Presentation to The Appraisal Institute AI Connect 2015 Presented by Steve Powel Constantine Tino Korologos MAI CRE Chief Executive Officer of Situs Managing Director of Situs ID: 671238
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Slide1
July,
2015
Appraiser’s Guide to CMBS and the Debt Capital Markets
Presentation to: The Appraisal Institute – AI Connect 2015 Slide2
Presented by:
Steve Powel, Constantine “Tino”
Korologos, MAI,
CRE
Chief Executive Officer
of Situs Managing Director of Situs,
ObjectiveSlide3
Todays Outline
Introductions
History of the the CMBS Markets
Brief look at the Debt Capital Markets
“Alphabet Soup”
Definitions - terminology
Who are the players and what do they do
How does the CMBS Market Work
CMBS Bond Structures
What’s the Process?
How does the Appraiser fit in?
The Rating Agencies
What do they do in the process?
How do they look at Appraisals?
Case Study on a large loan CMBS deal – 200 Park Avenue, NY, NY
QuestionsSlide4
Commercial Mortgage Backed Securities (CMBS) are bonds backed by pools of mortgages on commercial and multifamily real estate. As of
June, 2015,
the US market capitalization of the CMBS market was $746Bn.CMBS offer several advantages over commercial whole loans. Securitization allows for the division of the loan into credit classes so that an investor may buy a class rated from AAA to B and unrated.
CMBS are marked to market on a daily basis and hence are more liquid than whole loans. CMBS appeal to a wide array of investors because of attractive relative spreads and stronger call protection than residential mortgage securities.
Source: Trepp, Morgan Stanley Research
US CMBS Outstanding
Standard Property Types
Introduction to CMBSSlide5
History of the CMBS MarketSlide6
Before the mid-1990s the U.S. real estate business was predominantly a private market.
Lending was dominated by a handful of banks, life insurance companies, and pension funds.
Real estate ownership was regionally focused, with ownership concentrated in a few hands. Families and private partnerships were the largest owners.
In the real estate recession of the late 1980s and early 1990s, commercial real estate prices fell by 50% or more in some areas, and delinquency rates on loans soared to all-time highs.
Losses led to the exit of many traditional lenders from the commercial mortgage market.
Regulators and rating agencies turned more negative on commercial mortgage holdings, so that the remaining lenders became less willing to extend credit.
Low real estate values combined with the failure or exit of traditional lenders provided innovation opportunities and a shift from private to public ownership. REITs began buying undervalued real estate portfolios funded through public stock and bond offerings. REIT shares provided an opportunity for small, diversified investments in real estate.
Investment banks started to apply securitization legal structures developed during the 1970s and 1980s for residential mortgage-backed securities (RMBS) to commercial mortgages. In the mid- to late-1980s, issuers securitized a few loans on single properties into CMBS.Packaging of diversified pools of mortgages into CMBS developed in the mid-1990s when the Resolution Trust Corporation (RTC) pooled non-performing loans from failed institutions.
Some transactions exceeded $1 billion and led to the growth in the investor base for CMBS.
Source: Morgan Stanley Research
History and Development of the CMBS IndustrySlide7
Historical CRE (all) Debt Originations by YearSlide8
Historical CMBS Originations by Year (Trailing 12
mo
)Slide9
Historical CRE Debt Originations by YearSlide10
CMBS Loan Maturities… what lies aheadSlide11
Brief Introduction to the
Real Estate Capital MarketsSlide12
12
Capital Markets Debt Market Composition
Source: Federal Reserve BankSlide13
13
Capital Markets Transaction ActivitySlide14
Definition of capital markets
The marketplaces where money is raised and securities are traded
A place or system in which the requirements for capital of a business can be satisfiedCapital markets include stock markets (equity) and bond/credit markets (debt)
Credit ratings are a very important part of the credit markets and are used by:
investors; issuers; commercial banks; investment banks/broker-dealers; government agencies.
A classical approach to the real estate capital markets considers a simple “debt” and “equity” construct
“4 quadrants of capital”
14
Capital Markets OverviewSlide15
15
Public Debt & Public Equity:
Commercial Mortgage-Backed Securities (CMBS)
Collateralized Debt Obligations (CDOs)
Real Estate Investment Trusts (REITs)
Mutual Funds
Private Debt & Private Equity:
Whole Loans
Mezzanine Loans
B-Notes (Subordinate to I-grade portion of mortgage debt)
Limited Partnerships
Private REITsSeparate AccountsHowever, the capital markets have become much more complex in nature…..
Capital Markets – Real EstateSlide16
Structured Finance is a (
relatively new) subsector of finance that was developed to transfer risk using a complex legal frameworkSecuritization Is the process of taking an illiquid asset, or group of assets, and through financial engineering and legal definitions, transforming them into a tradable, liquid securities.
A structured finance technique that pools assets together and, in effect, turns them into a tradable securities held by a bankruptcy remote special purpose vehicle (SPV). Financial institutions and businesses of all kinds use securitization to immediately realize the value of a cash-producing asset; recognizing the arbitrage stemming from illiquid/liquid investments.
