[PPT]PowerPoint Presentation - AI Home | Appraisal Institute · Web viewTodays Outline Introductions History of the the CMBS Markets Brief look at the Debt Capital Markets “Alphabet

Proprietary & Confidential

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July, 2015

Appraiser’s Guide to CMBS and the Debt Capital MarketsPresentation to: The Appraisal Institute – AI Connect 2015


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Presented by: Steve Powel, Constantine “Tino” Korologos, MAI, CREChief Executive Officer of Situs Managing Director of Situs

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Objective


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Todays Outline

1. Introductions2. History of the the CMBS Markets3. Brief look at the Debt Capital Markets4. “Alphabet Soup”

1. Definitions - terminology2. Who are the players and what do they do

5. How does the CMBS Market Work1. CMBS Bond Structures 2. What’s the Process?3. How does the Appraiser fit in?

6. The Rating Agencies1. What do they do in the process?2. How do they look at Appraisals?

7. Case Study on a large loan CMBS deal – 200 Park Avenue, NY, NY8. Questions


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• Commercial Mortgage Backed Securities (CMBS) are bonds backed by pools of mortgages on commercial and multifamily real estate. As of June, 2015, the US market capitalization of the CMBS market was $746Bn.

• CMBS offer several advantages over commercial whole loans. Securitization allows for the division of the loan into credit classes so that an investor may buy a class rated from AAA to B and unrated.

• CMBS are marked to market on a daily basis and hence are more liquid than whole loans. CMBS appeal to a wide array of investors because of attractive relative spreads and stronger call protection than residential mortgage securities.

Source: Trepp, Morgan Stanley Research

($Bn) 2.0 Legacy TotalConduit 154 348 503SnglAsset/Borr 46 6 52Large Loan 8 3 11Agency 187 15 202Grand Total 394 372 767

US CMBS Outstanding Standard Property TypesOffice Retail Industrial

CBD High Rise Regional Mall Heavy/ManufacturingSuburban High Rise Discount/Outlet Mall Light/AssemblySuburban Low Rise Power Center Research & Development

Restaurant WarehouseAutomotive Self-Storage

Multifamily Hotel HealthcareHigh Rise Resort/Golf Independent LivingGarden Full Service Assisted Living

Limited Service Skilled NursingExtended Stay

Introduction to CMBS


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History of the CMBS Market


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• Before the mid-1990s the U.S. real estate business was predominantly a private market.

• Lending was dominated by a handful of banks, life insurance companies, and pension funds.

• Real estate ownership was regionally focused, with ownership concentrated in a few hands. Families and private partnerships were the largest owners.

• In the real estate recession of the late 1980s and early 1990s, commercial real estate prices fell by 50% or more in some areas, and delinquency rates on loans soared to all-time highs.

• Losses led to the exit of many traditional lenders from the commercial mortgage market.

• Regulators and rating agencies turned more negative on commercial mortgage holdings, so that the remaining lenders became less willing to extend credit.

• Low real estate values combined with the failure or exit of traditional lenders provided innovation opportunities and a shift from private to public ownership.

• REITs began buying undervalued real estate portfolios funded through public stock and bond offerings. REIT shares provided an opportunity for small, diversified investments in real estate.

• Investment banks started to apply securitization legal structures developed during the 1970s and 1980s for residential mortgage-backed securities (RMBS) to commercial mortgages. In the mid- to late-1980s, issuers securitized a few loans on single properties into CMBS.

• Packaging of diversified pools of mortgages into CMBS developed in the mid-1990s when the Resolution Trust Corporation (RTC) pooled non-performing loans from failed institutions.

• Some transactions exceeded $1 billion and led to the growth in the investor base for CMBS.

