Docstoc

mbs_lecture3

Document Sample
mbs_lecture3 Powered By Docstoc
					              Commercial
       Mortgage-Backed Securities
            National University of Singapore
                     July 27, 2001
              Notes from lecture given by Brent Ambrose at
              National University of Singapore – July 2001
July 2001            Brent W. Ambrose, University of Kentucky   1
 COMMERICAL MORTGAGE-
   BACKED SECURITIES
What is a CMBS?
• A commercial mortgage-backed security
  (CMBS) is a financial asset.
     – created when an issuer places a commercial
       mortgage (or collection of mortgages) into a
       trust
     – the trust issues classes of bonds backed by the
       underlying principal and interest payments.
July 2001        Brent W. Ambrose, University of Kentucky   2
            Objectives for this Session
• This session will cover the following topics:
     –      Differences between CMBS and MBS.
     –      The anatomy of a CMBS deal.
     –      Prepayment penalties on commercial mortgages.
     –      CMBS risks (prepayment & default)
     –      CMBS underwriting and the role of rating agencies.
     –      The role of CMBS servicers.
     –      Empirical studies of CMBS default and loss severity.
     –      How CMBS deals are rated.
July 2001               Brent W. Ambrose, University of Kentucky   3
                   CMBS vs. MBS
• Basic difference between residential MBS
  and commercial MBS:
     – PREPAYMENT
            • Commercial mortgages have prepayment lockouts
              and penalties.
            • This changes the termination options.
            • Default is now paramount.



July 2001            Brent W. Ambrose, University of Kentucky   4
            U.S. CMBS Legalities
• Real Estate Mortgage Investment Conduits
  (REMIC)
     – U.S. tax code provision that allows the pooling
       and securitization of mortgages. Once pool is
       formed, not allowed to substitute mortgages.




July 2001        Brent W. Ambrose, University of Kentucky   5
              U.S. CMBS Legalities
• Financial Asset Securitization Investment
  Trust (FASIT)
     – created in 1997
     – allows issuers to substitute and add collateral
       after securitization
            • now issuer can add mortgages to pool as they are
              originated



July 2001             Brent W. Ambrose, University of Kentucky   6
             U.S. CMBS Legalities
FASIT – Allow securitization of a broader
  class of assets including:
     1.     construction loans
     2.     commercial property bridge loans
     3.     automobile loans
     4.     credit card receivables
     5.     home equity loans

July 2001           Brent W. Ambrose, University of Kentucky   7
              CMBS Anatomy
•   Cash Flows
•   Subordination
•   Prepayment Penalties
•   CMBS Risks
•   Call Protection
•   Property Diversification
•   Credit Enhancements
•   Underwriting
•   Role of Servicers
July 2001        Brent W. Ambrose, University of Kentucky   8
                                 Typical CMBS Structure
                        Whole Loan Pool                                       CMBS
       Rating     Sub     DSCR    LTV         Spread        Rating   Sub     DSCR       LTV     Spread    Interest Principal




            BBB    0%     1.40         75%     250 BP         AAA    30%     2.00      52.50%   136 BP




                                                              AA     24%     1.84     57.00%    156 BP
                                                              A      18%     1.71     61.50%    176 BP
                                                              BBB    11%     1.57     66.75%    240 BP

                                                              BB     6%      1.49     70.50%    535 BP
                                                              B      3%      1.44     72.75%    825 BP
                                                              NR     0%      1.40     75.00%    2200 BP


                         Borrower Equity                                   Borrower Equity


                                                                                                                      Losses

             Source: Anthony Sanders


July 2001                                    Brent W. Ambrose, University of Kentucky                                          9
            Actual CMBS Examples
• GMAC Mortgage Pass-through Certificates
• NationsLink Commercial Mortgage Pass-
  through Certificates Series 1998-1




July 2001       Brent W. Ambrose, University of Kentucky   10
GMAC Mortgage Pass-through Certificates, Series 1997- C1
DMG was the Lead Manager of a $1.7 Billion conduit securitization - the largest of its kind at the
time of issuance

Co-Lead Managers:                 Deutsche Morgan Grenfell Inc.
                                  Lehman Brothers Inc.
Servicer:                         GMAC Commercial Mortgage Corporation
Sellers:                          ContiTrade L.L.C.
                                  German American Mortgage Corporation
                                  GMAC Commercial Mortgage Corporation
Issuance Date:                    September 25, 1997

Collateral:   Mortgage pool characteristics                                              eo rap ic istrib tio
                                                                                        G g h d          u n
              In l p o b la ce
                itia o l a n                           $1,696,984,278                    a rn
                                                                                        C lifo ia                                     17.29%
              N . o m rtg g lo n
                o f o ae as                                        355                   e o
                                                                                        N w Y rk                                      12.25%
              N . o m rtg g d p p rtie
                o f o a e ro e s                                   380                   en       n
                                                                                        P n sylva ia                                   7.54%
                   . u ff a a n
              Avg C t-o d te b la ce                       $4,780,237                    o n cticu
                                                                                        Cn e       t                                   6.07%
              W . Avg Mo a e ra
                td    . rtg g te                                8.62%                    e     rse
                                                                                        N w Je y                                       6.01%
                td
              W . Avg C t-o d te L
                      . u ff a TV                              71.04%                     xa
                                                                                        Te s                                           5.41%
                td    . SR
              W . Avg D C                                        1.33x

                  r ro erty typ
              Majo p p         es
                e
              R tail                                           25.51%
              Multifam  ily                                    18.79%
              O ffice                                          18.06%
              Industrial                                       10.21%
              H ospitality                                      9.42%
              S d nursing
                kille                                           7.13%                    The other remaining mortgaged properties are
              Mixe use
                    d                                           4.29%                    located throughout 37 other states, Puerto Rico
              S lf-storage
                e                                               2.86%                    and the District of Columbia
                           e
              Mobile hom park                                   2.65%
              C ongre gate care        d
                               /assiste living                  0.98%
                                                                         Source: Anthony Sanders
                the
              O r                                               0.10%
      July 2001                                  Brent W. Ambrose, University of Kentucky                                             11
GMAC Mortgage Pass-Through Certificates, Series 1997-C1

