Business, Legal & Accounting Glossary
A type of mortgage-backed security backed by commercial mortgages rather than residential mortgages. They are comprised of a variety of loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. In general, they carry less prepayment risk than loans backed by residential mortgages.
Commercial mortgage-backed securities (CMBS) are fixed-income investment products that are backed by mortgages on commercial properties rather than residential real estate. CMBS can provide liquidity to real estate investors and commercial lenders alike.
Because there are no rules for standardizing the structures of CMBS, their valuations can be difficult. The underlying securities of CMBS may include a number of commercial mortgages of varying terms, values, and property types—such as multi-family dwellings and commercial real estate. CMBS can offer less of a pre-payment risk than residential mortgage-backed securities (RMBS), as the term on commercial mortgages is generally fixed.
CMBS are bonds, like CDOs and CMOs. In the event of a default, the mortgage loans that comprise a single commercial mortgage-backed security serve as collateral, with principal and interest passed on to investors.
The loans are typically housed within a trust and vary greatly in terms, property types, and amounts. Loans for properties such as apartment buildings and complexes, factories, hotels, office buildings, office parks, and shopping malls are among the underlying loans securitized into CMBS, which are often held in the same trust.
A mortgage loan is typically classified as a non-recourse debt, which is any consumer or commercial debt that is secured solely by collateral. In the event of a default, the lender may not seize any of the borrower’s assets other than the collateral.
Because CMBS are complex investment vehicles, they necessitate the participation of a diverse group of market participants, including investors, a primary servicer, a master servicer, a special servicer, a directing certificate holder, trustees, and rating agencies. Each of these players plays a specific role in ensuring that CMBS functions properly.
The mortgages that back CMBS are classified into tranches based on their credit risk levels, which are typically ranked from senior (or highest quality) to lower quality. The highest-quality tranches will receive both interest and principal payments while carrying the least risk. Lower-ranking tranches offer higher interest rates, but the tranches that take on more risk absorb the majority of the potential loss that can occur as the tranches fall in rank.
The lowest tranche in a CMBS structure will contain the portfolio’s riskiest—and possibly speculative—loans. The securitization process involved in the design of a CMBS structure is critical for both banks and investors. It enables banks to make more loans overall, and it provides investors with easy access to commercial real estate while providing a higher yield than traditional government bonds.
However, investors should be aware that if one or more loans in a CMBS default, the highest tranches must be fully paid off, with interest, before the lower tranches receive any funds.
Because there are few options for the average investor, only very wealthy investors typically invest in CMBS. Although many real estate mutual funds invest a portion of their portfolios in CMBS, it is difficult to find mutual funds or exchange-traded funds (ETFs) that invest solely in this asset class.
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) issued new regulations in December 2016 to mitigate some of the risks associated with CMBS by establishing margin requirements for covered agency transactions, including collateralized mortgage obligations.
CMBS
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This glossary post was last updated: 26th January, 2022 | 0 Views.