CMBS 101®

An Introduction To Commercial Mortgage Backed Securities (CMBS)

Prepared by

The Education/Research Committee of the Commercial Mortgage Securities AssociationC

MB

S 10

1®C

MB

S 10

1®

Joseph Franzetti, Citigroup Global Markets

Gale Scott – Standard & Poor’s

2

The CMBS Process

The Participants in a Securitization

Securities

2 months (Loan Funding) + 2 months (Bond Issuance)

5

77

7

6

4

1 23

33

FinancialStatements Appraisals

EngineeringReports

Master Servicer

Rat

ing

Age

ncy

Rat

ing

Age

ncy

Rat

ing

Age

ncy

Rat

ing

Age

ncy

Special Servicer

Primary or Sub Servicer

Trustee/Fiscal Agent

Investors

Depositor (SPE)Issuer/

Investment BankerBorrowers

MortgageBankers

LoanOriginator/Loan Seller

Investors

Investors

4

The Participants in a Securitization

1 Borrower: Owns the property, has repayment and performance obligations

2 Mortgage Banker: Intermediary between borrower and loan originators/loan sellers

3 Loan Originators/Loan Sellers:

Lends money to the borrower, secured by a first priority lien, enters into a mortgage loan purchase agreement (“MLPA”) to sell the loan to the securitization depositor

4 Depositor: An entity set up by the investment bank sponsoring the securitization purchases commercial mortgage loans and immediately sells loans to a trust.

4 Investment Banker: Overall responsibility for structuring the securitization, selling the bonds/certificates to investors, helps maintain a liquid secondary market for trading the bonds/certificates.

4 Issuer: The trust is the record owner of the commercial mortgage loans, formed by the depositor pursuant to a pooling and servicing agreement (“PSA”).

5 Trustee: Responsible for administering the trust on behalf of and making payments to the investors.

6 Investors: Different investors with varying risk appetites purchase certificates rated from AAA/Aaa to B/B to and unrated certificates.

5

The Participants in a Securitization

7 Master Servicer: Responsible for servicing all mortgage loans owned by the trust.

7 Primary or Sub Servicer:

May be the originating mortgage bankers, often the initial point of contact for the borrower.

7 Special Servicer: Named at the issuance of the CMBS to be responsible for servicing any mortgage loans that may default in the future.

8 Rating Agencies: Assigns risk of loss ratings on certain bonds/certificates issued for a securitization transaction, monitors performance after securitization funds.

6

The Participants after the Securitization is Completed

Borrowers

Trustee/Fiscal Agent

TrustInvestment Bank/Secondary Traders

Investors

Investors

Investors

Master Servicer

Primary or Sub-Servicer /Mortgage Banker

Special Servicer

Rating Agencies

7

Where the Money Goes

Loan Originator /Loan Seller

(Lender)

Trustee- Distribution

Account

Servicer-CollectionAccount

Securities

Investors

Borrowers

Assignments of Rents and Leases

Loan Proceeds

Debt Service& Escrows

Debt ServiceLess Servicer FeePlus Advances

MortgageNotes

Monthly Bond

Coupon& Principal

Securities SaleProceeds at Closing

Securities SaleProceeds at Closing

8

Transaction Timetable

Initial analysis

Due diligence for securitization

Structuring process

B-buyer due diligence

Rating agency review

Selection of servicer & trustee

Legal documentation, both private & public securities offering

Pre-marketing of securities

Marketing / pricing Private offering: Pricing of below-investment grade Public offering: Pricing of investment grade

Closing of securities

LO Loan Originator SV Servicer UC Underwriter's Counsel Inv InvestorIB Investment Bank RA Rating Agency SC Seller's Counsel BB B-Piece Buyer

Activity

LO, IB

LO, IB, SC

LO, IB

LO, IB, BB

LO, IB, RA

LO, IB, SV

IB, Inv, RA

ALL

IB, Inv, RA

IB, Inv, BB, RA

ALL

Participant1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

9

Build-A-Bond

Hypothetical Structure: Credit Tranching

Last Loss

First Loss

Lowest Risk

Highest Risk

Loss Position

Credit R

isk

$100MMPool of Mortgages

$85MMInvestment Grade

CMBS:Aaa/AAA

$9MMOther Investment Grade:

Aa2/AAA2/A

Baa2/BBB

$4MMNon-Investment

Grade CMBS:Ba2/BB

B2/B

$2MMNon-Rated CMBS

11

Basic CMBS Structure — $100 MM, 10-Year, Fixed Rate

Class Size Rating Coupon Expected Life Subordination

Class A $85 MM Aaa / AAA 5.25% 9 years 15%

Class B $9 MMAa2/AA

A2/ABaa2/BBB

5.50% 9.5 years 6%

Class C $4 MM Ba2/BBB2/B 7.50% 9.75 years 2%

Class D $2 MM NR — 10 years —

NR = Non-Rated

12

B

Senior / Subordinated Structure — 10 Year Security

A

First9 years

After9.5 years

AA

B

C

P + i

i

i

B

C

B

C

P + i

i

After9.75 years

MortgagePool

D D D

After10 years

C

AA

D

A

ii

P + i

i P + i

13

Basic CMBS Structure

Subordination could be calculated as follows for Aaa/AAA level stress:

Foreclosure Frequency X Loss Severity =30% X 50% = .15 or 15% coverage or subordination

Class Rating Size Subordination Coupon

A Aaa/AAA $85MM 15% 5.25%

BAa2/AA

A2/ABaa2/BBB

$9MM 6% 5.50%

C Ba2/BBB2/B

$4MM 2% 7.50%

D NR $2MM 0 ---

14

Hypothetical Class Structure

Rating SizeLoss Coverage/ Subordination

Loss Frequency Loss Severity

Aaa/AAA $85MM 15% = 30% X 50%

Aa2/AA $3MM 12% = 30% X 40%

A2/A $3MM 9% = 30% X 30%

Baa2/BBB $3MM 6% = 20% X 30%

Ba2/BB $2MM 4% = 20% X 20%

B2/B $2MM 2% = 10% X 20%

NR $2MM — — —

15

Equally Weighted Portfolio Loss Rate =

How To Decide How Much Subordination? Loss Rate Scenarios

Source: Morgan Stanley. “Update: Commercial Mortgage Defaults: 30 Years of History.” September 2004 (Cumulative loss rates for about 18,000 commercial mortgages originated by eight life insurance companies between 1972 and 2002.)

Default19.6%

No Default80.4%

Restructured25%

Liquidated55%

Loss Rate33%

Loss Rate16.5%

Become Current20%

Loss Rate0%

(0.196)(0.55)(0.33) + 0.0356 +

(0.196)(0.25)(.0165) + 0.008 +

(0.196)(0.20)(0) 0 =

.0436 or 4.36%

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Basic CMBS Structure$100 MM, 10-Year, Fixed Rate with Interest Only Strip (IO)

Class Size Rating Coupon Average Life Subordination

Class A-1 $85 MM Aaa / AAA 5.00% 9 years 15%

Class A-X Notional1 Aaa / AAA 0.25% Not Meaningful1

Class B $9 MMAa2/AA

A2/ABaa2/BBB

5.50% 9.5 years 6%

Class C $4 MM Ba2/BBB2/B 7.50% 9.75 years 2%

Class D $2 MM NR — 10 years 0%

1 For illustration purposes, the INTEREST ONLY (IO) strip collects interest of 0.25%, or 25 bp on a NOTIONAL amount of $85MM. The notional amount could be the same as the size of an associated class or the size of the entire security. Here, the interest on Classes A-1 and A-X total the coupon of Class A alone in the earlier example.

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IF Y < C, then it is a premium bond (PR)IF Y = C, then it is a par bond (PAR)

IF Y > C, then it is a discount bond (D)

Assumptions: 5-year Treasury = 4.4% 10-year Treasury = 4.5%

Hypothetical Class Structure

Class Size Rating Coupon (“C”)Spread At Issue

(Yield, or “Y”) Average Life

A-1 15% Aaa/AAA 5.25% PR 70 bp 5 years

A-2 70% Aaa/AAA 5.30% PR 75 10 years

B 3% Aa2/AA 5.45% PR 90 10 years

C 3% A2/A 5.55% PR 100 10 years

D 3% Baa2/BBB 6.00% PAR 150 10 years

E 2% Ba2/BB 6.50% D 300 10 years

F 2% B2/B 6.50% D 700 10 years

G 2% NR 6.50% D 1200 10 years

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The CMBS Market

20

Holders of Commercial & Multifamily Mortgage Loans$626 billion of the $2.5 trillion U.S. commercial and multifamily mortgage loans

