cmbs primer 5th edition

FIFTH EDITION 2005

TransformingReal EstateFinanceA CMBS Primer

Primary Analysts: Howard EsakiMarielle Jan de BeurMasumi Goldman

This book is an overview of the CommercialMortgage-Backed Securities (CMBS) market.

The contents of this publication are over eightyears in the making and include excerpts ofresearch reports from as early as 1997. In thisfifth edition of our primer, we have reorganized thechapters to highlight the different investmentoptions within CMBS. New material since our lastedition includes sections on the various types ofAAA CMBS classes, total rate of return swaps,floating rate large loan transactions, and an updated version of the commercial mortgagedefault study.

We hope you find this book useful and welcome comments so that we can improve future editions.

450

The Primary Analyst(s) identified above certify that the viewsexpressed in this report accurately reflect his/her/their personalviews about the subject securities/instruments/issuers, and nopart of his/her/their compensation was, is or will be directly orindirectly related to the specific views or recommendationscontained herein.

This report has been prepared in accordance with our conflictmanagement policy. The policy describes our organizationaland administrative arrangements for the avoidance,management and disclosure of conflicts of interest. The policyis available at www.morganstanley.com/institutional/research.

Please see additional important disclosures at the end of this report.

Morgan Stanley & Co. Incorporated

December 16, 2004

FIFTH EDITION 2005

TransformingReal EstateFinanceA CMBS Primer

Primary Analysts: Howard Esaki

Marielle Jan de Beur

Masumi Goldman

INTRODUCTION TTO CCMBS 1 –– 88History and Structure 2Rating Agency Methodology 4

MAJOR PPROPERTY TTYPES IIN CCMBS 9 –– 339Property Classifications 10Retail 12Multifamily 14Office 16Manufactured Housing 18Industrial 20Self Storage 22Health Care 24Hotel 26

CALL PPROTECTION 41 –– 553Types of Call Protection 43Allocation of Prepayment Penalties 47Relative Value Analysis 48

AAA FFIXED RRATE CCMBS 55 –– 770Tight Window Bonds 56Multifamily Directed Bonds 62Amortizing Bonds 63Premium Dollar Priced Bonds 68

TOTAL RRATE OOF RRETURN SSWAPS 71 –– 774Mechanics of the Swap 72Break-even Analysis 73

CMBS IIOs 75 –– 991Overview 76PAC & Levered IO 81Age-Adjusted Default Analysis 84Pricing Benchmarks: E and J 88

FIXED RRATE LLARGE LLOANS 93 –– 999Fusion vs. Single Asset 94Characteristics 96Rating Agency Approach 98

BBB CCMBS AAND RREITs 101 –– 1122Overview 102Performance 109

CMBS CCONDUIT SSUBORDINATION LLEVELS 123 –– 1177The Right Subordination 124Projecting Losses on BBB- CMBS 128Projecting Losses on BB CMBS 146Projecting Losses on B CMBS 162

MULTIFAMILY MMBS 179 –– 1187Fannie Mae DUS and DMBS 180Ginnie Mae and Freddie Mac Programs 185

Transforming Real Estate Finance

A CMBS Primer1

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FLOATING RRATE LLARGE LLOAN CCMBS 189 –– 2207Extension Risk 190Ratings Drift 194Available Funds Cap Mechanics 204

COMMERCIAL MMORTGAGE DDEFAULTS 209 –– 2221Characteristics of Defaulted Loans 211Loss Severity 212Study Results and Impact on CMBS 214

TRANSACTION MMONITORING 223 –– 2265Monthly CMBS Delinquency Report 224Conduit Tracking Report 228Retail Study 234CMBS Rating Actions 242CMBS Loan Originators 252

EUROPEAN CCMBS 267 –– 2275

JAPANESE CCMBS 277 –– 2290

FACTORS TTO CCONSIDER BBEFORE IINVESTING IIN CCMBS 291 –– 2297

GLOSSARY 299 –– 3306

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Introduction to CMBS

Chapter 1

Please see additional important disclosures at the end of this report.



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chapter 1

Commercial Mortgage Backed Securities (CMBS) are bonds backed by pools ofmortgages on commercial and multifamily real estate. As of December 2004, theglobal market capitalization of the CMBS market was slightly over $541 billion.About 1 in 5 commercial and multifamily mortgages are in CMBS, compared toa securitization rate of about 50% for residential mortgages.

CMBS offer several advantages over commercial whole loans. Securitizationallows for the division of the loan into credit classes so that an investor may buya class rated from AAA to single-B and unrated. In addition, CMBS are markedto market on a daily basis and hence are more liquid than whole loans. CMBSappeal to a wide array of investors because of attractive relative spreads andstronger call protection than residential mortgage securities.

DEVELOPMENT OOF TTHE MMARKETBefore the mid-1990s the U.S. real estate business was predominately a privatemarket. Lending was dominated by a handful of banks, life insurance companies,and pension funds. Real estate ownership was regionally focused with ownershipconcentrated in a few hands. Families and private partnerships were the largestowners. Small and diversified investments in real estate were almost nonexistent.Real estate is a cyclical business moving through various stages of expansion,equilibrium, slow growth, and recovery. Private ownership of real estate and lackof public information fostered extreme real estate cycles. Development andlending was done on a regional basis with little national information.

The steep real estate recession of the late 1980s and early 1990s was the worstsince the Depression of the 1930s. Prices of commercial real estate fell by 50%or more in some areas and delinquency rates on loans soared to all-time highs.Losses on commercial loan portfolios led to the exit of many traditional lendersfrom the commercial mortgage market. Regulators and rating agencies turnedmore negative on commercial mortgage holdings, so that the remaining lendersbecame less willing to extend credit.

CMBS: DDIVERSIFIED PPUBLIC RREAL EESTATELow real estate values combined with the failure or exit of traditional lendersprovided innovation opportunities and a shift from private to public ownership.REITs began buying undervalued real estate portfolios funded through publicstock and bond offerings. REIT shares provided an opportunity for small, diver-sified investments in real estate.

As with REITs, CMBS provide investment opportunities in diversified real estatepools. Investment banks started to apply securitization legal structures, and tech-nology developed during the 1970s and 1980s for residential mortgage-backedsecurities to commercial mortgages. In the mid- to late-1980s, issuers securitizeda 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-performingloans from failed institutions. Some of these transactions exceeded $1 billionand led to the growth in the investor base for CMBS. After the success of theRTC transactions, CMBS gained wider acceptance with investors and non-gov-

ernment, or “private-label”, issuers. Issuance of CMBS in the U.S. grew rapidlyin the mid-1990s. In 2004, U.S. CMBS issuance is expected to reach an all-timehigh of nearly $90 billion.

Outside the U.S., CMBS has also taken hold as a financing vehicle, with $18.5billion issued in Europe in 2004. Most of the transactions are out of the UnitedKingdom, but deals have been done in several other countries. In Asia, Japan isfacing an RTC-like situation, with distressed properties and lenders. In 2004,about $5 billion of CMBS came to market in Asia.

STRUCTURES AAND RRATING AAGENCIES

CMBS have very simple structures compared to their residential mortgage coun-terparts. The bonds are almost always sequential pay, with amortization, prepay-ments, and default recoveries paid to the most senior remaining class. The low-est-rated remaining class absorbs losses. Since commercial mortgages almostalways have some form of prepayment penalty (Chapter 3), credit analysis playsa more important role than prepayment analysis. For residential MBS, prepay-ments are a much more important factor.

CMBS are static pools of commercial real estate loans divided into tranches withvarying subordination levels and credit ratings. A typical transaction has about90% investment grade bonds concentrated in AAA securities, with the remaining10% non-investment grade. Interest only (IO) bonds (Chapter 6) can be strippedoff all or part of the structure.StructureA typical fusion structure consists of sequential pay, fixed rate bonds. The AAAbonds are time-tranched and include a front-pay wide window bond. In additionto the front-pay class, the AAA CMBS market also includes tight window bullets,multifamily directed classes, amortizing bonds, super senior and junior AAAs.(See Chapter 4 for more information.)

In an environment of steadily declining subordination levels, the most recenttrend in CMBS issuance is the super senior deal structure. Prior to the emer-gence of this structure, which includes multiple super senior AAA bonds sup-

Please see additional important disclosures at the end of this report. 3

SAMPLE 20041

NEW ISSUEMARKET CMBS

STRUCTURE

exhibit 1

1Based on Commercial Mortgage Default Study. See Chapter 12.

Source: Morgan Stanley

ported by a 10-year junior AAA bond, AAA subordination levels in 2004 rangedin the low- to mid-teens. Issuers have been able to structure super senior AAAclasses with credit enhancement as high as 20% by carving out a smaller, subor-dinate AAA class. The subordinate 10-year AAA has a lower credit enhance-ment level than the other AAA-rated bonds.

In addition to the mortgage collateral, credit enhancements may be in the formof reserve funds, guarantees, letters of credit, cross-collateralization and cross-default provisions. Loans within the pool may have certain cash control provi-sions such as a “lock box” that requires payments from tenants to go directly tothe trust instead of through the borrower if certain default triggers occur.Virtually all loans within CMBS are bankruptcy remote.

The Trustee, Master Servicer and Special Servicer each play an ongoing role inthe transaction. The Pooling and Servicing Agreement, Prospectus, and otherlegal documents outline each party’s responsibilities and fees. Typically, theTrustee is responsible for reporting monthly payments and collateral perform-ance data to certificate holders. The Master Servicer is responsible for servicingall performing loans and monitoring loan document requirements. The SpecialServicer resolves defaulted or delinquent loan issues.

RATING AAGENCY MMETHODOLOGYBefore each CMBS is issued, the rating agencies review the collateral in the transaction and determine the tranche ratings and pool sizing. During theprocess the agencies review the property level cash flows, perform physicalinspections, and run various stress analyses on the underlying cash flows. Thissection examines the rating process for conduits, or diversified pools of mort-gages. A conduit originates loans for sale or securitization, and not for hold-ing in a portfolio.

When a conduit deal comes to market, the rating agency performs due dili-gence on a subset of the properties (typically between 35% and 75%). Thelarger loans in the deal are always underwritten while the remaining propertiesare chosen such that they provide a representative cross section of the deal.To determine credit enhancement levels, the underwritten cash flow (UCF)produced by each property is then assigned a “haircut” based on various sub-jective parameters. Following is a list of parameters that rating agencies con-sider when evaluating a CMBS conduit1:

• Loan Specific

Property type

Loan-to-value ratio

Debt service coverage ratio

Fixed/floating rate

Loan seasoning

Direct versus correspondent lending

• Real Estate Outlook

1 The parameters are similar to those considered for a non-conduit deal except for adjustments for loan diversification.



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chapter 1

• Deal Specific

Number of loans in the deal

Loan size

Degree of subordination

Balloon extension risk

Quality of master servicer and special servicer

Loans collateralized by different property types are generally ranked in the following order (best to worst): regional malls, multifamily, anchored communityretail, industrial, office and, finally, hotel. These rankings are based on historicaldefaults and cash flow volatility of the different property types. The variation ofrequired credit enhancement levels with debt service coverage (DSC) and loan-to-value (LTV) ratios is shown in Exhibit 2 for common property types. (Thecredit enhancement levels are from Duff and Phelps, which merged with Fitchin 2000. The levels are indicative only, and are different for each rating agency.)

For example at 80% LTV and 1.15 DSC, a regional mall requires 30.1% creditenhancement for a AAA rating while an office property requires double that fig-ure. The credit enhancement levels shown in Exhibit 2 are somewhat “sticky”with respect to a credit/real estate cycle.

It is therefore sometimes possible to “arb” this fact by, say, buying conduit CMBSbacked by office properties in an environment where the fact that office proper-ties are doing well is not reflected in credit enhancement levels. Obviously, AAAsecurities are much less conducive to this kind of play than lower-rated classes.


Individual CreditLoan Coverage Enhancement

LTV DSCR AAA AA A BBB BB B

30 2.50 3.9 2.9 2.2 1.5 1.0 0.5

40 2.00 7.8 5.8 4.3 3.0 1.6 1.0

50 1.75 13.1 9.7 7.2 5.0 2.7 1.1

60 1.50 20.9 15.5 11.5 8.0 4.4 1.7

65 1.45 27.2 20.2 14.9 10.4 5.7 2.3

70 1.35 35.8 26.6 19.6 13.7 7.5 3.0

75 1.25 47.1 34.9 25.8 18.0 9.9 3.9

80 1.15 60.2 44.6 33.0 23.0 12.6 5.0

BASE-CASE CREDIT ENHANCEMENTGUIDELINES FOR VARIOUS PROPERTY TYPES

exhibit 2

Source: The Rating of Commercial Mortgage-Backed Securities, Duff and Phelps Credit Rating Co.



30 2.50 2.0 1.5 1.1 1.0 0.5 0.5

40 2.00 3.9 2.9 2.2 1.5 1.0 0.5

50 1.75 6.5 4.8 3.6 2.5 1.4 1.0

60 1.50 10.5 7.8 5.7 4.0 2.2 1.0

65 1.45 13.6 10.1 7.5 5.2 2.8 1.1

70 1.35 17.9 13.3 9.8 6.9 3.8 1.5

75 1.25 23.5 17.5 12.9 9.0 4.9 2.0

80 1.15 30.1 22.3 16.5 11.5 6.3 2.5

OFFICE

PROPERTIES

REGIONAL

MALLS

Investors should also be concerned with the dispersion of DSC and LTV in theentire deal; that is, having all loans with a DSC of 1.5x is better than having 50%of the loans at 1.0x and the remainder at 2.0x. There may be some element of“gaming” credit-support levels to the extent that Fitch uses discrete DSC andLTV buckets while the other rating agencies use a continuous variation of credit-support with DSC and LTV. However, this is usually mitigated by the fact that atleast two rating agencies rate the investment grade classes of a CMBS.

Given the volatility of short-term interest rates, an adjustable-rate loan is under-written under an interest rate scenario that is substantially higher than currentrates. Loans without a track record of consistent payments are also rated moreconservatively than those seasoned at least five years. The origin of a loan,whether direct or via a correspondent, matters less than it previously did. Manysubjective assessments also go into the rating process and Exhibit 2 shows theaddition and subtractions that rating agencies apply to the credit support level.



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chapter 1



30 2.50 2.5 1.9 1.4 1.0 0.5 0.5

40 2.00 5.0 3.7 2.7 1.9 1.1 0.5

50 1.75 8.4 6.2 4.6 3.2 1.8 1.0

60 1.50 13.4 9.9 7.3 5.1 2.8 1.1

65 1.45 17.4 12.9 9.5 6.7 3.6 1.4

70 1.35 22.9 17.0 12.6 8.8 4.8 1.9

75 1.25 30.1 22.3 16.5 11.5 6.3 2.5

80 1.15 38.5 28.5 21.1 14.7 8.1 3.2

BASE-CASE CREDIT ENHANCEMENT GUIDELINES FOR VARIOUS PROPERTY TYPES (CONTINUED)

exhibit 2




30 2.50 2.6 1.9 1.4 1.0 0.5 0.5

40 2.00 5.2 3.9 2.9 2.0 1.1 0.5

50 1.75 8.7 6.5 4.8 3.3 1.8 1.0

60 1.50 13.9 10.3 7.6 5.3 2.9 1.2

65 1.45 18.1 13.4 9.9 6.9 3.8 1.5

70 1.35 23.9 17.7 13.1 9.1 5.0 2.0

75 1.25 31.4 23.3 17.2 12.0 6.6 2.6

80 1.15 40.1 29.7 22.0 15.3 8.4 3.3

INDUSTRIAL/

ANCHORED

RETAIL

PROPERTIES

MULTIFAMILY

PROPERTIES

On a deal level basis, conduits have diverged most significantly from the tradi-tional CMBS model in the degree of diversification provided by the large num-ber of underlying loans. It is not uncommon to see 200 or more loans in a con-duit. The rating agencies like to see at least 50 loans underlying a deal with nomore than 5% of the deal (by dollar amount) in any one state. Any single loanshould not constitute more than 5% of the deal. Credit-support levels are oftentested by defaulting the three largest loans.

At the triple-A rating level, subordination levels are likely to be very similaracross rating agencies. However, some degree of rating shopping is likely tooccur for lower-rated pieces, given the many subjective aspects of the ratingprocess. One of these aspects is the quality of the master and special servicers.The rating agency looks for a special servicer with a proven track record of realestate workouts.

The rating agency would be concerned if a large number of loans came due at thesame time. This is because loan documents typically allow for three one-year exten-sions, and this is not necessarily long enough to get through a credit downturn.

Finally, the rating agencies evaluate the real estate environment and where we arein the credit cycle.


Special Adjustment1 Other Factors Applied Additions Reductions on a Case-By-Case Basis

AmortizationFully 5% Floating Interest Rates

Interest Only 20% — Asset Quality

Less Than 5 Years Seasoning 10-20% — Market Barriers to Entry

Servicer/Special Cash Flow Volatility

Servicer Assessment 10% 10% Loan Size

Quality AssessmentOrigination 20% 5% Location AssessmentInformation 20% 5% Concentration

Cash Control — 10-20%

Reserves — 5-10%

SUBJECTIVE ADJUSTMENTS TO CREDIT SUPPORT LEVELS

exhibit 3

1Adjustments are applied as a percentage of base-case credit enhancement levels; i.e., if base-case creditenhancement is 10%, and the adjustment factor is 20%, the adjusted credit enhancement is 12% (10 x 1.2).


RATING AAGENCIES AAND IINVESTORS MMONITOR CCONDUIT QQUALITYSome investors have expressed concerns that commercial mortgage conduits havebecome too aggressive in lending and that the quality of loans in CMBS conduitpools will deteriorate. Other investors worry that conduits will chase after loansbacked by “B” or “C” -quality properties, leaving the top-tier loans to insurancecompanies. In our opinion, these fears are misplaced, since securitized loans mustultimately pass through the filters of both rating agencies and investors. If ratingagencies recognize a slide in credit-quality rating, they will increase credit supportlevels (or lower ratings). If investors perceive increased risk, they will demandwider spreads on the securities. Investors can make adjustments to a recognizeddrop in loan quality; it is the unrecognized slippage that is dangerous.

As discussed in the section above, rating agencies apply published standards toloans pooled into a CMBS and adjust the result by making qualitative assess-ments. Almost all CMBS carry at least two, and many have three, ratings.

Different rating agencies assign different levels of credit support to obtain agiven rating level. In order to avoid a split rating, an issuer must go with themost conservative collateral assessment. For example, if Fitch and Moody’s haveAAA credit support requirements of 23% and 25%, respectively, an issuer mustuse 25% enhancement to attain a dual AAA rating. (In a few instances, an issuerwill go with the lower credit support level and receive a split rating. Non-invest-ment grade classes, however, are often rated by only one agency). If an issuerstarts to raise LTVs, reduce DSC ratios, or lend on more risky property types orin more risky areas, rating agencies will respond by lifting credit support levels.The rating agencies thus act as a first level of defense against a potential unob-served fall in loan credit quality.



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chapter 1



Major Property Types in CMBS

Chapter 2



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chapter 2

While CMBS investors don’t need to be real estate experts, particularly at theAAA level, a general understanding of various real estate property types and ter-minology is helpful. In this chapter we explain the various types of real estateproperties and fundamentals that impact their performance.

Information in a transaction prospectus may contain descriptions of variousassets as Class A, B, or C. Below is a description of those asset classes.

CLASSIFICATIONSClass AANewly built; higher quality finishes and prominent locations.

Class BBGeneric real estate; 10-20 years old, well maintained, average locations,fewer amenities.

Class CCOlder properties needing frequent capital investment; uncertain future.

WHY DDO PPROPERTY CCLASSIFICATIONS MMATTER?• Generally, it is believed that Class A properties are the least risky from a

cash flow volatility standpoint.

• The Class A properties set the rental rates in a market. They attract the mostcredit worthy tenants and, by definition, typically have the least deferred maintenance and the lowest risk of functional obsolescence.

• In a market downturn these properties will have the highest demand for space, albeit at a lower rental rate.


class A

class B

class C



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chapter 2

Conduit CMBS transactions provide property type and geographic diversity.Currently, retail properties account for about 30% of outstanding CMBS in themarket, multifamily accounts for about 18%, office properties account for about24%, hotels account for about 8%, and the remaining 20% is composed of man-ufactured housing, industrial, self-storage, and senior housing.

Retail Loans

RELATED TTERMSCredit TTenant LLeaseAll payments guaranteed by credit of tenant (i.e., WalMart).

Triple NNet LLeaseTenant pays rent, real estate taxes, expenses, and maintenance.

Go DDark PProvisionsPrevents tenant from vacating the space while continuing to pay rent; landlordslike this because this vacant space is a detriment to other stores’ sales at the center.

Co-TTenancy PProvisionsPermits the tenant to cancel its lease if another major tenant closes.

Recapture PProvisionsPermits the owner to cancel a lease and to regain control of space after a tenantcloses its store.

TYPES OOF RRETAIL PPROPERTIESSuper RRegional MMallOver 1 million square feet with multiple department (4-5) stores as anchors.

Regional MMallOver 750,000 square feet with several department stores (2-3) as anchors.

In-LLine SStoreSmaller store within a center (i.e., Foot Locker or Hallmark Cards store).

Community CCenterOver 100,000–275,000 square feet of space; multiple anchors but not enclosed.

Anchored SStrip CCenterGrocery or discount retailer attracts tenants to small stores that are adjacent.

Shadow AAnchored SStripSame as the anchor strip, but the anchor is not part of collateral for the loan.

Typical Loan Terms

• 1.4 DSCR

• 65% LTV (based on a 9–10% capitalization rate)

• $75–$125 Loan Per Square Foot Value


Unanchored SStripNo major destination type tenant. Usually smaller local tenants. A particular location must have natural traffic to be successful. The best assets are located in highly developed areas with little vacant land.

Power CCenter/Big BBoxAnchor tenants and some small stores. Typically big discounters or mass retail-ers. Examples include Circuit City, Best Buy, and Target.

CONVENTIONAL IINVESTOR WWISDOM• Retail stores in general are under competitive pressures from alternative

distribution channels.

• Aggressive competition for market share leading to construction of big box/large store formats.

• Super-regional malls are the least affected by the negative factors listed above. Thesemalls are anchored by strong department stores that support the in-line tenants.

• Mid-market malls are viewed as under the most pressure from alternative retailing concepts. Anchor stores in these malls are less of a draw and compete directly with value-based retailers.

• Grocery/drug anchor strips are life insurance company favorites.

RATING AAGENCY VVIEW• Generally received favorable treatment from rating agencies as a result

of strong historical performance.

• Preference for longer leases; nationally or regionally rated credit tenants.

unanchored strippower center/big box

anchored stripcommunity center

Multifamily Loans

RELATED TTERMSCo-oop LLoans/Blanket LLoansVery low loan to value loans. Loans senior to co-op share loans.

Unit MMixDesirable ratio of 1-bedroom versus 2-bedroom apartments depends on themarket. Older complexes had higher proportions of 1-bedrooms; higher per-centages of 2-bedrooms are now preferred, since they provide more flexibility tofamilies and lifestyle renters.

ReservesUnderwriting usually includes $200-300 per unit per year for new paint, carpet,appliances, etc.; as apartments may be remarketed annually.

TYPES OOF MMULTIFAMILY PPROPERTIESGarden AApartmentsMultiple buildings; usually no more than 2-3 stories.

High RRise AApartmentsOver three stories; usually located in downtown areas.



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chapter 2

Typical Loan Terms

• 1.25x DSCR

• 75% LTV (based on a 8–9% capitalization rate)

• $20,000–$60,000 Loan Per Unit

high rise apartmentsgarden apartments

CONVENTIONAL IINVESTOR WWISDOM• Potential overbuilding in high growth markets of the Southeast and Southwest

— Houston, Atlanta, Las Vegas.

• Multifamily was the first sector to recover from the real estate recession.

• Birth dearth has resulted in fewer households in prime renting years of 25-34.This fact somewhat mitigated by the “lifestyle” renter.

• A lifestyle renter is someone who can afford a home but chooses to rent for convenience: divorcees, empty-nesters.

• Healthy apartment properties have occupancies of 93% and higher.Occupancies below 88% for existing properties are worrisome.

• Government sponsored entities desire transactions with high concentrations in multifamily properties.

RATING AAGENCY VVIEW• A “must have” property type for diversity.

• Lower default tendency due to constant mark-to-market of rental rates (1-year-lease terms).

• Basic need housing.

• Tolerated lower DSCR and higher LTV than other commercial property types.

• Basket of individual home owner credits; not specific business risks.

• Concerns of military or single employer concentrations.


Office Loans

RELATED TTERMSTenant IImprovementsCosts to build walls, ceilings, carpet for a new tenant, typically $5-40 per squarefoot. The landlord usually incurs this expense. In strong demand markets thelandlord can pass this expense through to the tenant in terms of a higher rentalrate. In weak markets, landlords must take tenant improvements out of netincome, which reduces cash flow.

Leasing CCommissionsFees paid to brokers to bring tenants, typically $2–4 per square foot at lease sign-ings. Landlords bear this expense.

RolloverTerm used to describe expiration of a tenant lease. Lease terms are generally for5-10 years; credit tenants may be longer. It is preferable to not have rollover con-centrations, which would expose an owner to uncertain rental market or poten-tially reduce NOI below debt service.

TYPES OOF OOFFICE BBUILDINGS



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chapter 2

Typical Loan Terms

• 1.4x DSCR

• 70% LTV (9–10% cap rate)

• $50–100 Loan Per Square Foot for Suburban Properties

• $70–150 Loan Per Square Foot for Downtown CentralBusiness District (CBD)

downtown suburban

CONVENTIONAL IINVESTOR WWISDOM• Above market rents are a concern if the market rent is insufficient to support

the debt service. Rating agencies usually underwrite to market rents.

• Overbuilding: Investors that lived through the last real estate depression arenervous about current levels of development.

• Downtown versus suburban: Suburban office has suffered recently. The recent pop in the “tech bubble” has increased the supply of subleased space.

RATING AAGENCY VVIEW• Very conservative approach makes underwriting these loans difficult.

• Very difficult to allow rollovers without cash reserves.

• Slow to accept market improvements in rental rates and values without manyother market comparable transactions.

• Want higher DSCR because of income volatility during lease rollover.

• Only give credit in underwriting for lesser of historical market rents or in place rents.

• Tenant improvements/leasing commissions reserved for in escrow or excludedfrom underwriting income, which reduces the amount of potential loan.

• Management fees of 5% used by rating agency underwriters are believed to be above market rate of 1-3%.


Manufactured Housing Community Loans

RELATED TTERMSManufactured HHousing CCommunitiesThe land, streets, utilities, landscaping, and concrete pads under the homes com-prise a manufactured housing community. The homes are independentlyfinanced. Homeowners pay monthly rent for the pad to the manufactured hous-ing community owner.

PadConcrete slab that supports each manufactured home.

Double WWide/Single WWideDescribes the size of manufactured home that a given slab will support. The double wide segment has experienced the fastest growth due to the growingacceptance of manufactured homes as a single family housing alternative.

TYPES OOF MMANUFACTURED HHOUSING CCOMMUNITIES3-SStar PParkOlder park lacking the amenities of a 5-star park; higher proportion of singlewide pads. Offer limited amenities and services.

4-SStar PParkUsually double-wide units in good condition. Features may include concretepatios or raised porches. Streets are generally paved. Many 4-star parks were for-merly 5-star parks that are now showing their age by their dated look and type ofimprovements.

5-SStar PParkCurvilinear streets (streets that have curbs); neighborhood feel; well-landscaped;high proportion of double wide pads. Located in desirable neighborhood withconvenient access to retail.

Trailer PParkThis is a lower-end asset class, often confused with manufactured housing com-munities. Trailer parks are highly transient, dense communities of homes onwheels. Tenants are provided with no amenities other than simple utilityhookups. Not typically seen in conduit pools.



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chapter 2

Typical Loan Terms

• 1.4x DSCR

• 70% LTV (9–10% cap rate)

• $10,000–$20,000 per pad

CONVENTIONAL IINVESTOR WWISDOM• Lack of familiarity; confusion with asset-backed manufactured housing loans

to individuals.

• Insurance companies typically didn’t lend on this product, and it has some-what of a stigma attached to it.

• Some investors have trouble distinguishing the relative investment stability ofmanufactured housing communities from the credit of individual homeown-ers. The credit characteristics are very different.

• Performance on these loans has been very strong. The security for loansrequires virtually no maintenance and very few manufactured homes are evermoved from the pad.

• Cost to move ($3,000–5,000 a year) exceeds pad rental ($300–500 a month).Upon homeowner foreclosure, bank will usually pay rent instead of movingthe foreclosed unit.

• Manufactured housing communities are also difficult to build as many communities have restrictive zoning ordinances against them.

RATING AAGENCY VVIEW• Rating agencies favorable on credit.

• Low volatility of cash flows.

• Physical turnover rate 3–5% in manufactured housing versus 50–60% in multifamily.

• Few capital reserves required.

• Often better than multifamily.


5-star park

Industrial Loans

RELATED TTERMSDistribution SSpacePrincipal use is distribution or light assembly. Minimal office space as a per-centage of total space (typically 0-10%). “Clear heights”, 24´ ceiling heights,are the minimum for modern distribution buildings. Higher clear heights aremore economical for tenants as they stack goods vertically and rent fewersquare feet.

Flex SSpace/Office WWarehouseHigher amount of office space as a percentage of total space. This results inhigher tenant improvement costs necessary upon lease renewals. These tenantsare less sensitive to clear heights and more sensitive to accessibility of qualifiedlabor pools.

Tilt-UUp CConstructionThis is the preferred construction type for industrial buildings. It includes pre-cast concrete panels that are “tilted-up” on a steel frame. Tilt-up is preferable tocorrugated metal exteriors for maintenance reasons.



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chapter 2

Typical Loan Terms

• 1.4x DSCR

• 70–75% LTV (8–10% Cap Rate)

• $10–25 PSF

• $30–50 PSF (if high office component)

distribution space


flex space/office warehouse

CONVENTIONAL IINVESTOR WWISDOM• Frequently exposed to single tenant credit; but generally lower tenant improve-

ment costs makes rollovers more palatable than office.

• Older buildings with less competitive clear heights becoming functionally obsolete. Constant roof repair is major expense item.

• Concerns over environmental contamination if property has had heavy industrial use.

• Construction cycle for industrial properties generally shorter than other property types (six to nine months versus two years for office); resulted in less overbuilding in last downturn.

RATING AAGENCY VVIEW• Like industrial for diversity.

• Review environmental issues from manufacturing uses.

• Very low cost to re-lease if tenant leaves, but short lease terms create rollover risk.



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Self Storage Loans

RELATED TTERMSSelf-SStorage FFacilityCommercial property that leases storage space to individuals or businesses on amonth-to-month basis. The average self-storage facility has between 40,000 and10,000 square feet of rentable space divided among 400 to 1,000 individual units.

ManagementHalf of all self-storage facilities have a manager living in an on-site apartment.The management team is important to solicit new business and to monitor anydelinquencies.

Tenant PProfile/TurnoverResidential users make up more than two-thirds of self-storage facility renters.The average length of self-storage rental is 12 months. Occupancy rates tend tobe in low-to mid-90s after long initial lease up period.

Typical Loan Terms

• 1.3x, 1.4x DSCR

• 65–70% LTV

• $20–50 PSF

self-storage facility

CONVENTIONAL IINVESTOR WWISDOM• Overbuilding and new competition are concerns, which are mitigated by

limited sites zoned for storage in populated areas.

• Properties are management-intensive.

• Population shifts affect demand; population inflow creates new demand butpopulation outflow may result in an increase in demand in the short term ashomeowners store excess items during relocation.

RATING AAGENCY VVIEW• Approve of it as an additional diversifier.

• Higher volatility because of monthly rental contracts but rental base has beenrelatively inert in moving stored items.

• Preference for infill or dense urban locations.


Health Care/Senior Housing Loans

TYPES OOF HHEALTH CCARE/SENIOR HHOUSING PPROPERTIESIndependent LLiving FFacilitiesMultifamily apartment complexes catering to senior citizens. They supply few serv-ices beyond building and ground maintenance. These facilities are unregulated.

Congregate SSenior HHousingThese are independent living facilities that provide a common dining facility andother services. Congregate senior housing has no medical component, but mayprovide access to emergency medical care through call buttons. Not licensed as a nursing home.

Assisted LLiving FFacilitiesA product type targeted to elderly needing assistance, but not full time medicalcare. These facilities typically consist of apartment style units with a kitchenette.The operator of the facility provides three meals a day and assists residents withdaily activities such as feeding, bathing, dressing, and medication reminders.

Skilled NNursing FFacilitiesIndependent nursing homes or a designated wing in a hospital. The facilities pro-vide full-time licensed skilled nursing, medical and rehabilitative services. Averagelength of stay can range from two months to two years, or more. Twenty-fourhour care is provided, with doctors and registered nurses on call. Facilities arelicensed by the state; operator must obtain a certificate of need from state beforebeginning operation.

Continuing CCare RRetirement CCommunitiesThese facilities offer the entire continuum of seniors housing from independentliving to skilled nursing facilities. Residents move within the facility dependingon the level of care required. Licensed operator.



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chapter 2

Typical Loan Terms

• 1.2–2.0X DSCR (depending on complexity of service)

• 50-80% Loan to Value

• $30,000-80,000 Loan Per Unit

CONVENTIONAL IINVESTOR VVIEW• Recent changes in Medicaid reimbursements have negatively affected skilled

nursing and continuing care facilities.

• Excess supply of assisted living facilities has resulted in higher vacancy ratesand poor performance.

• Few recent additions to supply due to changes in Medicaid reimbursements.

• Concerns exist over the quality of management of the licensed facilities.The license is owned by the manager; not the property owner. Many life com-panies avoided the senior sector because of confusion with licensed “nursinghomes.” Foreclosure could result in license forfeiture and force economicvacancy of asset until replacement manager is found and new license granted.

• Not easily converted to multifamily if license lost.

RATING AAGENCY VVIEW• Positive demographics; aging of the baby boomers.

• They prefer densely populated areas with heavier capital reserves.

• Skilled nursing requires higher DSCR because high ratio of income derivedfrom medical services that are not derived from location of property butrather need of specific patient.


Hotel Loans

RELATED TTERMSAverage DDaily RRateTotal guest room revenue divided by total number of occupied rooms.

Occupancy RRateNumber of occupied rooms divided by total number of rooms.

Revenue PPer AAvailable RRoom ((RevPAR)The revenue per available room is the total rooms revenue divided by the avail-able rooms for a given period.

FF&EFurniture, fixtures, & equipment; standard hotel underwriting includes a deduc-tion as an operating expense for the ongoing replacement of FF&E, typically4% to 5% of gross revenue. This differentiates hotel underwriting from apart-ment underwriting where some of those same expenses are considered capitalexpenditures and are not an operating expense deducted from NOI. Typicalrefurbishment of common areas of the hotel should occur every seven years.

Franchise FFeeFee paid to hotel company that allows hotel owner to “fly the flag” of a hotelcompany (i.e., Marriott, Sheraton, etc.) and benefit from advertising and reserva-tion network. Ranges from 4–7% of gross revenue.

TYPES OOF HHOTEL PPROPERTIESFull SServiceA hotel that offers banquet and convention services; one or more full servicerestaurants.

Limited SServiceNo food service other than continental breakfast; minimal public space and small staff.



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Typical Loan Terms

• 1.5x DSCR

• 65% LTV (10–12% cap rate)

• $20,000–60,000 Loan Per Room

• $80,000 + Full Service or Luxury

CONVENTIONAL IINVESTOR WWISDOM• Hotels have the highest cash flow volatility of the four major property types

as they reprice rooms on a daily basis.

• The full service downtown hotels are more protected from new supplybecause of high building costs and limited site availability.

• Limited service construction is up in many areas of the country.

• Full service hotels have higher fixed costs and lower operating margins thanlimited service hotels.

RATING AAGENCY VVIEW• Very conservative because use of average historical income often reduces

income to levels significantly below current highs.

• Maximum occupancy they will underwrite is 65–75%, despite actual figureshigher than that level.

• Use very conservative FF&E, franchise fee, management fees, instead of market fees.

• Bias toward national brands even if hotel is a niche segment that has strong history.


full service

limited service



28

chapter 2

Hotel Collateral in CMBSRating agencies and many investors have often viewed hotels as one of the riski-est property types. Unlike most other commercial real estate, which have long-term leases, hotels have daily changes in occupancy and rental rates. In this chap-ter, we examine the credit exposure of CMBS to hotels and discuss the historyof the hotel industry, hotel branding, and recent performance of hotels.

• Hotel demand is highly correlated with GDP and can be volatile.

• Supply of new hotel rooms built during the 1990s is 25% lower than the sup-ply built in the 1980s.

• The hotel industry is typically profitable although it is a cyclical business.

• After September 11, 2001, the rating agencies commented on the corporateratings of most public hotel companies and revised some underwriting stan-dards for new transactions.

• The aggregate CMBS market has about 8% exposure to hotels. Leverage levels aremore conservative on hotel loans than other property types, providing cushion.

GREATER SSHOCK TTO DDEMAND TTHAN EEARLY 11990S

Hotel demand is highly correlated to changes in GDP. When GDP is growing,consumer confidence rises resulting in greater discretionary income. The eventssurrounding September 11, 2001, resulted in a significant decline in hoteldemand. Industry data shows hotel demand declined significantly in late 2001,2002 and 2003. In 2004, hotel demand recovered significantly with nationwiderevenue per available room (RevPAR) growth over 7% through August.

PROPERTY TYPEMATRIX

exhibit 1



HOTEL SSUPPLY SSIGNIFICANTLY LLOWER IIN 11990S THAN 11980S

Over the past 15 years hotel ownership has experienced a significant shift fromprivate to public markets. The public capital markets have more efficientlymatched supply with demand than was the case in previous cycles.

The typical time frame for hotel development ranges between 12 and 36 months.Between 1990 and 1991, demand declined significantly as the United Statesentered a recession, at the same time supply continued to enter the marketthrough projects that were started in the late 1980s.

Currently, the industry is better suited from a new supply standpoint than it wasin the early 1990s.

TOTALCONSTRUCTION:1980s VS. 1990s

exhibit 2

Source: Morgan Stanley, PricewaterhouseCoopers

HOTEL ADDITIONSTO SUPPLY

1972–2004P

exhibit 3

Source: PriceWaterhouseCoopers

RevPAR PPERFORMANCE AAND PPROJECTIONSThe hotel industry measures performance in revenue per available room(RevPAR). RevPAR is defined as average daily rate (ADR) at a hotel multipliedby its occupancy rate. For example, if a hotel has an ADR of $100 and an occu-pancy of 80% its RevPAR is $80.00 ($100 x .80 =$80).

RevPAR has declined 3 out of the last 14 years, 1991 (Gulf War), 2001 (U.S. ter-rorist attack), and 2002 (U.S. economic decline).

HOTEL FFUNDAMENTALS CCONTINUE TTO IIMPROVEHealthy economic growth and limited new hotel development fueled solidnationwide RevPAR growth in 2004. The CPI numbers released for March andApril noted the “lodging away from home” component posted year-over-yeargrowth of 7.0% and 8.7%, respectively.

Year to date through August, nationwide RevPAR was up 7.1% over the sameperiod last year.

Hotel demand is highly correlated to GDP. Since our economists anticipatestrong GDP growth in the second half of 2004, we anticipate hotel fundamen-tals to remain strong. Annual 2005 RevPAR growth is projected to be 4.5% byPriceWaterhouseCoopers. PricewaterhouseCoopers uses its own GDP estimatesand other macroeconomic inputs to forecast RevPAR.

RATING AAGENCY VVIEWS OON HHOTELSAfter the events of September 11, 2001, rating agencies commented on the cor-porate ratings of several hotel companies, and revised rating guidelines forfuture CMBS transactions.

All three rating agencies commented on the ratings of several hotel operatingcompanies and hotel REITs.



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chapter 2

NATIONWIDEREVENUE PER

AVAILABLE ROOM(RevPAR) GROWTH

exhibit 4

Source: PricewaterhouseCoopers, Smith Travel Research

In addition to the comments on corporate ratings, Moody’s and Fitch outlinedchanges to underwriting guidelines for hotel loans within CMBS transactions.Standard & Poor’s has not made any changes to its underwriting guidelines forhotels in new issue transactions.

Fitch noted it was concerned about the performance of hotels. Therefore, fortransactions it will use the trailing 12-month RevPAR after August 31, 2001,reduced by 20%, or the 1999 RevPAR number, whichever is lower. In place ofthe significant RevPAR reduction, Fitch stated that the issuer could set up a 12-month debt service reserve for hotel loans. Fitch also intends to make adjust-ments to expenses based on any recently increased costs.

Fitch stated that for surveillance of CMBS transactions already issued, it will notapply the severe haircut to hotels but will compare the current operating num-bers to the performance when the transaction was issued.

Moody’s released a matrix outlining reserve requirements on hotel loans withinnew issue CMBS transactions. Reserve requirements range from 1-13 monthsdepending on the type of hotel property, the anticipated stress environment, andthe underwritten debt service coverage ratio (DSCR). For example, a full-servicehotel with a 1.35 DSCR at issuance would require 13 months P&I reserves in ahigh stress environment while a limited service hotel with a 1.35x DSCR wouldrequire 5 months P&I reserves in a high stress environment. The rating agencyalso noted that it would consider 1998-99 as stabilized operating performancefor hotels going forward.




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Source: Morgan Stanley, Moody’s, Fitch, S&P

RATING AGENCY VIEWS ON HOTEL COMPANIES,AS OF NOVEMBER 2004

exhibit 5

HOTEL DDELINQUENCIES IIN CCMBS TTRANSACTIONSBased on our October 2004 remittance reports data, delinquencies on hotelloans accounted for 2.44% of current balances. During 2004, hotel collateralwithin CMBS experienced significant improvement with delinquencies declining3.08%. We anticipate hotel delinquencies will continue to improve based on ourcurrent GDP forecast for 2005.


CMBSDELINQUENCIES

BY HOTELAND TOTAL

exhibit 6

130/60/90/Foreclosure/REO.

Source: Morgan Stanley, Intex



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BRANDING AAND SSEGMENTATIONAs the hotel industry has evolved, companies such as Marriott have segmentedthe market in order to meet customers’ needs, increase profitability, and diversifyits customer base. Branding has been used to attract guests to various pricepoints and increase the parent company’s exposure.

Positive brand identity is beneficial for the hotel manager and the hotel owner. Ifthe brand is effective in producing demand, management will spend less timemarketing nationally and focus on local operations and solicitations. The owneralso benefits financially from increased business through the reservation systemand through potentially lower marketing costs.

As the economy weakens consumers move down one or two positions in serviceand price from say a Hilton to an Embassy Suites. As the economy strengthensguests typically move up in service level and price.

UPPER UUPSCALEThese hotels are exclusive properties within major metropolitan markets thatprovide extensive amenities and high levels of service. A hotel within this seg-ment will have the highest ADR in its market and often the highest RevPAR inthe market. Amenities at these properties usually include health club/spa facili-ties, three- or four-star food and beverage outlets, concierge service, 24-hourroom service, valet, and retail spaces. These properties are located in primedowntown and resort real estate locations.

In general because of higher construction costs and high barriers to entry, luxu-ry hotel construction tends to lag behind the general trend of the market cycle.While this segment is the last to see new supply, during a recession it is the firstto experience a decline in occupancy as travelers become more budget-consciousand move down the service-level curve to less expensive accommodations.

HOTEL BRANDINGAND

SEGMENTATION

exhibit 7



UPSCALEUpscale hotels are full-service hotels that cater to individual business travelers,groups, and conventions. Typically the price points at these hotels are betweenupper upscale hotels and mid-scale hotels. Amenities at upscale hotels includeseveral food and beverage outlets, extensive meeting space, laundry service,concierge, and exercise facilities. Most of these properties enjoy downtown loca-tions near convention centers or strong suburban locations. These locations mayhave some barriers to entry because of limited availability of land. The guestprofile for these hotels is transient business travelers, extensive corporate busi-ness, and meeting/convention business.

MID-SSCALE WWITH FFOOD AAND BBEVERAGEThese hotels encompass a broad range of brands and product types dependingon the market and the age of the property. Amenities at these hotels usuallyinclude one restaurant, limited meeting space, and an exercise facility. Typically,these hotels cater to the more budget-conscious business travelers or “road war-riors.” Older properties in this segment can be somewhat outdated and sufferfrom inefficiencies. Concerns about this segment center around older propertiesin need of renovation and a tendency for travelers to prefer newer propertiesthat are entering many markets at similar price points.

MID-SSCALE WWITHOUT FF&B CCHAINSProperties in this segment typically have secondary locations such as major high-way intersections, airports, or suburban locations. The properties do not offerfood and beverage amenities except for continental breakfast in some locations,and may or may not have small exercise facilities. Food and beverage is providedby nearby fast food or chain restaurants. The typical guest is a budget-consciousbusiness traveler, or transient guest from the highway. Extensive developmenthas occurred in this segment. Construction costs for these properties are signifi-cantly lower than full-service hotels because of their secondary locations andlow rise nature.

ECONOMY/BUDGET SSEGMENTSmaller roadside motels with very limited amenities characterize these properties.Construction is inexpensive, low barriers to entry exist, and the developmenttimetable is short. The typical guest at these properties is a transient budget-con-scious business or pleasure traveler. Most bookings are made through the reser-vation system and repeat business is not significant.

HISTORY OOF TTHE HHOTEL IINDUSTRYLodging’s long history shows that demand for hotels and development of hotelsmove in cycles. The time period of these cycles depends on the demand (affect-ed by the overall state of the economy) and new supply.



36

chapter 2

1790–1920 GGROWTH OOF AAMERICA AAND FFINANCIAL BBOOMThe first American hotel, the 73-room City Hotel, was built in New York City in1794, and was much larger than its predecessors, the colonial inns. Between thelate 1700s and the mid-1800s, similar hotels were built in major metropolitancities such as Philadelphia, Boston, and Baltimore. During the 1800s, hotels fol-lowed the railroads westward and hotels were built in Chicago, Denver, and SanFrancisco. Now famous historic spas such as The Greenbrier in West Virginiawere built during this period. The Buffalo Statler hotel, built in 1908, was revolu-tionary because it offered baths in each guest room.

During the Roaring ’20s, as with many other areas of commerce, hotel demandand hotel development boomed. The 3,000-room Hotel Stevens (currently theChicago Hilton) was built in 1927. Hotels were built through community fundedbonds and often without regard for feasibility. Conrad Hilton began his chain ofHilton hotels during the 1920s by purchasing and developing eight hotels. Somany hotels entered the market nationwide in the 1920s that occupancy wentfrom 86% in 1920 to 68% in 1928, while room rates remained fairly constant.

1930–1940s THE GGREAT DDEPRESSIONThe boom of the ’20s was followed by the bust or Great Depression of the 1930s.Due to overbuilding and a significant decline in demand, more than 80% ofAmerican hotels went into foreclosure. Nationwide occupancy declined to 50%.

Enterprises that had cash during this period were able to obtain hotels at deepdiscounts to the original costs. Ernest Hendersen founded the Sheraton hotelchain in 1937 and was able to build the company’s portfolio during the 1930sand 1940s. The hotel industry did not recover from the overbuilding of the1920s until the early 1940s. World War II stimulated the economy and generateddemand for hotel rooms as troops and military personnel were moved domesti-cally and globally, an effect that continued after the war. By the mid-1940snationwide occupancy had increased to 90%.

1950–1960s BOOM AAFTER WWWIIWith World War II over, the United States entered a stage of economic growth.During the 1950s, transportation via the automobile became very popular. MostAmericans that had previously traveled by train were now using cars. Thisincreased prosperity and altered mode of transportation resulted in the develop-ment of the first roadside “motor hotels” or motels. Kemmons Wilson devel-oped the first Holiday Inn in 1952, and by 1960 there were more than 100Holiday Inns. Marriott and Hyatt were founded in 1957, Howard Johnson’s in1959, and Ramada and Radisson in 1962. Tax laws, highway development, and anincrease in franchising fueled the development of both hotels and motels duringthis period.

1970s QUICK CCYCLEWith several chains established and the motel concept fully developed, the early1970s became another boom for the hotel industry. At the same time, companiessuch as Holiday Inn and Marriott were looking to expand their presence through


franchising. The extensive capital available in the markets and ability to franchisebrands encouraged development of hotels, which resulted in overbuilding.

In 1974, inflation caused construction costs and interest rates to rise. The energycrisis reduced road travel and the recession prohibited business travel. This wasanother period of foreclosures and excess hotel supply. Although the overbuild-ing of the 1970s was similar to the 1920s the recovery to reasonable real estateprices came about more quickly than in the 1920s. By the end of the late-1970shotel prices had recovered due to the lack of building during the end of thedecade. By the end of the 1970s supply and demand were more in balance thanfive years prior and occupancy levels were rising.

1980sBy 1983, inflation had slowed and new tax policies created a favorable environ-ment for hotel development. The Savings and Loans (S&Ls) were in the processof deregulation and were an eager source of financing for real estate develop-ment. Lack of commercial real estate experience by the S&Ls resulted in looseunderwriting standards and liberal lending policies. During this time, syndicatedLimited Partnerships were the source of equity capital. Hotel partnerships weresold to wealthy individuals attracted by the aggressive growth projections and thetrophy real estate. In order to capture the greatest tax benefits for these invest-ments, this real estate was highly leveraged at 90%–100%. Investors benefitedfrom passive tax losses in the short term and real estate appreciation in thelonger term. A change in the tax laws in the late 1980s resulted in the revision ofthe allowance for these losses, slowing new development, but overbuilding wasalready under way, particularly in full-service hotels.

CAPITALIZATIONRATES AND 10-

YEAR TREASURYRATES

exhibit 8

Source: PricewaterhouseCoopers, Smith Travel Research



38

chapter 2

EARLY 11990sThe late 1980s to 1991 was a period of overbuilding in virtually all sectors ofreal estate, and hotels were no exception. Profitability nationwide for the hotelindustry was negative between 1986 and 1992. Demand sharply declined from itssignificant growth in late 1989, to a cycle low in 1991. Unfortunately, develop-ment was already in the pipeline and supply growth was high. During this time,many hotels defaulted on loans because they were so highly leveraged and unableto meet debt payments. In the early 1990s, the federal government formed theResolution Trust Corporation (RTC) to resolve the problems of the S&Ls, whowere suffering from defaulted real estate loans. Development during the early1990s was virtually halted and banks were unwilling to lend on real estate in gen-eral, hotels in particular. Capitalization rates during this period climbed, asinvestors demanded extremely high returns. Because of a lack of debt funding,most hotel purchases were made by companies with cash reserves.

The real estate devaluation and lock up in capital reduced the number of individ-ual hotel transactions from 130 in 1990 to 56 in 1991. Individual hotel transac-tions did not return to 108 again until 1994. Purchase prices per room were well-below development costs. Nationwide, the average purchase price per room in1990 was $136,000. This figure declined significantly in 1991 to $96,000 andreached a bottom of $80,000 in 1995.

MID- TTO LLATE 11990sBy late 1995, the RTC disposed of most real estate previously held by thedefunct S&Ls. Demand for hotel rooms outpaced supply between late 1992 andmid-1996. From 1993, increases in the average daily room rate (ADR) outpacedthe consumer price index. Beginning in 1994, the increase in profitability beganto attract investors. Prices began to increase as demand was outpacing supplyand transactions increased.