Bonds:



              Initial Cert.                        Rating      Percent of                    Initial Pass- Weighted
               Balance or                         (Moody's/   Initial Pool                  Through Rate Average L ife   Payment
Class        Notional Am  t.      Spread            Fitch)      Balance      Sub-ordination      (approx.)   (yrs)       Window
 A-1             $261, 582,000        48           Ass/AAA       15.4%           28.5%         6.830%        4.00          1 - 75
 A-2             $227, 661,000        62           Aaa/AAA       13.4%           28.5%         6.853%        7.50         75-108
 A-3              $724,100,000        65           Aaa/AAA       42.7%           28.5%         6.869%        9.71        108-119
  B                $67,879,000        70          Aa2/AA+         4.0%           24.5%         6.918%        9.94        119-120
  C                $50,909,000        75            A1/AA         3.0%           21.5%         6.898%        9.96        120-120
  D                $50,909,000        85            A2/A+         3.0%           18.5%         6.997%        10.01       120-125
  E                $93,334,000       100          Baa2/BBB        5.5%           13.0%         7.085%        11.45       125-158
  F                $25,454,000       118          Baa3/BBB-       1.5%           11.5%         7.222%        13.53       158-170
 G                 $84,849,000                      BB/BB         5.0%           6.5%          7.414%        14.93       170-195
 H                 $59,394,000                        B           3.5%           3.0%          6.600%        17.99       195-235
  J                $16,969,000                        B-          1.0%           2.0%          6.600%        19.78       235-242
 K                 $33,944,278                     Unrated        2.0%           0.0%          6.600%        22.0        242-358
  X             $1,696,984,278   Notional Amt      Aaa/AAA        N/A             N/A          1.629%         N/A          1-358

   Total        $1,696,984,278
Securities


       Source: Anthony Sanders




  July 2001                                     Brent W. Ambrose, University of Kentucky                                            12
 NationsLink Pass-through Certificates Series 1998-1
               $ 1 Billion (approximately) of CMBS

   Class    Rating         Principal         Coupon Subordination

   A-1      “AAA”          $ 200mm               6.49%                  101.00%
   A-2      “AAA”          $ 82mm                6.43%                  101.00%
   A-3      “AAA”          $ 434mm               6.40%                  101.00%
   A        “AAA”          $ 716mm                               30%
   B         “AA”          $ 54mm                6.44%           25%    101.00%
   C          “A”          $ 56mm                6.60%           20%    100.75%
   D        “BBB”          $ 80mm                6.90%           12%    100.50%
   E         “BB”          $ 60mm                7.00%            6%     85.00%
   F          “B”          $ 20mm                7.00%            2%     75.00%
   G        unrated        $ 40mm                7.00%            0%     45.00%
   IO       “AAA”           notional             0.90%             na     4.75%

July 2001             Brent W. Ambrose, University of Kentucky            13
                      CMBS Anatomy
• Cash flow prioritization:
     – 1) Principal repayments (both scheduled amortization
       and unscheduled prepayments) go to retire senior class
       debt first.
            •   CF go to senior classes AAA through BBB
            •   Intermediate class
            •   Junior class
            •   Unrated
            •   Equity holder
     – 2) Coupon interest paid to all classes

July 2001                Brent W. Ambrose, University of Kentucky   14
               CMBS Anatomy
• Loss prioritization:
     – Principal and interest due the most junior class
       bondholder must be completely exhausted
       before any loss is assigned to the class above it.




July 2001         Brent W. Ambrose, University of Kentucky   15
                     The Anatomy of a CMBS

                             Required Subordination

     The required level of subordination is computed as the expected loss
     in the event of a recession in the real property market. More
     specifically,

      required subordination = probability of loss (given a recession)
                               x severity of loss (given a default)

     The probability of loss varies from small (say 10%) to large (say
     50%), depending on the magnitude of the real property recession.
     The severity of loss is the amount of the loss conditional on a default.
     For example, a “Class B” real property recession will result in loan
     losses with a 10% probability. The severity of the loss is typically
     20% of the loan balance. Therefore, the required subordination for a
     “Class B” real property recession is 10% x 20% = 2%.
July 2001              Brent W. Ambrose, University of Kentucky             16
                        The Anatomy of a CMBS


                Example of Required Subordination Level Calculation
                             (NationsLink Example)

            Type of      Probability      x   Severity     =          Required
            Recession      of Loss            of Loss               Subordination

            “AAA”            50%         x      60%                      30%
             “AA”            45%         x      55%                      25%
              “A”            40%         x      50%                      20%
            “BBB”            30%         x      40%                      12%
             “BB”            20%         x      30%                       6%
              “B”            10%         x      20%                       2%




July 2001                Brent W. Ambrose, University of Kentucky                   17
                   The Anatomy of a CMBS

                           The Unrated Piece

  The unrated piece is used to provide subordination for the lowest
   rated junior piece.


  The size of the unrated bond reflects rating agency requirements for
   loans that are not cross-collateralized and cross-defaulted.


