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An Introduction To CMBS: J U N E 2 0 0 6
An Introduction To CMBS: J U N E 2 0 0 6
AN INTRODUCTION TO CMBS
CMBS RESEARCH
David Zhou
212.834.5302 david.x.zhou@jpmorgan.com
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 26 53 65
1981: Economic Recovery Tax Act 1982: Savings & Loan Deregulation
Late 80s-early 90s: Tax reforms gave REITs greater flexibility & facilitated institutional investment
An Introduction to CMBS
Commercial Mortgage Backed Securities (CMBS) are bonds collateralized by mortgages on commercial and multifamily properties that are income-producing and operated for economic profit. The mortgage payments are, in turn, dependent on the rental stream paid by tenants to the property owner (i.e., the borrower). CMBS offer diversification benefits as bonds are typically collateralized by a large number of loans with exposure to a wide range of property types and geographic regions. Main property types in CMBS collateral include retail, office, multifamily, hotel and industrial.
An Introduction to CMBS
Other, 5% Industrial, 6% Hotel, 12% Multifamily, 17% Office, 31% Retail, 29%
Fixed-rate conduit transactions dominate the new issue market, representing over 80% of all domestic new issuance in 2005.
An Introduction to CMBS
All categories of institutional investors invest in CMBS. In fact, the number of investors in the CMBS market has increased approximately 125% since 1998. The continued growth in transaction size and the introduction of senior/subordinated AAA classes has lured cross-over buyers into CMBS and away from corporates, RMBS and Agency debentures.
Other, 3%
Typical CMBS buyers by bond ratings Typical CMBS buyers by bond ratings An Introduction to CMBS
Class rating AAA Typical buyers Insurance companies, pension funds, hedge funds, money managers, government sponsored entities and banks Insurance companies and hedge funds Money managers and insurance companies CBO/CDO issuers, insurance companies, pension funds and money managers B-piece buyers
IO AA A BBB BBBBB B NR
An Introduction to CMBS
What
securitize portfolios of newly originated loans
Why
to empty the warehouse and take profits
to clear the balance sheet, adjust exposures or exit the sector to finance the acquisition and/or cash out of the investment to secure attractive financing as an alternative to a portfolio lender
An Introduction to CMBS
Commercial Mortgages
A pool of receivables is sold by originators into a special purpose vehicle. Bonds represent an ownership interest in this pool. Loans are typically secured by assets with relatively predictable cash flows.
An Introduction to CMBS
Assets are legally separated from the seller, limiting investor exposure to the seller. Feature credit enhancements which lead to high credit ratings.
Closing/ Documentation
CMBS Securitization
An Introduction to CMBS
Collateral review
Due diligence
Legal considerations
Structural analysis
Rating committee
Rating surveillance
An Introduction to CMBS
Delinquency summary Collections Losses Recoveries Credit line ranges Geographic distribution Industry distribution Collateral rating/credit grade distribution Biographies of key personnel
Company and mgmt. overview Origination practices Underwriting Investment philosophy Cash management and remittances Monitoring and collection process Systems/technology review Quality control
Analysis of legal documents Review of legal opinions Bankruptcy analysis for banks vs. nonbanks Evaluation of bankruptcy remote SPVs Review of legal transfers, ownership and security interests Tax treatment
Trust structure Cash flow allocations Mechanics of credit enhancement/ protection mechanisms Role of servicer Stress tests
Evaluate transaction and credit enhancement Issue deal reports Issue rating letter
Ensure rating reflects performance and transaction structure Identify transactions to be considered for ratings change Maintain contact with issuer Issue press release to notify public of rating change
10
11
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 26 53 65
Domestic
200
International
70
150
100 1 9 50 0 14
19 92 19 93
35 23 29 12 47 67 78 52 93 21 169
31
4 0 17
19 94
3 15
19 95
0
19 90
1 3
19 91
1 8
1 16
19 96
1 26 37
74
89
57
An Introduction to CMBS
Cumulative domestic issuance is above $860 billion, with about $577 billion outstanding as of the end of the first quarter in 2006.
20 06 1H
19 98
19 99
20 00
20 01
20 02
20 03
19 97
20 04
20 05
13
FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 29,795 40,462 36,274 54,282 73,960 136,160 11,232 4,766 1,100 46,893 12,116 1,148 1,328 10,506 13,586 2,599 67,153 22,714 4,466 4,931 11,564 3,424 812 52,074 28,706 12,832 6,850 15,032 7,612 925 77,851 20,803 5,585 7,983 13,094 4,441 1,618 93,113 35,197 8,402 6,220 18,649 10,784 2,927 168,520 70,299 21,263 4,625
% of 1H 2006 Total 75,679 85.3% 4,919 5.5% 6,625 7.5% 1,455 1.6% 88,678 100% 30,580 13,853 3,531
% yoy chg
61,000 -13%
* Other includes lease-backed deals and seasoned loan deals. ** CRE CDO data reflect U.S. and international deals that are composed of at least 50% CMBS or commercial real estate loans. Source: Commercial Mortgage Alert, JPMorgan
An Introduction to CMBS
Despite the heavy fixed-rate conduit issuance in the first half of the year, we expect a slowdown in the second half of the year from the tempering of the demand for loans due to rising interest rates. We expect FY 2006 conduit issuance of around $130 billion, roughly 5% less than in 2005. Expect less multiborrower floaters with more floating rate loan candidates being originated as shorter term fixed-rate loans or placed in CDO structures. In sharp contrast to 2004-2005 when international issuance volume surged, international issuance slowed in 1H 2006 due to a sharp decline in issuance in the U.K. We forecast 2006 international issuance of $61bn, a 13% drop from 2005.
