Commercial Mortgage-backed Securities Market Research Articles

Reexamining the Real Estate Quadrants

The real estate quadrant approach for categorizing the real estate investment universe is now 20 years old. These investment conduits have developed significantly over this time, and real estate allocations are shaped by both market and regulatory forces, which are leading investors to reexamine the broadening of blended strategies across these quadrants. In this article, the performance and interrelationships between the quadrants and the way that these have evolved over time are examined. The results show that significant diversification benefits are available to investors using the quadrants. The commercial mortgage-backed securities market is found to be the main transmitter of shocks among the quadrants and private real estate the most significant receiver, with a meaningful shift in their relationships before and after the global financial crisis. Finally, blended real estate portfolios are found to reduce estimated risk and enhance the risk-adjusted performance of a purely private real estate exposure. <b>Key Findings</b> ▪ Significant diversification benefits are available to investors using all forms of real estate exposure, given our finding that less than one-third of the system is influenced by itself in isolation. ▪ Using the dynamic connectedness methodology, the study finds that public real estate debt is the main transmitter of shocks among the quadrants and that private real estate equity is the most significant receiver of shocks among the real estate quadrants. ▪ Further evidence of blended real estate portfolios enhance the risk-adjusted performance of a purely private real estate exposure.

Safe Collateral, Arm’s-Length Credit: Evidence from the Commercial Real Estate Market

Abstract Two main creditors exist in commercial real estate: arm’s-length investors and banks. We model commercial mortgage-backed securities (CMBS) as the less informed source of credit. In equilibrium, these investors fund properties with a low probability of distress, and banks fund properties that may require renegotiation. As a natural experiment, we test the model using the collapse of the CMBS market during 2007–2009, when banks funded both collateral types. Our results show that properties likely to have been securitized were less likely to default or be renegotiated. This suggests that securitization in this market funds safe collateral.

Determinants of credit spreads in hotel CMBS loans

PurposeThis study aims to investigate the determinants of credit spreads in hotel loans securitized into commercial mortgage-backed securities (CMBS) between 2010 and 2015.Design/methodology/approachThe sample represents 1,579 US hotel fixed interest rate whole loans with an aggregate mortgage value of $26.6bn at loan origination. The relationship between credit spreads and property, loan and market characteristic is examined via multiple regression analysis. Additionally, the method of 2-stage least squares is used to control for endogeneity bias and identify the effect of the loan-to-value (LTV) ratio on credit spreads.FindingsThe multiple regression models explain 80 per cent of the variation in credit spreads and show a significant association of credit spreads with hotel and loan characteristics and market conditions. The findings indicate the debt coverage ratio to be the most important predictor of credit spreads followed by the loan maturity term, implied capitalization rate, LTV and yield curve. The results show the debt yield premium to be a stronger predictor of credit spreads than the debt yield ratio. The spread between the debt yield ratio and mortgage interest rate could be used in future research as an instrumental variable to identify the effect of the LTV on credit spreads.Research limitations/implicationsThis study is limited to the CMBS market and the period after the financial crisis. Additional limitations include sample selection bias, exclusion of multi-property loans and variable interest rate loans.Practical implicationsInterest rate increases in an expanding economy would likely increase the cost of borrowing for hotel owners leading to higher debt service payments and lower profitability. If an increase in interest rates is offset by a decline in credit spreads, hotel owners will still benefit from the ensuing stability in borrowing interest rates. The evidence also suggests that CMBS lenders favor select service and extended stay hotels. Owners and operators of these efficient and profitable hotels will likely obtain loans with lower credit spreads given their lower risk of default.Originality/valueThe current study provides evidence on the effects of loan and property characteristics in the pricing of loan risk and serves to inform CMBS market participants about the factors that drive credit spreads in hotel mortgage loans.

Safe Collateral, Arm's-Length Credit: Evidence from the Commercial Real Estate Mortgage Market

When collateral is safe, there are less opportunities for things to go wrong. We examine matching between collateral and creditors in the commercial real estate mortgage market by comparing loans in commercial mortgage backed securities (CMBS) conduits and bank portfolios. We model CMBS financing as lower cost but less informed, such that only safe collateral is funded by CMBS. This prediction is tested using the 2007-2009 shutdown of the CMBS market as a natural experiment. The loans funded by banks that would have been securitized are less likely to default or be renegotiated, indicating that the securitization channel, when available, funds safe collateral.