The securitization of real estate takes multiple forms:
Real Estate Investment Trusts (REITs)
Commercial Mortgage-Backed Securities (CMBS)
Collateralized Debt Obligations (CDO’s)Residential Mortgage-Backed Securities (RMBS)The securitization of real estate finance has blurred the lines of the 4-quadrants approach to capital marketsRisk Spectrum approach evaluates and prices “risk” rather than “debt” or “equity”
16
Capital Markets SecuritizationSlide17
“Alphabet Soup”
Terminology and the PlayersSlide18
Definitions & Terminology
Advances Appraisal Reduction ASERS
“B Piece” Bankruptcy Remote Entity Call Protection
CMBS Conduit Credit Enhancement
Defeasance Depositor First Loss Piece
Haircut Independent Director Interest Only Strip (IO)
Investment Grade Liquidation Fee Lock-Box Provision
Loss Severity Master Servicer Master Servicing Fee
Mezzanine Debt Non-Consolidation Opinion
Pari
Passu
Loan
Pooling & Servicing Agreement Private Placement Prospectus
Qualified Institutional Buyer REMIC (Real Estate Mortgage Investment Conduit)
Realized Loss Reps and Warranties SEC Rule 144A
Senior/Subordinate Structure Services Servicing Advances
Special Purpose Entities (SPE) Special Servicer Subordination
Tranche Trustee Waterfall
Yield MaintenanceSlide19
Who are the Players and what do they do
Borrowers
Mortgage
Loan
Originator, Mortgage Bankers and Brokers
Loan
Sellers
Depositors
Rating Agencies
Subordinate Bond Holders – Controlling Class Bond Holder
Investment Grade Certificate Bond Holders
Third Party Servicers (Master Servicers, Special Servicer & Operating Trust Advisor
TrusteeSlide20
How does the CMBS Market work?Slide21
CMBS Transactions Flow of Investments & Securities
Source: CREFCSlide22
Where the Money Goes
Loan Originator /
Loan Seller
(Lender)
Trustee-
Distribution
Account
Servicer-
Collection
Account
Securities
Investors
Borrowers
Assignments of Rents and Leases
Loan Proceeds
Debt Service
& Escrows
Debt Service
Less Servicer Fee
Plus Advances
Mortgage
Notes
Monthly
Bond
Coupon
& Principal
Securities Sale
Proceeds at Closing
Securities Sale
Proceeds at Closing
8
Mortgage lien and
CMBS BondsSlide23
CMBS have very simple structures compared to their residential mortgage counterparts.
Each tranche represents a security with its own credit rating, average life, and other characteristics.
Bonds are almost always sequential pay: amortization, prepayments, and default recoveries are paid to the most senior remaining class. The lowest-rated remaining class absorbs losses.
Unlike their residential counterparts, commercial mortgages almost always have some form of prepayment penalty, making credit analysis more important than prepayment analysis.
A CMBS investment requires analysis on three levels: property, loan, and bond.
CMBS Architecture
Source: Morgan Stanley Research
Property 1
Property 2
Property N
Mortgage 1
Mortgage 2Mortgage M
Real
Estate
Mortgage
Investment
Conduit
(REMIC)
AAA
AAA
AAA
NR
AA
Properties
Mortgages
Asset Pool
LiabilitiesSlide24
CMBS Structure and ParticipantsSlide25
Post-closing
Borrowers
Trustee/
Fiscal Agent
Trust
Investment Bank/
Secondary Traders
Investors
Investors
Investors
Master Servicer
Primary or Sub-Servicer /
Mortgage Banker
Special Servicer
Rating Agencies
7
$
$
$
Bonds traded in the
secondary market by
Continue to rate bondsSlide26
The CMBS “Playbook” – the Pooling and Servicing Agreement
What is the Pooling & Servicing Agreement (PSA)?
The PSA is a multifunctional document executed by the Depositor, Trustee, Master
Servicer, Special Services and Trust Advisor which implements:
Creation of the CMBS trust the owns the loans
Conveyance of the loans along with the assignment of rights & remedies of the depositor against the seller of the loans.
Appointment of the parties mentioned above and the detailed provisions governing the rights and obligations of the parties and the certificate holders.
Issuance of certificates of the beneficial interest in the CMBS Trust with the priorities and rights to payments for each class of investor.
Waterfall distribution
Rights, duties and obligations of the parties.
Election by the CMBS trust to be treated as a REMIC for purposes of Federal Tax
Definitions and provisions including the
application of the appraisal process
.Slide27
Appraisal Reductions – ARA and ASER
What is an appraisal reduction?
Appraisal reductions allow for a reduction of servicer advances for a loan that is expected to suffer a loss. To calculate those reductions, the special servicer obtains an independent third party appraisal. Such events are triggered by specific loan events as defined in the PSA. Examples might be 120 days of delinquency, 60 days delinquency after a borrower bankruptcy, or immediately after a loan becomes REO.
What is ARA?
Appraisal reduction amount generally equals the excess of the sum of the unpaid principal balance, unpaid servicer advances and other charges over the sum of 90% of the appraised value with the amounts of reserves, escrows & LOCs
So a $10m UPB and other charges, with a $9m appraised value with $200k reserves would be the excess of $10m over 90% of $9m ($8.1m) plus $200k or $1.7m.
