Commercial Mortgage Backed Securities (CMBS)
What is CMBS?
A CMBS, or commercial mortgage backed security, is a security based on an underlying pool of commercial real estate loans that have been securitized in order to be sold to investors.
CMBS Securitization Process
Traditionally, commercial mortgages were made by commercial banks or other financial institutions who held on to their commercial mortgages. However, commercial mortgages can be originated for the purpose of being pooled with other commercial mortgages and synthesized into a marketable security. The underlying commercial mortgage is referred to as a conduit loan or CMBS loan. The security is then sold on the CMBS Market. The CMBS market is a secondary market where commercial mortgage backed securities are sold to and traded among CMBS investors. This process is known as securitization.
Conduit Lender
The originator of the CMBS loan does not hold on to the commercial real estate mortgage, but acts as a "conduit" of commercial real estate mortgages between commercial property mortgage borrowers and investors in the CMBS market. The commercial banks, investment banks, or investment syndicates that lend the money are referred to as a conduit lenders. The conduit loan is administered by companies specialized in commercial mortgage servicing.
CMBS Market
The result is commercial mortgage backed securities provide additional liquidity to commercial real estate markets by funding the acquisition of commercial properties. With the ability to go to capital markets through the CMBS securitization process, commercial mortgage backed securities allow commercial mortgage borrowers to reach a larger pool of capital and investors to finance the acquisition and ownership of commercial real estate.
Commercial Mortgage Backed Securities
A Conduit For Commercial Real Estate Investing
The importance of commercial mortgage backed securities is that they provide greater access to capital markets and liquidity for the financing of commercial properties. CMBS finance means investment in commercial real estate debt is made available to investors on secondary markets without having to directly purchase and hold a portfolio of commercial mortgages.
The ability of CMBS finance to reach a large number of investors has proved to be an important feature of the CMBS market. This feature of commercial mortgage backed securities was critical in providing liquidity to the commercial investment property sector after the savings and loan crisis of the 1980's.
In addition to solving the problems of the S&L Crisis, CMBS financing can allow debt financing for large scale projects that would exceed the resources or risk preferences of any single lender. Through commercial mortgage backed securities, multiple CMBS lenders can contribute to large debt financing while reducing their exposure.
CMBS Structure
Mortgage backed securities are divided into different tranches. Each tranche bares a different level of risk, and has a different claim on the cash flows generated by the underlying mortgages. The cash flows involve interest payments and principal reductions on the loans. The risks include default risk or prepayment risk.
Since the CMBS loan has been securitized and sold as a Commercial Mortgage Backed Security to other investors, CMBS loans can have different features than the commercial property mortgage held by a commercial bank. The primary reason is investors have purchased a security based on a specified return and time horizon. These investors are also far removed from the market, transaction, and parties involved in originating the CMBS Loan.
Loan Defeasance, CMBS Default or Early CMBS Loan Payoff
Situations where the particularities of conduit loans or CMBS loans arise occur when a property owner would like to sell a commercial property before the commercial mortgage reaches maturity, or when a commercial property investor is in risk of defaulting on their commercial mortgage. The problem is investors in CMBS securities expect to get what they paid for when they made their investment. CMBS investors are distant from the originating transaction and have no direct relation to the parties involved.
When a borrower on a commercial property loan wants to pay off a CMBS loan or is in risk of default, defeasance is the process that allows the borrower to release themselves from their obligations under the conduit loan. The objective of defeasance is to ensure CMBS investor's returns while releasing the borrower from their debt and relinquishing the lien on the commercial property. Collateral is substituted for the property that provides yield to replace the mortgage payments due under the CMBS loan.