®

CMBS 101
CMBS 101®
An Introduction To Commercial
Mortgage Backed Securities
(CMBS)

Prepared by

The Education/Research Committee of

the Commercial Mortgage Securities
Association
Joseph Franzetti, Citigroup Global Markets

Gale Scott – Standard & Poor’s

2
The CMBS Process
 The Participants in a Securitization
6
Investors
5
Securities
Investors Trustee/
Fiscal Agent

Investors
33 4
1 2 3 Depositor (SPE)
Loan
Mortgage
Borrowers Originator/ Issuer/
Bankers
Loan Seller Investment Banker

Primary or
Sub Servicer
7

Master
Financial Engineering Servicer 77
Statements Appraisals
Reports

Agency

Agency

Agency

Agency
Rating

Rating

Rating

Rating
Special
Servicer

2 months (Loan Funding) + 2 months (Bond Issuance)

4
The Participants in a Securitization

1 Borrower: Owns the property, has repayment and performance obligations

2 Mortgage Banker: Intermediary between borrower and loan originators/loan sellers

3 Loan Originators/ Lends money to the borrower, secured by a first priority lien, enters into a mortgage loan purchase
Loan Sellers: agreement (“MLPA”) to sell the loan to the securitization depositor

4 Depositor: An entity set up by the investment bank sponsoring the securitization purchases commercial mortgage
loans and immediately sells loans to a trust.

4 Investment Banker: Overall responsibility for structuring the securitization, selling the bonds/certificates to investors, helps
maintain a liquid secondary market for trading the bonds/certificates.

4 Issuer: The trust is the record owner of the commercial mortgage loans, formed by the depositor pursuant to a
pooling and servicing agreement (“PSA”).

5 Trustee: Responsible for administering the trust on behalf of and making payments to the investors.

6 Investors: Different investors with varying risk appetites purchase certificates rated from AAA/Aaa to B/B to and
unrated certificates.

5
The Participants in a Securitization

7 Master Servicer: Responsible for servicing all mortgage loans owned by the trust.

7 Primary or Sub May be the originating mortgage bankers, often the initial point of contact for the borrower.
Servicer:

7 Special Servicer: Named at the issuance of the CMBS to be responsible for servicing any mortgage loans that may
default in the future.

8 Rating Agencies: Assigns risk of loss ratings on certain bonds/certificates issued for a securitization transaction, monitors
performance after securitization funds.

6
The Participants after the Securitization is Completed

Investors

Investors Trustee/
Fiscal Agent

Investors

Investment Bank/ Trust

Secondary Traders

Borrowers

Master Servicer

Rating Agencies
Primary or Sub-Servicer /
Mortgage Banker

Special Servicer

7
 Where the Money Goes
Loan Originator /
Assignments of Rents and Leases
Loan Seller
(Lender)
Loan Proceeds

Mortgage Securities Sale

Notes Proceeds at Closing

Servicer- Trustee-
Debt Service Debt Service
Borrowers Collection Distribution
& Escrows Less Servicer Fee
Account Account
Plus Advances
Monthly
Bond Securities Sale
Coupon Proceeds at Closing
& Principal

Securities

Investors

8
 Transaction Timetable

Activity 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Participant
Initial analysis LO, IB
Due diligence for securitization LO, IB, SC
Structuring process LO, IB
B-buyer due diligence LO, IB, BB

Rating agency review LO, IB, RA

Selection of servicer & trustee LO, IB, SV
Legal documentation, both ALL
private & public securities offering
Pre-marketing of securities IB, Inv, RA

Marketing / pricing
Private offering: IB, Inv, BB, RA
Pricing of below-investment grade
Public offering: IB, Inv, RA
Pricing of investment grade
Closing of securities ALL

LO Loan Originator SV Servicer UC Underwriter's Counsel Inv Investor

IB Investment Bank RA Rating Agency SC Seller's Counsel BB B-Piece Buyer
9
Build-A-Bond
 Hypothetical Structure: Credit Tranching
Last Lowest
Loss Risk

$85MM
Investment Grade
CMBS:
Aaa/AAA

Loss Position
$9MM

Credit Risk
Other Investment Grade:
Aa2/AA
A2/A
$100MM
Baa2/BBB
Pool of Mortgages
$4MM
Non-Investment
Grade CMBS:
Ba2/BB
First Highest
B2/B
Loss Risk