Beginning in 1993, hotel REITs began accessing the public capital markets. In1993, $34 million was raised in the capital markets for hotel REITs. Thisincreased to $600 million in 1994, doubled to approximately $1.2 billion in 1995and 1996, and reached a peak of almost $1.6 billion in 1997. This inflow ofpublic capital fueled supply growth and transaction activity for hotels as REITsacquired more properties and consolidation occurred. The consolidation ofhotel ownership from private partnerships to public companies increased operat-ing efficiencies and held owners accountable to shareholders, reducing hotelleverage levels. In general, hotel REITs did not exceed 60% leverage.


Capital flow into hotel REITs declined significantly in 1998 to just over $500million. This was due to Congress enacting legislation limiting acquisitions bypaired-share REITs, REIT investors’ fear of overbuilding in all real estate sec-tors, slower growth in REIT earnings than the broader market, and the capitalflight to quality in the fall of 1998. The change in the paired-share legislationsignificantly affected Starwood and Patriot American (now Wyndham) the twolargest paired-share hotel REITs, stopping their growth initiatives.

During the mid- to late-1990s, as the CMBS market grew, hotels were includedin pools of diversified mortgages. The nightly rents and intense on-site manage-ment combined with poor performance prior to the RTC clean-up resulted inlower LTV ratios for hotel loans than other types of real estate within CMBStransactions.

40




Call Protection

Chapter 3

EXECUTIVE SSUMMARY• Commercial mortgage loans differ from residential mortgage loans in that they

are call protected. Commercial mortgage loans typically contain provisionsthat either prohibit or economically penalize the borrower for prepaying theloan before maturity.

• There are four main categories of call features in commercial mortgage loans:hard or legal lockout, yield maintenance, fixed percentage penalty points anddefeasance. Most commercial mortgage loans contain at least one of these formsof call protection, and many contain some combination of these penalties.

• Allocation of the loan level prepayment penalties to bond classes in a CMBS dif-fers across deals and is an important characteristic in determining relative value.

• Lockout and defeasance provide investors with the greatest average life sta-bility. Credit events are the only source of cash flow variability in CMBSdeals where the underlying loans are locked out or defeased. With yieldmaintenance, some investors benefit from faster prepayments under someinterest environments.

• A number of major loan originators have gravitated to defeasance because offavorable pricing in the CMBS market.

INTRODUCTIONCommercial mortgage loans differ from single-family residential loans in a veryimportant aspect: call protection. Unlike single-family loans, commercial loanstypically are not fully prepayable at the borrower’s option. Call protection in com-mercial loans stems from the life insurance companies’ historical position as theprimary provider of capital to the real estate industry. As the dominant long-termlender in the market, the life insurance companies required call protection as astandard feature of the commercial loan market. Call protected loans were anattractive asset for an insurer to match against long duration liabilities. Thegrowth of the CMBS market has altered the form of call protection found innewly originated commercial loans. As an increasing percentage of commercialloans are being securitized, the preferences of bond investors are playing a largerole in defining the terms of the commercial mortgage markets. This chapter will:

1) Define the various types of call protection found in commercial mortgageloans;

2) Discuss different prepayment penalty allocation structures found in CMBS transactions;

3) Explore relative value of various forms of call protection; and

4) Discuss our expectation for future trends in CMBS call protection.


Call Protection

42

chapter 3

DEFINITION OOF TTYPES OOF LLOAN LLEVEL CCALL PPROTECTIONSeveral different types of call protection are found in commercial mortgage loans.

HARD LLOCKOUTThe most straightforward form of call protection is a “lockout” provision. Thelockout provision legally prohibits a borrower from prepaying a loan prior toscheduled maturity. The majority of commercial mortgage loans are not “lockedout” for the entire term of the loan. Lockout periods are usually three to fiveyears and are followed by penalty periods. During the penalty period, the borrow-er is allowed to prepay the loan, but the borrower must compensate the lenderfor the early termination right. The two forms of penalty are yield maintenanceand fixed percentage penalty points. Further, most lockout provisions allow a bor-rower to assign the loan if the property is sold during the lockout period.

YIELD MMAINTENANCEA yield maintenance penalty is designed to compensate the lender for the inter-est lost as a result of prepayments. The yield maintenance penalty in commercialmortgage loans is analogous to the “make whole” provisions found in corporatebond markets. Formulas used to calculate yield maintenance vary. Generally, theformulas provide a present value calculation of the positive interest differentialbetween the remaining mortgage payments due on the original loan and the pay-ments that would be due on a reinvestment of that repaid loan.

The yield maintenance penalty is designed to make the lender indifferent to a pre-payment. If interest rates are significantly higher at the time of prepayment thanat the time of loan origination, the borrower would not be required to make apenalty payment. The lender does not suffer an opportunity cost in this situationas the lender can reinvest the prepaid proceeds at higher market interest rates.

The key variable in calculating yield maintenance penalties is the discount rate orreference rate. The reference rate is compared to the existing mortgage loan rateto calculate the prepayment penalty. Reference rates are usually a comparablematurity Treasury rate, (referred to as “Treasuries flat”), or a comparable maturi-ty Treasury rate plus a spread. Clearly, the lender/investor prefers Treasuries flatas the reference rate. Treasuries flat results in a higher present value for the yieldmaintenance calculation. The following is an example of a yield maintenance cal-culation at Treasuries flat.

Assumptions• Loan Origination Date: 1/01/98 • Original Loan Balance: $10,000,000

• Loan Maturity Date: 12/31/07 • Mortgage Rate: 7.25%

• Start of Yield Maintenance Period: 1/01/98 • Reference Treasury Rate: 5.75%



Call Protection

44

chapter 3

To simplify the math, we will assume the loan prepays on the origination date.

As the term to maturity for the loan shortens, the yield maintenance penalty as apercentage of the remaining balance decreases. Yield maintenance penalties pro-vide less of a disincentive to the borrower to prepay as the remaining penaltyperiod declines. The importance of the yield maintenance penalty to the lenderalso decreases as the remaining penalty period declines. As the term to maturitydecreases, the remaining loan payments represent a lower percentage of thelender’s total return.

The following table illustrates the difference between reference rates ofTreasuries flat, Treasuries +25 bp, and Treasuries +50 bp as the penalty periodshortens from 10 years to three using the same assumptions as the prior example.

FIXED PPERCENTAGE PPENALTY PPOINTSFixed percentage penalty points are potentially the weakest form of call protec-tion. The prepayment penalty is a fixed percentage of the remaining loan bal-ance. Fixed percentage penalty points typically decline over the life of the loan.A representative example of the terms of a loan with fixed percentage penaltypoints would include a lockout period of five years followed by declining penaltypoints of 5% in year 6, 4% in year 7, 3% in year 8, 2% in year 9, and 1% in year10. Large interest rate moves and large increases in property values may over-whelm these fixed economic disincentives to prepay a fixed percentage penaltyloan as the penalties do not change with interest rates.

(PRESENT VALUE FACTOR) x (MORTGAGERATE – TREASURY RATE) x (REMAININGLOAN BALANCE)

Yield Maintenance Formula

1-(1+Reference Treasury Rate)-Penalty Period

Reference Treasury Rate

1-(1+5.75%)-10

5.75%

7.45%

(7.45)x(7.25%-5.75%)x($10,000,000)=$1,117,500

11.18% of the remaining loan balance

Present Value Factor=

Yield Maintenance

=

=

=

=

PREPAYMENT PENALTY AS A PERCENTAGE OF OUTSTANDING LOAN BALANCE

exhibit 1

Penalty Period

Reference Rate 10-YR 5-YR 3-YR

Treasuries Flat 11.18 6.36 4.03

Treasuries + 25 bp 9.20 5.27 3.34

Treasuries + 50 bp 7.27 4.18 2.66



The following exhibit indicates the required drop in the mortgage rate that compensates a borrower for fixed percentage penalty points. For example, if aborrower wanted to prepay a loan with a term to maturity of six years and a 5%fixed penalty, the borrower’s new mortgage rate would have to be 110 bp lowerthan the existing mortgage rate to justify paying the penalty.

DEFEASANCEDefeasance, a mainstay of the municipal market, has found its way into the com-mercial mortgage market. From the investor’s perspective, a loan with a defea-sance appears “locked-out” from prepayment. The borrower may prepay the loan,but the cash flows to the investor will not change as a result of the prepayment.

In exercising the defeasance option, the borrower replaces a mortgage loan witha series of U.S. Treasury strips which match the payment stream of the mort-gage loan as collateral for the loan. Not only is an investor indifferent to a pre-payment in a defeased loan, the investor actually prefers it. If the borrower exer-cises a defeasance option, the investor receives the benefit of improved creditquality on the collateral without a corresponding decline in return. Before theprepayment, the investor was exposed to commercial real estate credit risk.Following the prepayment, the investor is exposed to U.S. Treasury securitiescredit risk.

As an example, consider a $10 million non-amortizing commercial mortgageloan with a 7% coupon, three-year term to maturity, and annual payments. If theborrower wanted to defease the loan, the borrower would purchase three U.S.Treasury strips that would replicate the payments due on the mortgage loan. Forthe U.S. Treasury strips, we assumed the following rates and prices:

Penalty Loan Term to MaturityPoints 10-YR 8-YR 6-YR 4-YR 2-YR

10 150 180 220 300 540

9 140 160 200 270 490

8 120 140 170 240 430

7 110 130 150 210 380

6 90 110 130 180 330

5 80 90 110 150 280

4 60 70 90 120 220

3 50 60 70 90 170

2 30 40 50 60 110

1 20 20 20 30 60

ANNUAL BASIS POINTS OF SAVINGS REQUIRED TO PAYFOR PREPAYMENT PENALTY POINTS (bp)

exhibit 2

Note: Calculation assumes a 10% initial mortgage rate, annual coupon payment, and cash flows discountedat new mortgage rate. Table entries are rounded to the nearest 10 bp.



Call Protection

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chapter 3

Rates(%) Dollar Price• 1-Year 5.65 94.36• 2-Year 5.68 89.20• 3-Year 5.73 84.21

The chart shows the payments due from the borrower on the commercial mort-gage loan, the cost to purchase the U.S. Treasury strips and the payments to theCMBS trust from the U.S. Treasury strips.

The following steps describe the impact of a defeased prepayment on aCMBS transaction.

When a borrower wants to prepay a loan:

1) The borrower buys multiple U.S. Treasury strips in amounts that replicatethe remaining principal and interest payments due on the mortgage loan.

2) The borrower delivers a legal agreement that designates the CMBS trust ashaving the first priority on the U.S. Treasury securities.

3) The servicer is responsible for purchasing the U.S. Treasury securities onbehalf of the borrower. The borrower pays the execution costs.

In summary, the original loan remains an asset of the trust, but the mortgage,which is the lien on the property to secure the loan, is removed, and the collater-al securing the loan is now U.S. Treasury securities. A prepayment through theexercise of a defeasance option provides no disruption in cash flow to the bondinvestor whether interest rates are higher or lower.

The amount of defeased collateral in CMBS deals has increased dramatically.Today CMBS transactions generally have > 90% defeasance. Investors are valuinginterest only bonds (“IOs”) from CMBS deals backed by defeased collateral attighter spreads than those backed by collateral with yield maintenance penalties.The growth in CMBS issuance has resulted in an increase in both the number andtype of CMBS investors. CMBS backed by defeased mortgage loans offerinvestors the opportunity to avoid the complexities of commercial mortgage pre-payment analysis. The CMBS bonds that are created from defeased loans resem-ble corporate bullet securities and have attracted corporate crossover buyers.

CASH FLOWS TO CMBS TRUST UNDER DEFEASANCEexhibit 3

Payment Due Cost to Borrower Payments FromFrom Borrower to Purchase U.S. Treasury Strips

Time on Loan U.S. Treasury1 to CMBS Trust

Year 1 $700,000 $660,520 $700,000

Year 2 $700,000 $624,400 $700,000

Year 3 $10,700,000 $9,010,470 $10,700,000

1At time of prepayment.



ALLOCATION OOF PPREPAYMENT PPENALTIESFor loans with yield maintenance penalties or fixed percentage penalty points,the allocation of these penalties to the various securities in the CMBS structurediffers on a deal-by-deal basis. In older CMBS transactions (primarily 1996 andearlier), the prepayment penalties generally were allocated 75-100% to the IObonds while the amount of penalty paid to the coupon bondholders was cappedat some percentage, typically 0–25%.

More recent deals generally allocate the prepayment penalties in a way thatmakes the currently paying bond class “whole” and distributes the remainingpenalty to the IO. This more recent allocation method is analogous to the calcu-lation of the yield maintenance penalty on the underlying loan. The currentlypaying bond investor receives compensation for the early return of principal in alower interest rate environment. The IO holder generally receives 65–75% of thepenalty while the current principal paying bond receives the remainder making itwhole to the bond’s coupon, not “Treasuries flat.”

The following is a representative example of a yield maintenance, penalty sharingformula found on post-1996 deals. The class that is currently receiving principalwould receive an amount equal to the ratio of the difference between the bondrate and the reference Treasury rate and the difference between the mortgageloan coupon rate and the reference Treasury rate.

As discussed earlier, the yield maintenance penalty is calculated based on thedifference between the commercial mortgage loan rate and the referenceTreasury rate. The CMBS bond coupon is generally lower than the mortgageloan rate, so the investor needs a fraction of the entire yield maintenance penal-ty to be “made whole.”

The IO class would receive the remaining 69.3% of the penalty. Both fixed rate andIO investors need to be aware of the type of prepayment penalty sharing agree-ment found on a particular CMBS transaction as it influences an investor’s return.

Bond Pass Through Rate - Reference Treasury RateMortgage Loan Rate - Reference Treasury Rate

6.45%

8.25%

5.65%

6.45%-5.65%8.25%-5.65%

.802.60

30.7% of penalty

Prepayment Distribution Formula =

Bond Pass Through Rates

Mortgage Coupon Rate

=

=

=

=


Currently Paying Bond Receives

=

=

RELATIVE VVALUE AANALYSIS OOF DDIFFERENT TTYPES OOF CCALL PPROTECTIONThe relative value analysis of yield maintenance versus lockout/defeasance is ananalysis of the benefits of cash flow certainty versus the potential opportunitiesof cash flow uncertainty. With respect to locked-out or defeased deals, the onlycash flow variability in the bond will be related to credit events. Movements ininterest rates, spread levels, and the credit performance of the underlying loanswill determine returns. Locked out and defeased CMBS deals are not exposed tocommercial mortgage prepayment risk.

The relative value analysis of yield maintenance securities, on the other hand, isnot as straightforward. Earlier, we compared yield maintenance to “make whole”provisions found in the corporate market. Even if yield maintenance leaves thecommercial mortgage lender indifferent to prepayments, various securities withina given CMBS transaction and across different CMBS deals will perform differ-ently. In addition to the credit performance of the loans, the interest rate environ-ment, prepayment speeds in various interest rate environments, and the allocationof prepayment penalties within a particular deal structure will determine the yieldin a bond with yield maintenance loans. An investor in yield maintenance backedCMBS must analyze all of these variables in assessing relative value.

Market convention in CMBS scenario analysis is to assume that loans do notprepay during their yield maintenance periods. If 100% of the loans in the poolare yield maintenance protected for their entire term, the assumption of “yieldmaintenance equals lockout” provides the same result as defeasance or lockout.For the sake of this analysis, we assumed that loans in yield maintenance do pre-pay in order to ascertain under which scenarios an investor would prefer to ownbonds with yield maintenance over bonds with defeased collateral.

We analyzed several classes of bonds from different generations of CMBS trans-actions with yield maintenance as the predominant form of call protection onthe underlying loans1. The purpose of this analysis was to determine whichbonds benefit in various interest rate and prepayment scenarios. We performedprepayment and interest rate scenario analysis on CMBS deals that allocate all ofthe prepayment penalties to the IO and on CMBS deals that allocate prepaymentpenalties that make the currently paying bonds whole. We analyzed each bond atprepayment speeds from 0–100% CPR in the following interest rate scenarios:

1) Interest rates 300 bp lower

2) Interest rates 100 bp lower

3) Interest rates unchanged

4) Interest rates 100 bp higher

5) Interest rates 300 bp higher

The results were based on interest rate levels and prices as of April 1998, andmay vary in different interest rate environments.


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1 Not all of these deals were 100% protected by yield maintenance for their entire term. We chose actual secu-rities to analyze rather than a hypothetical 100% yield maintenance for life bond, as we are not aware of sucha CMBS transaction in the marketplace. We also made the simplifying assumption that pricing spread levelsremain unchanged at different bond dollar prices.

SHORT AAAA ((1ST PPAYMENT PPRIORITY) BBONDS WWITH SSHARED YYIELDMAINTENANCE PPENALTIESBecause the short AAA bonds are at a discount dollar price in the interest rateshigher scenario, faster prepayments during penalty periods result in a higher yieldto maturity for the investor. The borrower is not required to pay a prepaymentpenalty in an interest rates higher scenario, but the borrower is required to paythe par amount of the loan. The investor has effectively bought the loan at a dis-count and receives principal at a par dollar amount.

Why would a borrower prepay in a higher interest rate environment? There aretwo potential reasons to prepay:

1) Sale of the property

2) Refinancing driven prepayment

a) Equity take-out refinancingb) Fixed to floating rate refinancing

In the interest rates unchanged and lower scenarios, the yield to maturity alsoincreases as prepayments increase during yield maintenance penalty periods. Theamount of the prepayment penalty received by the short AAA holder exceedsthe premium dollar price on the bond.

As an example, assume:

• Bond Dollar Price: 106• Mortgage Loan Rate: 8.80%• Bond Coupon: 6.85%• Reference Treasury Rate: 5.65%• Yield Maintenance Penalty Period: 9 years


The yield maintenance penaltyin this example would equal:

Present Value Factor)x(Mortgage Rate-Treasury Rate)

1-(1+Reference Treasury Rate)-Penalty Period


1-(1+5.65%)-9

5.65%

6.91%

(6.91)x(8.80%-5.65%)

21.8%

Bond Coupon Rate-Reference Treasury RateLoan Coupon-Reference Treasury Rate

6.85%-5.65%8.80%-5.65%

38.1%

(38.1%)(21.8%)

8.3%

6%

2.3% (of current balances)

Yield Maintenance Formula

Present Value Factor

Yield Maintenance

Allocation to Short AAA

Allocation

Penalty Points Allocated to Short AAA

vs. Premium Dollar Price of Short AAA

Advantage

=

=

=

=

=

=

=

=

=

=

=

=


Call Protection

50

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The fact that the prepayment penalty allocated to the investor is higher than thepremium dollar percentage results in the prepayment benefiting the investor.

While the yield to maturity is higher in this scenario, the average life of thisbond decreases. For some investors, the shortening of the average life of thebond mitigates the benefits of a higher yield to maturity.

SHORT AAAA BBONDS WWHICH DDO NNOT SSHARE PPREPAY PPENALTIESThe yield to maturity on short AAA bonds from earlier CMBS deals generallydoes not increase as prepayments increase during yield maintenance periods.These bonds do not receive any of the prepayment penalties. When they aretrading at a premium dollar price, they lose yield as they receive prepayments atpar. If interest rates were to increase enough so that the bonds were trading at adiscount dollar price, the yield to maturity would increase as prepayment speedsincrease during yield maintenance periods.

AA BBONDSThe performance of the AA bonds generally follows the same pattern as theshort AAA bond. The AA bond, however, has a higher duration and a resultinghigher price sensitivity to interest rates. As a result, the AA bond is more likely tobe trading at a discount dollar price at smaller increases in interest rates than theshort AAA bond. So, in an interest rates up 100 bp scenario on an older deal, theyield to maturity on the short AAA bond decreases as prepayments increase, butthe yield to maturity on the AA bond increases. The AA bond is priced at a dis-count in the rates up 100 bp scenario while the short AAA bond is a premium.

For newer bonds with shared yield maintenance penalties, the actual speed ofprepayment will determine whether the investor receives a higher yield to maturi-ty than the 0% CPR case. Prepayment speeds must be fast enough to retire theAAA bonds during the yield maintenance period in order for the yield to maturi-ty to increase on the AA bond. If the AAA securities are retired and the AAbond becomes the currently paying bond, the AA bond receives a portion of theprepayment penalties. If the AA bond does not become the currently payingbond during the yield maintenance period, it does not receive any of the prepay-ment penalties. The average life shortens in either case.

Interest RatesBond Class –300 bp –100 bp Unchanged +100 bp +300 bp

Short AAA Decreases Decreases Decreases Decreases Increases

(IO ReceivesAll Penalties)

Short AAA Increases Increases Increases Increases Increases

(Make Bonds Whole)

EFFECT ON YIELD TO MATURITY AS PREPAYMENTSPEEDS INCREASE—SHORT AAAs

exhibit 4



INTEREST OONLY BBONDSIOs from CMBS deals with yield maintenance loans generally benefit as prepay-ment speeds increase during yield maintenance periods. The present value of thepenalty paid to the IO holder is usually greater than the present value of theforegone interest that would have been received from the loan that prepaid.When interest rates rise to the level where no prepayment penalty is due fromthe borrower, the IO holder does not benefit from faster prepayments. In thiscase, the IO bond loses the income stream from the prepaid loan and does notreceive a compensating prepayment penalty. Unlike a defeased IO, an IO from aCMBS deal backed by yield maintenance loans offers investor(s), the potentialfor higher returns with faster prepayments under certain interest rate scenarios.

TRENDS IIN CCMBS CCALL PPROTECTIONConduit loan originators have established defeasance as the standard call protec-tion in their origination programs. Which forms of prepayment protection doborrowers prefer? In some scenarios, yield maintenance is more expensive forborrowers and in some scenarios defeasance is more expensive for borrowers.We present three numerical examples of the costs to the borrower of defeasanceversus yield maintenance in the Appendix. Yield maintenance and defeasancehave very similar penalty calculations in current to lower interest rate environ-ments although defeasance may be slightly more expensive in steeper yield curveenvironments. In rising interest rate environments, yield maintenance and defea-sance prepayment disincentives tend to decline, but yield maintenance is eventu-ally disadvantageous to the borrower. We think the increasing influence of theCMBS market in commercial real estate finance will result in the dominance ofdefeasance in commercial mortgage loans.


AA Decreases Decreases Decreases Increases Increases


AA Varies Varies Increases Increases Increases

(Make Bonds Whole)

EFFECT ON YIELD TO MATURITY AS PREPAYMENTSPEEDS INCREASE (AA)

exhibit 5



IO Increases Increases Increases Increases Decreases


IO Increases Increases Increases Increases Decreases

(Make Bonds Whole)

EFFECT ON YIELD TO MATURITY AS PREPAYMENTSPEEDS INCREASE (IO)

exhibit 6



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Investors in CMBS have different sets of opportunities and investment decisionswith defeased deals versus deals with yield maintenance. The defeased deal elimi-nates the cash flow volatility resulting from commercial mortgage prepayments.Investors in CMBS with yield maintenance call protection have exposure to thebenefits and risks resulting from prepayment driven cash flow variability.Investors should carefully analyze the effect of interest rate movements and pre-payments on the yield of individual CMBS classes.

APPENDIX: TTHE BBORROWER’S PPERSPECTIVEThe following example compares a prepayment under defeasance to a prepay-ment under yield maintenance from the borrower’s perspective.

Assume the underlying loan has the following characteristics:

• Amount: $10,000,000• Term: 10 years• Amortization: 25 years• Coupon: 7.50%

We will assume that the reference rate on the yield maintenance penalty isTreasuries flat and that a minimum one percentage point fee is applicable toany prepayment.

Scenario 11:In five years, U.S. Treasury Rates are unchanged, but the borrower wants to sellthe property for personal reasons.

• Loan Balance at the End of Year 5: $9,189,718• Yield Maintenance Penalty: $779,020 (8.48%)• Cost of Treasury Strips: $9,970,826• Total Defeasance Cost: $781,108 (8.50%)

($9,970,826–$9,189,718)• Defeasance Advantage to Borrower: -$2,088 (0.02%)

So, the defeasance option in this case is more expensive to the borrower by0.02% or $2,088.


Scenario 22In five years, rates have risen just above the borrowers mortgage coupon, but theborrower wants to refinance to monetize the equity appreciation in his property.The 5-year Treasury is at 7.79%.

• Loan Balance at the End of Year 5: $9,189,718• Yield Maintenance Penalty (min 1%): $91,897 (1.00%)• Cost of Treasury Strips: $9,172,606• Total Defeasance Cost: ($17,112) (0.19%)• Defeasance Advantage to Borrower: $109,009 (1.19%)

The defeasance option is cheaper for the borrower by 1.19% or $109,009.

Scenario 33:Five years from now, rates will have risen to their highest levels in a decade,with 5-year Treasury rates at 9%. The borrower wants to sell the property.

• Loan Balance at the End of Year 5: $9,189,718• Yield Maintenance Penalty (min 1%): $91,897 (1.00%)• Cost of Treasury Strips: $8,741,211• Total Defeasance Cost: $(448,507) (4.88%)• Defeasance Advantage to Borrower: $540,404 (5.88%)

In this scenario, the borrower effectively has the option of prepaying the loan on a discounted basis. This results in a cost savings of 5.88%, or $540,404 ver-sus the amount paid under yield maintenance.

Our example assumes a fairly flat yield curve. All else being equal, the defea-sance option gets more expensive to the borrower as the yield curve steepens.Under the defeasance option, each mortgage loan payment is discounted at itscorresponding zero coupon Treasury rate. When there is a larger spread between1-year rates and 10-year rates, the discounted present value of the Treasury strippayments is higher, resulting in a greater cost to the borrower. Even in a steepyield curve environment, however, the defeasance option still allows the borrow-er the opportunity to prepay the loan at a discount. This option is not availableunder yield maintenance since the best a borrower can do is prepay at par.

54




AAA Fixed Rate CMBS

Chapter 4

This chapter discusses some of the different types of AAA classes that haveevolved in the fixed-rate CMBS market over the past few years. Today, transac-tions are issued with multiple AAA classes, and the characteristics of AAAs aredifferent from the classes issued in the past.

In addition to front-pay bonds and tight window bullets, the AAA CMBS mar-ket also includes multifamily directed classes, amortizing bonds, wide windowbonds, super senior and junior AAAs as well as the traditional 10-year AAAbullet. In this chapter, we discuss these bonds, as well as premium dollar price10-year AAAs.

Tight Window AAA BondsIn the late 1990s, the AAA CMBS world was a simpler place. Most conduittransactions were issued with only two AAA classes: a current pay 5-year widewindow bond and a locked-out, 10-year bond.

The more recent breed of 5-year AAAs is typically not structured as the front-pay class. With shorter classes ahead of the 5-year bond in the capital structure,many 5-year AAAs resemble bullets. They are initially locked out from receivingprincipal payments and ultimately pay down in a short period of time.


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CHARACTERISTICS OF 2004 5-YR AAA (TIGHT WINDOW) CLASSESexhibit 1

Source: Morgan Stanley, Trepp, Annex A Files

Principal # of MaturingTight-Window Window Loans Tied to Original5-Year AAA Bond (Months) Payoff of Class WAL (yr)

CGCMT 2004-C1 A2 6 29 4.8

BACM 2004-2 A2 7 26 4.8

LBUBS 2004-C6 A2 3 17 4.9

COMM 2004-LB2A A2 4 13 4.8

CSFB 2004-C3 A3 6 9 4.8

LBUBS 2004-C2 A2 3 9 4.8

WBCMT 2004-C14 A2 8 9 5.2

BSCMS 2004-T14 A2 6 7 4.6

GCCFC 2004-GG1 A3 6 5 4.7

JPMCC 2004-PNC1 A2 6 5 4.7

LBUBS 2004-C4 A2 4 5 4.7

LBUBS 2004-C7 A2 3 5 4.9

MSC 2004-HQ4 A3 5 4 5.0

WBCMT 2004-C11 A2 2 3 4.9

COMM 2004-LB3A A2 12 2 4.9

In order to gain a better understanding of the risk within short, locked out AAAclasses, we analyzed a group of tight-window AAA bonds. We examined theTrepp universe of 2004 conduit transactions and captured all 5-year average lifeAAA bonds with tight windows1. Our analysis captures 15 deals that include 5-year tight-window classes, most of which exhibit a strong dependence on theperformance of a small percentage of loans in the deal.

The timely repayment of principal on tight-window, locked out AAA classesmay be dependent on the ability of a few loans to pay off as scheduled.That is, a transaction may be backed by more than 100 loans, but the payoff of thetight-window AAA bond may be tied to the cash flows of only two or three loans.This concentrated risk is not necessarily consistent with the level of risk an investormay expect from a diversified pool of loans in a conduit/fusion transaction.

In our analysis, we found that the majority of 5-year, tight-window AAAs issuedin 2004 will be paid down by fewer than 10 maturing loans. (See Exhibit 1)

1We define a tight principal window as being 12 months or less


Manufactured SelfOffice Retail Multifamily Lodging Housing Storage

15% 0% 10% 0% 15% 60%

21% 51% 26% 0% 0% 2%

1% 51% 0% 8% 24% 16%

44% 19% 34% 0% 3% 0%

46% 11% 43% 0% 0% 0%

66% 18% 15% 0% 0% 1%

22% 77% 1% 0% 0% 0%

62% 26% 0% 9% 0% 3%

34% 66% 0% 0% 0% 0%

0% 87% 0% 13% 0% 0%

69% 30% 0% 0% 0% 1%

30% 70% 0% 0% 0% 0%

44% 0% 52% 0% 4% 0%

33% 31% 0% 0% 36% 0%

0% 92% 8% 0% 0% 0%

Property Type Concentration of Maturing Loans Tied to Tight Window Payoff(Based on Original Balance)

RISK IIS TTIED TTO TTHE NNUMBER OOF MMATURING LLOANS

Within the examined universe, COMM 2004-LB3A A2 has the most concen-trated risk of the 2004 tight-window 5-year AAAs, with only two loans tied toits principal repayment. Although five loans actually mature while the A2principal window is open, three of these loans are tied to the repayment ofthe multifamily directed class and do not contribute to the repayment of theA2 class. The class diverts the cash flows of some multifamily loans awayfrom the tight-window class. Therefore, the impact of a few loans on thetight-window class is intensified.

The COMM bond has concentrated risk in the performance of two loans, how-ever, it is important to note a mitigating factor. Of the 15 bonds that we ana-lyzed, this class has the longest principal window. Therefore, 15% of the bond’soriginal balance is paid down through amortization of the collateral pool priorto the two balloon maturities.

CGCMT 2004-C1 A2 has the least concentrated risk, in terms of number ofloans linked to final payoff of the bond. Principal cash flows from 29 loans areinvolved in the payoff of the A2 class. However, there are other factors to con-sider in addition to the number of loans involved in the payoff. For example,60% of the loans (based on original balance) that will pay down the A2 class arebacked by self storage properties. Although CGCMT 2004-C1 A2 offers the


AAA Fixed Rate CMBS

58

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EXPOSURE TO LARGEST MATURING LOANS INVOLVED IN PRINCIPAL REPAYMENT OF 5-YR AAA (TIGHT WINDOW) CLASSES

exhibit 2


Original Balance of# of Maturing Maturing Loans

Loans Involved In Involved In PayoffClass Payoff of Class of Class ($MM)

CGCMT 2004-C1 A2 29 163.0

BACM 2004-2 A2 26 242.2

COMM 2004-LB2A A2 13 162.4

CSFB 2004-C3 A3 9 244.7

LBUBS 2004-C6 A2 17 328.5

LBUBS 2004-C2 A2 9 317.1

WBCMT 2004-C14 A2 9 234.9

BSCMS 2004-T14 A2 7 176.2

GCCFC 2004-GG1 A3 5 280.5

WBCMT 2004-C11 A2 3 69.1

JPMCC 2004-PNC1 A2 5 126.1

LBUBS 2004-C4 A2 5 404.4

MSC 2004-HQ4 A3 4 46.8

LBUBS 2004-C7 A2 5 278.0

COMM 2004-LB3A A2 2 81.7

most diversified risk based on the number of loans tied to pay off, investors needto decide if they are comfortable with heavy exposure to self storage assets.

CONSIDER LLARGE LLOAN PPAPER AAS AAN AALTERNATIVEWe urge investors to examine the loans that are tied to the repayment of thetight-window bond. An investor’s analysis of tight-window 5-year AAAs shouldbe in-line with the type of monitoring and analysis required for a large loan deal.In fact, tight-window, AAA investors should consider fixed-rate large loanpaper as an alternative investment.

Currently, 5-year, tight-window AAAs are trading in the swaps + high teens areain the secondary market. In comparison, 5-year bullets on clean, single assetdeals are trading in the low 30s to swaps.


TotalExposure to

Largest 2nd-Largest 3rd Largest 4th Largest 5th Largest Largest 5Loan Loan Loan Loan Loan Loans

15% 9% 7% 5% 4% 40%

19% 17% 10% 8% 8% 62%

16% 15% 15% 13% 10% 69%

31% 22% 11% 10% 9% 83%

24% 21% 21% 11% 8% 85%

59% 17% 7% 6% 4% 93%

64% 19% 5% 4% 3% 95%

42% 24% 20% 9% 2% 97%

32% 30% 17% 16% 4% 99%

36% 33% 31% NA NA 100%

44% 33% 10% 9% 4% 100%

46% 29% 23% 1% 1% 100%

52% 24% 20% 4% NA 100%

54% 24% 16% 5% 1% 100%

92% 8% NA NA NA 100%

Concentration Risk of Largest Maturing Loans Involved in Principal Repayment (Based on Orig. Bal.)

RISK IIS AALSO TTIED TTO TTHE SSIZE OOF MMATURING LLOANSIn analyzing 5-year, tight-window AAAs, investors should also examine a bond’sexposure to the largest loans involved in paying down that class. Simply count-ing the number of loans involved in the payoff of a class may not necessarilycapture the concentration risk accurately.

For example, at first glance, BACM 2004-2 A2 appears to offer more diversifica-tion than COMM 2004-LB2A A2. With 26 loans tied to principal payoff, theBACM bond is affected by the cash flows of twice as many loans as the COMMbond, which is tied to 13 loans. However, on closer examination, the concentra-tion risk of these bonds is more similar than the number of loans implies.

In the case of the BACM bond, the largest five loans (of the 26 total loans)account for about 62% of the loan balances available for pay down of the A2class. The largest five loans affecting the COMM bond account for 69% ofloans tied to the principal repayment of the A2 class.

EXTENSIONS OON 55-YYR TTIGHT-WWINDOW BBONDSPrincipal loss is not a primary concern at the AAA level, but extension risk maybe. The CMBS market has not yet experienced a wave of loan maturities, but wecan look to the extension experience of floating rate large loans as a conservativeproxy for the extensions that may occur in the fixed rate market. We view theextension experience of floating rate large loans to be a conservative proxy, as webelieve these loans are riskier and more likely to extend than fixed rate loans.

Floating rate loans are often made on transitional properties and are structuredwith extension options, while fixed rate loans are typically backed by stabilizedassets. Some fixed rate loans may be ARD loans, but we would only expect creditimpaired loans to extend beyond their anticipated repayment dates. We recently


AAA Fixed Rate CMBS

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2004 5-YEAR AAA (TIGHT WINDOW) CLASSESLOANS SCHEDULED TO MATURE BEFORE OPENING OF TIGHT WINDOW

exhibit 4


Class Property Name

BACM 2004-2 A2 Cargill Office Building

COMM 2004-LB2A A2 Eldorado Mobile Home Estates

CSFB 2004-C3 A3 One Crown Center

CSFB 2004-C3 A3 Corona Plaza Shopping Center

GCCFC 2004-GG1 A3 DDR Portfolio

LBUBS 2004-C2 A2 Brittany Square

LBUBS 2004-C2 A2 Fairview Apartments

LBUBS 2004-C2 A2 Walgreens - Cheyenne Avenue

LBUBS 2004-C7 A2 Executive Plaza - Waco

MSC 2004-HQ4 A3 387-403 Fulton Avenue

WBCMT 2004-C11 A2 Pirate Plaza Shopping Center

published a piece that examined extension rates on floating rate large loans.2

Extension rates for floating rate loans are shown by property type in Exhibit 3.Extension risk on a 5-year tight-window class may also be dependent on loansthat mature outside of its principal window. For example, if extensions occuron loans that are scheduled to mature prior to the principal window opening, the5-year AAA class may be affected. Of the 15 tight-window bonds that weexamined, eight contain loans that are scheduled to mature prior to the openingof the tight window.3

Therefore, in addition to examining the loans that mature within the tight win-dow, investors concerned with extension should also examine the loans thatmature prior to the opening of the tight window.

2For more information, see chapter 11 of this primer.3Does not include LBUBS 2004-C6, in which 2 maturing loans are tied to the paydown of the multifamily-directed class.


Property Type Extension Rate (%)

Hotel 40

Office 30

Multifamily 18

Retail 8

Other 13

Total 23

EXTENSION RATES BY PROPERTY TYPE(BASED ON ORIGINAL BALANCE)

exhibit 3

Extension rate represents % of loans that exercised extension options at maturity.

Source: Morgan Stanley, Intex, Trepp

Original Loan Current Loan Maturity PropertyBalance ($MM) Balance ($MM) Date Type

18.0 18.0 9/1/2008 Office

2.3 2.3 10/1/2008 Mobile Home

6.0 6.0 12/11/2008 Office

4.3 4.3 2/11/2009 Retail

48.8 48.4 3/1/2008 Retail

4.3 4.3 10/11/2008 Retail

4.1 4.1 11/11/2008 Multifamily

4.3 4.3 12/11/2008 Retail

3.4 3.4 5/1/2009 Office

3.3 3.3 3/1/2009 Retail

0.8 0.8 10/11/2008 Retail

Multifamily Directed ClassesMultifamily directed classes, often labeled as A-1A bonds in the structure, arecollateralized by multifamily commercial mortgages. If a deal has a multifami-ly directed class, cash flows of most of the collateral pool’s multifamily mort-gages are tied exclusively to paying down that class. The multifamily directedclass is intended to encourage GSE participation.

According to the Commercial Mortgage Alert database of new issue transac-tions, 66% of the conduit/fusion deals issued in 2004 contain multifamily direct-ed (A-1A) classes. Despite the widespread use of A-1A tranches, all else beingequal, we prefer transactions that do not contain multifamily directed classes.

The use of A-1A classes within deal structures essentially has the effect ofreducing collateral diversity for non-A-1A holders.

At first glance, bondholders in deals without A-1A classes look no better offthan bondholders in deals containing A-1A classes – that is, the collateralcomposition of transactions containing A-1A classes looks as diverse as thecollateral composition of transactions without A-1A classes (see Exhibit 5).


AAA Fixed Rate CMBS

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Source: Commercial Mortgage Alert

2004 FIXED RATECMBS

COLLATERALCOMPOSITION:

DEALS WITH A-1A CLASSES

exhibit 5a


2004 FIXED RATECMBS

COLLATERALCOMPOSITION:

DEALS WITHOUT A-1A CLASSES

exhibit 5b

However, the majority of multifamily loans in transactions containing A-1Aclasses are tied to multifamily directed classes. As a result, the existence of anA-1A class results in a less diversified collateral pool for non-A-1A bondhold-ers (in terms of extension risk) and exposes these investors to higher concen-trations of fewer property types.

For example, in JPMCC 2004-CBX, multifamily loans comprise 23.6% of thecollateral pool. However, the majority of these loans are tied to the A-1Aclass and do not contribute cash flows to the rest of the capital structure. Ifwe calculate property type exposures for the non-A-1A classes based on theloans that contribute cash flows to these bonds, we find that the non A-1Aclasses have less than 1% exposure to multifamily cash flows. Exposure tooffice properties jumps to 38.4% from 29.6%, and retail exposure increases to35.5% from 27.4%. Four other recent fixed rate CMBS with A-1A classesexhibit a similar trend.

AAA classes with tight principal windows are particularly sensitive to the pres-ence of an A-1A class. Since the principal repayment of tight window classesis typically tied to a handful of loans, the A-1A class further reduces diversifi-cation by diverting most multifamily cash flows away from the tight windowbonds. Multifamily cash flows that would have otherwise been used to paydown bonds in the absence of a multifamily directed class are directed to paydown A-1A instead.

In 2004, the IQ, HQ, TOP and PWR shelves were among the new issue pro-grams that did not utilize multifamily directed classes.

Amortizing AAA BondsIn November 2004, the BACM 04-5 transaction priced with 2 tight-window AAAclasses in addition to its 10-year AAA classes. The 5-year and 7-year tight win-dow classes were created by incorporating a unique class (class A-AB) into thedeal’s structure.


Class Size ($MM) Subordination (%) A/L (Years) Principal Window Priced

A-1 57.600 20.00 2.89 1-56 S+26

A-1A 241.609 20.00 6.34 1-118 NA

A-2 250.910 20.00 4.77 56-60 S+17

A-3 305.377 20.00 6.77 80-84 S+24

A-AB 45.540 20.00 6.99 56-110 S+32

A-4 188.667 20.00 9.64 110-118 S+29

A-J 90.241 13.38 9.80 118 S+33

BACM 2004-5 AAA BONDSexhibit 6

Source: Commercial Mortgage Alert, Trepp

In this section, we refer to Class A-AB as an amortizing bond. The A-AB bondis structured to absorb the monthly P&I payments from loan amortization whileballoon payments are directed to pay down the tight window classes.

CONCLUSIONSWe believe that class A-AB is cheap relative to one other recently issued classwith a wide principal window, comparable average life and identical subordina-tion level. We recommend this new type of bond for investors whose primarymarket concern is extension risk.

Under no reasonable scenario were we able to extend class A-AB. We did find,however, that the class A-AB principal window shortens with minimal defaultstresses, although the bond will not pay off sooner than 2011 under our mostsevere scenarios. Early repayment of principal will provide upside for investorsif they purchase this bond at a discount in the future. With rates on the rise, itis likely that this bond will trade at a discount in the future.

LIMITED FFUTURE IISSUANCE

We expect future issuance of amortizing bonds to be limited since its existenceis dependent upon having enough 5-year and 7-year loans in the collateral poolto create tight window classes. If the market remains predominantly a 10-yearballoon mortgage market, and deals are issued with low percentages of 5- and7-year loans, we will not see heavy issuance of amortizing bonds.

The BACM 2004-5 collateral pool contains 30% 5-year loans, 24% 7-year loansand 46% 10+ year loans. Even with this seemingly heavy concentration of 5-and 7-year loans, the size of the A-AB class is small ($45.5 million) compared toother AAA classes.


AAA Fixed Rate CMBS

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Source: Morgan Stanley, Trepp

BACM 2004-5:LOAN

CONCENTRATION

exhibit 7

EXTENSION PPROTECTIONAs extension risk is a concern for many investors, the extension protectionoffered by the A-AB class is attractive. We found the A-AB class to have virtual-ly no extension risk.

This extension protection exists for two reasons:

• Payments to A-AB bond holders are not tied to balloon maturities.

• Class A-AB is at the top of the principal distributions waterfall, so its bal-ance is reduced to the planned principal amount prior to other classesreceiving principal.

Under reasonable assumptions, we would expect the A-3 class to pay downprior to the A-AB class. This is because the A-AB class will not receive addi-tional payments greater than its planned principal amount until classes A-1, A-2and A-3 are fully paid off. However, even in a scenario where all 15 loans tiedto the timely payoff of the A-3 class extend, the timing of the A-AB cash flowswill be unaffected. The A-AB class will continue to receive payments from themonthly loan amortization of the remaining loans and pay off in 2014.

We were only able to extend the average life of class A-AB under a very severe,unrealistic scenario. When we defaulted and liquidated the largest five loans inthe transaction, which account for 29.8% of the deal, the A-AB class extendedby less than one month.


Note: Loss severity in all scenarios is assumed to be 35% with a 12-month recovery period.


Prepayment Principal A/LScenario Default Details Speed Window (Years)

Base Case 0% CDR 0 CPR 07/09-01/14 6.998

Extension 1 12-Month Extension of All Collateral 0 CPR 7/09-1/14 6.998

Extension 2 12-Month Extension of Loans Tied to the Payoff of A-3 0 CPR 7/09-1/14 6.998

BACM 2004-5 A-AB: EXTENSION STRESS SCENARIOSexhibit 8

EARLY RREPAYMENT OOF AA-AABDespite the lack of extension risk, the A-AB bond is sensitive to principal win-dow contraction. The base case scenario of no prepayments or defaults pre-dicts payoff in 2014, but the bond’s principal window shortens with minimaldefault stresses.

The amortizing bond is sensitive to an earlier payoff because of its small classsize. This class was originally structured to receive loan amortization payments,not balloon payments. Therefore, the small A-AB class can be reduced to zeroprior to its scheduled maturity date if a large balloon payment becomes tied toits repayment. This can occur in a default scenario where liquidation proceedsare passed through the top of the structure, thereby promoting the payoff ofthe A1, A2 and A3 classes with unscheduled principal that would not otherwisebe tied to these classes. Any leftover principal cash flow that was originallyscheduled to pay down the A3 class in the base case scenario is now directed tothe A-AB class.


AAA Fixed Rate CMBS

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Prepayment Principal A/LScenario Default Details Speed Window (Years)

Base Case 0% CDR 0 CPR 07/09-01/14 6.998

Default 1 0% CDR for 24 months; 0.5% CDR thereafter 0 CPR 07/09-07/13 6.782

Default 2 0% CDR for 24 months; 2% CDR thereafter 0 CPR 07/09-06/12 6.472

Default 3 0% CDR for 24 months; 5% CDR thereafter 0 CPR 07/09-11/11 6.408

Default 4 3% CDR starting immediately 20 CPR 07/09-11/11 6.351

Default 5 Default Bank of America Center on 12/06 0 CPR 07/09-01/14 6.998

BACM 2004-5 A-AB: DEFAULT STRESS SCENARIOSexhibit 9

Note: Loss severity in all scenarios is assumed to be 35% with a 12-month recovery period.


In default scenario 1, we assume no defaults in the first 24 months and then aconstant annual default rate of 0.5% for the remainder of the deal. Loss severi-ty is assumed to be 35% with a 12-month recovery period. Rather than payingoff in 2014, the bond pays off in 2013, reducing the length of the principal win-dow by six months.

Using a more severe scenario, with 3% annual defaults starting immediately,and a 20% CPR prepayment assumption, the final cash flow on the A-ABbond is paid in 2011. The shortening of this class is limited to a 2011 payoff,since there are not enough 5-year loans in the pool to pay off the A-AB classprior to 2011.

BACM 22004-55 AA-AAB LLOOKS CCHEAPThe BACM 2004-5 transaction priced on November 8, 2004. Class A-AB, a 6.99year bond with 20% credit enhancement priced at swaps + 32 bp. One weeklater, on November 15th, the JPMCC 2004-CBX deal priced. The JPMCC trans-action does not have an amortizing bond, but does contain a comparable averagelife AAA bond (6.61 yr) with a wide principal window and a subordination levelof 20%. This bond (class A-4) priced at swaps + 25 bp, 7 bp tighter than theBACM amortizing A-AB class. Although there may be some spread conces-sion for the small size of the A-AB class and for the wider principal win-dow, we believe the BACM amortizing class, with its top priority in theprincipal distribution waterfall and stable cash flows, offers value.



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CMBS Premium BondsA premium priced CMBS bond can be examined for value by breaking it intotwo components: a par priced fixed-rate bond and an IO. By examining thespread on the embedded IO and comparing it to IOs in the market, we candetermine whether the premium bond is undervalued. To analyze our sample ofbonds, we used the Bond Splitter function on Trepp.

We examined a sample of second-pay AAA bonds with premium dollar prices.For our analysis, we examined 2001 and 2002 conduit transactions. We examinedall embedded IOs under a 100CPY prepayment assumption. We chose to analyzetransactions from 2001 and 2002, as recent vintages tend to have stronger callprotection than deals issued in 1997 or 1998. Analyzing older transactions usinga 100CPY scenario may be too aggressive and would result in less attractiveembedded IOs than those found in premium bonds of more recent vintages.

We performed this analysis in June 2003, after interest rates rallied significantly,resulting in premium priced CMBS trading at even higher dollar prices. At thetime, our trading desk estimated that on average, 10-yr AAA bonds off of con-duit deals were trading 3-4 points higher than they were about 1 month earlier.

We found that some premium bonds offered 5-10 bp of upside potentialbecause their dollar prices rose high enough, such that the concession offered inspread for each point of premium made the embedded IO look cheap in com-parison to market priced PAC IOs. In the sample of AAAs that we examined forthis analysis, the premium dollar prices ranged between $112 and $119.

Besides very high premium dollar prices, an investor should also consider thesize of the front-pay AAA class. Second-pay AAAs that are preceded by larger

Spread to Swaps

on Premium Bond

(Assuming Dollar

Deal Name Class 0,0,3CDR) Price

SBM7 2001-C2 A3 46 118-30.240

BAFU 2001-3 A2 43 112-3.750

JPMCC 2001-CIB2 A3 49 118-4.750

MSDWC 2001-TOP1 A4 47 119-15.875

GECMC 2001-1 A2 49 118-26.375

CSFB 2002-CKP1 A3 50 118-12.375

GMACC 2001-C2 A2 51 119-15.875

WBCMT 02-C1 A4 50 117-10.875

LBUBS 2002-C1 A4 52 118-18.875

ANALYSIS FOR CMBS PREMIUM AAA BONDSexhibit 10



front- pay AAAs may look attractive compared to second-pay AAAs that arepreceded by smaller front-pay AAAs. A larger front-pay class can shield the pre-mium priced second-pay AAA bond from recoveries on defaults, thereby pre-serving yield on the embedded IO.

One of the bonds that we analyzed was GMACC 2001-C2 A2. This class cur-rently has 23.4% credit enhancement and a dollar price of $119-15.875.

GMACC 2001-C2 A2 has an average life of 7.84, so we assumed that theembedded par bond has a spread of swaps + 32 bp. New issue 10-year AAAbonds from conduit transactions trade around swaps + 36 bp. We arrived atswaps+32 bp for the 7.84-year embedded par bond by making the marketassumption that each year of seasoning is worth 2 bp of spread.

We then calculated spreads for the embedded IO under different default scenarios.In each scenario, we applied defaults after 24 months. Assuming no defaults for24 months and 3% CDR thereafter, the embedded IO yield was T+177 bp.Running 6% CDR instead resulted in an IO yield of T+119 bp. We assumed a34% loss severity on defaults and a 12-month recovery period.

We then compared spreads on the embedded IO to new issue PAC IO spreads.The PAC IO is similar to the embedded IO in that it is well shielded fromlosses. The PAC IO is typically structured to withstand up to 6% annualdefaults. Currently, new issue PAC IOs are pricing at T+95 bp. The embed-ded IO in GMACC 2001-C2 A2 looks cheap in comparison, as yields rangefrom T+119 bp to T+177 bp, depending on the default scenario.

Premium

Embedded IO Spread Embedded IO Spread Spread to Swaps Cheapness to

to UST Assuming to UST Assuming on Premium Bond Hypothetical

3% CDR after 24 6% CDR after 24 when IO Spread PAC IO &

Months Months is T+95 bp AAA Combination

118.1 55.7 44.2 1.8

172.6 122.4 38.2 4.8

161.6 108.7 43.1 5.9

168.3 136.8 40.1 6.9

163.4 104.3 42.7 6.3

178.4 122.3 42.4 7.6

176.5 119.1 43.3 7.7

192.6 164.6 41.5 8.5

204.1 159.3 42.0 10.0


AAA Fixed Rate CMBS

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HOW CCHEAP IIS GGMACC 22001-CC2 AA2?The analysis above shows that the GMACC 2001-C2 A2 bond is cheap, but doesnot address the question of how cheap. We ran a breakeven analysis to figure outhow much the A2 bond would have to tighten before an investor would be indif-ferent between owning the premium bond versus owning a par bond and PAC IOat T+95 bp. We found that if we assume the embedded IO is priced at T+95 bpunder a 3% CDR scenario, the A2 bond would yield swaps+43 bp. This impliesabout 8 bp of value, since the A2 bond currently trades at swaps +51 bp.

