CMBS White Paper

7/30/2019 CMBS White Paper

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P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate

ntroduction

Commercial mortgage-backed

securities (CMBS) investors

have learned, i nothing else

han out o necessity, how to split the

heck. During the real estate boom,

nvestors modeled senior CMBS bonds

with minimal prepayment risk and were

willing to discount the probability o

osses to junior CMBS bonds. In todays

istressed environment, CMBS investorsace increased deault and prepayment

sk as a result o special servicers selling

onperorming loans and real estate

wned (REO) properties. It is imperative

or CMBS investors, or those who wish

o gain knowledge o the subject,

o understand how to evaluate both

ommercial mortgage credit and CMBS

ashows (or wateralls) to translate these

ague ears and worries into actionable

normation.

This white paper uses special servicer

ata and ratings agency methodologies

o analyze CMBS loans. By applying

his analysis, investors are empowered

o make their own determinations on

pricing and risk or CMBS, essential tools

or portolio management and CMBS

rading decisions (secondary CMBS).

CMBS is created by splitting the cash owrom commercial mortgages into dierent

bonds, known as tranches. Commercial

real estate investors with an opportunistic

strategy may appreciate how their skills can

be used to identiy pricing discrepancies

that then impact structured real estate

fnance. Structured fnance investors can

use this article to appreciate the impact that

unique attributes o individual real estate

assets have on CMBS investments.

Problematic deals that special servicers

are now tasked with resolving are numerous.

In act, about 8% o all outstanding CMBS

deals are delinquent as o September 2011,

according to Morningstar.

This article uses actual loans and CMBS

SPRING 2012 RESEARCH PUBLICATIO

Predicting CMBSPrepayments and Deaults

The Impact o Distressed Real Estate Loans on CMBS Perormanceresearch report prepared for the Steven L. Newman Real Estate Institute by Benjamin Polen, Senior Research Associate at the Institute.

I had been gettingsomething or nothing.That only delayed the

presentation o the bill.The bill always came.

~ Ernest Hemingway

The Sun Also Rises

issuances, as well as a high pbuilding, to illustrate risk to C

investors. Special servicer estimates

market inormation are applied to as

potential impacts on CMBS tranc

Ratings agency methodologies

applied to analyze current net opera

income (NOI) and estimate refnan

proceeds. Investors can apply these s

techniques to managing CMBS port

or when underwriting prospective Cinvestments.

Risk

In a bullish real estate market, m

investors expect both mortgages

structured CMBS to perorm as orig

modeled. When cash ows rom

estate can no longer support the

service due to a weak real estate ma

this generates risk or CMBS len

CMBS tranches allow investors a choirisk. Senior bonds oer lower yields

are created with credit support, which

generally succeeded in insulating t

rom deaults. The CMBS issuance

as an example in this article, WB

2006-C23, was created with 30% c

support. Junior bonds have less c

support but oer the opportunity

higher returns. Junior bonds will be

frst to absorb any losses rom deauPrepayment risk represents an

return o principal, eliminating u

interest cashows that would other

be made to bondholders. This risk

thought to be generally mitigated

lockout periods, deeasance and pe

ees. Rarely was serious considera

given to substantial prepaym

resulting rom distressed sales. Inve

Three Columbus Circle

Photograph credit: Benjamin Polen

Figure 1:


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PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201

n todays CMBS market need to pay careul

ttention to deault and prepayment risks

nd their impact inuence on total returns.1

Deault risk stems rom loan losses,

ltimately correlated with a borrowers

bility to refnance a loan, the causes

which are property specifc. Recent

property income inormation can be used

o re-underwrite a loan rom a lenders

perspective and determine refnancing

proceeds. I expected refnancing proceeds

re less than the loan exposure, CMBS

nvestors ace deault risk.

