Commercial mortgage-backed securities (CMBS) are bonds backed by commercial mortgage loans pooled together and sold to investors. CMBS are created when many commercial mortgages from a variety of properties, such as office buildings, shopping centers, apartments, hotels, etc., are packaged together and transferred to a trust. The trust then issues bonds of varying risk levels and maturities, backed by the cash flows from the underlying mortgage loans. CMBS provide borrowers an additional source of funding for commercial real estate and allow investors to participate in commercial real estate lending through smaller investments. However, CMBS also involve risks related to property cash flows, market conditions, and the potential for defaults. Thorough underwriting and analysis of

1. CMBS
Commercial Mortgage Backed Securities

2. CMBS Part I
Typical Characteristics
Brief History
Industry Participants

3. (CMBS)
What are Commercial Mortgage-Backed Securities?
CMBS consist of many single mortgages pooled together and
transferred to a trust. The trust issues a series of bonds
that vary in yield, duration and payment priority.
As several commercial bonds and mortgages are brought
together, investors get dividends funded by the pooled
mortgages.
Borrowers Guide to CMBS

4. CMBS are an increasingly popular investment option that
investors can consider during their asset allocation process
CMBS are similar to Mortgage-Backed Securities (MBS):
 Asset-backed securities secured by a mortgage or
collection of mortgages
 Bonds backed by mortgage payments
CMBS and MBS differ:
 MBS - loans related to residential property
 CMBS - loans related to commercial property

5. Typical Characteristics of CMBS
 Term Period –terms are typically three, five or ten years
long
 Repayment of Investment – principal and interest of the
mortgages is used to pay the principal and interest of the
CMBS
 Rates of Return – influenced by fluctuations in the overall
position of the real estate market
 RRSP Eligible – CMBS are eligible through The Registered
Retired Savings Plan

6. Typical Characteristics of CMBS continued…
 Ratings – credit ratings are assigned by nationally recognized
rating agencies:
(AAA/AAA through BBB-/Baa3)
(BB+/Ba1 through B-/B3)
Unrated Class
 Risk Structured Payment directly correlated with rating class
 REMIC – (real estate mortgage investment conduit) structured
as a pass-through securitized certificates, while individual
investors pay taxes on income they receive from REMICs, the
securities themselves are exempt from business income tax

7. Brief History of CMBS
 1968 - Ginnie Mae (GNMA), first mortgage backed pass through security - to provide a
liquid secondary market for existing loans; provided lender’s the ability to originate
more primary loans
 1971 - Freddie Mac (FHLMC) issued first mortgage pass through mostly of private
mortgages
 1981 - Fannie Mae (FNMA) issued its first mortgage backed security
 1983 - first CMBS transaction was priced - Fidelity Mutual Life Insurance, issued $60
million of commercial mortgage–backed securities to three life insurance companies
 1985 - total annual issuance of CMBS reached $3.7 billion and the market established
itself as an effective financing mechanism for commercial real estate
 1980’s and 1990’s - tax and regulatory reforms made these investments more appealing
and suitable for a wider range of investors

8. CMBS Industry Participants
Primary or Sub-Servicer
Master Servicer
Special Servicer
Directing Certificate Holder / Controlling Class / B-Piece Buyer
Trustee
Rating Agencies

9. CMBS Industry Participants
equitydefeasance.com

10. CMBS Part II
Advantages & Disadvantages
Borrower
Issuer
Investor

11. Borrower Advantages
 Creates additional sources of funding for the development of projects
by introducing diversified levels of risk
 Level of Protection Through Defeasance
As a substitution for collateral (real estate property) for the
remainder of the term on a mortgage note, a borrower can elect to
pay the note before its maturity date (defeasance) through the
substitutive purchase, exactly matching the cash flow of all
scheduled mortgage payments, of US Treasury bonds