Using this methodology, we found that all of the bonds in our sample offer valueunder a 3% CDR scenario. Under 6% annual defaults starting in 24 months, theembedded IO in SBM7 2001-C2 A3 class yields T+56 bp. The PAC IO, in com-parison, would not break under this default scenario and continue to yield T+95 bp.For investors that consider the 6% CDR scenario to be a reasonable assumption,the SBM7 2001-C2 A2 class would not provide good value (See Exhibit 10).



Total Rate of Return Swaps

Chapter 5

While Total Rate of Return Swaps (TRS) are not a new innovation in the CMBSmarket, they became an area of increased interest during the tight spread envi-ronment in 2004. With AAA CMBS trading at swaps +25 bp in January 2004,we received a number of questions on the TRS market during our roadshow, asinvestors searched for spread outside of the cash market.

WHAT IIS AA TTRSA TRS is a method of synthetically replicating the returns from the CMBS mar-ket. A TRS is a contract in which one party agrees to pay the total return on areference index or a basket of CMBS, while the other party pays a floating rate,based on 1-month LIBOR.

Total return is comprised of two components: income and price appreciation ordepreciation. The income component includes any interest that is paid duringthe life of the TRS contract, as well as interest that has accrued during that time.TRS are short-term contracts, typically three to twelve months in length.However, they reference a basket/index with durations typically found in 5-yr or10-yr average life CMBS cash bonds.

Investors may choose to be TRS payers to hedge long CMBS or loan positions,or choose to be receivers to obtain a diversified investment in CMBS through asingle trade.



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TOTAL RATE OFRETURN SWAP

(TRS)

exhibit 1

BREAK-EEVEN AANALYSISHow much CMBS spread widening can a TRS receiver tolerate before the tradeloses money? In order to answer this question, we first need to isolate the TRSfrom other sources of profit and loss, such as interest rate or swap rate movements.

In the diagram below, we have created a hypothetical example where aninvestor agrees to receive the total return on a basket of 10-year AAA CMBS,and simultaneously enters into an interest rate swap to mitigate interest raterisk. Let’s assume that the average yield on the basket of AAA securities isswaps +30 bp, and the average duration on these bonds is about seven years.In exchange for the total return on the AAA index, we will assume the investorpays 1-month LIBOR - 40 bp. For simplicity, we will perform the calculationassuming a 1-year time frame.

We can calculate the investor’s income by examining the cash flows from the twoswaps. The investor receives a yield of swap rate + 30 bp on one leg of theTRS and hedges the interest rate exposure by paying the fixed leg of an interestrate swap.

The investor also receives LIBOR from the floating rate leg of the interest rateswap and pays LIBOR - 40 bp on the TRS. Overall, the investor’s incomestream is (swap rate + 30 bp) - swap rate + LIBOR - (LIBOR-40 bp).Therefore, the total income from these 2 trades is equal to 70 bp.



THE RECEIVERPAYS FIXED

ON INTERESTRATE SWAP

exhibit 2

The investor’s break-even point on the trade occurs if the price of the AAACMBS bonds in the index declines by 0.70%, due to spread widening versusswaps. A 0.70% decline in price corresponds to approximately 10 bp of spreadwidening over the course of 1 year. (In a typical 3- or 6-month TRS contract, aninvestor’s break-even point would be reached after 2.5 bp or 5 bp of CMBSwidening, respectively.)

∆P/P = -0.70%

∆P/P= Y*Duration

∆Y*Duration = -0.70%

∆Y = 0.70% ÷ 7

∆Y = ~10 bp

An investor who chooses to buy the same basket of AAA bonds in the cashmarket could withstand about 4 bp of spread widening over the course of a year(30÷7 = 4.3 bp). The TRS receiver can withstand more widening on the CMBSbasket because there is an additional 40 bp of cushion from the TRS that helpsmitigate any CMBS spread widening that occurs.

The 40 bp of cushion in the TRS fluctuates over time with the amount of hedg-ing demand. Hedging demand comes from dealers hedging long secondary trad-ing positions, loan originators hedging conduit pipelines, and basis traders sellingCMBS versus other asset classes. Historically, the floating leg of the TRS hastraded between LIBOR-70 bp and LIBOR-10 bp. In 2003 and during the firsthalf of 2004, the market ranged between LIBOR-70 bp and LIBOR-35 bp.During the second half of 2004, increased investor interest in the TRS marketremoved most of the spread advantage of receiving the index.

FACTORS TTO CCONSIDERTotal rate of return swaps may not be ideal for all investors. TRS requireinvestors to have necessary swap documents before entering a trade. A consid-eration for non-mark-to-market investors is that TRS are effectively marked tomarket, since monthly payments are made based on the return of the index.Therefore, a TRS investor would experience regular realized gains or losses.Liquidity and counterparty risk are other factors to consider.



74

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CMBS IOs

Chapter 6


CMBS IOs

76

chapter 6

The first five pages of this chapter are excerpted from a piece originally written in 1998.

INTRODUCTIONThe CMBS interest-only securities (IO) market has both grown and maturedsince its inception in the mid-1990s. In this chapter, we trace the growth anddevelopment of the CMBS IO market and factors affecting issuance.

We examine current pricing conventions for IOs and look at several case studies toevaluate the impact of changing prepayment and default scenarios on IO returns.

Some of our major findings are:

• IOs offer an opportunity to ERISA constrained investors to buy credit sensitive CMBS.

• CMBS IO investors will benefit if prepayments fall short of the 100% CPRpricing assumption or if loans are extended at the balloon date.

• CMBS IO investors may benefit from prepayment penalties during yieldmaintenance periods.

WHAT IIS AA CCMBS IIO?As in the single-family residential market, CMBS IOs receive a coupon strippedfrom an underlying pool of mortgages or bond classes. Stripping a couponallows an issuer to sell par (or near par) priced securities, even if the coupon onthe underlying mortgages is well above the bond coupons. For example, a 1% IOstrip may be created off of collateral with a 7% coupon in order to sell 6% par-priced securities.

Both residential and CMBS IOs are typically rated AAA/Aaa. These ratings arebased on priority of cash flow rather than credit, and are meaningless except forregulatory purposes. Any loan default affects the yield of an IO, but from the rating agency perspective, the default does not affect the IO’s senior priority inreceiving existing cash flow. CMBS IOs are ERISA eligible investments because of their non-subordinated position in the structure.

Since the priority of the IO never changes, it is unlikely to be downgraded even if the credit quality of the collateral declines. In a declining credit environment,principal and interest bonds are more vulnerable to a downgrade. Owners ofthese bonds may be forced to liquidate if they have minimum rating require-ments. In such an environment, spreads on IOs could widen, but the rating forregulatory purposes would probably not change.

For IOs backed by residential mortgages, prepayments are the most important risk factor. Historically, defaults on residential mortgages have been a relativelyminor factor. Over the life of a residential mortgage pool, defaults have typicallytotaled less than 5% of the original balance compared to prepayments that rangefrom 5% to 30% per year. For commercial IOs, the situation is reversed, withdefaults potentially having a greater impact than prepayments. Most securitizedcommercial mortgages have either a prepayment lockout, yield maintenance ordefeasance. Historic cumulative lifetime commercial mortgage default rates atinsurance companies, however, have ranged from 4% to 32% for cohorts with atleast 10 years of seasoning (1972-1992).

STRUCTUREA traditional structure for a WAC CMBS IO is shown in Exhibit 1. Note thatmost of the IO’s cash flow is off of the AAA-rated classes, which typically con-stitute 70% or more of the principal balances of a CMBS. In addition, thecoupons on the AA, single A, and BBB securities are higher than on the AAAbonds, so less IO is stripped off of these classes.

INVESTOR BBASECurrent buyers of CMBS IOs include life insurance companies and bank portfo-lios to enhance portfolio yield. In addition, CMBS IOs appeal to money man-agers who seek a high-yielding AAA-rated asset.

IOs also appeal to investors seeking shorter duration CMBS instruments – theduration of a CMBS IO is about 4 years, compared to 7 years for classes ratedBBB or BB.

CMBS SSPREADS AAND PPREPAYMENT PPRICING AASSUMPTIONSBefore analyzing the relative value of IOs versus other CMBS sectors, we discusssome of the current prepayment pricing conventions for CMBS IOs and thenturn to credit analysis in the next section.



TYPICAL WAC IOSTRUCTURE

exhibit 1

The market currently prices CMBS IOs assuming that loans with yield mainte-nance prepayment penalties are equivalent to loans with absolute prepaymentlockout provisions. Participants in the CMBS market examine IO yields andspreads using a 100% CPY assumption, meaning that all loans prepay immedi-ately after the lockout or yield maintenance period. Some investors also examineyields under a 0% CPR1 assumption. The difference in spreads using the 0% and100% CPR assumptions is often referred to as the “slope” or drop in spreadfrom the slowest to the fastest prepayment speed.

The actual prepayment experience of a pool of commercial loans backing aCMBS can be quite different from the pricing assumptions. Loans can and haveprepaid in the yield maintenance period. Since a share of the penalty is passedon to the IO holder, this can prove beneficial to a CMBS IO investor, dependingon the level of interest rates when the loan prepays.

In addition, both the 0% and 100% CPR assumptions are unrealistic. Actual pre-payment speeds will vary on a monthly basis, with several months of 0% CPRpossibly followed by a sharp one-month increase if a loan prepays. Unlike theresidential mortgage market, there is very little historical data on commercialmortgage prepayments.

Due to the high percentage of loans with defeasance or yield maintenance intoday’s CMBS transactions, the primary investor analysis on CMBS IOs is defaultdriven. Recoveries and losses on defaulted loans are now the primary factoraffecting early payment of principal in a CMBS transaction.

DEFAULT AASSUMPTIONSAside from prepayments, defaults are the major factor influencing CMBS IOyields. Since default eventually may remove a loan from a pool, it is detrimentalto the return on a CMBS IO. The IO investor no longer receives the intereststrip after a defaulted loan is finally liquidated. A default, then, has a similareffect on a CMBS IO investor as a prepayment. However, default at a balloondate and subsequent extension of a mortgage, which lengthens its life, is benefi-cial to the IO investor.

In pricing a CMBS IO, CMBS IO market participants examine a variety ofdefault assumptions, ranging from 0% CDR to 5% CDR or higher. “CDR”stands for conditional default rate and is analogous to CPR for prepayments (seefootnote 1). Unlike prepayment assumptions, CDRs ignore any call protectionfeature on the loans. Given the historical pattern of commercial mortgagedefault rates, we believe that the expected average annual default rate on a newlyoriginated pool of commercial mortgages lies between 1% CDR and 4% CDR.


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1 CPR stands for “conditional prepayment rate.” It is an annualized prepayment rate expressed as a percentage of the remaining balance of the pool.


IMPACT OOF PPREPAYMENTS OON IIO YYIELD

Exhibit 2 shows the effect of increasing prepayments on 5 different CMBS IOs.

The current pricing convention for CMBS IOs, however, is 100% CPR afteryield maintenance or lockout. Reading exhibit 2 from right to left shows thepotential upside to an investor if prepayments are slower than the pricingassumption. In the five examples cited, an investor has from 14 bp to 140 bp ofupside if actual prepayments are 20% CPR rather than 100% CPR.

The greater the slope of the increase in yield as prepayments decline, the greaterthe potential benefit to the investor. The magnitude of this slope is determinedby the length of the open period between the end of the prepayment penaltyperiod and maturity. This window period can range from as little as one monthto as much as three years or more, depending on the terms of the loans in agiven transaction.

YIELD MMAINTENANCE PPENALTIES AAND IIOsIn most CMBS structures, IOs receive a share of any prepayment penalties paidby borrowers. In early structures (pre-1997), the IO could receive as much as100% of a yield maintenance penalty. More recently, CMBS IOs receive a shareof the penalty according to a formula such as:

In this example, if the principal and interest bond coupon were 6.0%, the mort-gage coupon 7.5%, and the UST 4.75%, the IO would receive 55% of the yieldmaintenance penalty. If the mortgage coupon is less than the UST, the borrowerdoes not pay a penalty. If a penalty is paid, and the bond coupon is less than theUST, then the IO receives all of the penalty.

CPR 0 CPR 20 CPR 50 CPR 100

DMARC 98-C1 10.63 9.97 9.48 8.59

NASC 98-D6 8.83 8.82 8.80 8.68

LBCMT 98-C1 10.36 9.85 9.46 8.59

FULBA 98-C2 9.95 9.50 9.19 8.68

MSC 98-WF2 9.27 9.18 9.08 8.67

PREPAYMENT RISK: YTM OF CONDUIT IOs IN PERCENTexhibit 2

Priced at +350 at 100 CPR; yield maintenance equals lockout.


P = % of penalty paid to IO =

(Bond Coupon – UST)(Mortgage Coupon – UST)

1 –


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For non-defeasance loans, prepayments during the yield maintenance period arebeneficial to the IO investor in a stable rate environment. Exhibit 3 shows thatin 4 out of the 5 sample deals, yields to maturity increase as prepaymentsincrease if interest rates remain unchanged. The sole exception, NASC 98-6, is aCMBS backed by loans with defeasance.

A sharp rise in rates coupled with high prepayments, however, is detrimental tothe yield to maturity of non-defeased IOs. Exhibit 4 shows the effect of aninstantaneous 300 bp increase in interest rates during the yield maintenance peri-od. Under this scenario, the drop in yield from 0% CPR to 100% CPR rangesfrom 15 bp to more than 1500 bp.

While IO bond yields decline greatly when prepayments and interest rates areboth high, we believe that these two factors are typically inversely correlated.Higher rates clearly dampen the refinance incentive. On the other hand, if highrates are coupled with increases in property prices, borrowers may be able torefinance and take proceeds out of a property.


DMARC 98-C1 10.63 13.51 15.42 17.66

NASC 98-D6 8.83 8.82 8.80 8.68

LBCMT 98-C1 10.36 11.44 12.48 14.31

FULBA 98-C2 9.95 10.72 11.37 12.10

MSC 98-WF2 9.26 10.85 11.63 13.48

PREPAYMENT RISK: YTM OF CONDUIT IOs:INTEREST RATES UNCHANGED (IN %)

exhibit 3

Priced at +350 at 100 CPR; yield maintenance equals lockout



DMARC 98-C1 10.63 6.89 3.32 -1.03

NASC 98-D6 8.83 8.82 8.80 8.68

LBCMT 98-C1 10.36 6.13 1.48 -5.15

FULBA 98-C2 9.95 8.20 6.96 5.51

MSC 98-WF2 9.26 5.22 1.41 -2.31

PREPAYMENT RISK: YTM OF RECENT CONDUIT IOs:INTEREST RATES UP 300 bp (IN %)

exhibit 4

Treasury rates up 300 bp; priced at +350 at 100 CPR; yield maintenance does not equal lockout; dollar price has not been adjusted for rate change.



The most notable feature of exhibits 3 and 4 is the stable profile of CMBS IOsbacked by defeasance loans, as demonstrated by NASC 98-D6. The loans in thistransaction must be defeased upon prepayment by substituting Treasury securi-ties for the mortgage in an amount such that the cash flow from the Treasuriesmatches that of the prepaid loan. IOs from defeased transactions present a morestable yield profile in rising rate/high prepayment environments, but less upsidein low prepayment scenarios or from penalty windfalls.

PAC && LLEVERED IIOS

The creation of two separate IO strips from one CMBS transaction is a morerecent structural nuance designed to accommodate the creation of larger IOswhile appealing to alternative IO buyers.3 The rapidly declining interest ratesresulting from a recessionary economy in early 2001 resulted in the creation ofmuch larger IOs, since the IO proceeds are directly proportional to the differ-ence in the weighted average coupon (WAC) of the underlying mortgages vs. theWAC of the bonds created. Ten year treasuries rallied over 100 basis points fromOctober of 2000 (5.80%) to March of 2001 (4.80%).

If the typical CMBS transaction in the fall of 2001 had a 40 basis point differen-tial in the WAC of the underlying mortgage pool (8.20%) vs. the WAC of thebonds (7.80%), approximately $25 million in IO would have been created on a$1 billion transaction. If 10-year Treasuries rallied just 25 bp after the mortgagepool was set, but prior to pricing the bonds, the mortgage pool WAC would be65 bp greater than the bond WAC, resulting in approximately $43 million in IOproceeds. This incremental increase in IO proceeds resulted in the developmentof the PAC IO/Levered IO structure, appealing to an investor base of riskadverse IO buyers drawn to the very stable yield profile of the PAC IO, with thetraditional IO investor base buying the higher yielding but less stable LeveredIO.

3 Some CMBS transactions in the early & mid-1990s had multiple IO classes, with individual IOs stripped off ofindividual bond classes.


CMBS IOs

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The traditional single class IO was stripped off of all (or most all) bond classesin the CMBS structure. The PAC IO is only stripped off of mezzanine bondclasses for a finite time; subsequently a Levered IO is stripped off of the moresenior and subordinate classes (See Exhibit 5). Recall, given the underlying callprotection of today’s commercial mortgages, the performance of any IO is pri-marily a function of credit. If a mortgage pool is comprised of 100% defeasedcollateral, the only unscheduled payment of principal is via default and recovery.Because recoveries paydown the A1 class first, and losses are applied to the mostsubordinate bond class, the yield profile on the PAC IO is insulated fromdefaults in the underlying mortgage pool. Subsequently, the yield on the LeveredIO has more exposure to defaults in the mortgage pool.

A PAC IO is a AAA rated security that can survive a 6 CDR stress scenariobefore giving up any yield. This stress is three times the standard commercialmortgage default rate per the ELS Study. The Levered IO is also rated AAA.This levered IO can be stressed at a 3 CDR (1.5 times the average default rateper the ELS study). While the Levered IO gives yield in a stressed environment,the investor is still buying a loss adjusted AAA.


SERIES 2001 - TOP 4 CAPITAL STRUCTUREexhibit 5

ANALYZING IIOS: AAPPLYING AAGE-AADJUSTED DDEFAULTSSeasoning is an important factor to consider when comparing older WAC IOs tomore recent levered IOs. Traditional default analysis of CMBS IOs usuallyignores the impact of aging collateral. Default rates are often applied to transac-tions in the same manner, whether the deal is newly issued or has seasoned for afew years. We believe using an age-adjusted default curve that accounts for col-lateral seasoning is a more accurate method of analyzing IOs.

Since defaults tend to be fairly low within the first couple of years after loanorigination, the results of an IO analysis may look quite different, depending onwhether the default curve is applied to a transaction beginning in year 1 or inyear 4 or 5.

Examining IOs with an age-adjusted default curve reveals that there is a pricingdiscrepancy between recently issued levered IOs and some seasoned WAC IOs.

In our analysis, we use the commercial mortgage default curve developed bySnyderman (1991) and later updated by Esaki (2001). The default curve reflectsthe average default experience of life insurance company mortgages that wereoriginated between 1972 and 2000. In the commercial mortgage default study, thepeak years for loan defaults occurred within 3 to 7 years after loan origination.

In Esaki’s study, all points on the default curve are expressed as percentages oforiginal loan balances. In order to run scenarios in TreppAnalytics, we convert-ed these default rates into numbers that mimic constant default rates (CDRs).


CMBS IOs

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DEFAULT CURVEBASED ON ESAKI

COMMERCIALMORTGAGE

DEFAULT STUDY

exhibit 6

APPLYING TTHE DDEFAULT CCURVEUnder a base case pricing scenario (no defaults, 100CPY, yield to call), we seethat there are several 1999 WAC IOs that are currently trading in the low-to-mid300 bp range over Treasuries.

If we perform a default analysis on the WAC IOs, using the default curve inExhibit 6 and assuming no seasoning of the collateral, the bonds lose about 80-100 bp of yield. Although the loans in these CMBS deals have seasoned for aminimum of 3 years, we applied the default curve beginning in year 1.


Base Case Apply Default Change

Pricing Scenario Curve, Beginning in Spread

Deal Name Class CUSIP (Spread to UST) with Year 1 (bp)

BSCMS 1999-C1 X 07383FBB3 300 191 -109

CCMSC 1999-2 X 161505DL3 300 218 -82

JPMC 1999-C7 X 617059FC9 270 189 -81

LBCMT 1999-C2 X 501773DN2 300 208 -92

MSC 1999-WF1 X 61745MKW2 300 189 -111

NLFC 1999-1 X 63859CBT9 330 229 -101

NLFC 1999-2 X 63859CDR1 300 251 -49

PNCMA 1999-CM1 S 69348HAA6 375 289 -86

PSSF 1999-C2 AEC1 74436JFH5 300 213 -87

Total/Simple Avg 308 220 -89

1999 WAC IO ANALYSIS: APPLY DEFAULT CURVEBEGINNING WITH YEAR 1 DEFAULT RATE

exhibit 8


exhibit 7

Base Case Pricing after Change

Pricing Scenario Defaults in Spread

Analysis (Spread to UST) (Spread to UST) (bp)

1999 WAC IO- Apply Default 308 220 -89

Curve, Beginning with Year 1

2002 Levered IO- Apply Default 409 214 -195


1999 WAC IO- Apply Default 308 112 -196



AVERAGE RESULTS OF DEFAULT ANALYSIS


CMBS IOs

86

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Base case pricing on select levered IOs, issued in 2002, is in the low-to-mid 400bp range over Treasuries. If we apply the same default curve to 2002 leveredIOs, the bonds experience a yield loss of about 200 bp.

Based on these analyses, the extra 100 bp of spread on the levered IO in the basecase pricing scenario appears warranted, since levered IOs lose about 100 bpmore of yield when subjected to defaults.

Applying an aged default curve to the 1999 transactions, however, leads us to a different conclusion.

We adjusted the default curve for seasoning and applied it beginning in year 4 forthe 1999 WAC IOs. For each IO, we applied an immediate default rate of 2%,followed by defaults of 2.2%, 2.4%, 3.1%, etc., in each of the following years.

On average, the bonds lost about 200 bp of yield. (These same bonds only lostabout 89 bp of yield in the traditional default analysis, which did not account forcollateral seasoning.) The 2002 levered IOs also lost about 200 bp of yield whensubjected to defaults (starting in year 1). Based on this analysis, both vintagesshould actually be trading at similar spreads to Treasuries.

Base Case Apply Default Change in

Pricing Scenario Curve, Beginning Spread from

Deal Name Class CUSIP (Spread to UST) with Year 1 Base Case (bp)

BACM 2002-2 XC* 05947UHT8 400 209 -191

BSCMS 2002-PBW1 X1* 07383FMR6 420 208 -212

CSFB 2002-CKN2 AX* 22540VV33 400 220 -180

GECMC 2002-1A X1* 36158YER6 400 210 -190

GMACC 2002-C2 X1* 361849UW0 400 221 -179

JPMCC 2002-CIB4 X1* 46625MKQ1 400 222 -178

LBUBS 2002-C2 XCL* 52108HKY9 390 207 -183

MSDWC 2002-HQ X1* 61746WNB2 400 213 -187

MSDWC 2002-TOP7 X1* 61746WPJ3 450 228 -222

WBCMT 2002-C2 IO1* 929766BY8 425 200 -225


2002 LEVERED IO ANALYSIS: APPLY DEFAULT CURVEBEGINNING WITH YEAR 1 DEFAULT RATE

exhibit 9


OTHER FFACTORS TTO CCONSIDERFrom the analysis presented above, levered IOs appear to offer value relative toolder WAC IOs. However, we have examined age-adjusted defaults without con-sideration for other factors, which could help explain why the older WAC IOstrade at tighter spreads.

While we have taken into account the effects of seasoning on expected defaultrates, we have not considered possible differences between the vintages, such asthe quality of the underlying collateral, call protection, underwriting standardsand investor comfort with real estate valuations/fundamentals in particular years.


Base Case Apply Default Change in

Pricing Scenario Curve, Beginning Spread from

Deal Name Class CUSIP (Spread to UST) with Year 4 Base Case (bp)

BSCMS 1999-C1 X 07383FBB3 300 95 -205

CCMSC 1999-2 X 161505DL3 300 115 -185

JPMC 1999-C7 X 617059FC9 270 74 -196

LBCMT 1999-C2 X 501773DN2 300 100 -200

MSC 1999-WF1 X 61745MKW2 300 66 -234

NLFC 1999-1 X 63859CBT9 330 118 -212

NLFC 1999-2 X 63859CDR1 300 167 -133

PNCMA 1999-CM1 S 69348HAA6 375 167 -208

PSSF 1999-C2 AEC1 74436JFH5 300 105 -195


1999 WAC IO ANALYSIS: APPLY AGE-ADJUSTED DEFAULTCURVE BEGINNING WITH YEAR 4 DEFAULT RATE

exhibit 10



CMBS IOs

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PAC IO Primer: E v. JAlthough PAC IO spreads are currently quoted to the J-curve, traders are increas-ingly examining these bonds to the E-curve. In this piece, we discuss the charac-teristics of “J” and “E”, and why the E-curve makes sense for PAC IO pricing.

WHAT IIS JJ1, AAND WWHY IISN’T IIT IIDEAL FFOR PPAC IIOS?The J-spread is defined as the difference between a bond’s yield and the interpo-lated Treasury rate that corresponds to the bond’s average life. By definition, aninterest only strip does not have any principal cash flows. Therefore, the averagelife of a PAC IO is actually the average life of the underlying securities fromwhich the IO is stripped.

Although the average life of a bond that pays principal is a fair proxy of wherethe bond’s average interest rate risk lies, the average life of a PAC IO does notdescribe the bond’s average interest rate risk. As a result, the average life of thePAC IO can vary considerably from its duration. For example, a PAC IO mayhave an average life of four years, while its duration may be closer to two years.

Since the duration of a PAC IO is often much shorter than its average life, it issomewhat arbitrary to compare a PAC IO yield to its average life point on theTreasury curve, which has considerably more interest rate risk.

The current steepness of the front end of the Treasury curve is another reasonwhy the J-curve is not an ideal pricing benchmark for PAC IOs. Currently, thereis a 137 bp slope between the 2-year and 5-year Treasury rates. Since the curveis this steep, small average life variability between PAC IOs could translate intolarge spread differences to the J-curve. Therefore, relative value between twoPAC IOs may not be readily apparent, since J-spreads can vary significantly withaverage lives.

For example, in a recent bid list, LBUBS 2003-C7 XCP (avg life 4.90 yrs) trad-ed near T+25 bp, while LBUBS 2003-C5 XCP (avg life 4.63 yrs) traded nearT+38 bp. Although the LBUBS 2003-C5 PAC IO traded 13 bp wider than theLBUBS 2003-C7 PAC IO, does this mean that the 2003-C5 PAC IO offers signifi-cantly better value? Pricing these bonds to the E-curve will answer this question.

WHAT IIS EE, AAND WWHY IIT MMAKES SSENSEThe front end of the swap curve is constructed with eurodollar futures contracts,which are future contracts on 3-month LIBOR. When a PAC IO is priced withthe E-curve, each bond cash flow is discounted by the E-spread plus the rate onthe eurodollar futures curve that corresponds to the timing of that cash flow.Unlike the J-spread, which is a spread over the bond’s average life point on theTreasury curve, the E-spread is a single constant spread that is added to each rele-vant point on the Eurodollar futures curve. This method of pricing the PAC IO ismore appropriate than discounting all cash flows with a single rate at an averagelife point that is somewhat arbitrary when looking at PAC IOs.

1 For more details on the J-curve as a pricing benchmark in CMBS, see the Appendix.

When using the E-curve, even if one PAC IO is slightly longer than another, theE-spreads are still comparable to assess relative value. This is because the dis-count rates for each cash flow on each bond are benchmarked off of the samerates on the eurodollar futures curve. Using the J-curve, however, two bondswith different average lives would be discounted with rates based on differentinterpolated Treasury rates. The J-spreads for each bond, as a result, are difficultto compare.

If we revisit our example of LBUBS 2003-C7 XCP and LBUBS 2003-C5 XCP, wefind that these bonds actually look very similar when compared to the E-curve.The LBUBS 2003-C7 PAC IO prices at E+57 bp, while the LBUBS 2003-C5 PACIO prices at E+55 bp. This example shows that LBUBS 2003-C5 XCP, which hadan extra 13 bp in J-spread over LBUBS 2003-C7 XCP, does not appear to offerbetter value using the E-spread methodology.


Avg Life J-Spread E-Spread

Bond (yr) (bp) (bp)

LBUBS 2003-C7 XCP 4.90 25 57

LBUBS 2003-C5 XCP 4.63 38 55

PAC IOS: E-SPREAD VS J-SPREADexhibit 11



CMBS IOs

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Appendix: More Details on JUntil 2001, secondary desks quoted spreads off the interpolated Treasury curve,otherwise known as the I-curve to Bloomberg users. Since then, they moved tothe convention of quoting CMBS spreads to the interpolated nominal Treasurycurve, or the J-curve. This change is primarily relevant for investors who pricebonds based on the Treasury curve.

Any spread difference between the curves results from assumptions used whileinterpolating points on the Treasury curve. Pricing a 9.5-yr CMBS bond as aspread to Treasuries involves interpolating yields for the on-the-run five- andten-year Treasury notes. The I-curve interpolates between the remaining maturityof the two notes. If both notes were issued three months ago, the interpolationwould involve 4.75 years as the starting point and 9.75 years as the end point. Incontrast, the J-curve ignores any seasoning that may have taken place in eitherissue. Therefore, no matter how long ago the on-the-run notes were issued, theinterpolation is based on the original maturities of five and ten years.

WHAT PPROMPTED TTHE CCHANGE?Although this curve discrepancy has always existed, the issue for CMBS only sur-faced in 2001. This is because of two technical factors present in the Treasurymarket at the time: longer intervals between new issues and a steep yield curve.

• Longer intervals – Given the budget surplus, the Treasury Departmentslowed the issuance of five-year and ten-year notes from monthly to quarter-ly and also increased the frequency of reopenings. As a result, on-the-runnotes could be up to six months shorter than their original maturity, com-pared to one month in earlier periods.

• Steep yield curve – Ten-year notes in 2001 yielded about 50 bp more thanthe five-year notes, about 20 bp more than the historical average since 1980.

For example, consider pricing MSC 1999-LIFE A2, an 8.0-yr CMBS tranche, on5/8/01 at LIBOR+45 bp:

Yield = Swap Rate + LIBOR Spread

UST Spread = Yield – Interpolated UST

The yield of the CMBS is set by the spread to its benchmark, the swap rate of5.85%. Accordingly, the CMBS tranche would yield 6.30%, or 5.85% plus 45 bp.The I-curve results in an interpolated Treasury yield of 5.08% or CMBS spreadat UST + 122 bp. The J-curve, however, results in an interpolated Treasury yieldof 5.05% or CMBS spread at UST + 125 bp, a 3 bp disparity to the I-curve.


I-Curve J-Curve

Maturity (yrs) Yield (%) Maturity (yrs) Yield (%)

Start point (5-yr UST) 4.52 4.74% 5.00 4.74%

End point (10-yr UST) 9.77 5.24% 10.00 5.24%

Interpolated (8-yr UST) 8.00 5.08% 8.00 5.05%

Spread Spread Spread Spread

to LIBOR to UST to LIBOR to UST

CMBS 45 122 45 125

I VS. J SPREAD COMPARISONexhibit 12

Source: Morgan Stanley, Bloomberg

92




Fixed Rate Large Loans

Chapter 7



94

chapter 7

INTRODUCTIONSince the terrorist attacks of September 11, 2001, investors have been apprehen-sive of the concentration risks associated with trophy properties. As a result,fixed rate large loan deals and single asset transactions have virtually disappearedfrom the new issue market place. While short-term large loan deals continue tobe issued today, the new vehicle for securitizing fixed rate large loans hasbecome the “fusion” transaction.

FUSIONLoans with large dollar balances are often mixed with smaller loans in deals thatthe market labels as “fusion.” The definition of “fusion” varies, but for pur-poses of classification, Commercial Mortgage Alert defines a fusion deal as atransaction that has conduit style loans and either has one loan that is morethan 10% of the pool balance or all loans of $50 million or more are at least15% of the deal. Many market participants classify a fusion transaction byexamining the top 10 loan concentration within a deal. The rule of thumb is toclassify the deal as a fusion transaction if the top 10 loans account for at least40% of the collateral.

STAND-AALONE LLARGE LLOANS“Stand-alone large loans” refer to mortgages of $50 million or more on com-mercial properties with an institutional borrower. Stand-alone large loan CMBShave taken the form of single-asset or single-borrower deals or transactionsbacked by a small number of commercial mortgages averaging $50 million ormore. For single asset transactions, the loan size may be as much as $500 million.Stand-alone large loans tend to have lower leverage and more credit-worthy bor-rowers than conduit loans.

Since the September 11th attacks, AAA securities from fixed rate large loantransactions trade about 15 bp to 30 bp wider than AAA tranches from diversi-fied conduit CMBS. At the lower investment grade level, large loan classes arealso trading at wider spreads to similarly rated classes from conduit deals.

HISTORY OOF TTHE FFIXED RRATE LLARGE LLOAN MMARKETThe CMBS market began in the 1980s with the securitization of commercialmortgages on large “trophy” assets. The market evolved in the 1990s to one thatwas dominated by large pools of small- to medium-sized loans. A typical poolmight consist of 200 loans on properties well diversified by geographic regionand property type. Mortgage conduits originate the loans and most range in sizefrom $1 million to $20 million.

As issuers sought to get loans off their books more quickly, deal size decreasedin line with loan accumulation periods. Smaller deal size meant that a large loanmade up a greater percentage of the transaction. In 1998, several CMBS transac-tions exceeded $2 billion. For transactions that large, a $50 million loan is only2.5% of the total balance and the deal does not receive a high concentrationpenalty from the rating agencies. As deal sizes dropped below $1 billion, issuersreceived better prices by issuing separate large loan deals rather than tainting anentire pool with concentration risk.


1As of November 1, 2004 pricing.

Does not include Agency CMBS or resecuritizations.


AVERAGE U.S.DEAL SIZE

exhibit 2

0

200

400

600

800

1000

1200

1Through November 1, 2004.

Source: Morgan Stanley, Commercial Mortgage Alert

U.S. CMBSISSUANCE

exhibit 1



96

chapter 7

CHARACTERISTICS OOF SSTAND-AALONE LLARGE LLOANSCreditTo date, the average stand-alone large loan has had a lower LTV and higherDSCR than the average conduit loan. Although LTVs for stand-alone large loansmay range from 40% to 100%, most fall in the range of 45% to 60%. Conduittransactions typically have weighted average LTVs in the 60% to 75% range.DSCRs for stand-alone large loans are frequently in excess of 1.50x, while forconduits, the weighted average DSCR is generally in the 1.25x to 1.40x range.

Some analysts believe that the reason for the lower leverage and higher debtservice coverage ratios for stand-alone large loans is that prices of large proper-ties are more volatile than for smaller properties. There is very little confirmationof this volatility, aside from anecdotal evidence about the fall in prices of “tro-phy properties” in the early 1990s. That higher priced properties have morevolatile prices makes some intuitive sense, because there is a much smaller baseof buyers than for average or low-priced properties. In the residential homemarket, for example, there is much evidence showing that high value homesboth rise and fall in price much faster than average value homes.

Stand-alone large loans tend to be on properties located in major markets, in con-trast to smaller conduit properties, which are more evenly spread out in both larg-er and smaller metropolitan areas. Location in larger markets has both advantagesand disadvantages. On the positive side, property markets in large markets areprobably more liquid and have more potential buyers than those in small markets.On the other hand, the concentration of properties in large urban centers, forexample, can create volatility in prices should the market suffer a downturn.

Structural FFeaturesLarge commercial loans generally have structural protections that are often not afeature of conduit loans. First, stand-alone large loans have “lock box” featuresthat separate the cash flow of the property from the borrower’s income. Second,the loans are usually placed in a “special purpose entity,” or SPE, which sepa-rates the loan from the other assets of the borrower in the case of bankruptcy.(In a conduit CMBS, the SPE may be less well defined at the borrower level.)Third, a stand-alone large loan often provides for removal of management, or“kick-out,” should the cash flow of the property deteriorate beyond a specifiedtarget level.

These features, while important in insulating investors against potential borrowerproblems, are not a protection against a general deterioration in real estate credit.For example, if a fall in operating income is caused by a regional economicdownturn, the replacement of management probably will not improve the creditrisk of the property.

Credit SStrength oof BBorrowerOffsetting the risks of potentially more volatile asset prices is the better credit of stand-alone large loan borrowers. These borrowers are often rated entities,compared to most conduit lenders, who are not rated. A bankruptcy of a bor-rower leading to default on a mortgage is thus more likely in the case of a con-duit borrower than a stand-alone large loan borrower.


Many of the borrowers in stand-alone large loan transactions are well-capitalizedfirms that have access to other sources of capital. This provides some protectionagainst default in a real estate downturn. Given the lower LTVs on most stand-alone large loans, the borrower’s equity stake is typically larger than for conduitsand may in some cases reach over $100 million.

According to a Moody’s study of corporate defaults between 1970 and 1997, lessthan 5% of investment grade corporations defaulted within 10 years. The defaultrate is 20% for companies in the Ba category, and almost 50% for firms rated inthe single-B category. It should be noted, however, that the default of a borrowerdoes not necessarily mean a default or loss on a mortgage made by the borrower.The CMBS is secured by the property, not the credit of the borrower. As long asthe value of the property is greater than the mortgage, or the cash flow greaterthan the debt payments, the borrower is unlikely to default on the mortgage.

Prepayment PProtectionStand-alone large loans and conduit loans have very similar prepayment protec-tion. Most currently have defeasance provisions. Earlier transactions had lockoutor yield maintenance periods followed by penalty points. For more details ontypes of call protections, see the “Call Protection” chapter in this book.

Information AAvailabilityIn 1999, it was often difficult to obtain individual property cash flow and DSCRdata after issuance. The situation has improved since 1999 and stand-alone trans-actions are now closely monitored after closing. Depending on the terms of theborrower’s loan agreement, the following documents are available to investors ona quarterly and/or annual basis from the servicer: property operating statements,rent rolls, sales reports for retail properties and property inspections.

EMPIRICAL SSTUDIESTwo recent studies addressed the relative risk of large loans. A default study byEsaki, L’Heureux, and Snyderman (1999)1 found that default rates for smallloans at insurance companies over the period 1973 to 1997 were slightly lessthan for large loans. The study, however, only had four categories of loans, ofwhich the largest size was “over $8 million.”

Another study published in April 1999 by Ziering and McIntosh2 examined therisk-return profiles of properties by size. The study also looked at properties infour categories, but the categories ranged from “less than $20 million” to “over$100 million.” Over the period 1981 through 1998, the authors found that largerproperties generally had higher average returns, but also higher volatility ofreturns. The authors cite the thin market for trophy properties as the reason forhigher volatility.

1 Howard Esaki, Stephen L’Heureux, and Mark Snyderman, “Commercial Mortgage Defaults: An Update,” RealEstate Finance, Spring 1999.

2 Barry Ziering and Willard McIntosh, “Property Size and Risk: Why Bigger Is Not Always Better,” PrudentialReal Estate Investors Research, April 1999.

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RATING AAGENCY AAPPROACH TTO LLARGE LLOANS

In rating single-borrower or single-asset transactions, the largest concern of rat-ing agencies is concentration risk. For example, one agency stated, “The distin-guishing characteristic of [single-asset] transactions is the concentration ofrisk…This is in contrast to pooled transactions, in which the diversification ofproperties and leases mitigates this risk.”3

To adjust for concentration risk, rating agencies have very conservative standardsfor single-borrower and single-asset transactions. For example, to obtain a AAArating, a large office property must have a debt service coverage ratio in therange of 2.30x to 2.75x and an LTV not exceeding 40%.

At the rating agencies, the advantage of diversified small to medium loan poolsis demonstrated in the level of credit support needed to obtain a higher ratinglevel than the collateral on a stand-alone basis. For example, consider a pool ofsmall multifamily properties, all with DSCRs of 1.35x and LTVs of 70%. Such apool would need 20% to 25% of subordination for the AAA class. A large loanwith equivalent characteristics would be shadow-rated BB. In order for a seniorportion of this loan to attain a rating of AAA, we estimate that a subordinationlevel of 35% is required. This subordination level would lower the effective LTVof the senior tranche of the large loan to 46%, which is the standard for astand-alone AAA. The 10% to 15% difference in subordination levels reflectsthe “penalty” for concentration.

In underwriting conduit transactions, rating agencies typically underwrite a sam-ple of loans in the pool. The sample usually is about 30%, and includes most ofthe largest loans. In contrast, a large loan or single-asset transaction will have100% underwriting by the agencies.

In stand-alone large loan deals, full environmental and engineering reports areprovided for each property. This is not the case for all conduit loans. It is notclear if the rating agencies adjust conduit subordination levels upward to adjustfor the uncertainty of less than 100% underwriting.

Based on their underwriting, rating agencies will adjust the cash flow and valua-tion on a property, deriving “adjusted” LTVs and DSCRs. In almost all cases, theLTV is adjusted upward (and NOI downward) from the reported number. Basedon our conversations with the rating agencies, these adjustments are usually inthe range of 10% to 20% for both stand-alone large loans and conduit loans.

DO RRATINGS CCORRECTLY AADJUST FFOR RRISK?Rating agencies universally state that a AAA rating means the same amount ofcredit risk across all types of fixed-income securities. Theoretically, a AAA-ratedcorporate bond should have the same degree of credit risk as a AAA-ratedCMBS. Within the CMBS sector, rating agencies state that they make adjust-ments for collateral quality so that a AAA conduit transaction has the sameamount of risk as a AAA stand-alone large loan deal.

3 The Rating of Commercial Mortgage Backed Securities,” Duff and Phelps, November 1994.



In practice, we believe that there can be substantial differences in risk amongsecurities with the same rating. We have long maintained that rating agencies havemore conservative standards in rating structured securities than corporate bonds.

INVESTOR PPREFERENCESSome CMBS investors prefer diversified pools of loans because they feel they donot have the real estate expertise to evaluate commercial mortgage credit risk ona single property. Some of these investors rely on the rating agencies to analyzedefault risk; others become comfortable with the general underwriting guidelinesof an originator. Investors preferring pool diversity tend to be money managerswith limited experience in underwriting real estate. They tend to view CMBS as afixed-income asset with good call protection, rather than a direct investment inreal estate.

Other investors prefer single-asset transactions, or those backed by only a fewloans, because they can then use their real estate expertise to underwrite eachloan in a CMBS pool. These investors tend to be insurance companies with largeunderwriting staffs. These investors focus more on the real estate aspects ofCMBS investments and often purchase stand-alone large loan CMBS as a com-pliment to their whole loan portfolio.

Because of this split in investor preferences, stand-alone large loan transactionstend to trade differently than diversified conduit pools. Money managers tend toshy away from single asset deals because of the lack of diversification and a per-ceived lack in liquidity. Insurance companies re-underwrite a stand-alone largeloan, and if they are comfortable with the asset, prefer to buy the lower invest-ment grade classes. The yield on the BBB class, for example, most closely match-es the yield on whole loans, the alternative investment for insurers.

Insurance companies purchase about 85% of the mezzanine classes from stand-alone large loan transactions and only 45% from conduit deals. In contrast,money managers buy 50% of the AAA bonds from conduit deals, but only abouta third of the AAA-rated securities from stand-alone large loan transactions.

As a consequence of these preferences, the AAA class from a stand-alone largeloan transaction tends to trade at a wider spread to Treasuries than a conduit deal.The difference has historically been in the range of 5 bp to 10 bp. The BBB classof a stand-alone large loan deal, however, trades at a narrower spread differenceto conduit BBBs and, in some instances, actually trades at a tighter spread than ina diversified pool. If insurers deem an asset as high quality, the small size of theBBB class often results in excess demand at the initial pricing level.


100




BBB CMBS and REITs

Chapter 8

102

chapter 8

BBB CMBS and REIT unsecured corporate bonds are often used as proxies forone another, as both are backed by real estate and have similar ratings. In thischapter, we examine the volatility, ratings history, liquidity, structural differences,the issuer’s perspective, the rating agencies’ perspective and performance of each.

We found that while differences exist among the security types, there is noapparent advantage of one over the other. Since the credit is similar and spreadshave historically converged, we recommend that BBB CMBS investors considerREIT debt as an alternative, particularly when spreads are wider on REIT debt.

We also advise investors who have focused on REIT debt to consider BBB CMBSas an alternative, particularly when CMBS spreads are wider than REIT debt.

SIMILAR VVOLATILITYHistorically, BBB CMBS and REIT paper have traded close to parity, withdivergence resulting in very short-term opportunities. Since the end of 1998,the average spread difference between both has been only one bp. Since webegan tracking the spreads in early 1998, the longest period that the spreaddifferential between BBB CMBS and REITs remained wider than 5 bp wasbetween August 2003 and May 2004. The average difference in spread duringthat period was 17 bp.

The standard deviation of historical BBB CMBS spreads to Treasuries over thepast several years is 22 bp; it is 36 bp for REITs. BBB CMBS stability is simi-lar to that of the BBB Industrial Index and is less volatile than REIT debt(Exhibits 2 and 3).

CHARACTERISTICS OF BBB CMBS AND REIT UNSECURED DEBT

exhibit 1

Source: Intex, Remittance Reports

CMBS REITs

Rating BBB+/BBB/BBB- BBB+/BBB/BBB-

Trading Range Since April 1998 114-325 bp 97-321 bp

Spread Volatility in Standard Deviation (bp) 22 36

Rating Actions in 2004 35 upgrades to 25 downgrades 1 upgrade and 7 downgrades

Market Capitalization $28 billion $58 billion

Bid Ask Spread 2 bp for on-the-run names 2-3 bp for large cap names

Monthly Trading Volume $750 million to $1 billion $1 billion

Leverage 70% LTV at BBB level 40% debt to market cap

Structural Differences Secured by specific properties Corporate debt covenants

Management Inactive management within the trust Active management of portfolio


BBB CMBS and REITs


RATINGS HHISTORYRating AActions BBest ffor BBBB CCMBSThrough September 2004, the upgrade/downgrade ratio for CMBS ratedBBB+/BBB/BBB- has been better than that of REIT paper. The rating agen-cies have changed their ratings on 372 BBB+/BBB/BBB- CMBS tranches sinceJanuary, with 311 upgrades and 61 downgrades. The 2004 ratio of 5.1 upgradesto 1 downgrade is a better record than the 3.3 to 1 ratio for all credit classeswithin CMBS for the same period.

Appendix A at the end of this report details all rating actions for CMBS ratedBBB+/BBB/BBB- in 2004.

1Through November 9, 2004.


BBB CMBS VS.REITS TO UST(APRIL 1998 -

NOVEMBER20041)

exhibit 2

SPREAD VOLATILITY: APRIL 1998-NOVEMBER 2004exhibit 3

Source: Morgan Stanley, Bloomberg

BBBBBB CMBS REITS Industrials

Mean (bp) 116 133 104

Standard Deviation (bp) 22 36 22


BBB CMBS and REITs

104

chapter 8

Throughout the first 10 months of 2004, REITs experienced a 1 to 1upgrade/downgrade ratio. Both CMBS and REITs have had a better ratingsrecord in 2004 than corporate bonds which experienced a 0.9 to 1 upgrade/downgrade ratio.

LIQUIDITY

Liquidity FFairly EEven ffor RREITs && BBBB CCMBSMarket capitalization, trading volume, deal size and bid-ask spread all con-tribute to liquidity within a sector. REIT paper has a market capitalization ofabout $58 billion.

The market capitalization of CMBS rated BBB is less than half that of REITpaper, with about $28 billion currently outstanding. On average, BBB bondsaccount for 4% of U.S. issuance volume. We anticipate that $3 billion of BBBCMBS was issued in 2004.

2004 YTD RATING CHANGES1 FOR REITSexhibit 4

1Based on Moody’s data only through October.Source: Moody’s

Company From To

Brandywine Realty Trust [P]Ba3 [P]Ba2

Crescent Real Estate Equities Ba3 B1

Equity Office Properties Baa1 Baa2

Glimcher Realty Trust Ba3 B1

iStar Financial, Inc Ba1 Baa3

National Health Investors B1 Ba3

Omega Healthcare B2 B1

Prime Property Funding II, Inc. A2 A3

Sun Communities Baa3 Ba1

United Dominion Realty Trust Baa3 Baa2

2004 RATING ACTIONSexhibit 5

1Based on Moody’s data only.Source: Moody’s

BBB+/BBB/BBB- CMBS REITs1

2004

Upgrade 311 5

Downgrade 61 5


Several factors reduce liquidity for both CMBS and REIT debt. For instance,the class sizes of BBB CMBS tranches have been shrinking over time, reducingliquidity. Additionally, structured vehicles (CDOs) have been big buyers of BBBCMBS and REIT paper. Recently insurance companies have been significantbuyers of BBB CMBS. Both CDOs and insurance companies tend to buy andhold rather than trade for total return, reducing the amount of paper traded.

We anticipate that the street trades about $750 million to $1 billion of BBBCMBS paper on a monthly basis. The inclusion of BBB CMBS as ERISA eligi-ble securities contributed slightly to liquidity.

Liquidity in a particular name may vary depending on the seasoning and delin-quencies within a transaction. Large blocks of on-the-run BBB CMBS with fewor no delinquencies trade with bid-ask spread of 2 bp or less.

Although the market capitalization is greater for REIT paper, REIT trading vol-ume is similar to CMBS. On average, the street trades about $1 billion of REITpaper per month, with heavier trading over the last several months. The mostliquid names are those with the most debt outstanding.

The more-liquid REIT names (EOP, SPG) trade with a 2-3 bp bid-ask spread inon-the-run maturities. The remaining names in the universe are less liquid andtypically trade with a 10 bp bid-ask spread.

CDO MMarket EEffectThe CDO market has had a significant impact on BBB CMBS and REIT debt.On the positive side, the CDO bid keeps spreads in check. Liquidity, however,may be limited by the buy-and-hold nature of CDOs.

About 7% of REIT unsecured debt has been put into various CDO deals, effec-tively removing about $3.8 billion from REIT unsecured debt secondary trading.

Nevertheless, we do not consider the 7% of outstanding REIT debt locked up inCDOs to be significant, despite the recent focus of CDOs on this sector. At thepeak of the CDO bid in the high yield market, many market participants noted25-30% of high yield new issue flows into CDOs. In the credit derivatives mar-kets today, flows from synthetic CDOs account for a similar percentage of thatmarket, as well.

The amount of BBB CMBS within CDOs is more significant than for REITdebt. We estimate that about $5.5 billion BBB CMBS, which is about 18% ofthe market, is contained in real estate CDOs.

STRUCTURAL DDIFFERENCES

REIT paper and CMBS have very similar credit characteristics in that both arebacked by payments generated by commercial real estate. However, significantdifferences arise in the structures of both credits.

Both CMBS and REIT paper benefit from the inherent diversity within a portfo-lio of properties. However, diversification within CMBS conduit transactions isgreater than within REIT paper. Conduit CMBS transactions are made up of100-200 smaller commercial loans providing diversity in terms of geography,borrowers and property types. Typically, REIT management teams have expert-

ise in one property type that may be concentrated in several regions rather thandiversified across the country.

However, the balance sheets and credit characteristics of REITs are usually signif-icantly stronger than the credit of borrowers within CMBS conduit transactions.In CMBS, a default on one asset within a conduit has little or no impact on pric-ing and liquidity. There has never been a default on REIT unsecured paper.

THE IISSUER’S PPERSPECTIVEAlthough REIT debt often trades close to parity with BBB CMBS, REITs asissuers of either secured or unsecured financing take into account the overallcost of capital for the transactions, as well as the flexibility of the debt relativeto their portfolios.

