THE CMBS MARKET IS HUGE ... AND LARGELY A MYSTERY
The CMBS (Collateralized Mortgage Backed Securities) market has fundamentally changed the landscape in the United States for commercial real estate finance--the legal structure, ownership, management, and rules of the game. Securitization (1) has also forever altered the behavior of the participants and consequences that follow in the mortgage default dance. (2)
By 2000, the Federal Reserve estimated that 19 percent, or almost one-fifth, of all outstanding commercial mortgage debt in the United States was securitized. This amounts to almost $281 billion in mortgage loans. The amount has been growing at more than $50 billion per year and is expected to continue growing at this rate for a decade or more.
Since the early 1990s, CMBS-financed loans may have been the most attractive and available loans for many borrowers, such as hotel owners and operators. They almost certainly have provided better execution than competing portfolio lenders, but the servicing and other restrictions on handling troubled loans will present many problems for borrowers in the next downturn as their loans get into trouble.
Given the pervasive "success" of CMBS financing, it is nothing short of amazing that so many borrowers and their advisors appear to have little understanding of the process, structure, and practical implications of their securitized debt or how to deal with it when times get tough. This article looks at a number of these issues and offers some explanations.
Given the strong sudden downdraft in the hospitality industry, this background may be particularly valuable for owners of hospitality properties financed with securitized debt.
HOW CMBS BECAME SO DOMINANT
Although securitization of residential real estate is both well-defined and mature, securitization of commercial real estate is a relatively new phenomenon and virtually untested by recession or other economic distress.
For years, commercial real estate was primarily financed by banks, thrifts, life insurance companies, and pension funds. But all this changed in the late 1980s, when the nation faced protracted economic downturn and a banking and S&L crisis of historic proportions. A virtual collapse in commercial real estate finance ensued in the early 1990s.
Taking a page from an earlier test balloon, (3) and faced with billions of dollars of troubled commercial real estate loans, the RTC helped launch the secondary market for this product. By 1993, the RTC's commercial real estate loan pools aggregated almost $14 billion. The rest is history.
Take note! This market has never been tested by the very economic stress that gave it birth. We expect many business and legal developments to evolve when it is. And the time may be close at hand. According to a recent PKF study, 36 percent of the hotels in the United States are expected to default in meeting debt service in 2002. Many of these loans have been financed from CMBS-driven sources.
NEW PARADIGMS REPLACE OLD ONES--THE FUNDAMENTALS
In contrast to traditional, non-securitized commercial real estate loans, the structure for CMBS loans is far more complex. A bank, mortgage...
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