ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

An Introduction to CMBS

Updated on June 27, 2013

My Experience

When I first heard of CMBS, it was New Year's Eve 2009, almost 2010. I was over at the house of one of my parent's friends. We played board games ate food and participated in all the other customary New Year's activities. Then, late into the night my dad's friend, a financial guy said he wanted to show us something; He told us it was something called Commercial Mortgage Backed Securities (CMBS). I don't remember much about what was said that night in specifics, but I do remember being intrigued at the both the opportunity and complexity.

Later, when I was studying Finance in college, I was looking for internships and applied for a semester-long co-op at a large-public financial company. I interviewed for their commercial real estate department and they told me all of these different areas, but one stuck out to me as I remembered back to a few years earlier when I first heard about CMBS.

So, I found myself working for 8 months in the world of CMBS. I want this lens to be an introduction to the history and structure of CMBS. I will try to write this to the person that is interested enough to know more, but not with such complexity that you need a Ph.D to understand it. Read on below!

"To create a mortgage-backed security (MBS), a large number of mortgages are pooled together; the mortgage-backed securities each have claim on payments made on those mortgages. The net effect is that each investor in the MBS owns a tiny piece of each mortgage, distributing each mortgage's risk of default among a large number of investors" (13 Bankers).

History

It all started in 1968 with Ginnie Mae. She's not my crazy aunt, in fact she's a government entity less glamorously known as Government National Mortgage Association (GNMA). Ginnie Mae was created by the US government to "promote home ownership". We'll talk about the specifics later, but it took a bunch of home mortgages, put them all in a large pool, and then sold the pool to investors. And since it was backed by the US government, it was super-safe. Salomon Brothers, in the early 1970's tried to create private mortgage backed securities, but ran into problems with government regulation.

Then came Lewis Ranieri. This guy has quite a story. He was born in Brooklyn and had aspirations to be an Italian chef. He pursued becoming a chef until he realized his asthma wouldn't allow him to spend his time in smoky kitchens. He instead got a job at the Salomon Brothers mailroom and moved his way up. In the late 1970's he was promoted to the head of Salomon's new mortgage trading desk. In 1977 he created the first private mortgage backed securities. Ranieri didn't even have a college degree, but he realized that he needed technical expertise. He hired math PhD.'s to develop the structure of these new bonds. Securitization is a term that Ranieri first used to describe the process of turning mortgages into bonds.

In 1983 Fidelity Mutual Life Insurance sold $60 million of commercial mortgages to three other life insurance companies, with Salomon mediating the transaction. The reason this is significant is that Fidelity actually serviced the mortgages and passed on the interest and principal to the "beneficial owners". There were a few more deals similar to this in the mid 1980's, but portfolio commercial mortgage loans overshadowed CMBS for at least the next 10 years.

The decade beginning in 1990 saw an in increase in the CMBS market and the real-estate bubble helped to fuel the new issuance to an all-time high of $230 Billion in 2007.

But in 2008, CMBS issuance fell off a cliff with only 5% of the 2007 issuance. The decade of the 2000's saw a "streamlining" of mortgage underwriting standards. There was a general optimism that the commercial real estate market was permanently changed. Innovation had created new wealth and access for all parties. Risk was perceived as low.

As we all know, this optimism did not rise forever. Commercial real estate, like residential crashed. In 2009 the new-issue CMBS market was effectively zero. The CMBS market has since recovered and with new regulation and underwriting continues what some say is healthy market.

Structure

Structuring
Structuring

The graph above is the best way I have found to describe CMBS. The whole rectangle represents a full CMBS bond.

The height represents interest rates; the width represents the total amount of a CMBS bond. The yellow and green columns represent the different classes or tranches of the bond. So the A1 class represents a tranche with a small proportion of the bond's balance, and a rate of less than 1%. The A4 tranche has a significantly larger proportion of the balance with an interest rate of about 3%. Most tranches have a fixed rate, but some tranches have a variable rate.

The real beauty of CMBS structuring through, is the seniority system. The rating agencies create a certain cutoff for subordination (let's say 30%) above which they will rate AAA. This means 70% of the bond can receive the highest rating. This creates a hard line for the securitizer. They can create whatever tranches they want, but above the 30% line, all trances will be rated AAA. Below this line is known as the B-piece. This B-piece is usually sold privately (not listed on the public market).

The tranches on the right are senior to the ones on the left (meaning the A-classes receive payment before the B-class). This works very well to manage risk match supply to demand. If a bond investor want more return, they can have it as long as they are willing to receive their payment last. Liquidation is also passed first from right to left. This structure is many times described as a waterfall with cash flow flowing from the most senior classes down.

There are also other factors not represented in this graph, such as maturities and credit rating.

CMBS is an amazing investment. Not only is there the yield of fixed income, there is a structure steeped in real estate. In a relatively small investment there is a great amount of diversification. One bond can hold mortgages from a variety of borrowers, geographies and property types.

CMBS deals can be widely variable in their unique structure, but generally they follow these guidelines: 50-500 loans (with the top 10-20 loans representing more than half of the deal value) $1-5 Billion total value.

Like all debt holders, CMBS bondholders don't really care about the upside; CMBS bondholders care primarily about the downside, risk. Both a mall that performs average and a mall that performs really well pay the mortgage. A mall that is losing money will not be able to pay the mortgage and may default.

For CMBS, there are two main risks. The first is apparent, liquidation risk. The risk is that a borrower will not pay the mortgage. The second is less obvious, prepayment risk. The risk is that a borrower will pay the mortgage, but pay it early. There are many protections against both types of risk built into the structure that is CMBS.

How exactly do you turn mortgages into a bond again? - Oh, thanks. I forgot it was so simple.

Legacy and Growth

CMBS had a cautious resurgence 2010 and after. But these new bonds were smaller, safer and the underwriting was much different. Many people call this CMBS 2.0 (or 3.0).

There has been a flurry of new regulation in the financial market including the all-encompassing Dodd-Frank. One proposed measure of Dodd-Frank, the Credit Risk Retention Rule would require any bank or financial institution to keep at least 5% of the credit risk of any security they securitize. This measure would most likely shut down the CMBS new-issue market in its current form and has been lobbied against repeatedly by the major U.S. banks.

CMBS has been and continues to be an essential part of US commercial property financing. About 1/4 of all commercial mortgages are securitized (that is put into CMBS). CMBS is the ultimate free-market innovation. It allows for originators and investment banks to do what they do best in the mortgage process and creates a security. This security is sliced up into products that are sought after by investors in a wide array of sectors.

And CMBS is not only in the U.S. There is major CMBS activity in the European Union, Japan, Hong Kong and Singapore. The domestic and foreign markets continue to expand.

working

This website uses cookies

As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://corp.maven.io/privacy-policy

Show Details
Necessary
HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
LoginThis is necessary to sign in to the HubPages Service.
Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
AkismetThis is used to detect comment spam. (Privacy Policy)
HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
Features
Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
MavenThis supports the Maven widget and search functionality. (Privacy Policy)
Marketing
Google AdSenseThis is an ad network. (Privacy Policy)
Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
Index ExchangeThis is an ad network. (Privacy Policy)
SovrnThis is an ad network. (Privacy Policy)
Facebook AdsThis is an ad network. (Privacy Policy)
Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
AppNexusThis is an ad network. (Privacy Policy)
OpenxThis is an ad network. (Privacy Policy)
Rubicon ProjectThis is an ad network. (Privacy Policy)
TripleLiftThis is an ad network. (Privacy Policy)
Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
Statistics
Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
ClickscoThis is a data management platform studying reader behavior (Privacy Policy)