Mortgage backed securities (MBS) come in two main varieties; commercial mortgage backed securities (CMBS) and residential mortgage backed securities (RMBS). While CMBS are backed by large commercial loans, referred to as CMBS or conduit loans, RMBS are backed by residential mortgages, generally for single family homes. Residential mortgage backed securities may be backed by a variety of different kinds of residential loan products, such as home equity loans, as well as FHA loans.
A CMBS, or Commercial Mortgage Backed Security, consists of a group of commercial property loans that have been pooled together and securitized, in order to be sold to investors. These securities are broken into various layers, or tranches, each of which has a different level of credit quality, carries a different amount of risk, and offers a different return for investors.
In the first quarter of 2019, a variety of trends and events have impacted the state of CMBS and conduit financing in the United States. Looking back at the 2018 year, while overall commercial loan transaction volume was up, CMBS issuances fell approximately 12%, to just under $77 billion. Overall, CMBS delinquency rates rose slightly, and, experts believe that troubled retail properties, including shopping malls, may be in for additional trouble if they cannot find a lender willing to refinance their debt.
When CMBS loans are pooled together to create commercial mortgage backed securities, these securities vary in credit quality and payment priority. Typically, they are divided between investment grade securities, (AAA/Aaa through BBB-/Baa3) and sub-investment grade securities (BB+/Ba1 through B-/B3). While the A-class bondholders are paid first, B-piece bondholders must wait until all A-class bondholders are fully paid before they receive any compensation. Due to their higher risk, however, B-piece CMBS offer investors significantly higher returns when compared to A-rated CMBS.
When it comes to getting financing for a multifamily property, Fannie Mae and Freddie Mac multifamily loans, also known as agency loans, are some of the most popular options on the market. When compared with CMBS financing, these agency loans have a variety of similarities and differences. Both agency and CMBS are typically non-recourse and fully assumable, and offer highly competitive interest rates. However, agency loans usually offer even lower rates than CMBS, with rates starting at 3.75-3.9%.
While many conduit loans require that borrowers engage in defeasance if they want to prepay their loan, some lenders permit borrowers to prepay using yield maintenance. Yield maintenance involves a borrower paying off the balance of their CMBS loan, plus an additional 1-3% fee in order to compensate the lender for the income they’ve lost as a result of loan prepayment.
Borrowers often consider conduit loans’ strict prepayment penalties to be one of their major downsides. Many CMBS loans must be prepaid in a process called defeasance, which involves a borrower purchasing alternative securities, often U.S. Treasury bonds, to replace the collateral and interest income that the lender will lose as a result of prepayment. Defeasance can be a complicated process, the details of which will typically be spelled out in a borrower’s loan agreement.
If you take out a CMBS loan, and you want to pay off the loan early, perhaps because you’re selling the property, you’ll usually have to pay a prepayment penalty. Prepayment penalties are designed to compensate the lender, or, in the case of CMBS loans, the investors, for the loss of income that will result from a borrower paying off their loan early.
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