Commercial Mortgages, CMBS, ABS, CDO
1. Commercial Mortgages & MBS – Ch14
2. ABS -- Ch15
3. Collateralized debt obligations – Ch16
Ch14-15
1
Commercial Mortgages
• A commercial mortgage loan is originated to finance
a commercial purchase or to refinance a prior
mortgage obligation.
• Commercial mortgage loans are for incomegenerating properties, including
•
•
•
•
•
•
Multifamily properties (apartment buildings)
Office building
Industrial properties
Shopping centers
Hotel
Health care facilities
Ch14-15
2
Characteristics of C. Mortgages
• Commercial mortgage loans are non-recourse
loans – lenders can only look to the incomeproducing property backing the loan for
interest and principal repayments.
Ch14-15
3
Performance Indictors
• Debt-to-service coverage ratio (DSC)
• The ratio of property’s net operating income (NOI) divided by the debt
service
• NOI = rental income – cash operating expenses
• Critical value is 1
• Loan-to-value ratio
• Value is the present value of the expected cash flow, different from
market value or appraised value for residential mortgage
• Valuation requires projecting an asset’s cash flow (NOI) and
discounting at an appropriate interest rate (capitalization rate)
Ch14-15
4
Call Protection
• Prepayment lockout (2-10 years)
• Defeasance
– The borrower provides sufficient funds for the servicer
in a portfolio of treasury securities that replicates the
cash flows that
• Prepayment Penalty Points (5-4-3-2-1)
• Yield Maintenance Charge
– A yield to make the lender indifferent as to the timing
of prepayments. The charge is based on the difference
between the mortgage coupon and the prevailing
Treasury rate.
Ch14-15
5
CMBS
• A commercial mortgage-backed security is a security
backed by one or more commercial mortgage loans.
It can be issued by agency or none agency backed.
– Ginnie Mae-issued securities are backed by FHA, called
project loans
• The purpose is to provide funding for commercial
mortgages
• Single borrower/multi-property deals and multi-borrower
deals
Ch14-15
6
CMBS vs RMBS
• Much lower prepayment risk for CMBS
• Lower probability of default for CMBS – the loan can be transferred
by the servicer to a special servicer when the borrower is in default,
imminent default, or in violation of covenant, who has the
responsibility to modify the loan terms in case of an imminent
default to reduce the likelihood of default.
– Servicer: collecting monthly loan payments, keeping records related payments,
maintaining property escrow for taxes and insurance …
– Special servicer: duties arise when a loan becomes more than 60 days past due
– See page 324
• Investors of CMBS typically are knowledgeable real estate investors
and they have reviewed the proposed pool of mortgages when the
structure is being created.
Ch14-15
7
Asset-backed Securities
Definition: A security created by pooling loans other than residential prime
mortgage loans and commercial mortgage loans is referred to as an assetbacked security.
Categorizing ABS:
a.
Existing asset securitizations or future flow securitizations
b.
Consumer ABS and commercial ABS
Consumer ABS
Commercial ABS
Home equity loan
Trade receivables (health care rec.)
Auto loan and leases
Equipment leasing
Credit card receivables
Operating assets (e.g., aircrafts, cargo containers)
Tariff receivables
Entertainment assets (film rights, music royalties)
Manufactured housing loans
Franchise loans
Student loans
Small business loans
Home improvement loans
Ch14-15
8
Creation of an ABS
• 1. Granting a loan
– Underwriting standards
– Originator of a loan
• 2. Securitization process
– Special purpose vehicle (SPV): the ABS issuer
• Legal implication: rating of ABS will be independent of the
originator (page 356)
– Conduit: the party who buys the loans and sell them to
SPV.
• 3. Credit enhancements
– External – bond insurance (page 358)
– Internal
Ch14-15
9
Two-step Securitizations
• Intermediate SPV (known as the depositor)
– A wholly owned subsidiary of the originator
– Purchase assets from the originator
– Sell the assets to second SPV
• Second SPV (known as the issuer)
– Issue the ABS
Ch14-15
10
Roles of SPV
1. The potential for reducing funding costs
(page 334)
2. To diversify funding sources
3. To accelerate earnings for financial reporting
purposes
4. For regulated entities, potential relief from
capital requirements.
