Commercial Mortgage-Backed Securities (CMBS)

Training 101

10 March 2017
Agenda

1. CMBS Deal Types:

• Private-label CMBS
• Agency (Freddie) CMBS
2. Hybrid Deal Types:
• Commercial Real Estate (CRE) - CLO
• Single-Family Rental (SFR)
3. Typical CMBS Transaction Review Process
4. The Focus of our Analysis: Loan and Property-Level Due
Diligence
5. Our Clients
6. CMBS Market Trends
7. Questions?

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 CMBS Deal Types
Private-label Deals and Agency Deals

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Private-label CMBS Deals

Feature Conduit Single-Borrower

Description Diverse pool of loans Typically one (or two) loans
meant specifically for contributed by a single
securitization, contributed borrowing entity. E.g. JP-ASH
by a team of loan sellers (portfolio or “trophy” property).
# Loans 40-75 1 or 2
# Properties 50-90 1-20
Pool Balance $800 million to $1.1 billion $350 million to $450 million
Balance per $12 million to $80 million $150 million or above
Loan
Loan Rate Type Fixed Fixed and/or Floating
Loan Term 10-year 3, 5 and 7-year
Property Type Diversified Concentrated
Geography Diversified Diverse or Concentrated

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Private-label CMBS Bond Structure
JPMCC 2017-JP5 Conduit

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Agency (Freddie) CMBS Deals
Freddie KF and KJ Platforms

Feature Freddie “KF” Freddie “KJ”

Platform Platform
Description Focused on recently- Exclusively junior-lien
originated, senior-lien supplemental (subordinate)
multifamily loans multifamily loans
# Loans 45-65 65-75
# Properties 45-65 65-75
Pool Balance $1 billion to $1.1 billion $210 million to $250 million
Balance per $20 million to $25 million $4 million to $5 million
Loan
Loan Rate Type Floating Fixed
Loan Term 7 and 10-year 5 and 7-year
Property Type Multifamily Multifamily
Geography Diversified Diversified

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Agency CMBS Deal Types
Wide range of Agency CMBS deal types under Freddie “K Series”

► Freddie K Series:
► K-000: multifamily with various terms, primarily 10-year

► K-500: 5-year term

► K-700: 7-year term

► K-F00: floating-rate
► K-J00: junior-lien
► K-P00: seasoned loans
► K-S00: multifamily (seniors housing)
► K-ABC: single-borrower
► MM00: tax exempt loans

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Agency CMBS Deals
High-Level: how do Freddie K-Series deals generally work?

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Agency CMBS Deals
High-Level: how do Freddie K-Series deals generally work?

► Origination:
► The asset pool is focused on recently-originated multifamily loans, the vast majority
of which support affordable rental housing.
► Multifamily rental housing is considered commercial – rather than residential – real
estate because these properties are developed and purchased for investment only.
► Collateral Tie Out:
► EY will work with Freddie primarily through the due diligence and tape tie out
process
► Thereafter will work with third-party banks on the offering documents.
► Structure:
► Two classes of bonds: guaranteed senior bonds and a related underlying private-
label trust that includes unguaranteed bonds known as subordinate and mezzanine
classes.
► Should credit losses materialize, those losses are initially borne by the private
investors who have purchased the subordinate bond.

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Agency CMBS Deals
High-Level: how do Freddie K-Series deals generally work?
► Investment Banks:
► Typically lead or co-managers/book runner(s) (e.g. Morgan Stanley and Credit
Suisse) act as third-party for the purchase of non-guaranteed certificates and
placement agent for guaranteed certificates.
► EY works with banks during the term sheet and offering document tie-out process.
► Rating Agencies:
► Class A are the senior certificates, which Freddie Mac guarantees.
► The senior guaranteed certificates (approximately $1 billion of the $1.2 billion in the
security) typically carry a AAA rating based solely on the quality of the underlying
collateral, and not based on the Freddie Mac guarantee.
► Rating agencies conduct independent reviews of the loans; typically, each fixed-
rate K-Deal is rated by two nationally recognized statistical rating organizations.
► Investor Base:
► Diversified, including conventional real estate investors who may view subordinate
bonds like other real estate equity investments; large institutional investors such as
life insurance companies and pension fund managers seeking high yield on
mezzanine bonds; and major financial institutions that treat the senior bonds as an
alternative to Treasury bonds.

