Professional Documents
Culture Documents
Presented by:
1. Introductions
2. History of the the CMBS Markets
3. Brief look at the Debt Capital Markets
4. “Alphabet Soup”
1. Definitions - terminology
2. Who are the players and what do they do
5. How does the CMBS Market Work
1. CMBS Bond Structures
2. What’s the Process?
3. How does the Appraiser fit in?
6. The Rating Agencies
1. 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, NY
8. Questions
• 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.
• 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.
13
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”
Public Private
Debt Debt
Public Private
Equity Equity
14
Public Debt & Public Equity: Private Debt & Private Equity:
Commercial Mortgage-Backed Whole Loans
Securities (CMBS)
Mezzanine Loans
Collateralized Debt Obligations
B-Notes (Subordinate to I-grade portion
(CDOs)
of mortgage debt)
Real Estate Investment Trusts
Limited Partnerships
(REITs)
Private REITs
Mutual Funds
Separate Accounts
Advantages Disadvantages Advantages Disadvantages
> High liquidity > High volatility > More "leveragable" > Low liquidity
> High transparency > Less leverage > Customizable Investment > Requires greater initial capital
> High Diversification > High Diversification Strategies investment
> High degree of current income > Difficult to project CF with > Low volatility > Investment periods are longer
> Investors can "select" risk CMBS (prepayments & defaults > More difficult to customize
diversified portfolios
However, the capital markets have become much more complex in nature…..
15
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 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”
16
“Alphabet Soup”
Terminology and the Players
Borrowers
Loan Sellers
Depositors
Rating Agencies
Third Party Servicers (Master Servicers, Special Servicer & Operating Trust Advisor
Trustee
Source: CREFC
Servicer- Trustee-
Debt Service Debt Service
Borrowers Collection Distribution
& Escrows Less Servicer Fee
Account Account
Plus Advances
Monthly
Bond Securities Sale
Coupon Proceeds at Closing
& Principal
Securities
CMBS Bonds
Investors
8
Proprietary & Confidential Page 22
®
CMBS Architecture
• 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.
Property 1 Mortgage 1
Real AAA AAAAAA
Estate
Property 2 Mortgage 2 Mortgage
Investment
Conduit
AA
(REMIC)
Property N Mortgage M NR
Post-closing
Investors
Investors Trustee/
Bonds traded in the Fiscal Agent
secondary market by Investors
$
Investment Bank/ Trust
Secondary Traders
$
Borrowers
$ Master Servicer
Rating Agencies
Primary or Sub-Servicer /
Mortgage Banker
7
Proprietary & Confidential Page 25
The CMBS “Playbook” – the Pooling and Servicing Agreement ®
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.
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.
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.
Proprietary & Confidential Page 29
Rating Agencies – The Meltdown and Regulations ®
Addenda
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