14
Source: Flow of Funds Accounts, Federal Reserve Board of Governors, Commercial Mortgage Alert, JPMorgan
An Introduction to CMBS
CMBS continue to increase in share of total commercial mortgage outstandings. CMBS represent 21% of the commercial mortgage market at $577 billion as of the end of 1Q 2006.
15
Multi-
Mobilehome 3.3% 3.9% 2.4% 2.0% 2.0% 1.9% 1.9% 2.1% 2.6% 4.3% 1.4% 1.3% Retail 30.6% 29.2% 30.3% 28.3% 27.9% 27.9% 29.6% 36.0% 38.5% 35.8% 32.0% 31.9%
Warehouse/ Industrial 9.8% 7.2% 7.3% 7.4% 8.0% 10.5% 9.8% 10.3% 6.4% 6.8% 6.8% 7.1% Other 2.0% 0.4% 1.6% 5.3% 4.5% 3.5% 2.3% 2.0% 2.5% 2.5% 2.9% 2.8%
Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*
An Introduction to CMBS
Office 5.4% 8.4% 17.0% 17.3% 20.1% 25.8% 29.1% 24.9% 28.4% 31.2% 33.6% 30.0%
Hotel 7.5% 10.0% 10.4% 11.3% 8.1% 6.4% 5.0% 1.5% 2.6% 3.1% 7.6% 11.6%
family 34.4% 38.9% 26.9% 25.7% 27.3% 23.1% 22.3% 23.3% 19.0% 16.3% 15.6% 15.1%
Nursing 6.9% 2.0% 3.9% 2.8% 2.0% 0.8% 0.1% 0.0% 0.0% 0.0% 0.1% 0.2%
* As of 2Q 2006
Source: Commercial Mortgage Alert
Core property types remain office, retail and multifamily. Property type concentrations shift as investors re-evaluate the attractiveness of each. As shown, the hotel sector has recently made a comeback.
16
Top 25 MSAs in floating rate deals Top 25 MSAs in floating rate deals
Metropolitan Statistical Areas 1 New York-New ark-Edison, NY-NJ-PA 2 Chicago-Naperv ille-Joliet, IL-IN-WI 3 Los Angeles-Long Beach-Santa Ana, CA 4 Washington-Arlington-Alex andria, DC-VA-MD-WV 5 Miami-Fort Lauderdale-Miami Beach, FL 6 Orlando, FL 7 San Francisco-Oakland-Fremont, CA 8 Phoenix -Mesa-Scottsdale, AZ 9 Dallas-Fort Worth-Arlington, TX 10 Houston-Bay tow n-Sugar Land, TX 11 Honolulu, HI 12 Minneapolis-St. Paul-Bloomington, MN-WI 13 Boston-Cambridge-Quincy , MA-NH 14 Atlanta-Sandy Springs-Marietta, GA 15 San Jose-Sunny v ale-Santa Clara, CA 16 Springfield, MA 17 Detroit-Warren-Liv onia, MI 18 Pittsburgh, PA 19 Tampa-St. Petersburg-Clearw ater, FL 20 San Diego-Carlsbad-San Marcos, CA 21 Las Vegas-Paradise, NV 22 Albany -Schenectady -Troy , NY 23 Buffalo-Cheektow aga-Tonaw anda, NY 24 New Orleans-Metairie-Kenner, LA 25 Nashv ille-Dav idson--Murfreesboro, TN Top 5 MSAs Top 25 MSAs All MSAs Balance ($bn) 5.9 1.6 1.5 1.0 1.0 0.8 0.7 0.7 0.6 0.5 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.2 11.0 19.2 32.1 % 18.4% 5.0% 4.7% 3.1% 3.1% 2.5% 2.3% 2.1% 2.0% 1.5% 1.5% 1.5% 1.3% 1.3% 1.2% 0.9% 0.9% 0.9% 0.9% 0.8% 0.8% 0.8% 0.8% 0.7% 0.6% 34.3% 59.7% 100.0%
An Introduction to CMBS
22 Minneapolis-St. Paul-Bloomington, MN-WI 23 Tampa-St. Petersburg-Clearw ater, FL 24 Charlotte-Gastonia-Concord, NC-SC 25 Sacramento--Arden-Arcade--Rosev ille, CA Top 5 MSAs Top 25 MSAs All MSAs
Source: Trepp * As of 7/17/06
CMBS loans are concentrated in large cities including NY, LA, DC and Chicago.