Most REITs choose to issue CMBS in the form of large loan transactions.Currently, approximately $12 billion of CMBS outstanding has been issued byREITs (Appendix B). Typically, these transactions contain about 65% AAAbonds, 11% AA bonds, 10% A bonds, 10% BBB bonds and 4% BBB- bonds.

While the actual cost of funding is lower for a large loan REIT CMBS transac-tion than for unsecured REIT debt, issuers give up some financial flexibilitybecause securitization requires mandatory capex reserves and limits refinancingand the sale or substitution of the assets. Large loan CMBS may have specificcovenants that require minimum debt service coverage ratios, lock boxes forcash flows and specific insurance coverage.

Lastly, issuing CMBS requires a rather long lead-time for marketing and sale ofthe transaction, while unsecured debt deals may be completed virtuallyovernight. Documentation is much simpler and execution is much quicker in theunsecured debt market.

RATING AAGENCY PPERSPECTIVESUnsecured RREIT DDebtRating agencies consider a number of factors when it comes to rating unsecuredREIT debt. These factors include depth of management and experience, qualityof property, geographic and tenant diversification, stability of cash flows, prof-itability and financial flexibility. As Moody’s stated in its September 2000 SpecialComment report, The Qualitative Factors - It’s Not All in the Numbers, “Financialratios, although not the dominant element in Moody’s rating process, are a criti-cal part of our rating methodology.” As none of the rating agencies will discloseaverage ratios per category, we reviewed all the companies we cover and attempt-ed to break out the ratios for each rating class.

With the many outliers, we found it difficult to discern specific ratios, as thisvaries for different sectors, with retail clearly exhibiting the most aggressivefinancial fundamentals. Generically, debt to gross real estate is in the low 40%range for high BBBs, in the mid-to-high 40% range for mid-BBBs and in thelow-to-mid 50% range for low-BBBs. Typically high BBBs have a fixed chargecoverage of over 2.5x, with mid BBBs and low BBBs slightly lower than that.Again, there are many outliers; our review serves to demonstrate that looking atthe financial fundamentals alone is only one piece of the rating process. Higherratings equate to greater availability on bank lines. Many high BBBs were not


BBB CMBS and REITs

106

chapter 8

reliant on their bank lines, while many low BBBs had drawn down significantlyon their bank lines.

Please see Appendix C for a breakdown of the rating agencies’ analyses of REITs.

CMBS DDebtBefore each CMBS is issued, the rating agencies review the collateral in thetransaction and determine the tranche ratings and pool sizing. The rating agen-cies apply published standards to loans pooled into a CMBS and adjust the resultby making qualitative assessments. Almost all CMBS carry at least two ratings,and many have three. Different rating agencies assign different levels of creditsupport to obtain a given rating level. During the process, the agencies reviewthe property level cash flows, perform physical inspections and run variousstress analyses on the underlying cash flows in order to simulate a worst-caserecession scenario.

When a conduit deal comes to market, the rating agency performs due diligenceon a subset of the properties (typically between 35% and 75%). The larger loansin the deal are always underwritten, while the remaining properties are chosensuch that they provide a representative cross-section of the deal. To determinecredit enhancement levels, the underwritten cash flow (UCF) produced by eachproperty is then assigned a “haircut” based on various subjective parameters.Exhibit 6 details a list of parameters that rating agencies consider when evaluat-ing a CMBS conduit.

The parameters are similar to those considered for a non-conduit deal except foradjustments for loan diversification.


CMBS EVALUATION PARAMETERSexhibit 6


Loan Specific Deal Specific

Property type Number of loans in the deal

Loan-to-value ratio Loan size

Debt service coverage ratio Degree of subordination

Fixed/floating rate Balloon extension risk

Loan seasoning Quality of master servicer and special servicer

Direct versus correspondent lending Real estate outlook


BBB CMBS and REITs

108

chapter 8

Loans collateralized by different property types are generally ranked in the fol-lowing order (best to worst): regional malls, multifamily, anchored communityretail, industrial, office and hotel. These rankings are based on historical defaultsand cash flow volatility of the different property types.

Rating agencies review the dispersion of DSC and LTV in the entire deal; that is,having all loans with a DSC of 1.5x is better than having 50% of the loans at1.0x and the remainder at 2.0x.

Given the volatility of short-term interest rates, an adjustable-rate loan is under-written using an interest rate scenario that is substantially higher than currentrates. Loans without a track record of consistent payments are also rated moreconservatively than those seasoned at least five years.

Lower LLeverage aand BBetter BBorrower CCredit iin RREITsTypically, conduit CMBS transactions have a 75% loan to value (LTV) ratio, andBBB bonds have subordination levels averaging about 5%, translating to a 70%LTV for the BBB classes.

Large loan transactions have lower leverage, with LTV ratios ranging between55-65%. Usually the BBB tranches within these transactions are the lowest-ratedclasses with minimal subordination.

REITs have debt to market capitalization ratios that average 41% and debt to grossreal estate ratios of about 49%, below the leverage within CMBS transactions.

Most REIT debt covenants require maintenance of a 60% debt to assets ratiobased on the book value without depreciation. Additionally, typically no morethan 40% of a REIT’s assets can be encumbered by secured financing. REITshave several avenues for financing, including lines of credit, unsecured corporatedebt, secured financing, selling properties and joint ventures. Most borrowerswithin conduit transactions only have access to capital via secured financing.

ATTRIBUTES OF REITS RELATIVE TO CMBSexhibit 7


Positives Negatives

Active Management May be more geographically concentrated

Better Disclosure Must pay out 90% of earnings subject to refinancing risk

Covenants Backed by corporate guarantee, as opposed to explicitly secured by assets

Lower Leverage Corporate entities subject to event risk

PERFORMANCE2004 CCMBS PPerformanceThrough October, CMBS has outperformed both corporate bonds and treasur-ies. Within CMBS, BBBs have produced the best performance. According tothe MSCI CMBS Index, investment grade CMBS produced a 4.24% totalreturn through October, and BBBs produced a total return of 6.02% duringthe same period.

Based on October data, delinquencies on deals with more than one year ofseasoning also remain low at 1.79% of current balances. When we examinedcumulative loss data through September 2004, we find the 1995 vintage hadthe highest loss rate (1.05%), well below the 5% average credit enhancementon BBB CMBS.

Since new issue CMBS have about 5% subordination to the BBB class, there issignificant cushion for current levels of delinquencies.



BBB CMBS and REITs

110

chapter 8

2004 RATING ACTIONS THROUGH SEPTEMBER 30, 2004

appendix A

Source: Fitch, Moody’s and S&P

1211 Avenue of the Americas Trust, 2000-C7 D BBB Upgrade BBB+ 4/7/2004

1211 Avenue of the Americas Trust, 2000-C7 E BBB- Upgrade BBB 4/7/2004

1251 Avenue of the Americas Trust, 1999-XL 1251 E BBB Upgrade BBB+ 5/26/2004

277 Park Avenue Finance Corp, 1997-C1 B-2 BBB+ Upgrade A 6/9/2004

Aetna Commercial Mortgage Trust, 1997-ALIC H BBB Upgrade A 3/18/2004

American Southwest Financial Securities Corp, 1995-C1 B-3 BBB Upgrade A 2/3/2004

AMRESCO Commercial Mortgage Funding I Corp, 1997-C1 E BBB+ Upgrade A 2/3/2004

AMRESCO Commercial Mortgage Funding I Corp, 1997-C1 F BBB Upgrade A- 2/3/2004

Annapolis Mall Mortgage Trust 2000-C1B B-4 BBB+ Upgrade A- 7/29/2004

Artesia Mortgage CMBS, 1998-C1 E BBB Upgrade BBB+ 6/15/2004

Asset Securitization Corp, 1995-A5 A-5 BBB Upgrade AA 8/25/2004

Asset Securitization Corp, 1995-MD4 A-4 BBB+ Upgrade AAA 2/10/2004

Asset Securitization Corp, 1995-Md4 A-5 BBB Upgrade AA 8/25/2004

Asset Securitization Corp, 1996-D3 A-4 BBB Upgrade A- 3/25/2004

Asset Securitization Corp, 1996-MD6

Asset Securitization Corp, 1997-D4 A-6 BBB+ Upgrade A+ 3/24/2004

Asset Securitization Corp, 1997-D4 A-7 BBB Upgrade A 3/24/2004

Asset Securitization Corp, 1997-D4 A-8 BBB- Upgrade BBB+ 3/24/2004

Asset Securitization Corp, 1997-D5



Banc of America Large Loan, 2001-7WTC

Banc of America Large Loan, 2001-7WTC

Banc of America Large Loan, 2001-7WTC G BBB+ Downgrade B+ 4/8/2004

Banc of America Large Loan, 2001-7WTC H BBB Downgrade B 4/8/2004

Banc of America Commercial Mortgage Inc., Series 2000-2



Banc of America Commercial Mortgage, 2001-PB1



Banc of America Large Loan, 2002-FLT1





Banc of America Structured Notes, 2002-1 A BBB- Upgrade BBB+ 1/8/2004

Banc One/FCCC Commercial Mortgage Loan Trust, 2000-C1

Banc One/FCCC Commercial Mortgage Loan Trust, 2000-C1

Bear Stearns Commercial Mortgage Securities, 2000-WF1 E BBB Upgrade BBB+ 6/30/2004

Bear Stearns Commercial Mortgage Securities, 2000-WF1 F BBB- Upgrade BBB 6/30/2004

Chase Commercial Mortgage Securities Corp, 1996-1

Chase Commercial Mortgage Securities Corp, 1997-1 E BBB+ Upgrade A+ 6/15/2004

Chase Commercial Mortgage Securities Corp 1998-1

Chase Commercial Mortgage Securities Corp 1998-1

Chase Commercial Mortgage Securities Corp, 1998-2 D BBB Upgrade BBB+ 4/13/2004

Chase Commercial Mortgage Securities Corp, 1998-2

Chase Commercial Mortgage Securities Corp, 2000-2 E BBB Upgrade BBB+ 4/13/2004

Chase Commercial Mortgage Securities Corp, 2001-245 Park Avenue F BBB- Downgrade BB+ 6/16/2004

Commercial Mortgage Asset Trust, 1999-C2


COMM 1999-1 E BBB Upgrade BBB+ 4/27/2004

COMM 2000-FL3 K-SR BBB Downgrade B 4/2/2004

COMM 2000-FL3 L-SR BBB- Downgrade B- 4/2/2004

COMM 2001-FL4

COMM 2001-FL4

COMM 2001-FL5 G BB Downgrade B+ 9/30/2004

COMM 2001-FL5

COMM 2001-FL5

COMM 2002-FL6 K-JP BBB Downgrade BBB- 6/10/2004

COMM 2002-FL6 M-JP BBB- Downgrade BB+ 6/10/2004

COMM 2002-FL6

COMM 2002-FL6

COMM 2002-FL6

COMM 2002-FL6

COMM 2002-FL7

COMM 2002-FL7

COMM 2002-FL7

COMM 2002-FL7

COMM 2002-FL7

COMM 2002-FL7 M-GR BBB- Upgrade BBB 5/27/2004

COMM 2002-FL7

COMM 2002-FL7

Commercial Capital Access One, Series 2 D BBB Upgrade A- 10/5/2004

Fitch

Old Current Date ofCMBS Transactions Class Rating Action Rating Rating Action


E Baa2 Upgrade A3 5/28/2004

F BBB Upgrade AA+ 7/19/2004

A-6 BBB Upgrade AA 1/12/2004

A-8Z BBB- Upgrade A- 7/9/2004

A-2 Baa3 Upgrade Aa3 7/20/2004 A_2 BBB Upgrade AA- 7/9/2004

A-3 BBB- Upgrade A- 7/9/2004

E Baa2 Downgrade Ba2 2/3/2004

F Baa3 Downgrade Ba3 2/3/2004

F BBB+ Upgrade A- 10/8/2004

G BBB Upgrade BBB+ 10/8/2004

H BBB- Upgrade BBB 10/8/2004

G BBB+ Upgrade A- 7/2/2004

H BBB Upgrade BBB+ 7/2/2004

J BBB- Upgrade BBB 7/2/2004

F Baa1 Upgrade A1 2/10/2004

G Baa2 Upgrade A2 2/10/2004

J-OM BBB+ Upgrade AA 3/25/2004

K-OM BBB Upgrade AA- 3/25/2004

L-OM BBB- Upgrade A+ 3/25/2004

E BBB+ Upgrade AAA 9/28/2004

F BBB Upgrade AAA 9/28/2004

E BBB+ Upgrade AA- 5/14/2004

E BBB+ Upgrade A 10/19/2004

D Baa2 Upgrade Aa3 9/7/2004 D BBB Upgrade A 10/7/2004

E Baa3 Upgrade A1 9/7/2004 E BBB- Upgrade A- 10/7/2004

D BBB Upgrade A- 9/27/2004

E BBB- Upgrade BBB+ 9/27/2004

E BBB Upgrade AA-

F BBB- Upgrade A

K-CH Baa1 Downgrade Ba1 10/20/2004

M-CH Baa3 Downgrade Ba3 10/20/2004

G BBB Downgrade B- 9/22/2004

K-CP Baa2 Downgrade Baa3 3/24/2004

L-CP Baa2 Downgrade Baa3 3/24/2004

K-WP BBB+ Upgrade A- 6/28/2004

L-WP BBB Upgrade BBB+ 6/28/2004

M-WP BBB- Upgrade BBB 6/28/2004

L-DC BBB Upgrade A 6/28/2004

M-DC BBB- Upgrade A- 6/28/2004

K-CS Baa1 Downgrade Baa3 1/23/2004

K-RP Baa1 Downgrade Baa2 1/23/2004 K-GR BBB+ Upgrade A 6/2/2004

L-CS Baa1 Downgrade Baa3 1/23/2004 L-GR BBB Upgrade A- 6/2/2004

L-RP Baa2 Downgrade Baa3 1/23/2004 L-NM BBB Upgrade BBB+ 6/2/2004

M-CS Baa2 Downgrade Ba1 1/23/2004 M-NM BBB- Upgrade BBB 6/2/2004

M-RP Baa3 Downgrade Ba1 1/23/2004 M-GR BBB- Upgrade BBB+ 6/2/2004

N-CS Baa3 Downgrade Ba1 1/23/2004

O-CS Baa3 Downgrade Ba2 1/23/2004

Moody’s S&P

Old Current Date of Old Current Date ofClass Rating Action Rating Rating Action Class Rating Action Rating Rating Action


BBB CMBS and REITs

112

chapter 8

2004 RATING ACTIONS THROUGH SEPTEMBER 30, 2004 (CONTINUED)

appendix A


Commercial Mortgage Acceptance Corp, 1996-C1 G BBB Upgrade A 3/18/2004

Commercial Mortgage Acceptance Corp, 1996-C2 F BBB+ Upgrade AAA 3/15/2004

Commercial Mortgage Acceptance Corp, 1998-C1


Commercial Mortgage Acceptance Corp, 1998-C2 D BBB+ Upgrade A+ 5/18/2004

Commercial Mortgage Acceptance Corp, 1998-C2 E BBB- Upgrade A- 5/18/2004




Commercial Mortgage Acceptance Corp, 1999-C1 E BBB+ Upgrade A 7/27/2004

Commercial Mortgage Acceptance Corp, 1999-C1 F BBB Upgrade A- 7/27/2004



Commercial Mortgage Asset Trust, 1999-C2 E BBB Upgrade A+ 5/24/2004

Commercial Mortgage Asset Trust, 1999-C2 F BBB- Upgrade A- 5/24/2004

Credit Suisse First Boston Mortgage Securities Corp, 1997-C1 D BBB+ Upgrade A- 5/5/2004

Credit Suisse First Boston Mortgage Securities Corp, 1997-C2 D BBB+ Upgrade A+ 7/19/2004

Credit Suisse First Boston Mortgage Securities Corp, 1998-C2 D BBB Upgrade A 5/5/2004

Credit Suisse First Boston Mortgage Securities Corp, 1998-C2 E BBB- Upgrade BBB+ 5/5/2004

Credit Suisse First Boston Mortgage Securities Corp, 2001-CF2 E BBB+ Upgrade A- 6/30/2004

Credit Suisse First Boston Mortgage Securities Corp, 2001-CF2 F BBB Upgrade BBB+ 6/30/2004

Credit Suisse First Boston Mortgage Securities Corp, 2001-CF2 G BBB- Upgrade BBB 6/30/2004

Credit Suisse First Boston Mortgage Securities Corp, 2001-CK6



Credit Suisse First Boston Mortgage Securities Corp, 2001-FL1

Credit Suisse First Boston Mortgage Securities Corp, 2001-FL1 H BBB+ Upgrade AAA 3/25/2004

Credit Suisse First Boston Mortgage Securities Corp, 2001-TFL1

Credit Suisse First Boston Mortgage Securities Corp, 2002-CKP1



Credit Suisse First Boston Mortgage Securities Corp, 2002-CP3 E BBB+ Upgrade A- 7/27/2004

Credit Suisse First Boston Mortgage Securities Corp, 2002-CP3 F BBB Upgrade BBB+ 7/27/2004






Credit Suisse First Boston Mortgage Securities Corp, 2002-TFL1 F-WBC BBB+ Downgrade BB+ 3/9/2004



Credit Suisse First Boston Mortgage Securities Corp, 2002-TFL1 G-WBC BBB- Downgrade BB- 3/9/2004


Credit Suisse First Boston Mortgage Securities Corp, 2002-TFL1 H-ALH BBB- Downgrade BB+ 3/9/2004

CRIIMI MAE Trust I, 1996-C1 B BBB Upgrade AAA 6/15/2004

CRIIMI MAE Trust I, 1996-C1 C BB+ Upgrade AA 6/15/2004

CRIIMI MAE CMBS Corp, 1998-1




DLJ Mortgage Acceptance Corp, 1996-CF1

DLJ Mortgage Acceptance Corp, 1996-CF2 B-3 BBB- Upgrade BBB+ 3/2/2004

DLJ Mortgage Acceptance Corp, 1997-CF2

DLJ Commercial Mortgage Corp, 1998-CF1 B-1 BBB Upgrade A 5/5/2004

DLJ Commercial Mortgage Corp, 1998-CF1

DLJ Mortgage Acceptance Corp, 1998-CG1 B-1 BBB+ Upgrade A- 9/28/2004

DLJ Commercial Mortgage Corp, 1999-CG2 B-1 BBB Upgrade A 5/18/2004

DLJ Commercial Mortgage Corp, 1999-CG2 B-2 BBB- Upgrade BBB+ 5/18/2004

DLJ Commercial Mortgage Corp, 2000-CKP1 B-1 BBB+ Upgrade A- 6/16/2004

Fashion Valley Mall Mortgage Trust, 2002-C1A

First Union National Bank Commercial Mortgage Trust, 1999-C1

First Union National Bank Commercial Mortgage Trust, 1999-C1

First Union National Bank Commercial Mortgage Trust, 1999 C-4 E BBB Upgrade BBB+ 5/18/2004

First Union National Bank Commercial Mortgage Trust, Series 2001-C4



First Union National Bank-Lehman Brothers Commercial Mortgage Trust, 1997-C1 D BBB Upgrade AA- 2/13/2004

First Union National Bank-Lehman Brothers Commercial Mortgage Trust, 1997-C1 E BBB- Upgrade A 2/13/2004

First Union National Bank-Lehman Brothers Commercial Mortgage Trust,1997-C1

First Union National Bank-Lehman Brothers Commercial Mortgage Trust,1997-C1

First Union National Bank-Lehman Brothers Commercial Mortgage Trust, 1997-C2 D BBB+ Upgrade A- 7/15/2004

First Union National Bank-Chase Manhattan Bank Commercial Mortgage Trust, 1999-1E BBB Upgrade BBB+ 4/27/2004

First Union National Bank-Chase Manhattan Bank Commercial Mortgage Trust, 1999-1F BBB- Upgrade BBB 4/27/2004

GE Capital Commercial Mortgage Corp, 2001-2 E BBB+ Upgrade A 7/20/2004

Fitch



D BBB Upgrade A 5/27/2004


D BBB+ Upgrade A+

E BBB- Upgrade A-


F Baa3 Upgrade Baa2 5/19/2004

G Baa3 Upgrade Baa2 5/19/2004

D Baa2 Upgrade Baa1 7/8/2004

E Baa3 Upgrade Baa2 7/8/2004

D Baa2 Upgrade A3 2/11/2004


F BBB+ Upgrade A- 8/26/2004



D Baa1 Upgrade Aa2 1/9/2004


K-CR BBB- Downgrade D 10/5/2004

F BBB+ Upgrade A 8/27/2004



D Baa2 Upgrade Aaa 10/20/2004

E Baa3 Upgrade Aa2 10/20/2004

D Baa2 Downgrade Ba2 5/11/2004 D BBB Downgrade BBB- 6/7/2004

E Baa3 Downgrade Ba3 5/11/2004 E BBB- Downgrade BB+ 6/7/2004

F-ALH Baa2 Downgrade Ba1 6/7/2004 F-ALH BBB Downgrade BBB- 9/3/2004

F-POR Baa1 Downgrade Baa3 6/7/2004

G-ALH BBB- Downgrade BB+ 9/3/2004

G-WBC Baa2 Downgrade Ba2 6/7/2004

G-POR Baa3 Downgrade Ba2 6/7/2004

H-WBC Baa3 Downgrade Ba3 6/7/2004

B BBB+ Upgrade AAA 8/27/2004

C BBB Upgrade AAA 8/27/2004

B BBB+ Upgrade AAA 9/22/2004




B-2 BBB+ Upgrade AAA 8/25/2004

B-2TB BBB- Upgrade BBB 1/30/2004

B-1 BBB Upgrade A 7/12/2004

B-2 BBB- Upgrade BBB+ 7/12/2004

B-5 Baa1 Upgrade A2 5/11/2004

D BBB Upgrade BBB+ 4/16/2004

E BBB- Upgrade BBB 4/16/2004

G BBB+ Upgrade A 9/2/2004

H BBB Upgrade A- 9/2/2004

J BBB- Upgrade BBB+ 9/2/2004





Moody’s S&P



BBB CMBS and REITs

114

chapter 8


appendix A


GE Capital Commercial Mortgage Corp, 2001-2 F BBB Upgrade BBB+ 7/20/2004

GE Capital Commercial Mortgage Corp, 2001-2 G BBB- Upgrade BBB 7/20/2004

GGP Mall Properties Trust, 2001-GGP1 D-2 BBB Upgrade BBB+ 3/30/2004

GGP Mall Properties Trust, 2001-GGP1 D-3 BBB Upgrade BBB+ 3/30/2004

GGP Mall Properties Trust, 2001-GGP1

GGP Mall Properties Trust, 2001-GGP1

GMAC Commercial Mortgage Securities, 1997-C1 E BBB Upgrade A 2/18/2004

GMAC Commercial Mortgage Securities, 1997-C1 F BBB- Upgrade BBB+ 2/18/2004

GMAC Commercial Mortgage Securities, 1998-C2


GMAC Commercial Mortgage Securities, 1999-C1 D BBB+ Upgrade A 5/18/2004

GMAC Commercial Mortgage Securities, 1999-C1 E BBB Upgrade A- 5/18/2004



GMAC Commercial Mortgage Securities, 1999-C3 E BBB Upgrade BBB+ 5/24/2004



GMAC Commercial Mortgage Securities, 2000-FL1


GMAC Commercial Mortgage Securities, 2000-Fl-F D BBB Upgrade AA 2/25/2004

GMAC Commercial Mortgage Securities, 2000-Fl-F E BBB- Upgrade A 2/25/2004



GMAC Commercial Mortgage Securities, 2001-FLA

GMAC Commercial Mortgage Securities, 2001-FLA

GS Mortgage Securities Corp II, 1997-GLl F BBB+ Upgrade A 2/4/2004

GS Mortgage Securities Corp II, 1997-GLl G BBB Upgrade BBB+ 2/4/2004

GS Mortgage Securities Corp II, 2001-GLIII





GS Mortgage Securities Corp II, 2002-GSFL V

Heller Financial Mortgage Asset Corp, 1999-Ph1 F BBB Upgrade A 6/17/2004

Heller Financial Mortgage Asset Corp, 1999-Ph1 G BBB- Upgrade A- 6/17/2004

iStar Asset Receivables (Stars) Trust, 2002-1



iStar Asset Receivables (Stars) Trust, 2002-1 L BBB+ Upgrade A- 10/27/2004

iStar Asset Receivables (Stars) Trust, 2002-1 M BBB- Upgrade BBB 10/27/2004

JP Morgan Commercial Mortgage Finance Corp, 1997-C4 F BBB+ Upgrade A 10/26/2004

JP Morgan Commercial Mortgage Finance Corp, 1997-C5

JP Morgan Commercial Mortgage Finance Corp, 1997-C5

JP Morgan Commercial Mortgage Finance Corp, 1999-PLS1 D BBB+ Upgrade AA- 2/25/2004

JP Morgan Commercial Mortgage Finance Corp, 2000-Fl1 D BBB+ Upgrade A- 2/10/2004

JP Morgan Commercial Mortgage Finance Corp, 2000-Fl1 E BBB Upgrade AAA 3/17/2004

JP Morgan Commercial Mortgage Finance Corp, 2000-Fl1 F BBB- Upgrade AAA 3/17/2004

JP Morgan Chase Commercial Mortgage Finance Corp, 2002-WHALE1 J BBB- Upgrade A- 8/24/2004

JP Morgan Chase Commercial Mortgage Finance Corp, 2002-WHALE1 K BBB Upgrade BBB+ 8/24/2004

JP Morgan Chase Commercial Mortgage Finance Corp, 2002-WHALE1 L BB Upgrade BBB- 8/24/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-A D BBB Upgrade AA 3/16/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-A E BBB- Upgrade A 3/16/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-Fl1 E BBB+ Upgrade AAA 1/7/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-Fl1 F BBB Upgrade AAA 1/7/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-Fl1 G BBB- Upgrade AA 1/7/2004

JP Morgan Chase Commercial Mortgage Securities Corp, 2001-Fl1 G BBB Upgrade AAA 7/1/2004

J.P. Morgan Chase Commercial Mortgage Securities Corp, 2002-FL1

Lakewood Mall Finance Co., Series 1995-C1

LB Commercial Conduit Mortgage Trust II, 1996-C2 E BBB Upgrade A 3/25/2004

LB Commercial Mortgage Trust, 1998-C1 D BBB Upgrade A+ 6/23/2004

LB Commercial Mortgage Trust, 1998-C1 E BBB- Upgrade A- 6/23/2004

LB Commercial Mortgage Trust, 1998-C4



LB-UBS Commercial Mortgage Trust, Series 2000-C4



LB-UBS Commercial Mortgage Trust, 2000-C3 E BBB+ Upgrade A- 7/27/2004

Lehman Brothers Floating Rate Commercial Mortgage Trust, 2000-LLF C7 K BBB Upgrade AA 8/17/2004

Lehman Brothers Floating Rate Commercial Mortgage Trust 2002-LLF C3

Lehman Brothers Floating Rate Commercial Mortgage Trust 2002-LLF C3

LTC Commercial Mortgage Pass-Through Certificates Series 1996-1 D BBB- Upgrade AAA 5/10/2004

LTC Commercial Mortgage Pass-Through Certificates Ser 1998-1

Meristar Commercial Mortgage Trust, 1999-C1

Fitch



D-2 Baa2 Upgrade A2 8/18/2004 D-2 BBB Upgrade AA+ 8/20/2004

D-3 Baa2 Upgrade A2 8/18/2004 D-3 BBB Upgrade AA+ 8/20/2004

E-2 Baa3 Upgrade A3 8/18/2004 E-2 BBB- Upgrade AA 8/20/2004

E-3 Baa3 Upgrade A3 8/18/2004 E-3 BBB- Upgrade AA 8/20/2004

D Baa2 Upgrade A3 2/23/2004 D BBB+ Upgrade A- 10/18/2004

E Baa3 Upgrade Baa1 2/23/2004 E BBB- Upgrade BBB+ 10/18/2004



E BBB Upgrade A 5/21/2004

F BBB- Upgrade A- 5/21/2004

S-MAC-2 Baa2 Downgrade Ba2 9/30/2004

S-MAC-3 Baa3 Downgrade Ba3 9/30/2004

D Baa2 Downgrade Ba1 1/26/2004

E Baa3 Downgrade Ba2 1/26/2004

D Baa1 Upgrade Aaa 4/6/2004 D BBB Upgrade AA 2/25/2004

E BBB- Upgrade A 2/25/2004

D BBB Upgrade AA 6/3/2004

E BBB- Upgrade AA- 6/3/2004

F-NFC Baa1 Upgrade A1 8/13/2004

F-GGP Baa1 Upgrade A3 8/13/2004

G-NFC Baa2 Upgrade A2 8/13/2004

G-GGP Baa2 Upgrade Baa1 8/13/2004

H-GGP Baa3 Upgrade Baa2 8/13/2004


H Baa1 Upgrade A3 1/26/2004 H BBB+ Upgrade A 1/26/2004

J Baa2 Upgrade Baa1 1/26/2004 J BBB Upgrade A- 1/26/2004

K Baa3 Upgrade Baa2 1/26/2004 K BBB- Upgrade BBB 1/26/2004



J BBB+ Upgrade A+ 5/12/2004

K BBB Upgrade A 5/12/2004

L BBB- Upgrade BBB 7/22/2004

E BBB+ Upgrade A- 8/19/2004

C BBB+ Upgrade AA 10/13/2004





D Baa2 Upgrade Baa1 6/21/2004


F BBB Upgrade BBB+ 9/16/2004

G BBB- Upgrade BBB 9/16/2004

J BBB+ Upgrade AA 8/23/2004

L BBB- Downgrade BB+ 8/23/2004

D BBB Upgrade A+ 9/15/2004

D BBB Upgrade A+ 9/15/2004

C Baa1 Downgrade Ba1 10/15/2004

Moody’s S&P



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116

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appendix A


Merrill Lynch Mortgage Investors, 1995-C2 E BBB- Upgrade BBB+ 3/15/2004

Merrill Lynch Mortgage Investors, 1996-C1

Merrill Lynch Mortgage Investors, 1996-C2 D BBB+ Upgrade AA 4/23/2004

Merrill Lynch Mortgage Investors, 1996-C2 E BBB Upgrade A+ 4/23/2004



Merrill Lynch Mortgage Investors, 1997-C2 D BBB+ Upgrade AA- 5/11/2004



Morgan Stanley Capital I, 1996-C1 E BBB Upgrade BBB+ 6/23/2004

Morgan Stanley Capital I, 1996-WF1

Morgan Stanley Capital I, 1997-C1 F BBB+ Upgrade A- 6/30/2004

Morgan Stanley Capital I, 1997-HF1 E BBB+ Upgrade AA 2/23/2004

Morgan Stanley Capital I, 1997-RR C BBB Upgrade AAA 2/17/2004

Morgan Stanley Capital I,1997-WF1

Morgan Stanley Capital I,1997-WF1

Morgan Stanley Capital I, 1997-XL1 E BBB Upgrade BBB+ 2/5/2004

Morgan Stanley Capital I, 1998-CF1

Morgan Stanley Capital I, 1998-HF2 E BBB Upgrade BBB+ 5/18/2004

Morgan Stanley Capital I, 1998-HF2 F BBB- Upgrade BBB 5/18/2004

Morgan Stanley Capital I, 1998-WF1 D BBB+ Upgrade A- 6/30/2004

Morgan Stanley Capital I, 1998-WF1

Morgan Stanley Capital I, 1998-XL1

Morgan Stanley Capital I, 1998-XL1

Morgan Stanley Capital I, 1999-CAM1 E BBB Upgrade A- 6/15/2004

Morgan Stanley Capital I, 1999-CAM1 F BBB- Upgrade BBB+ 6/15/2004

Morgan Stanley Capital I, 1999-LIFE1 E BBB Upgrade BBB+ 6/30/2004

Morgan Stanley Capital I, 1999-LIFE1 F BBB- Upgrade BBB 6/30/2004

Morgan Stanley Capital I, 1999-RM1 E BBB+ Upgrade A 7/15/2004

Morgan Stanley Capital I, 1999-RM1 F BBB Upgrade BBB+ 7/15/2004

Morgan Stanley Capital I, 1999-RM1 G BBB- Upgrade BBB 7/15/2004

Morgan Stanley Capital I, 2001-XLF



Morgan Stanley Dean Witter Capital I, 2001-PPM E BBB Upgrade BBB+ 8/3/2004

Morgan Stanley Dean Witter Capital I, 2001-PPM F BBB- Upgrade BBB 8/3/2004

Morgan Stanley Dean Witter Capital I, 2002-XLF

Mortgage Capital Funding, 1996-MC2


Mortgage Capital Funding, 1997-MC1 D BBB+ Upgrade A+ 4/21/2004




Mortgage Capital Funding, 1998-MC1 G BBB Upgrade BBB+ 6/22/2004

N-45 First CMBS Issuer Corp, 2000-1

NationsLink Funding Corp, 1998-2


NationsLink Funding Corp, 1999-1 D BBB+ Upgrade A+ 7/20/2004


Nomura Asset Securities Corp, 1996-MD5 A-4 BBB Upgrade AA 7/21/2004

Nomura Asset Securities Corp, 1996-MD5 A-5 BBB- Upgrade A+ 7/21/2004

Nomura Asset Securities Corp, 1998-D6 A-4 BBB Upgrade A- 1/6/2004

Nomura Asset Securities Corp, 1998-D6 A-5 BBB- Upgrade BBB+ 1/6/2004

NSS Mortgage Securities II Corp C BBB+ Upgrade A- 3/10/2004

Opryland Hotel Trust, 2001-OPRY

Opryland Hotel Trust, 2001-OPRY

Park Square Mortgage Trust. 2000-C5

Park Square Mortgage Trust. 2000-C5

Penn Mutual Life Insurance Company, 1996-PML M BBB Upgrade BBB 3/17/2004

PNC Mortgage Acceptance Corp, 1999 CM-1

PNC Mortgage Acceptance Corp, 1999 CM-1

PNC Mortgage Acceptance Corp, 2000-C1 E BBB Upgrade BBB+ 5/18/2004

PNC Mortgage Acceptance Corp, 2000-C2



Prudential Mortgage Capital Funding, ROCK 2001-C1 E BBB+ Upgrade A- 8/10/2004

Prudential Mortgage Capital Funding, ROCK 2001-C1 F BBB Upgrade BBB+ 8/10/2004

Prudential Mortgage Capital Funding, ROCK 2001-C1 G BBB- Upgrade BBB 8/10/2004

Prudential Securities Secured Financing Corp, 1998-C1

Prudential Securities Secured Financing Corp, 1998-C1

Prudential Securities Secured Financing Corp, KEY 2000-C1

Red Mountain Funding LLC, 1997-1 D BBB Downgrade BB+ 4/21/2004

Red Mountain Funding LLC, 1997-1 E BBB- Downgrade BB 4/21/2004

Salomon Brothers Mortgage Securities VII, 1993-9

Fitch



D BBB Upgrade A 10/19/2004


E BBB- Upgrade A- 4/7/2004

D Baa1 Upgrade A2 4/29/2004 D BBB Upgrade AA- 4/7/2004

E Baa3 Upgrade Baa2 4/29/2004 E BBB- Upgrade A- 4/7/2004






C BBB Upgrade AA- 7/12/2004


E BBB+ Upgrade AA+ 4/20/2004

F BBB Upgrade AA 4/20/2004

E BBB Upgrade BBB+ 8/25/2004

F BBB- Upgrade BBB 8/25/2004

F Baa2 Downgrade Ba1 5/17/2004

G1 Baa3 Downgrade Ba3 5/17/2004



D Baa1 Upgrade Aaa 9/30/2004




E BBB+ Upgrade A+ 4/17/2004

F BBB Upgrade A 4/17/2004


D Baa2 Upgrade A2 1/22/2004 D BBB+ Upgrade A 4/21/2004



E Baa3 Upgrade A3 5/17/2004 F BB Upgrade BBB- 7/19/2004

C A3 Upgrade A2 5/19/2004 C BBB Upgrade A+ 5/26/2004

D Baa3 Upgrade Baa2 5/19/2004 D B Upgrade BB+ 5/26/2004

B-2 Baa2 Downgrade Baa3 4/15/2004

B-3 Baa3 Downgrade Ba1 4/15/2004

B-1 BBB+ Upgrade A 9/7/2004

B-2 BBB Upgrade A- 9/7/2004

E BBB+ Upgrade A 8/6/2004

F BBB Upgrade A- 8/6/2004

G BBB- Upgrade BBB+ 8/6/2004

D Baa2 Upgrade A3 2/4/2004 D BBB Upgrade A 6/29/2004

E Baa3 Upgrade Baa1 2/4/2004 E BBB- Upgrade A- 6/29/2004


B-4 BBB- Upgrade BBB+ 6/15/2004

Moody’s S&P



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118

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appendix A


Salomon Brothers Mortgage Securities VII, 1999-AQ1

Salomon Brothers Mortgage Securities VII, 1999-C1 E BBB Upgrade A+ 6/9/2004

Salomon Brothers Mortgage Securities VII, 1999-C1 F BBB- Upgrade A 6/9/2004

Salomon Brothers Mortgage Securities VII, 1999-LB1

Salomon Brothers Mortgage Securities VII, 2000-1

Salomon Brothers Mortgage Securities VII, 2000-NL1 E BBB+ Upgrade AA 2/3/2004

Salomon Brothers Mortgage Securities VII, 2000-NL1 F BBB Upgrade AA- 2/3/2004

Salomon Brothers Mortgage Securities VII, 2000-NL1 G BB+ Upgrade BBB+ 2/3/2004

Salomon Brothers Mortgage Securities VII, 2000-NL1 G BBB+ Upgrade AA 3/25/2004

Salomon Brothers Mortgage Securities VII, 2000-NL1 H BBB Upgrade A 3/25/2004

Salomon Brothers Mortgage Securities VII, 2001-CDC


Salomon Brothers Mortgage Securities VII, 2001-CDC G-DS BBB- Downgrade BB+ 2/25/2004






SASCO Floating Rate Commercial Mortgage Trust, 2001-C8

SASCO Floating Rate Commercial Mortgage Trust, 2001-C8 J BBB+ Upgrade AAA 5/14/2004

SASCO Floating Rate Commercial Mortgage Trust, 2001-C8 K BBB Upgrade AAA 5/14/2004

SASCO Floating Rate Commercial Mortgage Trust, 2001-C8 L BBB- Upgrade AAA 5/14/2004

Sawgrass Mills Trust, 2001-XLSGM

Sawgrass Mills Trust, 2001-XLSGM

Scottsdale Fashion Square Trust D-1 BBB Upgrade A+ 5/6/2004

Scottsdale Fashion Square Trust D-2 BBB Upgrade A+ 5/6/2004

Scottsdale Fashion Square Trust E-1 BBB- Upgrade BBB 5/6/2004

Scottsdale Fashion Square Trust E-2 BBB- Upgrade BBB 5/6/2004

Strategic Hotel Capital LLC SHC, 2003-1 H BBB+ Downgrade BBB 4/19/2004

Strategic Hotel Capital LLC SHC, 2003-1 I BBB Downgrade BBB- 4/19/2004

Strategic Hotel Capital LLC SHC, 2003-1 J BBB- Downgrade BB+ 4/19/2004

Structured Asset Securities Corp, 1995-C1 F BBB- Upgrade AAA 5/26/2004

Structured Asset Securities Corp, 1997-LL1

SunAmerica Mortgage Trust, 1999-C2B

SunAmerica Mortgage Trust, 1999-C2B

TrizecHahn Office Properties Trust, 2001-TZH D-3 BBB Upgrade A- 7/29/2004

TrizecHahn Office Properties Trust, 2001-TZH D-4 BBB Upgrade A- 7/29/2004

TrizecHahn Office Properties Trust, 2001-TZH E-3 BBB- Upgrade BBB 7/29/2004

TrizecHahn Office Properties Trust, 2001-TZH E-4 BBB- Upgrade BBB 7/29/2004

UBS 400 Atlantic Street Mortgage Trust, 2002-C1A



Vornado Finance LLC, 2000-VNO

Vornado Finance LLC, 2000-VNO

Wisconsin Avenue Securities, 1995-M4 B BBB Upgrade AAA 10/14/2004

Wisconsin Avenue Securities, 1996-M3 C BBB Upgrade AAA 10/14/2004

Wisconsin Avenue Securities, 1996-M5 B BBB- Upgrade A 1/15/2004

Fitch



M-3 BBB Upgrade A 6/15/2004


F Baa3 Upgrade A3 10/28/2004

M-3 BBB Upgrade A 6/15/2004

B-3 BBB Upgrade AA+ 6/15/2004

G BBB Upgrade AA 9/20/2004

E-DS Baa1 Downgrade Ba1 6/25/2004

F-DS Baa2 Downgrade Ba1 6/25/2004

G-DS Baa3 Downgrade Ba3 6/25/2004

H-DS Baa3 Downgrade B3 6/25/2004

X-2B Baa3 Downgrade Ba1 8/26/2004

H-DEN Baa1 Downgrade Baa2 8/26/2004

J-DEN Baa2 Downgrade Baa3 8/26/2004

K-DEN Baa3 Downgrade Ba1 8/26/2004

H Baa1 Upgrade Aaa 5/27/2004

J Baa2 Upgrade Aaa 5/27/2004

K Baa3 Upgrade Aaa 5/27/2004

E BBB Upgrade BBB+ 6/24/2004

F BBB- Upgrade BBB 6/24/2004




D-3 Baa3 Upgrade Baa2 9/16/2004 D-3 BBB Upgrade AA 7/19/2004

D-4 Baa3 Upgrade Baa2 9/16/2004 D-4 BBB Upgrade AA 7/19/2004

E-3 BBB- Upgrade A 7/19/2004

E-4 BBB- Upgrade A 7/19/2004





F Baa3 Upgrade Baa2 9/14/2004

Moody’s S&P



BBB CMBS and REITs

120

chapter 8

LARGE LOAN CMBS WITH REITS AS BORROWERSappendix B

Source: Morgan Stanley, Commercial Mortgage Alert and Intex

Arden Realty Inc. Office - Suburban

Associated Estates Realty Apartments

Associated Estates Realty Apartments

BRE Properties Inc. Apartments












Crescent Real Estate Equities Diversified / Misc.



Equity Office Properties Trust Office - CBD

Equity Office Properties Trust Office - CBD

Getty Realty Corp. Triple-Net Lease





Host Marriott Corp. Hotel

HRPT Properties Trust Office - Suburban

Kimco Realty Corp. Shopping Center

Macerich Co. Regional Mall

MeriStar Hospitality Hotel

MeriStar Hospitality Hotel

Prentiss Properties Trust Office - Suburban

Prentiss Properties Trust Office - Suburban

Ramco-Gershenson Properties Shopping Center

Reckson Associates Realty Corp Office - Suburban

Simon Property Group Inc. Regional Mall




Tanger Factory Outlet Centers Outlet

Town & Country Trust Apartments

Vornado Realty Trust Diversified / Misc.

REIT Property Type


Lehman Large Loan, Series 1997-LL1 175.0 10/15/1997

Chase Commercial Mortgage Securities Corp, 2000-1 98.5 3/28/2000


COMM, 2002-FL7 123.0 10/21/2002

GS Mortgage Securities Corp II, 2003-GSFL VI 83.0 12/17/2003

Credit Suisse First Boston Mortgage Securities Corp, 2004-TFL1 77.2 4/6/2004

Bear Stearns Commercial Mortgage Securities Inc., 2004-ESA 2,050.0 6/29/2004

Bear Stearns Commercial Mortgage Securities Inc., 2004-HS2 660.0 4/1/2004

Bear Stearns Commercial Mortgage Securities Inc., 2002-HOME 400.0 2/22/2002

Structured Asset Securities Corp, 1998-C3 64.8 10/29/1998

Greenwich Capital Commercial Funding Corporation, 2004-FL2 235.0 11/23/2004

Lehman Brothers Floating Rate Commercial Mortgage Trust, 2003-LLF C2 69.4 6/9/2003

Bear Stearns Commercial Mortgage Securities Inc., 2003-BBA1 160.0 5/6/2003

Banc of America Large Loan, 2001-7WTC 383.0 8/9/2001

Structured Asset Securities Corp, 1997-L1 275.0 10/15/1997

iStar Asset Receivables Trust, 2000-1 97.1 5/17/2000

Asset Securitization Corp, 1995-MD4 239.0 10/30/1995

Nomura Asset Securities Corp, 1996-MD5 161.0 4/2/1996

Columbia Center Trust, 2000-CCT 195.0 6/21/2000

LB Commercial Mortgage Trust, 1999-C2 146.5 10/14/1999

Thirteen Affiliates of General Growth Properties 560.0 11/25/1997

GGP Ala Moana, 1999-C1 500.0 8/26/1999

GGP/Homart Commercial Mortgage-Backed Securities, 1999-C1 590.0 11/30/1999

GGP - Ivanhoe Commercial Backed Securities, 1999-C1 700.2 9/30/1999

Morgan Stanley Capital I Inc., 2003-XLF 53.0 7/9/2003

Host Marriott Pool Trust, 1999-HMT 665.0 8/18/1999

Office Portfolio Trust, 2001-HRPT 260.0 2/28/2001

First Union - Chase Manhattan Commercial Mortgage Trust, 1999-C2 120.9 5/20/1999

Morgan Stanley Dean Witter Capital I Inc., 2000-XLF 60.0 8/9/2000

MeriStar Commercial Mortgage Trust, 1999-C1 330.0 8/30/1999


Lehman Large Loan, 1997-LL1 180.1 10/15/1997


Morgan Stanley Capital I, 1998-XL1 50.0 6/11/1998



Credit Suisse First Boston Mortgage Securities Corp, 2001-SPG1 277.0 8/22/2001

iStar Asset Receivables Trust, 2000-1 54.2 5/17/2000

Morgan Stanley Dean Witter Capital I Inc., 2003-HQ2 61.3 3/27/2003

Morgan Stanley Capital I Inc., 2003-XLF 115.0 7/9/2003

GS Mortgage Securities Corp II, 2004-GG2 71.5 8/12/2004


Deal Name Amount (in $MM) Closing Date


BBB CMBS and REITs

122

chapter 8

Moody’s breaks down its five key credit characteristics as follows: strength and stability of cash

flow, profitability and operational efficiency, liquidity, asset quality, and capital adequacy and

structure. Within those, the rating agency focuses on earnings momentum, fixed charge cover-

age, operating margins, funding capacity and structure, unencumbered assets to total assets,

portfolio diversification, development focus, asset market value, capital structure, stock market

valuation and bond pricing.

Fitch breaks the same characteristics down quite clearly into three main components: financial

analysis, a review of the management team and a review of the property portfolio. Fitch con-

siders the ability to adapt to changing business environments one of the most important

aspects of a management team.

When examining financials, Fitch looks at the following:• Cash flow coverage• Property level data• Unencumbered/Encumbered cash flow• Refinance risk• Constant refinance rate• Debt maturity schedule• Capital Structure• Leverage

- Capitalization of Cash Flow- Debt/EBITDA- Debt to Book Value (not as effective)- Debt to Market Capitalization (not as effective)

Though the list is long, Fitch’s most important financial tests are unencumbered debt service

coverage, total debt service coverage and total fixed charge coverage.

Within Fitch’s review of the property portfolio, investment diversity and asset quality are

examined. Market, location, site plan, building, property management, tenant breakdown

and lease expiration schedule can all affect the quality of a portfolio.

S&P defines its two main components as business profile and financial profile, quite similar to

Fitch. Within the business profile, S&P examines a REIT’s market position, its asset quality,

diversification/stability of operations and operating strategy/management evaluation.

S&P’s analysis of the financial profile breaks down into five separate parts:

• Financial Policy (dividend, leverage, accounting, bank line usage, acquisitions/development, etc.)

• Profitability (efficiency measures, returns, property level performance, etc.)

• Capital Structure (debt/capital, character of debt, cost/flexibility of debt, fixed/variable

rate debt, debt maturity schedule, etc.)

• Cash flow protection (coverage measures, liquidity, etc.)

• Financial flexibility (degree to which holdings are encumbered, leveragability of assets,

sources of financing, quality of ownership base, etc.)

All in all, there are no hard and fast rules used when rating a REIT, but the main factors

examined by the different rating agencies are quite similar.

TOP RATING AGENCY CRITERIA FOR REITSappendix C



CMBS Conduit Subordination Levels

Chapter 9



124

chapter 9

Subordination: The Right RangeUntil the super senior structure emerged in fixed-rate CMBS in October 2004,AAA credit enhancement levels continued to shrink. In the first five months of2004, AAA CMBS subordination levels fell to an average of 14%. Five years ago,sub levels of 14% were consistent with single-A CMBS.

Particularly at the top of the capital structure, the rating agencies have beenreducing the subordination levels required to obtain a CMBS rating. Each yearsince 1995, subordination levels on investment grade CMBS have declined in aneffort to recalibrate CMBS bond ratings with corporate bond ratings.

In this section, we estimate what the original subordination levels should havebeen on 1997-2001 conduit deals in order to make their original ratings consis-tent with the credit of unsecured corporate bonds.

TODAY’S SSUB LLEVELS FFALL WWITHIN OOUR CCALCULATED RRANGESAfter running two scenarios on the seasoned transactions, we found that the“right” original subordination levels for AAA conduit CMBS should have beenbetween 9% and 15%. In our estimate, those levels would have resulted inidentical default rates for AAA CMBS and AAA corporates. Our hypothetical“right” subordination level range is much lower than the 21%-29% range usedby the rating agencies during 1998-2000. For BBB CMBS, our calculated“right” range is about 4% to 8%. That is, 4% to 8% subordination would haveresulted in the same percentage of BBB CMBS defaults as historical BBB cor-porate defaults.

AVERAGE SUBORDINATION FOR CONDUIT/FUSION TRANSACTIONS

exhibit 1

1As of August 19, 2004.

Source: Commercial Mortgage Alert, Morgan Stanley

1998 1999 2000 2001 2002 2003 20041

AAA 29% 27% 23% 21% 20% 17% 14%

AA 24% 22% 19% 17% 16% 14% 12%

A 18% 17% 14% 13% 12% 10% 9%

BBB 13% 12% 11% 9% 8% 7% 5%

BB 6% 6% 5% 4% 4% 3% 3%

B 3% 3% 3% 2% 2% 2% 2%


The results of this study show that today’s average subordination levels on newissue transactions are in a reasonable range, assuming commercial mortgage per-formance in the next decade is similar to the loan loss experience of seasoneddeals to date. Based on our estimates, however, there is still some room for sub-ordination levels to decline further.

At the June 2004 CMSA conference, the rating agencies said that they will exer-cise caution and refrain from lowering sub levels further (for now), even thoughempirical data supports lower levels.

METHODOLOGYIn our recent Projecting Losses studies, we used the Esaki-Snyderman default tim-ing curves to project expected losses for conduits issued from 1997 to 2001. Wecompared those losses to remaining subordination levels to estimate lifetimedefault rates for bonds issued during that period. We now calculate the hypo-thetical original subordination levels that result in expected default rates thatmatch historical corporate bond default rates.

In the Projecting Losses pieces, we calculated expected future losses on 159 conduittransactions that were issued between January 1997 and December 2001. Aftercalculating future losses for each transaction, we compared these numbers tocurrent subordination levels on BBB-, BB and single-B bonds. A subordination-to-loss ratio that is less than one implies a bond default prior to maturity.