  The unrated piece is sold privately and typically purchased by the
   special servicer.




July 2001            Brent W. Ambrose, University of Kentucky             18
                     The Anatomy of a CMBS

                      The Interest Only (IO) Piece

   The notional balance of the IO piece is initially the aggregate
     issue amount ($ 1 billion in the example)

   The notional balance of the IO piece equals the sum of the
     certificate balances for the sequential pay certificates.

   The IO piece typically pays a small coupon (e.g. 90bp) and sells
     at a steep discount.




July 2001              Brent W. Ambrose, University of Kentucky         19
                    CMBS Anatomy
•      Expected Cash Flows – Review
     – Principal repayment
            •   Scheduled amortization
            •   Unscheduled prepayment
     – Interest
     – Penalties
            •   Hyperamortization
            •   Prepayment Penalty
            •   Balloon Default

July 2001             Brent W. Ambrose, University of Kentucky   20
        CMBS Anatomy (Penalties)
A. Hyperamortization (cash trap):
            •   all cash flows in excess of operating expenses go
                to retire debt.
            •   Triggered by
                i.     Delinquency
                ii.    failure to maintain required DSCR
                iii.   failure to maintain debt rating
                iv.    failure to maintain adequate reserves




July 2001                  Brent W. Ambrose, University of Kentucky   21
        CMBS Anatomy (Penalties)
    B. Prepayment penalty:
            » penalty assessed the borrower for early repayment
              of debt.
            » Penalty may be computed in various ways.




July 2001             Brent W. Ambrose, University of Kentucky    22
        CMBS Anatomy (Penalties)
    C. Balloon default:
            • penalty assessed the borrower for failing to
              refinance at the end of the loan term.




July 2001              Brent W. Ambrose, University of Kentucky   23
        CMBS Anatomy (Penalties)
•     Prepayment Penalties
     1. A (declining) percent of the outstanding balance
        (e.g. 5-4-3-2-1) paid when the loan is prepaid
     2. Yield maintenance: the prepayment penalty is
        computed as the difference between the book value of
        the loan and the PV of the remaining contractual
        payments discounted at some required interest rate.
        The required interest rate is expressed as some spread
        over the rate prevailing on comparable maturity
        Treasuries.
            A.   300bp over Treasuries
            B.   zero spread: Treasuries flat
July 2001            Brent W. Ambrose, University of Kentucky   24
        CMBS Anatomy (Penalties)
•      Prepayment Penalties:
     3. Lockout – complete prohibition of prepayment
         of principal. Usually only in effect during the
         first few years of the mortgage.




July 2001        Brent W. Ambrose, University of Kentucky   25
      Simple Prepayment Example
• Mortgage Assumptions:
     – Two year, $10 million interest only mortgage
            • 10% interest rate on the loan at date of issuance
            • Loan is repaid after 1 year when interest rates fall to
              8%.




July 2001              Brent W. Ambrose, University of Kentucky     26
      Simple Prepayment Example
• Prepayment Penalties
     – Yield Maintenance penalty provision
            • Penalty = ($1,000,000 - $800,000) / (1+0.08)
            •         = $185,185
     – Percent of Prepaid Amount penalty provision
            • Assume 1% penalty in this example
            • Penalty = 1% * $10 million = $100,000



July 2001             Brent W. Ambrose, University of Kentucky   27
  Allocation of Prepayment Penalties

• Allocation is based on the language in the
  CMBS prospectus
     – Ultimately determined by investment bankers
       and lawyers during the creation of CMBS
     – Underwriters have a great deal of latitude
     – No standard approach exists



July 2001       Brent W. Ambrose, University of Kentucky   28
    Yield Maintenance Calculations
•      One bullet loan tranched into two classes:
     –      Assumptions:
            1. Underlying loan is a ten year bullet loan priced at
               par and pays a 9% coupon
            2. Multi-class structure:
               •   Senior class is $90 million and pays an 8% coupon
                   (priced at par).
               •   Subordinate class is a $10 million classs that pay an 18%
                   coupon (priced at par).
            3. Borrower prepays in full at at year 3. Current
               interest rates are 100bps lower than in year 0.
July 2001              Brent W. Ambrose, University of Kentucky           29
                              CMBS Prepayment Example
                  Whole Mortgage Prepayment Calculation -- Bullet Loan

  Principal                     $         100 Year Prepaid                         3
  Loan Type                     Non-amortizing Original Interest Rate             9%
  Term of Loan                              10 New Interest Rate                  8%

  Discount Rate                              8%


             Year                    Original          Discounted          Reinvested   Discounted
                                     Coupon               Cash              Interest       Cash
                                    Payments              Flows            Payments        Flows
                            1   $             -    $              -        $      -     $       -
                            2   $             -    $              -        $      -     $       -
                            3   $             -    $              -        $      -     $       -
                            4   $           9.00   $             8.33      $     8.00   $      7.41
                            5   $           9.00   $             7.72      $     8.00   $      6.86
                            6   $           9.00   $             7.14      $     8.00   $      6.35
                            7   $           9.00   $             6.62      $     8.00   $      5.88
                            8   $           9.00   $             6.13      $     8.00   $      5.44
                            9   $           9.00   $             5.67      $     8.00   $      5.04
                           10   $           9.00   $             5.25      $     8.00   $      4.67
                                                   $            46.86                   $     41.65

  Penalty (Difference in Cash Flows)               $                5.21

July 2001                 Brent W. Ambrose, University of Kentucky                                    30
•      Allocation of Penalty:

