9322 Research MortgageManual Paper

®
Appraiser’s Guide to CMBS and the Debt Capital

Markets
Presentation to: The Appraisal Institute – AI Connect 2015
July, 2015
Proprietary & Confidential Page 1

Objective ®
Presented by:
Steve Powel, Constantine “Tino” Korologos, MAI, CRE

Chief Executive Officer of Situs Managing Director of Situs

Todays Outline ®
1. Introductions
2. History of the the CMBS Markets
3. Brief look at the Debt Capital Markets
4. “Alphabet Soup”
1. Definitions - terminology
2. Who are the players and what do they do
5. How does the CMBS Market Work
1. CMBS Bond Structures
2. What’s the Process?
3. How does the Appraiser fit in?
6. The Rating Agencies
1. What do they do in the process?
2. How do they look at Appraisals?
7. Case Study on a large loan CMBS deal – 200 Park Avenue, NY, NY
8. Questions

Introduction to CMBS ®
• Commercial Mortgage Backed Securities (CMBS) are bonds backed by pools of mortgages on commercial and
multifamily real estate. As of June, 2015, the US market capitalization of the CMBS market was $746Bn.
• CMBS offer several advantages over commercial whole loans. Securitization allows for the division of the loan
into credit classes so that an investor may buy a class rated from AAA to B and unrated.
• CMBS are marked to market on a daily basis and hence are more liquid than whole loans. CMBS appeal to a
wide array of investors because of attractive relative spreads and stronger call protection than residential
mortgage securities.
US CMBS Outstanding Standard Property Types

($Bn) 2.0 Legacy Total Office Retail Industrial
Conduit 154 348 503 CBD High Rise Regional Mall Heavy/Manufacturing
SnglAsset/Borr 46 6 52 Suburban High Rise Discount/Outlet Mall Light/Assembly
Large Loan 8 3 11 Suburban Low Rise Power Center Research & Development
Agency 187 15 202 Restaurant Warehouse
Grand Total 394 372 767 Automotive Self-Storage
Multifamily Hotel Healthcare
High Rise Resort/Golf Independent Living
Garden Full Service Assisted Living
Limited Service Skilled Nursing
Extended Stay
Source: Trepp, Morgan Stanley Research

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History of the CMBS Market

®
History and Development of the CMBS Industry
• Before the mid-1990s the U.S. real estate business was predominantly a private market.
• Lending was dominated by a handful of banks, life insurance companies, and pension funds.
• Real estate ownership was regionally focused, with ownership concentrated in a few hands. Families
and private partnerships were the largest owners.
• In the real estate recession of the late 1980s and early 1990s, commercial real estate prices fell by 50% or
more in some areas, and delinquency rates on loans soared to all-time highs.
• Losses led to the exit of many traditional lenders from the commercial mortgage market.
• Regulators and rating agencies turned more negative on commercial mortgage holdings, so that the
remaining lenders became less willing to extend credit.
• Low real estate values combined with the failure or exit of traditional lenders provided innovation
opportunities and a shift from private to public ownership.
• REITs began buying undervalued real estate portfolios funded through public stock and bond offerings.
REIT shares provided an opportunity for small, diversified investments in real estate.
• Investment banks started to apply securitization legal structures developed during the 1970s and 1980s
for residential mortgage-backed securities (RMBS) to commercial mortgages. In the mid- to late-1980s,
issuers securitized a few loans on single properties into CMBS.
• Packaging of diversified pools of mortgages into CMBS developed in the mid-1990s when the Resolution Trust
Corporation (RTC) pooled non-performing loans from failed institutions.
• Some transactions exceeded $1 billion and led to the growth in the investor base for CMBS.
Source: Morgan Stanley Research

Historical CRE (all) Debt Originations by Year ®

Historical CMBS Originations by Year (Trailing 12 mo) ®

Historical CRE Debt Originations by Year ®

CMBS Loan Maturities… what lies ahead ®

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Brief Introduction to the

Real Estate Capital Markets

Capital Markets Debt Market Composition ®
Source: Federal Reserve Bank

12

Capital Markets Transaction Activity ®
13

Capital Markets Overview ®
Definition of capital markets

• The marketplaces where money is raised and securities are traded
• A place or system in which the requirements for capital of a business can be satisfied
• Capital markets include stock markets (equity) and bond/credit markets (debt)
Credit ratings are a very important part of the credit markets and are used by:
• investors; issuers; commercial banks; investment banks/broker-dealers; government
agencies.
A classical approach to the real estate capital markets considers a simple “debt” and “equity”
construct
• “4 quadrants of capital”
Public Private
Debt Debt
Public Private
Equity Equity
14

