit Risk$100MMPool of Mortgages$85MMInvestment GradeCMBS:Aaa/AAA
$9MMOther Investment Grade:Aa2/AAA2/ABaa2/BBB
$4MMNon-InvestmentGrade CMBS:Ba2/BBB2/B
$2MMNon-Rated CMBS11
Basic CMBS Structure $100 MM, 10-Year, Fixed RateNR = Non-Rated12
ClassSizeRatingCouponExpected LifeSubordinationClass A$85 MMAaa / AAA5.25%9 years15%
Class B$9 MMAa2/AAA2/ABaa2/BBB5.50%9.5 years6%Class C$4 MMBa2/BBB2/B7.50%9.75 years2%Class D$2 MMNR10 years
Senior / Subordinated Structure 10 Year Security
B
AFirst9 yearsAfter9.5 years
A
ABCP + iiBC
BCAfter9.75 yearsMortgagePoolDDDAfter10 years
CA
AD
A i13
Basic CMBS Structure Subordination could be calculated as follows for Aaa/AAA level stress:
Foreclosure FrequencyXLoss Severity=30%X 50%= .15 or 15% coverage or subordination14
ClassRatingSizeSubordinationCouponAAaa/AAA$85MM15%5.25% BAa2/AAA2/ABaa2/BBB $9MM 6% 5.50%CBa2/BBB2/B$4MM2%7.50% DNR$2MM0---
Hypothetical Class Structure15
RatingSizeLoss Coverage/ SubordinationLoss FrequencyLoss SeverityAaa/AAA$85MM15%=30%X50%Aa2/AA$3MM12%=30%X40%A2/A$3MM9%=30%X30%Baa2/BBB$3MM6%=20%X30%Ba2/BB$2MM4%=20%X20%B2/B$2MM2%=10%X20%NR$2MM
How To Decide How Much Subordination? Loss Rate Scenarios
Equally Weighted Portfolio Loss Rate =
Source: Morgan Stanley. Update: Commercial Mortgage Defaults: 30 Years of History. September 2004 (Cumulative loss rates for about 18,000 commercial mortgages originated by eight life insurance companies between 1972 and 2002.)(0.196)(0.55)(0.33) + 0.0356 +
(0.196)(0.25)(.0165) + 0.008 +
(0.196)(0.20)(0) 0 =.0436 or 4.36%16
Basic CMBS Structure$100 MM, 10-Year, Fixed Rate with Interest Only Strip (IO)1 For illustration purposes, the INTEREST ONLY (IO) strip collects interest of 0.25%, or 25 bp on a NOTIONAL amount of $85MM. The notional amount could be the same as the size of an associated class or the size of the entire security. Here, the interest on Classes A-1 and A-X total the coupon of Class A alone in the earlier example. 17
ClassSizeRatingCouponAverage LifeSubordinationClass A-1$85 MMAaa / AAA5.00%9 years15%Class A-XNotional1Aaa / AAA0.25%Not Meaningful1Class B$9 MMAa2/AAA2/ABaa2/BBB5.50%9.5 years6%Class C$4 MMBa2/BBB2/B7.50%9.75 years2%Class D$2 MMNR10 years0%
Hypothetical Class StructureIF Y < C, then it is a premium bond (PR)IF Y = C, then it is a par bond (PAR)IF Y > C, then it is a discount bond (D)Assumptions: 5-year Treasury = 4.4% 10-year Treasury = 4.5%18
ClassSizeRatingCoupon (C)Spread At Issue (Yield, or Y)Average LifeA-115%Aaa/AAA5.25% PR70 bp5 yearsA-270%Aaa/AAA5.30% PR7510 yearsB3%Aa2/AA5.45% PR9010 yearsC3%A2/A5.55% PR10010 yearsD3%Baa2/BBB6.00% PAR15010 yearsE2%Ba2/BB6.50% D30010 yearsF2%B2/B6.50% D70010 yearsG2%NR6.50% D120010 years
The CMBS Market
Holders of Commercial & Multifamily Mortgage Loans$626 billion of the $2.5 trillion U.S. commercial and multifamily mortgage loans outstanding are held as securities, a significant increase since 199020Source: Federal Reserve, Flow of Funds
CMBS Issuance: U.S. and Non-U.S.($ Billions)21Source: Commercial Mortgage Alert.