In CMBS, nonperorming mortgages

re sent into special servicing, where a

pecial servicer (predesignated at CMBS

ssuance) decides whether to engage in

workout, sell a nonperorming note or

oreclose (leading to REO). Each o these

ecisions will have a dierent eect on

CMBS investors. Understanding special

ervicer decisions and the resulting impact

n CMBS is key or investor underwriting.

or example, a note sale results in an

nexpected cash inow, but the servicer

s obliged to distribute cash according to

he structured ormula. This was the case at

Three Columbus Circle, as detailed in theext section o this paper, when the loan

ale resulted in a prepayment. Another

ption or a special servicer is a workout or

modifcation. One modifcation technique

hat has been used requently is a loan

xtension on the same terms, such as a one,

wo or three years. While a loan extension

an help keep a borrower current, it does

o at the continued risk to CMBS investors.

Principal payments, including

prepayments resulting rom an REO or

oan sale, ow frst to a senior bond. Cash

proceeds resulting rom a loan or property

ale are distributed to the CMBS tranches

hat are frst in line to receive principal

payments. In the event o a signifcant

principal prepayment, this can have a

Figure 2:

WBCMT-C23 Senior Bond Prices via Bloomberg Data History (BDH)

material eect on the bond price and yield. For investors who bought into three to

year bonds with a perception o an AAA sae and steady yield, receiving a large prin

prepayment could shorten the average lie down to one to three years. This reduces

yield and total return.

How a NYC Ofce Loan Impacts CMBS

In New York, the $250 million securitized loan on Three Columbus Circle (aka

Broadway, the ormer Newsweekbuilding) and its sponsor, Joe Moinian, is amiliar to m

real estate proessionals. The Three Columbus Circle loan was securitized into WBCMT 2

C23. The building, shown in Figure 1, underwent an extensive renovation and repositio

process, which resulted in a low occupancy o 68% as tenants let during the disrupt

The mortgage was sold to the Related Companies by special servicer CW Capital, resu

in a large $250 million prepayment to senior CMBS investors. (SL Green later partn

with Moinian in a recapitalization and paid o the Related-owned mortgage.) While j

CMBS investors were protected rom a loss, senior bondholders saw the market pri

their bonds drop as a result o the reduction in interest cashows. This eect is illustrat

Figure 2. The repayment and the impact on senior bondholders could have been pred

through an understanding o structured fnance and the CMBS issuance.The CMBS loan on Three Columbus Circle, originated in 2006, was structured w

our-year, interest-only period and a scheduled amortization period starting in Feb

2010. This amortization increased debt service by 20%, rom $14.4 million to $17.4 mi

According to press reports, when Moinian was unable to refnance the building, he ho

to negotiate an extension o the interest-only period. In order to do so under C

structure, it was necessary to deliberately skip loan payments in order to transer the

into special servicing. Unlike bank lending, a CMBS borrower cannot rely on a transact

These risks are formally known as constant default rate

CDR) and conditional prepayment rate (CPR).


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elationship or goodwill in a workout. In this instance, the missed payments triggered a

material deault o the loan.

A loan modifcation is generally employed when there are ew other palatable alternatives,

ncluding a lack o interested buyers and the inability to refnance. Given market reports

bout the borrowers various ailed attempts to refnance the loan, he may have viewed this

s a sign o the markets lack o appetite or the collateral. A calculated risk o withholding

oan payments to orce a modifcation may have been rational, but perhaps it was the

borrowers only choice. From the special servicers perspective, tasked with maximizing

proceeds to the trust, selling this loan quickly was an easy choice to make. To date, 2006

intage CMBS deals have had the second highest losses (Figure 3).

The ability to identiy likely loan resolution outcomes is the frst step to estimating the

mpact on CMBS. For example, an analysis o the distressed loan on Three Columbus Circle

ould reasonably determine sufcient demand or the frst mortgage loan, based on the

propertys location, size and loan to value (LTV) ratio. With a loan balance o $250 million,his represented a collateralization o $404 loan/square oot. Even with additional required

edevelopment costs, this opportunity is a compelling deal, given the propertys rontage

n 57th Street and its proximity to Columbus Circle. It is thereore a reasonable possibility

hat the special servicer could sell the loan at or near its par value o $250 million.

