Commercial Mortgage-backed Securities Research Articles

Assessing proxies for market prices of thinly traded assets with scheduled cash flows

Pseudo-market prices of infrequently traded assets with scheduled cash flows - commercial real estate appraisals and matrix prices of commercial mortgage backed securities - are compared against a VAR model to assess the extent to which these widely-used proxies are grounded in economic fundamentals. Property appraisals fail to fully incorporate the economic fundamentals underlying commercial real estate transactions. During the financial crisis, CMBS matrix prices captured underlying economic fundamentals and exhibited little pricing bias. However, matrix prices no longer exhibited such economic discipline after the financial crisis. Incorporating VAR forecasts considerably improves the predictive ability of appraisals and matrix prices.

Big is beautiful: The impact of bank–borrower relationship and sponsor size on credit spreads and underwriting fees in commercial real estate lending

This study uses a granular dataset to examine the impact of relationships between banks and borrowers and sponsor sizes on the credit spread and the associated underwriting fees of commercial real estate loans. This study focuses on commercial real estate banks that keep the loans on their books and do not use commercial mortgage-backed securities to transfer the credit risk to the capital market. Our findings reveal that credit spreads are lower for borrowers with a prior relationship with the bank; however, the impact of repeated lending varies across sponsor sizes. The prior relationship primarily reduces fees for small and medium-sized sponsors, whereas loans with large sponsors experience a stronger beneficial relationship effect in the credit spread.

Banks, non-banks, and the incorporation of local information in CMBS loan pricing

Comparing banks to non-bank lenders, we investigate whether the geographical distance between lenders, borrowers, and their properties is reflected in the pricing of US mortgages that were included in US commercial mortgage-backed security (CMBS) pools during the 2000 to 2017 period. The difference in loan spreads when the bank-borrower distance increases from zero to the median of about 700 miles is 10 basis points, and this effect is more pronounced if the loan is collateralized by a riskier property. On the contrary, geographical distance does not seem to have any effect on the loan spread of mortgages granted by non-bank lenders. The difference in loan pricing across originator types (even after controlling for key mortgage and property characteristics) suggests that banks and non-bank lenders have different incentives, lending technologies, and/or different types of borrowers. Our results contribute to the emerging literature on non-bank lender behavior.

Is COVID Revealing a Virus in CMBS 2.0?

ABSTRACTCommercial loan valuations crucially depend on accurate loan income, but underwritten income on commercial mortgage‐backed securities (CMBS) loans is commonly overstated relative to actual property income. Consistent with these differences being originator‐specific, income overstatement in CMBS 2.0 deals varies widely and persistently across originators, is priced by originators, is related across property types within an originator, is predictable ex ante, and is accompanied by inflation of past financials. Risk retention and associated regulation had no discernible effect on income overstatement. Originator income overstatement is highly predictive of pre‐ and COVID‐period loan distress. Overall, recent market stresses reveal large systemic differences in underwriting standards across originators.

How ‘bad’ is renter protection for institutional investment in multifamily housing?

We assess the role of state-level renter protection regulations on the pricing, performance and risk of multifamily housing. We construct a renter protection score (RPS) to measure the extent of renter protection in each state. Using a proprietary property-level dataset from loans backed by commercial mortgage backed securities (CMBS) and census tract socioeconomic variables, we study the role of RPS on initial capitalization (cap) rates, annual net operating income (NOI) and annual loan delinquency rates of multifamily housing. We find that, contrary to conventional wisdom that renter protection is ‘bad’ for investors, multifamily housing in high RPS states is associated higher annual NOI and NOI growth and lower delinquency rates. We also show that better tenant protection is associated with lower initial cap rates. The results point to investors perceiving properties in more regulated states as lower risk due to reduced income volatility. For institutional investors, higher levels of renter protection are, therefore, not ‘bad’ but are instead associated with lower cash flow volatility and better income growth prospects.

