CMBS Tsunami

Real estate professionals estimate that nearly $90 billion in CMBS related investments are expected to mature by 2013. With property values decreasing or stagnating, loans defaults rising, and tenants suffering from the economic slowdown, there will likely be a litigation tsunami. This is a quick primer on CMBS and possible litigation scenarios.

First, what is CMBS? CMBS stands for Commercial Mortgage Backed Securities. These “securities” are issued as a series of bonds and sold to investors. The support for these bonds are  loans and mortgages on commercial real estate. The real estate may be from several different types of income producing properties (i.e. shopping centers, apartment complexes, hotels, health care facilities etc).

These commercial loans were often bundled together (“pooled”) and seperated into different bond classes (“tranches”). The various tranches were underwritten and rated in a range from AAA (the highest quality) all the way down to B3 (lower quality). The pool of mortgages was transferred to a trust known as a Real Estate Mortgage Investment Conduit Trust (a “REMIC” trust).  After the pooled mortgages were transferred to the trust and  rated they were sold to investors.

As long as the developers/owners are paying their  mortgage payments, things hum along nicely. The payments are distributed by the servicer to the investors in order of priorty (higher classified bonds get paid first).

But what happens when a major tenant goes dark and can’t pay the rent? Then other tenants may have escape clauses in their leases and they may get a large reduction in rent. Or what if a developer/owner is experiencing cash flow problems and can’t afford common area maintenance and the asset depreciates? There are a number of things which may trickle down and impact the value of the bond you are holding.

Once the bonds are in jeopardy people start asking tough questions. For example who did the underwriting? What were the standards for the underwriting? Has the servicer complied with all of it’s obligations under the “Pooling and Servicing Agreement”? Has there been an event of default or disqualification under the REMIC trust?

There will be very few parties unscathed by the tsunami. There are potential claims against issuers, dealers, underwriters, appraisers, developers and servicers for fraud, misrepresentation, breach of contract or securities violations.

In the next few weeks I will spend some time exploring REMIC trusts, the impact of TALF on the CMBS market and the impact of Credit Default Swaps.

I am always interested in your feedback on these issues. I am also available to discuss your commercial real estate situation.


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