What is an ASER?
The Appraisal Subordinate Entitlement Reduction is the difference between the old and new monthly advances after the ARA was taken. Appraisals are generally updated every year and any further decreases in value would increase the ASER.Slide28
Addenda
The Rating AgenciesSlide29
What are the Rating Agencies and what do they do?
What
is the definition of a Credit Rating Agency
?
As defined by the U.S. Securities and Exchange Commission,
a credit rating agency is defined in the Rating Agency Act to be a person (a) engaged in the business of issuing credit ratings on the Internet or through another readily accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company; (b) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (c) receiving fees from either issuers, investors, or other market participants, or a combination thereof
.
NRSRO is a Nationally Recognized Statistical Rating Organization
.
Who are the Major Rating Agencies?
Moody’s Investors Service, Fitch Ratings, Standard & Poor's, Kroll Ratings, Morningstar Ratings, DBRS (Dominion Bond Ratings Service)
What is a Rating?
A
Rating is an opinion … just the way an appraisal is an
opinion. But protected under the First Amendment
AAA
Determined to have almost no risk of loss due to credit-related events. Assigned only to the very highest quality obligors and obligations able to survive extremely challenging economic events.
AA
Determined to have minimal risk of loss due to credit-related events. Such obligors and obligations are deemed very high quality.
A
Determined to be of high quality with a small risk of loss due to credit-related events. Issuers and obligations in this category are expected to weather difficult times with low credit losses.
BBB
Determined to be of medium quality with some risk of loss due to credit-related events. Such issuers and obligations may experience credit losses during stress environments.
BB
Determined to be of low quality with moderate risk of loss due to credit-related events. Such issuers and obligations have
fundamental
weaknesses that create moderate credit risk.
B
Determined to be of very low quality with high risk of loss due to credit-related events. These issuers and obligations contain many fundamental shortcomings that create significant credit risk. Slide30
Rating Agencies – The Meltdown and Regulations
Rating Agency Reform
Credit Rating Agency Reform Act passed in 2006
Since
the financial crisis regulators have encouraged “unsolicited” opinions on
deals. Ideally
this would cut down on ratings shopping
The
Dodd-Frank act enhanced the SEC’s enforcement mechanisms for credit rating agencies (NRSRO)
Establish
maintain, enforce, and document internal control structures governing implantation of and adherence to policies, procedures, and methodologies for determining credit
ratings
. An
annual report of
must
be submitted to the SEC
The
SEC may suspend or permanently revoke the registration of a NRSRO for a particular class or subclass of securities if they cannot consistently produce reports with integrity
Sales and marketing decisions are strictly prohibited from influencing the production of ratings
Review of work when a credit analyst leaves a NRSRO and if the prospect of future employment influenced their
work. These
reviews must be formalized and the SEC will review the NRSROs policies at least annually and whenever such policies are materially modified or amended
NRSRO’s must report to the SEC if new employees previously worked at another NRSRO in a credit rating capacity
Complete public disclosure of the NRSRO’s initial credit ratings and changes to credit ratings
Enhances the disclosure of transition and default
rates; Standardizes
those rates within NSRO’s
Compensation of each compliance officer is linked to financial performance of the NSRO in such a way to ensure independence of the officer’s judgement
Public Disclosure of procedures and methodologies including qualitative and quantitative data and models
Must promptly publish any changes to those things, why and the likely changes to current ratings as a result
Notice of significant error in existing procedures and methodologies
Disclose the version of the credit rating procedure or methodology used for a rating
Disclose with each rating essential qualitative and quantitative information as well as the methodology to give transparence to
investors and includes
key assumptions and possible limitationsSlide31
Rating Agency
Process – Office Properties
Source: Kroll Bond Rating Agency
Rating Agency Cash Flow Evaluation… consistently applied over timeSlide32
Rating Agency Process
Rating Agency Valuation Thresholds – All LTV’s aren’t created equal
Source: Kroll Bond Rating AgencySlide33
Rating Agency
Process – Sample Office Loan
Source: Kroll Bond Rating Agency
KLTV Thresholds for a High Leverage Loan in a SASB Transaction Slide34
Addenda
Case Study – Single Borrower CMBS Deal
200 Park Avenue, New York, NYSlide35
Case Study – SASB Deal 200 Park Avenue, New York, NYSlide36
Case Study – SASB Deal 200 Park Avenue, New York, NY
Source: KBRA Presale report BAML 2015-200PSlide37
Case Study – 200 Park Avenue, New York, NY
Source: KBRA Presale report BAML 2015-200PSlide38
Case Study – SASB Deal 200 Park Avenue, New York, NY
Source: KBRA Presale report BAML 2015-200PSlide39
Case Study – SASB Deal 200 Park Avenue, New York, NY
Source: KBRA Presale report BAML 2015-200PSlide40
Case Study – 200 Park Avenue, New York, NY
Source: KBRA Presale report BAML 2015-200PSlide41
Addenda
AddendaSlide42
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