1. Percentage Prepayed
    Senior Class (90%)                                 $     4.69
    Junior Class (10%)                                 $     0.52
                                                       $     5.21



July 2001         Brent W. Ambrose, University of Kentucky      31
                                  Using a Make-whole Calculation
                                          Senior Tranche
        Principal                  $           90 Year Prepaid                          3
        Loan Type                  Non-amortizing Original Interest Rate               8%
        Term of Loan                            10 New Interest Rate                   7%

        Discount Rate                             7%


                   Year                   Original          Discounted          Reinvested   Discounted
                                          Coupon               Cash              Interest       Cash
                                         Payments              Flows            Payments        Flows
                                 1   $             -    $              -        $      -     $       -
                                 2   $             -    $              -        $      -     $       -
                                 3   $             -    $              -        $      -     $       -
                                 4   $           7.20   $             6.73      $     6.30   $      5.89
                                 5   $           7.20   $             6.29      $     6.30   $      5.50
                                 6   $           7.20   $             5.88      $     6.30   $      5.14
                                 7   $           7.20   $             5.49      $     6.30   $      4.81
                                 8   $           7.20   $             5.13      $     6.30   $      4.49
                                 9   $           7.20   $             4.80      $     6.30   $      4.20
                                10   $           7.20   $             4.48      $     6.30   $      3.92
                                                        $            38.80                   $     33.95

        Penalty (Difference in Cash Flows)              $                4.85



July 2001                    Brent W. Ambrose, University of Kentucky                                      32
                               Using a Make-whole Calculation
                                       Junior Tranche
     Principal                  $           10 Year Prepaid                          3
     Loan Type                  Non-amortizing Original Interest Rate              18%
     Term of Loan                            10 New Interest Rate                  17%

     Discount Rate                            17%


                Year                   Original          Discounted          Reinvested   Discounted
                                       Coupon               Cash              Interest       Cash
                                      Payments              Flows            Payments        Flows
                              1   $             -    $                 -     $      -     $       -
                              2   $             -    $                 -     $      -     $       -
                              3   $             -    $                 -     $      -     $       -
                              4   $           1.80   $                1.54   $     1.70   $      1.45
                              5   $           1.80   $                1.31   $     1.70   $      1.24
                              6   $           1.80   $                1.12   $     1.70   $      1.06
                              7   $           1.80   $                0.96   $     1.70   $      0.91
                              8   $           1.80   $                0.82   $     1.70   $      0.78
                              9   $           1.80   $                0.70   $     1.70   $      0.66
                             10   $           1.80   $                0.60   $     1.70   $      0.57
                                                     $                7.06                $      6.67

     Penalty (Difference in Cash Flows)              $             0.39
     Total Penalty Payment (Junior + Senior)         $             5.24
     Difference in Penalty Payments                  $            (0.04)
July 2001                   Brent W. Ambrose, University of Kentucky                                    33
            CMBS Anatomy – Risk
                                                                   Prepayment               Credit/De
            Rating       Sub     DSCR       LTV        Price          Risk                  fault Risk




                                                               Premium
            AAA        30%     2.00     52.50%    102




                                                               Discount
            AA        24%      1.84     57.00%    101
            A         18%      1.71     61.50%    100
            BBB       11%      1.57     66.75%    98

            BB         6%      1.49     70.50%    75
            B          3%      1.44     72.75%    65
            NR         0%      1.40     75.00%    35
                                                                                Extension   Credit/De
                                                                                  Risk      fault Risk


                  Source: Anthony Sanders



July 2001                      Brent W. Ambrose, University of Kentucky                                  34
               CMBS Anatomy
• CMBS Risk impacted by:
     – property quality
     – geographic location
     – tenant creditworthiness




July 2001        Brent W. Ambrose, University of Kentucky   35
                       CMBS Risks
• Default risk:
     – Income property loans are typically
       nonrecourse.
            • Borrower has the financial incentive to default when
              the market value of the property falls below the
              outstanding balance of the loan (negative equity).
            • Also referred to as “optimal”, “strategic”, or
              “financial” default.


July 2001             Brent W. Ambrose, University of Kentucky   36
                       CMBS Risks
• Balloon risk:
     – income property mortgages typically have
       terms that are less than the loan amortization
       period, thus the borrower must refinance to
       continue making mortgage payments.
     – Circumstances in the property and capital
       markets may have changed in ways that make
       refinancing difficult or even impossible.
            • Also referred to as “refinancing risk”

July 2001              Brent W. Ambrose, University of Kentucky   37
                      CMBS Risks
• Prepayment risk:
     – Many income property mortgages provide some
       call protection.
            • lock-out provisions
            • prepayment penalties
            • Treasury defeasance
     – Some income property mortgages do not have
       any of these features.

July 2001             Brent W. Ambrose, University of Kentucky   38
              CMBS Call Protection
• Lock-out provisions:
     – prohibit loan prepayment over given period
• Prepayment penalties:
     – paid in a lump sum at the time of prepayment;
     – Cash flows are proportionally allocated to
       remaining certificate classes.
            • See previous examples of a (declining) percent of
              the outstanding loan balance or yield maintenance
              agreements

July 2001             Brent W. Ambrose, University of Kentucky    39
            CMBS Call Protection
• Treasury defeasance:
     – the borrower must purchase a series of
       Treasuries that provide the same future cash
       flows assuming the loan not prepaid.
• Property release provision:
     – prohibits asset substitution;
     – prevents the issuer/lender from removing the
       stronger properties from the pool.
July 2001        Brent W. Ambrose, University of Kentucky   40
             Property Diversification
• Diversification across:
     – Loan size:
            • usually no single loan exceeds 5% of the aggregate issue
              amount.
            • An exception to this is a fusion deal, where a single large loan
              is packaged with several smaller loans.
     – Property type
     – Property location
            • State
            • metropolitan area

July 2001                Brent W. Ambrose, University of Kentucky            41
                             Loan Diversification
            Table 2. The twenty largest loans underlying the GMAC 1999-C3 deal.

