CMBS: Commercial Mortgage Backed Security
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The US Commercial Mortgage Backed Security (CMBS) appears to be picking up after the housing crisis 2007. A CMBS is backed by mortgages on commercial real estate and is generally issued in tranches. The lockout provisions included in most commercial mortgages reduce prepayment risk generally associated with mortgage backed securities. Commercial mortgages can be subject to defeasance, yield maintenance and pre payment penalties to protect bondholders. The CMBS has emerged as a popular source of commercial mortgage lending because the worth of bonds backed by a pool of loans is generally more than the sum of the value of all the loans.[br]
Issuance of CMBS: Commercial Mortgage Backed Security
The issuance of CMBS involves pooling together several single mortgage loans of varying sizes, property types and locations, which are transferred to a trust or Special Purpose Vehicle (SPV). This trust issues a series of bonds or securities that may vary in terms of yield, duration and payment priority. These securities are rated by nationally recognized rating agencies into investment grades and below investment grades, depending on their risk and yield.
The interest received on all loans pooled for issuing CMBS is used to pay off the accrued investors’ interest, starting with investors holding the highest rated bonds to those holding the next category of bonds or securities. This sequential payment structure is called a ‘waterfall.” However, in case of shortfall in contractual loan payments, or if a loan collateral has to be liquidated and there are insufficient funds for distribution to all bond classes, investors in the most subordinate bond class incur a loss.
The securitization of commercial real estate loans is done through a real estate mortgage investment conduit (REMIC). A tax law creation, REMIC allows the trust to be a pass-through entity not subject to tax at the trust level.
Trends in CMBS: Commercial Mortgage Backed Security[br]
The securitized bonds market is witnessing renewed activity in the single borrower CMBS transactions. While certain deals are US government backed, others are proceeding without government assistance. CMBS issuance in the near term is likely to be restricted to stable properties, single borrowers and good guarantee issues. Over time, multiple borrower CMBS issues will be accepted only if they have a strong origination sponsor who can underwrite the balance sheet as well as securitize.