17
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 23 50 63
An Introduction to CMBS
NCF is used to calculate debt service coverage ratios (= NCF / Debt Service) and can also be used to estimate property values (= NCF / Cap Rate). The capitalization rate (Cap rate), which is calculated as NCF / Property Price can be seen as a property investors required rate of return.
19
Basic formulas LTV = Loan Amount / Property Value DSCR = Cash Flow (NOI or NCF)/ Debt Service (i.e., Principal + Interest) Actual LTV and DSCR - based on appraised values and actual debt service as follows: Actual LTV = Loan Amount / Appraised Property Value = $36,750,000 / $46,100,000 = 79.7% Actual DSCR = Net Cash Flow / Actual Debt Service Payments (during amortization period) = $3,045,812 / $2,529,742 = 1.20 Stressed LTV and DSCR - based on rating agency cap rate and constants as follows: Stressed LTV = Loan Amount / Est. Rating Agency Value (i.e., NCF / Rating Agency Cap Rate) = S36,750,000 / ($3,045,812/9.25%) = 111.61% Stressed DSCR = Net Cash Flow / Rating Agency Debt Service (i.e., Loan Amount X Rating Agency Constant) = $3,045,812 / ($36,750,000 X 10.09%) = 0.82
An Introduction to CMBS
LTV and DSCR are used to calculate loan proceeds and pricing. LTV and DSCR are important indicators of default potential. DSCR is a better predictor of term defaults. LTV is a better predictor of balloon-date defaults.
20
Case II 70% Leverage LTV (%)* 70.0 68.2 DSCR** 1.37x 1.10x
Underwritten Year 5
79.7 77.7
* LTV calculated off of appraised value at issuance. ** DSCR based off of debt service during amortization period.
21
An Introduction to CMBS
22
Mitigating prepayment risk: Common prepayment penalties for fixed-rate conduit loans
Defeasance No Penalty
2 to 5 Years
10 Years
23
Current exposure by type of call protection: Hard lockout then defeasance (> 90% of all fixed-rate loans). Hard lockout then yield maintenance (5% -10% of all fixed-rate loans). Hard lockout then a set penalty schedule such as 5%, 4%, 3%, 2%, 1% year by year (not common). Lock-out followed by defeasance is preferred by bond investors because it results in the most stable cash flow.
24
Typically 10-year loan terms (few selfamortizing loans) 20 to 30 year amortization period Spread + 10-year Treasury
Shorter loan terms (2 to 5 years) Interest only terms Spread + 1 month Libor; embedded interest rate caps and floors Can be transitional property Generally have DSCRs of 2.00 to 4.00x and LTVs of 40 to 65% Typically have 1-2 years of prepayment lock-out followed by ability to freely prepay or prepay with yield maintenance or percentage penalty Same
Stabilized property Minimum DSCR of 1.20 to 1.25x; Maximum LTV of 75 to 80% 2-5 years of prepayment lock-out followed by ability to prepay via defeasance, yield maintenance or other penalty
An Introduction to CMBS
Requires TI/LC escrows, real estate tax escrows, and capital expenditure reserves Non-recourse to the borrower Structured as single asset entity and special purpose vehicle
Same Same
25
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 26 53 65
Liquidity considerations
Liquidity Depth of investor base Total issuance for asset class Sector growth potential Issuer name recognition Issuer track record Established deal structure Transaction size/tranche size Public, private, 144A, ERISA, 2a-7, global offering, etc. Bid/ask spread
An Introduction to CMBS
27
10.50%
AA
$62MN
8.10%
$35MN
BBB
$35MN
Losses
BBB-
$7MN
10-year
BB
$35MN
1.25%
$18MN
Unrated
$18MN
Sequential pay structure with principal and interest applied first to senior classes and losses applied first to lower-rated bonds. Rating agencies determine subordination levels, which sets bond class sizes.
28
1996 AAA AA A
An Introduction to CMBS
BBB BBBBB B
29
Can include triple-A bonds swapped to floating rate using a balance guaranteed swap.