Avg Default Timing 1986 Default Timing

34% Severity 43% Severity

Aaa 9.1% 15.4%

Aa2 8.3% 14.3%

A2 4.9% 9.8%

Baa2 3.8% 7.8%

Ba2 2.1% 4.1%

B2 1.1% 1.6%

CMBS SUBORDINATION LEVELS CONSISTENT WITHCORPORATE BOND RATINGS

exhibit 2


1Projecting Losses on BBB- CMBS, April 16, 2004; Projecting Losses on BB CMBS, May 21, 2004; ProjectingLosses on Single-B CMBS, May 28, 2004.



126

chapter 9

For this chapter, we adjusted subordination levels on the 159 bonds until thenumber of bonds with ratios below one was consistent with the corporate bonddefault rate for a particular rating. For example, according to Moody’s, the aver-age 10-year cumulative default rate for single-A corporate bonds is 1.88%. Sincewe are examining a universe of 159 deals, this 1.88% default rate corresponds to2.99 CMBS bonds out of 159 defaulting. We rounded the 2.99 bond defaults to3 defaults, and kept lowering subordination levels across all deals until the uni-verse had 3 bond defaults and was on the verge of experiencing 4 bond defaults.

We repeated this procedure for all ratings from Aaa to B2 under two differentscenarios that we used in the Projecting Losses articles to forecast future losses.One scenario assumed the average default timing curve from Esaki’s commercialmortgage default study and the average severity rate of 34%. The other scenarioassumed the default timing curve of the 1986 origination cohort from the EsakiStudy, and a 43% severity rate, which is the severity experienced by liquidatedCMBS loans. For more details on these scenarios and the assumptions we usedto forecast losses, see our Projecting Losses pieces1.


Moody’s Average 10-Year Corresponding # of CMBS

Cumulative Default Rates for Defaults Necessary to be

Corporate Bonds, 1983-2002 (%) Consistent With Corporates

Aaa 0.38 0.60

Aa2 0.73 1.16

A2 1.88 2.99

Baa2 5.71 9.08

Ba2 15.81 25.14

B2 46.22 73.49

CMBS DEFAULTS CALIBRATED TO CORPORATE BOND DEFAULTS

exhibit 3

Source: Moody’s Investors Service, Morgan Stanley



128

chapter 9

Section I: Projecting Losses on BBB- CMBS

SUBORDINATION VVS. EEXPECTED LLOSSESIn order to test the hypothesis that current credit enhancement levels continueto provide adequate support for mezzanine and subordinate CMBS, we examinethe ratio of BBB- subordination to expected losses on all conduit deals issuedbetween 1997 and 2001. (We describe the methodology for predicting expectedlosses later in this section.)

A ratio that is less than 1 means that we expect the class to default before matu-rity; a ratio of greater than 1 means we expect no default. Depending on theseverity assumption and timing curve used to project future losses, between 0and 5 bonds have subordination-to-loss ratios of less than 1. (See Exhibit 4)Under the most severe assumptions, about 11% of classes have a ratio between1 and 2. We believe that classes with a ratio between 1 and 2 may be vulnerableto a downgrade.

The majority of BBB- bonds, however, have a ratio of greater than 5. In ourview, this shows that there is currently minimal default risk in the investmentgrade CMBS sector. If the majority of BBB-s are well protected from real estaterisk, higher rated classes are even more insulated.

BBB- SUBORDINATION-TO-EXPECTED-LOSS RATIOS FOR 1997-2001 CONDUITS

exhibit 4


Ranges for BBB- Average Default Average Default

Subordination to Timing Curve; Timing Curve;

Expected Loss Ratio 34% Severity 43% Severity

# of Deals % of Deals # of Deals % of Deals

0-1 0 0.0 0 0.0

1-2 4 2.5 4 2.5

2-3 5 3.1 9 5.7

3-4 8 5.0 9 5.7

4-5 6 3.8 4 2.5

5-6 4 2.5 6 3.8

6-7 4 2.5 5 3.1

7-8 5 3.1 4 2.5

>8 123 77.4 118 74.2

1Ratio of 60.8, assuming average default timing curve from Esaki study and 34% severity rate; Ratio of 96.2,assuming 1986 default timing curve and 43% severity rate.


In Exhibit 8 of this section, we rank our universe of BBB- CMBS based on sub-ordination to expected loss ratios. We believe that the bonds at the bottom ofthe list (with the highest ratios) have the highest level of principal protection andgreatest chance for rating agency upgrade. Likewise, we believe that the bondsat the top of the list (with the lowest ratios) have a higher chance of default anddowngrade.

SCOPE OOF TTHE SSTUDYThis study analyzes and ranks bonds based on the level of principal protectionfrom losses. Our analysis does not assess the risk of potential downgrades thatmay occur for other reasons, such as interest shortfalls.

For example, while ASC 1997-D5 A2 has a high subordination to expected lossratio,1 this class was downgraded by Moody’s in September 2003 to Baa3 from itsoriginal A1 rating. The downgrade was prompted by interest shortfalls causedby servicer reimbursements of non-recoverable advances. Likewise, S&P down-graded this class to BBB from A+.

1986 Default 1986 Default

Timing Curve; Timing Curve;



4 2.5 5 3.1

14 8.8 17 10.7

8 5.0 10 6.3

11 6.9 12 7.5

7 4.4 6 3.8

6 3.8 10 6.3

8 5.0 10 6.3

8 5.0 9 5.7

93 58.5 80 50.3

2See Projecting Losses: BBB- Upgrade Potential, May 2003



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A high subordination to expected loss ratio1 does not mean a BBB- class neces-sarily offers good value. The market may have already priced in the probabilityof an upgrade. There may be cases, however, where the spread has not fullyadjusted for the credit. For example, JPMC 1997-C4 F is currently rated BBB-by S&P. With a current subordination level of 13.09% and a subordination-to-loss ratio of 1581.4, we would argue that this class is a good upgrade candidate.This class currently has a $109 price and trades around S+100 bp.

PROJECTING LLOSSES - MMAY 22003In order to assess the strength of this study as a predictor of rating actions, wereviewed rating changes on BBB- bonds from the prior version of this study.2

PROJECTING LOSSES STUDY - MAY 2003RATING AGENCIES UPGRADED 13 OF THE 20 CLASSES WITH THEHIGHEST SUBORDINATION-TO-LOSS RATIOS

exhibit 5

1As of May 2003.2Expected loss ratio equals zero.

*S&P Rating

Source: Morgan Stanley, Rating Agencies

Subordination Ratings Old Old Currentto Expected Actions Since Moody’s Fitch Moody’s

Deal Loss Ratio1 May 2003 Rating1 Rating1 Rating

CCMSC 2000-3 NA2 - - BBB- -MSC 1997-WF1 1090.0 Upgraded Baa3 - A2JPMC 1999-C7 326.0 Upgraded - BBB-* -JPMC 1997-C4 309.4 Upgraded Baa2 BBB+ A3MSC 1998-WF2 159.8 - - BBB- -MSC 1997-HF1 150.8 Upgraded - BBB+ -NLFC 1999-2 120.0 Upgraded - BBB -CCMSC 1997-1 118.5 Upgraded - BBB -PNCMA 2000-C2 113.6 - Baa3 - Baa3MSDWC 2000-LIF2 110.1 - Baa3 BBB- Baa3GMACC 1999-C2 91.5 Upgraded Baa3 BBB- Baa3MCFI 1997-MC2 87.9 - Baa3 - Baa3FULB 1997-C1 77.1 Upgraded Baa3 BBB- A3CMAC 1999-C1 72.6 Upgraded Baa3 BBB- Baa3 NASC 1998-D6 69.9 Upgraded Baa3 BBB- Baa3 ACMF 1997-C1 66.0 Upgraded - BBB- -GMACC 1997-C1 62.6 Upgraded Baa3 BBB- Baa3JPMC 1997-C5 53.6 Upgraded Baa3 BBB-* Baa3DLJCM 1999-CG2 48.4 - Baa3 BBB- Baa3CCMSC 1998-2 47.9 - - BBB- -


Over the course of a year, we would expect the bonds with the highest subordi-nation-to-loss ratios to experience the greatest number of upgrades. We foundthat 65% of the 20 BBB- classes with the highest subordination-to-loss ratioswere upgraded during the past year (Exhibit 5). The upgrade percentagedeclined for the next highest 20 (40%).

We would also expect the BBB- bonds with the lowest subordination-to-lossratios to experience fewer upgrades and potentially experience some down-grades. We found that 2 of the 20 BBB- classes with the lowest ratios weredowngraded during the past year. Only 1 class was upgraded.

Date of CurrentMoody’s FitchUpgrade Rating Date of Fitch Upgrade

- BBB- -2/26/2004 - -

- BBB* 7/22/2003*7/23/2003 AAA Two Upgrades: 11/12/2003 and 3/30/2004

- BBB- -- AA 2/23/2004- A- 9/10/2003- BBB+ 9/10/2003- - -- BBB- -- BBB 7/7/2003- - -

3/9/2004 A 2/13/2004- BBB 11/25/2003- BBB+ Two Upgrades: 11/18/2003 and 1/06/2004- AA+ Three Upgrades: 7/11/2003, 2/3/2004 and 3/17/2004- BBB+ 2/18/2004- BBB* 9/23/2003*- BBB- -- BBB- -

METHODOLOGYIn this section, we analyze the lowest rated investment grade class of 159 conduittransactions tracked by Trepp. Each conduit transaction was issued betweenJanuary 1997 and December 2001. 140 of 159 classes are currently rated BBB- byMoody’s, Fitch or S&P; the other 19 classes are rated single-A, A-, BBB+ or BBB.

For each transaction, we calculate a future expected loss rate based on historicallosses and losses implied by the current level of 30, 60, and 90-day delinquencies,REO, foreclosures, performing specially serviced loans and servicer watchlistedloans. We do not account for the impact of defeased collateral within the deals.

We begin by assigning a probability of liquidation for each delinquency category,based on results from Esaki’s commercial mortgage default study.

Assumptions ffor PProbabilities oof LLiquidationIn Esaki’s study, about 55% of loans that became more than 90 days delinquentwere ultimately liquidated. For this section, we borrow the results from theEsaki study and assume that 55% of 90+ day delinquent loans will be liquidated.We then assume that 60-day delinquent loans will have a 25% liquidation rate,and 30-day delinquent loans will have a 10% liquidation rate.

To be conservative, we assume that all foreclosed and REO loans will be liqui-dated. We assign a 2.5% liquidation rate to servicer watchlisted loans and a 5%liquidation rate to performing specially serviced loans. We assume a low proba-bility of liquidation for the performing specially serviced loans because theseloans could have been transferred to the special servicer for technical rather thanmonetary defaults.

Calculating LLoan LLosses: AAverage TTiming oof DDefaultsWe then multiply the projected liquidated loan total by a severity rate to computeeach deal’s expected loss rate for the year. For our analysis, we consider two lossseverity rates: 34% and 43%3.

The first severity rate that we assume is 34%. Liquidated life insurance companyloans in the Commercial Mortgage Default Study: 1972-2000, by Howard Esaki,experienced a 34% severity rate. The average severity rate on liquidated CMBSloans is higher, at 43%3. The calculated loss rates for the year are then used inconjunction with historical losses to project future loss rates.

Since the calculated losses are based on current delinquency levels, we assumethat the resulting losses will occur within one year from today.

For example, with a 34% severity rate assumption, DLJCM 2000-CKP1, isexpected to have a 0.4% loss rate based on current levels of delinquencies, spe-cially serviced loans and watchlisted loans. This transaction has seasoned for 3years, so we assume losses will occur in year 4. The projected loss based on cur-rent delinquencies (0.4%) is then added to the deal’s historical losses of 2.5%.

To project future losses, we assume that the timing of CMBS loan losses in thisstudy mirrors the average timing of defaults on the life insurance company loansfrom Esaki’s study.

3See special servicer severities, February 6, 2004.



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According to the timing of defaults presented in Esaki’s study, about 33% ofloans default by the end of year 4. The DLJCM 2000-CKP1 transaction isexpected to have a 2.9% loss rate by year 4, based on historical losses and pro-jected losses of currently delinquent loans. If we apply the results of Esaki’sstudy, this 2.9% loss rate should correspond to 33% of total loan losses.Therefore, we conclude that this transaction may suffer from a 5.9% loss rate(based on original balances) during its remaining lifetime, since 67% of loan loss-es have yet to occur. (2.9*(1-33%)¸33%=5.9% loss rate) A 5.9% loss rate basedon original balances corresponds to a 6.3% loss rate, based on current balances.

The timing of defaults presented in Exhibit 6 is fairly evenly distributed, with47% of loan losses occurring in the first five years after loan origination, and theremaining 53% of losses occurring in years 6 through 10. If the timing ofdefaults in CMBS deviates from this average, it is possible that our analysiswould yield different results.


Total Cumulative

Default Rates from Defaults That Occur Level of Defaults

Year Esaki’s Study (%) Each Year (%) Through Time (%)

1 0.2 1.5 1.5

2 1.0 6.9 8.4

3 1.7 11.5 19.9

4 2.0 13.1 33.0

5 2.1 13.9 46.9

6 2.3 15.2 62.1

7 2.8 18.9 81.0

8 1.5 9.7 90.7

9 0.9 5.7 96.4

10 0.5 3.6 100.0

AVERAGE TIMING OF DEFAULTS FROM ESAKI’S COMMERCIAL MORTGAGE DEFAULT STUDY1

exhibit 6

1Real Estate Finance, Commercial Mortgage Defaults: 1972-2000, by Howard Esaki, Winter 2002 Edition.


We repeated our analysis, applying the default timing curve experienced by lifeinsurance company loans that were originated in 1986. The 1986 originationcohort experienced the highest default rate of any origination year between 1972and 1995. For the purposes of this analysis, we do not focus on the absolutelevel of defaults, but we apply the 1986 default timing curve as a proxy for thetiming of CMBS loan losses in a real estate downturn. Life insurance companyloans originated in 1986 experienced 70% of all defaults in years 6 through 10after origination.

Since most of the CMBS transactions in our study have seasoned for less thansix years, the 1986 default timing curve assumes that the majority of losses havenot yet occurred. Using this back-loaded timing curve, the projected future loss-es for these CMBS transactions are higher than in our initial analysis, resulting inlower subordination-to-loss ratios.



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Total Cumulative



1 0.0 0.0 0.0

2 0.9 3.2 3.2

3 2.3 7.9 11.1

4 2.1 7.5 18.6

5 3.3 11.3 29.9

6 5.8 20.2 50.2

7 10.3 35.8 86.0

8 2.5 8.6 94.6

9 1.3 4.6 99.2

10 0.2 0.8 100.0

TIMING OF DEFAULTS FOR 1986 COHORT FROMESAKI’S COMMERCIAL MORTGAGE DEFAULT STUDY1

exhibit 7





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1997-2001 CONDUIT DEALS RANKED BY SUBORDINATION-TO-LOSS RATIO (34% SEVERITY; AVERAGE DEFAULT TIMING CURVE)

exhibit 8


* S&P Rating

DLJCM 2000-CKP1 B1 Baa3 BBB+ 0.00 0.02 0.08 0.25 0.20

BACM 2001-PB1 J Baa3 - 0.00 0.00 1.71 0.00 0.00

CCMSC 2000-1 F - BBB- 0.84 1.64 7.95 1.21 7.45

JPMCC 2001-C1 G - BBB- 0.18 0.00 1.59 0.00 1.87

BACM 2001-1 H Baa3 BBB- 0.35 0.00 4.83 0.11 1.05

BAFU 2001-3 J - BBB- 0.00 0.00 0.54 0.00 0.00

SBM7 2000-C2 G Baa3 BBB- 0.00 0.00 0.00 5.46 1.93

SBM7 2001-C1 G Baa3 - 0.13 0.00 3.62 0.00 1.77

GMACC 2001-C1 G - BBB- 0.77 1.25 3.98 0.00 1.66

JPMC 2000-C9 F Baa3 BBB- 0.00 0.24 0.78 0.00 0.00

FUNBC 2001-C4 J Baa3 - 0.00 0.00 0.48 1.03 0.33

GECMC 2000-1 F Baa3 BBB- 1.69 1.37 2.41 0.00 0.00

SBM7 2000-C3 G Baa3 - 2.41 0.11 0.00 0.00 1.63

GMACC 2000-C2 F - BBB- 1.18 0.00 3.16 0.00 0.00

MLMI 1999-C1 E - BBB-* 0.40 0.00 6.26 1.71 2.69

MSDWC 2001-TOP1 F - BBB- 0.00 0.00 2.86 0.00 0.00

CSFB 2001-CF2 G Baa3 BBB- 0.11 0.22 1.27 0.00 0.33

BSCMS 2001-TOP2 F - BBB- 0.00 0.00 2.65 0.00 0.00

GMACC 2000-C3 F Baa3 BBB- 0.33 0.00 0.86 0.00 0.54

LBUBS 2000-C5 G Baa3 - 0.00 0.00 2.40 0.00 0.47

CSFB 2001-CKN5 H Baa3 - 0.00 0.00 0.00 0.50 0.00

JPMC 1999-C8 F Baa3 BBB 0.67 0.00 1.69 0.00 0.30

GECMC 2001-3 G - BBB- 0.00 0.00 0.00 0.85 0.00

CSFB 1999-C1 F Baa3 BBB- 0.00 0.00 0.10 0.58 2.91

KEY 2000-C1 G Baa3 - 0.00 0.00 1.11 0.74 3.08

JPMCC 2001-CIBC F - BBB- 0.00 0.00 1.31 0.00 0.57

MLMI 1998-C3 D Baa3 - 0.63 0.00 1.88 0.00 0.00

SBM7 2001-C2 H Baa3 - 1.44 0.00 0.79 0.00 0.00

COMM 2000-C1 F - BBB- 0.00 0.00 0.00 1.48 0.00

GMACC 2000-C1 F Baa3 BBB- 0.00 1.14 4.56 0.00 0.50

CSFB 2000-C1 F - BBB- 0.00 0.69 0.83 0.00 2.05

FUNBC 2000-C2 G - BBB- 0.00 0.00 0.00 1.21 0.07

GECMC 2001-2 G Baa3 BBB- 0.00 0.50 0.00 0.00 0.50

LBUBS 2000-C3 G Baa3 BBB- 0.74 0.00 1.28 0.16 0.08

FUBOA 2001-C1 H Baa3 BBB- 1.14 0.00 0.00 0.00 0.00

Current Current

Moody’s Fitch 30 Days 60 Days 90 Days FOR. REO

Deal Name Class Rating Rating Del (%) Del (%) Del (%) (%) (%)


0.00 25.88 0.4 2.5 6.3 9.8 1.6

0.00 12.35 0.4 0.6 4.4 8.0 1.8

0.00 43.93 4.8 0.0 5.6 10.3 1.8

0.00 11.34 1.0 0.0 4.2 7.7 1.8

0.40 25.85 1.5 0.1 3.4 8.7 2.5

0.00 12.76 0.2 0.6 3.3 8.5 2.6

2.67 25.66 2.5 0.6 3.9 10.0 2.6

4.57 14.68 1.4 0.1 3.2 8.9 2.7

0.00 24.00 1.6 0.0 3.3 9.2 2.8

0.00 37.22 0.4 1.8 2.9 8.9 3.1

0.09 19.13 0.7 0.0 2.9 9.3 3.2

0.00 29.26 0.8 0.5 2.9 9.2 3.2

0.00 6.58 0.7 0.4 2.3 8.1 3.5

0.00 27.93 0.8 1.0 2.1 7.9 3.7

1.12 13.68 2.6 0.0 3.2 12.4 3.9

0.80 13.34 0.6 0.0 1.3 5.2 3.9

0.06 19.47 0.5 0.4 2.0 7.8 3.9

2.45 12.86 0.6 0.0 1.3 5.3 4.0

0.00 30.38 0.6 0.2 1.6 7.4 4.5

0.65 21.28 0.8 0.0 1.6 7.4 4.5

0.00 17.34 0.3 0.1 1.7 8.1 4.7

0.75 17.69 0.5 2.5 2.1 9.8 4.8

0.00 19.98 0.4 0.0 1.9 9.2 5.0

8.63 17.57 1.4 0.4 2.1 10.8 5.0

0.00 16.12 1.5 0.2 2.1 10.8 5.2

4.81 26.45 0.7 0.1 1.6 9.1 5.5

0.00 31.19 0.5 2.3 2.1 12.6 6.0

0.00 16.31 0.3 0.0 1.4 8.6 6.4

0.35 47.64 0.8 0.3 1.4 9.2 6.7

0.73 19.01 1.2 0.0 1.5 9.8 6.7

0.56 27.67 1.1 0.0 1.3 9.1 6.8

0.53 22.56 0.6 0.0 1.3 9.3 7.2

0.00 29.92 0.5 0.1 1.2 8.9 7.2

1.12 25.53 0.6 0.2 0.9 6.7 7.5

3.53 22.94 0.3 0.2 1.1 8.5 7.7

Future

Expected Loss Expected

for Currently Losses, Based

Delinquent, on Historical

Watchlisted Losses and Current BBB-

or Performing Exp. Loss for Subordination Ratio of BBB-

Perf. Specially Historical Current (or lowest Subordination

Spec. Serviced Cumulative Delinquency investment to Future

Serv. Watchlist Loans (% of Loss (% of Levels (% of grade class Expected

(%) (%) orig. bal.) orig. bal.) curr. bal.) subordination) Loss



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1997-2001 CONDUIT DEALS RANKED BY SUBORDINATION-TO-LOSS RATIO (34% SEVERITY; AVERAGE DEFAULT TIMING CURVE) (CONTINUED)

exhibit 8


FUNBC 1999-C4 F - BBB- 1.31 0.00 2.50 0.00 1.21

PMCF 2001-ROCK G Baa3 BBB- 0.00 0.00 0.00 0.00 0.00

PMAC 1999-C1 E Baa3 BBB- 0.33 0.00 0.84 1.63 1.19

BSCMS 2001-TOP4 F Baa3 - 0.00 0.23 0.26 0.00 0.00

MSDWC 2000-LIFE F - BBB- 0.00 0.00 1.55 0.00 0.00

HFCMC 2000-PH1 F Baa3 BBB- 3.47 0.10 0.72 0.00 0.29

GSMS 1999-C1 E Baa3 - 1.09 2.21 2.68 0.51 0.65

GMACC 1999-C3 F Baa3 BBB- 5.88 0.22 1.34 0.00 1.32

FUNBC 2001-C2 J Baa3 - 0.00 0.00 0.22 0.00 0.32

BACM 2000-2 H Baa3 - 0.00 0.00 0.00 0.00 0.17

BSCMS 2000-WF2 F - BBB- 0.00 0.00 2.01 0.00 0.00

LBUBS 2001-C2 G Baa3 BBB- 0.17 0.00 0.53 0.00 0.00

PNCMA 2000-C1 F Baa3 BBB- 1.31 1.43 1.27 0.00 0.12

JPMC 2000-C10 F Baa3 BBB- 1.05 0.55 0.55 0.38 0.00

MSC 1999-FNV1 F - BBB- 3.07 0.00 0.36 1.58 2.59

FUNBC 2000-C1 F - BBB- 0.24 0.00 0.00 0.00 0.00

SBM7 2000-C1 G Baa3 - 1.68 0.00 1.82 0.00 0.64

BSCMS 1999-C1 E Baa3 - 0.00 0.00 1.37 0.00 0.00

CCMSC 2000-3 F - BBB- 0.00 0.35 1.43 0.50 0.00

DLJMA 1997-CF1 A3 - A 0.00 0.26 4.38 1.93 1.00

LBCMT 1999-C2 F Baa3 BBB- 0.00 0.00 0.35 2.06 0.00

LBUBS 2000-C4 G Baa3 - 0.00 0.84 0.18 0.08 0.52

LBCMT 1999-C1 E Baa3 BBB- 0.41 0.00 0.24 0.00 0.00

CSFB 1997-C2 E Baa3 - 0.94 5.98 0.00 0.00 1.25

MSC 1998-HF2 F - BBB- 0.00 0.00 0.82 0.00 0.48

MSC 1998-CF1 C A2 - 0.98 2.82 0.74 3.91 4.25

DLJCM 2000-CF1 B2 - BBB- 3.35 1.98 0.43 0.00 0.12

NLFC 1998-2 E - BBB- 0.39 0.00 1.32 0.00 0.58

PNCMA 1999-CM1 B2 - BBB 0.17 0.00 0.00 0.00 0.00

BSCMS 1999-WF2 F Baa3 BBB- 0.00 0.00 1.68 0.00 0.49

CSFB 2001-CK6 H Baa3 - 0.02 0.00 0.07 0.00 0.00

GMACC 2001-C2 H - BBB- 0.00 0.00 0.56 0.00 0.00

GMACC 1999-C2 G Baa3 - 0.00 0.00 5.66 0.00 0.00

CSFB 1998-C2 E Baa1 BBB- 0.00 0.00 0.00 0.85 0.00

GMACC 1999-C1 E - BBB 0.23 0.00 2.62 0.00 0.00

Current Current




2.18 23.17 1.1 0.0 1.3 10.4 7.9

0.49 5.56 0.1 0.4 1.0 8.0 8.1

1.58 17.47 1.1 0.9 1.4 11.8 8.2

0.00 10.07 0.1 0.0 0.6 5.2 8.3

0.33 15.90 0.4 0.4 1.0 8.1 8.4

1.86 18.35 0.5 0.5 1.2 10.8 9.1

0.31 25.07 1.2 0.8 1.4 13.1 9.6

0.00 16.49 1.0 0.7 1.1 10.5 9.8

0.75 27.91 0.4 0.0 0.8 8.0 9.8

0.00 35.16 0.3 0.1 1.0 9.8 9.9

0.49 12.49 0.5 0.0 0.6 5.7 10.2

0.00 30.31 0.3 0.0 0.7 7.6 10.3

0.70 20.83 0.6 0.2 0.9 9.5 10.4

1.38 10.43 0.4 0.3 0.9 9.6 10.6

0.00 21.24 1.6 0.1 1.1 12.6 11.0

1.86 33.46 0.3 0.4 0.9 10.1 11.4

0.81 16.40 0.7 0.0 0.9 10.5 12.1

0.00 14.10 0.3 0.6 0.7 8.1 12.4

0.65 25.74 0.7 0.0 0.8 9.9 12.6

2.91 0.00 1.2 8.1 1.5 18.7 12.6

0.00 22.15 0.9 0.0 0.6 7.4 12.6

0.75 25.33 0.5 0.0 0.6 8.0 13.1

2.11 33.21 0.3 0.4 0.5 6.6 13.2

0.82 18.98 1.0 2.1 0.8 11.2 13.3

4.14 27.21 0.5 0.5 0.7 10.0 13.5

3.63 19.52 2.8 2.5 1.5 20.5 13.6

2.59 20.83 0.6 0.0 0.7 10.0 13.8

1.01 8.22 0.5 0.8 0.9 12.4 13.8

1.09 16.95 0.2 0.5 0.8 11.0 13.9

0.00 4.96 0.5 0.4 0.6 8.0 14.0

0.70 14.07 0.1 0.0 0.6 8.4 14.3

0.00 25.68 0.3 0.0 0.7 9.4 14.3

0.00 12.30 1.1 0.0 0.7 10.6 14.3

4.11 21.05 0.5 0.8 0.9 12.3 14.4

0.11 21.46 0.6 0.8 0.9 13.7 14.7

Future












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chapter 9


exhibit 8


CSFB 2001-CK1 G Baa3 BBB- 0.12 0.00 0.00 0.00 0.21

MSDWC 2001-TOP5 F Baa3 - 0.00 0.00 0.00 0.00 0.00

FUNCM 1999-C2 F Baa3 BBB- 0.00 0.00 1.33 0.00 0.00

BSCMS 2000-WF1 F - BBB- 0.00 0.00 0.45 0.00 0.46

GECMC 2001-1 G Baa3 BBB- 0.00 0.00 0.20 0.00 0.00

JPMCC 2001-CIB2 F - BBB- 0.00 0.00 0.51 0.00 0.00

DLJCM 1999-CG1 B2 Baa3 BBB- 0.00 0.94 0.00 0.00 1.22

LBUBS 2001-C7 H Baa3 - 0.28 0.00 0.10 0.00 0.00

CSFB 2001-CK3 G1 Baa3 BBB- 0.00 0.10 0.00 0.00 0.00

CMAT 1999-C1 E Baa3 - 0.00 0.96 1.41 0.00 1.10

DLJCM 1999-CG2 B2 Baa3 BBB- 1.35 0.00 0.72 0.00 1.84

CMAT 1999-C2 F Baa3 BBB- 0.00 0.00 0.67 0.00 0.00

FUNBC 2001-C3 H - BBB- 0.16 0.00 0.18 0.00 0.00

COMM 1999-1 F Baa3 BBB- 0.00 0.00 0.33 1.25 1.19

MSDWC 2000-LIF2 F Baa3 BBB- 0.00 0.00 0.00 0.00 0.00

MLMI 1998-C2 E Baa3 - 0.56 0.00 1.34 0.00 1.52

MSDWC 2001-TOP3 F Baa3 BBB- 0.27 0.00 0.41 0.00 0.00

MSC 1999-LIFE1 G - BBB- 0.00 0.00 0.00 1.76 0.00

MCFI 1998-MC3 E Baa3 - 1.06 0.00 0.30 0.00 1.39

CSFB 1998-C1 E - BBB- 0.00 0.00 1.27 0.95 0.97

CCMSC 1999-2 F - BBB- 2.65 0.00 0.00 0.00 0.00

PSSF 1999-C2 F Baa3 - 0.00 0.00 0.00 0.93 0.57

DLJCM 1998-CF2 B-2 Baa3 BBB- 0.00 0.00 0.77 0.00 0.00

LBUBS 2001-C3 G - BBB- 0.00 0.00 0.00 0.00 0.00

GMACC 1997-C2 D Baa1 BBB+ 0.00 0.00 2.04 0.68 3.73

CSFB 2001-CP4 G - BBB- 0.00 0.00 0.00 0.00 0.00

PSSF 1999-NRF1 E Baa3 BBB 0.00 0.00 0.00 0.48 0.00

FUCMT 1999-C1 E Baa3 - 0.00 0.14 0.00 0.24 0.33

DLJCM 1999-CG3 B2 Baa3 BBB- 0.79 0.00 0.37 1.10 0.00

MCFI 1998-MC2 E - BBB- 0.00 0.00 0.00 0.00 0.47

DMARC 1998-C1 E Baa3 BBB- 0.48 0.00 0.40 1.61 4.53

GSMS 1998-C1 E - BBB- 0.00 0.63 1.33 1.15 1.50

CCMSC 2000-2 F Baa3 - 0.86 0.00 0.00 0.00 0.00

BACM 2000-1 F Baa3 - 3.19 0.00 0.97 0.00 0.00

CCMSC 1998-2 E - BBB- 0.00 0.00 0.69 0.00 0.00

Current Current




0.15 27.57 0.3 0.0 0.6 9.5 14.9

0.00 10.01 0.1 0.0 0.3 5.2 15.0

0.64 32.57 0.5 0.6 0.7 11.0 15.1

1.52 8.74 0.3 0.1 0.5 7.4 15.3

1.42 26.57 0.3 0.0 0.6 9.0 15.4

0.62 15.05 0.2 0.0 0.5 8.5 15.6

0.26 0.00 0.5 0.6 0.7 10.8 15.8

0.00 6.40 0.1 0.0 0.3 5.5 16.5

0.76 24.75 0.2 0.0 0.5 8.0 16.7

1.13 15.61 0.8 0.2 0.7 11.5 17.0

0.62 26.24 1.0 0.1 0.7 11.5 17.1

0.30 10.07 0.2 0.4 0.7 11.5 17.2

1.36 24.65 0.3 0.0 0.6 9.6 17.3

3.17 26.77 1.1 0.0 0.7 13.0 17.4

0.00 19.88 0.2 0.0 0.3 6.2 18.0

2.90 0.00 0.6 1.5 0.6 11.7 18.1

0.00 6.60 0.1 0.0 0.3 5.3 18.4

0.00 9.56 0.6 0.0 0.4 7.9 18.9

0.15 26.88 0.7 0.3 0.7 12.8 19.0

5.21 31.63 1.1 1.2 0.6 11.7 19.2

6.92 31.85 0.5 0.0 0.5 10.6 19.5

0.00 21.36 0.6 0.3 0.6 12.4 19.7

1.34 27.45 0.4 0.5 0.6 11.9 19.8

0.00 18.08 0.2 0.0 0.3 6.3 20.1

2.95 32.86 1.7 1.5 1.0 19.7 20.1

2.17 14.03 0.2 0.0 0.4 8.2 20.3

0.21 21.65 0.3 0.5 0.6 12.3 20.4

1.59 19.83 0.4 0.5 0.6 11.5 20.5

2.61 31.39 0.7 0.1 0.5 10.9 20.7

0.80 25.57 0.3 1.2 0.4 8.9 20.7

5.08 16.14 2.0 0.6 0.7 15.2 20.7

0.58 17.22 1.2 0.9 0.6 12.3 21.2

0.00 43.17 0.4 0.0 0.4 9.5 21.2

2.37 8.68 0.4 0.1 0.5 11.6 21.9

0.00 17.37 0.3 0.4 0.5 10.3 21.9

Future












142

chapter 9


exhibit 8


* S&P Rating

Current Current



AMC 1998-C1 E Baa3 BBB 0.00 0.00 1.24 0.00 0.96

PNCMA 2000-C2 G Baa3 - 0.00 0.00 0.19 0.00 0.00

FULBA 1998-C2 F Ba1 BBB-* 0.56 0.00 0.00 0.66 0.74

CASC 1998-D7 A-5 Baa3 BBB- 0.27 0.00 1.20 2.30 0.48

MLMI 1997-C2 E Baa3 - 0.71 0.40 3.11 1.15 0.00

FULB 1997-C2 E Baa3 BBB 1.16 0.00 1.39 0.18 1.92

MCFI 1998-MC1 G - BBB 0.00 0.00 1.80 0.00 0.00

NLFC 1999-1 E Baa3 - 0.00 0.00 0.00 0.45 0.00

HFCMC 1999-PH1 G Baa3 BBB- 0.00 0.14 1.68 0.00 0.00

JPMC 1998-C6 E - BBB- 0.76 0.00 8.09 0.00 0.00

MSC 1999-RM1 F - BBB 0.54 0.00 0.00 0.00 0.56

LBCMT 1998-C4 E Baa3 - 0.00 0.51 0.13 0.35 0.70

NLFC 1998-1 E Baa3 - 0.75 0.00 3.98 0.00 0.00

LBCMT 1998-C1 E Baa1 BBB- 0.76 1.07 0.64 0.00 0.15

SBM7 1999-C1 F Baa3 BBB- 0.00 0.00 2.64 0.00 0.00

JPMCC 2001-CIB3 F - BBB- 0.00 0.00 0.00 0.00 0.00

JPMC 1999-C7 E - BBB- 0.00 0.00 0.00 0.00 1.11

CCMSC 1997-2 E - A- 0.56 0.00 4.11 0.00 0.00

MSC 1998-HF1 E - BBB+ 0.00 1.02 0.20 0.00 0.00

JPMC 1997-C5 E Baa3 - 1.04 1.45 1.73 0.00 0.00

MLMI 1997-C1 E Baa3 - 0.00 1.12 11.91 0.77 1.97

PNCMA 2001-C1 G Baa3 - 0.00 0.00 0.00 0.00 0.00

SBM7 2001-MMA E1-E8 Baa2 - 0.00 0.00 0.00 0.00 0.00

CMFUN 1999-1 F - BBB- 0.00 0.00 0.22 0.25 0.00

MSC 1997-C1 G Ba3 BBB 0.00 0.00 0.00 0.00 3.87

MSC 1998-WF1 E - BBB 0.00 0.00 4.41 0.00 0.00

GMACC 1998-C1 F - BBB- 0.00 0.00 1.18 0.00 0.00

DLJMA 1997-CF2 B2 Baa3 - 0.00 0.00 15.24 0.00 0.00

GMACC 1997-C1 F Baa3 BBB+ 0.00 0.00 0.22 0.00 0.80

CCMSC 1998-1 E Baa3 - 0.00 0.00 0.00 0.00 0.00

PSSF 1998-C1 F Baa3 - 0.00 0.00 0.24 0.22 0.00

CMAC 1998-C2 E - BBB- 0.84 0.16 3.13 0.00 0.35

MCFI 1997-MC1 E Baa3 - 0.00 3.68 3.62 0.00 1.94

FULB 1997-C1 F - BBB 0.87 0.23 1.58 1.32 0.69

BSCMS 1998-C1 E Baa3 BBB- 0.00 0.00 0.49 0.00 1.31


Future










0.27 22.13 0.6 1.4 0.6 14.2 23.2

0.00 20.03 0.2 0.0 0.4 10.1 24.1

5.53 18.54 0.6 0.7 0.4 9.1 24.2

0.13 12.26 1.1 0.6 0.5 11.7 24.7

1.69 31.49 1.1 0.7 0.5 12.6 24.7

2.76 20.40 0.9 0.8 0.6 13.7 24.8

0.00 26.50 0.5 1.3 0.5 12.7 27.2

0.75 26.10 0.3 0.3 0.5 13.2 27.2

1.47 18.41 0.5 0.1 0.4 11.3 28.2

0.00 18.96 1.5 0.0 0.4 11.5 28.9

0.00 19.60 0.3 0.3 0.4 12.2 29.4

0.90 16.37 0.5 0.0 0.4 10.5 29.6

0.63 16.89 0.7 0.8 0.5 14.3 31.1

0.53 32.99 0.5 1.0 0.4 13.7 31.6

0.00 16.88 0.6 0.0 0.4 12.8 33.0

0.00 6.54 0.1 0.0 0.2 7.4 33.2

0.00 27.41 0.5 0.0 0.4 13.1 35.2

0.95 23.29 0.7 0.5 0.4 14.2 36.5

0.91 15.48 0.2 1.0 0.3 12.6 36.7

0.00 20.57 0.4 2.0 0.4 14.7 37.1

0.00 28.57 1.8 0.9 0.5 20.7 38.2

0.84 8.68 0.1 0.0 0.2 7.6 38.6

0.00 13.76 0.1 0.0 0.2 9.3 39.0

0.00 18.61 0.3 0.2 0.3 10.6 39.1

0.00 26.25 0.8 0.8 0.3 12.3 39.3

0.27 26.28 0.8 0.2 0.3 12.3 39.6

17.21 32.87 0.7 0.3 0.3 11.1 40.7

0.94 21.47 2.4 0.2 0.3 14.1 41.1

2.86 24.29 0.4 1.8 0.3 13.9 43.1

0.00 24.60 0.2 0.7 0.3 11.0 43.2

0.50 14.07 0.2 0.6 0.2 10.5 43.4

1.08 11.93 0.8 0.3 0.3 12.9 46.4

2.11 36.31 1.4 0.7 0.3 15.7 50.6

2.53 25.84 0.8 0.2 0.2 9.0 52.1

1.46 17.87 0.7 0.0 0.2 9.0 52.1



144

chapter 9


exhibit 8


* S&P Rating

Current Current



DLJCM 1998-CG1 B3 - BBB 0.00 0.44 0.44 0.00 0.39

GMACC 1998-C2 E Baa1 BBB- 0.78 0.49 1.02 0.09 0.00

ACMF 1997-C1 G - BBB- 0.00 0.00 6.74 0.00 0.00

CSFB 1997-C1 E Baa3 - 0.00 0.00 3.28 0.18 0.00

CCMSC 1997-1 E - BBB+ 0.00 0.00 0.96 0.00 4.15

ASC 1997-D5 A2 Baa3 AA 0.12 0.21 0.00 2.86 1.70

ASC 1997-D4 B-1 - BBB- 0.16 0.00 2.98 0.00 0.00

MCFI 1997-MC2 E Baa3 - 0.60 0.42 0.98 0.00 0.00

CMAC 1998-C1 E Baa2 BBB-* 0.64 0.00 0.36 0.00 0.00

MSC 1997-HF1 F - BBB- 1.96 0.00 1.44 0.00 0.00

NLFC 1999-2 E - A- 0.00 0.00 0.00 0.00 0.00

CMAC 1999-C1 G Baa3 - 0.41 0.88 0.00 0.00 0.00

DLJCM 1998-CF1 B2 Baa3 - 0.00 0.72 0.00 0.00 0.00

NASC 1998-D6 A-5 Baa3 BBB+ 0.06 0.05 1.33 0.00 0.00

MSC 1999-WF1 G Ba1 BBB 0.53 0.00 0.00 0.00 0.00

MSC 1998-WF2 G - BBB- 0.00 0.00 0.00 0.00 0.00

JPMC 1997-C4 F - BBB-* 0.00 0.00 0.43 0.00 0.00

MSC 1997-WF1 E A2 - 0.00 0.00 0.00 0.00 0.00

IFUND 2001-A D - BBB* 0.00 0.00 0.00 0.00 0.00


Future










1.90 25.98 0.4 0.3 0.2 10.8 52.3

0.21 21.97 0.4 0.3 0.2 11.3 56.8

2.74 33.56 0.9 0.0 0.2 9.3 57.0

8.78 19.64 0.7 0.9 0.2 13.4 59.0

0.00 14.91 1.2 0.4 0.2 14.4 60.2

0.61 15.00 1.5 1.3 0.3 20.2 60.8

9.61 7.56 0.6 0.6 0.2 10.0 61.5

2.20 14.33 0.3 0.4 0.2 13.5 63.4

0.16 20.31 0.2 0.5 0.2 12.9 63.5

0.00 25.93 0.3 0.4 0.1 8.6 66.5

1.44 18.44 0.1 0.0 0.2 14.4 70.2

1.49 15.67 0.2 0.0 0.2 10.8 71.4

0.93 16.98 0.2 0.3 0.1 11.6 90.9

1.29 16.44 0.4 0.1 0.1 11.3 97.1

0.00 2.13 0.0 0.1 0.1 7.9 116.5

0.00 11.18 0.1 0.0 0.0 6.1 271.9

0.00 0.00 0.0 0.0 0.0 13.1 1581.4

2.11 5.17 0.1 0.0 0.0 17.0 2072.7

0.00 0.00 0.0 0.0 0.0 12.5 NA



146

chapter 9

Section II: Projecting Losses on BB CMBSIn Section I, we ranked BBB- CMBS bonds based on their level of principalprotection from losses. In this section, we apply the same methodology fromPart I to rank the universe of BB conduit CMBS. We measure the level of prin-cipal protection on a bond by comparing the future expected losses for the deal’scollateral to the current credit support for the bond. The rankings by subordina-tion to expected loss ratio are provided in Exhibit 13 of this section.

RATIOS AAND RRANKINGSWe believe that the bonds at the bottom of the list (with the highest ratios) havethe highest level of principal protection and the greatest chance for ratingagency upgrade. Likewise, we believe that the bonds at the top of the list (withthe lowest ratios) have a higher chance of default and downgrade.

A ratio that is less than 1 means that we expect the class to default before matu-rity; a ratio of greater than 1 means we expect no default. Depending on theseverity assumption and timing curve used to project future losses, between 2and 15 bonds have subordination-to-loss ratios of less than 1 (See Exhibit 9).Between 9 and 21 bonds have a ratio between 1 and 2. We believe that classeswith a ratio between 1 and 2 may be vulnerable to a downgrade.

BB SUBORDINATION-TO-EXPECTED-LOSS RATIOS FOR 1997-2001 CONDUITS

exhibit 9

Source: Morgan Stanley, Trepp, Bloomberg

Ranges for BB Average Default Average Default




0-1 2 1.3 2 1.3

1-2 9 6.0 12 7.9

2-3 8 5.3 11 7.3

3-4 13 8.6 10 6.6

4-5 4 2.6 12 7.9

5-6 13 8.6 13 8.6

6-7 10 6.6 7 4.6

7-8 7 4.6 12 7.9

>8 85 56.3 72 47.7

2Ratio of 35.8, assuming average default timing curve from Esaki study and 34% severity rate.3See Projecting Losses: Are BBs Safe? May 2003.



For example, while ASC 1997-D5 A5 has a high subordination to expected lossratio,2 this class was downgraded by Fitch in September 2003 to BB from BBB.The downgrade was prompted by interest shortfalls caused by servicer reim-bursements of non-recoverable advances. S&P also downgraded this tranche toD from BBB.

PROJECTING LLOSSES - MMAY 22003In order to assess the strength of this study as a predictor of rating actions, wereviewed rating changes on the 112 BB bonds from the prior version of this study.3

Over the course of a year, we would expect the bonds with the lowest subordi-nation-to-loss ratios to experience the greatest number of downgrades.Likewise, we would expect the bonds with the highest subordination-to-lossratios to experience the greatest number of upgrades.





12 7.9 15 9.9

18 11.9 21 13.9

16 10.6 20 13.2

15 9.9 16 10.6

13 8.6 9 6.0

5 3.3 3 2.0

6 4.0 3 2.0

1 0.7 3 2.0

65 43.0 61 40.4

3See Projecting Losses: Are BBs Safe? May 2003.



148

chapter 9

We found this to be true when we compared the number of rating actions onthe top half of the ranked list of bonds to the rating actions on the bottom halfof the ranked list. The 56 bonds with the highest ratios experienced 13upgrades and 5 downgrades, while the 56 bonds with the lowest ratios experi-enced 13 downgrades and 1 upgrade.

We also found that the rating actions were concentrated at the extremes of thelist. The 20 bonds with the highest subordination-to-loss ratios experienced themajority of the upgrades (8), and the 20 bonds with the lowest subordination-to-loss ratios experienced half of the downgrades (9).

METHODOLOGYIn this section, we analyze non-investment grade classes of 151 conduit transac-tions tracked by Trepp. Each conduit transaction was issued between January1997 and December 2001. 142 of 151 classes are currently rated BB byMoody’s, Fitch or S&P; the other 9 classes are rated BB+ or BB-.

For each transaction, we calculate a future expected loss rate based on historicallosses and losses implied by the current level of 30, 60, and 90-day delinquencies,

REO, foreclosures, performing specially serviced loans and servicer watchlistedloans. We do not account for the impact of defeased collateral within the deals.


# of Classes # of ClassesRankings2 Upgraded Downgraded

1-56 13 5

57-112 1 13

PROJECTING LOSSES STUDY - MAY 2003# OF UPGRADES AND DOWNGRADES ON 112 BB BONDS1

exhibit 10

1Since May 2003.2Highest Ratio: Rank of 1; Lowest Ratio: Rank of 112


4See Special Servicer Severities, February 6, 2004.




Calculating LLoan LLosses: AAverage TTiming oof DDefaultsWe then multiply the projected liquidated loan total by a severity rate to computeeach deal’s expected loss rate for the year. For our analysis, we consider two lossseverity rates: 34% and 43%.

The first severity rate that we assume is 34%. Liquidated life insurance companyloans in the Commercial Mortgage Default Study: 1972-2000, by Howard Esaki, expe-rienced a 34% severity rate. The average severity rate on liquidated CMBS loansis higher, at 43%4. The calculated loss rates for the year are then used in con-junction with historical losses to project future loss rates.




According to the timing of defaults presented in Esaki’s study, about 47% ofloans default by the end of year 5. The DLJCM 2000-CKP1 transaction isexpected to have a 2.8% loss rate by year 5, based on historical losses and pro-jected losses of currently delinquent loans. If we apply the results of Esaki’sstudy, this 2.8% loss rate should correspond to 47% of total loan losses.Therefore, we conclude that this transaction may suffer from a 3.2% loss rate(based on original balances) during its remaining lifetime, since 53% of loan loss-es have yet to occur. (2.8%*(1-47%)¸47%=3.2% loss rate) A 3.2% loss rate basedon original balances corresponds to a 3.5% loss rate, based on current balances.



Since most of the CMBS transactions in our study have seasoned for less than 6years, the 1986 default timing curve assumes that the majority of losses have notyet occurred. Using this back-loaded timing curve, the projected future lossesfor these CMBS transactions are higher than in our initial analysis, resulting inlower subordination-to-loss ratios.



