Transcript CMBS 101 ® An Introduction To Commercial Mortgage Backed Securities

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 & Poor’s
2
The CMBS Process
The Participants in a Securitization
Investors
6
5
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)
4
7
77
Rating
Agency
3
Rating
Agency
Loan
Originator/
Loan Seller
4
Rating
Agency
Borrowers
Mortgage
Bankers
33
Rating
Agency
1
2
The Participants in a Securitization
1
Borrower:
Owns the property, has repayment and performance obligations
2
Mortgage Banker:
Intermediary between borrower and loan originators/loan sellers
3
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
4
Depositor:
An entity set up by the investment bank sponsoring the securitization purchases commercial mortgage
loans and immediately sells loans to a trust.
4
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.
4
Issuer:
The trust is the record owner of the commercial mortgage loans, formed by the depositor pursuant to a
pooling and servicing agreement (“PSA”).
5
Trustee:
Responsible for administering the trust on behalf of and making payments to the investors.
6
Investors:
Different investors with varying risk appetites purchase certificates rated from AAA/Aaa to B/B to and
unrated certificates.
5
The Participants in a Securitization
7
Master Servicer:
Responsible for servicing all mortgage loans owned by the trust.
7
Primary or Sub
Servicer:
May be the originating mortgage bankers, often the initial point of contact for the borrower.
7
Special Servicer:
Named at the issuance of the CMBS to be responsible for servicing any mortgage loans that may
default in the future.
8
Rating Agencies:
Assigns risk of loss ratings on certain bonds/certificates issued for a securitization transaction, monitors
performance after securitization funds.
6
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
7
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
8
Transaction Timetable
Activity
1
2
3
4
5
6
7
8
9
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
9
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
A
B
B
P+i
A
i
B
P+i
B
i
C
i
C
P+i
C
D
i
D
i
D
Mortgage
Pool
i
13
C
P+i
D
Basic CMBS Structure
Class
Rating
Size
Subordination
Coupon
A
Aaa/AAA
Aa2/AA
A2/A
Baa2/BBB
Ba2/BB
B2/B
$85MM
15%
5.25%
$9MM
6%
5.50%
$4MM
2%
7.50%
B
C
D
NR
$2MM
0
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%
X
50%
Aa2/AA
$3MM
12%
=
30%
X
40%
A2/A
$3MM
9%
=
30%
X
30%
Baa2/BBB
$3MM
6%
=
20%
X
30%
Ba2/BB
$2MM
4%
=
20%
X
20%
B2/B
$2MM
2%
=
10%
X
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)
1
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
B
3%
Aa2/AA
5.45% PR
90
10 years
C
3%
A2/A
5.55% PR
100
10 years
D
3%
Baa2/BBB
6.00% PAR
150
10 years
E
2%
Ba2/BB
6.50% D
300
10 years
F
2%
B2/B
6.50% D
700
10 years
G
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 $2.5 trillion U.S. commercial and multifamily mortgage loans
outstanding are held as securities, a significant increase since 1990
1990
2005 3Q
CMBS Issuers
4%
Commercial
Banks 36%
Life Insurance
Cos. 22%
Others 18%
Commercial
Banks 43%
CMBS Issuers
25%
Life Insurance
Cos. 10%
Savings
Institutions
18%
Others 11%
Government
Sponsored
Enterprises
2%
Source: Federal Reserve, Flow of Funds
Government
Sponsored
Enterprises
3%
20
Savings
Institutions
8%
CMBS Issuance: U.S. and Non-U.S.
($ Billions)
69
250
200
150
34
1
29
9
169
12
4
50
0
21
23
100
3
1
1
0.3
1
3
1
8
0
14
17
17
16
90
91
92
93
94
95
Source: Commercial Mortgage Alert.
74
26
96
57
49
99
00
37
97
Domestic
21
98
Non-US
78
74
93
52
01
02
03
04
05
U.S. CMBS Issuance
($ Billions)
180
169.2
160
140
120
100
93.1
80
74.3
56.6
60
77.8
74.4
52.1
48.7
36.8
40
26.4
20
3.4
14.0
17.2
17.4
15.7
92
93
94
95
7.6
0
90
91
96
97
Source: Commercial Mortgage Alert
US only, non-agency, non-CDO.
