CMBS 101

CMBS 101
An Introduction To Commercial
Mortgage Backed Securities
(CMBS)
Prepared by

The Education/Research Committee of

the Commercial Mortgage Securities
Association

Joseph Franzetti, Citigroup Global Markets

Gale Scott Standard & Poors

The CMBS Process

The Participants in a Securitization

Investors

Securities

Trustee/
Fiscal Agent

Investors
Investors

Depositor (SPE)
Issuer/
Investment Banker

Primary or
Sub Servicer

Financial
Statements

Engineering
Reports

Appraisals

Master
Servicer
Special
Servicer

2 months (Loan Funding) + 2 months (Bond Issuance)

77
Rating
Agency

Loan
Originator/
Loan Seller

Rating
Agency

Rating
Agency

Borrowers

Mortgage
Bankers

Rating
Agency

33

The Participants in a Securitization

1

Borrower:

Owns the property, has repayment and performance obligations

Mortgage Banker:

Intermediary between borrower and loan originators/loan sellers

Loan 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 depositor

Depositor:

An entity set up by the investment bank sponsoring the securitization purchases commercial mortgage
loans and immediately sells loans to a trust.

Investment Banker:

Overall responsibility for structuring the securitization, selling the bonds/certificates to investors, helps
maintain a liquid secondary market for trading the bonds/certificates.

Issuer:

The trust is the record owner of the commercial mortgage loans, formed by the depositor pursuant to a
pooling and servicing agreement (PSA).

Trustee:

Responsible for administering the trust on behalf of and making payments to the investors.

Investors:

Different investors with varying risk appetites purchase certificates rated from AAA/Aaa to B/B to and
unrated certificates.

The Participants in a Securitization

7

Master Servicer:

Responsible for servicing all mortgage loans owned by the trust.

Primary or Sub
Servicer:

May be the originating mortgage bankers, often the initial point of contact for the borrower.

Special Servicer:

Named at the issuance of the CMBS to be responsible for servicing any mortgage loans that may
default in the future.

Rating 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

Investors
Trustee/
Fiscal Agent

Investors
Investors

Investment Bank/
Secondary Traders

Trust

Borrowers
Master Servicer
Primary or Sub-Servicer /
Mortgage Banker
Special Servicer

Rating Agencies

Where the Money Goes

Loan Originator /
Loan Seller
(Lender)

Assignments of Rents and Leases

Loan Proceeds

Mortgage
Notes

Borrowers

Debt Service
& Escrows

ServicerCollection
Account

Securities Sale
Proceeds at Closing
TrusteeDistribution
Account

Debt Service
Less Servicer Fee
Plus Advances
Monthly
Bond
Coupon
& Principal

Securities Sale
Proceeds at Closing

Securities

Investors

Transaction Timetable
Activity

10

11

12

13

14

15

16

Participant

Initial analysis

LO, IB

Due diligence for securitization

LO, IB, SC

Structuring process

LO, IB

B-buyer due diligence

LO, IB, BB

Rating agency review

LO, IB, RA

Selection of servicer & trustee

LO, IB, SV

Legal documentation, both

private & public securities offering

ALL

Pre-marketing of securities

IB, Inv, RA

Marketing / pricing
Private offering:
Pricing of below-investment grade
Public offering:
Pricing of investment grade

IB, Inv, BB, RA

IB, Inv, RA

Closing of securities
LO Loan Originator
IB Investment Bank

ALL
SV Servicer
RA Rating Agency

UC Underwriter's Counsel Inv Investor

SC Seller's Counsel
BB B-Piece Buyer

Build-A-Bond

Hypothetical Structure: Credit Tranching

Last
Loss

Lowest
Risk

$85MM
Investment Grade
CMBS:
Aaa/AAA

$2MM
Non-Rated CMBS
11

Credit Risk

$4MM
Non-Investment
Grade CMBS:
Ba2/BB
B2/B

Loss Position

$100MM
Pool of Mortgages

$9MM
Other Investment Grade:
Aa2/AA
A2/A
Baa2/BBB

First
Loss

Highest
Risk

Basic CMBS Structure $100 MM, 10-Year, Fixed Rate

Class

Size

Rating

Coupon

Expected Life

Subordination

Class A

$85 MM

Aaa / AAA

5.25%

9 years

15%

Class B

$9 MM

Aa2/AA
A2/A
Baa2/BBB

5.50%

9.5 years

6%

Class C

$4 MM

Ba2/BB
B2/B

7.50%

9.75 years

2%

Class D

$2 MM

NR

10 years

NR = Non-Rated

12

Senior / Subordinated Structure 10 Year Security

First
9 years

After
9.5 years

After
9.75 years

After
10 years

A
A

A
A

P+i

P+i

P+i

Mortgage
Pool

13

C
P+i

Basic CMBS Structure

Class

Rating

Size

Subordination

Coupon

Aaa/AAA

$85MM

15%

5.25%

$9MM

6%

5.50%

$4MM

2%

7.50%

B
C

Aa2/AA
A2/A
Baa2/BBB
Ba2/BB
B2/B

NR

$2MM

Subordination could be calculated as follows for Aaa/AAA level stress:

Foreclosure Frequency
30%

X
X

Loss Severity
=
50% = .15 or 15% coverage or subordination

14

---

Hypothetical Class Structure

Rating

Size

Loss Coverage/
Subordination

Aaa/AAA

$85MM

15%

30%

50%

Aa2/AA

$3MM

12%

30%

40%

A2/A

$3MM

9%

30%

30%

Baa2/BBB

$3MM

6%

20%

30%

Ba2/BB

$2MM

4%

20%

20%

B2/B

$2MM

2%

10%

20%

NR

$2MM

Loss Frequency

15

Loss Severity

How To Decide How Much Subordination?

