Commercial mortgage-backed security
Encyclopedia
Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security
backed by mortgages on commercial rather than residential real estate.
CMBS issues are usually structured as multiple tranche
s, similar to CMOs, rather than typical residential "passthroughs." The typical structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit
(REMIC), a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level.
Many American
CMBSs carry less prepayment risk than other MBS types, thanks to the structure of commercial mortgages. Commercial mortgages often contain lockout provisions after which they can be subject to defeasance
, yield maintenance and prepayment penalties to protect bondholders. European CMBS issues typically have less prepayment protection. Interest on the bond
s is usually floating, i.e. based on a benchmark (like LIBOR/EURIBOR) plus a spread.
Commercial real estate first mortgage debt is generally broken down into two basic categories: (1) loans to be securitized ("CMBS loans") and (2) portfolio loans. Portfolio loans are originated by a lender and held on its balance sheet through maturity.
In a CMBS transaction, many single mortgage loans of varying size, property type and location are pooled and transferred to a trust. The trust issues a series of bonds that may vary in yield, duration and payment priority. Nationally recognized rating agencies then assign credit ratings to the various bond classes ranging from investment grade (AAA/Aaa through BBB-/Baa3) to below investment grade (BB+/Ba1 through B-/B3) and an unrated class which is subordinate to the lowest rated bond class.
Investors choose which CMBS bonds to purchase based on the level of credit risk/yield/duration that they seek. Each month the interest received from all of the pooled loans is paid to the investors, starting with those investors holding the highest rated bonds, until all accrued interest on those bonds is paid. Then interest is paid to the holders of the next highest rated bonds and so on. The same thing occurs with principal as payments are received.
This sequential payment structure is generally referred to as the "waterfall". If there is a shortfall in contractual loan payments from the Borrowers or if loan collateral is liquidated and does not generate sufficient proceeds to meet payments on all bond classes, the investors in the most subordinate bond class will incur a loss with further losses impacting more senior classes in reverse order of priority.
The typical structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit
(REMIC). A REMIC is a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level. The CMBS transaction is structured and priced based on the assumption that it will not be subject to tax with respect to its activities; therefore, compliance with REMIC regulations is essential. CMBS has become an attractive capital source for commercial mortgage lending because the bonds backed by a pool of loans are generally worth more than the sum of the value of the whole loans. The enhanced liquidity and structure of CMBS attracts a broader range of investors to the commercial mortgage market. This value creation effect allows loans intended for securitization to be aggressively priced, benefiting Borrowers.
(Also see primary servicer)
In some cases the borrower may deal with a primary servicer that may also be the loan originator or mortgage banker who sourced the loan. The primary servicer maintains the direct borrower contact, and the master servicer may sub-contract certain loan administration duties to the primary or sub-servicer.
Master servicer
The master servicer’s responsibility is to service the loans in the pool through maturity unless the borrower defaults. The master servicer manages the flow of payments and information and is responsible for the ongoing interaction with the performing borrower.
Special servicer
(Also see special servicer
)
Upon the occurrence of certain specified events, primarily a default, the administration of the loan is transferred to the special servicer
. Besides handling defaulted loans, the special servicer also has approval authority over material servicing actions, such as loan assumptions.
Directing certificateholder / controlling class / B-piece buyer
The most subordinate bond class outstanding at any given point is considered to be the directing certificateholder, also referred to as the controlling class. The investor in the most subordinate bond classes is commonly referred to as the "B-piece buyer". B-piece buyers generally purchase the B-rated and BB/Ba-rated bond classes along with the unrated class.
Trustee
The trustee’s primary role is to hold all the loan documents and distribute payments received from the master servicer to the bondholders. Although the trustee is typically given broad authority with respect to certain aspects of the loan under the PSA [Pooling and Servicing Agreement], the trustee typically delegates its authority to either the special servicer or the master servicer.
Rating agency
There will be as few as one and as many as four rating agencies involved in rating a securitization. Rating agencies establish bond ratings for each bond class at the time the securitization is closed. They also monitor the pool’s performance and update ratings for investors based on performance, delinquency and potential loss events affecting the loans within the trust.
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
backed by mortgages on commercial rather than residential real estate.
CMBS issues are usually structured as multiple tranche
Tranche
In structured finance, a tranche is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion, and is cognate to English trench . In the financial sense of the word, each bond is a different slice of the deal's...
s, similar to CMOs, rather than typical residential "passthroughs." The typical structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit
Real Estate Mortgage Investment Conduit
Real Estate Mortgage Investment Conduits, or "REMICs," are a type of special purpose vehicle used for the pooling of mortgage loans and issuance of mortgage-backed securities...
(REMIC), a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level.
Many American
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
CMBSs carry less prepayment risk than other MBS types, thanks to the structure of commercial mortgages. Commercial mortgages often contain lockout provisions after which they can be subject to defeasance
Defeasance
-Defeasance of a Securitized Commercial Mortgage Loan:Defeasance of a securitized commercial mortgage is a process in commercial real estate finance by which a borrower substitutes other income-producing collateral for a piece of real property to facilitate the removal of an existing lien without...
, yield maintenance and prepayment penalties to protect bondholders. European CMBS issues typically have less prepayment protection. Interest on the bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
s is usually floating, i.e. based on a benchmark (like LIBOR/EURIBOR) plus a spread.