150

chapter 9

Total Cumulative



1 0.2 1.5 1.5

2 1.0 6.9 8.4

3 1.7 11.5 19.9

4 2.0 13.1 33.0

5 2.1 13.9 46.9

6 2.3 15.2 62.1

7 2.8 18.9 81.0

8 1.5 9.7 90.7

9 0.9 5.7 96.4

10 0.5 3.6 100.0

AVERAGE TIMING OF DEFAULTS FROM ESAKI’SCOMMERCIAL MORTGAGE DEFAULT STUDY1

exhibit 11




Total Cumulative



1 0.0 0.0 0.0

2 0.9 3.2 3.2

3 2.3 7.9 11.1

4 2.1 7.5 18.6

5 3.3 11.3 29.9

6 5.8 20.2 50.2

7 10.3 35.8 86.0

8 2.5 8.6 94.6

9 1.3 4.6 99.2

10 0.2 0.8 100.0


exhibit 12

1Real Estate Finance, Commercial Mortgage Defaults: 1972-2000, by Howard Esaki, Winter 2002 Edition




152

chapter 9


exhibit 13


* S&P Rating

Current Current



DLJCM 2000-CKP1 B5 B3 BB 0.00 0.00 0.10 0.25 0.20

JPMCC 2001-C1 J - BB 0.10 0.00 0.54 0.00 3.10

JPMC 2000-C9 H B1 BB 0.00 0.00 0.46 0.56 0.00

SBM7 2000-C3 J Ba3 BB* 2.43 2.14 0.00 0.00 1.63

SBM7 2000-C2 J Ba2 BB 0.00 0.00 2.14 4.01 1.93

BACM 2001-1 K Ba2 BB 0.35 0.00 4.66 0.11 1.05

SBM7 2001-C1 J Ba2 - 0.40 0.00 3.62 0.00 1.77

GECMC 2000-1 H Ba2 BB- 0.00 1.37 2.41 0.00 0.00

FUNBC 2001-C4 L Ba2 - 0.00 0.00 0.00 1.51 0.33

MSDWC 2001-TOP1 H - BB 0.00 0.36 2.50 0.00 0.00

GMACC 2001-C1 J - BB 1.20 0.00 5.32 0.00 0.00

GMACC 2000-C2 G - BB* 5.02 0.00 3.16 0.00 0.00

GMACC 2000-C3 J Ba2 BB 0.17 0.00 0.86 0.00 0.54

BSCMS 2001-TOP2 H - BB 0.00 0.00 2.67 0.00 0.00

CSFB 2001-CF2 J Ba2 BB 0.07 0.07 1.08 0.00 0.21

BACM 2001-PB1 L Ba2 - 0.00 0.00 0.00 0.00 0.00

KEY 2000-C1 J Ba2 - 0.00 0.00 1.11 0.74 3.09

PNCMA 2001-C1 J Ba2 - 0.00 0.00 0.00 0.00 0.00

BAFU 2001-3 L - BB 0.00 0.00 0.54 0.00 0.00

GMACC 2000-C1 H Ba2 BB 0.00 1.46 5.18 0.00 0.50

LBUBS 2000-C5 H Ba1 BB* 0.00 0.00 2.40 0.00 0.47

FUBOA 2001-C1 L Ba2 BB 0.29 0.17 0.69 0.00 0.00

COMM 2000-C1 G - BB 0.00 0.00 0.00 0.98 0.00

GMACC 1999-C3 G Ba2 - 0.35 0.00 7.18 0.00 0.00

LBUBS 2000-C3 J Ba2 BB 0.00 0.00 0.44 0.16 0.92

FUNBC 1999-C4 H - BB 0.00 0.00 0.17 1.46 1.25

JPMC 1999-C8 G Ba3 BB+ 0.64 0.00 1.69 0.00 0.30

GECMC 2001-2 I Ba2 BB 0.00 0.00 0.50 0.00 0.50

PMCF 2001-ROCK J Ba2 BB 0.00 0.00 0.00 0.00 0.00

CSFB 2000-C1 H - BB 0.19 0.00 1.33 0.00 2.05

MSDWC 2000-LIFE J - BB 0.60 0.00 0.38 0.00 1.19

JPMCC 2001-CIBC H - BB 0.67 0.00 1.31 0.00 0.57

PNCMA 2000-C1 H Ba2 BB 0.29 0.85 2.69 0.00 0.36

MSC 1998-CF1 D Ba2 - 1.37 0.10 0.92 4.07 0.26

CSFB 1999-C1 H - BB 0.13 1.51 0.10 0.58 2.91


Future




Watchlisted Losses and

or Performing Exp. Loss for Ratio of BB

Perf. Specially Historical Current Subordination

Spec. Serviced Cumulative Delinquency Current BB to Future

Serv. Watchlist Loans (% of Loss (% of Levels (% of Subordination Expected

(%) (%) orig. bal.) orig. bal.) curr. bal.) (%) Loss

0.00 23.89 0.3 2.5 3.5 2.2 0.6

0.00 12.79 1.2 0.0 5.1 4.6 0.9

0.66 35.79 0.5 2.0 3.3 4.1 1.3

0.00 11.36 0.9 0.6 3.2 4.1 1.3

1.97 25.19 2.4 0.6 3.7 5.0 1.3

0.85 28.86 1.5 0.1 3.4 4.7 1.4

4.57 15.74 1.5 0.1 3.3 4.8 1.5

1.69 29.03 0.8 0.5 2.8 4.7 1.7

0.09 19.70 0.8 0.0 3.2 5.5 1.7

1.49 23.71 0.7 0.0 1.5 2.8 1.9

0.00 29.06 1.2 0.0 2.6 5.0 1.9

0.00 24.86 0.9 1.0 2.3 4.5 2.0

0.00 33.43 0.6 0.2 1.7 3.8 2.3

1.72 12.96 0.6 0.0 1.3 3.0 2.3

0.01 0.00 0.3 0.5 1.7 3.9 2.3

1.24 12.22 0.1 0.6 1.6 4.3 2.7

0.00 17.31 1.6 0.2 2.1 6.0 2.9

0.84 12.75 0.1 0.5 1.4 4.0 2.9

0.00 15.60 0.2 0.6 1.7 5.1 3.0

1.20 21.17 1.4 0.0 1.7 5.5 3.3

0.65 19.95 0.7 0.0 1.6 5.3 3.3

3.53 26.32 0.4 0.2 1.4 4.7 3.3

0.36 44.34 0.7 0.7 1.6 5.5 3.4

0.00 19.70 1.4 0.7 1.4 4.7 3.4

1.12 32.68 0.7 0.2 1.1 3.7 3.4

1.02 22.95 1.1 0.1 1.5 5.2 3.5

0.67 18.81 0.5 2.5 2.1 7.3 3.5

0.00 25.26 0.5 0.1 1.2 4.8 3.8

0.25 5.57 0.0 0.4 1.0 3.8 3.8

0.56 20.04 1.1 0.0 1.3 5.1 3.9

0.00 16.04 0.6 0.4 1.2 4.7 3.9

6.50 0.00 0.6 0.1 1.3 5.1 3.9

0.83 23.23 0.9 0.2 1.2 5.5 4.4

6.11 21.83 1.6 5.7 2.2 10.3 4.7

7.00 17.35 1.5 0.4 1.2 5.8 4.7



154

chapter 9

1997-2001 CONDUIT DEALS RANKED BY SUBORDINATION-TO-LOSS RATIO (34% SEVERITY; AVERAGE DEFAULT TIMING CURVE)(CONTINUED)

exhibit 13


* S&P Rating

Current Current



GSMS 1999-C1 F Ba2 - 0.23 0.00 4.91 0.52 0.25

LBUBS 2000-C4 J Ba2 - 0.00 0.00 0.08 0.00 1.55

CSFB 2001-CK6 K Ba2 - 0.19 0.97 0.01 0.00 0.00

SBM7 2001-C2 K Ba2 - 1.67 0.79 0.00 0.00 0.00

DLJCM 2000-CF1 B4 - BB 0.30 6.34 0.22 0.00 0.23

FUNBC 2001-C2 L Ba2 - 0.00 0.00 0.00 0.22 0.32

HFCMC 2000-PH1 H Ba2 - 1.31 0.10 0.72 0.00 0.29

CSFB 2001-CKN5 K Ba2 - 0.00 0.00 0.00 0.50 0.00

MLMI 1999-C1 F - BB* 1.14 0.00 2.92 4.82 3.15

GECMC 2001-3 I - BB 0.00 0.00 0.00 0.85 0.00

JPMC 2000-C10 H Ba2 BB 0.00 0.00 1.10 0.00 0.38

MSC 1999-FNV1 H - BB 0.27 0.00 3.08 1.58 2.58

BSCMS 2000-WF2 H - BB* 2.04 0.00 2.01 0.00 0.00

FUNBC 2000-C1 H - BB 0.00 0.00 0.00 0.00 0.00

BSCMS 1999-C1 G Ba2 - 0.81 0.00 1.37 0.00 0.00

DLJCM 1999-CG1 B4 - BB 0.93 0.00 0.95 0.00 1.22

LBCMT 1999-C1 G Ba2 - 0.00 0.00 0.67 0.00 0.00

BSCMS 2000-WF1 H - BB 0.00 0.64 0.00 0.00 0.46

DMARC 1998-C1 F - BB+ 0.10 0.00 0.00 2.17 1.02

CSFB 2001-CK1 J Ba2 BB 0.15 0.12 0.00 0.00 0.21

LBCMT 1999-C2 H Ba2 - 0.00 0.00 0.36 0.98 1.10

SBM7 2000-C1 J Ba2 - 0.55 0.00 1.83 0.00 0.64

CCMSC 2000-3 H - BB* 0.35 0.00 1.43 0.50 0.00

LBUBS 2001-C2 J Ba2 BB 0.00 0.20 0.33 0.00 0.00

JPMCC 2001-CIB2 H - BB 0.00 0.00 0.00 0.00 0.51

GMACC 1999-C2 H Ba2 - 0.00 0.00 5.66 0.00 0.00

GMACC 2001-C2 K - BB 0.00 0.00 0.56 0.00 0.00

GECMC 2001-1 I Ba2 BB 0.86 0.00 0.20 0.00 0.00

DLJCM 1999-CG2 B4 Ba2 BB 0.07 0.00 1.88 0.13 1.67

BSCMS 1999-WF2 H - BB 0.00 0.00 1.01 0.00 0.49

FUNCM 1999-C2 H Ba2 BB 0.00 0.00 1.33 0.00 0.00

FUNBC 2000-C2 H - BB 0.34 0.00 0.00 1.21 0.07

GMACC 1999-C1 F - BB 0.00 0.00 2.47 0.00 0.00

BSCMS 2001-TOP4 H Ba2 - 0.00 0.00 0.49 0.00 0.00

FUNBC 2001-C3 K - BB 0.00 0.00 0.18 0.00 0.00


Future










0.38 28.35 1.3 0.9 1.5 7.2 4.8

3.46 19.85 0.7 0.0 0.9 4.4 5.0

0.70 15.07 0.2 0.0 0.9 4.7 5.0

0.00 12.43 0.2 0.0 0.9 4.8 5.1

2.26 23.10 0.9 0.0 1.0 5.4 5.2

0.75 25.88 0.4 0.0 0.8 4.4 5.2

0.91 21.30 0.4 0.5 1.1 5.7 5.2

0.00 19.13 0.3 0.1 0.9 4.7 5.3

0.18 18.95 3.1 0.0 2.1 11.2 5.3

0.00 24.70 0.5 0.0 1.0 5.4 5.3

2.19 12.83 0.4 0.3 1.0 5.3 5.5

0.36 18.54 2.0 0.1 1.4 7.7 5.6

0.00 13.53 0.5 0.0 0.6 3.7 5.8

2.11 33.34 0.3 0.4 0.9 5.1 5.8

0.00 13.92 0.4 0.6 0.7 4.0 6.0

0.26 32.28 0.8 0.6 0.9 5.7 6.1

1.76 29.61 0.4 0.4 0.5 3.3 6.3

1.07 7.50 0.3 0.2 0.6 3.8 6.3

1.74 23.83 1.0 3.5 1.4 9.0 6.6

0.00 31.82 0.3 0.0 0.7 4.9 6.7

0.00 22.92 0.9 0.0 0.6 4.0 6.7

2.12 16.74 0.7 0.0 0.9 5.8 6.8

0.65 24.90 0.7 0.0 0.8 5.2 6.8

0.17 29.40 0.3 0.0 0.7 4.6 6.8

0.62 15.11 0.3 0.0 0.7 5.0 7.1

0.00 15.12 1.1 0.0 0.8 5.4 7.2

0.00 30.04 0.4 0.0 0.7 5.4 7.4

1.42 27.03 0.3 0.0 0.7 5.0 7.7

0.60 28.22 1.1 0.2 0.8 6.6 7.8

0.00 6.62 0.4 0.4 0.5 4.0 7.8

0.63 33.13 0.5 0.6 0.7 5.9 7.9

0.53 21.55 0.6 0.0 0.7 5.8 8.1

1.72 0.00 0.4 0.8 0.8 6.7 8.3

0.00 10.81 0.2 0.0 0.4 3.1 8.3

1.37 27.50 0.3 0.0 0.6 5.4 9.0



156

chapter 9


exhibit 13


* S&P Rating

Current Current



CSFB 2001-CK3 J Ba2 BB 0.00 0.00 0.10 0.00 0.00

MSDWC 2001-TOP5 H Ba2 - 0.00 0.00 0.00 0.00 0.00

JPMCC 2001-CIB3 H - BB 0.00 0.00 0.00 0.00 0.00

MCFI 1998-MC2 G - BB 0.00 0.00 0.00 0.00 0.48

MSDWC 2001-TOP3 H Ba2 BB 0.00 0.00 0.50 0.00 0.00

BACM 2000-2 K Ba2 - 0.00 0.00 0.00 0.00 0.17

COMM 1999-1 G - BB 0.00 0.00 0.33 1.25 1.19

CSFB 2001-CP4 J - BB 0.00 0.00 0.00 0.00 0.00

MSC 1999-LIFE1 J - BB 0.00 0.00 0.00 1.75 0.00

LBUBS 2001-C3 J - BB 0.00 0.00 0.00 0.00 0.00

GSMS 1998-C1 F - BB+* 0.07 0.00 1.52 1.15 1.50

PSSF 1999-NRF1 G Ba2 BB 0.00 0.00 0.00 0.48 0.00

PSSF 1999-C2 J - BB* 0.00 0.00 0.00 0.93 0.57

DLJCM 1999-CG3 B4 Ba2 BB 0.95 0.00 1.17 0.30 0.37

LBUBS 2001-C7 K Ba2 - 0.00 0.00 0.10 0.00 0.00

BACM 2000-1 H Ba2 - 0.00 0.00 1.68 0.00 0.00

FUCMT 1999-C1 F Ba2 - 0.00 0.00 0.00 0.24 0.32

MLMI 1998-C3 E Ba1 BBB-* 0.00 2.51 0.00 0.00 0.00

MLMI 1997-C2 F - BB 0.74 0.00 2.65 1.02 0.22

CSFB 1997-C2 F - BB 0.56 0.00 5.98 0.00 1.25

CCMSC 2000-2 H Ba2 - 0.00 0.86 0.00 0.00 0.00

GMACC 1997-C2 E Ba1 Ba1 0.00 0.00 1.55 0.00 3.86

AMC 1998-C1 F Ba2 BB 0.00 0.00 1.24 0.00 0.97

CASC 1998-D7 B-2 - BB 0.00 0.13 1.20 2.30 0.48

HFCMC 1999-PH1 J - BB 0.38 0.00 1.69 0.00 0.00

PNCMA 1999-CM1 B4 - BB* 0.54 0.17 0.00 0.00 0.00

JPMC 1998-C6 F - BB 0.00 0.63 8.23 0.00 0.00

FULBA 1998-C2 G Ba2 - 0.43 0.57 0.00 0.20 1.09

MCFI 1998-MC3 F Ba1 BB* 0.32 0.23 0.29 0.00 1.39

MSC 1998-HF1 G - BB* 0.00 0.00 1.23 0.00 0.00

JPMC 1997-C5 F - BB 0.00 0.71 2.96 0.00 0.00

LBCMT 1998-C1 G - BB 0.15 0.23 1.71 0.00 0.16

MCFI 1998-MC1 H - BB+* 0.76 0.00 1.25 0.48 0.07

NLFC 1999-1 F Ba2 - 0.00 0.00 0.00 0.45 0.00

MSDWC 2000-LIF2 J Ba2 BB 0.00 0.00 0.00 0.00 0.00


Future










0.76 23.92 0.2 0.0 0.5 4.5 9.2

0.00 9.77 0.1 0.0 0.3 3.1 9.3

0.00 14.56 0.1 0.0 0.5 4.6 9.3

0.80 26.08 0.3 1.3 0.5 4.3 9.3

0.00 7.88 0.2 0.0 0.3 3.0 9.3

0.00 34.89 0.3 0.1 0.5 5.1 9.5

2.74 31.76 1.1 0.0 0.8 7.3 9.5

3.27 15.48 0.2 0.0 0.5 4.6 9.8

0.00 22.61 0.7 0.0 0.5 4.7 9.8

1.01 18.90 0.2 0.0 0.4 3.6 9.9

0.94 17.17 1.2 1.4 0.7 7.0 10.1

0.21 23.83 0.3 0.5 0.6 6.4 10.5

0.00 22.47 0.6 0.3 0.6 7.1 11.1

0.92 36.30 0.8 0.1 0.5 6.1 11.2

0.00 6.31 0.1 0.0 0.3 3.3 11.4

4.88 8.70 0.4 0.1 0.6 7.0 11.5

1.73 21.73 0.4 0.5 0.6 6.6 11.7

0.00 28.53 0.4 2.8 0.9 11.1 12.0

1.71 31.03 1.0 0.7 0.5 6.0 12.1

1.13 20.39 1.5 2.1 0.4 5.4 12.4

0.00 34.33 0.4 0.0 0.4 5.2 12.4

3.05 35.75 1.5 1.9 1.1 13.2 12.5

0.00 23.48 0.6 1.4 0.6 8.3 13.4

0.00 11.08 1.1 0.6 0.5 6.4 13.5

0.43 17.49 0.4 0.1 0.4 5.4 13.8

0.90 15.41 0.2 0.5 0.4 6.2 14.1

0.00 18.99 1.5 0.0 0.4 5.9 14.3

5.37 17.25 0.6 0.7 0.4 5.6 14.9

0.66 26.23 0.7 0.3 0.7 10.2 15.2

0.91 16.57 0.3 1.0 0.4 5.8 15.6

0.40 22.67 0.5 2.0 0.4 6.7 16.0

1.46 31.78 0.6 1.1 0.5 7.6 16.3

0.00 26.40 0.6 1.3 0.5 8.2 16.6

0.75 25.83 0.3 0.3 0.5 8.1 16.7

0.00 20.34 0.2 0.0 0.2 3.3 16.8



158

chapter 9


exhibit 13


* S&P Rating

Current Current



NLFC 1998-2 F - BB* 0.52 0.07 1.33 0.00 0.58

NLFC 1998-1 F - BB 0.25 0.37 3.66 0.00 0.00

CSFB 1998-C2 F Ba2 BB 0.53 0.00 0.00 0.86 0.00

SBM7 1999-C1 H - BB 0.00 0.00 2.64 0.00 0.00

CMAC 1998-C2 G - BB 0.78 0.00 3.15 0.00 0.00

CMFUN 1999-1 H - BB* 0.00 0.00 0.22 0.00 0.25

JPMC 1999-C7 F - BB 0.12 0.00 0.00 0.00 1.11

GMACC 1997-C1 G - BB+ 2.11 0.00 0.22 0.00 0.82

CMAT 1999-C2 J Ba2 - 0.00 0.00 0.67 0.00 0.00

CCMSC 1997-1 F - BB* 0.00 0.00 0.96 0.00 4.15

MCFI 1997-MC1 F - BB 0.00 0.00 7.88 0.00 2.09

PNCMA 2000-C2 J Ba2 - 0.00 0.00 0.19 0.00 0.00

DLJMA 1997-CF2 B3TB B1 BB* 0.00 0.00 3.69 10.73 0.00

DLJCM 1998-CG1 B4 - BB 0.66 0.81 0.44 0.00 0.00

CCMSC 1998-1 F Ba2 - 0.00 0.00 0.00 0.00 0.00

CMAT 1999-C1 G Ba2 - 0.66 0.00 2.20 0.00 1.28

CCMSC 1999-2 H - BB 2.65 0.00 0.00 0.00 0.00

GMACC 1998-C2 G - BB 0.11 0.78 1.41 0.00 0.00

MSC 1998-WF1 G - BB 0.00 0.00 0.39 1.70 0.00

DLJCM 1998-CF2 B-3 - BB 0.08 0.00 0.00 0.77 0.00

MSC 1999-RM1 H Ba2 BB+ 0.00 0.00 0.00 0.00 0.56

FULB 1997-C2 G - BB* 1.17 0.18 1.40 0.00 1.93

PSSF 1998-C1 H Ba2 - 0.00 0.00 0.24 0.22 0.00

ASC 1997-D4 B-2 - BB 0.91 0.00 3.14 0.00 2.20

CMAC 1998-C1 G - BB* 0.24 0.00 0.36 0.00 0.00

BSCMS 1998-C1 G Ba2 - 0.95 0.00 0.49 0.00 1.31

MSC 1998-HF2 G - BB 0.00 0.00 0.83 0.00 0.48

CCMSC 1998-2 F - BB 0.00 0.00 0.69 0.00 0.00

CSFB 1997-C1 F - BB 0.00 0.00 2.67 0.19 0.00

LBCMT 1998-C4 G Ba2 - 0.51 0.00 0.13 0.87 0.17

CCMSC 1997-2 F - BB 0.56 0.00 4.11 0.00 0.00

ASC 1997-D5 A5 - BB 0.00 0.00 0.00 2.90 0.88

GMACC 1998-C1 H - BB 0.00 0.31 0.18 0.00 0.00

NASC 1998-D6 B-2 - BB 0.12 0.00 1.38 0.43 0.00

CMAC 1999-C1 J Ba2 - 0.96 0.89 0.00 0.00 0.00


Future










1.07 6.11 0.5 0.8 0.3 6.0 17.6

1.15 15.17 0.7 0.8 0.5 8.1 17.9

3.38 20.39 0.5 0.9 0.4 6.3 17.9

0.00 19.05 0.6 0.0 0.4 7.6 18.8

0.98 11.93 0.6 0.7 0.4 6.8 19.4

0.00 18.87 0.3 0.2 0.3 5.4 19.7

0.00 30.16 0.6 0.0 0.4 7.7 19.8

0.85 23.45 0.4 1.9 0.3 6.8 19.9

0.30 0.00 0.1 0.4 0.3 6.2 20.2

0.00 15.47 1.2 1.0 0.3 6.6 20.5

2.28 30.85 1.6 0.7 0.4 7.6 20.5

0.00 22.49 0.2 0.0 0.3 5.3 20.6

0.00 21.29 3.5 0.3 0.5 11.2 21.9

1.91 26.87 0.4 0.5 0.3 5.6 22.0

0.00 25.45 0.2 0.7 0.3 5.7 22.1

0.63 15.31 1.0 0.2 0.3 6.5 22.1

2.45 34.80 0.4 0.0 0.3 5.9 22.6

1.09 23.40 0.5 0.3 0.2 5.2 23.3

2.61 24.22 0.7 0.2 0.3 6.5 23.8

0.00 37.73 0.5 0.5 0.3 6.6 24.7

0.00 0.00 0.2 0.3 0.3 7.8 25.4

2.59 20.51 0.9 0.9 0.2 6.6 26.7

0.50 13.85 0.2 0.6 0.2 6.6 27.1

7.41 6.60 1.2 0.6 0.2 6.9 28.4

0.49 27.78 0.3 0.5 0.2 6.2 28.5

0.52 19.03 0.7 0.0 0.2 5.2 29.0

3.16 23.68 0.5 0.5 0.3 8.1 29.4

0.00 17.37 0.3 0.4 0.2 5.4 31.9

9.08 18.31 0.6 0.9 0.2 7.3 33.2

0.90 29.33 0.6 0.0 0.2 5.3 33.9

0.96 23.76 0.7 0.5 0.2 6.1 35.7

0.82 16.78 1.2 1.6 0.3 12.1 35.8

18.01 0.00 0.3 0.3 0.2 6.3 36.4

0.79 14.66 0.5 0.1 0.1 5.6 38.4

0.55 16.22 0.2 0.0 0.2 6.0 38.6



160

chapter 9


exhibit 13


* S&P Rating

Current Current



DLJCM 1998-CF1 B4 - BB 0.00 0.00 0.72 0.00 0.00

ACMF 1997-C1 G - BB* 9.58 0.00 6.74 0.00 0.00

FULB 1997-C1 F - BB* 0.00 0.74 1.35 1.40 0.73

NLFC 1999-2 G - BB* 0.00 0.00 0.00 0.00 0.00

MCFI 1997-MC2 F - BB 0.00 0.00 1.41 0.00 0.00

MSC 1997-C1 F Ba2 BBB+ 0.00 0.00 0.00 0.00 2.00

MSC 1997-HF1 G - BB+ 0.00 1.17 1.52 0.00 0.00

MSC 1999-WF1 H Ba2 BB+ 0.00 0.00 0.00 0.00 0.00

MSC 1998-WF2 H - BB 0.00 0.00 0.00 0.00 0.00

JPMC 1997-C4 G - BB- 0.00 0.00 0.43 0.00 0.00

MSC 1997-WF1 G - BB 0.00 0.00 0.00 0.00 0.00


Future










0.93 20.71 0.3 0.3 0.2 6.7 44.1

0.00 32.57 1.1 0.0 0.2 9.4 48.9

2.69 23.65 0.8 0.3 0.2 9.5 52.4

1.45 19.41 0.1 0.0 0.1 6.6 56.8

2.21 19.53 0.4 0.6 0.1 7.4 59.3

1.92 23.76 0.5 0.8 0.3 15.9 63.1

0.00 0.00 0.2 0.4 0.1 7.6 65.3

0.00 2.90 0.0 0.1 0.1 5.7 91.4

1.18 11.26 0.1 0.0 0.0 5.0 182.6

0.00 0.00 0.0 0.0 0.0 5.6 678.9

2.12 6.03 0.1 0.0 0.0 6.2 694.4



162

chapter 9

Section III: Projecting Losses on Single-B CMBSIn Sections I and II, we ranked BBB- and BB CMBS bonds based on their levelof principal protection from losses. In this section, we complete our ProjectingLosses trilogy on subordinate CMBS by ranking the universe of single-B conduitbonds. We measure the level of principal protection on a bond by comparing thefuture expected losses for the deal’s collateral to the current credit support forthe bond. The rankings by subordination to expected loss ratio are provided inExhibit 17 of this section.

RATIOS AAND RRANKINGSWe believe that the bonds at the top of the list (with the lowest ratios) have thehighest chance of default and downgrade. Likewise, we believe that the bonds atthe bottom of the list (with the highest ratios) have a higher level of principalprotection and a lower chance for rating agency downgrade.

SINGLE-B SUBORDINATION TO EXPECTED LOSS RATIOS FOR 1997-2001 CONDUITS

exhibit 14


Ranges for Single B Average Default Average Default




0-1 12 7.9 17 11.2

1-2 20 13.2 24 15.8

2-3 20 13.2 24 15.8

3-4 18 11.8 10 6.6

4-5 10 6.6 14 9.2

5-6 11 7.2 9 5.9

6-7 10 6.6 8 5.3

7-8 7 4.6 7 4.6

>8 44 28.9 39 25.7

2Ratio of 27.2, assuming average default timing curve from Esaki study and 34% severity rate; Ratio of 44.0,assuming 1986 default timing curve and 43% severity rate.


A ratio that is less than 1 means that we expect the class to default before matu-rity; a ratio of greater than 1 means we expect no default. Depending on theseverity assumption and timing curve used to project future losses, between 12and 39 bonds have subordination to loss ratios of less than 1 (See Exhibit 14).Between 20 and 32 bonds have a ratio between 1 and 2. We believe that classeswith a ratio between 1 and 2 may be vulnerable to a downgrade.


For example, while ASC 1997-D5 A6 has a high subordination to expected lossratio2, this class was downgraded by Fitch in September 2003 to B from BB+.The downgrade was prompted by interest shortfalls caused by servicer reim-bursements of non-recoverable advances. S&P also downgraded this tranche toD from BBB-.





33 21.7 39 25.7

32 21.1 32 21.1

16 10.5 16 10.5

7 4.6 3 2.0

3 2.0 5 3.3

4 2.6 4 2.6

6 3.9 4 2.6

3 2.0 4 2.6

48 31.6 45 29.6



164

chapter 9

Projecting LLosses - JJune 22003In order to assess the strength of this study as a predictor of rating actions, wereviewed rating changes on the 117 single-B bonds from the prior version ofthis study.

Over the course of a year, we would expect the bonds with the lowest subordi-nation to loss ratios to experience the greatest number of downgrades. Wefound that 13 of the 20 single-B classes with the lowest ratios were downgradedduring the past year. The number of downgraded classes declined as ratiosincreased, with only 4 of the next 20 ranked bonds being downgraded.

Likewise, we would expect the bonds with the highest subordination to lossratios to experience the fewest downgrades and/or the most upgrades. Of the20 bonds with the highest ratios, we found that 2 were downgraded during thepast year, while 2 were upgraded. The number of upgraded classes declined asratios decreased, with only 1 of the next 20 ranked bonds experiencing anupgrade. No other classes were upgraded since the prior version of the study.

METHODOLOGYIn this section, we analyze single-B classes of 152 conduit transactions trackedby Trepp. Each conduit transaction was issued between January 1997 andDecember 2001. 126 of the 152 classes are currently rated single-B by Moody’s,Fitch or S&P; the other 26 classes are rated B+ or B-.

For each transaction, we calculate a future expected loss rate based on histori-cal losses and losses implied by the current level of 30, 60, and 90-day delin-quencies, REO, foreclosures, performing specially serviced loans and servicerwatchlisted loans. We do not account for the impact of defeased collateralwithin the deals.




3See Special Servicer Severities, February 6, 2004.


Calculating LLoan LLosses: AAverage TTiming oof DDefaultsWe then multiply the projected liquidated loan total by a severity rate to computeeach deal’s expected loss rate for the year. For our analysis, we consider two lossseverity rates: 34% and 43%.

The first severity rate that we assume is 34%. Liquidated life insurance companyloans in the Commercial Mortgage Default Study: 1972-2000, by Howard Esaki,experienced a 34% severity rate. The average severity rate on liquidated CMBSloans is higher, at 43%3. The calculated loss rates for the year are then used inconjunction with historical losses to project future loss rates.




According to the timing of defaults presented in Esaki’s study, about 47% ofloans default by the end of year 5. The DLJCM 2000-CKP1 transaction isexpected to have a 2.8% loss rate by year 5, based on historical losses and pro-jected losses of currently delinquent loans. If we apply the results of Esaki’sstudy, this 2.8% loss rate should correspond to 47% of total loan losses.Therefore, we conclude that this transaction may suffer a 3.2% loss rate (basedon original balances) during its remaining lifetime, since 53% of loan losses haveyet to occur. (2.8%*(1-47%)¸47%=3.2% loss rate) A 3.2% loss rate based onoriginal balances corresponds to a 3.5% loss rate, based on current balances.



Since most of the CMBS transactions in our study have seasoned for less thansix years, the 1986 default timing curve assumes that the majority of losses havenot yet occurred. Using this back-loaded timing curve, the projected future loss-es for these CMBS transactions are higher than in our initial analysis, resulting inlower subordination to loss ratios.



166

chapter 9

Total Defaults Cumulative

Default Rates from That Occur Level of Defaults


1 0.2 1.5 1.5

2 1.0 6.9 8.4

3 1.7 11.5 19.9

4 2.0 13.1 33.0

5 2.1 13.9 46.9

6 2.3 15.2 62.1

7 2.8 18.9 81.0

8 1.5 9.7 90.7

9 0.9 5.7 96.4

10 0.5 3.6 100.0

AVERAGE TIMING OF DEFAULTS FROM ESAKI’SCOMMERCIAL MORTGAGE DEFAULT STUDY1

exhibit 15




Total Defaults Cumulative

Default Rates from That Occur Level of Defaults


1 0.0 0.0 0.0

2 0.9 3.2 3.2

3 2.3 7.9 11.1

4 2.1 7.5 18.6

5 3.3 11.3 29.9

6 5.8 20.2 50.2

7 10.3 35.8 86.0

8 2.5 8.6 94.6

9 1.3 4.6 99.2

10 0.2 0.8 100.0


exhibit 16





168

chapter 9


exhibit 17


* S&P Rating

Current Current



DLJCM 2000-CKP1 B6 Caa1 B+ 0.00 0.00 0.10 0.25 0.20

JPMCC 2001-C1 M - B 0.10 0.00 0.54 0.00 3.10

GECMC 2000-1 K - B 0.00 1.37 2.41 0.00 0.00

SBM7 2000-C3 L B3 B* 2.43 2.14 0.00 0.00 1.63

MSDWC 2001-TOP1 L - B 0.00 0.36 2.50 0.00 0.00

SBM7 2001-C1 M B2 - 0.40 0.00 3.62 0.00 1.77

CSFB 2001-CF2 M B2 B 0.07 0.07 1.08 0.00 0.21

GMACC 2000-C3 M B2 B 0.17 0.00 0.86 0.00 0.54

GMACC 2001-C1 M - B 1.20 0.00 5.32 0.00 0.00

SBM7 2000-C2 L B2 B 0.00 0.00 2.14 4.01 1.93

BACM 2001-1 N B2 B 0.35 0.00 4.66 0.11 1.05

FUNBC 2001-C4 O B2 - 0.00 0.00 0.00 1.51 0.33

BSCMS 2001-TOP2 L - B 0.00 0.00 2.67 0.00 0.00

CCMSC 2000-1 H - B* 0.00 0.84 9.59 1.21 7.45

GMACC 1999-C3 K B2 - 0.35 0.00 7.18 0.00 0.00

LBUBS 2000-C3 M B2 - 0.00 0.00 0.44 0.16 0.92

KEY 2000-C1 M B2 - 0.00 0.00 1.11 0.74 3.09

JPMC 2000-C9 H B1 BB 0.00 0.00 0.46 0.56 0.00

PNCMA 2001-C1 M B2 - 0.00 0.00 0.00 0.00 0.00

GMACC 2000-C2 J - B+* 5.02 0.00 3.16 0.00 0.00

GMACC 2000-C1 L B2 B 0.00 1.46 5.18 0.00 0.50

PMCF 2001-ROCK M B2 B 0.00 0.00 0.00 0.00 0.00

BSCMS 1999-C1 I B2 - 0.81 0.00 1.37 0.00 0.00

MSDWC 2000-LIFE L - B 0.60 0.00 0.38 0.00 1.19

BAFU 2001-3 O - B 0.00 0.00 0.54 0.00 0.00

COMM 2000-C1 K - B* 0.00 0.00 0.00 0.98 0.00

FUBOA 2001-C1 O B2 B 0.29 0.17 0.69 0.00 0.00

CSFB 2000-C1 L - B 0.19 0.00 1.33 0.00 2.05

GECMC 2001-2 L B2 B 0.00 0.00 0.50 0.00 0.50

LBCMT 1999-C1 J B2 - 0.00 0.00 0.67 0.00 0.00

PNCMA 2000-C1 L B2 B 0.29 0.85 2.69 0.00 0.36

JPMCC 2001-CIBC L - B 0.67 0.00 1.31 0.00 0.57

JPMC 1999-C8 H B3 BB- 0.64 0.00 1.69 0.00 0.30

FUNBC 1999-C4 L - B 0.00 0.00 0.17 1.46 1.25

LBUBS 2000-C4 M B2 - 0.00 0.00 0.08 0.00 1.55


Future





or Performing Exp. Loss for Ratio of B


Spec. Serviced Cumulative Delinquency Current B to Future



0.00 23.89 0.3 2.5 3.5 1.4 0.4

0.00 12.79 1.2 0.0 5.1 2.5 0.5

1.69 29.03 0.8 0.5 2.8 2.0 0.7

0.00 11.36 0.9 0.6 3.2 2.3 0.7

1.49 23.71 0.7 0.0 1.5 1.1 0.7

4.57 15.74 1.5 0.1 3.3 2.5 0.8

0.01 0.00 0.3 0.5 1.7 1.3 0.8

0.00 33.43 0.6 0.2 1.7 1.4 0.8

0.00 29.06 1.2 0.0 2.6 2.2 0.8

1.97 25.19 2.4 0.6 3.7 3.3 0.9

0.85 28.86 1.5 0.1 3.4 3.0 0.9

0.09 19.70 0.8 0.0 3.2 3.2 1.0

1.72 12.96 0.6 0.0 1.3 1.3 1.0

0.00 44.17 5.0 0.0 5.9 6.0 1.0

0.00 19.70 1.4 0.7 1.4 1.4 1.0

1.12 32.68 0.7 0.2 1.1 1.2 1.1

0.00 17.31 1.6 0.2 2.1 2.2 1.1

0.66 35.79 0.5 2.0 3.3 4.1 1.3

0.84 12.75 0.1 0.5 1.4 1.8 1.3

0.00 24.86 0.9 1.0 2.3 2.9 1.3

1.20 21.17 1.4 0.0 1.7 2.3 1.4

0.25 5.57 0.0 0.4 1.0 1.4 1.4

0.00 13.92 0.4 0.6 0.7 1.0 1.4

0.00 16.04 0.6 0.4 1.2 1.7 1.5

0.00 15.60 0.2 0.6 1.7 2.5 1.5

0.36 44.34 0.7 0.7 1.6 2.7 1.6

3.53 26.32 0.4 0.2 1.4 2.3 1.7

0.56 20.04 1.1 0.0 1.3 2.2 1.7

0.00 25.26 0.5 0.1 1.2 2.2 1.7

1.76 29.61 0.4 0.4 0.5 1.0 1.9

0.83 23.23 0.9 0.2 1.2 2.4 1.9

6.50 0.00 0.6 0.1 1.3 2.5 1.9

0.67 18.81 0.5 2.5 2.1 4.2 2.0

1.02 22.95 1.1 0.1 1.5 3.1 2.1

3.46 19.85 0.7 0.0 0.9 1.8 2.1



170

chapter 9


exhibit 17


* S&P Rating

Current Current



BSCMS 2000-WF1 K - B 0.00 0.64 0.00 0.00 0.46

BSCMS 2000-WF2 L - B 2.04 0.00 2.01 0.00 0.00

CSFB 2001-CKN5 N B2 - 0.00 0.00 0.00 0.50 0.00

LBUBS 2000-C5 K B1 B* 0.00 0.00 2.40 0.00 0.47

LBCMT 1999-C2 L B2 - 0.00 0.00 0.36 0.98 1.10

GSMS 1999-C1 G B3 - 0.23 0.00 4.91 0.52 0.25

JPMC 2000-C10 L B2 B 0.00 0.00 1.10 0.00 0.38

CSFB 2001-CK1 M B2 - 0.15 0.12 0.00 0.00 0.21

HFCMC 2000-PH1 L B2 B 1.31 0.10 0.72 0.00 0.29

CSFB 2001-CK6 N B2 - 0.19 0.97 0.01 0.00 0.00

LBUBS 2001-C2 M B2 B 0.00 0.20 0.33 0.00 0.00

SBM7 2001-C2 N B2 - 1.67 0.79 0.00 0.00 0.00

GECMC 2001-3 L - B 0.00 0.00 0.00 0.85 0.00

DLJCM 1999-CG1 B7 - B 0.93 0.00 0.95 0.00 1.22

CMAT 1999-C1 K B2 - 0.66 0.00 2.20 0.00 1.28

GECMC 2001-1 L B2 - 0.86 0.00 0.20 0.00 0.00

CSFB 1999-C1 K - B 0.13 1.51 0.10 0.58 2.91

FUNBC 2001-C2 O B2 - 0.00 0.00 0.00 0.22 0.32

FUNBC 2000-C1 L - B 0.00 0.00 0.00 0.00 0.00

DLJCM 2000-CF1 B7 - B 0.30 6.34 0.22 0.00 0.23

MLMI 1999-C1 G - B 1.14 0.00 2.92 4.82 3.15

GMACC 1999-C2 K B2 - 0.00 0.00 5.66 0.00 0.00

MCFI 1998-MC2 J - B- 0.00 0.00 0.00 0.00 0.48

CSFB 2001-CK3 M - B- 0.00 0.00 0.10 0.00 0.00

FUNCM 1999-C2 L B2 B 0.00 0.00 1.33 0.00 0.00

PSSF 1999-NRF1 K B2 - 0.00 0.00 0.00 0.48 0.00

CCMSC 2000-3 K - B* 0.35 0.00 1.43 0.50 0.00

MSC 1999-FNV1 K - B 0.27 0.00 3.08 1.58 2.58

JPMCC 2001-CIB2 L - B 0.00 0.00 0.00 0.00 0.51

BSCMS 2001-TOP4 L B2 - 0.00 0.00 0.49 0.00 0.00

GMACC 2001-C2 N - B 0.00 0.00 0.56 0.00 0.00

DLJCM 1999-CG2 B7 - B 0.07 0.00 1.88 0.13 1.67

MSDWC 2001-TOP3 L B2 B 0.00 0.00 0.50 0.00 0.00

MSDWC 2001-TOP5 L B2 - 0.00 0.00 0.00 0.00 0.00

SBM7 2000-C1 M B2 - 0.55 0.00 1.83 0.00 0.64


Future










1.07 7.50 0.3 0.2 0.6 1.2 2.1

0.00 13.53 0.5 0.0 0.6 1.3 2.1

0.00 19.13 0.3 0.1 0.9 2.0 2.2

0.65 19.95 0.7 0.0 1.6 3.7 2.3

0.00 22.92 0.9 0.0 0.6 1.4 2.3

0.38 28.35 1.3 0.9 1.5 3.5 2.3

2.19 12.83 0.4 0.3 1.0 2.3 2.4

0.00 31.82 0.3 0.0 0.7 1.8 2.5

0.91 21.30 0.4 0.5 1.1 2.8 2.5

0.70 15.07 0.2 0.0 0.9 2.5 2.7

0.17 29.40 0.3 0.0 0.7 1.8 2.7

0.00 12.43 0.2 0.0 0.9 2.6 2.8

0.00 24.70 0.5 0.0 1.0 2.8 2.8

0.26 32.28 0.8 0.6 0.9 2.7 2.9

0.63 15.31 1.0 0.2 0.8 2.3 3.0

1.42 27.03 0.3 0.0 0.7 1.9 3.0

7.00 17.35 1.5 0.4 1.2 3.6 3.0

0.75 25.88 0.4 0.0 0.8 2.6 3.1

2.11 33.34 0.3 0.4 0.9 2.8 3.1

2.26 23.10 0.9 0.0 1.0 3.3 3.2

0.18 18.95 3.1 0.0 2.1 6.8 3.2

0.00 15.12 1.1 0.0 0.8 2.4 3.2

0.80 26.08 0.3 1.3 0.5 1.5 3.2

0.76 23.92 0.2 0.0 0.5 1.6 3.2

0.63 33.13 0.5 0.6 0.7 2.5 3.3

0.21 23.83 0.3 0.5 0.6 2.1 3.4

0.65 24.90 0.7 0.0 0.8 2.6 3.4

0.36 18.54 2.0 0.1 1.4 4.8 3.4

0.62 15.11 0.3 0.0 0.7 2.4 3.4

0.00 10.81 0.2 0.0 0.4 1.3 3.5

0.00 30.04 0.4 0.0 0.7 2.6 3.5

0.60 28.22 1.1 0.2 0.8 3.1 3.6

0.00 7.88 0.2 0.0 0.3 1.2 3.7

0.00 9.77 0.1 0.0 0.3 1.3 3.9

2.12 16.74 0.7 0.0 0.9 3.4 4.0



172

chapter 9


exhibit 17


* S&P Rating

BSCMS 1999-WF2 J - B+ 0.00 0.00 1.01 0.00 0.49

GMACC 1999-C1 H - B 0.00 0.00 2.47 0.00 0.00

PMAC 1999-C1 F B3 - 0.00 0.00 0.51 1.64 1.20

DMARC 1998-C1 G - B 0.10 0.00 0.00 2.17 1.02

MSC 1999-LIFE1 M - B 0.00 0.00 0.00 1.75 0.00

MLMI 1998-C3 F - B+* 0.00 2.51 0.00 0.00 0.00

MSC 1998-CF1 D Ba2 B* 1.37 0.10 0.92 4.07 0.26

DLJCM 1999-CG3 B7 B2 B 0.95 0.00 1.17 0.30 0.37

CSFB 2001-CP4 M - B 0.00 0.00 0.00 0.00 0.00

JPMCC 2001-CIB3 L - B 0.00 0.00 0.00 0.00 0.00

COMM 1999-1 J - B 0.00 0.00 0.33 1.25 1.19

PSSF 1999-C2 M - B* 0.00 0.00 0.00 0.93 0.57

MLMI 1997-C2 H - B 0.74 0.00 2.65 1.02 0.22

MLMI 1998-C2 F - B* 0.29 0.27 1.34 0.00 1.53

FUCMT 1999-C1 G B3 B* 0.00 0.00 0.00 0.24 0.32

MSC 1998-HF1 J - B* 0.00 0.00 1.23 0.00 0.00

FUNBC 2001-C3 N - B 0.00 0.00 0.18 0.00 0.00

CCMSC 2000-2 K B2 - 0.00 0.86 0.00 0.00 0.00

CASC 1998-D7 B4 - B- 0.00 0.13 1.20 2.30 0.48

LBUBS 2001-C3 M - B 0.00 0.00 0.00 0.00 0.00

FUNBC 2000-C2 K - B* 0.34 0.00 0.00 1.21 0.07

CSFB 1998-C1 G - B* 1.85 0.78 1.18 1.05 0.97

BACM 2000-2 N B2 - 0.00 0.00 0.00 0.00 0.17

PNCMA 1999-CM1 B7 - B* 0.54 0.17 0.00 0.00 0.00

LBUBS 2001-C7 N B2 - 0.00 0.00 0.10 0.00 0.00

MCFI 1998-MC1 L - B* 0.76 0.00 1.25 0.48 0.07

BACM 2000-1 L B2 - 0.00 0.00 1.68 0.00 0.00

CSFB 1998-C2 H B2 B 0.53 0.00 0.00 0.86 0.00

AMC 1998-C1 G - B 0.00 0.00 1.24 0.00 0.97

MSDWC 2000-LIF2 M B2 B 0.00 0.00 0.00 0.00 0.00

GMACC 1997-C2 F B2 - 0.00 0.00 1.55 0.00 3.86

CCMSC 1998-1 H B3 - 0.00 0.00 0.00 0.00 0.00

JPMC 1998-C6 G - B- 0.00 0.63 8.23 0.00 0.00

CMAC 1998-C2 J - B 0.78 0.00 3.15 0.00 0.00

LBCMT 1998-C1 J - B 0.15 0.23 1.71 0.00 0.16

Current Current




0.00 6.62 0.4 0.4 0.5 2.1 4.1

1.72 0.00 0.4 0.8 0.8 3.4 4.1

2.21 21.36 1.1 1.0 1.5 6.1 4.2

1.74 23.83 1.0 3.5 1.4 5.8 4.2

0.00 22.61 0.7 0.0 0.5 2.1 4.4

0.00 28.53 0.4 2.8 0.9 4.3 4.6

6.11 21.83 1.6 5.7 2.2 10.4 4.8

0.92 36.30 0.8 0.1 0.5 2.6 4.8

3.27 15.48 0.2 0.0 0.5 2.3 4.9

0.00 14.56 0.1 0.0 0.5 2.4 4.9

2.74 31.76 1.1 0.0 0.8 4.0 5.3

0.00 22.47 0.6 0.3 0.6 3.4 5.3

1.71 31.03 1.0 0.7 0.5 2.6 5.3

1.91 0.00 0.6 2.1 0.8 4.5 5.4

1.73 21.73 0.4 0.5 0.6 3.1 5.4

0.91 16.57 0.3 1.0 0.4 2.0 5.5

1.37 27.50 0.3 0.0 0.6 3.4 5.5

0.00 34.33 0.4 0.0 0.4 2.3 5.6

0.00 11.08 1.1 0.6 0.5 2.7 5.7

1.01 18.90 0.2 0.0 0.4 2.1 5.7

0.53 21.55 0.6 0.0 0.7 4.3 5.9

2.61 29.66 1.2 1.3 0.7 4.1 6.1

0.00 34.89 0.3 0.1 0.5 3.3 6.1

0.90 15.41 0.2 0.5 0.4 2.7 6.2

0.00 6.31 0.1 0.0 0.3 1.8 6.2

0.00 26.40 0.6 1.3 0.5 3.1 6.3

4.88 8.70 0.4 0.1 0.6 4.0 6.7

3.38 20.39 0.5 0.9 0.4 2.4 6.8

0.00 23.48 0.6 1.4 0.6 4.2 6.8

0.00 20.34 0.2 0.0 0.2 1.4 6.9

3.05 35.75 1.5 1.9 1.1 7.3 6.9

0.00 25.45 0.2 0.7 0.3 1.8 7.1

0.00 18.99 1.5 0.0 0.4 2.9 7.1

0.98 11.93 0.6 0.7 0.4 2.5 7.2

1.46 31.78 0.6 1.1 0.5 3.4 7.2

Future












174

chapter 9


exhibit 17


* S&P Rating

Current Current



HFCMC 1999-PH1 L B2 B 0.38 0.00 1.69 0.00 0.00

NLFC 1998-1 H - B 0.25 0.37 3.66 0.00 0.00

GSMS 1998-C1 G - B+ 0.07 0.00 1.52 1.15 1.50

CMAT 1999-C2 M B2 - 0.00 0.00 0.67 0.00 0.00

NLFC 1998-2 H - B-* 0.52 0.07 1.33 0.00 0.58

NLFC 1999-1 H B2 B 0.00 0.00 0.00 0.45 0.00

CMFUN 1999-1 K - B* 0.00 0.00 0.22 0.00 0.25

SBM7 1999-C1 K - B 0.00 0.00 2.64 0.00 0.00

DLJCM 1998-CG1 B6 - B 0.66 0.81 0.44 0.00 0.00

MCFI 1998-MC3 H B2 - 0.32 0.23 0.29 0.00 1.39

JPMC 1999-C7 G - B 0.12 0.00 0.00 0.00 1.11

PNCMA 2000-C2 M B2 - 0.00 0.00 0.19 0.00 0.00

FULBA 1998-C2 J B1 - 0.43 0.57 0.00 0.20 1.09

MSC 1998-WF1 J - B* 0.00 0.00 0.39 1.70 0.00

FULB 1997-C2 J - B-* 1.17 0.18 1.40 0.00 1.93

CCMSC 1999-2 K - B 2.65 0.00 0.00 0.00 0.00

GMACC 1998-C2 K - B 0.11 0.78 1.41 0.00 0.00

DLJCM 1998-CF2 B-5 - B 0.08 0.00 0.00 0.77 0.00

CCMSC 1997-1 H - B-* 0.00 0.00 0.96 0.00 4.15

MSC 1998-HF2 K - B 0.00 0.00 0.83 0.00 0.48

CMAC 1998-C1 K - B* 0.24 0.00 0.36 0.00 0.00

MSC 1999-RM1 L B2 B 0.00 0.00 0.00 0.00 0.56

CCMSC 1998-2 H - B 0.00 0.00 0.69 0.00 0.00

NASC 1998-D6 B-5 - B 0.12 0.00 1.38 0.43 0.00

PSSF 1998-C1 K - B+ 0.00 0.00 0.24 0.22 0.00

JPMC 1997-C5 F - B+* 0.00 0.71 2.96 0.00 0.00

CMAC 1999-C1 M B2 - 0.96 0.89 0.00 0.00 0.00

LBCMT 1998-C4 K B2 - 0.51 0.00 0.13 0.87 0.17

DLJCM 1998-CF1 B6 - B* 0.00 0.00 0.72 0.00 0.00

CCMSC 1997-2 H - B 0.56 0.00 4.11 0.00 0.00

GMACC 1997-C1 G - B+* 2.11 0.00 0.22 0.00 0.82

MLMI 1997-C1 F - B* 0.00 0.00 5.97 0.75 1.68

DLJMA 1997-CF2 B3TB B1 - 0.00 0.00 3.69 10.73 0.00

ASC 1997-D4 B3 - B+* 0.91 0.00 3.14 0.00 2.20

MSC 1997-C1 H B3 B+ 0.00 0.00 0.00 0.00 2.00


Future










0.43 17.49 0.4 0.1 0.4 2.9 7.4

1.15 15.17 0.7 0.8 0.5 3.6 7.9

0.94 17.17 1.2 1.4 0.7 5.6 8.0

0.30 0.00 0.1 0.4 0.3 2.5 8.2

1.07 6.11 0.5 0.8 0.3 2.8 8.3

0.75 25.83 0.3 0.3 0.5 4.1 8.5

0.00 18.87 0.3 0.2 0.3 2.5 9.1

0.00 19.05 0.6 0.0 0.4 3.6 9.1

1.91 26.87 0.4 0.5 0.3 2.3 9.1

0.66 26.23 0.7 0.3 0.7 6.7 10.0

0.00 30.16 0.6 0.0 0.4 4.0 10.3

0.00 22.49 0.2 0.0 0.3 2.7 10.3

5.37 17.25 0.6 0.7 0.4 3.9 10.3

2.61 24.22 0.7 0.2 0.3 3.0 10.8

2.59 20.51 0.9 0.9 0.2 2.8 11.2

2.45 34.80 0.4 0.0 0.3 2.9 11.2

1.09 23.40 0.5 0.3 0.2 2.5 11.4

0.00 37.73 0.5 0.5 0.3 3.2 11.9

0.00 15.47 1.2 0.4 0.2 3.0 12.4

3.16 23.68 0.5 0.5 0.3 3.5 12.5

0.49 27.78 0.3 0.5 0.2 2.8 12.9

0.00 0.00 0.2 0.3 0.3 4.0 13.1

0.00 17.37 0.3 0.4 0.2 2.3 13.9

0.79 14.66 0.5 0.1 0.1 2.1 14.2

0.50 13.85 0.2 0.6 0.2 3.5 14.6

0.40 22.67 0.5 2.0 0.4 6.7 16.0

0.55 16.22 0.2 0.0 0.2 2.7 17.5

0.90 29.33 0.6 0.0 0.2 2.8 17.9

0.93 20.71 0.3 0.3 0.2 2.8 18.0

0.96 23.76 0.7 0.5 0.2 3.1 18.3

0.85 23.45 0.4 1.9 0.3 6.6 19.3

7.13 29.11 1.2 1.0 0.4 8.8 20.3

0.00 21.29 3.5 0.3 0.5 11.4 22.3

7.41 6.60 1.2 0.6 0.2 5.6 23.1

1.92 23.76 0.5 0.8 0.3 6.2 24.6



176

chapter 9


exhibit 17


* S&P Rating

Current Current



FULB 1997-C1 H - B-* 0.00 0.74 1.35 1.40 0.73

ACMF 1997-C1 J - B 9.58 0.00 6.74 0.00 0.00

MCFI 1997-MC2 H - B 0.00 0.00 1.41 0.00 0.00

ASC 1997-D5 A6 - B 0.00 0.00 0.00 2.90 0.88

CSFB 1997-C1 G - B* 0.00 0.00 2.67 0.19 0.00

GMACC 1998-C1 J - B 0.00 0.31 0.18 0.00 0.00

MSC 1997-HF1 H - B 0.00 1.17 1.52 0.00 0.00

MSC 1999-WF1 L B2 - 0.00 0.00 0.00 0.00 0.00

NLFC 1999-2 H - B* 0.00 0.00 0.00 0.00 0.00

MSC 1998-WF2 K - B+ 0.00 0.00 0.00 0.00 0.00

MSC 1997-WF1 H - B* 0.00 0.00 0.00 0.00 0.00

JPMC 1997-C4 G - B* 0.00 0.00 0.43 0.00 0.00


Future










2.69 23.65 0.8 0.3 0.2 4.5 25.0

0.00 32.57 1.1 0.0 0.2 5.1 26.6

2.21 19.53 0.4 0.6 0.1 3.4 27.1

0.82 16.78 1.2 1.6 0.3 9.2 27.2

9.08 18.31 0.6 0.9 0.2 6.0 27.4

18.01 0.00 0.3 0.3 0.2 5.1 29.4

0.00 0.00 0.2 0.4 0.1 3.9 33.9

0.00 2.90 0.0 0.1 0.1 2.2 35.8

1.45 19.41 0.1 0.0 0.0 3.8 85.9

1.18 11.26 0.1 0.0 0.0 3.2 118.2

2.12 6.03 0.1 0.0 0.0 3.9 434.0

0.00 0.00 0.0 0.0 0.0 5.6 678.9

178




Multifamily MBS

Chapter 10

FANNIE MMAEIn addition to “private-label” CMBS, the CMBS market also encompasses multi-family agency securities, issued by Fannie Mae, Ginnie Mae and Freddie Mac.The single largest issuer of multifamily MBS is Fannie Mae.