                 Name                    Location, MSA                      Category    Loan Amount
            1    Biltmore Fashion        Phoenix, Arizona                   Retail       $80,000,000
            2    Prime Outlets           Niagara Falls, New York            Retail       $62,835,426
            3    Equity Inns             Various                            Hotel        $46,511,317
            4    One Colorado            Pasadena, California               Retail       $42,628,093
            5    Comerica Bank           San Jose, California               Office       $33,640,510
            6    120 Monument            Indianapolis, Indiana              Office       $28,955,362
            7    125 Maiden              New York, New York                 Office       $28,500,000
            8    Texas Development       Houston, Texas                     Apartment    $26,926,701
            9    Sherman Plaza           Van Nuys, California               Office       $25,984,904
            10   Alliance TP             Various                            Apartment    $24,888,157
            11   Bush Tower              New York, New York                 Office       $23,000,000
            12   County Line             Jackson, Mississippi               Retail       $20,990,264
            13   Sherwood Lakes          Schererville, Indiana              Apartment    $20,162,442
            14   Laurel Portfolio        Various                            Apartment    $17,950,331
            15   Sweet Paper             Various                            Warehouse    $17,420,000
            16   Sheraton Portsmouth     Portsmouth, New Hampshire          Hotel        $15,949,087
            17   Trinity Commons         Fort Worth, Texas                  Retail       $15,242,981
            18   Village Square          Indianapolis, Indiana              Apartment    $14,993,950
            19   Golden Books            Fayetteville, North Carolina       Warehouse    $14,493,350
            20   Air Touch               Dublin, Ohio                       Office       $13,992,523

            Source: Charter Research.




July 2001                          Brent W. Ambrose, University of Kentucky                            42
                Geographic Diversification
Table 4. Aggregate loan amounts by state for GMAC 1999-C3 deal.

                State               Loan Amount        No. of Loans       % of Pool
                California           $257,522,410                33         22.35%
                Texas                $162,355,125                26         14.09%
                New York             $130,070,471                 7         11.29%
                Arizona               $99,942,794                 5          8.68%
                Indiana               $68,623,516                 5          5.96%
                Ohio                  $44,982,528                 5          3.90%
                Mississippi           $23,067,864                 2          2.00%
                New Jersey            $22,983,973                 5          2.00%
                Other                $342,473,371                50         29.73%




                Total              $1,152,022,052                138       100.00%




Source: Charter Research.
    July 2001                  Brent W. Ambrose, University of Kentucky               43
        Property Type Diversification
Table 5. Aggregate loan amounts by property type for GMAC 1999-C3 deal.

                     Property Type          Loan Amount       No. of Loans    % of Pool

                     Apartment               $259,779,802                39     22.55%
                     Office                  $322,053,844                36     27.96%
                     Retail                  $350,683,062                34     30.44%
                     Warehouse                $99,126,075                15      8.60%
                     Hotel                   $105,832,139                 8      9.19%
                     Other                    $14,547,130                 6      1.26%




                     Total                 $1,152,022,052               138    100.00%




Source: Charter Research.

   July 2001                 Brent W. Ambrose, University of Kentucky                     44
            Credit Enhancements
• Subordination
• Cross collateralization:
     – properties that collateralize individual loans are
       pledged against all loans in the pool
• Cross default:
     – allows the lender to call ALL LOANS in the
       event a single loan is in default.

July 2001         Brent W. Ambrose, University of Kentucky   45
                  Credit Enhancements
• Lock box:
     – Gives the trustee control of the property gross revenues.
       The trustee assigns priority in the following order:
            •   (1) taxes and insurance;
            •   (2) operating expenses;
            •   (3) debt service;
            •   (4) management fees;
            •   (5) reserves for replacements;
            •   (6) equity investor




July 2001                  Brent W. Ambrose, University of Kentucky   46
               Credit Enhancements
• Overcollateralization:
     – When the book value of the loans exceed the
       par value of the bonds issued.
     – Most common in residential MBS
            • Especially common in CMO structure




July 2001            Brent W. Ambrose, University of Kentucky   47
                        Reserve Funds
• Established at loan closing to:
     – Provide liquidity:
            • to pay interest for investment grade bonds
     – Service the asset:
            • to pay
               –   property taxes
               –   property insurance
               –   legal fees
               –   Maintenance

July 2001                Brent W. Ambrose, University of Kentucky   48
                  Standardized CMBS
                     Underwriting
• Key Underwriting Characteristics
     –      Debt Service Coverage Ratio (DSCR)
     –      Loan to Value Ratio (LTV)
     –      Average loan size
     –      Max loan not to exceed certain percentage (e.g. 5%)
     –      Diversification across
             • Property types
             • Geographic locations
     – Prepayment terms
     – Loan maturities

July 2001                Brent W. Ambrose, University of Kentucky   49
            Role of rating agencies
• Establish different rating criteria for various
  property types.
• Negotiate subordination levels with issuers.
• Track property performance/delinquencies
• Servicer and trustee report ongoing loan level
  performance
     – Monthly/quarterly DSCRs
     – occupancy levels
     – updated bond information

