Skip navigation


I just completed a podcast with CREPIG. Will let you know when it is available. The podcast is based on my work on portfolio Credit Risk loss behavior. I have distilled the “Solomon’s 5 Rules” for building CMBS portfolios. These rules apply to other MBS portfolios, too.
1. Number of Properties: Portfolios should consist of more than 100 properties, ideally between 150 & 200 properties. Portfolios are less sensitive to any one default. Note, this is not about dollar values. It is about the number of properties and loans in a portfolio.
2. Similar loan sizes: Keep all loans sizes to a similar size as this reduces the risk of a single large loan taking down the entire bond stack. For example, if a deal consist of 149 $1 million loans and 1 $50 million loan, the deal risk is substantially skewed to the risk of that single $50 million deal.
3. No Cross Collateralized: Avoid any cross collateralized loans or multiple property loans. These carry much higher risk than single property loans and have a 150 basis points higher default rate.
4. Slicing & Dicing: Don’t do it. At best it has a small positive effect on the loss characteristics of the deal or portfolio, but generally it is much worse because it triggers multiple defaults and increases the portfolio’s severity of loss. And to make matters worse, servicers have difficulty reporting loan statistics for sliced and diced loans.
For example, slice 250 properties into 100 slices each and recombine each property slice into 100 mortgages. Then 2 or 3 non-paying properties do not appear to have any effect on any of the mortgages. But if the number of non-paying properties rises to 6, 7 … 10 or higher, then all mortgages default. Then we find ourselves in a position where 100% of the mortgages have defaulted, instead of 6/250 to 10/250 or 2.4% to 4% of single property mortgage defaults.
What slicing & dicing does is that it converts 250 diversified properties into 100 identical mortgages, i.e. it negates any and all diversification that the portfolio may have had.
5. Single Property, Multiple Loans: If you have a multiple loans to cover a single multistory
building use a fail-soft approach and be specific about each loan.
5. 1 Clearly Designate Income Allocation:
For example loan 1 is secured against income from floors 1 to 5. Loan 2 is secured against income from floors 6 to 10, etc. These loans now behave like loans in neighboring buildings. This reduces the correlation risk between the loans, and a single loan default does not cause the other loans to default.
This is much better for the borrower, because the borrower does not lose his property as a result of a partial loss of income. And more importantly for the investment banker, when the mortgages are securitized into a CMBS deal, the smaller loan defaults slow the loss escalation through the bond stack.
5.2 No Cross Tenants: As far as possible make sure no single tenant appears in more than one loan. Cross tenants increase multiple loan defaults.
___________________________________________________________________
Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: