What is Commercial Mortgage-Backed Security (CMBS)?

Commercial mortgage-backed security definition refers to the financial instruments that feature mortgages on commercial areas instead of residential properties. The major goal of the CMBS is to facilitate liquidity for both commercial and residential lenders. Since there isn’t any fixed or proper method for regulating the structure of commercial mortgage-backed security, it might be a little challenging for people to get the valuations right.

The securities and financial instruments might come with different types of commercial mortgages that might vary in terms, value, and other aspects. The major difference between the CMBS and RMBS is that the latter is associated with a lower prepayment risk than the commercial mortgage-backed security.

CMBS is available as Bonds. Here, the mortgage loans work as the Collateral or the security that will be used in the case of a payment Default. To put it in simple terms, commercial Real Estate loans are used as the collateral for the CMBS. These loans are quite popular in commercial properties, including hotels, malls, factories, buildings, and offices. The banks and financial institutions bundle a couple of commercial real estate loans and offer them in the form of bonds. Each series of bonds are arranged into different segments. Let’s understand the concept with an illustration.

Understanding the CMBS

Suppose an investor plans on buying a commercial property. They approach the credit union or the Bank to finance the buying cost. Basically, the investor applies for a mortgage at the bank. Now, this bank groups the mortgage with other loans and converts them into bonds that could be sold to the potential investors after they are done ranking them. The bonds are ranked on the Basis of senior and junior issues.

The person who has lent these bonds to the investors will make money from the sale. They use this money for mortgage payments. The process allows banks and credit unions to develop more mortgages using the amount they generate from the bundled mortgages or bonds lent to the investors. Not only does it allow banks to lend more funds, but this technique enables commercial borrowers to get quick access to the required funds for financing their commercial properties.

There is no denying that commercial mortgage-backed securities are likely to be more complicated as compared to residential securities. This is mainly because of the complexity of the Underlying securities involved in the CMBS. Any sort of mortgage loan is seen as a non-Recourse debt, in which, the debt is obtained by collateral only.

If the customer fails to repay the debt, the lender will seize the collateral, but the liability of the user will be limited to the collateral only. Nothing beyond that will be seized. Due to the complexities involved in the CMBS, they need a servicer, a master and primary servicer, trustees, and other parties. Every individual involved in the process plays a significant role in ensuring that all activities related to the mortgage loan are executed properly.