July 2001         Brent W. Ambrose, University of Kentucky   50
              Role of Servicers
• Master Servicer:
     – Oversees the deal and servicing agreements
     – Facilitates timely payment of principal and
       interest
     – May provide (servicer) advances for
       delinquent/defaulted loans
• Sub-Servicer:
     – loan originator in a conduit deal who retains
       servicing
July 2001        Brent W. Ambrose, University of Kentucky   51
                   Role of Servicers
• Special Servicer:
     – Becomes engaged when loan more than 60 days
       delinquent.
     – Has the authority to
            • Extend the loan
            • Modify/restructure the loan (based on an appraisal)
            • Foreclose



July 2001             Brent W. Ambrose, University of Kentucky      52
                          Pricing CMBS
• Unlike residential MBS, the underlying mortgages have little
  prepayment risk.
• However, default risk is now relevant due to these risks:
   – Lease termination risk
   – Lease rollover risk
• Imperative to monitor developments in the overall real estate
  market.
     – For example, low vacancy rates may lead to additional
       construction.
            • This additional supply can result in reduced real lease rates in future
              years.
            • Has implications on the ability of the property to service the debt in
              future years.


July 2001                  Brent W. Ambrose, University of Kentucky                     53
                   Pricing CMBS
• Rating agencies play a critical role in the CMBS
  pricing process.
     – S&P, Moodys, and Duff & Phelps maintain internal models of
       collateral risk in order to rate default risk associated with
       CMBS deals.
• In addition to having to price deals in accordance with
  rating agency opinions, it is wise to understand the
  underlying real estate markets in order to anticipate
  payments delays or defaults.
     – Example. Lease rates and vacancy rates may look great at
       the moment, but will these indicators prompt
       developers/banks into another frenzy of construction?

July 2001           Brent W. Ambrose, University of Kentucky      54
                 Pricing CMBS
• Remember – CMBS product is part
  of the fixed-income universe.
     – Capital markets are linked such that
       shocks in one market impact others.
            • For example – Russian debt crises in
              1998
              – See following charts.
July 2001           Brent W. Ambrose, University of Kentucky   55
July 2001   Brent W. Ambrose, University of Kentucky   56
                                                   NCREIF Total Returns


          0.04


          0.03


          0.02


          0.01


             0
 Return




                  1990   1991   1992     1993    1994     1995          1996   1997   1998   1999   2000   2001

          -0.01


          -0.02


          -0.03


          -0.04


          -0.05
                                                                 Date




July 2001                              Brent W. Ambrose, University of Kentucky                             57
July 2001   Brent W. Ambrose, University of Kentucky   58
July 2001   Brent W. Ambrose, University of Kentucky   59
July 2001   Brent W. Ambrose, University of Kentucky   60
                                                     Bond Market Yields


    12



    10



    8


                                                                                                                       AAA
%




    6                                                                                                                  BBB
                                                                                                                       Treas


    4



    2



    0
    Jan-90   Jan-91   Jan-92   Jan-93   Jan-94   Jan-95     Jan-96   Jan-97   Jan-98   Jan-99   Jan-00   Jan-01
                                                          Date



         July 2001                      Brent W. Ambrose, University of Kentucky                                  61
                                              Bond Spreads
                                                         Bond Credit Spreads


          3



         2.5



          2
Spread




                                                                                                                             AAA
         1.5
                                                                                                                             BBB


          1



         0.5



          0
          Jan-90   Jan-91   Jan-92   Jan-93   Jan-94   Jan-95     Jan-96   Jan-97   Jan-98   Jan-99   Jan-00   Jan-01
                                                                Date

July 2001                                Brent W. Ambrose, University of Kentucky                                       62
                          Income Property Debt:
                         Default and Loss Severity                                           *




• What do we know about income property
  default and loss severity?
      –     1.     Fitch ICBA, Inc. (1998)
      –     2.     Corcoran and Kao (1998)
      –     3.     Vandell, Barnes, Hartzell, Kraft, and Wendt (1993)
      –     4.     Snyderman (1994)


*-these notes are based on lecture material provided by Thomas Thibodeau at Southern Methodist University.


July 2001                         Brent W. Ambrose, University of Kentucky                                   63
                   Income Property Debt:
                  Default and Loss Severity
                       Fitch IBCA, Inc. (1998)
Study examines Fitch rated transactions between 1991 and 1996


 18,839 loans (in 33 CMBS transactions)

 total principal $16.1 billion

 84% thrift loans (mostly RTC)

 16% conduit loans


July 2001               Brent W. Ambrose, University of Kentucky   64
                    Income Property Debt:
                   Default and Loss Severity
                        Fitch IBCA, Inc. (1998)
Examines relationship between default/loss severity and:

   Debt service coverage ratio (DSCR)
   Property type
   State
   Loan Size
   Fixed/floating rate loan
   Loan type (e.g. amortizing, balloon)
   Servicer flexibility
   Foreclosure type


July 2001               Brent W. Ambrose, University of Kentucky   65
                 Income Property Debt:
                Default and Loss Severity
                     Fitch IBCA, Inc. (1998)

 Default:   > 60 days past due on debt service
                             or
             > 90 days past due on balloon payment


 3,134 lifetime defaulted loans (16.64%)

 3,002 RTC loans (96% of defaults)

 annual default rate 4.3%

July 2001             Brent W. Ambrose, University of Kentucky   66
                  Income Property Debt:
                 Default and Loss Severity
                       Fitch IBCA, Inc. (1998)
 Loss =     loan balance at securitization
             + interest advanced
             + property protection expenses
             - loan amortization
             - property income
             - net sales proceeds

Losses reported as a percent of loan balance at securitization for loans
COMPLETELY resolved (e.g. properties sold).