The main Fannie Mae program is Delegated Underwriting and Servicing (DUS).

THE FFANNIE MMAE DDUS PPROGRAMFannie Mae created the DUS program in 1988 to streamline the underwritingprocess and help fulfill its commitment to multifamily housing. Under the pro-gram, specially approved lenders may underwrite, close, service and sell mort-gages to Fannie Mae without prior review by Fannie Mae. DUS lenders benefitfrom this special relationship because they have greater autonomy in underwrit-ing and servicing and can also be more competitive given that DUS loan ratesare lower than in the prior approval program. Before this program, the processwas lengthier given that the agency had to underwrite and approve the transac-tion in advance of purchase.

CHARACTERISTICS OOF DDUS LLOANSLoans originated under the DUS program are generally either fixed-rate balloonmortgages with 5-, 7-, 10-, or 15-year terms or fixed-rate fully amortizing loanswith 25- or 30-year terms. Variations, such as 20-year fully amortizing loans, arealso permissible. The loans are secured by mortgages on income-producing, mul-tifamily rental or cooperative buildings with at least five units and with occupan-cy rates of at least 90%. The buildings may be existing or recently completedand may require moderate rehabilitation.

Loan amounts are $1 million to $50 million. There is always a loss sharing agree-ment between Fannie Mae and DUS lenders in case of default. Loans must havebeen originated within 6 months of Fannie Mae’s purchase.

PREPAYMENT PPROTECTIONOne of the main advantages of multifamily securities over residential MBS is theprepayment protection on multifamily loans. Most DUS loans have yield mainte-nance premiums in the event of an early prepayment. The premium is usuallyyield maintenance calculated at the relevant treasury rate, or “Treasuries flat.”Common yield maintenance terms are:

• Balloon Term (years) Yield Maintenance Term (years)5 3 or 4.57 5 or 6.510 7 or 9.515 1030 10


Multifamily MBS

180

chapter 10

After the yield maintenance period ends, the borrower is still required to pay a1% premium on prepayment which is retained by Fannie Mae. This premium iswaived during the last 90 days of the loan term to facilitate refinancing.Curtailments are not allowed and, consequently, the borrower is faced with thechoice of either prepaying the entire loan balance or not at all.

Prepayment fees are passed through to the investor by Fannie Mae only to theextent they are received from the borrower. Fannie Mae’s obligation extends onlyto the outstanding principal balance of the security, i.e., if an MBS DUS defaultsas a premium security, the investor receives a minimum of par but may losesome or all of the premium.

Most DUS loans can be assumed by a new, and creditworthy, borrower on pay-ment of a 1% assumption fee that is not passed through to the investor. Giventhat the pricing speed assumption of DUS is usually 0% CPR, the assumabilityoption does not add any negative convexity to the security.

The prepayment fee actually due from the borrower is calculated by substitutingthe note rate for the coupon in the above calculation. The difference between thefee received and the fee paid to the investor is shared by FNMA and the lender.

UNDERWRITINGDUS lenders have strong incentives to underwrite high quality loans. First andforemost, Fannie Mae monitors the performance of their DUS lenders. In addi-tion, when a DUS loan defaults, losses up to the first 5% of the UPB are bornesolely by the lender and losses in excess of 5% are shared by Fannie Mae and thelender according to a formula. The lender’s share of the loss is limited to 20-40%of the UPB. The yield maintenance premium is also part of the loss computationgiving the lender a vested interest in enforcing payment of the premium.

For pricing and underwriting purposes, Fannie Mae categorizes DUS loans intoone of four credit “tiers” based on debt service coverage and loan-to-valueratios. Tier 4 loans have the highest credit quality, while Tier 1 loans have thelowest. Most DUS loans tend to fall into the middle two tiers. Tier 1 loans areextremely rare. Fannie Mae may also designate loans with a ‘+’ in each category,based on subjective criteria such as property location and management. A ‘+’reduces the guarantee fee by about 10 bp.


DUS UNDERWRITING TIERSexhibit 1

Minimum Debt Maximum Service Coverage Ratio Loan-to-Value Ratio

Tier 1 1.15 80%

Tier 2 1.25 80%

Tier 3 1.35 65%

Tier 4 1.55 55%

Note: Most DUS loans are in Tier 2 or Tier 3.

Source: Fannie Mae


Multifamily MBS

182

chapter 10

FANNIE MMAE DDMBSIn 1996, Fannie Mae began issuing discount MBS (DMBS) as a means of sellingmultifamily loans in the secondary mortgage market. Fannie Mae started routine-ly securitizing multifamily loans on a programmatic basis in 1994, but these secu-rities did not possess the characteristics of DMBS.

DMBS CCHARACTERISTICSDMBS are Fannie Mae’s only short-term, non-interest bearing securities that arecollateralized by mortgages. Since DMBS are non-interest bearing securities, theyare sold to investors at a discount and repaid at par upon maturity.

DMBS maturities generally range between three and nine months, with occasionalexceptions.

To date, almost all DMBS issuance has consisted of three-month securities. SinceDMBS were first issued in 1996, more than $18 billion securities have been sold.

During 2001, DMBS issuance totaled $8.6 billion, a 38% increase over issuancein 2000. Despite low interest rates, many borrowers chose to maintain financialflexibility by using short term financing. For 2002, Fannie Mae projects DMBSissuance to be close to 2001 levels. As of February 1st, 2002, Fannie Mae issued$681 million of DMBS.

FANNIE MMAE GGUARANTEEDMBS, like all other Fannie Mae securities, carry Fannie Mae’s guarantee of fulland timely payment of principal. DMBS are not rated by the rating agencies butare equivalent to agency credits. In the event of a principal shortfall, paymentson DMBS are pari passu with other senior debt of Fannie Mae.

Notes: 1As of February 1, 2002.Issuance volumes prior to 2000 only represent DMBS with 3-month maturities.Source: Fannie Mae

DMBS ISSUANCE

exhibit 2


LOAN CCHARACTERISTICSWhile single-asset executions are available, DMBS are most often secured by a pool of cross-collateralized, cross-defaulted, first-lien mortgages on income-producing residential properties with at least 5 units. These multifamily mort-gages are typically underwritten to conform to the Fannie Mae DelegatedUnderwriting and Servicing (DUS) requirements.

DMBS loans tend to be more conservative than multifamily loans in conduittransactions, in terms of loan-to-value (LTV) ratios and debt service coverageratios (DSCR). LTVs on DMBS collateral range between 50% and 75%, whileDSCRs typically range between 1.65X and 1.30X. In typical CMBS conduittransactions, multifamily loans tend to have 1.25X DSCR and 75% LTVs.

The loans supporting DMBS are extended to borrowers, such as REITs and pen-sion funds, under a credit facility agreement. The credit facility provides borrow-ers with short-term advances that are funded by the sale of DMBS. Borrowersreceive proceeds from DMBS issuance, which are determined by market dis-count. These loans mimic variable-rate financing, as they may be “rolled” everyfew months when the DMBS mature. The facility term may be 5, 7 or 10 yearsin length.

In Exhibit 3, we have illustrated an example where a borrower requests a short-term advance of $100 million, with $200 million of multifamily properties ascollateral. Fannie Mae issues $100 million of DMBS, and the market discount of0.5% on the securities results in the borrower receiving $99.5 million.

1Assumes $99.5MM discounted proceeds from sale of DMBS.

Source: Fannie Mae

MULTIFAMILYCREDIT FACILITY

exhibit 3


Multifamily MBS

184

chapter 10

At maturity, the investor will receive $100 million, via proceeds from new DMBSissuance, or a payoff by the borrower.

PREPAYMENTS AAND DDEFAULTSDMBS are locked out from prepayments for their entire term and, therefore,have no prepayment risk. Default risk is also non-existent to DMBS investors, asFannie Mae guarantees payments of principal when due. To date, there havebeen no defaults, but in the case of default, Fannie Mae would pay DMBSinvestors par at maturity.

TRADING LLEVELSDiscounts on new issue three-month DMBS may be converted to annualizedyields or spreads to LIBOR. Historically, three-month DMBS have yieldedLIBOR less 15-16 bp. During the first few weeks of 2002, three-month DMBShave been issued with average yields of LIBOR – 6 bp.

In the secondary market, Morgan Stanley traded nearly $5 billion of DMBS in2001, and $700 million in 2002 YTD. We estimate that Morgan Stanley isinvolved in 20-25% of DMBS trades in the secondary market.

INVESTOR BBASEDMBS are purchased primarily by money market investors who view these secu-rities as an attractive alternative to Treasury Bills.

Fannie Mae DMBS are similar to Treasuries, in that they are permitted invest-ments for federally supervised institutions and for trusts and funds investedunder the authority of the U.S. DMBS can also be purchased in unlimitedamounts by national banks, federally chartered credit unions and federal savingsand loans associations.

Source: Fannie Mae

DMBS TRADES:THREE-MONTH

MATURITY

exhibit 4

GINNIE MMAE/FHAWithin the agency multifamily market, the second largest issuer in the agencymarket is the Government National Mortgage Association (GNMA). Projectloans may be made under a number of Housing and Urban DevelopmentDepartment (HUD) programs, including:

• 221(d)4: Construction or permanent financing• 223(f): Refinancing• 223(a)7: Accelerated refinancing• 232: Nursing home/assisted living• 241(f): Equity take-out second mortgage

All Ginnie Mae securities are backed by loans originated by the Federal HousingAdministration (FHA) and are either permanent loan certificates (PLCs) or con-struction loan certificates (CLCs).

PLCs are usually 35-year fully amortizing fixed-rate mortgages. Prepayment pro-tection is either (1) a 5-year lockout followed by declining penalty points (5, 4, 3,2, 1) over the next five years or (2) a 10-year lockout. Many PLCs begin as CLCsand are converted to PLCs upon completion of the construction project. CLCstrade at wider spreads than PLCs because of liquidity and uncertainty associatedwith funding a construction loan.

Exhibit 5 shows some of the major differences between Ginnie Mae and FHAproject loans:

Effective April 1, 1997, Ginnie Mae reduced pool processing time from 10 daysto 5 days and added other features to streamline its multifamily MBS program.1


CHARACTERISTICS OF GINNIE MAE AND FHAPROJECT LOANSexhibit 5

Ginnie Mae FHA

Government guarantee Explicit Implicit

Principal paymentin case of default 100% 99%

Delay days 44 54

Delivery PTC Physical

Data on Bloomberg Yes No

Source: Fannie Mae

1 See inside MBS & ABS, May 1, 1997, p.3.


Multifamily MBS

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FREDDIE MMACFreddie Mac, a large issuer in the 1980s, reduced its role in the multifamily securitization market in the 1990s. The agency has recently begun to increase itsmultifamily loan production.

A PROFILE OF GINNIE MAE MULTIFAMILY MBSexhibit 6

Issuer Ginnie Mae approved mortgage lender

Issue Type GNMA I

UnderlyingMortgages FHA Insured multifamily mortgages

Pool Types Construction Loan Securities(CL) Security rate remains constant with conversion to permanent loan(CS) Security rate changes with conversion to permanent loan Project Loan Securities(PL) Level payment permanent securities(PN) Non-level payment permanent securities(LM) Securities for Mature Loans. Loans pooled after more than 24 months of amortization(LS) Securities for Small Loans. Loans of no more than $1MM

SecuritiesInterest Rate Fixed; at .25 to .50 percent below the interest rate of the

underlying mortgage(s)

Guaranty Full and timely payment of principal and interest

Guarantor Ginnie Mae (full faith and credit of the United States)

Principaland Interest Paid monthly to securities holders

Maturity Varies, typically 40 years

MinimumCertificate Size $25,000 (may be less for aged securities)

Transfer Agent Chase (formerly Chemical Bank)

Source: Reprinted from Ginnie Mae website, www.ginniemae.gov, 1997

PROGRAM PPLUS

Freddie Mac’s Program Plus is similar to Fannie Mae’s DUS program. Under theprogram, Freddie Mac pre-approves multifamily lenders with “local marketexpertise.” Since 1993, Freddie Mac has financed $5.3 billion (1,400 properties)under Program Plus.

To be eligible for Program Plus, loans must be between $5 million and $50 mil-lion and have the following characteristics:

• Terms of 7, 10, 15, 20, or 25 years• Amortization period of 20, 25, or 30 years• Maximum LTV of 75% • Minimum DSCR of 1.3

The yield maintenance terms of the loans are:

• Term(years)/Yield Maintenance(years)7/6.5 10/9.5 15/14 20/15


188




Floating Rate Large Loan CMBS

Chapter 11



190

chapter 11

In this chapter, we examine three aspects of floating rate CMBS. In Section I,we examine the incidence of extensions in the floating rate large loan universe.In Section II, we examine whether floating rate CMBS deals are inclined toexperience a negative ratings drift over time. In Section III, we describe themechanics of available funds caps in the context of a hypothetical floating rateCMBS structure.

Section I: Floating Rate Large Loan ExtensionsMOTIVATIONS FFOR EEXTENDINGIn this section, we examine the incidence of extensions in the floating rate largeloan universe as well as the motivations for exercising extension options (i.e.,credit vs. non-credit related reasons). Our main findings are that nearly a quarterof loans exercised extension options at maturity, and that the majority of exten-sions were motivated by credit issues.

Floating rate loans within CMBS transactions typically have a substantial princi-pal balance remaining at the time of maturity. In order to repay this balance, aborrower may refinance the loan or sell the underlying property. If the loan’sterms include an extension option, the borrower may instead choose to post-pone repayment of the loan.

Whereas a borrower’s incentive to prepay a loan in the residential mortgage mar-ket is heavily dependent on prevailing interest rates, a borrower’s incentive toextend a loan in the commercial mortgage market is predominantly driven bycredit-related issues.

A borrower’s decision to extend a loan could be a result of credit problems, suchas the property’s weak financial condition or deterioration in the property’s oper-ating performance.

The borrower may also need to extend for a variety of other reasons, unrelatedto credit. For example, the borrower may find refinancing prior to the loan’smaturity, but need to extend because the new loan’s closing date is beyond theoriginal loan’s maturity date. Another possibility is that the borrower believesthat the underlying property’s financial performance could improve over the nextyear and allow the borrower to refinance at lower rates than the property cur-rently allows. Additionally, improved financials could result in higher valuations,which may result in additional proceeds to the borrower. If commercial lendingis scarce, the borrower may also have a difficult time finding refinancing andneed to extend.


There also may be some instances in which the level of interest rates motivatesthe borrower to extend. That is, the borrower holds the view that interest rateswill decline in the coming year, allowing the borrower to access cheaper rates inthe future.

23% OOF LLOANS EEXERCISE EEXTENSION OOPTIONS AAT MMATURITYFor our analysis, we examined the universe of floating rate large loan CMBSissued since January 2000. The majority of loans within this sample were issuedwith extension options. Extendable loans account for 69% of the universe, basedon loan count, and 86% of the universe, based on loan balance. To date, abouthalf of the extendable loan balances have reached maturity. Of the extendableloan balances that have reached maturity, 23% have extended. Based on loancount, the results were similar, with 27% of loans exercising extension options.

COMPOSITION OOF EEXTENDED LLOANSIn all, we found 112 matured loans that exercised extension options. Office loansaccounted for nearly half of the extended loan pool, while hotel loans accountedfor 16% of the loans, and multifamily loans accounted for 14% of the loans.Although office loans comprise a large portion of the extended loan pool, theydid not experience the highest extension rate of the major property types.


LOANEXTENSIONS

WITHIN FLOATINGRATE CMBS(BASED ON

ORIGINALBALANCE)

exhibit 1

HOTEL LLOANS EEXPERIENCE HHIGHEST EEXTENSION RRATEWhile we found that on average, 23% of loan balances exercised extensionoptions, we found that this experience varied depending on collateral type. Forexample, based on loan balances, hotel loans exercised 40% of extension options,while retail loans exercised 8%. (See Exhibit 3)

This observation is not surprising since we also determined that the majority ofextended loans (68%) chose to extend for credit-related reasons. Over the pastcouple of years, the retail sector has remained healthy, while the hotel sector hassuffered a downturn. As a result, we found the higher incidence of hotel loanextensions to be linked to deterioration in operating performance and lower occu-pancy rates.



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1Includes industrial, manufactured housing, mixed use, and senior housing loans.


PROPERTY TYPESOF EXTENDED

LOANS BASED ONSECURITIZED

LOAN BALANCES

exhibit 2

Property Type Extension Rate (%)1

Hotel 40

Office 30

Multifamily 18

Retail 8

Other2 13

Total 23

EXTENSION RATES BY PROPERTY TYPE(BASED ON ORIGINAL BALANCE)

exhibit 3

1Represents percentage of loans that exercised extension options at maturity.2Includes industrial, manufactured housing, mixed use, and senior housing loans.


METHODOLOGYIn order to determine the rate at which borrowers exercise extension options onfloating rate large loans, we examined floating rate large loan CMBS transactionsthat were issued since January 2000. We identified 76 floating rate loans withinthis universe that were flagged with a CMSA modification code of 1 (maturitydate extension) or CMSA workout code of 4 (extension) in Trepp or Intex.Unfortunately, the servicer files, which are the source for this extension informa-tion, do not always flag all of the extended loans. In order to capture extendedloans that were not flagged in the servicer files, we searched for loans that werestill outstanding at least one year after the original maturity date. Using thismethodology, we identified an additional 53 loans.

In total, we were able to identify 129 floating rate loans that extended. We elimi-nated 17 of the 129 loans, which did not have extension options, and limited ouranalysis to the remaining 112 extendable loans.

In order to determine the motivations for exercising extension options on these112 loans, we examined changes in property performance (DSCR and occupancy)since loan origination. In addition, we considered servicer commentary inmonthly watchlist files and consulted Realpoint analysts for their opinions. Wefound that 75 loans (68%) exercised extension options due to credit problems.


Section II: A Discussion of DriftIn this section, we examine whether floating rate CMBS deals are inclined toexperience negative ratings drift over time.

Floating rate loans appeal to CMBS borrowers, in part, because they provideflexibility for prepayment or extension. A borrower can replace floating ratefinancing with longer term fixed rate financing, if a property has stabilized priorto maturity. Likewise, a borrower may exercise an extension option and buymore time to improve a property’s cash flows. These structural features, howev-er, seem to imply that floating rate CMBS deals may ultimately be left with apool of weak assets, if all of the stabilized assets prepay or pay off as scheduledon their maturity dates.

We address this topic and examine whether floating rate CMBS deals are inclinedto experience a negative ratings drift over time. We tackle this question by exam-ining the ratings history of floating rate CMBS deals issued in 2000. We chooseto examine the 2000 vintage, as we specifically want to focus on the perform-ance of transactions after significant loan paydowns have occurred. Floatingrate CMBS tend to be short transactions (~3 years). Therefore, the 2000 vintageshould have experienced significant paydowns, as these deals have seasoned for3-4 years.

OUR FFINDINGSFor our analysis, we examined the ratings drift of 224 classes. Since issuance,these 224 classes have experienced 118 downgrades by the rating agencies. Withthe exception of four downgrades on GSMS 2000-GSFL, which were related toinadequate terrorism insurance, all downgrades resulted from the deteriorationof remaining loans. This seems to support the observation that floating rateCMBS ratings deteriorate over time as loans pay down. We found, however, thatthese paydowns also increase credit enhancement on many classes. In the caseof the 2000 floating rate cohort, paydowns resulted in 1401 upgrades.

Over time, the 2000 floating rate vintage experienced a positive upgrade/down-grade ratio of 1.2 to 1. A positive ratio does not necessarily imply a positive rat-ings drift across all classes.

In order to determine which classes have positive and negative ratings drift, weexamined the rating actions on non-rake floating rate tranches issued in 2000.

We did not to include rake classes, which are tied to the performance of a singleloan. Almost all rating actions on rake classes have been downgrades (29 tranch-es downgraded and 1 tranche upgraded).

1The 224 classes experienced a total of 144 upgrades (140 due to increased credit enhancement; 4 due toimproved terms of terrorism insurance in GSMS 2000-GSFL).



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chapter 11

We began by aggregating non-rake tranches into buckets, based on their originalratings. We then calculated the average notch drift of the tranches in each ofthese original rating buckets. If a tranche was upgraded/downgraded by morethan one rating agency, we used the lowest ratings drift to get the most conser-vative result. Therefore, if a class was upgraded 2 notches by Moody’s and 3notches by S&P, we used the 2 notch drift. Likewise, if a class was downgraded2 notches by Moody’s and 3 notches by S&P, we used the -3 notch drift.

CONCLUSION

We found that each category, with the exception of A-, experienced a positiveaverage ratings drift since issuance. (see Exhibit 4)


Original Rating Average Notch Drift1

AAA 0.0

AA+ 1.0

AA 1.7

AA- 2.0

A+ 0.8

A 0.8

A- -3.7

BBB+ 3.3

BBB 3.1

BBB- 3.6

BB+ 4.5

BB 1.2

BB- 3.3

B+ 3.0

B 1.9

B- 0.3

CCC+ NA

CCC 3.0

CCC- NA

Total 1.6

AVERAGE NOTCH DRIFTS FOR 2000 FLOATING RATE CMBS1

exhibit 4

1Data set only includes non-rake tranches that have been upgraded/downgraded by at least one rating agency.

Source: Morgan Stanley, Moody’s, S&P, Fitch

The downward drift of the A- category was driven by downgrades on MSDWC2000-XLF D, COMM 2000-FL2 F and COMM 2000-FL3 D. The latter twoclasses were the lowest rated non-rake tranches in those structures.

We also found that although the ratings drift for floating rate CMBS classes hasbeen positive as a whole, the ratings drift pattern differs at each rating agency.As shown in Exhibit 6, classes that were originally rated lower than BBB+ byS&P exhibit a negative ratings drift. Fitch rating actions, on the other hand,have resulted in positive ratings drift across almost every original rating category.



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chapter 11

NUMBER OF TRANCHES UPGRADED/DOWNGRADED BY EACH RATING AGENCY1

exhibit 5

1Does not include upgrades/downgrades on rake tranches.2Includes plus and minus designations at each rating level.


Moody’s S&P

Upgrades Downgrades Upgrades

Full Rating # of % of # of % of # of % of

Category2 Tranches Tranches Tranches Tranches Tranches Tranches

AAA 0 0% 0 0% 0 0%

AA 9 28% 0 0% 7 39%

A 8 25% 6 46% 7 39%

BBB 9 28% 3 23% 3 17%

BB 5 16% 2 15% 1 6%

B 1 3% 2 15% 0 0%

CCC 0 0% 0 0% 0 0%

Total 32 100% 13 100% 18 100%


Original Rating Moody’s S&P Fitch

AAA 0.0 NA NA

AA+ NA 1.0 1.0

AA 1.6 1.8 2.0

AA- 2.0 3.0 2.0

A+ -2.0 2.0 2.3

A 0.3 0.3 3.1

A- -4.7 -2.6 -0.3

BBB+ 4.5 1.0 7.0

BBB 0.0 -4.0 7.7

BBB- 5.0 -0.5 6.5

BB+ 7.0 -1.0 10.0

BB 1.0 -1.3 3.6

BB- 3.0 -2.0 2.5

B+ NA -3.0 3.5

B 2.0 -2.0 2.2

B- -1.0 -2.0 1.5

CCC+ NA NA NA

CCC NA -1.0 7.0

CCC- NA NA NA

Total 1.1 -0.7 3.5

AVERAGE NOTCH DRIFTS FOR 2000 FLOATING RATE CMBS1

BY RATING AGENCYexhibit 6

1Data set only includes non-rake tranches that have been upgraded/downgraded by at least one rating agency.


S&P Fitch

Downgrades Upgrades Downgrades

# of % of # of % of # of % of

Tranches Tranches Tranches Tranches Tranches Tranches

0 0% 0 0% 0 0%

0 0% 14 28% 0 0%

5 29% 11 22% 2 20%

3 18% 12 24% 1 10%

4 24% 7 14% 3 30%

4 24% 5 10% 4 40%

1 6% 1 2% 0 0%

17 100% 50 100% 10 100%



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chapter 11

2000 FLOATING RATE CMBS RATING ACTIONS SINCE ISSUANCEexhibit 7

Source: Moody’s, S&P, Fitch, Intex

Chase Commercial Mortgage Securities Corp, 2000-FL1






COMM 2000-FL1 B Aa2 Upgrade Aaa 12/13/2001

COMM 2000-FL1 C Aa2 Upgrade Aaa 12/13/2001

COMM 2000-FL1 D A2 Upgrade Aa2 12/13/2001

COMM 2000-FL1 E A2 Upgrade Aa2 12/13/2001

COMM 2000-FL1 F Baa1 Upgrade A2 12/13/2001

COMM 2000-FL1 G A3 Upgrade Aaa 10/24/2002

COMM 2000-FL1 G Baa3 Upgrade A3 12/13/2001

COMM 2000-FL1 H Aa2 Upgrade Aaa 4/7/2003

COMM 2000-FL1 H Baa2 Upgrade Aa2 10/24/2002

COMM 2000-FL1 H Baa3 Upgrade Baa2 12/13/2001

COMM 2000-FL1 J A2 Upgrade Aa3 4/7/2003

COMM 2000-FL1 J Baa3 Upgrade A2 10/24/2002

COMM 2000-FL1 J Ba1 Upgrade Baa3 12/13/2001

COMM 2000-FL1 K Ba2 Upgrade Ba1 12/13/2001

COMM 2000-FL2 B Aa2 Upgrade Aaa 9/11/2003

COMM 2000-FL2 D A1 Downgrade A3 10/24/2002

COMM 2000-FL2 E Baa2 Downgrade Ba1 9/11/2003

COMM 2000-FL2 E A2 Downgrade Baa2 10/24/2002

COMM 2000-FL2 F Baa3 Downgrade Ba3 9/11/2003

COMM 2000-FL2 F A3 Downgrade Baa3 10/24/2002

COMM 2000-FL2 GCO Baa1 Downgrade Baa2 10/24/2002

COMM 2000-FL2 GHM Baa1 Downgrade Baa3 10/24/2002

COMM 2000-FL2 GLP Baa1 Downgrade Ba1 10/24/2002

COMM 2000-FL2 GNS Ba3 Downgrade B1 9/11/2003

COMM 2000-FL2 GNS Ba1 Downgrade Ba3 6/18/2003

COMM 2000-FL2 GNS Baa1 Downgrade Ba1 10/24/2002

COMM 2000-FL2 GWH Baa1 Downgrade Ba3 10/24/2002

COMM 2000-FL2 HCO Baa2 Downgrade Baa3 10/24/2002

COMM 2000-FL2 HHM Baa2 Downgrade Ba1 10/24/2002

COMM 2000-FL2 HLP Baa2 Downgrade Ba2 10/24/2002

COMM 2000-FL2 HNS B1 Downgrade B2 9/11/2003

COMM 2000-FL2 HNS Ba2 Downgrade B1 6/18/2003

COMM 2000-FL2 HNS Baa2 Downgrade Ba2 10/24/2002

COMM 2000-FL2 HWH Baa2 Downgrade B1 10/24/2002

COMM 2000-FL2 JCO Baa3 Downgrade Ba1 10/24/2002

COMM 2000-FL2 JHM Baa3 Downgrade Ba2 10/24/2002

COMM 2000-FL2 JLP Baa3 Downgrade Ba3 10/24/2002

COMM 2000-FL2 JNS B2 Downgrade B3 9/11/2003

COMM 2000-FL2 JNS Ba3 Downgrade B2 6/18/2003

COMM 2000-FL2 JNS Baa3 Downgrade Ba3 10/24/2002

COMM 2000-FL2 JWH Baa3 Downgrade B2 10/24/2002

COMM 2000-FL3 KQA Baa1 Downgrade Ba1 5/30/2003

COMM 2000-FL3 KSR Baa1 Downgrade Ba2 5/30/2003

COMM 2000-FL3 KWC Baa1 Downgrade B1 5/30/2003

COMM 2000-FL3 KWS Baa1 Downgrade Ba1 5/30/2003

COMM 2000-FL3 LQA Baa2 Downgrade Ba2 5/30/2003

COMM 2000-FL3 LSR Baa2 Downgrade Ba3 5/30/2003

COMM 2000-FL3 LWS Baa2 Downgrade Ba2 5/30/2003

COMM 2000-FL3

COMM 2000-FL3

COMM 2000-FL3

COMM 2000-FL3

COMM 2000-FL3

COMM 2000-FL3

DLJ Commercial Mortgage Corp, 2000-STF1 B4 Ba2 Upgrade Baa2 9/11/2003

DLJ Commercial Mortgage Corp, 2000-STF1 B5 Ba3 Upgrade Baa3 9/11/2003

DLJ Commercial Mortgage Corp, 2000-STF1





GMAC Commercial Mortgage Asset Corp, 2000-FL-A C Aa2 Upgrade Aaa 9/3/2003

Moody’s

Old New Date ofCMBS Transactions Class Rating Action Rating Rating Action


C A Downgrade BBB+ 11/13/2003

D A- Downgrade BBB 11/13/2003

E BBB Downgrade BB 11/13/2003

F BBB- Downgrade BB- 11/13/2003

G BB Downgrade B 11/13/2003

H B Downgrade B- 11/13/2003

B AA Upgrade AAA 10/16/2001

C AA+ Upgrade AAA 12/14/2001

C AA- Upgrade AA+ 10/16/2001

D A Upgrade AA 10/16/2001

F A Upgrade AAA 8/16/2002

G A- Upgrade AAA 8/16/2002

H BBB Upgrade A+ 8/16/2002

J BBB- Upgrade BBB+ 8/16/2002

K BB Upgrade BB+ 8/16/2002

B AA Upgrade AAA 10/14/2003

C A Upgrade AA 10/14/2003

C A+ Downgrade A 1/15/2003

D A Downgrade BBB+ 1/15/2003

GCO BBB+ Downgrade BB+ 1/15/2003

GWH BB+ Downgrade B+ 1/15/2003

GWH BBB+ Downgrade BB+ 4/12/2002

HCO BBB Downgrade BB 1/15/2003

HWH BB Downgrade B 1/15/2003

HWH BBB Downgrade BB 4/12/2002

JCO BBB- Downgrade BB- 1/15/2003

JWH BB- Downgrade B- 1/15/2003

JWH BBB- Downgrade BB- 4/12/2002

B AA Upgrade AAA 5/19/2003 B AA Upgrade AAA 10/16/2003

D A- Downgrade BBB- 5/19/2003 D BB Downgrade BB- 4/2/2004

KHS BBB+ Downgrade BB+ 5/19/2003 D BBB- Downgrade BB 10/16/2003

KWC BBB+ Downgrade B+ 5/19/2003 D A- Downgrade BBB- 4/22/2003

LHS BBB- Downgrade BB- 5/19/2003 KHS BBB- Downgrade BB 10/16/2003

KQA BBB+ Downgrade BB+ 10/16/2003

KSR BBB Downgrade B 4/2/2004

KSR BBB+ Downgrade BBB 10/16/2003

LHS BBB Downgrade BB 10/16/2003

LQA BBB Downgrade BB 10/16/2003

LSR BBB- Downgrade B- 4/2/2004

LSR BBB Downgrade BBB- 10/16/2003

MHS BBB- Downgrade BB- 10/16/2003

A2 AA Upgrade AAA 8/14/2003

A3 A Upgrade AAA 8/14/2003

B1 BBB Upgrade AAA 8/14/2003

B2 BBB- Upgrade AAA 8/14/2003

B4 BB Upgrade A 8/14/2003

B5 BB- Upgrade BBB 8/14/2003

B6 B Upgrade BB- 8/14/2003

B AA Upgrade AA+ 5/27/2003 B AA+ Upgrade AAA 9/3/2002

S&P Fitch

Old New Date of Old New Date ofClass Rating Action Rating Rating Action Class Rating Action Rating Rating Action



200

chapter 11

2000 FLOATING RATE CMBS RATING ACTIONS SINCE ISSUANCE(CONTINUED)

exhibit 7


GMAC Commercial Mortgage Asset Corp, 2000-FL-A D A2 Upgrade A1 9/3/2003

GMAC Commercial Mortgage Asset Corp, 2000-FL-B






GMAC Commercial Mortgage Asset Corp, 2000-FL-F B Aa2 Upgrade Aa1 4/14/2003

GMAC Commercial Mortgage Asset Corp, 2000-FL-F C A2 Upgrade A1 4/14/2003

GMAC Commercial Mortgage Asset Corp, 2000-FL-F





GMAC Commercial Mortgage Securities, 2000-FL1 C A2 Downgrade Baa1 1/26/2004

GMAC Commercial Mortgage Securities, 2000-FL1 D Baa2 Downgrade Ba1 1/26/2004

GMAC Commercial Mortgage Securities, 2000-FL1 E Baa3 Downgrade Ba2 1/26/2004

GMAC Commercial Mortgage Securities, 2000-FL1 F Ba2 Downgrade B2 1/26/2004

GS Mortgage Securities Corp II, 2000-GSFL III A Aa1 Upgrade Aaa 10/29/2003

GS Mortgage Securities Corp II, 2000-GSFL III A Aaa Downgrade Aa1 9/27/2002

GS Mortgage Securities Corp II, 2000-GSFL III F Baa2 Upgrade Baa1 10/29/2003

GS Mortgage Securities Corp II, 2000-GSFL III G3 Baa3 Upgrade Baa1 10/29/2003

GS Mortgage Securities Corp II, 2000-GSFL III X0 Aa1 Upgrade Aaa 10/29/2003

GS Mortgage Securities Corp II, 2000-GSFL III X0 Aaa Downgrade Aa1 9/27/2002





JP Morgan Commercial Mortgage Finance Corp, 2000-FL1 B Aa2 Upgrade Aa1 1/7/2003

JP Morgan Commercial Mortgage Finance Corp, 2000-FL1 C A2 Upgrade A1 1/7/2003

JP Morgan Commercial Mortgage Finance Corp, 2000-FL1 G Ba2 Downgrade Ba3 1/7/2003

JP Morgan Commercial Mortgage Finance Corp, 2000-FL1 H B2 Downgrade B3 1/7/2003

JP Morgan Commercial Mortgage Finance Corp, 2000-FL1 J B3 Downgrade Caa1 1/7/2003

JP Morgan Commercial Mortgage Finance Corp, 2000-FL1











Lehman Brothers Floating Rate Commercial Mortgage Trust, 2000-LLF C7

















Morgan Stanley Dean Witter Capital I, 2000-XLF B A2 Upgrade Aa2 9/11/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF B Aa2 Downgrade A2 6/5/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF C Baa2 Downgrade Ba2 6/5/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF C A3 Downgrade Baa2 1/27/2003

Moody’s



C A Upgrade A+ 5/27/2003 B AA Upgrade AA+ 2/6/2002

B A Upgrade AAA 10/17/2002


D BBB- Upgrade AAA 10/17/2002

E AA Upgrade AAA 7/30/2003

E BB Upgrade AA 10/17/2002

F B Upgrade BB+ 10/17/2002

B AA+ Upgrade AAA 2/25/2004

B AA Upgrade AA+ 9/10/2002

C A+ Upgrade AAA 2/25/2004

C A Upgrade A+ 9/10/2002


E BBB- Upgrade A 2/25/2004

F BB Upgrade BBB- 2/25/2004


B AA Upgrade AA+ 8/28/2002


C AA Upgrade AA+ 2/10/2004

C A+ Upgrade AA 5/16/2003

C A Upgrade A+ 8/28/2002

D A- Upgrade AAA 3/17/2004

D BBB+ Upgrade A- 2/10/2004


E BBB Upgrade AAA 3/17/2004


F BBB- Upgrade AAA 3/17/2004

F BB+ Upgrade BBB- 8/28/2002

G BB Upgrade BBB 3/17/2004

H B Downgrade CCC 5/16/2003

J B- Downgrade CC 5/16/2003

B AA+ Upgrade AAA 3/31/2003 B AA+ Upgrade AAA 8/20/2003

C AA Upgrade AAA 3/31/2003 C AA Upgrade AAA 8/20/2003

D AA- Upgrade AAA 3/31/2003 D AA- Upgrade AAA 8/20/2003

E A+ Upgrade AA 3/31/2003 E A+ Upgrade AAA 8/20/2003

F A Upgrade A+ 3/31/2003 F A Upgrade AA 8/20/2003

G A- Upgrade A 3/31/2003 G A- Upgrade AA- 8/20/2003

H BBB+ Upgrade A- 3/31/2003 H A- Upgrade A+ 8/20/2003

JBO BBB+ Downgrade BB- 3/31/2003 L BBB- Downgrade BB+ 3/10/2003

KBO BBB Downgrade B+ 3/31/2003 M BB- Downgrade B+ 3/10/2003

LBO BBB- Downgrade B 3/31/2003 N BB Downgrade B+ 12/2/2002

M BB+ Downgrade BB 3/31/2003 P BB- Downgrade B 12/2/2002

N BB Downgrade B+ 3/31/2003 Q B+ Downgrade B- 12/2/2002

P BB- Downgrade B 3/31/2003 S B Downgrade B- 12/2/2002

Q B+ Downgrade CCC+ 3/31/2003

S B Downgrade CCC 3/31/2003

T B- Downgrade CCC 3/31/2003

U CCC Downgrade CCC- 3/31/2003

C BBB Downgrade BB 7/9/2003

C A Downgrade BBB 2/11/2003

S&P Fitch




202

chapter 11

2000 FLOATING RATE CMBS RATING ACTIONS SINCE ISSUANCE(CONTINUED)

exhibit 7


Morgan Stanley Dean Witter Capital I, 2000-XLF C A2 Downgrade A3 9/6/2002

Morgan Stanley Dean Witter Capital I, 2000-XLF D B2 Downgrade Caa1 9/11/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF D Ba2 Downgrade B2 6/5/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF D Baa2 Downgrade Ba2 1/27/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF D A3 Downgrade Baa2 9/6/2002

Morgan Stanley Dean Witter Capital I, 2000-XLF E Caa2 Downgrade Ca 9/11/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF E B3 Downgrade Caa2 6/5/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF E Ba3 Downgrade B3 1/27/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF E Baa2 Downgrade Ba3 9/6/2002

Morgan Stanley Dean Witter Capital I, 2000-XLF F1 Caa2 Downgrade Ca 6/5/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF F1 B2 Downgrade Caa2 1/27/2003

Morgan Stanley Dean Witter Capital I, 2000-XLF F1 Baa3 Downgrade B2 9/6/2002

Salomon Brothers Mortgage Securities VII, 2000-FL1 B Aa2 Upgrade Aaa 6/29/2001

Salomon Brothers Mortgage Securities VII, 2000-FL1 C A2 Upgrade Aaa 6/29/2001

Salomon Brothers Mortgage Securities VII, 2000-FL1 D Baa2 Upgrade A1 6/29/2001

Salomon Brothers Mortgage Securities VII, 2000-FL1 E Baa3 Upgrade Baa1 6/29/2001

Salomon Brothers Mortgage Securities VII, 2000-FL1 F Ba1 Upgrade A3 4/30/2002

Salomon Brothers Mortgage Securities VII, 2000-FL1 F Ba2 Upgrade Ba1 6/29/2001

Salomon Brothers Mortgage Securities VII, 2000-FL1 G B2 Upgrade Baa3 4/30/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 D Aa2 Upgrade Aaa 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 E Aa3 Upgrade Aa1 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 F A2 Upgrade Aa3 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 G A3 Upgrade A1 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 H A2 Upgrade Aaa 10/31/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 H Baa1 Upgrade A2 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 J A3 Upgrade Aaa 10/31/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 J Baa2 Upgrade A3 3/1/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 K Baa1 Upgrade Aa2 10/31/2002

SASCO Floating Rate Commercial Mortgage Trust, 2000-C2 K Baa3 Upgrade Baa1 3/1/2002























Moody’s



D CCC Downgrade D 11/6/2003

D B Downgrade CCC 7/9/2003

D A- Downgrade B 2/11/2003

E CCC Downgrade D 7/9/2003

E BBB Downgrade CCC 2/11/2003

F1 BBB- Downgrade D 2/11/2003



C AA Upgrade AA+ 10/8/2001

D AA Upgrade AAA 7/3/2002

D AA- Upgrade AA 10/8/2001

E AA- Upgrade AA 7/3/2002

E A+ Upgrade AA- 10/8/2001

F A+ Upgrade AA- 7/3/2002

F A Upgrade A+ 10/8/2001

G A Upgrade A+ 7/3/2002

G A- Upgrade A 10/8/2001

H A Upgrade AAA 11/21/2002

H A- Upgrade A 7/3/2002

H BBB+ Upgrade A- 10/8/2001

J A- Upgrade AAA 11/21/2002

J BBB+ Upgrade A- 7/3/2002

J BBB Upgrade BBB+ 10/8/2001

K BBB+ Upgrade AAA 11/21/2002

K BBB Upgrade BBB+ 7/3/2002

K BBB- Upgrade BBB 10/8/2001

L BBB- Upgrade AAA 11/21/2002

L BB+ Upgrade BBB- 7/3/2002

M BB+ Upgrade AA 11/21/2002

M BB Upgrade BB+ 7/3/2002

N BB Upgrade AA- 11/21/2002

N BB- Upgrade BB 7/3/2002

P BB- Upgrade A+ 11/21/2002

P B+ Upgrade BB- 7/3/2002

Q B+ Upgrade A 11/21/2002

Q B Upgrade B+ 7/3/2002

S B- Upgrade BBB 11/21/2002

T CCC Upgrade BB+ 11/21/2002

S&P Fitch


Section III: Available Funds Cap MechanicsAvailable funds caps are a commonly discussed topic in the home equity world,as investors are concerned with rising rates and the basis risk between fixed ratecollateral and floating rate bonds. Although CMBS structures are not typicallyfaced with an interest rate mismatch between collateral and bonds, the conceptof available funds cap does exist in some CMBS deals.

In this section, we will describe the mechanics of available funds cap in the con-text of a hypothetical floating rate CMBS structure.

HOW DDOES AAN AAVAILABLE FFUNDS CCAP WWORK?An available funds cap limits the coupon on specified CMBS bonds to the collat-eral weighted average coupon (WAC).1 The available funds cap is triggered on aCMBS class if the bond coupon for that class exceeds the weighted average col-lateral coupon. When such a scenario occurs, the cap initially limits the couponon the affected class to the collateral coupon, but typically, any additional cashthat remains after paying interest on all classes is paid sequentially to eachcapped class. This additional cash makes up the difference between the capped

1The available funds cap is also referred to as a WAC cap.



204

chapter 11

Loan Balance ($MM) Interest Rate2 Interest Payment ($MM)

1 500 LIBOR+70 0.750

2 500 LIBOR+130 1.000

1,000 LIBOR+100 1.750

AVAILABLE FUNDS CAP EXAMPLE:ASSETS IN MONTH 11

exhibit 8a

AVAILABLE FUNDS CAP EXAMPLE:LIABILITIES IN MONTH 1

exhibit 8b

1Interest only loans, 36-month term, 24-month lockout period.21-Month LIBOR=1.10%3Difference between bond’s stated coupon and collateral WAC.4Subject to WAC Cap5Notional Amount


Accrued Accrued Interest

Class Size Pass-Through Interest Capped at

Class ($MM) Rate2 ($MM) WAC ($MM)

A 600 LIBOR+30 0.700 0.700

B 200 LIBOR+60 0.283 0.283

C4 100 LIBOR+90 0.167 0.167

D4 100 LIBOR+120 0.192 0.175

X5 1,000 WAC/IO

1,000 LIBOR+51

coupon payment and the original specified coupon payment. Any remainingcash after paying all of the coupons is passed to the IO.

To illustrate this concept, consider a simple, hypothetical floating rate CMBSdeal that is backed by two loans. These two loans have a weighted averagecoupon of LIBOR+100 bp. The liabilities consist of four classes and an IO.The very senior classes of a CMBS deal are typically not subject to a WAC cap,but the mezzanine classes may be. In our example, classes C and D have speci-fied coupons of LIBOR+90 bp and LIBOR+120 bp and are subject to an avail-able funds cap.

In this hypothetical transaction, the collateral WAC in month 1 will pay the stat-ed coupons on classes A, B and C. Class D, however, will be capped at the col-lateral WAC of LIBOR+100 bp, since its stated coupon (LIBOR+120 bp)exceeds the collateral WAC.

After paying the full coupons on classes A through C and the capped coupon onclass D, $0.425 million in collateral interest is still available for distribution. Thisis enough cash to pay class D an additional $0.017 million, such that it receivesits full coupon payment. The remaining $0.408 million is distributed to the IO.

The available funds cap may also be triggered in a scenario where the highercoupon loans pay off, leaving the lower coupon loans in the pool.


Additional

WAC Cap Interest Interest Interest

Shortfall3 Amount Payment Shortfall

($MM) ($MM) ($MM) ($MM)

- - 0.700 -

- - 0.283 -

- - 0.167 -

0.017 0.017 0.192 -

0.408

1.750

In Exhibits 9a & 9b, we revisit the same structure but assume that one of theloans pays off, leaving a single loan with a coupon of LIBOR+70 bp. In thisscenario, class C as well as class D triggers the available funds cap. After payingthe capped coupons, there is enough cash to pay the full class C coupon. ClassD, however, does not receive its full coupon of $0.192 million and only receives$0.183 million. Therefore, this class experiences an interest shortfall of $0.009million. The IO in this case does not receive any interest.



206

chapter 11

Loan Balance ($MM) Interest Rate2 Interest Payment ($MM)

1 500 LIBOR+70 0.750

2 - LIBOR+130 -

500 LIBOR+70 0.750

AVAILABLE FUNDS CAP EXAMPLE: MONTH 26ASSETS1

exhibit 9a

AVAILABLE FUNDS CAP EXAMPLE: MONTH 26LIABILITIES

exhibit 9b

1Interest only loans, 36-month term, 24 month lockout period.21-Month LIBOR=1.10%3Difference between bond’s stated coupon and collateral WAC.4Subject to WAC Cap5Notional Amount


Accrued Accrued Interest

Class Size Pass-Through Interest Capped at

Class ($MM) Rate2 ($MM) WAC ($MM)

A 100 LIBOR+30 0.117 0.117

B 200 LIBOR+60 0.283 0.283

C4 100 LIBOR+90 0.167 0.150

D4 100 LIBOR+120 0.192 0.150

X5 500 WAC/IO

500 LIBOR+72


Additional

WAC Cap Interest Interest Interest

Shortfall3 Amount Payment Shortfall

($MM) ($MM) ($MM) ($MM)

- - 0.117 -

- - 0.283 -

0.017 0.017 0.167 -

0.042 0.033 0.183 0.009

-

0.750

208




Commercial Mortgage Defaults

Chapter 12

This chapter contains our commercial mortgage default study which covers thetime period 1972-2002. Our main conclusion is that most investment gradeCMBS (with the exception of BBBs from more recent vintages) are well protectedagainst the most severe real estate downturn of the last 30 years.

The addition of two years of new data alters the original conclusion only slightly.In the past, all investment-grade CMBS were protected from the magnitude oflosses experienced by life insurance company loans. With continued reductionsin subordination levels, a greater proportion of recently rated BBB classes wouldnow be vulnerable to a downturn of the magnitude of the late 1980s and early1990s.

In our updated study:

• We added 1,383 new loans, increasing the total to nearly 18,000.

• The average lifetime cumulative default rate (based on loan balances) forcohorts with at least 10 years of seasoning decreased from 20.5% to 19.6%over the last two years.

• 1986 remained the worst origination year, with nearly 32% of the total bal-ance eventually defaulting.

• The average severity on liquidated loans was about 33%.

• Of the cohorts with at least 10 years of seasoning, the 1991 and 1992 origi-nation years had the lowest cumulative default rates.

• For a given cohort, on average, the peak years for defaults were years 3-7after origination.

• About 55% of the defaulted loans were liquidated.

BACKGROUNDMark Snyderman authored two pioneering studies in 1991 and 1994 on cumula-tive lifetime default rates on commercial mortgages held by life insurance com-panies. His 1994 article tracked defaults (90+ day delinquent loans) on eightlarge insurance companies through 1991. The studies were the first to track com-mercial mortgage credit through several complete real estate cycles. Snydermanwas able to follow the performance of loans originated in a given year (cohort)until all of the loans had either matured, prepaid, or defaulted.

In 1999, Snyderman, L’Heureux, and Esaki (ELS) used the same insurance com-panies and data sources as the original studies to update the default data through1997. The period of the ELS extension included the final years of the worst realestate downturn since the Great Depression of the 1930s. One of the findings ofthe study was that the 1986 cohort of originations was the worst in the past 30years, with a cumulative default rate of 28%. Investment-grade CMBS from theaverage conduit deal issued at that time, however, would not have lost principal ifsubjected to the default and loss rates experienced by the 1986 cohort.

Two years ago (2002), Esaki updated the study, adding three years of data. Themain finding was that declining subordination levels would put some BBBCMBS at risk if the default rates of the worst cohort were repeated.



210

Chapter 12


COMPARISON TTO PPREVIOUS SSTUDIESOur update through 2002 shows little difference from the results of the previousstudy with data through 2000. Only 21 loans from the database defaulted during2001 and 2002. This represents only 0.3% of the total number of loans originat-ed in the last 10 years of the study.

In the current update, we examined the credit performance of 17,978 individualloans, an increase of about 1,400 loans from the 2002 study. The average life-time cumulative default rate for origination cohorts with at least ten years of his-tory was 19.6%, slightly lower than the 20.5% in the prior default study pub-lished by Esaki in 2002. On average, about 91% of defaults occurred within thefirst 10 years of origination. The cumulative default rate of almost 32% fororiginations in 1986 was again the highest for any cohort.

NUMBER OOF LLOANS BBY OORIGINATOR AAND OORIGINATION YYEARIn the current study, we tracked commercial mortgage default rates from lifeinsurance company annual statements for 2001 and 2002. We then aggregatedour data with the two previous Snyderman studies, the ELS findings, and theEsaki (2002) report. As in the earlier studies, we chose to include cohorts with aminimum of five years of seasoning. Of the 17,978 total loans originated, about2,700 (15.3%), had defaulted by 2002.