30
20.000% 12.375%
AAA
$279 MN
AAA
$213 MN
AA
$63 MN
$42 MN
BBB
$28 MN
10-year
Losses
An Introduction to CMBS
BBB-
$42 MN
BB
$14 MN
$7 MN
Unrated
Source: JPMorgan
$31 MN
31
Collateral Pool
nly
Interest Only
Inter est O
An Introduction to CMBS
5-year loans
7-year loans
10-year loans
tO res e I nt
P& I
P&I
I P&
nly
32
$ $ $ $ $ $
Original Maturity Term by Dollar Amount Original Maturity Term by Dollar Amount
181-240, 1% 121-180, 2% 60, 7% 61-84, 5%
An Introduction to CMBS
85-120, 86%
85-120, 88%
Source: JPMorgan
33
Balloon payment
An Introduction to CMBS
10-year loan
P&I
60
84
120
34
35
BONDS
A-2: 8/103/11
A-3B: 3/133/14
A-4: 5/151/16
Balloon repayments
Balloon payment
7-year loan
An Introduction to CMBS
LOANS
10-year loan
60
84
120
36
Tight-window 7-year AAA: Somewhat interest rate sensitive. Loans have exited hard lockout. May prepay via yield maintenance. Credit specific analysis required, focusing on loans with term dates that occur during bond repayment window Focus on loans with full-term IO, coupon dispersion from mean, low DSCRs 3 CDR type analysis does not apply Need to consider the possibility that loans may extend at their maturity date
37
Tight-window 10-year AAAs (A-4, A-M, A-J): Somewhat interest rate sensitive. Loans have exited hard lockout. May prepay via yield maintenance or freely prepay in the open period. Less credit specific analysis required, since bulk of loans maturing. 3 CDR type analysis does apply. We recommend a more realistic 0.5 CDR, 12 month lag to recovery, 35% severity of loss, 100% P&I advance by servicer. Can overlay loan-specific scenarios
An Introduction to CMBS
38
An Introduction to CMBS
Note: The general pricing scenario for IO structures assumes 100 CPR after lockout and yield maintenance (this is also referred to as 100CPY)
39
An Introduction to CMBS
40
An Introduction to CMBS
2001 2002 2003 2004 2005 33 36 46 57 55 $33.220 $35.347 $53.379 $71.449 $120.361 7 7 11 10 11 $2.556 $2.472 $2.765 $2.583 $4.066 5 7 8 9 9 547 892 513 923 428 859 344 810 297 711
41
42
An Introduction to CMBS
Many deals use a modified Pro-Rata Structure Partial pay down of junior bond classes pari passu with senior bond classes. Most of these deals have a trigger that switch to a sequential pay structure when only a few loans or less than 30% of the original principal balance remains Prepayment penalties are often used to compensate the IO; Extension fees often go to the loan seller.
44
Fre ely P
Yie ld Ma in
te na nc e
in ta
e bl ya pa re tP No
Interest
Principal
rep ay ab le
sh Ca ow Fl
Retained by seller
An Introduction to CMBS
45
An Introduction to CMBS
46
AAA Principal Bonds AA+ AA AAA+ A ABBB+ BBB+ BBB+ BBB+ BBB BBB BBB BBB- BBB- BBBL1 L2 L3 L4 L5
AAA IOs
An Introduction to CMBS
B1
B2
B3
B4
B5
B6
B7
47
AAA Principal Bonds AA+ AA AAA+ A ABBB+ BBB BBBAll Collateral (First Mortgages) Pooled
L1 L2 L3 L4 L5 L6 L7
AAA IOs
An Introduction to CMBS
B1
B2
B3
B4
B5
B6
B7
48
An Introduction to CMBS
49
Can an investor get a floating-rate CMBS that offers: The credit quality, diversification and subordination of a fixed-rate AAA bond. Any WAL from 5 to 10 years designed specifically to meet investor demand. Cash flow stability with respect to bond extensions or shortening? Yes, through a balance guarantee swap embedded in a fixed-rate triple-A conduit bond.
