Commercial Mortgage Backed Securities (CMBS) are a type of mortgage backed securities that are backed by commercial rather than residential real estate. Mortgage backed securities are nothing but asset backed securities that are pooled and converted into bonds. This leads not only to a good investment strategy but also frees up capital for the issuer of the mortgage. Essentially mortgage backed securities create a secondary market for mortgages making it more liquid.

• The major difference between commercial and residential mortgage backed securities is that the former uses tranches instead of pass-through that are used in residential mortgages. A tranche is one of a number of securities that are offered in the same transaction and are defined by using classes. The structure for securitization for commercial real estate loans is Real Estate Mortgage Investment Conduit (REMIC). REMIC is a special purpose vehicle that is used for pooling of mortgage loans and issuance of mortgage backed securities.
• Another factor that separates commercial mortgage backed securities from residential ones is that there is less prepayment risk in such type of investments. For instance if the borrower prepays the mortgage when the interest rates are lower then investors would have to invest their capital at lower interest rates. This mitigation of risk is possible due to the structure of CMBS and REMIC.
• Commercial real estate first mortgage debt is broken down into two categories; loans to be securitized and portfolio loans. The former is also called CMBS loans and these have a “waterfall” concept of payment to investors. The mortgages are broken into categories giving them ratings according to which interest payment is made to investors. This means that those who invest in high rated bonds will get the interest first and then the next level and so on in a sequential manner. Thus the word “waterfall” concept is used in such transactions.
• The structure for the securitization of commercial real estate loans is a Real Estate Mortgage Investment Conduit (REMIC). REMIC’s are basically investment vehicles that hold commercial as well as residential mortgages in trusts and issue securities. It does this through the assembling of mortgages into pools and issuing pass-through certificates, multi-class bonds and securities to investors.
• There are several industry participants in mortgage backed securities and include the Primary Servicer, Master Servicer, Directing Certificate holder, Trustee and the Rating Agency. In many case the borrower may deal with the primary servicer who is also the mortgage banker or the loan originator. The Master servicer manages the flow of payments and also interacts with the performing borrower. A special servicer comes into the picture under certain circumstances; usually default.
• The most subordinate bond class outstanding is the directing certificate holder and is also referred to as the b-piece buyer. The B-piece buyer usually purchases B rated and BB/Ba- rated bond classes with unrated ones. The role of the trustee is to hold all the loan documents and hand out payments received from the Master Servicer to the bondholders. A securitization can be rated by a single or as many as four rating agencies and they establish bond ratings for each bond class when the securitization is closed. Rating agencies are also responsible for updating the ratings for investors based on various criteria and performance.

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