The next step is in understanding the impact o a $250 million prepayment would have

n the CMBS trust. In The Handbook o Mortgage Backed Securities, Jacob, Manzi,

nd Fabozzi wrote, For large loan pools, CMBS investors should identiy the loans that

nuence a given bond the most and then develop plausible prepayment scenarios to reveal

the bonds perormance activity.2 At T

Columbus Circle, plausible prepaym

scenarios would certainly include

payment o the ull $250 million amoun

What i the special servicer had exten

the loan? CMBS bondholders will

dierent viewpoints depending on

tranche owned. Distressed real e

loans held inside a CMBS conduit ma

resolved in several ways by the sp

servicer, including an outright sale o

loan or oreclosure and sale o the

estate asset.

Besides a sale o the loan (or orecl

property), other resolution strate

include a modifcation o loan te

an extension o balloon payment

receivership. Each will have a die

impact on bondholders. In this case, a

extension would have helped the se

A-PB tranche, which would not have t

such a large prepayment and subseq

hit on its market price (Figure 2).

Exploring CMBS Risk

Real estate proessionals can

their market knowledge to estimate

likelihood o prepayments and losse

CMBS conduits. For example, app

market cap rates to property income

derive a property value. A loan amo

based on 65% loan-to-value ratio,

then be backed out o the property v

Alternatively, one could apply a req

debt service coverage ratio and int

rate to determine the propertys abili

support a refnancing.

When refnancing proceeds are less

the loan balance, loss and prepaym

estimates are applied to their correspon

junior and senior tranches. Near-

(within 12 months) prepayments and lo

are most likely to immediately occur

the sale o properties or delinquent l

2 Handbook of Mortgage Backed Securities, C

50, The Impact of Structuring on CMBS Bond

Performance by David P. Jacob, James M. Manz

Frank J. Fabozzi.

Figure 3:

Cumulative CMBS Losses by Vintage (Bloomberg)



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4

ontrolled by the special servicer (as was

he case with Three Columbus Circle).

ortunately, it is possible or investors

o access the inormation maintained

by special servicers that describes both

elinquent loans and oreclosed properties,

lso known as the previously mentionedREO.

REO Generates High Prepayment Risk

REO assets are destined to be sold by

he special servicer, most likely in the near

erm. While it is true that a special servicer

may hire a management company to lease

REO property and attempt to increase

he property value, this strategy can take

more than a year to implement. Thus, REO

properties provide the highest likelihoodor prepayment. According to the special

ervicers reports on WBCMT 2006-C23,

here are eight REO loans with a total

principal balance o $87.7 million and a

otal loan exposure o $98.6 million.3

The special servicer estimates REO

ales at 90% o the most recent value,

which would result in a prepayment o

57.8 million (Figure 4). As a result, there

s a total potential loss risk estimated at

40.8 million (Table 1), representing the

hortall between sale proceeds and total

oan exposure. The $57.8 million o cash

ow would go to the senior tranches and

epay servicer advances. Considering the

urrent balance o the senior A-PB tranche

s $66.4 million, this prepayment would pay

own 87% o that bonds principal balance

Figure 6). Senior bond investors would

uer rom high principal repayments and

sk an inability to replace those yields in

urrent markets. The losses o $40.8 million

The total exposure balance reected in the loss estimates

ncludes advances made by the special servicer. These

dvances include principal and interest, along with

roperty management and loan sale expenses. Since

roceeds from a loan sale are rst used to repay servicer

dvances before paying down bond classes, a long, drawn

ut and expensive loan battle can hurt recoveries to both

unior and senior investors. In WBCMT 2006-C23,

he REO loans have a total of $10.9 million in servicer

dvances.

Figure 4:

WBCMT 2006-C23 REO & Potential Losses based on Special Servicer Estimates as of September2011 (Special Servicer Report)

REO could result in a $57.8 million prepayment to senior tranches, and write down the junior tranches with $40.8 million in losses.

