how commercial mortgage backed securities cmbs work
as with collateralized debt obligations cdo and collateralized mortgage obligations cmo cmbs are in the form of bonds the mortgage loans that form a single commercial mortgage backed security act as the collateral in the event of default with principal and interest passed on to investors the loans are typically contained within a trust with different terms property types and amounts the underlying loans that are securitized into cmbs include loans for properties such as apartment buildings and complexes factories hotels office buildings office parks and shopping malls often within the same trust a mortgage loan is typically what is considered a non recourse debt any consumer or commercial debt that is secured only by collateral in case of default the lender may not seize any assets of the borrower beyond the collateral because cmbs are complex investment vehicles they require a wide range of market participants including investors a primary servicer a master servicer a special servicer a directing certificate holder trustees and rating agencies each of these players performs a specific role to ensure that cmbs performs properly the cmbs market accounts for approximately 2 of the total u s fixed income market types of cmbsthe mortgages that back cmbs are classified into tranches according to their levels of credit risk which typically are ranked from senior or highest quality to lower quality the highest quality tranches will receive both interest and principal payments and have the lowest associated risk lower tranches offer higher interest rates but the tranches that take on more risk also absorb most of the potential loss that can occur as the tranches go down in rank the tranches are usually divided as follows the lowest tranche in a cmbs structure will contain the riskiest and possibly speculative loans in the portfolio the securitization process that s involved in designing a cmbs s structure is important for both banks and investors it allows banks to issue more loans in total and it gives investors easy access to commercial real estate while giving them more yield than traditional government bonds investors should understand however that in the case of a default on one or more loans in a cmbs the highest tranches must be fully paid off with interest before the lower tranches will receive any funds components of a cmbscriticism of cmbstypically only very wealthy investors invest in cmbs because there are not many options here for the average investor it s difficult to find mutual funds or exchange traded funds etf that invest solely in this asset class though many real estate mutual funds invest a portion of their portfolios into cmbs requirements for cmbsin december 2016 the securities and exchange commission sec and financial industry regulatory authority finra introduced new regulations to mitigate some of the risks of cmbs by creating margin requirements for covered agency transactions including collateralized mortgage obligations advantages and disadvantages of a cmbsas with other types of debt securities investors assume certain risks when they purchase a cmbs however there are some features that make them popular for borrowers and investors cmbs loans come with fixed interest rates meaning that repayments will not fluctuate over the lifetime of the loan this is a benefit for commercial borrowers who cannot count on their revenues increasing with the loan terms a cmbs loan is non recourse meaning that lenders cannot hold borrowers personally responsible if they fail to repay the loan however there are some circumstances such as fraud or misrepresentation that would give investors recourse against the borrower 