Source: Morgan Stanley Research

History and Development of the CMBS Industry


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Historical CRE (all) Debt Originations by Year


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Historical CMBS Originations by Year (Trailing 12 mo)


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Historical CRE Debt Originations by Year


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CMBS Loan Maturities… what lies ahead


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Brief Introduction to theReal Estate Capital Markets


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Capital Markets Debt Market Composition

Source: Federal Reserve Bank


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Capital Markets Transaction Activity


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Definition of capital markets• The marketplaces where money is raised and securities are traded• A place or system in which the requirements for capital of a business can be satisfied• Capital markets include stock markets (equity) and bond/credit markets (debt)

Credit ratings are a very important part of the credit markets and are used by:• investors; issuers; commercial banks; investment banks/broker-dealers; government

agencies.

A classical approach to the real estate capital markets considers a simple “debt” and “equity” construct

• “4 quadrants of capital”

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EquityEquity

PublicDebt

PrivateDebt

Public Private

Capital Markets Overview


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Public Debt & Public Equity: Commercial Mortgage-Backed

Securities (CMBS) Collateralized Debt Obligations

(CDOs) Real Estate Investment Trusts

(REITs) Mutual Funds

Private Debt & Private Equity:Whole LoansMezzanine LoansB-Notes (Subordinate to I-grade portion of

mortgage debt)Limited PartnershipsPrivate REITsSeparate Accounts

Advantages Disadvantages> High liquidity > High volatility> High transparency > Less leverage> High Diversification > High Diversification> High degree of current income > Diffi cult to project CF with > Investors can "select" risk CMBS (prepayments & defaults

Advantages Disadvantages> More "leveragable" > Low liquidity> Customizable Investment > Requires greater initial capital

Strategies investment> Low volatility > Investment periods are longer

> More diffi cult to customizediversified portfolios

However, the capital markets have become much more complex in nature…..

Capital Markets – Real Estate


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Structured Finance is a (relatively new) subsector of finance that was developed to transfer risk using a complex legal framework

Securitization• Is the process of taking an illiquid asset, or group of assets, and through financial engineering and legal definitions, transforming them into a tradable, liquid securities.

• A structured finance technique that pools assets together and, in effect, turns them into a tradable securities held by a bankruptcy remote special purpose vehicle (SPV). Financial institutions and businesses of all kinds use securitization to immediately realize the value of a cash-producing asset; recognizing the arbitrage stemming from illiquid/liquid investments.

The securitization of real estate takes multiple forms:• Real Estate Investment Trusts (REITs)• Commercial Mortgage-Backed Securities (CMBS)• Collateralized Debt Obligations (CDO’s)• Residential Mortgage-Backed Securities (RMBS)

The securitization of real estate finance has blurred the lines of the 4-quadrants approach to capital markets

• Risk Spectrum approach evaluates and prices “risk” rather than “debt” or “equity”

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Capital Markets Securitization


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“Alphabet Soup”Terminology and the Players


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Definitions & Terminology

Advances Appraisal Reduction ASERS“B Piece” Bankruptcy Remote Entity Call ProtectionCMBS Conduit Credit EnhancementDefeasance Depositor First Loss PieceHaircut Independent Director Interest Only Strip (IO)Investment Grade Liquidation Fee Lock-Box ProvisionLoss Severity Master Servicer Master Servicing FeeMezzanine Debt Non-Consolidation Opinion Pari Passu LoanPooling & Servicing Agreement Private Placement ProspectusQualified Institutional Buyer REMIC (Real Estate Mortgage Investment Conduit)Realized Loss Reps and Warranties SEC Rule 144ASenior/Subordinate Structure Services Servicing AdvancesSpecial Purpose Entities (SPE) Special Servicer SubordinationTranche Trustee WaterfallYield Maintenance


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Who are the Players and what do they do

Borrowers

Mortgage Loan Originator, Mortgage Bankers and Brokers

Loan Sellers

Depositors

Rating Agencies

Subordinate Bond Holders – Controlling Class Bond Holder

Investment Grade Certificate Bond Holders

Third Party Servicers (Master Servicers, Special Servicer & Operating Trust Advisor

Trustee


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How does the CMBS Market work?


