7/30/2019 CMBS White Paper
1/8
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:
7/30/2019 CMBS White Paper
2/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
2
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).
7/30/2019 CMBS White Paper
3/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
3
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)
PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201
7/30/2019 CMBS White Paper
4/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
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
PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201
7/30/2019 CMBS White Paper
5/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
5
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:
PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201
7/30/2019 CMBS White Paper
6/8
7/30/2019 CMBS White Paper
7/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
7
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.
PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201
7/30/2019 CMBS White Paper
8/8
P: 646.660.6950 / 137 East 22nd Street, New York, NY 10010www.baruch.cuny.edu/realestate
8
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
PREDICTING CMBS PREPAYMENTS AND DEFAULTS SPRING 201