Table 1:

WBCMT 2006-C23 loss & prepayment risk from delinquent and REO loans as of September 201

REO $40,811,082 $57,775

Delinquent $53,751,743 $112,197

Total $94,562,824 $169,973

Loan Status Loss Risk Prepayment



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Figure 5:

WBCMT 2006-C23 Potential Losses from Delinquent Loans based on Special Servicer Estimates as ofeptember 2011. (Special Servicer Report & authors analysis)

Delinquent loans could result in a $112 million prepayment to senior tranches and a write down o the junior tranches with $53.8 million inosses. (Note: Two loans are not expected to have losses.)

would write down the balance o the j

tranches, wiping out the entire balanc

the most junior S tranche (Figure 7).

Applying this analysis to the C

universe, a review o the ten largest

loans shows the CMBS deals and

corresponding risk exposure (Table 2).

REO with the largest loan balance is a

in Caliornia, built in 1968. The CMBS

has $190 million in loan exposure, bu

special servicer estimates the prop

valued at $153 million, a $37 million d

to the loan balance. However, a porto

Southeast ofce buildings has the gre

loss risk o REO loans, with $68.3 milli

loss exposure on a $180.9 million loan

is valued at only $112.64 million. Inve

in those CMBS deals should be cogn

o the prepayment and deault risk at h

The CMBS deals associated with those l

have some o the highest REO loan bala

and REO loss risk exposures (Tables 3

4). The prepayment risk to specifc C

bonds is noted in these tables. The la

REO loan balance, the Caliornia

would prepay the A2 bond o the WB

2006-C28 issuance. The REO loan

the greatest risk loss, the Southeast oportolio, would prepay JPMCC 2005-C

A2FL. The Bloomberg CMBS tool m

it easy to identiy prepayment risk up

collateral chain, rom loan to CMBS de

Delinquent Loans Are Troubleso

Special Servicer Options

The next, or even equally risky bask

Rank Loan Name Deal Target Bond State PropertyType

Current TrustBalance

Recent Value Value Date Loss Ris

1 Montclair Plaza(2) WBCMT 2006-C28 A2 CA Retail $190,000,000 $153,000,000 2/3/2011 ($37,000

2 DRA-CRT Portfolio I JPMCC 2005-CB13 A2FL Various Office $180,900,000 $112,640,000 n/a ($68,260

3 Ariel Preferred Retail Portfolio GSMS 2006-GG8 A2 Various Retail $90,009,189 $65,650,000 n/a ($24,359

4 Moreno Valley Mall CGCMT 2007-C6 A1 CA Retail $84,565,377 $42,700,000 10/17/2011 ($41,865

5 FRI Portfolio BACM 2005-3 A2 Various Office $70,000,000 $37,825,000 8/19/2011 ($32,175

6 Highland Mall JPMCC 2002-CIB4 A3 TX Retail $61,104,416 $128,000,000 6/1/2001

7 Windsor/RECP Hotel Portfolio GCCFC 2005-GG5 A2 CA Hotel $53,783,787 $50,400,000 12/16/2010 ($3,383

8 55 Park Place BACM 2006-4 A3A GA Office $51,303,123 $42,000,000 5/20/2011 ($9,303

9 Four Seasons Nevis WBCMT 2007-WHL8 A1 Various Hotel $51,000,000 $110,000,000 9/27/2010

10 Tower Place 200 GSMS 2006-GG8 A2 GA Office $50,500,000 $27,050,000 6/1/2011 ($23,450

Table 2:



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Rank Loan Name Deal Target Bond State PropertyType

Current TrustBalance

Recent Value Value Date Loss Ri

1 Trinity Hotel Portfolio BACM 2006-5 A2 Various Hotel $127,777,001 $113,120,000 1/13/11 ($14,657

2 The Shore Club JPMCC 2005-CB13 A2FL FL Hotel $107,030,785 $91,500,000 12/14/10 ($15,530

3 Continental Plaza JPMCC 2004-CBX A5 NJ Office $88,000,000 $50,300,000 12/20/10 ($37,700

4 DDR/Macquarie Mervyns Portfolio GMACC 2006-C1 A3 Various Retail $70,988,785 $397,650,000 7/1/05 5 717 North Harwood Street CSMC 2007-C1 A1A TX Office $64,000,000 $35,000,000 3/24/10 ($29,000