Organization
The following is a descriptive passage from the "Borrower Guide to CMBS" published by the Commercial Mortgage Securities Association and the Mortgage Banker's Association:Commercial real estate first mortgage debt is generally broken down into two basic categories: (1) loans to be securitized ("CMBS loans") and (2) portfolio loans. Portfolio loans are originated by a lender and held on its balance sheet through maturity.
In a CMBS transaction, many single mortgage loans of varying size, property type and location are pooled and transferred to a trust. The trust issues a series of bonds that may vary in yield, duration and payment priority. Nationally recognized rating agencies then assign credit ratings to the various bond classes ranging from investment grade (AAA/Aaa through BBB-/Baa3) to below investment grade (BB+/Ba1 through B-/B3) and an unrated class which is subordinate to the lowest rated bond class.
Investors choose which CMBS bonds to purchase based on the level of credit risk/yield/duration that they seek. Each month the interest received from all of the pooled loans is paid to the investors, starting with those investors holding the highest rated bonds, until all accrued interest on those bonds is paid. Then interest is paid to the holders of the next highest rated bonds and so on. The same thing occurs with principal as payments are received.
This sequential payment structure is generally referred to as the "waterfall". If there is a shortfall in contractual loan payments from the Borrowers or if loan collateral is liquidated and does not generate sufficient proceeds to meet payments on all bond classes, the investors in the most subordinate bond class will incur a loss with further losses impacting more senior classes in reverse order of priority.
The typical structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit
Real Estate Mortgage Investment Conduit
Real Estate Mortgage Investment Conduits, or "REMICs," are a type of special purpose vehicle used for the pooling of mortgage loans and issuance of mortgage-backed securities...
(REMIC). A REMIC is a creation of the tax law that allows the trust to be a pass-through entity which is not subject to tax at the trust level. The CMBS transaction is structured and priced based on the assumption that it will not be subject to tax with respect to its activities; therefore, compliance with REMIC regulations is essential. CMBS has become an attractive capital source for commercial mortgage lending because the bonds backed by a pool of loans are generally worth more than the sum of the value of the whole loans. The enhanced liquidity and structure of CMBS attracts a broader range of investors to the commercial mortgage market. This value creation effect allows loans intended for securitization to be aggressively priced, benefiting Borrowers.
Industry participants
Primary servicer (or sub-servicer)(Also see primary servicer)
In some cases the borrower may deal with a primary servicer that may also be the loan originator or mortgage banker who sourced the loan. The primary servicer maintains the direct borrower contact, and the master servicer may sub-contract certain loan administration duties to the primary or sub-servicer.
Master servicer
The master servicer’s responsibility is to service the loans in the pool through maturity unless the borrower defaults. The master servicer manages the flow of payments and information and is responsible for the ongoing interaction with the performing borrower.
Special servicer
(Also see special servicer
Special servicer
The term Special Servicer refers to companies that have specialized processes in place to deal with loans that require unusual attention, i.e., currently in or about to go into default. Special Servicers can obtain the loans themselves or just the servicing rights to loans...
)
Upon the occurrence of certain specified events, primarily a default, the administration of the loan is transferred to the special servicer
Special servicer
The term Special Servicer refers to companies that have specialized processes in place to deal with loans that require unusual attention, i.e., currently in or about to go into default. Special Servicers can obtain the loans themselves or just the servicing rights to loans...
. Besides handling defaulted loans, the special servicer also has approval authority over material servicing actions, such as loan assumptions.
Directing certificateholder / controlling class / B-piece buyer
The most subordinate bond class outstanding at any given point is considered to be the directing certificateholder, also referred to as the controlling class. The investor in the most subordinate bond classes is commonly referred to as the "B-piece buyer". B-piece buyers generally purchase the B-rated and BB/Ba-rated bond classes along with the unrated class.
Trustee
The trustee’s primary role is to hold all the loan documents and distribute payments received from the master servicer to the bondholders. Although the trustee is typically given broad authority with respect to certain aspects of the loan under the PSA [Pooling and Servicing Agreement], the trustee typically delegates its authority to either the special servicer or the master servicer.
Rating agency
There will be as few as one and as many as four rating agencies involved in rating a securitization. Rating agencies establish bond ratings for each bond class at the time the securitization is closed. They also monitor the pool’s performance and update ratings for investors based on performance, delinquency and potential loss events affecting the loans within the trust.
See also
- Residential mortgage-backed securityResidential mortgage-backed securityResidential mortgage-backed securities are a type of bond commonly issued in American security markets. They are a type of mortgage-backed security which are backed by mortgages on residential rather than commercial real estate.-Origins:...
- Fixed income securities
- Structured financeStructured financeStructured finance is a broad term used to describe a sector of finance that was created to help transfer risk and avoid lawsStructured finance is a broad term used to describe a sector of finance that was created to help transfer risk and avoid laws...
- Debt service coverage ratioDebt service coverage ratioThe debt service coverage ratio , also known as "debt coverage ratio," is the ratio of cash available for debt servicing to interest, principal and lease payments. It is a popular benchmark used in the measurement of an entity's ability to produce enough cash to cover its debt payments...
External links
- AST Defeasance Services
- Testing the Efficiency of the Commercial Real Estate Market: Evidence from the 2007-2009 Financial Crisis paper by Otto Van Hemert, NYU Stern & AQR Capital Management
- Discovering Distressed Assets: Whole Loan Workouts and Recapitalization Opportunities CMBS analysis whitepaper by Benjamin Polen, Newman Real Estate Institute, Baruch College