Issuance Activity and Interconnectedness in the CMBS Market

The purpose of this paper is to provide background information on commercial mortgage backed securities (CMBS) by providing an analysis of issuance volumes, structure and participants. In addition, we analyze concentration and interconnectedness in the CMBS market before and after the global financial crisis.

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

In this article, the authors discuss the importance and development of the commercial mortgage-backed securities (CMBS) market. They then review several issues that will play an important role in fostering recovery of the CMBS market or impeding the CMBS markets or particular segments within that market: (1) the risk-retention rule applicable to commercial real estate loans and CMBS under the Dodd–Frank Act, (2) the U.S. federal banking regulators’ adoption of the U.S. Basel III rule, and (3) federal government participation in the reinsurance market for terrorist insurance.

Commercial Real Estate CLOs: Features That Make Them an Attractive Asset Class

In the world of securitization and structured finance, a new hybrid asset class—commercial real estate (CRE) collateralized loan obligations (CLOs)—has appeared on the scene, boasting the most attractive structural and underlying collateral features of its parents: the commercial mortgage-backed securities (CMBS) securitization transaction and the standard CLO transaction. The CRE CLO structure is one that can be used as a means of potentially averting financial loss in advance of the “maturity wave” (also known as the maturity wall, CMBS refinancing risk, and CMBS balloon risk), a lurking phenomenon wherein a number of CRE mortgage loans, including balloon loans and anticipated repayment date (ARD) loans, constituting more than one trillion dollars of the underlying collateral in CMBS securitizations from vintages of 5 to 10 years ago, are going to be coming due in 2015–2017. CRE CLOs may create appealing opportunities for lenders, because shorter-term financing can be used to refinance these legacy-maturity CRE mortgage loans into the more stabilized product that CRE CLOs offer. Also, CRE CLOs contain CLO structural features absent in a standard CMBS securitization, including a reinvestment period, a ramp-up period, various collateral quality tests, and an active management feature that empowers CRE CLO collateral managers with the ability and discretion to substitute poorly performing collateral in the CRE CLO’s underlying CRE mortgage loan collateral pool with “new” collateral that satisfies certain rigorous criteria. Moreover, today’s CRE CLO’s collateral is more resilient than CRE mortgage loan collateral from yesteryear because of the following: 1) more stringent lending and underwriting guidelines are in place today for CRE mortgage loans compared with those in place in 2007 at the height of the CMBS market and 2) today’s CRE CLOs do not contain split loans, mezzanine loans, or B-pieces; instead they contain only as collateral CRE senior mortgage whole loans with much shorter durations than the CRE mortgage loans from the pre-2008, CLO 1.0 era. Additionally, a CRE CLO may offer higher yield than other structured products because the collateral manager has “skin in the game” tied to the CRE CLO’s overall performance and payment waterfall, and therefore the collateral manager’s interests are more closely aligned with those of the investor. From a relative-value and performance perspective, investors looking to maximize their yield can thus find comfort investing in a lower tranche in the capital stack without potentially as high a risk exposure for non-payment as if they invested in a lower tranche in a CMBS securitization transaction. Finally, from a regulatory compliance perspective, the CRE CLO’s hybrid structure enables it to fall under certain exemptions under the Investment Company Act of 1940—including the “qualified purchasers” exemption under Section 3(c)(7) and the real estate mortgage loan exemption of Section 3(c)(5)(C)—and to fall under the Volcker Rule’s carve-out for securitization of loans, all of which enable a CRE CLO to escape “covered fund” status under the Volcker Rule.

Ratings Competition in the CMBS Market

We consider the relationship between competition among credit rating agencies and the ratings of commercial mortgage‐backed securities (CMBS) using data from 2002 to 2007. We characterize competition using Fitch's aggregate share of CMBS ratings and a measure of Fitch's deal‐specific market share constructed as the probability of Fitch being hired for a specific transaction. Controlling for deal characteristics, we find that subordination levels were lower when Fitch's aggregate and deal‐specific market shares were higher, which suggests that ratings competition yielded less stringent ratings when Fitch was a more significant competitor, although this effect dissipates when Fitch's market shares were high.

