The Commercial Classroom: Understanding CBMS

Issue 101: Understanding Commercial Backed Mortgage Securities (CBMS) CBMS Basics A bank makes a $10 million loan with commercial real estate as collateral. If the loan remains on the banks books they have a risk exposure of $10 million if the loan defaults. To minimize the risk the bank packages this loan with other commercial loans and creates a Commercial Backed Mortgage Security (CBMS) Trust. The trust then creates bonds, these are rated and then sold to investors. By reducing their loan risk the bank can loan more money. CBMS are historically bought by insurance companies and pension plans. They have been considered safe, conservative investments. These types of investments began being issued in the late 1990s. By 2007 over $230 billion CBMS were being issued annually. Their counterpart residential backed mortgage securities led to the "mortgage meltdown" in 2007-2008. In 2008 we saw the issuance of CBMS decline 94% to only $12 billion issued that year. In 2009 there were virtually no CBMS issued. In 2010 we saw a slight return to issuance of CBMS with $11.5 billion being issued. 2011 has, so far, been a very interesting year for these investments. In the spring of 2011, there was $22 billion of CBMS issued. But as we headed into the summer we had the economic conflicts in Washington, D.C. coupled with the European Financial Crises; turbulence in the market reigned. In July, 2011 the delinquencies on CBMS reached a historical high of 9.88%. That same month Standard and Poor refused to rate a $1.5 billion CBMS being underwritten by Goldman & Sachs and Citibank. In August, this package was rewritten providing less risk and was sold off. On the optimistic side there was an announcement in late August that Wall St. would be issuing a $5 billion CBMS in October. Everyone has a different opinion as to how this year will end. We have seen estimates for $25 to $40 billion CBMS being issued. A lot has to do with how the economy evolves. This category of investment, CBMS is very important as it directly affects banks ability to make loans. Today 1,300 banks are having loan problems; 884 banks are on the FDIC watch list. 350 banks have closed since 2008. It is estimated the nationally 50% of the commercial loans are "under water." Meaning the current value of the property does not justify the outstanding loan balance on it. When the loan becomes due, the reduced value creates a gap between what is due and what can be refinanced under today's underwriting standards. The borrower must either come up with more cash to fill the gap and refinance, or the bank must decide to foreclose on the loan or extend it. Plus the bank must also consider the bank regulators...difficult times for everyone. Ironically, even in these circumstances the monthly payments of many of these loans are being made-they are performing loans! Real estate works in cycles, I feel we are bottomed out and now we head up again. It is a great time to buy real estate! Want some investment tips? Purchase my latest book, "Buy the Numbers: Investing in Real Estate" on Amazon.com. Edward Smith, Jr., CREI, ITI, CIC, GREEN, RECS, is the eastern regional director of Coldwell Banker Commercial NRT, Syosset, N.Y.