Appraisal bias in the lodging sector: Evidence from CMBS transactions

The main objective of this study is to investigate the size and direction of appraisal bias in the lodging sector. The hypothesis that appraisals of hotels are biased upwards is tested by comparing hotel appraisal prices (values) with their associated transaction prices in a sample of 480 hotel loans that were securitized by commercial mortgage-backed securities (CMBSs) between 2010 and 2019. The results of the study show an upward bias, and a significant negative effect of the loan-to-value (LTV) ratio on appraisal bias consistent with the observation that a decrease in leverage will increase appraisal bias. Additional findings reveal that an increase in appraisal bias is associated with an increased probability of default.

Toxic Asset Subsidies and the Early Redemption of TALF Loans

This paper develops a formula to numerically estimate the unsubsidized, fair-market value of the toxic assets purchased with Federal Reserve loans. It finds that subsidy rates on these loans were on average 33.9 percent at origination. In contrast, by the 3rd quarter of the 2010, there was on average no subsidy in TALF loans. The theoretical model is used to predict the early redemption of Term Asset-Backed Securities Loan Facility (TALF) loans used to purchase commercial mortgage-backed securities (CMBS). The predictions of the model are strongly supported by the data. In addition, this paper looks at the determinants of early redemption. CMBS originated inside the peak bubble years of 2005–2007 were much less likely to be redeemed early. The giant investment managers, Blackrock and PIMCO, were much more likely to redeem their TALF loans early than smaller investment managers.

The effect of hotel brand affiliation on commercial mortgage loan underwriting in the lodging sector

The main purpose of this study is to investigate the influence of hotel brand affiliation on commercial mortgage loan underwriting. Using a sample of 2443 hotel loans securitized into commercial mortgage-backed securities (CMBS) between 2010 and 2018, the results of this study show a significant effect of hotel brand affiliation on credit spreads, loan-to-value (LTV) and debt coverage ratios (DSCR). More importantly, there is a significant interaction effect between hotel brand and lending on credit spreads. The evidence is consistent with the observation that some hotel brands are less risky than other hotel brands, and therefore, receive favorable lending terms from lenders.

Intermediary Segmentation in the Commercial Real Estate Market*

AbstractBanks, life insurers, and commercial mortgage‐backed security (CMBS) lenders originate the vast majority of U.S. commercial real estate (CRE) loans. While these lenders compete in the same market, they differ in how they are funded and regulated, and therefore, specialize in loans with different characteristics. We harmonize loan‐level data across the lenders and review how their CRE portfolios differ. We then exploit cross‐sectional differences in loan portfolios to estimate a simple model of frictional substitution across lender types. The substitution patterns in the model match well the observed shift away from CMBS when spreads rose in late 2015 and early 2016. Counterfactuals suggest that the ability to substitute to other lenders offsets about 20% of the effect of a 25 basis point CMBS supply shock.

Commentary: Credit Rating Failures in the Aftermath of the Mortgage Meltdown

Credit ratings from the major rating agencies failed to signal the true risk content of residential mortgage-backed securities (RMBS), collateralized debt obligations (CDOs), and commercial mortgage-backed securities (CMBS) issued from 2005 through 2007. This article compares the failures across rating agencies and asset classes, using data filed by the rating agencies with the Securities and Exchange Commission (SEC). The data confirm the terrible performance of RMBS ratings. The likely causes include a combination of the breakdown of mortgage industry lending practices and the concurrent deterioration of rating agency practices. The data show that CDO ratings perform somewhat better than RMBS ratings. That result is perhaps surprising and likely reflects the confounding effects of the SEC’s definitions of its reporting categories. The data also show bad performance for CMBS ratings although the underlying causes differ from those driving the results for RMBS and CDOs. Moreover, the data show high levels of rating withdrawals across all asset classes, raising the question of possible underreporting of defaults. <b>Key Findings</b> ▪ Rating agency data reported to the SEC confirm the terrible performance of RMBS ratings, with triple-A-rated RMBS displaying 10-year default rates of 30% to 35% as of year-end 2017. The likely causes include a combination of the breakdown of mortgage industry lending and securitization practices and the concurrent deterioration of rating agency practices. ▪ The data show that CDO ratings performed better than RMBS ratings, likely because the data include ratings for many synthetic corporate CDOs. Other studies indicate that performance is significantly worse for CDOs backed by structured finance assets. ▪ CMBS ratings also performed poorly. Although CMBS rated triple-A displayed 10-year default rates of only 2% to 3%, those rated double-A had default rates of 12% to 19% while single-A-rated CMBS default rates were 23% to 32%. ▪ The data document high levels of unexplained rating withdrawals on structured finance securities. The effect of such withdrawals may be to artificially depress the reported default rates.

