Free Custom «Commercial Mortgage Backed Securities» Essay Paper

This paper investigates the literature that is available on the Commercial Mortgage Backed Security. It establishes how this financial product resulted from the financial innovation and how the market has received it. In addition, it analyses the market for the innovation and what makes the product special in the market. In the analysis, the paper thoroughly describes the product, telling why it was resulted from the financial innovation, identifying the reason for the financial innovation, discussing how the product is used or can be used. Moreover, it establishes the level of success of the Commercial Mortgaged Backed Securities. According to literature available, these are types of securities that are backed by commercials’ real estate rather than the conventional use of residential estates (Cebula and Hung 121).

History

This market product was resulted from the chronic failure of the associations that provided loans and saving services. According to the United States economic history, this was after the assets of these associations were seized by the Resolution Trust Corporation. The corporation had the responsibility to liquidate the acquired assets without having to keep them as their standing portfolio. This Resolution Trust Corporation had earlier unsuccessfully tried the same ventures in 1991. Since nothing bad had been anticipated, the corporation had been at the forefront giving loans to people who wanted them for their businesses. Also called conduit lenders, these businessmen originate the mortgages, so that they can use them at a later date as security for loans. Thus, the buying firm keeps them in a pool where standards sections are sold to generate the interest income for the investors. The use of business properties as security for loans has become very popular in the United States lately. Although, there are no fundamental differences between this type of mortgage and residential mortgage, attention of investors has considerably shifted to the commercial property mortgages. This has been the trend, in spite of the fact that this business product has a higher interest rate, as compared to the commercial property (Ross 213).

 

Type of service

Type of assignment

Title of your paper *

Academic level

Pages

Timeframe

Spacing

Currency

  Order now

Considering that there has been an equal steady rise in the prices of both commercial and residential property, and the fact that this trend is supposed to continue for some time, most lenders are getting convinced that commercial mortgage backed securities are the best option. Although, both products require a commitment to remit payment after a stated time, the use of commercial property is more lucrative, because the commercial mortgage loan can be used in other business engagements, besides the security purpose. In addition, commercial mortgages generally have less risk in terms of repayment, as the period over which they are secured is always fixed (Keith 91).

Securitization

The securitization of commercial mortgages is mostly done by attorneys at Cadwalader. In the United States, they are well-known as the prime handlers of commercial mortgage backed security. This idea of tracking the participation of a law firm in this service began way back in 1994. Since then, a lot of progress has been made, especially with the entry of Commercial Mortgage Alert. In addition to servicing mortgage users and underwriters, these market players also represent other transactions undertaken by credit enhancers and loan sellers among others. Over the years, the Capital Market Department has worked closely with these firms with a view to financing all forms of financing within the real estate sector. The services offered by this group of legal companies include directly issuance and securitization of the notes. Although, it only started on properties, it has significantly focused on student loans, automobile leases and commercial mortgages. According to the literature available, the legal company has taken part in over $ 1 trillion cases of mortgage securitization (Cebula and Hung 121).

Innovativeness of the Project

This inventive business product has literally set new standards for mortgages, where real estate holdings have been used as securities for a long time. Notably, the most prevalent complaint in business quarters has been the huge repayment risks that were involved in real estate mortgage backed securities. It must, therefore, be considered as a great innovative step that the designers of commercial mortgage backed securities would come up with a modified form that involves less repayment risks. This is due to the fact that the basic structure of commercial mortgages is defined by certain elements that are popular with the people of the United States (Ross 213).

In addition, there is the element of early repayment that enables investors to remit their turnovers before the stipulated date. This is a complete break from the norm, whereby the remittance is mostly done after the settlement date has passed. Conventionally, these payments usually occur two to three days after the specified date has elapsed. The emergence of the commercial mortgage backed securities has enabled businesspersons who wish to receive their dividends on a certain date to make early payments. Moreover, the element of yield maintenance which is a penalty imposed on persons, such that the lender will end up attaining the same amount in the mortgage schedule payment, even if the borrower makes an early payment. Ideally, this eliminates the worry of lenders that they would make considerable losses, in case the borrower makes an early repayment. For instance, if a businessman on a 15-year mortgage that is at 7% decides to make a prepayment midway at a time when the Treasury bond stands at 5%, the borrowing investor would have to pay for the 2% deficit in each of the remaining years, so that the lender does not make undue losses. This principle is particularly targeted at cushioning the lender against making losses, due to the fact that the borrower has decided to pay them before the maturity of the loans. Although, the formula for calculating yield maintenance differs considerably, they are both aimed at protecting the interests of investors and securing their funds.  In the same manner, business lenders operating commercial mortgage backed securities enjoy an innovative plan of early repayment penalty that ensures that lenders make no losses and that borrowers do not get undue advantages for the funds they borrow. These elements make commercial mortgage backed securities quite very lucrative (Hayre 42).