Capital Markets – Real Estate ®
Public Debt & Public Equity: Private Debt & Private Equity:
 Commercial Mortgage-Backed Whole Loans
Securities (CMBS)
Mezzanine Loans
 Collateralized Debt Obligations
B-Notes (Subordinate to I-grade portion
(CDOs)
of mortgage debt)
 Real Estate Investment Trusts
Limited Partnerships
(REITs)
Private REITs
 Mutual Funds
Separate Accounts
Advantages Disadvantages Advantages Disadvantages
> High liquidity > High volatility > More "leveragable" > Low liquidity
> High transparency > Less leverage > Customizable Investment > Requires greater initial capital
> High Diversification > High Diversification Strategies investment
> High degree of current income > Difficult to project CF with > Low volatility > Investment periods are longer
> Investors can "select" risk CMBS (prepayments & defaults > More difficult to customize
diversified portfolios
However, the capital markets have become much more complex in nature…..
15

Capital Markets Securitization ®
Structured Finance is a (relatively new) subsector of finance that was developed to transfer risk
using a complex legal framework
Securitization
• Is the process of taking an illiquid asset, or group of assets, and through financial
engineering and legal definitions, transforming them into a tradable, liquid securities.
• A structured finance technique that pools assets together and, in effect, turns them into a
tradable securities held by a bankruptcy remote special purpose vehicle (SPV). Financial
institutions and businesses of all kinds use securitization to immediately realize the value of
a cash-producing asset; recognizing the arbitrage stemming from illiquid/liquid investments.
The securitization of real estate takes multiple forms:

• Real Estate Investment Trusts (REITs)
• Commercial Mortgage-Backed Securities (CMBS)
• Collateralized Debt Obligations (CDO’s)
• Residential Mortgage-Backed Securities (RMBS)
The securitization of real estate finance has blurred the lines of the 4-quadrants approach to
capital markets
• Risk Spectrum approach evaluates and prices “risk” rather than “debt” or “equity”
16

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“Alphabet Soup”
Terminology and the Players

Definitions & Terminology ®
Advances Appraisal Reduction ASERS

“B Piece” Bankruptcy Remote Entity Call Protection
CMBS Conduit Credit Enhancement
Defeasance Depositor First Loss Piece
Haircut Independent Director Interest Only Strip (IO)
Investment Grade Liquidation Fee Lock-Box Provision
Loss Severity Master Servicer Master Servicing Fee
Mezzanine Debt Non-Consolidation Opinion Pari Passu Loan
Pooling & Servicing Agreement Private Placement Prospectus
Qualified Institutional Buyer REMIC (Real Estate Mortgage Investment Conduit)
Realized Loss Reps and Warranties SEC Rule 144A
Senior/Subordinate Structure Services Servicing Advances
Special Purpose Entities (SPE) Special Servicer Subordination
Tranche Trustee Waterfall
Yield Maintenance

Who are the Players and what do they do ®
Borrowers
Mortgage Loan Originator, Mortgage Bankers and Brokers
Loan Sellers
Depositors
Rating Agencies
Subordinate Bond Holders – Controlling Class Bond Holder
Investment Grade Certificate Bond Holders
Third Party Servicers (Master Servicers, Special Servicer & Operating Trust Advisor
Trustee

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How does the CMBS Market work?

CMBS Transactions Flow of Investments & Securities ®
Source: CREFC

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Where the Money Goes

Mortgage lien and
Loan Originator /
Assignments of Rents and Leases
Loan Seller
(Lender)
Loan Proceeds
Mortgage Securities Sale

Notes Proceeds at Closing
Servicer- Trustee-
Debt Service Debt Service
Borrowers Collection Distribution
& Escrows Less Servicer Fee
Account Account
Plus Advances
Monthly
Bond Securities Sale
Coupon Proceeds at Closing
& Principal
Securities
CMBS Bonds
Investors
8
®
CMBS Architecture
• CMBS have very simple structures compared to their residential mortgage counterparts.
• Each tranche represents a security with its own credit rating, average life, and other characteristics.
• Bonds are almost always sequential pay: amortization, prepayments, and default recoveries are paid to
the most senior remaining class. The lowest-rated remaining class absorbs losses.
• Unlike their residential counterparts, commercial mortgages almost always have some form of
prepayment penalty, making credit analysis more important than prepayment analysis.
• A CMBS investment requires analysis on three levels: property, loan, and bond.
Properties Mortgages Asset Pool Liabilities
Property 1 Mortgage 1
Real AAA AAAAAA
Estate
Property 2 Mortgage 2 Mortgage
Investment
Conduit
AA
(REMIC)
Property N Mortgage M NR
Source: Morgan Stanley Research