Ch14-15
11
Credit Enhancement of ABS
• External credit enhancement
• Guaranty from third party like bond insurance
• Internal credit enhancement
• Cash flow waterfall (or simply waterfall)
• -- cash flow to senior bondholders first, then
to lower priority classes.
Ch14-15
12
Collateral Type and Securitization
Structure
•
•
•
•
Amortizing assets
Nonamortizing assets -- page 336
Amortization schedule
Amortization period – page 336
Ch14-15
13
Credit Risks with ABS
• Asset risk
– Credit quality
– Concentration risk
• Structure risk
-- make sure if the collateral’s cash flows
match the payments that must be made to
satisfy the issuer’s obligations.
• Third-party providers
• -- Page 338-339
Ch14-15
14
Credit Card Receivable-Backed
Securities
• This is an example of ABS -- Page 340.
• Credit card issuers have receivables
– financing charges collected, fees and principals.
• IBs use the future cash flows from credit card
receivables as collaterals to issue ABS or CDOs
Ch14-15
15
Other types of ABS
• Auto loan-backed securities
– Prepayment is a concern
• Rate reduction bonds
– Backed by a special charge (tariff) included in the
utility bills of utility customers.
Ch14-15
16
Dodd-Frank Wall Street Reform and
Consumer Protection Act
• Securitizers retain a portion of the transaction’s
credit risk
• Reporting standards and disclosure for a
securitization transaction
• The representation and warranties required to be
provided in securitization transactions and the
mechanisms for enforcing them
• Due diligence requirement with respect to loans
underlying securitization transactions
Ch14-15
17
Collateralized Debt Obligations
• A security backed by a diversified pool of one or more of
the following types of debt obligations
• U.S. domestic investment-grade and high-yield corporate
bonds
• U.S. domestic bank loans
• Emerging market bonds
• Special situation loans and distressed debt
• Foreign bank loans
• Asset-backed securities
• Residential and commercial mortgage-back securities
Ch14-15
18
Structure of A CDO
•
•
•
•
Collateral managers
Collateral
Collateral assets
The funds to purchase collateral assets come from
the issuance of debt obligations.
• Structure of debt obligations
•
Senior tranches
•
•
Mezzanine tranches
Subordinate/equity tranches
Ch14-15
19
Categories of CDOs
• Arbitrage transactions
•
when the motivation of the sponsor is to earn
the spread between the yield offered on the
collateral and the payments made to the various
tranches
• Balance sheet transactions
•
when the motivation is to remove debt
instruments (primarily loans) from its balance sheet,
typically financial institutions such as banks seeking
to reduce their capital requirement specified by bank
regulators
Ch14-15
20
Cash vs Synthetic Structures
• Synthetic CDO structures involve the use of
credit derivatives.
Ch14-15
21
Arbitrage Transactions
Create an arbitrage CDO is whether a structure can offer a
competitive return for the subordinate/equity tranche as below:
Tranche
Par Value
Coupon Value
Coupon Rate
Senior
$80,000,000
Floating
LIBOR+70 basis
points
Mezzanine
$10,000,000
Fixed
Treasury rate +
200 basis point
Subordinate/Equity $10,000,000
Assumptions
• The collateral of the CDO:
• bonds that all mature in 10 years
• The coupon rate for every bond is a fixed rate
• The fixed rate at the time of purchase of cash bond is the 10 year
treasury plus 400 basis points
• To finance the senior tranche,
• collateral manager enters into an interest-rate swap with another
party with a notional principal of $80 million in which it agrees to do
the following:
• Pay a fixed rate each year equal to the 10-year Treasury rate plus 100
basis points
• Receive LIBOR
Ch14-15
23
Cash flows
• Assuming the 10-year rate at the time the CDO is issued is
7%.
• Interest received from collatoral:
• Interest to senior tranche:
• Interest to mezzanine tranche:
• Interest to swap counterpart:
• Interest received from swap counter part
• As a result,
• Total interest received:
• Total interest paid:
• Net interest
Ch14-15
24
Synthetic CDOs
• In a synthetic CDO, the collateral absorbs the
economic risk associated with specified assets
but does not have legal ownership of those
assets
• Requires the use of CDS
Ch14-15
25