CMBS Market Research Articles

Predictive Modeling of Default Scenarios in the CMBS Market: A Macroeconomic Approach

This study analyzes potential default risks in Mortgage-Backed Securities (MBS) using time series data from 2010 to 2023. Employing Vector Autoregression (VAR) models to forecast economic indicators and calculate DTI and LTV ratios, which are crucial for predicting defaults in the MBS market. Our analysis, based on two economic models, examines the influence of macroeconomic factors and credit default risks on residential and commercial properties, such as Fixed-Rate and Adjustable-Rate Mortgages. The findings suggest that despite the significant impact of the pandemic, the likelihood of default in the American MBS market over the next 15 years remains relatively low. The study emphasizes the significance of comprehending the relationship between macroeconomic conditions and MBS default risks, providing a comprehensive methodology for future research.

Informational Efficiency in Securitization after Dodd-Frank

Abstract We analyze how Dodd-Frank-mandated risk retention affects the information investors extract from issuers’ retention choices in the CMBS market. We show that the required retention level is both binding and stringent. Although this implies issuers cannot signal using the level of retention, we provide a model showing that signaling can occur by varying the retention structure. The model is consistent with spreads being empirically lower in deals with a purely first-loss retention structure. A stated concern of rulemakers is asymmetric information. However, we show that, post-crisis, the level of asymmetric information in this market is quite low.

Informational Efficiency in Securitization After Dodd-Frank

We analyze how Dodd-Frank mandated risk retention affects the information investors extract from issuers' retention choices in the CMBS market. We show that the required retention level is both binding and stringent. Although this implies issuers cannot signal using the level of retention, we provide a model showing that signaling can occur by varying retention structure. The model is consistent with spreads being empirically lower in deals with a purely first-loss retention structure. A stated concern of rulemakers was asymmetric information. However, we show that, post-crisis, the level of asymmetric information in this market is quite low.

Reputation, Information, and Herding in Credit Ratings: Evidence from CMBS

We find strong evidence of herding behavior among credit rating agencies (CRAs) in the CMBS market. CRAs are more likely to change their rating if another CRA had changed its rating on the same bond in the previous period. CRAs tend to adjust their ratings to make them converge with those of other CRAs when there is rating disagreement in the previous period. CRA reduced their herding behavior during the financial crisis and herding after the crisis was still lower than it was pre-crisis. We also find evidence that herding in corporate bonds is largely limited to below-investment grade companies. In contrast, we see evidence of herding in CMBS in both high and low rated tranches. These results are consistent with predictions from a theoretical model where CRAs use both public and private information in determining their credit ratings.

CMBS market efficiency: The crisis and the recovery

This paper presents a reduced form credit risk model to study CMBS pricing and CMBS market efficiency during and after the credit crisis with a comprehensive loan, bond and deal level data set. Using a model determined fair value, an automated trading strategy based on a newly determined risk ratio buys undervalued and sells overvalued CMBS. These strategies result in substantial trading profits between November 2007 and June 2015. Controlling for CMBS sector risk factors, we reject CMBS market efficiency over the entire sample period. When we split the sample into the Crisis and Recovery periods, we observe persistent abnormal returns over both subperiods, which is consistent with an inefficient CMBS market. Because the CMBS market appears to be inefficient, our results suggest that the approach presented in this paper may facilitate the increased financial stability of the CRE sector through the better pricing and risk management of CMBS.

Green Buildings in Commercial Mortgage‐Backed Securities: The Effects of LEED and Energy Star Certification on Default Risk and Loan Terms

AbstractWe study the impact of green building on loans in the CMBS market. A hazard model shows green buildings carry 34% less default risk, all else equal. A matched‐sample analysis gives similar results. We attribute the effect to a loan‐to‐value channel, where risk is lowered by a green price premium. The benefit comes at least partly from the level of green achievement, not only the label itself. Loans on buildings that were green at loan origination have slightly better terms than loans on nongreen buildings. That difference is growing over time, but the effect is economically small compared to default risk.