CMBS Structure and Participants ®

®
Post-closing
Investors
Investors Trustee/
Bonds traded in the Fiscal Agent
secondary market by Investors
$
Investment Bank/ Trust
Secondary Traders
$
Borrowers
$ Master Servicer
Rating Agencies
Primary or Sub-Servicer /
Mortgage Banker
Special Servicer Continue to rate bonds
7
The CMBS “Playbook” – the Pooling and Servicing Agreement ®
What is the Pooling & Servicing Agreement (PSA)?
The PSA is a multifunctional document executed by the Depositor, Trustee, Master

Servicer, Special Services and Trust Advisor which implements:
• Creation of the CMBS trust the owns the loans

• Conveyance of the loans along with the assignment of rights & remedies of the
depositor against the seller of the loans.
• Appointment of the parties mentioned above and the detailed provisions
governing the rights and obligations of the parties and the certificate holders.
• Issuance of certificates of the beneficial interest in the CMBS Trust with the
priorities and rights to payments for each class of investor.
• Waterfall distribution
• Rights, duties and obligations of the parties.
• Election by the CMBS trust to be treated as a REMIC for purposes of Federal Tax
• Definitions and provisions including the application of the appraisal process.

Appraisal Reductions – ARA and ASER ®
What is an appraisal reduction?

Appraisal reductions allow for a reduction of servicer advances for a loan that is
expected to suffer a loss. To calculate those reductions, the special servicer obtains an
independent third party appraisal. Such events are triggered by specific loan events as
defined in the PSA. Examples might be 120 days of delinquency, 60 days delinquency
after a borrower bankruptcy, or immediately after a loan becomes REO.
What is ARA?
Appraisal reduction amount generally equals the excess of the sum of the unpaid
principal balance, unpaid servicer advances and other charges over the sum of 90% of
the appraised value with the amounts of reserves, escrows & LOCs
So a $10m UPB and other charges, with a $9m appraised value with $200k reserves
would be the excess of $10m over 90% of $9m ($8.1m) plus $200k or $1.7m.
What is an ASER?
The Appraisal Subordinate Entitlement Reduction is the difference between the old
and new monthly advances after the ARA was taken. Appraisals are generally updated
every year and any further decreases in value would increase the ASER.

Addenda ®
The Rating Agencies

What are the Rating Agencies and what do they do? ®
What is the definition of a Credit Rating Agency?
As defined by the U.S. Securities and Exchange Commission, a credit rating agency is defined in the Rating Agency
Act to be a person (a) engaged in the business of issuing credit ratings on the Internet or through another readily
accessible means, for free or for a reasonable fee, but does not include a commercial credit reporting company;
(b) employing either a quantitative or qualitative model, or both, to determine credit ratings; and (c) receiving fees
from either issuers, investors, or other market participants, or a combination thereof. NRSRO is a Nationally
Recognized Statistical Rating Organization.
Who are the Major Rating Agencies?

Moody’s Investors Service, Fitch Ratings, Standard & Poor's, Kroll Ratings, Morningstar Ratings, DBRS (Dominion
Bond Ratings Service)
What is a Rating?
A Rating is an opinion … just the way an appraisal is an opinion. But protected under the First Amendment
AAA Determined to have almost no risk of loss due to credit-related events. Assigned only to the very
highest quality obligors and obligations able to survive extremely challenging economic events.
AA Determined to have minimal risk of loss due to credit-related events. Such obligors and obligations
are deemed very high quality.
A Determined to be of high quality with a small risk of loss due to credit-related events. Issuers and
obligations in this category are expected to weather difficult times with low credit losses.
BBB Determined to be of medium quality with some risk of loss due to credit-related events. Such issuers
and obligations may experience credit losses during stress environments.
BB Determined to be of low quality with moderate risk of loss due to credit-related events. Such issuers
and obligations have fundamental weaknesses that create moderate credit risk.
B Determined to be of very low quality with high risk of loss due to credit-related events. These issuers
and obligations contain many fundamental shortcomings that create significant credit risk.
Rating Agencies – The Meltdown and Regulations ®
Rating Agency Reform