6 Investcorp Porfolio JPMCC 2005-CB13 A2FL PA Industrial $56,100,000 $46,850,000 n/a ($9,250

7 Fairmont Sonoma Mission Inn & Spa BACM 2006-1 A2 CA Hotel $55,000,000 $85,100,000 1/19/11

8 Novo Nordisk Headquarters CGCMT 2005-C3 A2 NJ Office $49,058,499 $32,200,000 3/1/11 ($16,858

9 Birtcher/Charlesbank Office Portfolio GCCFC 2005-GG3 A2 CA Office $45,371,159 $39,300,000 n/a ($6,071

10 Four Falls GSMS 2005-GG4 A2 PA Office $42,200,000 $40,000,000 4/7/11 ($2,200

Table 6:

argest loans in foreclosure and loss risk

an eort to estimate the ability o immed

refnancing proceeds to payo the exi

loan balances.6 I these estimated

proceeds are less than the loan bala

then a loss to the CMBS trust is expec

I the loan proceeds are greater than

loan balance, then there would not

loss to trust. Moodys stated method w

backwards rom current NOI and uses

lesser amount o proceeds resulting

either a DSCR o 1.25 (1.50 or hotels) o

LTV o 65% (75% or hotels) test.7 Unde

method, an ofce property with $5 m

in NOI would qualiy or a $43.2 m

refnancing using the LTV approach (wit

million in debt service).8

Applying Moodys methodology to

44 loans in WBCMT 2006-C23 with DS

below 1.0 results in an estimated los

$631.1 million. This extreme loss w

wipe out all o the $524 million ju

tranches that provide credit suppor

the deal, and the A-J tranche would

a $107 million loss (Figure 7). In addi

senior bonds would take in $116 millio

prepayments, urther eroding the yield

value o senior bonds.

While the Moodys loan analysis se

to err on conservative side by app

Figure 6:

Visualization of WBCMT 2006-C23 tranchesas of September 2011

Senior tranches (frst pay) are at the bottom, junior tranches(frst loss) are at the top.

Figure 7:

WBCMT 2006-C23 junior tranchesas of September 2011

Tranches N through S with a total balance o $75 million would bewiped out i the REO and delinquent loans took the $94.6 millionlosses explained herein. Tranche M would lose 93% o its value.

6 Published by Moodys in US CMBS and CRE

Surveillance Review Q2 2010 (August 19, 2010).

7 Moodys uses an interest-only loan originated at a 9

interest rate, while the LTV approach uses an 8.0%

rate. DSCR Proceeds = (NOI/DSCR)/9.25%.

Proceeds = (NOI/8.0%) * LTV.

8 The proceeds of $43,243,243 obtained by the D

method are less than $46,875,00 obtained using a

cap rate and 75% LTV.



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Bibliography

CTSLink, CTSLink. N.p., n.d. Web. http://www.ctslink.com.

Find a Securitization, CMBS.com - Providing Standardized Tools for the CMBS Industry.N.p., n.d. Web. http://www.cmbs.com/searchresults.aspx?showall=1.

acob, David P., Manzi, James M. and Fabozzi, Frank J., Handbook o Mortgage Backedecurities, Chapter 50, The Impact o Structuring on CMBS Bond Class Perormance.

Moinian misses payments on 1775 Bway . Crains New York Business, June 2, 2010:ttp://www.crainsnewyork.com/article/20100602/REAL_ESTATE/100609962.

Moinian misses payment on third property . Crains New York Business, November 11,009: http://www.crainsnewyork.com/article/20091113/FREE/911139985.

Securitization, CMBS.com - Providing Standardized Tools for the CMBS Industry. N.p.,.d. Web. http://www.cmbs.com/securitization.aspx?dealsecuritizationid=1399.