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CMBS Transactions Flow of Investments & Securities

Source: CREFC


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Where the Money GoesLoan Originator /

Loan Seller(Lender)

Trustee- Distribution

Account

Servicer-CollectionAccount

Securities

Investors

Borrowers

Assignments of Rents and Leases

Loan Proceeds

Debt Service& Escrows

Debt ServiceLess Servicer FeePlus Advances

MortgageNotes

Monthly Bond

Coupon& Principal

Securities SaleProceeds at Closing

Securities SaleProceeds at Closing

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Mortgage lien and

CMBS Bonds


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• CMBS have very simple structures compared to their residential mortgage counterparts.

• Each tranche represents a security with its own credit rating, average life, and other characteristics.

• Bonds are almost always sequential pay: amortization, prepayments, and default recoveries are paid to the most senior remaining class. The lowest-rated remaining class absorbs losses.

• Unlike their residential counterparts, commercial mortgages almost always have some form of prepayment penalty, making credit analysis more important than prepayment analysis.

• A CMBS investment requires analysis on three levels: property, loan, and bond.

CMBS Architecture

Source: Morgan Stanley Research

Property 1

Property 2

Property N

Mortgage 1

Mortgage 2

Mortgage M

RealEstate

MortgageInvestment

Conduit

(REMIC)

AAA AAAAAA

NR

AA

Properties Mortgages Asset Pool Liabilities


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CMBS Structure and Participants


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Post-closing

Borrowers

Trustee/Fiscal Agent

TrustInvestment Bank/Secondary Traders

Investors

Investors

Investors

Master Servicer

Primary or Sub-Servicer /Mortgage Banker

Special Servicer

Rating Agencies

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$

$

$

Bonds traded in the secondary market by

Continue to rate bonds


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The CMBS “Playbook” – the Pooling and Servicing Agreement

What is the Pooling & Servicing Agreement (PSA)?

The PSA is a multifunctional document executed by the Depositor, Trustee, MasterServicer, Special Services and Trust Advisor which implements:

• Creation of the CMBS trust the owns the loans• Conveyance of the loans along with the assignment of rights & remedies of the

depositor against the seller of the loans.• Appointment of the parties mentioned above and the detailed provisions

governing the rights and obligations of the parties and the certificate holders.• Issuance of certificates of the beneficial interest in the CMBS Trust with the

priorities and rights to payments for each class of investor.• Waterfall distribution• Rights, duties and obligations of the parties.• Election by the CMBS trust to be treated as a REMIC for purposes of Federal Tax• Definitions and provisions including the application of the appraisal process.


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Appraisal Reductions – ARA and ASER

What is an appraisal reduction?Appraisal reductions allow for a reduction of servicer advances for a loan that is expected to suffer a loss. To calculate those reductions, the special servicer obtains an independent third party appraisal. Such events are triggered by specific loan events as defined in the PSA. Examples might be 120 days of delinquency, 60 days delinquency after a borrower bankruptcy, or immediately after a loan becomes REO.

What is ARA?Appraisal reduction amount generally equals the excess of the sum of the unpaid principal balance, unpaid servicer advances and other charges over the sum of 90% of the appraised value with the amounts of reserves, escrows & LOCs

So a $10m UPB and other charges, with a $9m appraised value with $200k reserves would be the excess of $10m over 90% of $9m ($8.1m) plus $200k or $1.7m. What is an ASER?The Appraisal Subordinate Entitlement Reduction is the difference between the old and new monthly advances after the ARA was taken. Appraisals are generally updated every year and any further decreases in value would increase the ASER.


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Addenda

The Rating Agencies


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What are the Rating Agencies and what do they do?What is the definition of a Credit Rating Agency?

As defined by the U.S. Securities and Exchange Commission, a credit rating agency is defined in the Rating Agency Act to be a person (a) engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company; (b) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (c) receiving fees from either issuers, investors, or other market participants, or a combination thereof. NRSRO is a Nationally Recognized Statistical Rating Organization.

