Difference between CMBS and CLOs?
What is the difference between a CMBS loan and a CLO? I believe CMBS is fixed rate while CLOs are floating? Is this correct? Any other differences?
Will appreciate any insights. Thank you.
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Following. If anyone has any resources on how CRE CLOs work / are structured, would be highly interested
CREFC has a nice primer on this, although I think you’ll need to pay for it. Otherwise, Google is your friend.
CMBS are generally fixed rate but some are floating (single asset, large loan deals). CLOs are floating rate because they're bridge loans. CMBS are for stabilized assets
CMBS is essentially securitized, permanent debt. CLO is securitized, bridge debt for value add deals, etc.
Conduit/SASB CMBS are also static pools of asset(s) that do not change. CLOs have an issuer, traditionally a non-bank lender, who stays on as collateral manager, as well as the controlling bond holder/equity tranche holder. Their pools are either setup as static or managed; static pools of assets don’t change*, while managed pools allow the CM to swap out assets during a certain timeframe as long as it conforms to certain pre determined UW parameters and concentration limits (super gray area and gives a lot of discretion to CMs). These ‘blind pools’ can be difficult for investors as the composition of the pool can change significantly from issuance, so you end up UW the issuer and their UW standards, similar to the traditional CLO market.
As an added protection, CLOs have two recurring tests that if failed, essentially turn off payments of interest to the equity tranche and use those funds to payoff the most senior bonds (AAAs at first), providing credit enhancement; these are interest coverage and par value tests. Basically the pool needs ratios above a threshold (110% as an example) of either interest coverage or asset values vs outstanding bonds, otherwise this hyper-amortization feature kicks in. So if a mortgage defaults or is at risk of default it should be excluded from the calc.
Unfortunately, these tests and defined terms in the indenture are extremely vague as to what is a defaulted mortgage and when it actually becomes one, so these can be easily gamed by the issuer to the detriment of other bondholders(thanks lawyers!).
Another protection feature in CLOs is ability of issuer to repurchase assets at par to avoid these tests tripping. Historically in most CLO pools to date, this has occurred and led to strong protection to investors as these distressed assets have defaulted and/or needed workouts that were beyond the scope of what may make sense within the CLO.
If you need to foreclose or structure a complex mod, it is cheaper to do so on your balance sheet and let the juice keep flowing to your equity/unrated tranche. If you don’t buy it out, you may trip a coverage test, lose cash flow, and be required to pay SS/Liq/Workout fees to your hired special servicer, which decreases available cash to your bonds/equity as first loss pieces at resolution (some of these are fee shared but might as well not have to pay them at all or keep 100%) This is the reason why repurchases make sense and actually have been working.
(Not to mention the reputational risk if you as an issuer don’t do this and everyone else in market does, good luck tapping the bond markets again in the future when originations pickup again).
What most people don’t realize is that these issuers may actually be closed end funds that have finite lives and may start winding down. On top of crappy assets that may not recover on their own, this added headwind will likely lead to many more defaults occurring within CLOs in 2024-2025.
I think some of these deals’ mezz tranches that are still rated IG at A/BBB are likely underwater and just relying on repurchase faith to not also get blown out if the music stops (ie rates continue to stay higher, cap rates don’t compress much, issuer repurchases end, and loan sponsors elect to walk away rather than keep carrying cooked properties). Time will tell.
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Second question to Mr. Tranche: a bondholder in a CMBS deal (SASB or conduit), do they own the underlying collateral? My assumption is no, they do not (trust owns).
So at a high level (not a lawyer) the trust (securitization vehicle) owns the mortgages that are pooled together from the originator(s). The Bondholders would not directly own the mortgages nor the underlying properties (though the Lender should have a security interest/perfected lien on the properties (sure hope so!)). These are typicaly REMIC trusts that are tax advantaged to avoid double taxation.
If the Lender completes a foreclosure, then the Trust would own the property outright as REO at that time.
Also, the ‘Lender’ in these contexts is typically controlled by the DCH, uses the servicers as the mouthpiece to speak with the Borrower, (they are indemnified, DCH isn’t), but is essentially all classes of investors in the deal. That is why ‘servicing standard’ is to think of all the bondholders when servicers make important credit decisions, regardless of relationships or any one given class of investors (easier said than done).
I feel dumb
Think I’m just happy
Mr Tranche: I’ve heard that in CMBS 2.0 (post GFC securitizations) foreclosing the debt to get to the real estate is much more difficult, whereas in the past a PE firm could buy the fulcrum security, take control, and exercise its remedies. What has changed in 2.0 with respect to for-control distress investing? Can you still buy the fulcrum, collapse the CMBS structure after paying off senior tranches (and wiping anyone junior), and take possession of the RE?
So in 1.0, cleaning up a deal near end of life would be possible. Basically, different deal parties would each have an option in priority that they could elect to exercise in the event the pool shrunk down enough where very few assets remained. That party could buy the remaining loans out at par or could sell/assign that option to a third party who would buy the loans out at par, plus some accrued interest, expenses, etc. It saved the bondholders from having nominal dollar trust expenses eat away at the small portion of remaining cash flows.
Most 3rd party investors wouldn’t buy a deal that still had a ton of NPLs though (not paying par for them), they’d target acquiring remaining performing loans and it’s all or nothing for these.
There could also be older 1.0 deals where rather than a ‘control shift event’ occurring, control would flow up the stack as each most junior class of bonds was wiped out or appraised out of control, so an investor could plan to buy a little higher up in the stack knowing that they could eventually take control. In 2.0, I think the advent of the operating advisor has largely changed this but I could be wrong as I haven’t really dug into those provisions in 2.0 deals given it hasn’t really come up in the past few years.
There are plenty of stories out there of a new controlling bondholders buying in and altering workout strategy/negotiations around defaulted loans depending on the risk retention structures of certain deals post the 5-yr mark, but I’m not sure I’ve heard of someone going in and attempting to collapse a trust themselves other than the first point. I have seen some note sales at or close to par, however, where the fact pattern allowed a 3rd to believe they could recoup more than the purchase price by exercising rights/remedies against a Borrower in default, and that was the best/fastest recovery to bondholders.
This is great, thanks! What’s the best way to see a comprehensive list of these CLOs (primarily interested in multi/resi)? I’ve been going through some debt brokers but feel like there’s a more efficient way.
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