50
JPMCC 2005-LDP2 offered certificates Underlying bonds are positioned in the middle of the triple-A capital Class Rating WAL C/E structure and better protected than pure floating-rate CMBS from A-1 AAA 2.65 30.000%
A-2 A-3 AAA AAA 4.91 6.97 6.98 9.81 7.01 9.90 9.98 NA 9.98 9.98 9.98 9.98 9.98 30.000% 30.000%
30.000% 30.000% 30.000% 20.000% 12.750% NA 12.125% 10.750% 9.875% 9.000% 8.000%
20-30% subordination Bond can be selected to match investor WAL requirements Fixed coupon is guaranteed Most issuers price at least 1 conduit deal each quarter Consistent supply alleviates supply/demand imbalance Floating rate issuance equals about $15bn each year
Losses due to default
A-SB AAA A-M A-J X-2 B C D E F AAA AAA AAA AA+ AA AAA+ A
An Introduction to CMBS
Conduit issuance has grown steadily each of the past five years and totaled $136bn in 2005 These characteristics make triple-A CMBS excellent balance guarantee swap candidates
51
Investors
$ A-M Coupon (S + 32)
Trust
1 month Libor + 22
Swaption
An Introduction to CMBS
By issuing floating-rate liabilities, the Trust is exposed to the interest rate mismatch between the fixed-rate return earned on the assets and the floating-rate payable on the liabilities The Trust is required to execute a swap in order to eliminate any interest rate mismatch JPMorgan will agree to pay floating to the Trust in exchange for a set fixed rate In order to act as an effective hedge for the Trust, the swap must have a balance guarantee feature The swap is initially executed based on the initial size of the asset pool and amortizes based upon the expected amortization speed of the underlying collateral
52
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 26 53 65
U.S. conduit loans with interest-only periods U.S. conduit loans with interest-only periods
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2001 2002 Full 2003 Partial 2004 Amortizing 2005 1H2006
95%
8%
An Introduction to CMBS
90%
7%
85%
6%
80%
5%
75%
4%
2001Q1
2001Q2
2001Q3
2001Q4
2002Q1
2002Q2
2002Q3
2002Q4
2003Q1
2003Q2
2003Q3
2003Q4
2004Q1
2004Q2
2004Q3
2004Q4
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2006Q2
70%
3%
54
0.56%
An Introduction to CMBS
0.0% Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Jun-06
55
CMBS also exhibit low delinquency and default rates by property type
60+ Day Delinquencies (excluding FC/REO) and FC/REO rates by Property Type as of June 2006 60+ Day Delinquencies (excluding FC/REO) and FC/REO rates by Property Type as of June 2006
4.5 4.0 3.5 3.0 Percentage 2.5 2.0 1.5 1.0 0.5 0.0 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 0.0 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-05 Jun-06 Jun-06 Percentage 1.0
1.5
Office
0.5
Multi-Family
1.5
Retail
1.5
1.0
1.0 Percentage
An Introduction to CMBS
Percentage 0.5
0.5
0.0 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Jun-06
0.0 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Jun-05
56
C 0 0 0 0 0 0 0
Stable (%) Downgrade (%) 99.6 98.9 97.7 97.1 95.9 94.1 83.7 85.7 0.4 1.1 2.3 2.9 4.1 5.9 16.3 14.3
6.6 87.9
0.1 0.2
3.2 90.5
CC
57
* CMBS rating transitions measured between 1985-2005 ABS rating transitions measured between 1982-2005 Corporate rating transitions measured between 1982-2005 RMBS rating transitions measured between 1978-2005
Source: Standard & Poors
58
An Introduction to CMBS
7/98
1/99
7/99
1/00
7/00
1/01
7/01
1/02
7/02
1/03
7/03
1/04
7/04
1/05
7/05
1/06
Source: JPMorgan
Triple-A CMBS spreads have come back in from its recent wides in December 2005 as investors found that CMBS offered attractive spreads versus other sectors. Good performance in CMBS as well as less fixed-rate issuance in competing sectors, such as corporate bonds and ABS, should help maintain a strong technical backdrop for CMBS spreads.
59
Relative value trades: 10yr triple-A CMBS versus 10-year Agency debentures
10yr Triple-A CMBS basis 10yr Agencies Asset Swap Spread Spread Differential (bp) 10yr Triple-A CMBS basis 10yr Agencies Asset Swap Spread Spread Differential (bp)
55
50
45
40
35
30
25
20
An Introduction to CMBS
15 1/02
4/02
7/02
10/02
1/03
4/03
7/03
10/03
1/04
4/04
7/04
10/04
1/05
4/05
7/05
10/05
1/06
4/06
60
Relative value trades: Triple-A CMBS versus Single-A Corporate Bank paper
10yr Triple-A CMBS basis JULI US Banks A 7 - 10 Par Asset Swap Spread Differential (bp) 10yr Triple-A CMBS basis JULI US Banks A 7 - 10 Par Asset Swap Spread Differential (bp)
10
-10
-20
-30
-40
-50
An Introduction to CMBS
-60 1/00
5/00
9/00
1/01
5/01
9/01
1/02
5/02
9/02
1/03
5/03
9/03
1/04
5/04
9/04
1/05
5/05
9/05
1/06
5/06
Source: JPMorgan
10yr triple-A CMBS are currently trading near parity with single-A rated bank paper.
61
50
40
30
20
10
An Introduction to CMBS
1/01 4/01 7/01 10/01 1/02 4/02 7/02 10/02 1/03 4/03 7/03 10/03 1/04 4/04 7/04 10/04 1/05 4/05 7/05 10/05 1/06 4/06
Source: JPMorgan
10yr triple-A CMBS are currently trading near their widest spread differential to 30-yr current coupon FNMA paper.
62
Triple-A / triple-B CMBS credit curve has flattened dramatically this year
Triple-A CMBS basis Triple-B CMBS Spread Differential (bp) Triple-A CMBS basis Triple-B CMBS Spread Differential (bp)
115
105
95
85
75
65
55
An Introduction to CMBS
45 1/00
5/00
9/00
1/01
5/01
9/01
1/02
5/02
9/02
1/03
5/03
9/03
1/04
5/04
9/04
1/05
5/05
9/05
1/06
5/06
Source: JPMorgan
Triple-B spreads have rallied dramatically in early 2006 due to demand by CDO issuers and the search for assets with spread/yield.