$2MM
Non-Rated CMBS

11
 Basic CMBS Structure — $100 MM, 10-Year, Fixed Rate

Class Size Rating Coupon Expected Life Subordination

Class A $85 MM Aaa / AAA 5.25% 9 years 15%

Aa2/AA
Class B $9 MM A2/A 5.50% 9.5 years 6%
Baa2/BBB

Ba2/BB
Class C $4 MM 7.50% 9.75 years 2%
B2/B

Class D $2 MM NR — 10 years —

NR = Non-Rated

12
 Senior / Subordinated Structure — 10 Year Security

First After After After

9 years 9.5 years 9.75 years 10 years

A A
P+i A
A A A

Mortgage
Pool
i B P+i B B B
i i
C C P+i C
C
i i
D i D D P+i D

13
 Basic CMBS Structure

Class Rating Size Subordination Coupon

A Aaa/AAA $85MM 15% 5.25%
Aa2/AA
B A2/A $9MM 6% 5.50%
Baa2/BBB
C Ba2/BB $4MM 2% 7.50%
B2/B
D NR $2MM 0 ---

Subordination could be calculated as follows for Aaa/AAA level stress:

Foreclosure Frequency X Loss Severity =

30% X 50% = .15 or 15% coverage or subordination

14
 Hypothetical Class Structure

Loss Coverage/
Rating Size Loss Frequency Loss Severity
Subordination
Aaa/AAA $85MM 15% = 30% X 50%
Aa2/AA $3MM 12% = 30% X 40%
A2/A $3MM 9% = 30% X 30%
Baa2/BBB $3MM 6% = 20% X 30%
Ba2/BB $2MM 4% = 20% X 20%
B2/B $2MM 2% = 10% X 20%
NR $2MM — — —

15
 How To Decide How Much Subordination?
Loss Rate Scenarios
Default No Default
19.6% 80.4%

Liquidated Restructured Become Current

55% 25% 20%

Loss Rate Loss Rate Loss Rate

33% 16.5% 0%

Equally Weighted Portfolio Loss Rate =

(0.196)(0.55)(0.33) + (0.196)(0.25)(.0165) + (0.196)(0.20)(0)

.0436 or 4.36%
0.0356 + 0.008 + 0 =

Source: Morgan Stanley. “Update: Commercial Mortgage Defaults: 30 Years of History.” September 2004
(Cumulative loss rates for about 18,000 commercial mortgages originated by eight life insurance companies between 1972 and 2002.)

16
 Basic CMBS Structure
$100 MM, 10-Year, Fixed Rate with Interest Only Strip (IO)
Class Size Rating Coupon Average Life Subordination

Class A-1 $85 MM Aaa / AAA 5.00% 9 years 15%

Class A-X Notional1 Aaa / AAA 0.25% Not Meaningful1

Aa2/AA
Class B $9 MM A2/A 5.50% 9.5 years 6%
Baa2/BBB

Ba2/BB
Class C $4 MM 7.50% 9.75 years 2%
B2/B

Class D $2 MM NR — 10 years 0%

1 For illustration purposes, the INTEREST ONLY (IO) strip collects interest of 0.25%, or 25 bp on a NOTIONAL amount of $85MM. The notional amount could be the same as
the size of an associated class or the size of the entire security. Here, the interest on Classes A-1 and A-X total the coupon of Class A alone in the earlier example.

17
 Hypothetical Class Structure

Spread At Issue
Class Size Rating Coupon (“C”) (Yield, or “Y”) Average Life
A-1 15% Aaa/AAA 5.25% PR 70 bp 5 years
A-2 70% Aaa/AAA 5.30% PR 75 10 years
B 3% Aa2/AA 5.45% PR 90 10 years
C 3% A2/A 5.55% PR 100 10 years
D 3% Baa2/BBB 6.00% PAR 150 10 years
E 2% Ba2/BB 6.50% D 300 10 years
F 2% B2/B 6.50% D 700 10 years
G 2% NR 6.50% D 1200 10 years

IF Y < C, then it is a premium bond (PR)

IF Y = C, then it is a par bond (PAR)
IF Y > C, then it is a discount bond (D)
Assumptions:
5-year Treasury = 4.4%
10-year Treasury = 4.5%

18
The CMBS Market
 Holders of Commercial & Multifamily Mortgage Loans
$626 billion of the $2.5 trillion U.S. commercial and multifamily mortgage loans
outstanding are held as securities, a significant increase since 1990

1990 2005 3Q

CMBS Issuers
4%

Commercial Life Insurance Commercial CMBS Issuers

Banks 36% Cos. 22% Banks 43% 25%

Savings Life Insurance

Institutions Cos. 10%
18%
Others 18% Others 11%
Government Savings
Government
Sponsored Institutions
Sponsored
Enterprises 8%
Enterprises
2%
3%

Source: Federal Reserve, Flow of Funds

20
 CMBS Issuance: U.S. and Non-U.S.
($ Billions)

250 69

200

150
34

23 21
100
29 169
1
9
12

50 4 93
1 74 74 78
3 1 57
0 0.3 49 52
1 1 37
17 17 26
8 14 16
0 3
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

Domestic Non-US
Source: Commercial Mortgage Alert.
21
 U.S. CMBS Issuance
($ Billions)