outstanding are held as securities, a significant increase since 1990

2005 3Q

Life Insurance Cos. 10%

Savings Institutions

8%

Government Sponsored Enterprises

3%

Others 11%

Commercial Banks 43%

CMBS Issuers 25%

Source: Federal Reserve, Flow of Funds

1990

Life Insurance Cos. 22%

Savings Institutions

18%Government Sponsored Enterprises

2%

Others 18%

Commercial Banks 36%

CMBS Issuers 4%

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CMBS Issuance: U.S. and Non-U.S.($ Billions)

Source: Commercial Mortgage Alert.

3 8 14 17 17 16 26 37

7457 49

7452

7893

169

1 10 0.3 3 1

14

19

12

23

29

21

34

69

0

50

100

150

200

250

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

Domestic Non-US

22

U.S. CMBS Issuance ($ Billions)

Source: Commercial Mortgage Alert

US only, non-agency, non-CDO.

3.47.6

14.0 17.2 17.4 15.7

26.4

36.8

74.3

56.648.7

74.4

52.1

77.8

93.1

169.2

0

20

40

60

80

100

120

140

160

180

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

23

U.S. CMBS Issuance and Interest Rates

Source: Commercial Mortgage Alert and Federal Reserve

0

10

20

30

40

50

60

70

90 1

Q

90 3

Q

91 1

Q

91 3

Q

92 1

Q

92 3

Q

92 1

Q

93 3

Q

94 1

Q

94 3

Q

95 1

Q

95 3

Q

96 1

Q

96 3

Q

97 1

Q

97 3

Q

98 1

Q

98 3

Q

99 1

Q

99 3

Q

00 1

Q

00 3

Q

01 1

Q

01 3

Q

02 1

Q

02 3

Q

03 1

Q

03 3

Q

04 Q

1

04 Q

3

05 Q

1

05 Q

3

Issu

ance

($

billi

ons)

3

4

5

6

7

8

9

10-y

ear

Tre

asur

y (%

)

US CMBS Issuance 10-Yr Treasury

24

Multifamily Mortgage Securitization

Source: Federal Reserve, Flow of Funds

0

100

200

300

400

500

600

700

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 053Q

$ B

illio

ns

0%

5%

10%

15%

20%

25%

30%

35%

40%

Sh

are

of

tota

l sec

uri

tize

d

Multifamily Mortgages Outstanding Securitized Share of Total Securitized

25

Commercial Mortgage Securitization

Source: Federal Reserve, Flow of Funds

0

200

400

600

800

1000

1200

1400

1600

1800

2000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 053Q

$ B

illio

ns

0%

5%

10%

15%

20%

25%

Sh

are

of

tota

l sec

uri

tize

d

Commercial Mortgages Outstanding Securitized Share of Total Securitized

26

Single Family and Commercial/Multifamily Securitization Market Penetration

Source: Federal Reserve, Flow of Funds

Date through 2004, year 14 (CMBS) and year 34 (Single Family)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

Sh

are

of

ou

tsta

nd

ing

s

Commercial/Multifamily (year 1=1991) Single Family (year 1=1971)

23.7%

59.6%

27

CMBS Issuance: Shift from RTC to Conduits

Source: Commercial Mortgage Alert

* RTC: Resolution Trust Company

0

10

20

30

40

50

60

70

80

1990 1991 1992 1993 1994 1995 1996 1997 1998

$ B

illi

on

s

RTC* Conduit Issuers Other Issuers

28

CMBS Spreads Over 10-Year Treasury: Investment Grade

Source :Morgan Stanley

0

50

100

150

200

250

300

350

0

50

100

150

200

250

300

350

Aaa/AAA Aa2/AA A2/A Baa2/BBB

29

CMBS Spreads Over 10-Year Treasury: Non-Investment Grade

Source: Morgan Stanley

0

100

200

300

400

500

600

700

800

900

1000

1100

0

100

200

300

400

500

600

700

800

900

1000

1100

Ba2/BB B2/B

30

CMBS Spreads and Swap Spreads

Source: Morgan Stanley

0

20

40

60

80

100

120

140

160

180

200

0

20

40

60

80

100

120

140

160

180

200

Gap CMBS Aaa Spreads (10-year) Swap Spread Average Gap of Period

31

Market Size Comparison(as of 12/31/04)