Tussle over 1775 Broadway goes down to wire . Crains New York Business, December 6,010: http://www.crainsnewyork.com/article/20101206/REAL_ESTATE/101209910.

US CMBS and CRE CDO Surveillance Review Q2 2010, Moodys, August 19, 2010.

Baruch College, CUNY137 East 22nd StreetBox C-0120New York, NY 10010

Tel: 646.660.6950 Fax: 646.660.6951www.baruch.cuny.edu/realestate

Mitchel B. Wallerstein,President, Baruch Col

William Newman,Founding Chair

Richard Pergolis,Co-Chair

Jack S. Nyman,Director

Emily Grace,Associate Director of Research

This research report is published by the Stev

Newman Real Estate Institute, Baruch CoCUNY.The Newman Real Estate Institute graacknowledges the support of the sponsorsmake possible our efforts to promote cthinking on topical issues for the real estate inThe views expressed in the research report areof the authors and not necessarily those of BCollege, City University of New York, or any affiliated organizations, foundations, and sponPlease address inquiries to Jack S. Nyman, Direc

high interest rate, the derived loan

mount is based on an interest-only loan.

An amortizing loan with the same interest

ate would result in substantially lower

unds available to borrowers. However,

multiamily properties able to obtain

erms competitive with Fannie Mae or

reddie Mac fnancing can obtain greater

oan proceeds than Moodys estimates.

or example, on a loan with multiamily

ollateral at 6.5% interest rate and a 25-year

mortization period, loan proceeds would

be 14% greater than Moodys estimates.urthermore, these broad brushstrokes do

ot provide a nuanced appraisal specifc to

he property.

The loans with DSCRs under 1.0 are

severely troubled, and they very well may

be the next crop o bad loans that the

special servicer will be orced to workout.

To gain a better understanding o possible

outcomes, urther analysis o the 44 loans

could include special servicer reports, the

opinions o local brokers and local market

data to assess property conditions. A more

precise outcome could then be estimated

and the prepayment expectations could be

entered into pricing models to understand

the impact on junior and senior CMBS

tranches.

The data shows that special servicers have

been less aggressive in addressing distress

than non-CMBS lenders. According to Real

Capital Analytics (RCA), CMBS distress

increased $7.7 billion through September

2011. In comparison, non-CMBS lenders

have reduced their distress balances by

about the same amount. The comparison

also highlights the signifcant dierences

between CMBS and non-CMBS lenders

in dealing with roughly the same amount

o distressed commercial property, RCA

said in a press release. According to RCA,

Non-CMBS lenders have been moreaggressive at working out problem loans

and have relied ar less on modifcations or

extensions, which risk becoming problem

loans again. As a result o the aggre

workouts, Non-CMBS lenders also

much higher REO balances compare

CMBS, the RCA statement concluded

Conclusion

This article provides a real market exam

o how a distressed commercial mortg

resulted in a signifcant prepaymen

senior CMBS investors. It also demonst

how to analyze CMBS loan data using

special servicer reports and ratings ag

methodologies to understand the im

on CMBS tranches.

The techniques described in this w

paper can be applied in numerous insig

and proftable ways. Investors can com

dierent CMBS issuances and tranto determine which oer the best v

or purchases on the secondary ma

In addition, current owners o CMBS

perorm a thorough credit analysis

their portolios to make hold as well a

decisions.

JPMCC 2005-CB13 $167,946,611

BACM 2006-5 $127,777,001JPMCC 2004-CBX $88,000,000

GSMS 2005-GG4 $83,125,000

GMACC 2006-C1 $70,988,785

GCCFC 2005-GG3 $67,727,758

CSMC 2007-C1 $64,000,000

LBFRC 2006-LLFA $57,361,673

BACM 2006-1 $55,000,000

BACM 2005-3 $50,923,880

Deal Name Foreclosure LoanBalance

Table 7:

CMBS deals with largest foreclosureoan balances


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