Investor Sentiment and Prepayment Hazard: The Case of Multifamily MBS Loans

Rising property prices are one explanation for higher prepayments of commercial mortgages as borrowers refinance to take out equity or sell their assets. However, prices may be driven not only by fundamentals but also investor irrationality. We investigate the informative value of investor sentiment for prepayments of loans underlying commercial mortgage-backed securities (CMBS). We employ Cox Proportional Hazard models to analyze a sample of 10,728 multifamily securitized loans for the period of 2001 to 2015. We find that, controlling for fundamentals, interest rates and loan characteristics, irrational investor sentiment can explain the exercise of the prepayment option by fixed- and floating-rate borrowers in times of increased property prices. The effect of irrational sentiment on prepayment hazard is robust to different sentiment measures as well as originator, geographic, and deal characteristics. Our findings suggest that irrational investor sentiment is a source of information for lenders and CMBS investors interested in predicting prepayments.

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.

Risk Retention Rules and the Issuance of Commercial Mortgage Backed Securities

We study the impact of the risk retention rule - requiring 5% of underlying credit risk for commercial mortgage backed securities - on commercial real estate markets. Since the primary objective of this rule is for the deal sponsors to have skin in the game, we expect that underwriting standards should tighten following the implementation of the rule. Consistent with this notion, we find the reform led to a decrease in price premium and probability of rating shopping by the sponsors, as well as longer time-to-securitization and lower default probability. We also show that the Dodd-Frank risk retention rule can impact banks’ credit supply by curtailing credit growth. As a result, we provide novel evidence on the effect of the risk retention rule on underwriters most exposed to the regulation.

2020 Office Quarantine

The hotel and retail sectors have been at the forefront of COVID-19-related investor concerns in commercial real estate. The office sector is the single largest property sector across commercial mortgage-backed securities with $149bn of outstanding balances across conduit and single asset, single borrower. Office sector delinquencies have remained relatively low through the COVID-19 crisis; however, COVID shutdowns have forced many corporations to shift to work from home (WFH) situations across the US. The success of WFH and the potential to reduce corporate occupancy costs may have longer term implications on office demand beyond the pandemic. This article reviews the health of the office sector, looks at office performance during the Great Financial Crisis, and considers the impact of wider acceptance of WFH policies on future office demand. <b>TOPICS:</b>CMBS and commercial mortgage loans, credit risk management, financial crises and financial market history <b>Key Findings</b> ▪ Office commercial mortgage-backed securities (CMBS) delinquencies to date have remained relatively low compared with the hotel and retail sectors. ▪ The office sector does not face significant near-term deadlines. Office debt maturities and lease rolls in CMBS are back-ended. Only 10% of office debt maturities (conduit) and 18% of reported lease rolls in CMBS are due in the next 2 years. The duration of office leases provides a longer runway for problems to be worked out. ▪ During the Great Financial Crisis (GFC), office revenues declined by roughly −17% and did not bottom for about 2½ years. Milder recession than the GFC; WFH acceptance has dented office demand, but this will be partly offset by higher square footage per employee needs once offices can reopen normally. Longer term office demand will return.

