Commercial mortgage-backed securities (CMBS)
are mortgage-backed securities on commercial and / or residential properties. CMBS provide liquidity to real estate investors and commercial lenders; however, they are characterized by greater complexity and volatility than residential mortgage-backed securities due to the individual nature of their underlying real estate assets.
CMBS assessments can be very complicated due to the lack of rules to standardize their structures. Normally, the securities underlying the CMBS are a series of different commercial mortgages (different values, different nature) such as: multi-family dwellings and commercial real estate. CMBS issues are usually structured as multiple tranches, similar to collateralized mortgage obligations (CMO).
There is a difference between American and European CMBS.
The former carry much less prepayment risk due to the nature of US commercial mortgages. In fact, these mortgages usually provide for a block (generally a period of 1-5 years in which there can be no advance payment of the loan) which may be subject to penalties in case of cancellation. European CMBSs, on the other hand, typically have lower prepayment protection. Interest on bonds can be either fixed or floating rate (LIBOR, EURIBOR) plus a spread.
In a CMBS transaction
, a trust is created within which various types of mortgages with different locations, properties and sizes are grouped. The trust then issues a series of bonds which can vary in terms of duration, interest rates and payment properties. Therefore a rating is assigned by the reference agencies; this can range from a high investment grade (AAA and similar) to a lower one (BB + / Ba1 and similar). Finally there will be an unrated class which is subordinate to the lowest rated bond class. Investors therefore decide to purchase a different class of CMBS depending on the risk / return they desire. Interest is paid to investors starting with those investors who hold the highest rated bonds, and thereafter to the others. This sequential payment structure is generally referred to as a "cascade". The risk, for those who own lower classes of bonds, is in the possibility that there is a deficit in payments by the borrowers or in the event that the loan guarantee is liquidated but does not generate sufficient proceeds to repay all the classes of bonds.
An example of a class A1 CMBS can be: Arrow CMBS 2018-1, FRN 22may2030, EUR (18-1, class A1)
. While, an example of a lower class of the same CMBS series is: Arrow CMBS 2018-1, FRN 22may2030, EUR (18-1, class C)