12. Issuer Advantages
 "CMBS helps in converting immovable real estate into liquid and
tradable capital market instruments.
 CMBS acts as an additional source of funding for the
bank/developer.
 The rating on CMBS defined can be separated from the rating of
the bank/developer for a desired rating on the CMBS instrument.
 CMBS is more beneficial than bank loans as it reduces the overall
cost of funds and optimizes the funds raised, due to offering
different categories of options to suit different investor classes.
 CMBS helps lenders manage risk, by securitizing selected
commercial mortgages and buying or selling suitable CMBS
papers." - www.ilikeinvesting.com

13. Investor Advantages
 "Investors are able to participate in real estate lending in
amounts that are small.
 Investors can meet their objectives by choosing options
that suit their credit and maturity preferences.
 Investors can gain access to segments of the sector at low
transaction and information costs.
 Internationally, defaults experienced on CMBS are much
lower than on other types of securities." - www.ilikeinvesting.com

14. Disadvantages
Borrowers
 Borrowers may be locked out of prepayments, leading to financial losses
in an environment of lower interest rates.
 Borrowers are expected to make a balloon payment at the end of the
loan term and becomes dependent on a source of funding to either
retire the debt, or refinance. Higher rates may lead to financial losses.
Inability to obtain funding may result in default loss, referred to as
extension risk.

15. Disadvantages
Lenders
 There is a much higher rate of default in CMBS issuances due to the
reliance on cash flows and income from commercial tenants and
financial risk due to macro and local economic conditions and
demographic trends.
 The loans are generally made without recourse, leaving the lender
dependent on the sale of the property to recoup costs and losses.
 Lenders ability to recoup their investment is determined by the
tranche position of their investment. Senior tranches are paid first,
followed by subordinated and residual class investors. Liquidity
crunches and financial loss can cause an investor to lose their entire
investment if sale proceeds do not exceed the debt.

16. CMBS Part III
Valuation of CMBS
&
Difficulties in Valuation

17. VALUATION OF CMBS
CMBS collateral property valuations require
the analysis of details and inherent complexities
attributed to the uniqueness of
each commercial property

18. Commercial properties are each distinct owing to their
competitive positioning within their markets and the
makeup of their physical structure, tenancy/occupancy,
and management.
 Parking Lots  Office Properties
 Hotels  Industrial Properties
 Malls  Multi-Family Properties
 Restaurants  Retail Shops
 Hospitals  Self-Storage Facilities

19. A Few Examples of Risk Considerations
 Location/Visibility  In place vs. Market
Rate Leases
 Demographic Trends  Environmental Risks
 Rent Roll
 Employment Growth  Availability of Nearby
 Government Subsidies Undeveloped Land
 Supply and Demand
Dynamics  Management/Franchise  Security
Agreements
 Occupancy/Tenancy/Co-  Consolidations
Tenancy/Shadow  Competition/Competitiv
Anchors e Strength  Expenses
 Subleasing/Subleasing  Structure/Design/Physic  Shareholder Profiles
Rates al
Attraction/Layout/Parki
ng

20. Property Cash Flow Analysis
A collateral property’s net cash flow is the principal indicator as
to whether a proposed loan’s periodic debt service will be paid.
Cash flow analysis requires the underwriter to obtain information
on Net Operating Income (total recurring revenue less total
expenses) generated by the income producing property from its
usual operations.

21. Property Cash Flow Analysis continued…
 Revenues - income from tenancy or occupancy, and
reimbursement of operating expenses
However, recurring revenue related to a property’s operations
could come from a variety of sources.
Example, in addition to rent, income from a retail tenant based
on the percentage of sales by the retail store can be an additional
source of revenue for the property.

