An Introduction to Commercial Mortgage Backed Securities CMBS

1
An Introduction to Commercial Mortgage Backed
Securities (CMBS)

• Prepared by
• The Education/Research Committee of the
  Commercial Mortgage Securities Association

2

• The CMBS Process
• Joseph Franzetti, Citigroup Global Markets
• Build-A-Bond
• Sally Gordon, Moodys Investor Service
• The CMBS Market
• Diana Reid, Beekman Advisors
• Investors of CMBS
• Diana Reid, Beekman Advisors

3

• The CMBS Process

4
The Participants in a Securitization
6
6
Investors
Securities
5
5
Trustee/ Fiscal Agent
Investors
Investors
4
Depositor (SPE) Issuer/ Investment Banker
LoanOriginator/Loan Seller
3
4
3
3
Borrowers
Mortgage Bankers
1
2
2
3
1
7
Primary or Sub Servicer
7
Financial Statements
Engineering Reports
Appraisals
Master Servicer
8
Rating Agency
Rating Agency
Rating Agency
Rating Agency
7
7
Special Servicer
2 months (Loan Funding) 2 months (Bond Issuance)
5
The Participants in a Securitization
6
The Participants in a Securitization
7
The Participants after the Securitization is
Completed
8
Where the Money Goes
Assignments of Rents and Leases
Loan Proceeds
Mortgage Notes
Securities Sale Proceeds at Closing
Loan Debt Service Escrows
Debt Service Less Servicer Fee Plus Advances
Monthly Bond Coupon Principal
Securities Sale Proceeds at Closing
9
Transaction Timetable
Activity
10

• Build-A-Bond

11
Hypothetical Structure Credit Tranching
Last Loss
Lowest Risk
85MMInvestment GradeCMBSAaa/AAA
9MMOther Investment GradeAa2/AAA2/ABaa2/
BBB 4MMNon-InvestmentGrade CMBSBa2/BBB2/B
2MMNon-Rated CMBS
100MMPool of Mortgages
Credit Risk
Loss Position
First Loss
Highest Risk
12
Basic CMBS Structure 100 MM, 10-Year, Fixed
Rate
NR Non-Rated
13
Senior / Subordinated Structure 10 Year
Security
First 9 years
After 9.5 years
After 10 years
After 9.75 years

A
MortgagePool
A
A
A
A
A
P i
B
B
B
B
i
C
C
C
C
D
D
D
D
i
14
Basic CMBS Structure
Subordination could be calculated as follows
for Aaa/AAA level stress Foreclosure Freque
ncy X Loss Severity 30 X 50 .15 o
r 15 coverage or subordination
15
Hypothetical Class Structure
16
How To Decide How Much Subordination? Loss Rate
Scenarios
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

.0436 or 4.36
Source Morgan Stanley. Update Commercial Mort
gage 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.)
17
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.
18
Hypothetical Class Structure
IF Y 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
19

• The CMBS Market

20
Holders of Commercial Multifamily Mortgage
Loans626 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
21
CMBS Issuance U.S. and Non-U.S.( Billions)
Source Commercial Mortgage Alert.
22
U.S. CMBS Issuance ( Billions)
Source Commercial Mortgage Alert
US only, non-agency, non-CDO.
23
U.S. CMBS Issuance and Interest Rates
Source Commercial Mortgage Alert and Federal
Reserve
24
Multifamily Mortgage Securitization
Source Federal Reserve, Flow of Funds
25
Commercial Mortgage Securitization
Source Federal Reserve, Flow of Funds
26
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)
27
CMBS Issuance Shift from RTC to Conduits
Source Commercial Mortgage Alert
RTC Resolution Trust Company
28
CMBS Spreads Over 10-Year Treasury Investment
Grade
Source Morgan Stanley
29
CMBS Spreads Over 10-Year Treasury
Non-Investment Grade
Source Morgan Stanley
30
CMBS Spreads and Swap Spreads
Source Morgan Stanley
31
Market Size Comparison(as of 12/31/04)
REITs Market Cap 1
Microsoft Market Cap (largest in NYSE) 2
GDP of Switzerland (17th largest) 3
Commercial and Multifamily Securitizations 4
Source (1) NAREIT (2) Microsoft Website (3)
World Bank (4) Federal Reserve, Flow of Funds
32
Market Size Comparison(as of September 30, 2005)
US Government Securities
All Commercial Multifamily Mortgages
Single Family Mortgages
Single Family Securities
Corporate Bonds
Source Federal Reserve, Flow of Funds
33

• Investors of CMBS

34
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

35
Investors of CMBS in 2004
Source Morgan Stanley
36
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

37
Yield Differential(10-Year Sector Yield over
Treasury)
Source Merrill Lynch
38
Credit Performance

• Maturity of markets
• Position in Asset Class
• Past performance is no guarantee of future success

Source FitchRatings
39
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

40
Non-Correlated Risks
41
Investing in Non-Correlated Risks