- Credit Rating Agency Reform Act passed in 2006
- Since the financial crisis regulators have encouraged “unsolicited” opinions on deals. Ideally this would cut down on
ratings shopping
- The Dodd-Frank act enhanced the SEC’s enforcement mechanisms for credit rating agencies (NRSRO)
o Establish maintain, enforce, and document internal control structures governing implantation of and adherence
to policies, procedures, and methodologies for determining credit ratings. An annual report of must be submitted
to the SEC
o The SEC may suspend or permanently revoke the registration of a NRSRO for a particular class or subclass of
securities if they cannot consistently produce reports with integrity
o Sales and marketing decisions are strictly prohibited from influencing the production of ratings
o Review of work when a credit analyst leaves a NRSRO and if the prospect of future employment influenced their
work. These reviews must be formalized and the SEC will review the NRSROs policies at least annually and
whenever such policies are materially modified or amended
o NRSRO’s must report to the SEC if new employees previously worked at another NRSRO in a credit rating capacity
o Complete public disclosure of the NRSRO’s initial credit ratings and changes to credit ratings
 Enhances the disclosure of transition and default rates; Standardizes those rates within NSRO’s
o Compensation of each compliance officer is linked to financial performance of the NSRO in such a way to ensure
independence of the officer’s judgement
o Public Disclosure of procedures and methodologies including qualitative and quantitative data and models
 Must promptly publish any changes to those things, why and the likely changes to current ratings as a result
 Notice of significant error in existing procedures and methodologies
 Disclose the version of the credit rating procedure or methodology used for a rating
o Disclose with each rating essential qualitative and quantitative information as well as the methodology to give
transparence to investors and includes key assumptions and possible limitations
Rating Agency Process – Office Properties ®
Rating Agency Cash Flow Evaluation… consistently applied over time
Source: Kroll Bond Rating Agency

Rating Agency Process ®
Rating Agency Valuation Thresholds – All LTV’s aren’t created equal

Rating Agency Process – Sample Office Loan ®
KLTV Thresholds for a High Leverage Loan in a SASB Transaction

Addenda ®
Case Study – Single Borrower

CMBS Deal
200 Park Avenue, New York, NY

Case Study – SASB Deal 200 Park Avenue, New York, NY ®

Source: KBRA Presale report BAML 2015-200P

Case Study – 200 Park Avenue, New York, NY ®



Case Study – 200 Park Avenue, New York, NY ®

Addenda ®
Addenda

Who We Are ®
Global Operations
Strategic
United States Europe
Outsourcing Atlanta Copenhagen
Boca Raton Dublin
Solutions for Des Moines Frankfurt
Houston London
the Financial New York Madrid
Robbins, NC India
Services Industry San Francisco
• Founded in 1985 • Involved in one- • Focused on process support, • Blue chip customer
trillion+ dollars of platforms and servicing/asset base
• More than 600 employees CRE-related management
transactions • Partner platforms
• REFI Advisor of the Year Award • Solutions address full spectrum with clients improve
• Over $100 billion of of finance industry, including cost by leveraging
• In 2015, Situs was acquired by assets under investment life cycle, deal lower-cost
Stone Point Capital management in US execution, transformation environments
and Europe consulting and asset
management platform
CRE CRE Consulting

Servicing Solutions Valuation Technology
Advisory Fulfillment

What We Do ®
CRE Advisory F.I.G. Solutions Asset/Loan Servicing

• Loan Sizings/Screenings • Master Servicing
• CCAR / DFAST
• Mark to Market Analysis • Primary Servicing
• Data Aggregation
• Scenario Analysis • CMBS Special Servicing
• Valuation / Analysis
• Securitization Support • NPL, Asset Management and Workouts
• Due Diligence & Asset Underwriting (balance • ALLL / Probable Loss Derivations
• Asset and Portfolio Administration
sheet and all CMBS tranches/structures • M&A Due Diligence/Valuation • Payment Processing & Cash
• Agreed Upon Procedures (AUP) • Data Aggregation Management
• Asset Evaluation & Cash Flow Modeling • Regulatory/Compliance Audits • Construction Management & Draw
• Lease Abstraction Processing
• Portfolio De-risking Strategies
• Variance Analysis • Warehouse Line Underwriting and
• Loan Credit Administration, Loan Risk
• PI & LC Rollover Analysis Servicing
Rating Analysis /Support
• Loan Closing Support
• Document Imaging/Scanning/Indexing
Valuation Solutions Technology Solutions