COVID-19 and Structured Finance Litigation: CMBS and CLO Disputes on the Horizon

This article describes the structure of the trillion-dollar CMBS and CLO markets and their current distressed states, given the ongoing economic effects of the COVID-19 pandemic. It then outlines various disputes that may arise from this distress. For CMBS, these include control and valuation disputes; waterfall disputes; “busted deal” disputes; REIT, “repo,” and margin call disputes; fraudulent selling and misrepresentation disputes; and repurchase claims. For CLOs, the potential disputes involve CLO managers, CLO arrangers, CLO investors and trustees, and CLO valuation issues. In each instance, the article describes the parties involved, the legal issues that are likely to arise, and—where possible—the applicable law from prior litigation in respect to the same or similar issues. The article concludes that many of these disputes are likely to result in litigation again soon, given the ongoing effects of the COVID-19 pandemic and current economic forecasts within the CMBS and CLO markets. <b>TOPICS:</b>CMBS and commercial mortgage loans, CLOs, CDOs, and other structured credit <b>Key Findings</b> • The world is facing a COVID-driven economic slowdown that many believe will expose flaws in the market for commercial mortgage-backed securities (CMBS) comparable to those seen in the residential mortgage-backed securities (RMBS) market in 2007–2008. • This broad, multisector, economic downturn is also likely to severely impact the hundreds of billions of dollars of collateralized loan obligations (CLOs) that have been issued in recent years. Wide-ranging, cross-sector defaults are expected for the loans that collateralize CLOs, and extreme loss severity is expected when those defaults occur. • Both CMBS and CLO industry participants and legal counsel involved, or looking to become involved in the industries, should scrutinize potential disputes closely and prepare for potential litigation in the near future.

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.

The Pricing of New Interest Rate Derivative Futures

This paper reviews the development of commercial real estate mortgage-backed securities. In addition, summarizes the relevant pricing formula of futures contracts and commercial real estate mortgage-backed securities. Based on the above research, this paper puts forward a new type of interest rate derivative futures, that is to say CMBS futures. In this paper, both the CIR model and the generalized method of moments are used to deduce the relevant pricing formula of the new financial derivatives, the CMBS futures. At the same time, the 261 real commercial mortgage backed security transaction data from May 3, 2015 to April 26, 2020 in the U.S. stock market are downloaded and used to test the derived pricing formula that derived above, and at last a specific CMBS futures contract is designed in order to provide reference for publishers when they are issuing the CMBS futures products. The research of this paper has certain practical significance for promoting the interest rate marketization, broadening the existing financing channels for investors, promoting the development of interest rate derivatives market and interest rate futures market. It also has certain theoretical significance for the development of financial derivatives and futures market, especially the development of interest rate derivatives and its futures products.

Using commercial mortgage loans to assess risk and return in the lodging sector

Abstract The purpose of this study is to investigate the risk and return features of the lodging sector using a large sample of 16,898 commercial mortgage loans securitized into commercial mortgage-backed securities (CMBS) in the U.S. between 2010 and 2018. The results of the analysis show significantly lower loan-to-value (LTV), higher debt service coverage ratios (DSCR), and higher credit spreads in the lodging sector than all other commercial property sectors. Additional findings document significantly higher lodging sector capitalization rates and equity dividend rates. Taken together, the results of the study provide strong empirical support for the positive relationship between risk and return in the lodging sector. Therefore, investors will require higher returns to compensation them for the additional risk of investing in the lodging sector. The theoretical and practical implications of these results are also discussed.

Intermediary Segmentation in the Commercial Real Estate Market

Banks, life insurers, and commercial mortgage-backed securities (CMBS) lenders originate the vast majority of U.S. commercial real estate (CRE) loans. While these lenders compete in the same market, they differ in how they are funded and regulated, and therefore specialize in loans with different characteristics. We harmonize loan-level data across the lenders and review how their CRE portfolios differ. We then exploit cross-sectional differences in loan portfolios to estimate a simple model of frictional substitution across lender types. The substitution patterns in the model match well the observed shift of borrowers away from CMBS when CMBS spreads rose in 2016.

Competition and Strategic Incentives in the Market for Credit Ratings: Empirics of the Financial Crisis of 2007

We study the market for ratings agencies in the commercial mortgage backed securities sector leading up to and including the financial crisis of 2007–2008. Using a structural model adapted from the auctions literature, we characterize the incentives of ratings agencies to distort ratings in favor of issuers. We find an important equilibrium distortion, which decreased after the crisis. We study several counterfactual experiments motivated by recent policymaking in this industry. (JEL D44, G01, G24)