63
64
Agenda
Introduction Market Overview Loan Structure Bond Structure Performance CMBS Derivatives
An Introduction to CMBS
1 12 18 26 53 65
66
There are two types of TRS: Traditional TRS (or TRS with duration): Receiver receives the total return of the index and hence is exposed to both spread and interest rate risk. Duration-neutral TRS: Version of TRS which removes interest rate risk and isolates spread risk (most common form today).
67
TRS Payer pays total return on CMBS Index, if return is positive. Return is composed of: 1.) Return due to price changes in underlying bonds over the holding period; 2.) return from reinvested interest and 3.) gain or loss from the return of principal (at par) on bonds that were priced at a discount or premium.
An Introduction to CMBS
TRS Receiver pays financing cost. In addition, if return is negative, Receiver must pay the Payer the absolute value of the return amount. TRS Receiver is exposed to interest rate risk embedded in an indexs total return and can choose to hedge that risk with an interest rate swap. TRS Receiver will pledge collateral equal to 1 to 5% of the notional amount of the trade depending on counterparty credit.
* The direction of the total return flows in the diagram reflects the assumption of a positive return on the index. If negative, the direction would be reversed.
68
Duration-neutral TRS focuses exclusively on the change in spread of a given index. Price changes in the index due to prepayments, defaults or interest rate movements no longer, or minimally, affect either party. TRS Payer pays the excess return of a given index, if return is positive. Netted with funding advantage
An Introduction to CMBS
TRS Receiver pays funding advantage. In addition, if return is negative, Receiver must pay the Payer the absolute value of the spread return amount. Similar to the traditional TRS, Receiver will pledge collateral equal to 1% to 5% of the notional amount. Unlike traditional TRS, an interest rate swap is unnecessary.
69
% of Index N/A
% of Main N/A
Other indices- Broad indices (e.g., Lehman ERISA, Lehman Investment-grade), BBB Index, Long investment-grade indices.
70
Credit enhancement and tranching create different rating levels, allowing involvement of a wide investor base.
71
Predominantly Commercial Banks, Insurance Companies Corporate Issuers, Hedge Funds Structures Almost exclusively Cash Flow in the late 1990s Often static pools (not actively managed; assets are administered and run-off) Portfolio is usually close to 100% ramped at closing In recent years, synthetic transactions allow for more efficient execution
72
ABS/CMBS/CDOs/Whole Loans and other Structured Products Issuers Asset Managers including money managers, hedge funds, banks and insurance companies Credit Structures Portfolio actively managed (invested/monitored/traded) Cash, synthetic or hybrid format Portfolio often not fully acquired at closing
73
Class A Notes
An Introduction to CMBS
Equity/First Loss
74
An Introduction to CMBS
75
Cash
Synthetic
2002
2003
2004
2005
2006YTD*
76
May be executed separately from other exposures to the same asset or Can not be easily attained in the cash market.
77
12,430
8,422 5,442
An Introduction to CMBS
632 1H2001
919 2H2001
1,563
2,192
2,688
3,779
1H2002
2H2002
1H2003
2H2003
1H2004
2H2004
1H2005
2H2005
Source: JPMorgan
78
Protection Seller
Long risk Sell CDS/Protection Receive fixed periodic payments Economically similar to owning a cash bond
Protection Buyer
Short risk Buy CDS/Protection Pay fixed periodic payments Economically similar to shorting a cash bond
Protection Buyer: The counterparty that wants to eliminate, or reduce, credit risk.
An Introduction to CMBS
The buyer pays a fixed periodic premium, which is quoted in basis points as a percentage of the notional amount of the trade. The premium amount is directly related to the riskiness (either perceived or real) of the reference asset: the riskier the reference asset, the greater the premium required. Protection Seller: The counterparty that wants to gain exposure to the reference asset. Collects periodic fixed payment from the protection buyer, but is obligated to pay the protection buyer in the instance a credit event occurs (e.g., write-down, interest shortfall or failure to pay principal).
80
Physical settlement
Protection Seller
Protection Buyer
Cash settlement
Source: JPMorgan
Protection Seller
Protection Buyer
An Introduction to CMBS
Physical Settlement: deliver bonds Limited cash bonds Possibility of short squeeze
81
Example
$10 million notional, annual premium of 135bp
Fixed payment
Protection Buyer
($10mn notional)*(1.35%)=$135,000
In the event of a write-down, the notional amount of the trade is written down by the amount of the floating payment
Protection Seller
Protection Buyer
82
Protection Seller
Protection Buyer
Protection Seller
Protection Buyer
Source: JPMorgan
83
Uncapped Mandates full reimbursement for the entire coupon that suffers a shortfall.
