Question

1. Consider a single-loan CMBS deal of size $1bn, with a B-piece of $100m. The loan has become delinquent and been transferred to special servicing. Expected losses are $150m if the property is foreclosed on. If the loan is restructured, there is a 30% chance the borrower will start performing, reducing losses to zero, but a 70% chance that final losses will rise to $300m.

   1. What should the CMBS investors do to maximize total expected return?

   2. If the special servicer wants to maximize their own short-term interests, what

      should they do? Why? [a couple of sentences]

   3. Thinking about the longer run, are there any reasons why the special servicer

      might not want to undertake the actions you suggest in part (b) above? [a couple of sentences]

d. Why do you think the CMBS market features a key role for B-piece investors, but the RMBS market does not? [a couple of sentences]

Answer 1

a.            Consider a single-loan CMBS deal of size $1bn, with a B-piece of $100m. The loan has become delinquent and been transferred to special servicing. Expected losses are $150m if the property is foreclosed on. If the loan is restructured, there is a 30% chance the borrower will start performing, reducing losses to zero, but a 70% chance that final losses will rise to $300m.

What should the CMBS investors do to maximize total expected return?

Ans:

Current loss		150 Mn
Expected loss= ∑ loss/Gain X Probabaility
	Gain/Loss	Probability	Prodcut (A X B)
	100	30%	30
	-300	70%	-210
	Expected Gain/Loss		-180

b.            If the special servicer wants to maximize their own short-term interests, what

should they do? Why? [a couple of sentences]

Ans:

CMBS loans are combined, securitized and sold to investors on the secondary market as pooled commercial mortgage-backed securities. Once sold they are not usually supported & serviced by the original lender. Instead, they are generally served by a major service provider, an external company that handles payments and communicates with borrowers known as master servicer. However, if the CMBS loan becomes insolvent, the service will generally be switched to a special service provider who will act to determine if the borrower can become current again (generally through repayment of debt or modification of the loan). The traditional non-performance of a loan is not the only event that can cause the loan to be sent to a special service - sometimes simply losing the main tenant can send the loan to a special service. If a special service provider wants to maximize their short-term interests, they will have one of the following steps:

• Sell off the mortgages and recover the money. This will help him curtail the losses, clean the books and look for alternative business opportunity.
• Look for secondary sell to another asset Management company. Here if there is a long-term investor, he may be willing to offer a better price and special service provider may try curtailing losses to some extent.

c.            Thinking about the longer run, are there any reasons why the special servicer

might not want to undertake the actions you suggest in part (b) above? [a couple of sentences]

Ans

B-pieces represent a large amount of the actual commercial mortgage backed securities that are sold, so, the availability and price of CMBS loans is directly related to the market demand for these securities. While CMBS risk-retention rules have changed the market, the impact has not been negative. The new rules, which stem from the Dodd-Frank Act, mandate that CMBS lenders keep at least 5% of a loan on their books, and also require that B-piece buyers hold onto their investment for a minimum of 5 years. This means that hedge funds and other players who were actively trading B-piece securities can no longer do so and thus buyers may be limited. As the loss is very high a 150 Mn loss on original investment Special service provider may want to hold the loan and look for restructuring the debt thus taking a Chance of revival. (Normally not a preferred step if the objective is short term benefit)

d. Why do you think the CMBS market features a key role for B-piece investors, but the RMBS market does not? [a couple of sentences]

Ans: While the A-class bondholders are paid first, B-piece bondholders must wait until all A-class bondholders are fully paid before they receive any compensation. Due to their higher risk, however, B-piece offer investors significantly higher returns when compared to A-rated.

Since RMBS is anyways a lower preferred mortgage category, there may not be so many takes for B Piece in RMBS due to higher risky nature of RMBS. However, CMBS is a an area of interest for B-Piece investors.