Using Cash Flow Dynamics to Price Thinly Traded Assets

We investigate the importance of cash flows as opposed to discount rates to the pricing of assets that, unlike common stock, are thinly traded but have reliable cash flow information. We rely on the dynamic Gordon model, which we adapt to deal with the thin trading environment, by developing a self-propagating rolling VAR. Using data from the CMBS market, we find that cash flows are informative in valuing these thinly traded assets. Predicted yields resemble transaction yields and outperform yields based on matrix prices, especially when cash flows are more volatile, and therefore more informative.

Governance and Capital Structure: Theory and Evidence from the CMBS Market

Theory and evidence are presented on how governance structure affects security design. Two types of frictions are isolated as they affect agent incentives to resolve financial distress: moral hazard in costly effort provision and risk-shifting incentives. A tension is shown to exist between the two effects, favoring a focus on one or the other depending on asset resale market conditions anticipated at the time of securities issuance. We show that, although effort provision is efficient with direct subordinate securityholder control over loan modification, there exist market conditions when concerns over risk-shifting costs predominate. As a result, governance mechanisms that limit risk shifting can be value enhancing. Empirical analysis of two distinct samples of commercial mortgage-backed securities issuances supports many of the model predictions, including the relative efficiency of junior security control over the workout specialist. We also empirically isolate the value-enhancing properties of specific governance mechanisms, the relative effects of which are time and market dependent.

The Post-Crisis CMBS Market:Will Regulations Prevent Another Market Meltdown?

The Post-Crisis CMBS Market:Will Regulations Prevent Another Market Meltdown?

Likely and Unlikely Reasons for Securitized Borrowing: Evidence from the CMBS Market

We assemble a unique dataset of commercial mortgages with information on loan characteristics at origination and subsequent performance. The most significant difference between securitized and balance sheet loans is the size of the loan. The loans in the highest loan size decile have a 43% percent chance of securitization whereas the ones in the lowest decile have only a 1% chance. This result is consistent with diversification being a key motivation for securitization. We also find that loans that require substantial monitoring are less likely to be securitized. Finally, securitized loans get resolved less quickly after defaulting.

Does SkinninntheeGame Affect Security Performance? Evidence from the Conduit CMBS Market

We document that the amount of first-loss security retention in the conduit CMBS market has a significant impact on the probability that more senior tranches ultimately default. In particular, we demonstrate that an increase in the amount of first loss security retention is correlated with better security performance, after controlling for information available at issue. We then identify plausibly exogenous variation in the amount of first-loss security retention, relying on the greater ability of larger first loss investors to sell these positions into CRE CDOs given the need for large pools of collateral. Using this variation as an instrument, we measure a causal link between retention and performance. Further, we demonstrate that the risk associated with this agency problem was not priced at origination, as the interest rate on senior securities is not correlated with the amount of retention. Together, the evidence is consistent with the hypothesis that first-loss security retention is not supported by competitive market equilibrium and suggests that regulation of retention could improve outcomes.

Mortgage Fund Flows, Capital Appreciation, and Real Estate Cycles

This paper provides strong evidence for a positive feedback loop between property prices and mortgage supply, using data from the U.S. commercial property and mortgage markets over the 1991 to 2011 period. The empirical analyses control for the endogeneity of property prices, mortgage flows, mortgage interest rates, and loan to value ratios, and provide two main findings. First, exogenous increases in mortgage supply, measured with the growth of the CMBS market, significantly reduce property cap rates. Second, volatility of past price changes and the “biggest loss” in property values in the past significantly affect mortgage supply. This positive feedback loop may be an important driving force for real estate cycles.