An Introduction to CMBS
Not limited to the fixed-rate premium paid by buyer. Protection seller may be required to pay the amount equal to (Shortfall-Premium) out of own pocket.
84
Percent of class not paid at termination date of CDS times notional balance
An Introduction to CMBS
Principal Writedown
85
86
2005 47%
BBB67%
Source: JPMorgan
Source: JPMorgan
CDS spreads have tightened, indicating more protection sellers than protection buyers
An Introduction to CMBS
87
70 50
An Introduction to CMBS
30 10 3-Month
Source: JPMorgan
6-Month
9-Month
1.00 Year 1.25 Years 1.50 Years 1.75 Years 2.00 Years
88
Fixed Rate Payments Floating Rate Payments Additional Fixed Payments Quotations Credit Event Settlement
Source: JPMorgan, Markit
89
Deal-level criteria: All bonds must be US dollar denominated, fixed-rate securities. The transaction must be rated by at least any two of Fitch, Moodys or S&P. The deals aggregate balance must be greater than $700mn. The deal must include securities with tranches rated AAA/Aaa, AA/Aa2, A/A2, BBB/Baa2 and BBB-/Baa3. In instances where there are more than one triple-A class with equal credit enhancement, the tranche with the longest weighted average life will be included. In instances where a tranche is split-rated, the lower of the ratings will be used.
An Introduction to CMBS
The securities must be collateralized by at least 50 separate mortgages that are obligations of at least 10 borrowers who are unaffiliated with each other or with the issuer of the CMBS transaction. The maximum concentration of any single property-type can not exceed 60% by dollar value. The maximum concentration in any single state must not exceed 40% by dollar value.
90
91
An Introduction to CMBS
20 21 22 23 24 25
Source: Markit
92
Total
S&P
Min
Avg. $12.4 $18.5 $16.8 $12.4 $10.8 $9.4 $17.3 $10.5 $10.9 $24.8 $14.4 $14.2 $11.5 $14.4 $21.5 $20.0 $16.4 $16.9 $18.2 $10.9 $7.0 $7.3 $11.4 $13.9 $16.8 $14.3
Other 3.8% 6.0% 9.3% 9.9% 3.5% 9.3% 5.2% 8.5% 3.0% 1.1% 9.8% 4.6% 0.9% 1.9% 2.7% 4.4% 3.6% 3.0% 8.9% 4.9% 9.4% 8.7% 2.0% 9.2% 14.5% 5.9%
09/15/2005 BACM 2005-4 09/30/2005 BACM 2005-5 12/16/2005 BACM 2005-6 12/09/2005 BSCMS 2005-PWR10 09/14/2005 BSCMS 2005-PWR9 10/20/2005 BSCMS 2005-TOP20 10/27/2005 CD 2005-CD1 10/26/2005 CSFB 2005-C5 12/14/2005 CSFB 2005-C6 10/20/2005 GCCFC 2005-GG5 12/02/2005 GECMC 2005-C4 01/25/2006 GMACC 2006-C1 11/18/2005 JPMCC 2005-CIBC13 09/22/2005 JPMCC 2005-LDP4 12/16/2005 JPMCC 2005-LDP5 08/15/2005 LBUBS 2005-C5 10/25/2005 LBUBS 2005-C7 01/20/2006 LBUBS 2006-C1 12/01/2005 MLMT 2005-CKI1
30.1% 42.8% 72.9% 100.8% 102.1% 29.2% 44.4% 73.6% 23.8% 37.8% 61.6% 14.0% 41.9% 55.9% 24.7% 43.5% 68.2% 17.8% 47.5% 65.3% 30.5% 48.4% 78.9% 16.2% 43.8% 60.0% 90.6% 98.0% 98.4% N/A 99.1% 93.5% 97.7%
$110.0 $1.0 $260.0 $1.0 $275.7 $1.0 $137.5 $1.0 $121.1 $0.5 $290.0 $1.3 $310.0 $0.5
38.6% 15.6% 23.6% 11.4% 1.5% 14.5% 42.5% 18.8% 10.1% 4.2% 15.8% 45.9% 22.0% 8.6% 26.4% 38.0% 40.1% 29.8% 14.9% 6.6% 26.0% 30.6% 25.3% 8.6% 29.0% 29.9% 29.1% 5.8% 33.0% 35.3% 29.8% 35.8% 14.1% 8.2% 29.9% 26.1% 29.2% 7.8% 36.1% 27.3% 22.2% 7.8% 44.7% 25.5% 20.8% 2.1% 4.2% 3.5% 1.2% 3.3% 2.3% 2.4% 5.7% 4.1% 8.8% 10.1% 7.6%
19.6% 45.9% 65.5% 95.2% 33.5% 22.0% 55.5% 83.1% 10.3% 60.1% 70.4% 93.9%