CMBS Overview

The CMBS panel held on October 18, 2011, focused on recent developments in the Commercial Mortgage-Backed Securities (CMBS) market. The panelists addressed how the most recent CMBS deals compare with CMBS deals that were issued before the credit crisis in 2008/2009 and with the CMBS deals that restarted the CMBS market after the credit crisis. The expectation is that the market will continue to grow in 2012, although it will be buffeted by European headwinds. Macro-induced volatility has cheapened the sector even while the credit fundamentals remain sound at the top of the capital stack, creating investment opportunities. <b>TOPICS:</b>MBS and residential mortgage loans, CMBS and commercial mortgage loans

The U.S. Financial System in 2011: How Will Sufficient Credit Be Provided?

This paper uses Flow of Funds data on the level of net new credit extension to construct a bird’s-eye view of what the financial market landscape might look like once the turmoil subsides and the economy has begun to recover. The paper targets two related questions: (1) How much credit must be extended in order to return the economy to its long-run trend growth? (2) What roles will the major credit providers likely play in that process? The mix of sources supplying credit for the home mortgage, consumer, and nonfinancial business sector markets is different, and so we consider each of those markets separately. We focus on the roles of banks, traditional nonbank credit providers (such as finance companies and pension funds), the corporate bond and commercial paper markets, and structured finance, including government-sponsored enterprise (GSE) mortgage-backed securities (MBS) issuance, consumer (i.e., nonmortgage) asset-backed securities (ABS) issuance, and the commercial mortgage-backed securities (CMBS) market. As a reasonable assumption as to how the credit market may develop we start by positing a “baseline” scenario under which banks return to their long-run trend level of financing for home mortgage, consumer, and business sector borrowing. We then examine the extent to which other major providers of credit are likely to fill the remaining demand for credit. We consider what would happen if various of these credit providers were unable to meet the credit supply role asked of them in order to fulfill credit demand. We conclude that the revival of structured finance is crucial for home mortgage, consumer, and business sector credit provision if sharp adjustments in the cost of credit and major structural adjustments in credit markets are to be avoided. Specifically: (1) in the home mortgage market, GSE’s sales of MBS sufficient to support about half of borrowers’ credit needs are required for banks and private-label securitizers to operate at normal levels; and at least a modest role for private label MBS issuance is probably necessary to ensure adequate mortgage credit availability at a normal interest cost, (2) for consumer borrowing, without a substantial revival of the ABS market, banks and nonbank credit providers would not likely make up for the resultant shortfall without a sharp rise in the cost of consumer credit, and (3) for business sector credit, the re-emergence of the CMBS market is likely essential for adequate provision of commercial mortgage credit since, in the absence of large changes in the price of credit, banks are unlikely to make up for a large shortfall of CMBS-supported business sector credit extension. In contrast, banks and other credit channels likely would replace a credit shortfall resulting from a moribund commercial paper market without an undue rise in the cost of business credit.

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 commercial mortgage-backed securities (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, after controlling for observable determinants of loan pricing, conduit loans enjoyed a 34 basis points pricing advantage over portfolio loans in the CMBS market.

The Development of Commercial Mortgage-Backed Securities in Australia

The paper explores the development of the Australian Commercial Mortgage-Backed Securities (CMBS) market from 1999 to 2006 and outlines similarities and dissimilarities with the United States (US) and European (EU) CMBS markets. Whilst the US has been the market leader in terms of issuance volumes and diversity of asset classes backing the issues, the other two regions have not lagged far behind and have replicated the US CMBS model to suit their local needs. In comparison to the much bigger US and EU CMBS markets, the Australian CMBS market is well matured as seen by the diversity of asset classes backing the issues and transaction types, tightening spreads and record issuance volumes. The strong commercial real estate market outlook supports further CMBS issuance, with Listed Property Trusts (LPTs) continuing their dominance as issuers.

Understanding the commercial mortgage-backed securities market in the hospitality sector

Before the advent of the commercial mortgage-backed securities (CMBS) market, long-term permanent real estate lending had been traditionally limited to commercial banks, thrifts and insurance companies that provided new mortgage loan originations to local markets. The CMBS market was born from the lending crunch that developed in the 1980s, as some traditional lenders backed away from real estate lending. Financial intermediaries filled this gap in the market by constructing new forms of real estate debt securities which appealed to a greater range of investors. As a result, since the inception of the CMBS market there has been a broader range of investors in real estate securities, including money managers, hedge funds, pension funds, real estate funds and mutual funds. The objective of this paper is to provide a general overview of the CMBS securitisation process as it relates to hotels and discuss the advantages and disadvantages of the CMBS market, challenges confronting the CMBS hospitality sector and the servicing of CMBS.