Commercial Real Estate Loan Performance at Failed U.S. Banks

Exposure to commercial real estate (CRE) loans at regional and small banks and thrifts has soared over the last two decades. As banks’ balance sheets become more concentrated in these types of loans, banks have become more sensitive to swings in CRE fundamentals. The concentration in CRE loans peaked in 2007, just as commercial real estate prices started a historic free fall, declining more than 30 percent in just two years. Over this same time CRE concentration has been a significant factor in recent bank failures. Default and loss models of CRE mortgages have previously been estimated using loan data from large, income-generating properties financed by insurance companies and the commercial real estate mortgage (CMBS) market. Early research used data from insurance companies (Synderman (1991), Esaki et al (1999), Vandell et al (1993), Ciochetti et al (2003), while more recently researchers have used data from the CMBS market (Ambrose and Sanders (2003), Archer et al (2002), Deng et al (2004), Seslen and Wheaton (2010), An et al (2009). Black et al (2010) found that loans in CMBS pools that had been originated by portfolio lenders, such as insurance companies or commercial banks, were of a higher quality and outperformed loans originated by conduit lenders or investment banks. The CMBS and insurance company loans used in these studies differ in structure and underlying collateral from the loans backed by bank CRE loans. Roughly a third of bank CRE loans are backed by owner-occupied CRE and another 20 to 30 percent by land and construction loans. The owner-occupied properties, which lack an external and explicit rental stream, are usually not candidates for securitisation. The loans in bank portfolios backed by land acquisition, development, and construction (ADC) projects are even less similar to those in CMBS and in insurance company portfolios. Land and construction loans are short term and the collateral is the raw land or the partially completed construction project. Finally, the loans on banks’ books backed by existing income-generating commercial properties are likely to be different from those found in CMBS pools or in insurance company portfolios.Regional and small banks also make much smaller loans than those usually seen in CMBS pools or in insurance company portfolios. Clearly, each of these types of loans has performed differently during this recent financial crisis, yet we are still dependent on default and loss models estimated using data from only one type of loan.Ours is the first paper to estimate CRE default and loss models using a loan-level dataset drawn from bank portfolios. We develop a unique dataset consisting of loan-level information on CRE portfolios for a sample of banks entering FDIC receivership over the past several years. We use this dataset to estimate a series of default and loss models. We estimate these models on the loans backed by existing CRE properties and compare the results with those from other papers that estimate CRE default using data from the CMBS and insurance companies. We then extend our analysis to the performance of land and construction loans, providing the first loan-level analysis of the performance of such loans.Full publication: Property markets and financial stability

Asymmetric Information, Adverse Selection, and the Pricing of CMBS

We demonstrate that asymmetric information between sellers (loan originators) and purchasers (investors and securities issuers) of commercial mortgages gives rise to a standard “lemons problem”, whereby portfolio lenders use private information to liquidate lower quality loans in CMBS markets. Conduit lenders, who originate loans for direct sale into securitization markets, mitigate problems of asymmetric information and adverse selection in loan sales. Our theory provides an explanation for the pricing puzzle observed in CMBS markets, whereby conduit CMBS loans are priced higher than portfolio loans, despite widespread belief that conduit loans are originated at lower quality. Consistent with theoretical predictions of a “lemons discount”, our empirical analysis of 141 CMBS deals and 16,760 CMBS loans shows that upon controlling for observable determinants of loan pricing, conduit loans enjoyed a 34 bps pricing advantage over portfolio loans in the CMBS market.

A-Reits: Impact of the Global Financial Crisis

For the past 20 years, the Australian Real Estate Investment Trust (A-REIT) sector has consistently produced returns that have outperformed the general equities market. However, the sector has succumbed to the global financial crisis, with the market capitalisation for A-REITs listed on the ASX dropping 53% in the last 12 months to March 2009 to A$47 billion. The relative loss of value was all the more shocking because it followed a period. The current environment is likely to make many features of the previous model difficult to replicate and will almost inevitably lead to a substantial review of the A-REIT structure. It is certain that some will query whether the current model is sustainable. The paper explores the future of A-REITS including conflict of interest management, the impact of higher levels of gearing and falling property values, the potential for a looming catastrophe in the Australian property market as foreign banks exit with no replacement for the CMBS market, the emergence of a government response to market failure through the Australian Business Investment Partnership, the future of the stapled structure and the possible impact of tax review.

