Pricing commercial mortgage‐backed securities
| DOI | https://doi.org/10.1108/14635780110406860 |
| Pages | 498-518 |
| Date | 01 December 2001 |
| Published date | 01 December 2001 |
| Author | Clark L. Maxam,Jeffrey Fisher |
| Subject Matter | Property management & built environment |
JPIF
19,6
498
Journal of Property Investment &
Finance, Vol. 19 No. 6, 2001,
pp. 498-518. #MCB University
Press, 1463-578X
ACADEMIC PAPERS
Pricing commercial
mortgage-backed securities
Clark L. Maxam
New York Life Investment Management, LLC and Montana State
University, Bozeman, Montana, USA, and
Jeffrey Fisher
Indiana University, Bloomington, Indiana, USA
Keywords Securities markets, Mortgages, Regression analysis, Pricing
Abstract This paper presents the first known non-proprietary empirical examination of the
relationship between Commercial Mortgage Backed Security (CMBS) pricing. CMBS prices are
examined as a function of the ``moneyness'' of the default option, the age of the security, the
interest rate, interest rate volatility, property price volatility, amortization features and yield curve
slope utilizing a proprietary data set of monthly prices on 40 CMBS securities. We find that
though the senior tranche CMBS in the sample are effectively immune from default loss per se,
they are not immune from early return of principal and resulting duration shift implied by
increasing default probabilities. Thus, they behave very much like residential mortgage backed
securities in that discount security prices are positively related to explanatory variables associated
with potential shifts in duration. As a result, senior tranche CMBS prices increase with
explanatoryd factors that raise the likelihood of default such as property volatility and loan to
value ratio whereas CMBS prices decrease with variables that lower default probability such as
amortization. These empirical results fit well with existing theoretical models of multi-tranche
CMBS pricing and models of commercial mortgage default and suggest that senior tranche
CMBS may embody elements of risk that justify their seemingly rich spreads to similar duration
corporate securities.
This paper presents the first known non-proprietary empirical examination of the
relationship between Commercial Mortgage Backed Security (CMBS) pricing and
the characteristics of the underlying mortgages and general economic conditions
utilizing monthly prices and specific underwriting information on a set of 40
senior tranche[1] CMBS securities with a combined value of approximately $900
million. CMBS prices are examined as a function of the ``moneyness'' of the default
option, the age of the security, the interest rate, interest rate volatility, property
price volatility, amortization features and yield curve slope utilizing a proprietary
data set of monthly prices on 40 CMBS securities with a combined portfolio value
of $900 million.
Due to the lack of both theoretical and empirical evidence regarding CMBS, we
first employ non-parametric multi-variate kernel density estimation as a means
of uncovering the pricing characteristics of CMBS in the absence of any
functional or distributional assumptions. In addition, we examine the power of
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The authors would like to acknowledge helpful comments from Richard Stanton, Brent
Ambrose, and Tim Riddiough.
Academic papers:
Pricing CMBS
499
several theorized explanatory variables using linear regression techniques. In
this manner,the efficacy and intuitionof both empirical and theoretical models of
CMBS pricing is evaluated. An observable empirical fact is that identical
duration, identically rated CMBS trade at a yield premium to their corporate
counterparts. Market participants typicallyattribute this to a liquidity premium.
However, we find that though the senior tranche CMBS in the sample are
effectively immune from default loss per se, they are not immune from early
return of principal and the resulting duration shift implied by increasing default
probabilities. Thus, they behave very much like residential mortgage backed
securities in that discount security prices are positively related to explanatory
variables associated with potential shifts in duration. As a result, senior tranche
CMBS prices increase with explanatory factorsthat raise the likelihoodof default
such as propertyvolatility and loan to value ratio whereas CMBSprices decrease
with variables that lower default probability such as amortization. These
empirical results fit well with existing theoretical models of multi-tranche CMBS
pricing and models of commercial mortgage default and suggest that senior
tranche CMBS may embody heretofore unrecognized risks that justify their
seeminglyrich spreads to similar duration,similar rated corporate securities.
CMBS market structure and background
CMBSs are debt instruments collateralizedbynon-recourseloanswhichare
secured by commercial real estate[2] typically multi-family dwellings (apartments),
retail centers, hotels, restaurants, warehouses and office buildings. The CMBS is
one of the fastest growing securitized products in the capital markets. A secular
downturnincommercialrealestateandageneral contraction in the traditional
bank sources of funds during the late 1980s has led to much innovation in the real
estate market. While initially focusing on the residential market with products
such as residential collateralized mortgage obligations (CMOs), this innovation has
more recently been directed at the commercial mortgage market. Surprisingly, the
Resolution Trust Corporation (RTC), a government agency formed to handle the
disposition of failed S&L assets, was a catalyst in the development of the
securitized commercial mortgage market. Unable to satisfactorily dispose of
properties on a case by case basis, the RTC successfully securitized the mortgages
of failed thrifts by enhancing them with cash. These highly rated securities were
well accepted by the public and led to further commercial loan securitizations by
Wall Street firms.
CMBS issuance totaled $8 billion in 1991 and increased to over $20 billion in
1995 and 1996 despite substantially reduced RTC activity. Approximately $160
billion in existing commercial mortgages are available for refinancing each year
(due to balloon payments). In total, commercial mortgage debt accounts for about
6 percent of the fixed income universe and thus represents an integral part of a
fixed income portfolio. Furthermore, only about 7 percent of the $1 trillion
commercial mortgage market has been securitized to date versus about 60 percent
of residential mortgages. If the percentage of securitized commercial mortgages
reaches 20 percent, the outstanding market will be approximately $200 billion.
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