U.S. CMBS Issuance ($ Billions)22Source: Commercial Mortgage AlertUS only, non-agency, non-CDO.
U.S. CMBS Issuance and Interest Rates 23Source: Commercial Mortgage Alert and Federal Reserve
Multifamily Mortgage Securitization24Source: Federal Reserve, Flow of Funds
Commercial Mortgage Securitization25Source: Federal Reserve, Flow of Funds
Single Family and Commercial/Multifamily Securitization Market Penetration26Source: Federal Reserve, Flow of FundsDate through 2004, year 14 (CMBS) and year 34 (Single Family)23.7%59.6%
CMBS Issuance: Shift from RTC to Conduits27Source: Commercial Mortgage Alert* RTC: Resolution Trust Company
CMBS Spreads Over 10-Year Treasury: Investment Grade28Source :Morgan Stanley
CMBS Spreads Over 10-Year Treasury: Non-Investment Grade29Source: Morgan Stanley
CMBS Spreads and Swap Spreads30Source: Morgan Stanley
Market Size Comparison(as of 12/31/04)31Source : (1) NAREIT; (2) Microsoft Website; (3) World Bank; (4) Federal Reserve, Flow of FundsREITs Market Cap 1Microsoft Market Cap (largest in NYSE) 2GDP of Switzerland (17th largest) 3Commercial and Multifamily Securitizations 4
Market Size Comparison(as of September 30, 2005)32All Commercial + Multifamily MortgagesSource: Federal Reserve, Flow of FundsCorporate Bonds US Government Securities Single Family Securities Single Family Mortgages
Investors of CMBS
Who Buys CMBS?Institutional fixed income securities investors buy public bondsReal estate high yield investors buy private bondsVaries by class, by rating, by structure, by underlying collateral
34
Investors of CMBS in 200435Source: Morgan Stanley
Why?Yield differential (relative value investing)Credit performanceAsset allocation (satisfy allocation to real estate debt)Non-correlated risks (compare to MBS and corporates)Comparative Credit Risk
Remember:Credit Risk Yield
36
Yield Differential(10-Year Sector; Yield over Treasury)37Source: Merrill Lynch
Credit PerformanceMaturity of marketsPosition in Asset ClassPast performance is no guarantee of future success
Source: FitchRatings38
Corporate vs. CMBS Bond Defaults: 19902003 (%)
Cumulative Defaults
Corporate
CMBS
Investment Grade
2.10 %
0.10%
Below Investment Grade
55.00%
1.61%
All Bonds
11.00%
0.19%
Average Annual Defaults
Corporate
CMBS
Investment Grade
0.15%
0.01%
Below Investment Grade
3.94%
0.12%
All Bonds
0.78%
0.01%
Satisfying Asset Allocation to Real Estate DebtRisk based capital treatment for insurance companies gives advantage to CMBSMortgages = 3% Risk Based Capital (depending on insurers experience)Investment Grade Public Securities = 0.3% Risk Based CapitalCost of management (direct loan vs. securities investment)Liquidity (ease of trading in and out of the portfolio)Creates diversified investment portfolio
39
Non-Correlated Risks40
CMBSMBSCorporatesPRIMARY RISKReal estate credit riskPrepayment riskCorporate credit riskMATURITYSome extension riskNo extension riskNo extension riskDEFAULTDSCR is a predictor of default riskLTV is a predictor of default riskCorporate credit risk a better predictor of default riskLIQUIDITYGrowing but smaller overall market than MBS and corporatesHighly liquid marketHighly liquid marketINFORMATIONDifferent for public buyers versus private buyersWidely disseminatedWidely disseminated
Investing in Non-Correlated Risks41
CMBSMBSCorporatesRATING AGENCIES10 years of experience30 years of experience100 years of experienceSECURITYSet pools of assets; first priority mortgage liensSet pools of uniform assets; first priority mortgage liensUnsecured; investors exposed to future decisions at the corporationPERFORMANCEShould outperform MBS and corporates in falling rate environmentMore interest rate sensitiveInterest rate sensitiveRATINGSVolume of AAA and Non-Investment GradeAlmost all AAA and AAMostly A, BBB