Insuring against Terrorism: The Policy Challenge

The terrorist attacks during the past decade in London, Israel, the United States, and elsewhere have spawned an interest in understanding not only how governments can mitigate terrorism risk but also how governments might help to finance future losses. A burgeoning academic literature—and an intense lobbying effort by various industries—have argued that government assistance is needed due to a host of problems: the large size of potential losses, the difficulty of pricing the losses, the government's existing role as the guarantor of last resort, asymmetric information, the relationship between terrorism losses and government military policies, and other reasons. These arguments served as an important catalyst for the Terrorism Risk Insurance Act (TRIA) that President Bush signed into law in November 2002. Although TRIA's passage was held up in Congress for almost a year over a debate on limiting tort actions, both Democratic and Republican leaders supported the act. Over the past fifty years, the public has accepted a larger role for the government in insuring natural catastrophic losses.1 The general acceptance of the U.S. government's role in financing non-natural terrorist [End Page 139] losses, therefore, is probably not surprising, especially since the losses are partly in the government's control. This paper takes a contrarian view. I argue that mostly unfettered insurance and capital markets are capable of insuring large terrorism losses, even losses ten times larger than the $40 billion loss incurred on September 11, 2001. A $400 billion loss in capital markets is common. U.S. capital markets alone routinely gain or lose $100 billion on a daily basis and often several trillion dollars on a monthly basis. Moreover, a significant amount of these risks can be traced to new companies that have very little history or few close substitutes from which investors can accurately assess future earnings. Furthermore, a significant amount of the net earnings of most corporations is influenced by the government's nonmilitary policies through a vast sea of tax regulations, oversight regulations, and torts. Despite these numerous problems and government policy risks, investors provide enormous liquidity to U.S. firms, producing one of the most efficient mechanisms for financing risks that has ever existed. Product and environmental liability markets have also remained vibrant despite shifting court standards during the 1970s and 1980s that generated large, correlated losses to insurers. Indeed, shifts in legal standards are probably less predictable than many terrorist acts. So why do insurers appear to have a hard time providing insurance against a large loss that is "chicken scratch" in comparison to daily losses in other capital markets? This paper argues that capital and insurance markets are not to blame. Rather, if there is any "failure," it rests with government policies. Government tax, accounting, and regulatory policies make it costly for insurers to hold surplus capital. They also hinder the implementation of instruments that could securitize the underlying risks. In other words, the "market failures" that appear to justify government intervention in the terrorism insurance market are best viewed as "government failures." Correcting these policies would likely enable private insurers to cover both terrorism and war risks. To be clear, the purpose of this paper is not to provoke. In general, I believe that government policy, including progressive income taxation, can sometimes play an important role in enhancing risk sharing.2 Indeed, one of the justifications for the government's largest historic intrusion into insurance markets—the creation of the Social Security system—is that people are either too myopic (if they do not anticipate retirement) or too [End Page 140] smart (if they strategically save too little in order to rely on public aid) for their own good or the good of society. But the idea that government tax and regulatory policies can hinder the development of insurance markets and securitization should not be surprising. For example, whereas the commercial mortgage-backed securities market was very small a decade ago, deregulation...

A heterogeneous panel cointegration‐error correction approach to modelling commercial mortgage‐backed security prices

Provides the first empirical time series analysis of commercial mortgage‐backed securities (CMBS) prices using a proprietary data set of 15 senior tranche securities. Postulates and tests the hypothesis that nonstationary CMBS and corporate bond prices are cointegrated since CMBS are priced analogous to corporate bonds. States that given the emerging status of the CMBS market, price data is limited to less than three years. To overcome the low power of unit root and cointegration methodology for short data sets, appeals to the concept of cointegration in heterogeneous panels advanced by Pedroni (1995). Claims the presence of cointegration between CMBS and corporate bond prices confirms that the stationary first difference in CMBS and corporate bond prices must be modelled in an error correction framework (ECM). Further states the sensitivity of CMBS price changes to changes in the default probability, proxied by the market value of loans to property value, is tested in a simple first order approximation ECM framework. The results suggest that senior tranche CMBS which comprise no more than 70 per cent are immune to the risk from default loss and supports the predictions in Childs et al. (1996).