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 Hybrid Deal Types
Commercial Real Estate (CRE) - CLO
Single-Family Rental (SFR)

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Hybrid CRE Deal Types

Feature Single-Family CRE - CLO

Rental
Description CMBS-led (review loan-side), static or actively managed pool
plus RMBS team (sample backed by commercial real estate
property-side) whole loan or participations with
future funding component
# Loans 75-165 15-30
# Properties 2,100-2,950 15-30
Pool Balance $800 million to $1.1 billion $275 million to $350 million
Balance per Loan $500 thousand to $12 million $15 million to $30 million
Loan Rate Type Fixed Floating
Loan Term 5 and 10-year 2 and 3-year with extension
options
Property Type single-family rental Diversified
Geography Diversified Diversified

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 Typical CMBS Transaction Review Process

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3 Key Phases of EY’s CMBS Transaction Review

1.
1. Loan
Loan File
File to
to Data
Data File
File Due
Due 2.
2. Red
Red Preliminary
Preliminary Offering
Offering 3.
3. Black
Black Print
Print
Diligence
Diligence Review
Review and
and Close
Close

• Term Sheet • Black Print

• Loan and property-level due  Top 10-15 Loans
diligence  Maps, Site Plans and Layouts • Red and
Black AUP
• Accounting tape exception • Preliminary Prospectus (“the Reports and
listings book”) “Tick
Pages”
• Annex A-1 (condensed tape)
• Tape “tie-out” and Footnotes • Transaction
Close
• Loan File to Data File Agreed- • Annex A-2 (Strat Tables) and
Upon Procedures (AUP) Report Footnotes

• Bond Structure package • Schedule AL

received after tie-out • EY Sign Off and Red Print

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 The Focus of our Analysis:
Loan-Level and Property-Level Due Diligence

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Loan-Level Due Diligence

Sourced from “legals” support documents, we focus primarily

on the following items:
Payment (“Money”) Terms
► Principal Amount, Interest Rate, Monthly Debt Payment, Amortization Type, etc.
► Payment terms dictate the amount of cash flows paid to investors
Prepayment Provisions
► Prepayment “String”, Defeasance, Yield Maintenance, Partial Releases, etc.
► Prepayment Provisions dictate the timing of cash flows paid to investors
Cash Management Terms
► Cash Management terms dictate control of cash flows generated from the property
Reserves
► Tax, Insurance, CapEx / FF&E, TI/LC Reserves, Required Repairs, etc.
Additional Debt
► Pari Passu, Subordinate B-Note, and Mezzanine

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Property-Level Due Diligence

Sourced from “third party” support documents, we focus primarily

on the following items:

Appraisal
►Property Type, Appraised Value, Year Built/Renovated
Property Condition Report (PCR)
►Seismic Zone
Environmental Site Assessment (ESA)
►Recognized Environmental Conditions (Need for Phase II / Insurance / Reserve)
Rent Roll
►Square Footage / Units / Rooms, Largest Tenants, Current Occupancy, Lease Expirations
Insurance Summary
►Insurance Certificates
Underwriting
►Historical Financial Results, UW Financials (Revenue, Vacancy, Expenses, NOI, NCF),
Hotel Metrics

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CMBS vs. other SFAS Asset Classes
Overall, how is CMBS deal review unique?

CMBS has some key differences from the other asset classes, which
make it particularly unique:
Feature
# Loans and Properties
Unique Loan and Property
Features
Collateral Stratification
Loan/Prop-Specific
Disclosure in Offering Docs
Diversity in Property Types
Level Impact
Low Review entire pool. No sampling
High In-depth loan reviews and large #
of tape characteristics (200+)
Yes Exception being Single Borrowers
High Top 10-15 Loans Profiled in Term
Sheet and collateral-specific
disclosures in Prelim Prospectus
High High-profile properties (e.g. Sears
Tower, EY 5 Times, Google, Riot
Games campus) hotel, retail, mall,
office, multifamily, mixed use,
industrial, storage and
manufactured housing.