Who are the Major Rating Agencies?Moody’s Investors Service, Fitch Ratings, Standard & Poor's, Kroll Ratings, Morningstar Ratings, DBRS (Dominion Bond Ratings Service)

What is a Rating? A Rating is an opinion … just the way an appraisal is an opinion. But protected under the First Amendment

AAA Determined to have almost no risk of loss due to credit-related events. Assigned only to the very highest quality obligors and obligations able to survive extremely challenging economic events.AA Determined to have minimal risk of loss due to credit-related events. Such obligors and obligations are deemed very high quality.A Determined to be of high quality with a small risk of loss due to credit-related events. Issuers and obligations in this category are expected to weather difficult times with low credit losses.BBB Determined to be of medium quality with some risk of loss due to credit-related events. Such issuers and obligations may experience credit losses during stress environments.BB Determined to be of low quality with moderate risk of loss due to credit-related events. Such issuers and obligations have fundamental weaknesses that create moderate credit risk.B Determined to be of very low quality with high risk of loss due to credit-related events. These issuers and obligations contain many fundamental shortcomings that create significant credit risk.


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Rating Agencies – The Meltdown and RegulationsRating Agency Reform

- Credit Rating Agency Reform Act passed in 2006- Since the financial crisis regulators have encouraged “unsolicited” opinions on deals. Ideally this would cut down on

ratings shopping- The Dodd-Frank act enhanced the SEC’s enforcement mechanisms for credit rating agencies (NRSRO)

o Establish maintain, enforce, and document internal control structures governing implantation of and adherence to policies, procedures, and methodologies for determining credit ratings. An annual report of must be submitted to the SEC

o The SEC may suspend or permanently revoke the registration of a NRSRO for a particular class or subclass of securities if they cannot consistently produce reports with integrity

o Sales and marketing decisions are strictly prohibited from influencing the production of ratingso Review of work when a credit analyst leaves a NRSRO and if the prospect of future employment influenced their

work. These reviews must be formalized and the SEC will review the NRSROs policies at least annually and whenever such policies are materially modified or amended

o NRSRO’s must report to the SEC if new employees previously worked at another NRSRO in a credit rating capacityo Complete public disclosure of the NRSRO’s initial credit ratings and changes to credit ratings

Enhances the disclosure of transition and default rates; Standardizes those rates within NSRO’so Compensation of each compliance officer is linked to financial performance of the NSRO in such a way to ensure

independence of the officer’s judgemento Public Disclosure of procedures and methodologies including qualitative and quantitative data and models

Must promptly publish any changes to those things, why and the likely changes to current ratings as a result Notice of significant error in existing procedures and methodologies Disclose the version of the credit rating procedure or methodology used for a rating

o Disclose with each rating essential qualitative and quantitative information as well as the methodology to give transparence to investors and includes key assumptions and possible limitations


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Rating Agency Process – Office Properties

Source: Kroll Bond Rating Agency

Rating Agency Cash Flow Evaluation… consistently applied over time


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Rating Agency Process

Rating Agency Valuation Thresholds – All LTV’s aren’t created equal



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Rating Agency Process – Sample Office Loan


KLTV Thresholds for a High Leverage Loan in a SASB Transaction


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Addenda

Case Study – Single Borrower CMBS Deal

200 Park Avenue, New York, NY


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Case Study – SASB Deal 200 Park Avenue, New York, NY


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Source: KBRA Presale report BAML 2015-200P


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Case Study – 200 Park Avenue, New York, NY



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Case Study – 200 Park Avenue, New York, NY



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Addenda

Addenda


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TechnologyConsulting Solutions ValuationServicingCRE

FulfillmentCRE

Advisory

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United StatesAtlantaBoca RatonDes MoinesHoustonNew YorkRobbins, NCSan Francisco

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India

• Founded in 1985

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Asset/Loan ServicingF.I.G. Solutions

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What We Do

Technology Solutions

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Documents

[PPT]PowerPoint Presentation - AI Home | Appraisal Institute · Web viewTodays Outline Introductions History of the the CMBS Markets Brief look at the Debt Capital Markets “Alphabet