22
98
99
00
01
02
03
04
05
US CMBS Issuance
Source: Commercial Mortgage Alert and Federal Reserve
23
10-Yr Treasury
05 Q3
05 Q1
04 Q3
04 Q1
03 3Q
03 1Q
02 3Q
02 1Q
01 3Q
01 1Q
00 3Q
00 1Q
99 3Q
99 1Q
98 3Q
98 1Q
97 3Q
97 1Q
96 3Q
96 1Q
95 3Q
95 1Q
94 3Q
94 1Q
93 3Q
92 1Q
92 3Q
92 1Q
91 3Q
91 1Q
90 3Q
90 1Q
Issuance ($ billions)
70
60
7
40
6
30
5
20
10
4
0
3
10-year Treasury (%)
U.S. CMBS Issuance and Interest Rates
9
8
50
Multifamily Mortgage Securitization
700
40%
600
35%
$ Billions
25%
400
20%
300
15%
200
10%
100
5%
0
0%
90
91
92
93
94
95
96
97
Multifamily Mortgages Outstanding
98
99
Securitized
Source: Federal Reserve, Flow of Funds
24
00
01
02
03
Share of Total Securitized
04
05
3Q
Share of total securitized
30%
500
Commercial Mortgage Securitization
2000
25%
1800
20%
$ Billions
1400
1200
15%
1000
800
10%
600
400
5%
200
0
0%
90
91
92
93
94
95
96
97
98
Commercial Mortgages Outstanding
99
Securitized
Source: Federal Reserve, Flow of Funds
25
00
01
02
03
Share of Total Securitized
04
05
3Q
Share of total securitized
1600
Single Family and Commercial/Multifamily Securitization
Market Penetration
70.0%
60.0%
59.6%
40.0%
30.0%
23.7%
20.0%
10.0%
(2
00
4)
32
33
34
Commercial/Multifamily (year 1=1991)
Source: Federal Reserve, Flow of Funds
Date through 2004, year 14 (CMBS) and year 34 (Single Family)
30
31
28
29
26
27
24
25
22
23
20
21
18
19
16
17
(2
00
4)
15
12
13
14
9
10
11
8
7
6
5
4
3
2
0.0%
1
Share of outstandings
50.0%
26
Single Family (year 1=1971)
CMBS Issuance: Shift from RTC to Conduits
80
70
60
$ Billions
50
40
30
20
10
0
1990
1991
1992
1993
RTC*
1994
Conduit Issuers
Source: Commercial Mortgage Alert
* RTC: Resolution Trust Company
27
1995
Other Issuers
1996
1997
1998
Au
g9
De 6
c9
Ap 6
r- 9
Au 7
g9
De 7
c9
Ap 7
r- 9
Au 8
g9
De 8
c9
Ap 8
r- 9
Au 9
g9
De 9
c9
Ap 9
r- 0
Au 0
g0
De 0
c0
Ap 0
rAu 01
g0
De 1
c0
Ap 1
r- 0
Au 2
g0
De 2
c0
Ap 2
r- 0
Au 3
g0
De 3
c0
Ap 3
r- 0
Au 4
g0
De 4
c0
Ap 4
r- 0
Au 5
g0
De 5
c05
CMBS Spreads Over 10-Year Treasury: Investment Grade
350
350
300
300
250
250
200
200
150
150
100
100
50
50
0
0
Aaa/AAA
Aa2/AA
Source :Morgan Stanley
28
A2/A
Baa2/BBB
Au
g9
De 6
c9
Ap 6
rAu 97
g9
De 7
c9
Ap 7
rAu 98
g9
De 8
c9
Ap 8
r- 9
Au 9
gDe 99
c9
Ap 9
r- 0
Au 0
gDe 00
c0
Ap 0
r- 0
Au 1
gDe 01
c0
Ap 1
r- 0
Au 2
gDe 02
c0
Ap 2
r- 0
Au 3
g0
De 3
c0
Ap 3
r- 0
Au 4
g0
De 4
c0
Ap 4
r- 0
Au 5
g0
De 5
c05
CMBS Spreads Over 10-Year Treasury:
Non-Investment Grade
1100
1100
1000
1000
900
900
800
800
700
700
600
600
500
500
400
400
300
300
200
200
100
100
0
0
Ba2/BB
Source: Morgan Stanley
29
B2/B
Au
g9
De 6
c9
Ap 6
r- 9
Au 7
g9
De 7
c9
Ap 7
r- 9
Au 8
g9
De 8
c9
Ap 8
r- 9
Au 9
g9
De 9
c9
Ap 9
r- 0
Au 0
g0
De 0
c0
Ap 0
rAu 01
g0
De 1
c0
Ap 1
r- 0
Au 2
g0
De 2
c0
Ap 2
r- 0
Au 3
g0
De 3
c0
Ap 3
r- 0
Au 4
g0
De 4
c0
Ap 4
r- 0
Au 5
g0
De 5
c05
CMBS Spreads and Swap Spreads
200
200
180
180
160
160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
0
0
Gap
CMBS Aaa Spreads (10-year)
Source: Morgan Stanley
30
Swap Spread
Average Gap of Period
Market Size Comparison
(as of 12/31/04)
600
$548
500
$ Billions
400
300
$359
$290
$264
200
100
0
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)
10
10
$8.8
$ Trillions
9
9
8
8
7
7
6
6
$5.2
$4.6
5
5
4
4
$3.0
3
3
$2.5
2
2
1
1
0
All Commercial +
Multifamily Mortgages
Corporate Bonds
US Government
Securities
Single Family
Securities
Current CMBS Outstandings
Source: Federal Reserve, Flow of Funds
32
Single Family
Mortgages
0
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
Banks
25%
Insurance Companies
24%
Government
Sponsored Entities
9%
Opportunity Funds
Finance Companies
Pension Funds
14%
Investment Advisors/
Money Managers
28%
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)
100
90
88
78
Basis points over Treasury
80
77
70
65
62
60
56
50
42
40
36
30
20
10
0
Aaa CMBS
Agencies
Aaa Credit Card ABS
Recent (as of 12/09/05)
Source: Merrill Lynch
37
6-Month Average
Single-A Industrials
Credit Performance
Corporate vs. CMBS Bond Defaults: 1990–2003 (%)
–––––– Cumulative Defaults –––––
Corporate
CMBS
Investment Grade
Below Investment Grade
All Bonds
2.10 %
55.00%
11.00%
0.10%
1.61%
0.19%
–––– Average Annual Defaults –––
Corporate
CMBS
Investment Grade
Below Investment Grade
All Bonds
0.15%
3.94%
0.78%
0.01%
0.12%
0.01%
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 insurer’s 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