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 Our Clients

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CMBS Group Client Base
Core (Investment Bank, GSE) and Emerging (SFR and CRE CLO)

Core: top banks such as JP Morgan and Goldman, as well as Freddie Mac

Emerging: However, more recently we have diversified through acquisition of

additional clients related to our single-family rental and CRE CLO transaction
review offerings.

Investment Banks Government (GSE) Various

• JP Morgan • Federal Home Loan • Arbor Realty
• Citigroup Mortgage Corporation • Ares Capital
• Barclays (Freddie Mac) • Blackstone
• Goldman Sachs • Colony Capital
• Morgan Stanley • Greystone
• Deutsche Bank • KeyBank
• Cantor Fitzgerald • Starwood
• Bank of America • Benefit Street

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 Key CMBS Securitization Participants
Investment Bank and Lawyers – Our Primary Points of Contact
Accounting Firm Rating Agency Lawyers
• Evaluate collateral Rate • Outline Legal Terms
Due Legal
• Collateral tie out quality Certificates Documentation
Diligence • Oversee offering docs
• Structure tie out • Determine • Primary contact for EY
subordination levels for prospectus
review process

Investment Banks Certificate Investors

Deposit • AAA
• Loan Sellers Issue
Mortgage • AA
Certificates
Loans Newly Formed • A
• Deal Bookrunners CMBS Trust • BBB
• Primary contact • BB
for collateral and • B
structure tie out • NR

Trustees Master Servicer Special Servicer

Fiduciary of the Collect P&I Services Service

Trust Payments Delinquent Loans Loans/
Oversee Trust
Investor and Tax Advances P&I “Works out” or
Reporting Payments Forecloses

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 CMBS Market Trends

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CMBS Issuance: Pre and Post Crisis
Primary market issuance of CMBS fell from approximately $229 billion USD in 2007 to just $3 billion USD in
2009, followed by recent strength in recovery.

Issuance (US$bn)
250.0

200.0

150.0

100.0

50.0

0.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Est.
Sources:
Commercial Mortgage Alert (1996-2015) Issuance (US$bn)
S&P Global Market Intelligence (2016 estimate)

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CMBS Conduit Pricing (Spread over Swaps)
Issuance and Sensitivity to Spreads
New issuance CMBS bonds are priced relative to their benchmark swap rate –i.e. a spread over the 10-year US
Treasury Rate. For example, if the pricing rate for a 10-year AAA CMBS bond is 4.25% and the 10-year Treasury
note swap is yielding 3%, then the spread is 125 basis points over the 10-year swap. Thus, a spread widening =
sign of perceived increase in credit risk

The CMBS issuance market for 2016 started with pronounced spread widening, to levels not seen since the Euro
crisis in 2011, primarily a result of broader macro volatility in global capital markets and regulatory uncertainty.
However, 2016 ended with considerably tighter spreads, as illustrated below in comparing Q1 vs. Q4 2016.

Deal Size Risk Retention 3Yr 5Yr 7Yr

Pricing Date Deal Name ($mn) Compliant AAA AAA AAA 7Yr AAA A-SB 10Yr AAA
1/27/2017 CD 2017-CD3 1,327 L-Shaped 32 50 77 90
12/14/2016 CSMC 2016-NXSR 607 Vertical 44 56 98 115
12/9/2016 WFCM 2016-C37 751 43 56 111 101 115
12/9/2016 CFCRE 2016-C7 653 45 106 118
12/7/2016 CGCMT 2016-P6 913 42 56 114 99 114
12/6/2016 MSBAM 2016-C32 907 43 80 98 113
12/5/2016 JPMCC 2016-JP4 998 42 53 98 110
11/22/2016 MSC 2016-UBS12 824 36 53 100 112

3/3/2016 COMM 2016-DC2 806 80 105 160 173

2/23/2016 JPMBB 2016-C1 1,022 80 90 171 150 166
2/19/2016 MSC 2016-UBS9 667 80 165 149 165
2/18/2016 WFCM 2016-NXS5 875 68 90 167 150 165
2/12/2016 MSBAM 2016-C28 956 68 90 150 165
2/3/2016 WFCM 2016-C32 960 68 85 139 151
2/3/2016 CGCMT 2016-GC36 1,156 70 89 162 144 157
1/27/2016 COMM 2016-CR28 1,027 70 87 142 155
Sources: J.P. Morgan, Commercial Mortgage Alert, Bloomberg, Commercial RealEstate Direct