July 2001              Brent W. Ambrose, University of Kentucky            67
                     Income Property Debt:
                    Default and Loss Severity
                       Fitch IBCA, Inc. (1998)
Source of losses:

    Decrease in property value                                    35.8%
    + advanced interest                                           10.5%
    + advanced property protection expenses                        7.7%
    - amortization
    - property income (combined)                                  14.9%

    Average Loss Rate:                                            39.1%



July 2001              Brent W. Ambrose, University of Kentucky           68
             Income Property Debt:
            Default and Loss Severity
               Fitch IBCA, Inc. (1998)
DSCR                                 Default Rate         Loss

0.01-0.49                                 8.0%            47%
0.50-0.79                                 7.0%            52%
0.80-0.89                                 6.6%            42%
0.90-0.99                                 6.5%            41%
1.00-1.14                                 4.4%            29%
1.15-1.24                                 2.6%            48%
1.25-1.34                                 2.4%            27%
1.35-1.49                                 2.8%            36%
1.50-1.74                                 3.1%            41%
  1.75+                                   2.9%            22%
July 2001      Brent W. Ambrose, University of Kentucky          69
                 Income Property Debt:
                Default and Loss Severity
                   Fitch IBCA, Inc. (1998)
Property Type                            Default Rate         Loss

Lodging                                       4.2%            27%
Multifamily                                   3.9%            46%
Nursing                                       4.0%            11%
Office                                        4.8%            38%
Industrial                                    4.7%            27%
Other                                         4.2%            46%
Retirement                                    4.7%            34%
Warehouse                                     2.5%            29%


July 2001          Brent W. Ambrose, University of Kentucky          70
              Income Property Debt:
             Default and Loss Severity
                 Fitch IBCA, Inc. (1998)
State                                  Default Rate         Loss

Highest 5:   New York                       6.8%            32%
             Louisianna                     5.8%            69%
             New Mexico                     5.5%            25%
             Arizona                        5.2%            22%
             Massachusetts                  5.2%            40%

Lowest 5:    Iowa                           3.5%            65%
             Florida                        3.1%            44%
             Texas                          3.1%            45%
             Washington                     2.4%            25%
             Oregon                         1.9%            34%

July 2001        Brent W. Ambrose, University of Kentucky          71
                 Income Property Debt:
                Default and Loss Severity
                   Fitch IBCA, Inc. (1998)
Loan Size                                Default Rate         Loss

$0.0M - $0.5M                                 4.0%            38%

$0.5M - $1.0M                                 5.5%            42%

$1.0M - $5.0M                                 4.9%            39%

$5.0M - $10M                                  3.9%            37%

  > $10M                                      2.0%            34%

July 2001          Brent W. Ambrose, University of Kentucky          72
                     Income Property Debt:
                    Default and Loss Severity
                            Fitch IBCA, Inc. (1998)
Other Results                                     Default Rate         Loss

Interest Rate:

            Floating rate                              5.4%            42%
            Fixed rate                                 3.5%            35%

Loan Type:

            Amortizing                                 2.6%
            Balloon                                    6.0%

Judicial foreclosures take longer and cost (between 8% and 26%)
more than nonjudicial (e.g. power of sale states) foreclosures.

July 2001                   Brent W. Ambrose, University of Kentucky          73
                   Income Property Debt:
                  Default and Loss Severity
                          Vandell et. al. (1993)
   Use a proportional hazards model to examine the joint effect of loan,
    borrower, property and market characteristics on the length of time to
    default.

   The hazard function is the conditional probability of default in the next
    period given the loan is currently a performing loan.

   Data: 2,899 completed loans originated during 1962-1989:3 period
          175 defaults (6%)

   Use the Frank Russell Company Index to market property values to
    market over time.

July 2001               Brent W. Ambrose, University of Kentucky                74
                 Income Property Debt:
                Default and Loss Severity

                      Vandell et. al. (1993)
Estimation results:
 Higher L/V            higher default rate
 Higher interest rate  higher default rate
 DSCR is not a contributing influence
 All property types have higher default rates RELATIVE TO RETAIL
      Greatest risk: hotel, office, apartment
      Least risk:     retail, industrial
 Partnerships exhibit greater default risk compared to alternatives




July 2001             Brent W. Ambrose, University of Kentucky          75
                 Income Property Debt:
                Default and Loss Severity
                         Snyderman (1994)
Snyderman examines:

    (1) incidence of lifetime default for 10,955 Insurance Co. loans:
        a. originated between 1972 and 1989
        b. tracked over 1972-1991 period
        c. 1,512 lifetime defaults (13.8%)

    (2) severity of losses:
        a. defaults that end in foreclosure (46% of defaults)
        b. defaults resolved some other way (e.g. workout)

    (3) estimates “yield cost” of default between 31 and 52 basis points
July 2001             Brent W. Ambrose, University of Kentucky             76
                  Income Property Debt:
                 Default and Loss Severity

                              Snyderman (1994)
Average Loss Severity:

 for foreclosed loans:                               36%

 for other loans:             (assumed to be) 18%


Foregone interest a major component of loss severity (average time between
default and disposition was 3.5 years).


