Commercial mortgage-backed securities (also known as CMBS) are a type of fixed-income security forming 2% of the fixed-income market. These are financial investment products on commercial properties, as opposed to residential realty. They are also mortgage loans (typically non-recourse debts), so any commercial or consumer debt is secured solely by collateral. In the event of a default, the lender cannot seize any assets belonging to the borrower over the collateral amount.
The purpose of a CMB mortgage is to offer liquidity to both real estate investors and commercial lenders. Like CMOs (collateralized mortgage obligations) and CDOs (collateralized debt obligations), CMBS are available as bonds.
If a business owner or real estate investor purchases a piece of commercial property, they obtain a mortgage from a bank to purchase it. The bank then groups this mortgage with other mortgages, which are then turned into bonds, rated, and sold back to the investors.
Once the bank then receives profits from the bond sales, a servicing manager then takes control of the bonds. The bonds can then produce fixed yields for those holding them, while the bank uses money gained from selling the bonds to lend to another shareholder.
These bonds are composed of underlying loans, usually contained within trusts. The loans work as a type of collateral, with interest and principal being passed to investors in case of a default.
These are then divided into tranches known as segments.
The mortgages backing CMBS are classed according to the level of credit risk, ranked from highest (low-risk senior issue) quality mortgages, which receive both principal and interest rates to cheaper, higher risk junior issue mortgages that absorb more potential loss.
Securitization refers to the pooling of assets to create interest bearing securities like CMBS. Those involved in buying these repackaged securities then obtain interest and principal payments of the original assets. As an investment vehicle, CMB securities are complex, requiring a number of different participating bodies to ensure functionality.
Securities within CMBS may include a collection of commercial mortgages with various values, terms, and a diverse range of property types (often within the same trust), including:
New regulations for CMBS were introduced in December 2016, when the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) brought in measures to mitigate some potential risks of CMB securities through margin requirements for covered agency transactions like collateralized mortgage obligations (CMOs).