Loss Rate Scenarios
Default
19.6%

No Default
80.4%

Liquidated
55%

Restructured
25%

Become Current
20%

Loss Rate
33%

Loss Rate
16.5%

Loss Rate
0%

Equally Weighted Portfolio Loss Rate =

(0.196)(0.55)(0.33)
0.0356

+
+

(0.196)(0.25)(.0165)
0.008

+
+

(0.196)(0.20)(0)
0

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.)

16

.0436 or 4.36%

Basic CMBS Structure

$100 MM, 10-Year, Fixed Rate with Interest Only Strip (IO)

Class

Size

Rating

Coupon

Average Life

Subordination

Class A-1

$85 MM

Aaa / AAA

5.00%

9 years

15%

Class A-X

Notional1

Aaa / AAA

0.25%

Class B

$9 MM

Aa2/AA
A2/A
Baa2/BBB

5.50%

9.5 years

6%

Class C

$4 MM

Ba2/BB
B2/B

7.50%

9.75 years

2%

Class D

$2 MM

NR

10 years

0%

Not Meaningful1

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

Hypothetical Class Structure

Class

Size

Rating

Coupon (C)

Spread At Issue
(Yield, or Y)

A-1

15%

Aaa/AAA

5.25% PR

70 bp

5 years

A-2

70%

Aaa/AAA

5.30% PR

75

10 years

3%

Aa2/AA

5.45% PR

90

10 years

3%

A2/A

5.55% PR

100

10 years

3%

Baa2/BBB

6.00% PAR

150

10 years

2%

Ba2/BB

6.50% D

300

10 years

2%

B2/B

6.50% D

700

10 years

2%

NR

6.50% D

1200

10 years

IF 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

Average Life

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 1990

Source: Federal Reserve, Flow of Funds

20

CMBS Issuance: U.S. and Non-U.S.

($ Billions)

Source: Commercial Mortgage Alert.

21

U.S. CMBS Issuance

($ Billions)

Source: Commercial Mortgage Alert

US only, non-agency, non-CDO.

22

U.S. CMBS Issuance and Interest Rates

Source: Commercial Mortgage Alert and Federal Reserve

23

Multifamily Mortgage Securitization

Source: Federal Reserve, Flow of Funds

24

Commercial Mortgage Securitization

Source: Federal Reserve, Flow of Funds

25

Single Family and Commercial/Multifamily Securitization

Market Penetration
59.6%

23.7%

Source: Federal Reserve, Flow of Funds

Date through 2004, year 14 (CMBS) and year 34 (Single Family)

26

CMBS Issuance: Shift from RTC to Conduits

Source: Commercial Mortgage Alert

* RTC: Resolution Trust Company

27

CMBS Spreads Over 10-Year Treasury: Investment Grade

Source :Morgan Stanley

28

CMBS Spreads Over 10-Year Treasury:

Non-Investment Grade

Source: Morgan Stanley

29

CMBS Spreads and Swap Spreads

Source: Morgan Stanley

30

Market Size Comparison

(as of 12/31/04)

REITs Market Cap 1

Microsoft Market Cap

(largest in NYSE) 2

Source : (1) NAREIT; (2) Microsoft Website; (3) World Bank; (4) Federal Reserve, Flow of Funds

31

GDP of Switzerland
(17th largest) 3

Commercial and
Multifamily
Securitizations 4

Market Size Comparison

(as of September 30, 2005)

All Commercial +
Multifamily Mortgages

Corporate Bonds

US Government
Securities

Source: Federal Reserve, Flow of Funds

32

Single Family
Securities

Single Family
Mortgages

Investors of CMBS

Who Buys CMBS?

Institutional fixed income securities investors buy public bonds

Real estate high yield investors buy private bonds
Varies by class, by rating, by structure, by underlying collateral

34

Investors of CMBS in 2004

Source: Morgan Stanley

35

Why?

Yield differential (relative value investing)

Credit performance
Asset 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)

Source: Merrill Lynch

37

Credit Performance

Maturity of markets
Position in Asset Class
Past performance is no guarantee of future success
Source: FitchRatings

38

Satisfying Asset Allocation to Real Estate Debt

Risk based capital treatment for insurance companies gives advantage to CMBS
Mortgages = 3% Risk Based Capital (depending on insurers experience)
Investment Grade Public Securities = 0.3% Risk Based Capital

Cost of management (direct loan vs. securities investment)

Liquidity (ease of trading in and out of the portfolio)

Creates diversified investment portfolio

39

Non-Correlated Risks
CMBS

MBS

Corporates

PRIMARY RISK

Real estate credit risk

Prepayment risk

Corporate credit risk

MATURITY

Some extension risk

No extension risk

No extension risk

DEFAULT

DSCR is a predictor of default

risk

LTV is a predictor of default risk

Corporate credit risk a better

predictor of default risk

LIQUIDITY

Growing but smaller overall

market than MBS and corporates

Highly liquid market

Highly liquid market

INFORMATION

Different for public buyers versus

private buyers

Widely disseminated

Widely disseminated

40

Investing in Non-Correlated Risks

CMBS

MBS

Corporates

RATING AGENCIES

10 years of experience

30 years of experience

100 years of experience

SECURITY

Set pools of assets; first priority

mortgage liens

Set pools of uniform assets; first

priority mortgage liens

Unsecured; investors exposed to

future decisions at the
corporation

PERFORMANCE

Should outperform MBS and

corporates in falling rate
environment

More interest rate sensitive

Interest rate sensitive

RATINGS

Volume of AAA and NonInvestment Grade

Almost all AAA and AA

Mostly A, BBB

41