July 2001                 Brent W. Ambrose, University of Kentucky     77
                  Income Property Debt:
                 Default and Loss Severity
                     Corcoran and Kao (1998)

 Examine deliquency experience for Life Insurance Company loans

 Regress deliquency rate on:

     Regional price index (NCREIF Regional Index for 8 Regions)

     Sector (e.g. property type) price (NCREIF Sector Price Index)

 Conclusions: Delinquencies INCREASE with DECREASING

     regional prices (more important)

     national sector prices
July 2001             Brent W. Ambrose, University of Kentucky        78
                Income Property Debt:
               Default and Loss Severity
                   Corcoran and Kao (1998)
                     Risk-Neutral Credit Spread


                      Promised cash flow
               Discount rate with credit risk spread

                                    

            Promised cash flow  Credit loss adjustment
                      Treasury discount rate
July 2001           Brent W. Ambrose, University of Kentucky   79
                      Corcoran and Kao (1998)
                Example: Risk-Neutral Credit Spread
   Commercial Mortgage @ 8.5% Coupon, 10-Year Term, 20 Year Amort

Year               Ending Balance                   Credit Loss @ 27bp
  1                  $980.0977                                2.6463
  2                   958.4362                                2.5828
  3                   943.8600                                2.5241
  4                   909.2000                                2.4548
  5                   881.2719                                2.3794
  6                   850.8751                                2.2974
  7                   817.7915                                2.2080
  8                   781.7836                                2.1108
  9                   742.5930                                2.0050
 10                   699.9383                                1.8898
“Fair or intrinsic” value of credit loss is $16.19 = PV @ Treasury rate of 7.5%


  July 2001             Brent W. Ambrose, University of Kentucky           80
            Default and Loss Severity
• To summarize, the studies show that:
     – Commercial mortgage default estimates are
       highly dependent upon the data source.
     – Most CMBS deals were originated during
       period of unprecedented economic growth and
       expansion.
            • Loans have not been tested through full economic
              cycle.

July 2001             Brent W. Ambrose, University of Kentucky   81
              Rating CMBSs
•   Property Cash Flow Adjustments
•   Capitalization Rate Adjustments
•   Pool analysis
•   Ideal Pool for Small Income Property Loans




July 2001      Brent W. Ambrose, University of Kentucky   82
                           Rating CMBSs
                   Property Cash Flow Adjustments
Rental income          =    min {contract rent, market rent}

Non-rental income      =    frequently ignored

Vacancy loss           =    max {actual, market, 10%}

Operating expenses     =    max {historical, industry standards, appraisal}

Management fees        =    max {historical, appraisal, 5% for MF}
                       =    max {historical, appraisal, 4% for commercial}

Capital reserves       =    $250 - $450 per unit for MF
                       =    $0.15 - $0.30 per square foot for office
                       =    $0.15 - $0.25 psf for retail
                       =    4-5% of Gross Revenues for hotel
July 2001              Brent W. Ambrose, University of Kentucky               83
                         Rating CMBSs

               Property Cash Flow Adjustments
Sources of Information for Industry Standard Operating Expenses

(1) Building Owners and Managers Association (BOMA)

(2) Institute of Real Estate Management (IREM)

(3) Urban Land Institute (ULI)
    a. Dollars and cents of shopping centers
    b. Dollars and cents of retail
    c. Etc.


July 2001             Brent W. Ambrose, University of Kentucky    84
                         Rating CMBSs

                Property Cash Flow Adjustments
 Expected property cash flows also adjusted for:

    (1) Average lease term (by property type)

    (2) Tenant retention (50-60%)
        a. new tenant improvements
        b. renewal tenant improvements

    (3) Leasing commissions
        a. new leasing commissions (4-6%)
        b. renewal leasing commissions (varies by property type)

July 2001             Brent W. Ambrose, University of Kentucky     85
                         Rating CMBSs

               Property Cash Flow Adjustments
 Financing cash flows adjustments:

    (1) below market interest rates increased

    (2) loan term adjusted for remaining economic life of the property




July 2001             Brent W. Ambrose, University of Kentucky           86
                          Rating CMBSs

            Property Capitalization Rate Adjustments

 Cap rates can be adjusted down 50-75bp for net cash flow after adjusting
  cash flows for capital items, tenant improvements and leasing
  commissions.

 Cap rates adjusted up50-150bp for non-cured environmental impairments
  and for lower quality properties.

 Cap rates adjusted up to reflect market conditions.



July 2001              Brent W. Ambrose, University of Kentucky         87
                            Rating CMBSs

                                Pool Analysis
 Probability of loss: the probability that any loan will default, be
  foreclosed on, and be liquidated.

 Probability of loss = f(LTV, DSCR, property type, loan structure,
                       fixed/floating rate, loan quality, seasoning,
                       management, ownership structure, barriers to
                       entry (loan to replacement cost, CF volatility,
                       recourse)

 Loan loss = f (cost to obtain the asset, time to sell, cost to sell)


July 2001               Brent W. Ambrose, University of Kentucky         88
                           Rating CMBSs

       Ideal Pool for Small Income Property Loans

     At least 500 loans

     No one loan > 1% of loan balance

     Geographically diversified

     Taxes, insurance, and capital reserves escrowed

     Full recourse


July 2001             Brent W. Ambrose, University of Kentucky   89
                          CMBS in Singapore

• MAS declared that real estate securitization is a strategic goal.
• Current debt securitization programs:
     – Mortgage-Backed bonds
            • Similar to single mortgage securitization.
            • Typical deal will have additional credit enhancements from mortgage
              borrower.
            • Does not have credit rating or credit enhancements from 3rd parties.
     – Asset-Backed Securitization
            • One step further than mortgage-backed bonds in that property securing the
              debt is transferred to a “special-purchase vehicle”.




July 2001                  Brent W. Ambrose, University of Kentucky                       90

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:1
posted:5/18/2012
language:English
pages:90
fanzhongqing fanzhongqing http://
About