• Valuation Management • Situs INSIGHT
• Valuation Management System Market Information Management
• Process Management, Bidding & Engaging Appraisers, • Situs RERC VMS
Document Management, Reporting, and Audit Support
Valuation Management System
• Valuation Advisory
• Fiduciary Services • CLOSER*
Underwriting/Asset Management Database
• Portfolio Valuation & Analysis, Debt Valuation and
Fairness Opinions • MIDAS
• Appraisals, Market Studies and Tax Consulting Proprietary, Web-Based Special
Servicing System
• Purchase Price Allocations
• Research Publications/DataCenter
*affiliate business with CJC Technologies Proprietary & Confidential Page 43

How We Do It ®
With 30+ years of tried & tested business practices, Situs provides
experienced execution platforms which augment our client/partner’s team
Scalability & Variable Competitive Cost Customized Comprehensive

Staffing Model Model Leveraging Solutions Execution Strategies
Lower-Cost
• Flexible delivery models – on • Experienced professionals
• Established business practices Environments premise or off premise; including multiple product
allow team to quickly scale “as dedicated, semi-dedicated or specialists – Valuation, Hotel,
needed” resources • 15 offices across the US and project-based support Multifamily, AUP, Lease
Europe, including three Abstract & Portfolios
• Seamless management of the operations centers • Short-term project
peaks and valleys of your requirements with our 600 • Skilled and tenured team,
business • Lower cost model, that experienced real estate leveraging over 30 years of
leverages geography, professionals Situs’ experience with
• Improved staff efficiency – quality & time zones
right-sized team enhanced work product quality
• End-to-end life cycle solutions

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Appraiser’s Guide to CMBS and the Debt Capital

Proprietary & Confidential Page 1

Steve Powel, Constantine “Tino” Korologos, MAI, CRE

Proprietary & Confidential Page 2

Proprietary & Confidential Page 3

US CMBS Outstanding Standard Property Types

Source: Trepp, Morgan Stanley Research

Proprietary & Confidential Page 4

History of the CMBS Market

Proprietary & Confidential Page 5

Source: Morgan Stanley Research

Proprietary & Confidential Page 6

Proprietary & Confidential Page 7

Proprietary & Confidential Page 8

Proprietary & Confidential Page 9

Proprietary & Confidential Page 10

Brief Introduction to the

Proprietary & Confidential Page 11

Source: Federal Reserve Bank

Proprietary & Confidential Page 12

Proprietary & Confidential Page 13

Definition of capital markets

Proprietary & Confidential Page 14

Proprietary & Confidential Page 15

The securitization of real estate takes multiple forms:

Proprietary & Confidential Page 16

Proprietary & Confidential Page 17

Advances Appraisal Reduction ASERS

Proprietary & Confidential Page 18

Mortgage Loan Originator, Mortgage Bankers and Brokers

Subordinate Bond Holders – Controlling Class Bond Holder

Investment Grade Certificate Bond Holders

Proprietary & Confidential Page 19

How does the CMBS Market work?

Proprietary & Confidential Page 20

Proprietary & Confidential Page 21

Where the Money Goes

Mortgage Securities Sale

Properties Mortgages Asset Pool Liabilities

Source: Morgan Stanley Research

Proprietary & Confidential Page 24

Special Servicer Continue to rate bonds

What is the Pooling & Servicing Agreement (PSA)?

The PSA is a multifunctional document executed by the Depositor, Trustee, Master

• Creation of the CMBS trust the owns the loans

Proprietary & Confidential Page 26

What is an appraisal reduction?

Proprietary & Confidential Page 27

The Rating Agencies

Proprietary & Confidential Page 28

What is the definition of a Credit Rating Agency?

Who are the Major Rating Agencies?

Rating Agency Reform

Rating Agency Cash Flow Evaluation… consistently applied over time

Source: Kroll Bond Rating Agency

Proprietary & Confidential Page 31

Rating Agency Valuation Thresholds – All LTV’s aren’t created equal

Source: Kroll Bond Rating Agency

Proprietary & Confidential Page 32

KLTV Thresholds for a High Leverage Loan in a SASB Transaction

Source: Kroll Bond Rating Agency

Proprietary & Confidential Page 33