Source : (1) NAREIT; (2) Microsoft Website; (3) World Bank; (4) Federal Reserve, Flow of Funds

$290$264

$359

$548

0

100

200

300

400

500

600

$ B

illio

ns

REITs Market Cap 1 Microsoft Market Cap (largest in NYSE) 2

GDP of Switzerland (17th largest) 3

Commercial and Multifamily

Securitizations 4

32

Market Size Comparison(as of September 30, 2005)

$2.5$3.0

$4.6$5.2

$8.8

0

1

2

3

4

5

6

7

8

9

10

$ Tr

illio

ns

0

1

2

3

4

5

6

7

8

9

10

Current CMBS Outstandings

All Commercial + Multifamily Mortgages

Source: Federal Reserve, Flow of Funds

Corporate Bonds US Government Securities

Single Family Securities

Single Family Mortgages

Investors of CMBS

Who Buys CMBS?

Institutional fixed income securities investors buy public bonds

Real estate high yield investors buy private bonds

Varies by class, by rating, by structure, by underlying collateral

34

35

Investors of CMBS in 2004

Source: Morgan Stanley

Insurance Companies 24%

Banks25%

Government Sponsored Entities

9%

Investment Advisors/Money Managers

28%

Opportunity Funds Finance Companies

Pension Funds 14%

Why?

Yield differential (relative value investing)

Credit performance

Asset allocation (satisfy allocation to real estate debt)

Non-correlated risks (compare to MBS and corporates)

Comparative Credit Risk

Remember: Credit Risk ≠ Yield

36

37

Yield Differential(10-Year Sector; Yield over Treasury)

Source: Merrill Lynch

88

42

62

7778

36

56

65

0

10

20

30

40

50

60

70

80

90

100

Aaa CMBS Agencies Aaa Credit Card ABS Single-A Industrials

Ba

sis

po

ints

ov

er

Tre

as

ury

Recent (as of 12/09/05) 6-Month Average

Corporate vs. CMBS Bond Defaults: 1990–2003 (%) –––––– Cumulative Defaults ––––– Corporate CMBS Investment Grade 2.10 % 0.10% Below Investment Grade 55.00% 1.61% All Bonds 11.00% 0.19%

–––– Average Annual Defaults ––– Corporate CMBS Investment Grade 0.15% 0.01% Below Investment Grade 3.94% 0.12% All Bonds 0.78% 0.01%

Source: FitchRatings

Credit Performance

Maturity of marketsPosition in Asset ClassPast performance is no guarantee of future success

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Satisfying Asset Allocation to Real Estate Debt

Risk based capital treatment for insurance companies gives advantage to CMBS

Mortgages = 3% Risk Based Capital (depending on insurer’s experience)

Investment Grade Public Securities = 0.3% Risk Based Capital

Cost of management (direct loan vs. securities investment)

Liquidity (ease of trading in and out of the portfolio)

Creates diversified investment portfolio

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Non-Correlated Risks

CMBS MBS Corporates

PRIMARY RISK Real estate credit risk Prepayment risk Corporate credit risk

MATURITY Some extension risk No extension risk No extension risk

DEFAULT DSCR is a predictor of default risk

LTV is a predictor of default risk Corporate credit risk a better predictor of default risk

LIQUIDITY Growing but smaller overall market than MBS and corporates

Highly liquid market Highly liquid market

INFORMATION Different for public buyers versus private buyers

Widely disseminated Widely disseminated

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Investing in Non-Correlated Risks

CMBS MBS Corporates

RATING AGENCIES 10 years of experience 30 years of experience 100 years of experience

SECURITY Set pools of assets; first priority mortgage liens

Set pools of uniform assets; first priority mortgage liens

Unsecured; investors exposed to future decisions at the corporation

PERFORMANCE Should outperform MBS and corporates in falling rate environment

More interest rate sensitive Interest rate sensitive

RATINGS Volume of AAA and Non-Investment Grade

Almost all AAA and AA Mostly A, BBB

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