106.0% 104.3% $320.0 $1.5 105.9% 105.5% $122.0 $1.9 N/A $106.3 $1.0 N/A N/A 98.1% 91.8% 91.0% 97.9% 98.8% 99.9% 95.2% 83.8% 102.0% $180.9 $0.9 100.5% $349.7 $1.1 97.1% N/A N/A N/A 98.4% $335.0 $0.9 $285.1 $1.1 $285.1 $1.3 $420.8 $1.1 $255.0 $0.3
26.5% 50.0% 76.5% 96.8% 101.6% 24.4% 41.2% 65.6% 102.4% 29.0% 39.7% 68.7% 100.8% 34.3% 40.9% 75.2% 95.1% 37.3% 33.8% 71.1% 89.4% 40.5% 31.8% 72.3% 90.0% 41.6% 30.1% 71.7% 90.1% 19.6% 42.5% 62.1% 3.8% 65.7% 69.5% 16.3% 31.9% 48.2% 24.1% 35.2% 59.3% 36.6% 28.2% 64.8% N/A N/A N/A N/A N/A
29.6% 35.4% 18.6% 3.3% 11.1% 37.3% 34.9% 10.5% 11.6% 1.3% 50.1% 23.0% 12.2% 10.0% 1.2% 38.6% 26.9% 24.3% 43.4% 7.4% 21.4% 2.7% 8.4% 10.0% 5.0% 2.9% 2.1% 2.6% 3.8%
An Introduction to CMBS
12/16/2005 MLMT 2005-LC1 11/17/2005 MSC 2005-HQ7 10/12/2005 MSC 2005-IQ10 01/20/2006 MSC 2006-TOP21 10/14/2005 WBCMT 2005-C21 12/15/2005 WBCMT 2005-C22 Average
24.5% 33.2% 27.2% 7.3% 34.2% 23.8% 23.7% 7.4% 25.1% 49.2% 45.2% 15.7% 20.4% 6.9% 32.2% 31.0% 18.0% 9.1%
31.9% 48.3% 80.2% 100.7% 103.7% 101.1% $200.0 $0.6 21.6% 56.1% 77.7% 101.0% 104.1% 101.7% $162.5 $1.4 25.5% 42.1% 67.6% 95.3% 98.5% 98.3% $216.7 $1.0
* The statistics are based on rating agency presale reports so they may not reflect the precise composition at the launch of the indices. Source: JPMorgan, Rating Agency Presale Reports
93
An Introduction to CMBS
94
An Introduction to CMBS
95
CMBX.NA.AAA
10.00
7.50
-0.09
0.00
0.50
-2.50
CMBX.NA.AA
25.00
18.58
-0.04
-0.09
0.72
-6.42
80 60
CMBX.NA.A
35.00
30.12
-0.12
0.54
1.95
-4.88
40 20
CMBX.NA.BBB
76.00
71.67
-0.95
-1.33
5.03
-4.33
An Introduction to CMBS
0 AAA
AA 06/30/2006
A 06/23/2006
BBB
BBB-
CMBX.NA.BBB-
134.00
115.00
-0.19
-0.92
1.71
-19.00
At Roll Date
Source: Markit
96
CMBX.NA.AAA CMBX.NA.AA CMBX.NA.A CMBX.NA.BBB CMBX.NA.BBB7.5900 18.6200 30.2400 72.6200 115.1900 100.17% 100.18% $13.89 ($715.12) $1,739.88 $1,753.77 100.47% 100.47% $34.72 ($730.53) $4,687.48 $4,722.21 100.35% 100.36% $48.61 ($726.52) $3,502.77 $3,551.38 100.24% 100.25% $105.56 ($729.91) $2,411.23 $2,516.78 101.39% 101.41% $186.11 ($748.30) $13,914.72 $14,100.83
1.06 bp
2.55 bp
4.16 bp
9.95 bp
15.39 bp
97
Cash BBB- (LH Axis) CDS BBB- (LH Axis) Basis (RH Axis)
(5)
150
(10)
(10)
(15)
(15)
130 120 110 (25) 100 02/16/2006 02/21/2006 02/26/2006 03/03/2006 03/08/2006
Source: JPMorgan
(20)
110 100 03/08/2006
(25)
(30) 03/23/2006
Source: JPMorgan
98
An Introduction to CMBS
Percent Tightening Since Roll Date -25% -31% -21% -20% -17%
6-month Historical Cash Spread Volatility (bp) 1.37 2.12 2.45 10.00 13.00
99
Step
1. 2. 3. Net
An Introduction to CMBS
In this example, an investor would pick up 1bp by buying the CMBX.NA.AAA at 10bp instead of buying cash CMBS AAAs at S+26bp.
100
Conclusion
The growth of the CMBS industry has broadened its investor base and has increased their sophistication. This has led to more efficient structures Ability to gain/shed risk speculatively Transfer economic exposure without selling cash asset Hedge an existing portfolio Create structures otherwise impossible if one was limited to cash bond assets Should ultimately lead to more efficient pricing
An Introduction to CMBS
101
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