22. Property Cash Flow Analysis continued…
 Expenses - costs of operating and maintaining property:
• management fees • facility supplies
• franchise fees • costs of goods sold
• utilities • insurance
• leased equipment • service agreements like
• maintenance landscaping or marketing
• employee salaries

23. An underwriter’s document requirements from the borrower are specific
to the uniqueness of each property and at minimum include the
following:
 Operating statements – current plus three prior calendar years
 Operating budget – current and following year’s operating budget
 Current Rent Roll – includes tenant names, co‐tenancy provisions,
leased square foot area, lease commencement dates, lease expiration
dates, current rents (contractual rent increases during lease terms),
renewal options, termination options, and current or future
concessions

24. Market Analysis
By tracking and projecting market trends, an underwriter can
reasonably predict the commercial viability of a particular
property over the term of the loan and beyond the anticipated
refinance period to provide the basis for the probable
performance of the collateral.

25. Market Analysis continued…
Macro and Local Economic and Demographic
Tr e n d s I n f l u e n c e t h e D e m a n d f o r S p a c e
 Supply and Demand Conditions
 Nominal GDP (as indicative of  Local Population Growth
increasing prices)
 Major Local Employers
 Employment Growth Rate
 Local Job Patterns
 Disposable Income
 Household Formation
 Changing Demographics in
Markets  Median and Disposable Income
 Market‐Specific Economic

26. Risk Analysis
To properly value CMBS, an underwriter must consider all
the risk factors specific to the uniqueness of each property.
Additionally, underwriters must also consider a borrower’s
ability to make timely payments and eventual repayment on
the loan at the maturity date.
This calls for lenders to customize their underwriting to
reflect the risk within each proposed loan in relation to the
criteria and conditions of each property.

28. Monetary Risks
 Term Default -“Term Risk” is the probability of default from loan
origination through loan maturity:
Underwriter’s Considerations:
probabilities in fluctuations in cash flows due to lease turnover
and
changes in expenses
Require higher debt service coverage ratio and credit enhancements
such as; reserve funds based on the uniqueness of each property

29. Monetary Risks
 Maturity Default – “Maturity Risk” is the probability of default at
the date a loan is due:
Reflects ability of a borrower to:
attain refinance proceeds to fully repay the matured loan
or
sell the property and utilize sales proceeds to repay the loan
Debt constants, debt-yields and loan‐to‐value ratios are
used to assess Maturity Risk

30. Non-Monetary Risks
 Technical Default – determining the probability of a technical
default, an underwriter evaluates:
borrower’s motivation
and
capacity to abide with constraints of loan agreements
beyond payment terms
Technical defaults can have severe repercussions if not cured by borrower
within a reasonable period of time
Example: borrower neglects to sufficiently insure a property, the property and
loan may suffer adverse consequences and risk of loss

31. Rating Issues
http://youtu.be/36q1fLiH3lw
http://www.theratingsdebate.com/

32. Conclusion
http://youtu.be/KGrQv1fZ0jU

33. CMBS - PowerPoint Presentation 2011
By
Natalie Cohen
Neville O’Callaghan
Mark Ungewitter
Public Domain Photo Credits
Photo By Denise Gould
Photo By Jim Peaco
Photo By David Hafley
Photo By Natalie Cohen

34. Sources
 CMBS.Com, http://www.cmbs.com/Mission.aspx, accessed December 2011
 Invetopedia, http://www.investopedia.com/terms/c/cmbs.asp#axzz1ZaNvpHhi, accessed December 2011
 Ilikeinvesting, http://www.ilikeinvesting.com/general-investment-articles/commercial-mortgage-securities.php,
accessed December 2011
 CMBS Borrower’s Guide,accessed December 2011
 http://equitydefeasance.com/assumptions_process.html , accessed December 2011
 Urbanland, http://urbanland.uli.org/Articles/2011/Mar/SepciCMBS , accessed December 2011
 CREFC.org
http://www.crefc.org/uploadedFiles/CMSA_Site_Home/Industry_Standards/CREFC_Underwriting_Principles_121510.pdf
, accessed December 2011
 Defeasnce, Wikipedia – http://en.wikipedia.org/wiki/Defeasance accessed December 2011
 The Ratings Debate, YouTube – http://youtu.be/36q1fLiH3lw, accessed December 2011
 Buffet on Derivatives, YouTube - http://youtu.be/KGrQv1fZ0jU, accessed December 2011