Value Creation through Securitization: Evidence from the CMBS Market

Despite recent volatility and constraints in secondary market funding, analysts have ascribed substantial value creation to the securitization of commercial mortgages. Such value creation likely emanates from liquidity enhancements, regulatory arbitrage, price discrimination and risk diversification by pooling and tranching, gains from specialization in origination, servicing, and holding of mortgages, and the like. Indeed, such value creation would be consistent with past accelerated growth in the mortgage- and asset-based securities markets and the sizable profits earned by secondary market intermediaries. In this paper, we estimate the pricing effects of commercial mortgage securitization. We do so by applying loan level data from 1992–2003 to compare the pricing of conduit and portfolio loans held in CMBS structures. In contrast to portfolio loans, which are held for investment by originating institutions, conduit loans are originated for the sole purpose of sale and securitization in the secondary market. If securitization creates value, it should be evidenced in the relative pricing of conduit loans sold into CMBS pools and in a lower cost of capital to loan originators. We estimate a reduced-form model, in which the interest rate spread between commercial mortgages and comparable-maturity treasury securities varies with loan characteristics, capital market conditions, and conduit loan status. Estimation results indicate that securitization of conduit loans leads to an 11 basis points reduction in commercial mortgage interest rates. We assess robustness of results via hazard model tests for omitted variables and originator-specific effects. We further estimate a simultaneous equations model that accounts for the potential endogeneity of mortgage loan terms to the mortgage-treasury rate spread. Results of that analysis suggest a larger 20 basis points reduction in loan pricing among conduit loans sold into CMBS structures.

The CMBS Market Is Still Stable

The CMBS Market Is Still Stable

Value Creation Through Securitization: Evidence from the CMBS Market

Despite recent volatility and constraints in secondary market funding, analysts have ascribed substantial value creation to the securitization of commercial mortgages. Such value creation likely emanates from enhancements to originator liquidity, tranching of claims on cash-flows, gains from specialization in origination, servicing, and holding of mortgages, regulatory arbitrage, and the like. Indeed, such value creation would be consistent with past accelerated growth in the mortgage- and asset-based securities markets and the substantial profits earned by secondary market intermediaries. In this paper, we estimate the pricing effects of commercial mortgage securitization. We do so by applying loan level data from 1992 - 2003 to compare the pricing of conduit and portfolio loans held in CMBS structures. In contrast to portfolio loans, which are held for investment by originating institutions, conduit loans are originated for the sole purpose of sale and securitization in the secondary market. If securitization creates value, it should be evidenced in the relative pricing of conduit loans sold into CMBS pools and in a lower cost of capital to loan originators. We estimate a reduced-form model, in which the interest rate spread between commercial mortgages and comparable-maturity treasury securities varies with loan characteristics, capital market conditions, and conduit loan status. Estimation results indicate that securitization of conduit loans leads to an 11 basis points reduction in commercial mortgage interest rates. We assess robustness of results via hazard model tests for omitted variables and originator-specific effects. We further estimate a simultaneous equations model that accounts for the potential endogenity of mortgage loan terms to the mortgage-treasury rate spread. Results of that analysis suggest a larger 20 basis points reduction in loan pricing among loans sold into CMBS structures.

China: An Emerging CMBS Market

China: An Emerging CMBS Market

Commercial Mortgage Backed Securities: How Much Subordination is Enough?

The commercial mortgage-backed security market has experienced rapid growth in recent years, but relatively little academic research has questioned the apparent success of the CMBS capital structure. In this paper, we study whether the recent growth in the CMBS market actually reflects the mitigation of a market imperfection, as some have suggested, or reflects ever thinner subordination levels, perhaps backed up by overly aggressive assumptions about future commercial real estate performance. Preliminary results from our analysis based on a multi-factor structural model of expected commercial mortage defaults indicate that, somewhat surprisingly, the optimal levels of subordination are lower than those observed in recent CMBS deals. One interpretation of these results is that, in the absence of a performance track record for securitized commercial mortgages, the subordination levels of early deals were set too high. Under this interpretation, our results imply that in the future the CMBS market will likely see further reductions in subordination and continued rapid growth. An indirect implication of this conclusion is that the CMBS capital structure does create value.