180
169.2

160

140

120

100 93.1

77.8
80 74.3 74.4

60 56.6
48.7 52.1

40 36.8
26.4
20 14.0 17.2 17.4 15.7
7.6
3.4
0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

Source: Commercial Mortgage Alert

US only, non-agency, non-CDO. 22
 Issuance ($ billions)

10
20
30
40
50
60
70

0
90 1Q
90 3Q
91 1Q
91 3Q
92 1Q
92 3Q
92 1Q
93 3Q
94 1Q
94 3Q

Source: Commercial Mortgage Alert and Federal Reserve

95 1Q
95 3Q
96 1Q
96 3Q
97 1Q
97 3Q

23
98 1Q

US CMBS Issuance
98 3Q
99 1Q
99 3Q
00 1Q
00 3Q
10-Yr Treasury 01 1Q
01 3Q
02 1Q
02 3Q
03 1Q
03 3Q
04 Q1
U.S. CMBS Issuance and Interest Rates

04 Q3
05 Q1
05 Q3
3
4
5
6
7
8
9

10-year Treasury (%)

 Multifamily Mortgage Securitization
700 40%

600 35%

30%
500

Share of total securitized

25%
400
$ Billions

20%
300
15%

200
10%

100 5%

0 0%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
3Q

Multifamily Mortgages Outstanding Securitized Share of Total Securitized

Source: Federal Reserve, Flow of Funds

24
 Commercial Mortgage Securitization
2000 25%

1800

1600 20%

1400

Share of total securitized

1200 15%
$ Billions

1000

800 10%

600

400 5%

200

0 0%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
3Q

Commercial Mortgages Outstanding Securitized Share of Total Securitized

Source: Federal Reserve, Flow of Funds

25
 Single Family and Commercial/Multifamily Securitization
70.0%
Market Penetration
60.0%
59.6%

50.0%
Share of outstandings

40.0%

30.0%
23.7%

20.0%

10.0%

0.0%
4)

4)
1
2
3
4
5
6
7
8
9
10
11
12
13

15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
00

00
(2

(2
14

34
Commercial/Multifamily (year 1=1991) Single Family (year 1=1971)

Source: Federal Reserve, Flow of Funds

Date through 2004, year 14 (CMBS) and year 34 (Single Family) 26
 CMBS Issuance: Shift from RTC to Conduits
80

70

60

50
$ Billions

40

30

20

10

0
1990 1991 1992 1993 1994 1995 1996 1997 1998

RTC* Conduit Issuers Other Issuers

Source: Commercial Mortgage Alert

* RTC: Resolution Trust Company 27
 Au
g-

0
50
100
150
200
250
300
350
9
De 6
c-
9
Ap 6
r- 9
Au 7
g-
9
De 7

Source :Morgan Stanley

c-
9
Ap 7
r- 9
Au 8
g-
9
De 8
c-
9
Ap 8
r- 9
Au 9
g-
9
De 9
c-
9
Ap 9

Aaa/AAA
r- 0
Au 0
g-
0
De 0
c-
0
Ap 0
r-

Aa2/AA
Au 01

28
g-
0
De 1
c-
0
Ap 1
r- 0

A2/A
Au 2
g-
0
De 2
c-
0
Ap 2
r- 0
Au 3
g-
0
Baa2/BBB
De 3
c-
0
Ap 3
r- 0
Au 4
g-
0
De 4
c-
0
Ap 4
r- 0
Au 5
g-
0
De 5
c-
05
CMBS Spreads Over 10-Year Treasury: Investment Grade

0
50
100
150
200
250
300
350
 Au
g-

0
100
200
300
400
500
600
700
800
900
1000
1100
9
De 6
c-
9
Ap 6
r-
Au 97
g-
9
De 7

Source: Morgan Stanley

c-
9
Ap 7
r-
Au 98
g-
9
De 8
c-
9
Ap 8
r- 9
Au 9
g-
De 99
c-
9
Ap 9
r- 0
Au 0
g-
De 00
c-
0
Ap 0
r- 0
Au 1

Ba2/BB

29
g-
De 01
c-
0
Ap 1
r- 0
Au 2

B2/B
g-
De 02
c-
0
Non-Investment Grade

Ap 2
r- 0
Au 3
g-
0
De 3
c-
0
Ap 3
r- 0
CMBS Spreads Over 10-Year Treasury:

Au 4
g-
0
De 4
c-
0
Ap 4
r- 0
Au 5
g-
0
De 5
c-
05
0
100
200
300
400
500
600
700
800
900
1000
1100
 Au
g-

0
20
40
60
80
100
120
140
160
180
200
9
De 6
c-
9
Ap 6
r- 9
Au 7
g-
9
De 7

Source: Morgan Stanley

c-
9
Ap 7
r- 9
Au 8
g-
9

Gap
De 8
c-
9
Ap 8
r- 9
Au 9
g-
9
De 9
c-
9
Ap 9
r- 0
Au 0
g-
0
De 0
c-
0
Ap 0
r-

