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Complex interactions between collateral and structure.
Commercial mortgage-backed securities (CMBS) are bonds backed by a single commercial mortgage or, more generally, a pool of commercial mortgage loans. The commercial mortgages that back CMBS are loans on income-producing properties such as office buildings, retail properties, and apartment buildings. (Construction loans and loans on land are generally not in CMBS pools.) The interest and principal from the loans are passed through to the bond classes created in the CMBS structure.
The structures have evolved from simple passthroughs to fairly complicated multiclass senior/subordinated structures, with bonds rated from AAA to unrated, and with multiple interest-only bond classes. While most deals are backed by fixed-rate mortgages, there is a market for deals backed by floating-rate loans as well.
The earliest deals date back as far as the mid-1980s, but the market received its first big push from the Resolution Trust Corporation (RTC), created by Congress to deal with the assets of failed savings and loan institutions. Some of these deals were backed by pools of performing loans, while others included non-performing loans that were to be liquidated.
The market has grown to over $300 billion outstanding; yearly issuance is in the $60-$70 billion range. While the main sources of financing of commercial real estate were once banks, savings and loans, insurance companies, pension funds, and tax shelter syndicates, the CMBS market has become a major source of funding for the $2 trillion commercial real estate market.
CMBS, as a mature sector, is represented in the Lehman bond indexes. Certain large issues are considered benchmark deals. There is excellent liquidity in the senior bond classes, and the analytics and information systems for this sector are plentiful.
In the new issue market, the role of the rating agencies, given a pool of loans, is to set the credit enhancement levels. In the secondary market, the rating agencies are responsible for surveillance. As issues arise, they may place bond classes on their watchlist. These classes may subsequently have their ratings changed.1
The CMBS market has matured in the United States, but is still in its infancy around the world. Most of the issuance outside the U.S. has been in the U.K., followed by Japan. We are increasingly seeing deals out of...