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CMBS Investor Base
Dynamic Buyer Base and Growth in Specialized Investors
This year, insurance and pension funds overtook asset managers as the primary buyers of AAAs, the former rising
from 32% of purchases in 2015 to 50% as of YE 2016, while asset managers diverted some of their attention
further down the credit quality stack, seeing their AAA share fall from 57% to 36%.

Hedge funds reduced their share of BBB purchases substantially in 2016, as the space came to be dominated by
specialized real estate investors, who also comprise the bulk of B-piece purchasers. As hedge fund demand has
faded, the same investors bidding to be the controlling certificate holder (B-piece) have stepped in, having already
completed the credit analysis.

Source: J.P. Morgan

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CMBS Investment Risk Factors

► Loan-level: floating interest rate risk, balloon payment risk, additional

debt, prepayment risk, and LTV/DY/DSCR metrics tied to leverage and ability
to meet debt service.
► Property-level: tenant vacancy or termination rights, proximity to
competing properties, revenue vs. operating expenses, age and renovation
requirements.
► Economic: national, regional or local economic slowdown, industry
slowdowns, unemployment rate, demographics, and consumer preference.
► Market Risk: global macro volatility, interest rates, pricing spreads,
regulatory demands, CRE lending environment, and changes in investor
appetite.

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“Wall of Maturities” and Refinance Risk

► A $90 billion wave of maturing commercial mortgages is coming due, as

leftover debt from the 2007 lending boom. It’s getting more difficult for
Borrowers to find new loans to pay off the old ones, leading to forecasts for
higher delinquencies.

► Obstacles to Refinancing: tighter lending standards (debt service metrics),

lender risk-aversion for certain geographies and property types, concerns
regarding overheated CRE valuations, interest rate risk, etc.

► Delinquency Rates: forecast to climb by as much as 2.4 percentage points to

5.75 percent in 2017, according to Fitch Ratings. That sets the stage for
bondholder losses, but if 2015 and 2016 are potential benchmarks for
impact, then the risk should be relatively manageable (as supported by
forecasts from JP Morgan).

Source: Bloomberg, January 24, 2017

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Big Short 2.0?
CMBS, Retail, and the Rise of E-Commerce Dominance

► Analysts at Deutsche Bank Recommend Shorting Opportunity: one of the biggest

underwriters of bonds tied to U.S. commercial mortgages, recently issued a report
suggesting CMBS with disproportionally high exposure to retail property could be the
next “big short”.

► E-Commerce Effect: a combination of bankruptcies and closures could lead to faster-

than-expected mortgage defaults for stores and malls, as long-term pressure from
internet competitors wears many companies down, the analysts wrote.

► Deutsche Bank recommends that investors bet against two series of indexes of
commercial mortgage bonds: one from 2012, and another from 2013, a trade that
amounts to shorting the underlying securities. Those indexes have larger exposure to
malls than their more recent counterparts. Specifically, they advised buying credit
default protection on the parts of CMBX indexes that are a single step above junk,
known as the BBB- tranches.

Source: Bloomberg, February 8, 2017

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JP Morgan 2017 CMBS Market Outlook
Conservatively Optimistic

 Regulation – Risk Retention (first effective year for CMBS). Per JP Morgan
research, the CMBS market has thus far digested RR-compliant deals
without widespread, significantly negative impact. However, the same
uncertainty expressed last year still remains as deals continue to test the
market in 2017.

 Origination Volume: modest increase with an estimate of USD $75-80 bn

compared to $70 bn in 2016. No dramatic pullback in issuance is expected.

 Investor Demand: a notable portion of the existing buyer base of CMBS, per a
JP Morgan survey, expect to increase their allocations in 2017.

 Modest Spread Tightening: assuming modest increase in new issue supply

is met with steady demand and market volatility remains in check.

Source: J.P. Morgan Research - 2017 CMBS Market Outlook

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Questions?

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