CMBS Aaa Spreads (10-year)

30
Au 01
g-
0
De 1
c-
0
Ap 1
r- 0
Au 2
g-
0

Swap Spread
De 2
c-
0
Ap 2
r- 0
Au 3
g-
0
De 3
c-
0
Ap 3
r- 0
Au 4
g-
0
CMBS Spreads and Swap Spreads

De 4
Average Gap of Period

c-
0
Ap 4
r- 0
Au 5
g-
0
De 5
c-
05
0
20
40
60
80
100
120
140
160
180
200
 Market Size Comparison
(as of 12/31/04)
600
$548

500

400
$359
$ Billions

$290
300
$264

200

100

0
REITs Market Cap 1 Microsoft Market Cap GDP of Switzerland Commercial and
(largest in NYSE) 2 (17th largest) 3 Multifamily
Securitizations 4
Source : (1) NAREIT; (2) Microsoft Website; (3) World Bank; (4) Federal Reserve, Flow of Funds
31
 Market Size Comparison
(as of September 30, 2005)
10 10

9
$8.8 9

8 8

7 7

6 6
$ Trillions

$5.2
5 $4.6 5

4 4
$3.0
3 $2.5 3

2 2

1 1

0 0
All Commercial + Corporate Bonds US Government Single Family Single Family
Multifamily Mortgages Securities Securities Mortgages
Current CMBS Outstandings
Source: Federal Reserve, Flow of Funds
32
Investors of CMBS
 Who Buys CMBS?

 Institutional fixed income securities investors buy public bonds

 Real estate high yield investors buy private bonds
 Varies by class, by rating, by structure, by underlying collateral

34
 Investors of CMBS in 2004
Banks
25%

Insurance Companies
24%

Government
Sponsored Entities
9%

Opportunity Funds
Finance Companies
Pension Funds
Investment Advisors/
14%
Money Managers
28%

Source: Morgan Stanley

35
 Why?

 Yield differential (relative value investing)

 Credit performance
 Asset allocation (satisfy allocation to real estate debt)
 Non-correlated risks (compare to MBS and corporates)
 Comparative Credit Risk
Remember:
 Credit Risk ≠ Yield

36
 Yield Differential
(10-Year Sector; Yield over Treasury)
100
88
90

80 78 77
Basis points over Treasury

70 65
62
60 56

50
42
40 36

30

20

10

0
Aaa CMBS Agencies Aaa Credit Card ABS Single-A Industrials

Recent (as of 12/09/05) 6-Month Average

Source: Merrill Lynch

37
 Credit Performance
Corporate vs. CMBS Bond Defaults: 1990–2003 (%)

–––––– Cumulative Defaults –––––

Corporate CMBS

Investment Grade 2.10 % 0.10%

Below Investment Grade 55.00% 1.61%
All Bonds 11.00% 0.19%

–––– Average Annual Defaults –––

Corporate CMBS

Investment Grade 0.15% 0.01%

Below Investment Grade 3.94% 0.12%
All Bonds 0.78% 0.01%

Maturity of markets
Position in Asset Class
Past performance is no guarantee of future success
Source: FitchRatings

38
 Satisfying Asset Allocation to Real Estate Debt

 Risk based capital treatment for insurance companies gives advantage to CMBS

 Mortgages = 3% Risk Based Capital (depending on insurer’s experience)

 Investment Grade Public Securities = 0.3% Risk Based Capital

 Cost of management (direct loan vs. securities investment)

 Liquidity (ease of trading in and out of the portfolio)

 Creates diversified investment portfolio

39
 Non-Correlated Risks

CMBS MBS Corporates

PRIMARY RISK Real estate credit risk Prepayment risk Corporate credit risk

MATURITY Some extension risk No extension risk No extension risk

DEFAULT DSCR is a predictor of default LTV is a predictor of default risk Corporate credit risk a better
risk predictor of default risk

LIQUIDITY Growing but smaller overall Highly liquid market Highly liquid market
market than MBS and corporates

INFORMATION Different for public buyers versus Widely disseminated Widely disseminated
private buyers

40
 Investing in Non-Correlated Risks

CMBS MBS Corporates

RATING AGENCIES 10 years of experience 30 years of experience 100 years of experience

SECURITY Set pools of assets; first priority Set pools of uniform assets; first Unsecured; investors exposed to
mortgage liens priority mortgage liens future decisions at the
corporation

PERFORMANCE Should outperform MBS and More interest rate sensitive Interest rate sensitive
corporates in falling rate
environment

RATINGS Volume of AAA and Non- Almost all AAA and AA Mostly A, BBB
Investment Grade

41