Stay Connected

Live Chat Order now

The opportunity to open mortgage associations has been another front on which the designers of the commercial mortgage backed securities have been very innovative. For instance, the government national mortgage association has been mandated by the Department of Housing to offer the special assistance and liquidation functions to the stakeholders with a view to ensuring a better security for their investments. In this method, the United States legal system guarantees absolutely timely payments to the lenders on both their principal capital, as well as their accumulating interests. This gives investors a greater confidence that their money would be safely invested (Ross 213).

Market for the Innovation

The commercial mortgage backed securities have found market all over the world. For instance, in the United States, this product has become progressively popular, especially after 2007. According to literature, commercial mortgages were initially dominant in America before they became dormant again. However, the recent years have seen a complete resurrection of this product due to the financial crises that redefined global business. Indeed, it has been reported that several banks, including the Royal Bank of Scotland, have been attracted to this product by its conservative nature, especially with regards to the bottoming-out of values, as well as the underwriting. In fact, there is a general concession that the situation as it is now in the United States is a radical improvement of the situation two years ago. Before this resounding comeback, a significant number of deals of the commercial real estate were basically funded by the mortgage backed loans. Ideally, this system allows banks and other financial institutions to eliminate loans from their financial systems. This is mostly achieved by pooling these resources and using them in bond issuance. According to financial analysts, this move is quite significant in that it provides for funds that are put forward from the sales to be used in putting future real estate loans. According to Colliers International, commercial mortgages totaling to more than $230 billion originated from the United States. However, this figure considerably plummeted the following year to $ 12 billion, due to the rapidly falling property values and the moribund nature of the real estate market (Hayre 42).

This bold resurgence has been attributed to the courage of most financial institutions, as well as the government’s intervention. For instance, financially strong properties in New York, Washington and Boston have been receiving the steady financing. At the same time, properties located in smaller cities have considerably lost value over time. This has significantly stirred public interest on these products, especially for lenders who are eying future financial securities. According to financial reports, the investors have consistently recorded positive response to the commercial mortgage backed securities. In fact, the demand currently exceeds the supply in the United States of America. This significant success has been attributed by most players as being the result of conservative underwriting standards that have since been introduced. Nonetheless, the government program that is popularly known as Term Asset Loan Facility has greatly contributed to this success by providing the debt capital to lenders in the United States (Cebula and Hung 121).

In the United Kingdom, several commercial mortgage backed securities have been formed in the past few years. Before 2007, this financial product was not popular in the European market. According to the financial reports, a paltry 11.5 billion of commercial mortgages were given in the United Kingdom during the first half of 2007. In comparison to American market, this was insignificant considering that they recorded a good value of 38.5 billion in the month of March alone. Undoubtedly, commercial mortgage backed securities have equally suffered the effects of the global financial crisis. In fact, investors are too afraid to invest in this mortgage to the extent that no new deals took place in the entire United Kingdom in 2008. According to Financial Times, the entry into 2008 saw a radical fall of 89%, thereby dipping people’s hopes about the prospects of commercial mortgages (Ross 213).  

The market for commercial mortgage backed securities has not been stable, either since the onset of the global financial crisis. Recently, some significant change has been noted in Asia, in spite of the fact that some market players are still wary of the future. This stems from the fact that the quality of commercial securities currently provided is a way lower that it was before the financial crisis. Even as they attempt to turn a blind eye to the economic uncertainties, investors in this financial product have consistently complained about the eminent lack of diversity and the consistent increase in the loan-value ratios. According to re-known financial analysts in Asia-Pacific, the securities that have extremely high loan-value ratio tend to be more risky, as compared to those with a smaller ratio. For instance, the loan-value ratio increased from 99% to 110% in 2008. This trend has been a cause for alarm for most investors, especially due to the fact that it implies a deterioration of the quality of assets. However, the greatest cause of panic in the business quarters has been the radical rise in the ratio. In addition, investors are certainly worried about the idea that 60% of Asian loans that are contained in these types of securities are basically for retail property. This is in contradiction to conventional guidelines that specify that investors should diversify their investments and that no single investor should invest more than 30% of his or her resources in one line of property (Hayre 42).

Commercial mortgage backed securities have also found the market in Africa. Although, this product is only taking root in Africa, the relevant financial institutions have put in place requirements that persons engaging in this investment must have perfect knowledge of the overall portfolio. This follows a period of uncertainty during the mortgage crisis in the South Africa. However, significant progress is being recorded at the moment with the recovery of the global market. In 2010, the continent recorded sales totaling to $12.2 billion, a 20% from the previous year. This trend has remained unchanged for quite some time now, with the current values standing at $35 billion for the year ended 2011. This certainly portends a bright future for the new product. Indeed, the fact that commercial mortgage backed securities have become more popular after the financial crisis indicates their significance in stimulating a struggling economy. That is why the strong financial markets are keen to fully adopt it as a way of ensuring a full recovery (Ross 213).

In conclusion, the modification of mortgage policies to suit the commercial mortgage backed securities was one of the most innovative financial ideas of the moment. Indeed, the three elements continue to remain the pillars of the mortgage market. That is why the global economic community must focus on improving the markets through these securities.