SIZE OOF LLOANSThe median loan size was about $4.2 million, and the average loan size wasabout $8.5 million. Average loan size has trended up over time, increasing from$3 million in 1972 to $14 million in 1997. Over 70% of the loans were less than$8 million.

The less-than-$2 million loan category had the lowest default rate, while the $4-8million category had the highest default rate. This is the same as previous studies.

GEOGRAPHIC DDISTRIBUTIONAs in earlier studies, the loans are geographically well diversified, with the largestpercentages in the West (23%) and Northeast (22%). The highest default rateswere in the South Central region (25%), with the lowest in the West (10%).

DEFAULTS BBY OORIGINATION CCOHORTThe cumulative lifetime default rate (by loan balance) for cohorts with at least 10years of history ranged from 4.0% for 1992 originations to 31.7% for 1986 orig-inations. The average lifetime cumulative default rate (based on loan balance)for cohorts with at least 10 years of seasoning was 19.6%, down from 20.5% inthe previous study. The drop resulted from the addition of 1991 and 1992,which had the two lowest cumulative default rates of any cohort.



212

Chapter 12

TIMING OOF DDEFAULTS

On average, the annual default rate was low within the year of loan origination,but rose to about 1% in the first year following origination, then jumped to arange of 1.5% to 2.7% for the next six years. Default rates then declined to lessthan 1% for the next three years, and tailed off gradually. These results are near-ly identical to the Esaki (2002) study. As in that study, there is no spike indefaults at balloon dates. Some research analysts have noted that loan restruc-tures result in the appearance of low default rates in balloon years, but there isno evidence to support this in our study.

The default timing pattern for individual cohorts can vary widely from the aver-age. The timing and total defaults of a cohort are highly dependent on its posi-tion in the real estate cycle. For almost all cohorts, however, the peak indefaults is in years three through seven after origination.

LIQUIDATIONS AAND RRECOVERIESAs in previous studies, not all defaulting (90+ days delinquent) loans liquidate. Wefound that only about half of the loans we recorded as entering default for thefirst time went straight through to liquidation. Another quarter of the loans wererestructured, while the rest became current again. Of the loans becoming current,about 60% were eventually restructured, and another 30% defaulted again. Weestimate that about 55% of loans entering default are eventually liquidated, 40%are restructured, 3% become delinquent again, and only 2% fully recover.

Our finding that 20% of loans entering default initially recover is similar to aFitch (2001) CMBS default study finding that 22% of defaulted loans in CMBSreturn to current status. Our study goes one step further, however, and findsthat only about 9% of these loans remain current. This means that only about2% (20% x 9%) of loans entering default return permanently to current status.

SEVERITY OOF LLOSSThe loss severity on liquidated loans for the loans added to the previous studywas about 31%, the same as in the previous study and less than the 36% in theoriginal Snyderman studies. The severity calculation includes foregone interestand expenses, as well as lost principal.

In Exhibit 1, we outline the components that are used in the loss severity calcu-lation. For loans that were liquidated within the last 10 years of the study, fore-gone interest accounted for a large portion of loss severity. On average, theloans liquidated within this 10-year time period experienced 24 months betweendefault and liquidation.


For the entire 1972-2002 period, the average severity of loss on foreclosed loansis about 33%. As in earlier studies, the range of severities for individual loans islarge. Some loans had severities of over 100%, while others recorded no loss.


SEVERITY OF LOSSON LIQUIDATED

LOANS(1992-2002)

exhibit 1

IMPACTS OOF DDEFAULTS OON CCURRENT BBOND SSTRUCTURES

In the Esaki (2002) study, we found that the average cohort with at least 10 yearsof seasoning lost about 5.4% of its original balance through defaults. In thisstudy, the average cohort with at least 10 years of seasoning lost slightly less,about 4.9% of its original balance.

This calculation assumes that restructured loans have half of the severity(16.5%) of liquidated loans. Since the average conduit/fusion transaction todayis being issued with BBB subordination levels of about 5%, most investment-grade CMBS are still protected against the average loss of origination cohorts ofthe last 30 years.

The loss on the worst cohort, 1986, has an estimated loss of 8.1% of its originalbalance. This exceeds the average BBB subordination level on conduit andfusion CMBS transactions being issued today, and would result in the default ofeven some single-A classes. It is, however, still below the lowest credit supportlevels for AAA CMBS.



214

Chapter 12

AVERAGE SUBORDINATION FOR CONDUIT/FUSION TRANSACTIONS

exhibit 2

1As of August 19, 2004.

Source: Commercial Mortgage Alert, Morgan Stanley

1998 1999 2000 2001 2002 2003 20041

AAA 29% 27% 23% 21% 20% 17% 14%

AA 24% 22% 19% 17% 16% 14% 12%

A 18% 17% 14% 13% 12% 10% 9%

BBB 13% 12% 11% 9% 8% 7% 5%

BB 6% 6% 5% 4% 4% 3% 3%

B 3% 3% 3% 2% 2% 2% 2%

NUMBER OF LOANS BY ORIGINATOR, 1972-1997exhibit 3

Number Percentage Change Total LoanOriginator of Loans from Esaki (2002) Amount ($BN)

Aetna Life Insurance Company 3,042 1.1% 26.6

Connecticut Mutual Life Insurance Company 1,062 15.9% 5.7

Equitable Life Insurance Company 1,838 1.1% 17.2

John Hancock Mutual Life Insurance Company 2,538 13.0% 18.1

New England Mutual Life Insurance Company 1,736 25.0% 11.5

The Northwestern Mutual Life Insurance Company 1,108 21.9% 13.6

The Prudential Insurance Company of America 4,349 7.6% 42.6

The Travelers Insurance Company 2,305 1.7% 17.4

Total 17,978 8.3% 152.8


Our loss estimates are based on a number of assumptions. The most importantassumption for loss calculation is that the severity of restructured loans is halfthat for liquidated loans. If we assume, as some market participants believe, thatrestructured loans have close to 0% severity, the loss for the worst cohort dropsto 6.1%. On the other hand, if we assume that restructured and liquidated loanshave the same severity of 33%, the loss rate estimate rises to 10.6%.

CONCLUSIONS

The results from our update of commercial mortgage defaults through the year2002 do not significantly change the previous findings on cumulative default andloss rates, the severity of losses on liquidated loans, or the shape of the loss curve.

REFERENCESEsaki, Howard. “Commercial Mortgage Defaults: 1972-2000.” Real Estate Finance,Winter 2002.

Esaki, Howard, Steven L’Heureux, and Mark P. Snyderman. “CommercialMortgage Defaults: An Update.” Real Estate Finance, Spring 1999.

Lans, Diane M. and Noel Cain. “Dissecting Defaults and Losses: 2001 CMBSConduit Loan Default Study.” Fitch IBCA Special Report, August 2001.

Snyderman, Mark P. “Commercial Mortgages: Default Occurrence andEstimated Yield Impact.” Journal of Portfolio Management, Fall 1991.

Snyderman, Mark P. “Update on Commercial Mortgage Defaults.” Real EstateFinance, Summer 1994.




216

Chapter 12


NUMBER OF LOANS BY

ORIGINATION YEAR

exhibit 4


AVERAGELOAN AMOUNT BYORIGINATION YEAR

exhibit 5

LOANS ORIGINATED AND DEFAULT RATES BY REGIONexhibit 7

PercentageNumber of Change from Amount of

Loans from Esaki (2002) Loans ($BN)

West Coast 4,120 9.2 37.0

South Central 3,042 7.3 19.6

Northeast 3,891 6.7 40.1

Mid-Central 3,317 8.0 25.4

Southeast 3,069 8.8 27.4

Canada/Other 539 20.9 3.3

Total 17,978 8.3 152.8



LOANS ORIGINATED AND DEFAULT RATES BYPRINCIPAL AMOUNT

exhibit 6

Percentage Percent Loan CountLoan Amount Loans Change from of Default Rate($MM) Originated Esaki (2002) Total (%)

1-2MM 4,083 3.3% 22.7% 12.9%

2-4 MM 4,473 5.2% 24.9% 15.6%

4-8 MM 4,326 9.8% 24.1% 16.7%

>8MM 5,096 14.5% 28.3% 15.7%

Total 17,978 8.3% 100.0% 15.3%


By Loan Count By Loan Amount

PercentagePercent of Change from Default Percent of Percentage Default

Total Esaki (2002) Rate (%) Total Change Rate (%)

22.9 0.2 10.2 24.2 -0.4 11.6

16.9 -0.2 24.6 12.8 0.2 23.7

21.6 -0.3 13.3 26.3 -0.4 13.9

18.5 0.0 15.8 16.7 0.0 16.6

17.1 0.1 15.7 17.9 0.5 14.4

3.0 0.3 9.8 2.1 0.1 15.7

100.0 NA 15.3 100.0 NA 15.2



218

Chapter 12


LIFETIME DEFAULTRATES BY

ORIGINATIONCOHORT

(BY PRINCIPALBALANCE)

exhibit 8a


LIFETIME DEFAULTRATES BY

ORIGINATIONCOHORT

(BY LOAN COUNT)

exhibit 8b


AVERAGE TIMINGOF DEFAULTS –

LOAN COUNT

exhibit 9a



AVERAGE TIMINGOF DEFAULTS –LOAN AMOUNT

exhibit 9b


LIQUIDATED,RESTRUCTURED,AND RECOVERED

LOANS

exhibit 10



220

Chapter 12

10 Y

ear

Lifet

ime

% in

01

23

45

67

89

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

Tot

al

Tot

al

10 y

rs

AVG

0.3

31.1

91.6

41.7

11.6

71.8

11.6

61.0

80.9

60.7

20.6

90.5

50.5

10.4

30.3

10.4

30.3

70.1

80.1

40.2

00.1

20.0

40.0

10.0

20.0

00.0

30.0

00.0

00.0

00.0

00.0

013.0

215.2

785.2

5

1972

0.0

02.4

43.7

53.5

63.1

91.3

10.1

90.3

80.0

00.0

00.0

00.1

90.1

90.3

80.7

50.9

40.5

60.1

90.1

90.7

50.3

80.0

00.1

90.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

014.8

219.5

175.9

6

1973

0.1

42.9

95.0

33.4

01.4

90.4

10.0

00.1

40.1

40.1

40.1

40.0

00.8

20.9

50.6

80.8

20.6

80.1

40.2

70.8

20.2

70.2

70.0

00.1

40.0

00.0

00.0

00.0

00.0

00.0

013.9

919.8

470.5

5

1974

0.7

16.2

33.2

61.4

20.5

70.7

10.1

40.1

40.1

40.4

20.0

00.1

40.4

20.7

10.4

20.7

10.7

10.2

80.2

80.1

40.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

013.7

417.5

678.2

3

1975

2.3

32.3

31.9

40.5

80.5

80.5

80.3

90.0

00.3

90.3

90.0

01.1

71.3

60.5

80.7

80.7

80.7

80.5

80.3

90.0

00.0

00.0

00.0

00.0

00.0

00.1

90.0

00.0

09.5

116.1

259.0

4

1976

0.2

10.8

20.4

11.2

30.2

10.0

00.2

10.0

00.0

01.0

30.6

21.2

30.4

10.2

10.2

11.8

50.8

20.4

10.6

20.6

20.2

10.0

00.0

00.0

00.0

00.0

00.0

04.7

211.2

941.8

2

1977

0.0

00.8

50.1

40.2

80.1

40.2

80.1

40.7

10.5

61.5

50.9

90.5

60.1

40.5

60.4

20.5

60.8

50.0

00.2

80.1

40.0

00.1

40.0

00.0

00.0

00.0

05.6

59.3

260.6

1

1978

0.2

80.1

90.0

90.0

00.3

80.0

00.0

90.6

61.8

01.1

41.5

20.8

51.4

20.6

60.9

50.9

50.5

70.0

90.0

00.0

00.1

90.0

00.0

00.0

00.0

06.1

611.8

552.0

0

1979

0.2

70.3

60.0

90.6

20.1

80.3

60.1

82.1

30.9

81.9

61.1

61.1

61.5

11.4

20.8

00.3

60.1

80.3

60.0

00.0

00.0

00.0

00.0

00.0

08.2

714.0

458.8

6

1980

0.2

40.4

70.2

40.0

00.5

91.3

02.2

51.5

42.0

11.5

42.0

12.0

11.4

20.8

30.1

20.2

40.3

60.2

40.0

00.1

20.2

40.0

00.0

012.2

017.7

768.6

7

1981

0.7

50.0

01.0

00.5

00.7

52.7

42.0

02.4

92.4

91.2

51.7

52.2

40.7

50.2

50.0

00.5

00.2

50.2

50.0

00.0

00.0

00.0

015.7

119.9

578.7

5

1982

1.3

80.9

22.2

92.7

55.0

51.8

30.0

01.3

83.6

70.0

00.9

20.9

20.0

00.4

60.0

00.0

00.0

00.4

60.0

00.0

00.0

020.1

822.0

291.6

7

1983

1.2

50.3

11.1

04.3

92.5

13.2

90.7

80.4

71.8

80.7

81.1

00.1

60.1

60.0

00.0

00.0

00.0

00.0

00.0

00.0

017.8

718.1

898.2

8

1984

0.0

01.4

13.1

71.9

44.5

92.2

93.7

01.7

62.2

91.5

90.5

30.3

50.0

00.1

80.0

00.0

00.0

00.0

00.0

023.2

823.8

197.7

8

1985

0.0

82.4

02.0

82.4

82.5

63.6

03.2

81.6

81.1

20.3

20.4

80.0

80.1

60.0

80.0

00.0

00.0

80.0

020.1

020.5

098.0

5

1986

0.0

01.1

82.1

62.0

63.4

44.9

28.4

62.2

61.2

80.4

91.0

80.2

00.1

00.1

00.0

00.0

00.0

027.3

427.7

398.5

8

1987

0.2

10.3

11.7

72.7

14.3

85.6

33.6

52.0

91.0

40.3

10.7

30.4

20.2

10.0

00.0

00.0

022.8

423.4

697.3

3

1988

0.1

00.2

91.8

74.7

24.1

34.5

22.7

51.2

81.2

80.2

90.1

00.0

00.0

00.1

00.0

021.3

421.4

499.5

4

1989

0.3

50.9

33.1

33.3

62.5

52.0

92.6

71.7

40.7

00.5

80.2

30.1

20.1

20.0

018.3

118.5

498.7

5

1990

0.4

13.1

34.6

32.1

82.1

83.0

01.0

90.2

70.0

00.2

70.1

40.2

70.0

017.3

017.5

798.4

5

1991

0.7

21.2

01.6

81.6

81.2

00.2

40.4

80.4

80.0

00.0

00.2

40.0

07.9

37.9

3100.0

0

1992

0.9

40.3

11.8

81.2

50.0

00.0

00.0

00.0

00.0

00.3

10.0

04.6

94.6

9100.0

0

1993

0.2

10.6

20.0

01.0

40.0

00.6

20.2

10.0

00.0

00.2

12.9

02.9

0100.0

0

1994

0.4

30.0

00.6

40.4

30.2

10.0

00.0

00.2

10.0

01.9

31.9

3100.0

0

1995

0.0

00.3

60.3

60.0

00.0

00.0

00.0

00.7

11.4

21.4

2100.0

0

1996

0.0

00.1

60.0

00.0

00.1

60.3

20.1

60.8

00.8

0100.0

0

1997

0.0

00.0

00.0

00.0

00.0

00.1

40.1

40.1

4100.0

0

TIM

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Tappendix

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Life

Insu

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com

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10 Y

ear

Lifet

ime

% in

01

23

45

67

89

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

Tot

al

Tot

al

10 y

rs

AVG

0.1

90.9

21.5

11.7

21.8

42.0

02.6

81.4

90.9

10.6

10.8

70.4

30.3

00.3

60.2

40.2

30.2

80.1

50.1

40.0

90.0

80.0

50.0

20.0

40.0

00.0

20.0

00.0

00.0

00.0

00.0

013.8

915.2

085.8

1

1972

0.0

01.6

82.5

22.9

910.2

01.2

50.0

60.2

30.0

00.0

00.0

00.2

20.0

80.2

30.6

90.5

40.7

00.1

40.1

00.4

70.1

60.0

00.3

50.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

018.9

422.6

383.7

1

1973

0.2

62.2

44.5

92.4

61.0

60.4

00.0

00.0

50.1

50.0

40.1

10.0

00.4

20.8

00.5

00.7

20.4

90.0

50.1

20.3

60.4

00.4

40.0

00.3

80.0

00.0

00.0

00.0

00.0

00.0

011.3

516.0

370.8

3

1974

0.8

17.1

04.5

51.0

20.7

40.8

50.0

70.1

20.1

10.9

60.0

00.0

70.4

10.4

20.3

80.6

00.5

20.1

50.7

40.2

70.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

00.0

016.3

319.9

082.0

8

1975

1.9

13.0

41.1

80.5

40.2

00.2

30.1

50.0

00.4

40.6

70.0

01.1

11.5

80.1

90.5

90.2

50.3

90.4

10.3

60.0

00.0

00.0

00.0

00.0

00.0

00.1

10.0

00.0

08.3

613.3

662.5

5

1976

0.3

21.3

50.1

51.6

90.1

50.0

00.0

70.0

00.0

00.8

80.7

30.7

20.5

80.1

00.0

71.7

90.3

90.3

51.1

00.3

50.1

10.0

00.0

00.0

00.0

00.0

00.0

05.3

410.9

048.9

8

1977

0.0

01.4

40.0

42.7

60.0

42.8

30.1

83.3

30.4

01.7

60.4

40.5

30.0

30.3

32.2

21.0

00.4

60.0

00.0

90.0

40.0

00.0

80.0

00.0

00.0

00.0

013.2

118.0

073.4

1

1978

0.1

40.0

70.0

40.0

00.2

90.0

00.0

30.4

71.4

81.6

41.6

30.8

01.1

30.4

60.8

30.6

10.4

90.1

40.0

00.0

00.1

60.0

00.0

00.0

00.0

05.7

810.4

055.6

4

1979

0.1

10.3

20.9

70.5

70.4

30.2

80.1

42.6

20.9

82.2

70.8

90.9

01.3

23.1

30.4

20.1

80.3

80.5

50.0

00.0

00.0

00.0

00.0

00.0

09.5

916.4

758.2

1

1980

0.0

80.2

50.1

60.0

00.5

32.1

61.6

91.2

21.2

21.5

32.0

51.5

40.9

21.2

70.8

00.2

50.5

00.1

10.0

00.0

30.0

80.0

00.0

010.8

916.3

866.5

0

1981

0.6

90.0

00.5

70.5

00.5

32.2

10.8

32.0

53.4

40.9

22.1

10.9

10.4

80.0

40.0

00.4

30.1

50.7

30.0

00.0

00.0

00.0

013.8

416.5

883.4

8

1982

0.7

31.5

41.7

71.4

42.6

61.3

10.0

00.5

33.1

90.0

04.4

20.6

80.0

02.3

90.0

00.0

00.0

00.1

50.0

00.0

00.0

017.5

920.8

084.5

3

1983

0.8

20.1

61.0

93.8

12.4

62.9

91.5

30.8

01.8

40.6

50.7

90.1

40.0

40.0

00.0

00.0

00.0

00.0

00.0

00.0

016.9

517.1

398.9

2

1984

0.0

01.2

71.9

91.2

22.5

21.1

47.7

64.7

92.7

52.2

70.1

71.1

80.0

00.1

00.0

00.0

00.0

00.0

00.0

025.8

827.1

695.2

8

1985

0.0

52.3

31.8

32.4

52.9

22.9

02.8

62.2

41.3

00.3

80.9

30.0

70.2

70.3

20.0

00.0

00.4

60.0

020.1

721.2

994.7

5

1986

0.0

00.9

22.2

82.1

43.2

55.8

210.3

02.4

71.3

10.2

42.3

20.2

30.3

10.0

60.0

00.0

00.0

031.0

531.6

698.0

9

1987

0.1

30.2

01.2

32.8

64.6

04.7

34.6

32.8

40.4

90.1

81.0

70.4

10.1

00.0

00.0

00.0

022.9

523.4

697.8

2

1988

0.0

90.2

81.8

53.6

53.4

73.4

34.2

51.4

21.1

60.1

30.0

80.0

00.0

00.0

30.0

019.8

119.8

399.8

7

1989

0.1

01.2

82.3

83.5

51.8

51.8

44.3

31.5

00.4

90.5

60.7

30.4

90.1

50.0

018.6

019.2

496.7

0

1990

0.0

92.4

75.9

51.8

02.8

73.2

61.0

20.2

70.0

00.1

00.0

30.4

60.0

017.8

518.3

197.4

9

1991

0.5

01.2

20.8

51.1

11.2

70.3

70.3

70.1

80.0

00.0

00.2

80.0

06.1

46.1

4100.0

0

1992

1.0

50.1

81.3

90.8

00.0

00.0

00.0

00.0

00.0

00.5

70.0

04.0

04.0

0100.0

0

1993

0.2

70.3

70.0

01.8

10.0

00.3

70.1

00.0

00.0

00.1

13.0

33.0

3100.0

0

1994

0.3

40.0

00.6

90.1

70.2

30.0

00.0

00.0

30.0

01.4

71.4

7100.0

0

1995

0.0

00.0

90.3

40.0

00.0

00.0

00.0

00.7

81.2

01.2

0100.0

0

1996

0.0

00.1

00.0

00.0

00.0

80.1

40.1

30.4

40.4

4100.0

0

1997

0.0

00.0

00.0

00.0

00.0

00.1

10.1

10.1

1100.0

0

12.4

814.5

885.6

0

TIM

ING

OF

DEFA

ULT

S BY

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– LO

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Eappendix

A-2

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222




Transaction Monitoring

Chapter 13



224

chapter 13

In this chapter, we provide samples of transaction monitoring pieces that wepublish regularly. Section I contains an example of our monthly delinquencyarticle which reports delinquencies for the entire universe as well as for sea-soned, multiborrower CMBS. Section II contains an excerpt from our conduittracking report of specially serviced loans in Morgan Stanley transactions.Section III includes an excerpt from our retail study analyzing risky tenant expo-sure in Morgan Stanley deals. Section IV provides an example of our quarterlytracking of CMBS rating actions. Section V contains our most recent report onthe credit performance of CMBS originators.

Section I. CMBS Delinquency ReportBased on October 2004 remittance reports, delinquencies on all CMBS transactionsdeclined 4 bp to 1.13% of original balances. Most of the improvement was attrib-utable to office collateral. Sixty-plus day delinquencies on all CMBS declined 2 bpto 0.97%.

After peaking at 2.62% in November 2003, seasoned delinquencies have declinedconsistently over the past eight months. Based on October remittance reports,delinquencies on seasoned transactions (aged over one year) declined 10 bp to1.79%. The liquidation of a $33.4 million loan in MSC 1997-ALIC (CambridgePark 2) accounted for 3 bp of the decline. The remaining 7 bp of improvement isattributable to a large number of small loans. Sixty-plus day delinquencies onseasoned deals declined 4 bp to 1.55%.


DELINQUENCIESIN SEASONED

CMBS DEALS ANDLIFETIMEAVERAGE

exhibit 1

ORIGINATION YYEAROf the cohorts with more than $20 billion in collateral outstanding, the 1997 cohort posted the greatest improvement, declining 35 bp to 3.11%.


Current Balance 30/60/90+ Forc. & Change From

Year ($BN) Days REO Total Last Month

1990 0.2 19.46 0.00 19.46 0.04

1991 0.1 0.00 0.00 0.00 0.00

1992 0.2 0.00 0.00 0.00 0.00

1993 0.4 1.33 0.95 2.27 0.02

1994 0.7 1.21 3.39 4.60 1.18

1995 3.1 0.89 2.21 3.09 -0.80

1996 9.2 1.01 0.89 1.90 0.13

1997 26.4 1.65 1.46 3.11 -0.35

1998 57.0 0.84 1.04 1.88 -0.07

1999 34.2 1.35 1.01 2.36 -0.19

2000 32.6 0.94 1.22 2.15 0.06

2001 52.3 0.71 0.34 1.04 0.06

2002 48.9 0.24 0.12 0.36 0.04

2003 82.0 0.09 0.00 0.09 0.03

2004 59.0 0.06 0.00 0.06 0.05

Total/Average 406.3 0.60 0.53 1.13 -0.04

CMBS DELINQUENCIES BY YEAR OF ORIGINATION (IN %) (AS OF OCTOBER 2004 REMITTANCE REPORTS)

exhibit 2


Product Current Balance 30/60/90+ Forc. & Change From

Type ($BN) Days REO Total Last Month

Hotel-Motel 29.0 1.06 1.39 2.44 -0.13

Industrial-Warehouse 21.9 0.73 0.83 1.56 -0.01

Mixed 16.3 0.21 0.46 0.67 -0.11

Mobile Home 8.3 0.45 0.13 0.58 0.14

Multifamily 70.4 1.15 0.58 1.73 0.10

Office 100.0 0.46 0.49 0.95 -0.14

Retail 124.7 0.45 0.35 0.80 -0.02

Self-Storage 5.6 0.25 0.03 0.28 0.03

Senior Housing 3.9 1.55 1.06 2.61 -0.65

Other 26.2 0.01 0.36 0.37 0.00

Total/Average 406.3 0.60 0.53 1.13 -0.04

CMBS DELINQUENCIES BY PROPERTY TYPE (IN %) (AS OF OCTOBER 2004 REMITTANCE REPORTS)

exhibit 3


The liquidation of the Cambridge Park 2 loan was responsible for 13 bp ofthe improvement.

MULTIFAMILY DDELINQUENCIES RRISEDelinquencies on multifamily collateral rose 10 bp during the month to 1.73%.Although multifamily fundamentals are showing signs of improvement (vacan-cies nationwide declined 20 bp in 3Q04) we continue to maintain a cautious viewon the sector.

OFFICE CCOLLATERAL PPOST 114 BBP IIMPROVEMENTOffice delinquencies declined 14 bp to 0.95% of current balances. Eight basispoints of the decline is attributable to the liquidation of three office properties,Allen Center in GMACC 1997-C2, the Bell Atlantic Building in CMAC 1998-C2and Cambridge Park 2 in MSC 1997-ALIC. The weighted average loss severityon those loans was 28.6%.

CUMULATIVE LLOSSESCumulative losses for the seasoned universe rose 3 bp to 0.59% of original bal-ances. MCFI 1997-MC1 experienced the greatest rise in cumulative losses (104bp) due to the liquidation of the Radisson Hotel & Suites-Buffalo. The loan’sloss severity was 100%.



226

chapter 13

CMBS DELINQUENCIES BY PROPERTY TYPE AND YEAR(IN %) (AS OF OCTOBER 2004 REMITTANCE REPORTS)

exhibit 4


Product Type 1990 1991 1992 1993 1994 1995 1996

Hotel-Motel 0.00 N/A N/A 0.00 1.26 21.59 8.97

Industrial-Warehouse 0.00 0.00 0.00 0.00 12.97 4.53 1.97

Mixed 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Mobile Home N/A N/A 0.00 0.00 0.00 11.46 0.00

Multifamily 0.00 0.00 0.08 1.47 0.00 2.20 2.34

Office 38.92 0.00 0.00 0.00 0.00 0.00 0.37

Retail 0.00 0.00 0.00 9.85 10.11 2.96 0.94

Self-Storage N/A N/A N/A N/A N/A 0.00 0.00

Senior Housing N/A N/A N/A N/A 1.62 12.90 5.93

Other 0.00 0.00 0.00 0.00 0.00 0.00 0.00


Current Balance % Total Change From

State ($BN) Delinq. Last Month

CA 59.3 0.53 -0.06

NY 45.3 0.43 -0.07

TX 25.9 2.79 0.24

FL 23.0 1.70 -0.06

IL 12.6 2.11 -0.10

NJ 12.7 0.76 0.03

VA 12.6 0.14 -0.08

MA 10.5 1.39 -0.49

PA 10.2 1.75 -0.22

MD 9.9 0.27 -0.11

Total/Average 221.9 1.06 -0.06

CMBS DELINQUENCIES BY STATE (IN %) (AS OF OCTOBER 2004 REMITTANCE REPORTS)

exhibit 5


1997 1998 1999 2000 2001 2002 2003 2004

7.40 3.64 2.15 1.44 1.52 0.00 0.00 0.00

3.67 3.62 2.24 3.02 0.76 0.25 0.00 0.00

4.43 1.09 2.60 4.20 0.62 0.00 0.00 0.00

0.54 0.86 0.39 0.69 0.33 1.16 0.00 0.00

1.50 1.01 3.66 3.44 3.74 1.19 0.26 0.00

3.92 2.99 3.82 2.41 0.24 0.22 0.04 0.00

3.63 1.42 1.46 1.25 0.53 0.09 0.04 0.00

0.41 0.55 0.66 1.75 0.00 0.00 0.00 0.00

4.55 3.05 2.33 2.33 2.09 0.00 0.00 N/A

6.41 2.59 2.04 0.00 0.00 0.00 0.00 0.00



228

chapter 13

Section II. Summer UpdateIn this summer 2004 issue of our tracking report, we provide details on 73 spe-cially serviced loans ($447.6 million in current balances) in Morgan Stanley con-duit transactions.

Loans in this report are either currently in special servicing or are resolved loansthat were covered in our previous report. Conduit transactions issued offMorgan Stanley’s shelf that do not have any loans in special servicing are not inthis report.

The information provided is based on July 2004 and August 2004 remittancereports and recent conversations with special servicers.

MORGAN STANLEY TRANSACTIONS (JULY 2004 REMITTANCE REPORTS)

exhibit 6

Source: Intex, Remittance Reports

Original Current

Balance Balance

Deal Name ($MM) ($MM) Factor

Morgan Stanley Capital I, 1996-C1 340.5 128.3 0.38

Morgan Stanley Capital I, 1996-WF1 605.4 234.2 0.39

Morgan Stanley Capital I, 1997-ALIC 802.7 312.0 0.39

Morgan Stanley Capital I, 1997-C1 640.7 315.6 0.49

Morgan Stanley Capital I, 1997-HF1 622.4 270.7 0.43


Morgan Stanley Capital I, 1998-CF1 1,107.3 850.8 0.77

Morgan Stanley Capital I, 1998-HF1 1,283.7 992.2 0.77

Morgan Stanley Capital I, 1998-HF2 1,066.3 898.2 0.84

Morgan Stanley Capital I, 1998-WF1 1,392.2 1,069.6 0.77

Morgan Stanley Capital I, 1998-WF2 1,062.0 898.1 0.85

Morgan Stanley Capital I, 1999-FNV1 632.1 582.6 0.92

Morgan Stanley Capital I, 1999-LIFE 594.0 559.2 0.94

Morgan Stanley Capital I, 1999-RM1 867.1 739.1 0.85


Morgan Stanley Dean Witter Capital, 2000-LIFE 689.0 641.8 0.93

Morgan Stanley Dean Witter Capital, 2001-TOP1 1,172.2 1,080.2 0.92

Morgan Stanley Dean Witter Capital, 2001-TOP3 1,031.2 989.9 0.96

Morgan Stanley Dean Witter Capital, 2002-TOP7 976.6 931.4 0.95

Morgan Stanley Capital I, 2003-TOP11 1,194.9 1,180.4 0.99

Total/Weighted Average 17,608.0 13,829.0 0.83

TRANSACTION SSTATISTICSBased on July remittance reports, delinquencies on the transactions we reviewedwere 2.20% of current balances, 14 bp higher than the average for seasonedCMBS deals (aged over one year). Cumulative losses on the transactions we cov-ered were 64 bp, versus 54 bp for seasoned CMBS.

LOAN SSTATISTICSTwelve loans accounting for about $88.5 million in current balances are new spe-cially serviced loans since our last report. Twelve problem loans accounting forabout $42.7 million in current balances have been resolved since our last report,either through liquidation, payoff or by being returned to the master servicer.


Delinquency Data (%) Specially Serviced Data

Specially

Serviced or % of Specially

30, 60 Forc. & Cum Resolved Serviced or

& 90+ REO Total Loss Loans ($MM) Resolved Loans

2.65 3.21 5.85 1.02 7.5 1.7

0.00 0.00 0.00 1.32 18.3 4.1

13.62 0.00 13.62 0.39 42.5 9.5

0.00 0.00 0.00 0.81 6.6 1.5

2.94 0.00 2.94 0.36 7.9 1.8

0.00 0.00 0.00 0.00 7.6 1.7

1.26 4.75 6.01 5.70 105.5 23.6

1.27 0.00 1.27 0.96 21.9 4.9

0.83 0.88 1.71 0.52 13.3 3.0

2.93 1.70 4.63 0.21 50.5 11.3

0.00 0.00 0.00 0.00 10.7 2.4

4.49 3.19 7.69 0.10 45.8 10.2

0.00 1.76 1.76 0.00 9.9 2.2

0.55 0.57 1.12 0.27 4.2 0.9

0.00 0.00 0.00 0.06 4.2 0.9

0.00 1.57 1.57 0.39 12.2 2.7

2.15 1.13 3.28 0.01 40.2 9.0

0.50 0.00 0.50 0.06 6.8 1.5

0.00 0.47 0.47 0.00 4.4 1.0

0.00 0.00 0.00 0.00 27.6 6.2

1.26 0.94 2.20 0.64 447.6 100.0

Based on current balances, office properties accounted for 26.4% of the loansreviewed, followed by retail (19.6%) and multifamily (15.6%).

In terms of loan count, retail properties had the greatest representation (16loans), followed by multifamily (15 loans), office (13 loans), industrial-warehouse(12 loans) and hotel (7 loans).

RATING AACTIONSYear-to-date through August 25, 2004, tranches on deals covered in this reportexperienced a 16.5 to 1 upgrade/downgrade ratio. Over the same period, theCMBS universe experienced a 3.4 to 1 upgrade/downgrade ratio.



230

chapter 13


Source: Intex, Trepp, Remittance Reports

SPECIALLY SERVICED LOANS IN MORGAN STANLEY TRANSACTIONS(JULY 2004 REMITTANCE REPORTS)

exhibit 7

Specially Serviced % ofor Resolved Specially Serviced or

Property Type Number of Loans Loans ($MM) Resolved Loans

Office 13 118.3 26.4

Retail 16 87.6 19.6

Multifamily 15 69.6 15.6

Industrial-Warehouse 12 68.3 15.3

Hotel 7 64.7 14.5

Health Care 5 29.1 6.5

Mobile Home 3 6.4 1.4

Mixed Use 1 2.6 0.6

Self Storage 1 1.0 0.2

Total 73 447.6 100



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Sample Loan Summary:HILLSIDE MOBILE HOME PARK• Original Balance: $4,839,717

• Current Balance: $4,115,841

• Percent of Pool Balance: Not Applicable

• Master Servicer: GMAC COMMERCIAL MORTGAGE CORP.

• Special Servicer: LENNAR PARTNERS.

• Trustee: LASALLE NATIONAL BANK

Status: Discounted Payoff

Paid Though Date: Not Applicable

Location: Stillwater, New York

Size: 383 Units

Year Built: 1971

Property Type: Mobile Home

Originator: Morgan Stanley

Appraisal Value: $2,650,000

Appraisal Date: November 2003

Original LTV: 57.6%

Original Loan per Unit: $12,636

Current LTV: Not Applicable

Current Loan per Unit: Not Applicable

Underwritten DSCR: 1.53

Current DSCR: 0.72 (July 2004)

Closest MSA: Albany, New York - 23 Miles

Market Average Occupancy for Property Type: Not Available

Market Average Rent for Property Type: Not Available

property description valuation information

market data

Source: Intex, Trepp, REIS, Special Servicers, Remittance Reports

REASON FFOR SSPECIAL SSERVICING TTRANSFERPayment default.

UPDATEAccording to the August 2004 remittance report, there was a discounted payoffof the loan on August 16, 2004, with a $1,979,805 loss to the trust.

As of July 2004, the DSCR was 0.72. An updated appraisal in November 2003valued the property at $2,650,000.

PREVIOUS SSTATUS OOF RRESOLUTIONIn our last report, escrows and principal and interest payments were past due.According to the special servicer, the borrower had fallen behind on principaland interest payments due to the increase in escrow requirements and its recentincrease in expenditures.

The borrower fell behind in escrow payments when the state required a waterand sewer upgrade. The special servicer had indicated that the borrower was inthe process of funding approximately $150,000 in upgrades to connect the parkto the county sewer system. In addition, there had been a general increase inestimated taxes and insurance.

According to the special servicer, the DSCR was 1.13 as of July 9, 2003. Thespecial servicer indicated that a forbearance agreement was being negotiated.Terms of the agreement stipulated that the borrower would pay $5,000 permonth for the next 10 months to bring the escrows current, and the special ser-vicer would waive the default interest.

ASSET SSUMMARYThe subject property is a 383-unit mobile home park, located in Stillwater, NewYork. The mobile home park has several amenities, including a clubhouse and aswimming pool. The property was approximately 74% occupied as of May 2002.The special servicer indicated that a 2001 property inspection found the proper-ty to be in good condition.

MATURITY DDATEFebruary 1, 2006


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Section III. Retail DetailIn 2001, we published our Retail Detail study, which assessed the exposure ofrisky retailers within Morgan Stanley underwritten CMBS. At the time, severalU.S. retailers announced bankruptcies or store closings, and the health of theretail sector was deteriorating.

Today, the economy is showing signs of improvement and the retail sector as awhole has weathered the economic downturn well. According to Reis, vacancyrates for retail properties have remained in a stable range of 6.8% to 7.1% sincethe end of 2001. As of the end of 2Q03, the retail vacancy rate was 6.9%.

Although we are less concerned with the retail sector than we are with otherproperty sectors, we still recognize the importance of monitoring deals for expo-sure to weak retailers.

In this update of the retail study, we examine 42 Morgan Stanley deals for expo-sure to 116 risky retail credits. The risky retail credits were identified by theREIT equity research team using the Z-score methodology. All Morgan Stanleytransactions underwritten prior to July 2003 with outstanding retail loans wereincluded in this analysis (Exhibit 8). The equity research risky tenant list is basedon 4Q02 financial results (Exhibit 9).

Our main findings are:

• Morgan Stanley CMBS deals have limited exposure to risky tenants. On arisk-weighted basis, 1.2% of Morgan Stanley CMBS collateral has exposureto the retailers. Risk-weighting accounts for the portion of a loan that canbe attributed to the retailer, based on its gross leasable area.

• On average, Morgan Stanley deals have 18% total exposure to the risky ten-ants. Total exposure includes the full balance of all loans with exposure toany of the 116 risky tenants.

• With the exception of MSC 1997-LB1, all Morgan Stanley deals (with retailloans) have some exposure to the risky tenants.

• Retail loans within large loan transactions have slightly more risk exposurethan retail loans within conduit deals. On a risk-weighted basis, 3.7% of theretail loans within the large loan deals had exposure to the risky tenants.Within conduit deals, the retail loans had 3.4% exposure. While it is some-what surprising that the risky tenant exposure is slightly higher in large loandeals, we do not believe that the regional and super-regional malls backinglarge loan transactions pose more risk than the strip centers and smallershopping centers that are typically found in conduit transactions. This studyonly captures risky public companies and does not assess the risk of local,non-public retailers, which are often found in strip centers.

• MSDWC 2001-PGM had the highest risk-weighted exposure as a percentageof the entire deal at 5.7%.




Deal Aug 2003 Total Delinquencies (%)

MSC 1996-C1 2.53

MSC 1996-WF1 2.27

MSC 1997-ALIC 1.53

MSC 1997-C1 1.85

MSC 1997-HF1 0.29

MSC 1997-LB1 0.00

MSC 1997-WF1 2.01

MSC 1997-XL1 0.00

MSC 1998-CF1 11.09

MSC 1998-HF1 1.14

MSC 1998-HF2 2.68

MSC 1998-WF1 2.76

MSC 1998-WF2 0.00

MSC 1998-XL1 0.00

MSC 1998-XL2 0.00

MSC 1999-CAM1 1.51

MSC 1999-FNV1 4.72

MSC 1999-LIFE 1.77

MSC 1999-RM1 1.53

MSC 1999-WF1 0.63

MSC 2000 HG 0.00

MSDWC 2000-LIFE 0.82

MSDWC 2000-LIFE2 0.00

MSDWC 2000-PRIN 0.00

MSDWC 2001-PGMA 0.00

MSDWC 2001-PPM 0.00

MSDWC 2001-TOP1 1.39



MSDWC 2001-FRMA 0.00

MSDWC 2001-SGMA 0.00

MSDWC 2001-DFMA 0.00

MSDWC 2001-IQA 0.00

MSDWC 2001-XLF 0.00

MSDWC 2002-HQ 0.00

MSDWC 2002-IQ2 0.00

MSDWC 2002-IQ3 0.00

MSDWC 2002-XLF 0.00



MSDWC 2003-HQ2 0.00

MSC 2003-IQ4 0.00

MORGAN STANLEY CMBS DEALSexhibit 8




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MOTIVATION FFOR TTHE SSTUDYStore closing announcements and retailer bankruptcies are often followed by anotification from CMBS data providers detailing the number of CMBS dealsaffected by the closing. In order to calculate the deal exposure to a troubled ten-ant, most CMBS data providers use databases containing the top three tenantsfor each loan. While this analysis is informative, we think it falls short in at leastthree aspects:

(1) The procedure misses all but the top three tenants within a loan (Some loansonly list the top tenant.).

(2) The tenant information that is used by the data providers is often not updat-ed after deal issuance.

(3) The analysis does not look at the cumulative risk of all unhealthy tenants.

We were prompted to publish a comprehensive study that addresses the short-comings listed above.

Using a database from the National Research Bureau, we are able to capture82% of the loan balances of retail tenants in Morgan Stanley underwrittenCMBS deals. This compares with only 32% covered by a database of the topthree tenants. In addition, we look at the cumulative exposure of a list of riskyretailers, rather than deal exposure to just one retailer.

RETAIL PPROPERTY OOVERVIEWIn aggregate, retail properties typically constitute 27%-30% of the collateral inCMBS transactions and historically have been among the most common proper-ty types within CMBS. Within retail properties, grocery-anchored communitycenters and super-regional malls are considered more desirable than box centersor mid-market malls. Strong regional malls and grocery-anchored communitycenters typically have lower defaults and cash flow volatility than other retailproperty types within CMBS.


Deal Z-Score Deal Z-Score

A. Hirsch & Son (1.8) Kids ’R Us 2.5Allied Tires 1.2 Kindy Optical (26.6)Ames - Kmart 2.4Babies ’R Us 2.5 Landry’s Seafood House 2.1Benson Optical (26.6) Levi’s Outlet by Designs 2.2BestPrice! Fashions 2.7 Maier & Berkele (0.9)BestPrice! Kids 2.7 Manhattan Bagel 0.4Big Bear 2.6 Mayor’s Jewelers (0.9)Big Bear Plus 2.6 Monfried Optical (26.6)Big Kmart 2.4 Montgomery Ward Optical 2.2Bi-Lo 2.6 National Vision Centers 1.7BJ’s Optical 2.2 Nevada Optical (26.6)Blockbuster Video Stores 1.4 Newport News 0.2BOGO’s Food and Deals 3.4 Noah’s New York Bagels 0.4Books and Co 2.3 O’Charleys 2.0Books-A-Million 2.3 One Price & More! 2.7Cadilac 2.1 P&C 2.6Calloway’s Nursery 1.9 Paper Warehouse 1.5Candies Outlet 2.2 Party Universe 1.5Carrow’s 0.1 Pearle Vision 2.2Casual Male Big & Tall 2.2 Pearle Vision Express 2.2CD Exchange 0.9 Pep Boys 2.2CD Warehouse 0.9 Perfumania 1.5Champps Americana 2.1 Quality 2.6Checkers 1.6 Rainforest Café 2.1Chesapeake Bagel Bakery 0.4 Rally’s 1.6Cinema Ride (11.9) Right Start 0.9Coco’s 0.1 Rite Aid 2.2Cole Vision Center 2.2 Rite Aid Pharmacy 2.2dELiA*s 0.5 Samuel’s (1.8)Denny’s 0.1 Schubach (1.8)Disc-Go-Round 0.9 Sears Optical 2.2Dockers Outlet by Designs 2.2 Service Merchandise 0.8Duling Optical (26.6) Silverman’s (1.8)Eagle Country Market 3.4 Silversmiths and Mission Jewelers (1.8)Eagle Discount Foods 3.4 Singer/Specs Discount Vision (26.6)Ecko Unltd 2.2 Site for Sore Eyes (26.6)Eddie Bauer 0.2 Sizes Unlimited 2.4Einstein Bros 0.4 Souplantation 2.3Elegant Illusions 5.4 Southern Optical (26.6)Elegant Pretenders (1.4) Spiegel 0.2FAO Schwartz 0.9 Sterling Optical (26.6)Florsheim (0.4) Superior Optical (26.6)Foodco 3.4 Sweet Tomatoes 2.3Goodyear Auto Service Center 1.2 Target Optical 2.2Harold’s 0.7 The Avenue 2.4Harry’s In A Hurry (4.3) The Avenue Plus 2.4Hatfield Jewelers (1.8) The Crab House 2.1Hearex Hearing Centers (1.0) Things Remembered 2.2Hill’s Department Store 0.6 Today’s Man 0.8Homeland Grocery 3.0 Tommy Hilfiger 2.1Hometown Auto Retailers 4.0 Toys ’R Us 2.5Imaginarium 2.5 Vista Optical 1.7Imposters (1.4) Ward’s Optical 2.2IPCO Optical (26.6) Wayne Jewelers (1.8)Jennifer Convertibles 4.7 Wickes Lumber 2.6Jennifer Leather 4.7 Willie G’s 2.1Joe Mugg’s Newstand 2.3 Wing Foot 1.2Joe’s Crab Shack 2.1 Xando Cosi (2.8)Just Tire 1.2 Zany Brainy 0.9

RISKY TENANTS AND Z-SCORES BASED ON FOURTHQUARTER 2002 FINANCIAL STATEMENTS

exhibit 9




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Risky RRetailersRisky tenants were determined from the Z-Score methodology, which was devel-oped by Professor Edward Altman of NYU and implemented by the MorganStanley REIT equity research team. The Z-score methodology is a statisticaltechnique, which attempts to predict financial distress of corporations usingfinancial ratios. Altman’s methodology uses multiple discriminant analysis(MDA) and a sample of 66 firms to derive the best linear combination of thefirms’ financial ratios.

The discriminant function that results from the MDA considers five financialratios, which are multiplied by different coefficients to produce a score:

Z-Score:1.2* (Working Capital / Total Assets)+

1.4* (Retained Earnings / Total Assets) +

3.3* (EBIT / Total Assets) +

0.6 * (Market Value of Equity / Liabilities) +

1.0 * (Sales / Total Assets)

Based on Altman’s findings, Morgan Stanley’s equity research REIT group used acutoff Z-score of 2.4 to identify unhealthy companies. Any publicly traded com-pany with a Z-score below 2.4 is included as one of the risky tenants. In addi-tion, the REIT group also included companies with stock prices below $1.00,even if their Z-scores were above 2.4. Companies that trade on the NASDAQbulletin board or companies that had been delisted because of delinquency in fil-ings were also included. The resulting 116 risky tenants are listed in Exhibit 10.

For further discussion of the Z-score methodology and the financial ratios,see Predicting Financial Distress of Companies: Revisiting the Z-score and Zeta Modelsby Edward I. Altman.

METHODOLOGYIn order to assess CMBS exposure to the 116 risky retailers, we used theNational Research Bureau Shopping Center Directory to locate risky tenantswithin the CMBS deals. The Shopping Center Directory lists all tenants within40,000 shopping centers nationwide, giving us the ability to locate many tenantsthat would be undetected in conventional CMBS tenant searches. The NationalResearch Bureau Shopping Center Directory is updated semi-annually. Thisreport was based on data in the first 2003 version released in June. CMBS dataproviders and prospectus material typically only list the largest three tenantswithin a shopping center. Therefore, the information provided in the directoryallows us to look at smaller tenants within various retail properties.

With both the shopping center directory and S&P Conquest data, we can track82% of retail balances in Morgan Stanley deals. If this study were performedusing data solely from the S&P Conquest database, only 32% of the retail loanbalances would have complete tenant information.

In total, we had some level of tenant information for 97% of the retail loanswithin the transactions that we examined. Sixty-nine percent of the loans were


covered through information from the National Research Bureau ShoppingCenter Directory, and had complete tenant information for the shopping centers.Twenty-eight percent of the loans were covered through data obtained from theS&P Conquest database, which only provided information on one to three ten-ants per shopping center. Tenant information was not available for about 3% ofthe retail loans.

For each deal, we calculated a “weighted-risk” retail exposure (in $). We defineweighted-risk retail exposure as the sum of all weighted-risk retail balances foreach shopping center with risky tenants. The weighted-risk retail balance foreach shopping center is computed in the following way:

[Current balance of shopping center loan with risky tenant exposure]*[Sum ofgross leasable areas (GLA) of risky tenants in the shopping center] / [GLA ofentire shopping center]

We also computed total risk exposure for each deal, which is equal to the sum ofall current shopping center loan balances with risky tenant exposure.

In our previous study, we did not consider the retail risk of any multipropertyloans. In this publication, we have increased the scope of our study to includemultiproperty loans, most of which are found within the XL deals. To calculateweighted-risk retail balances for multiproperty loans, we considered each shop-ping center individually by using allocated loan amounts.

SHORTFALLS/OTHER FFACTORS TTO CCONSIDERAs with most studies, there are a few caveats that should be highlighted. Risk-weighted exposure is not necessarily a true indicator of the riskiness of a shop-ping center. There are financially distressed retailers that are not captured in thisstudy, as we only cover publicly traded companies.

Risk-weighted exposure also implies that only a portion of the loan is at riskwhen stores become distressed. This may be true if a couple of small retailersgo out of business. However, the entire loan may be at risk if a number ofstores in the shopping center become distressed. We did not account for this inour study.

For the purposes of this study, we also examined and included all adjacent oradjoining retailers within a specific shopping center, regardless of whether thetenant’s space is collateral in the securitization. It is possible that we are includ-ing out-parcels or portions of shopping centers that are not part of the MorganStanley securitizations. However, inclusion is important since retailers are affect-ed by the health of the shopping center as a whole.

In addition, we computed risk-weighted exposures based on the size of the retail-er, rather than by the portion of property cash flows represented by the retailer.An anchor store, for example, with a large GLA, would be weighted heavily, eventhough anchors typically pay lower rents than other smaller tenants within a mall.For example, within a newly built center, a grocery store anchor may pay rent ofonly $10 per square foot but occupy 70% of the GLA, while the in-line tenantsmay pay $20 per square foot and only occupy 30% of the GLA.



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MSC 1996-C1exhibit 10


SAMPLE DEAL SUMMARY

Section IV. CMBS Ratings Actions• Rating changes at each of the three rating agencies followed similar patterns

during the first three quarters of the year. At least 84% of each agency’supgrades were on mezzanine CMBS, while more than 59% of each agency’sdowngrades were on subordinate tranches.1

• Fitch was the most active, accounting for more than half of all rating actions.Moody’s was the least active but accounted for almost half of the downgrades.Fitch had the highest upgrade/downgrade ratio (6.4 to 1), while Moody’s had amore balanced ratio (1.3 to 1) and S&P had a ratio closer to the ratio of theoverall universe (3.8 to 1).

• As the rating agencies moved in concert, so did the direction of the bonds.Upgrades outnumbered downgrades on investment-grade CMBS by a ratio of8.8 to 1, while downgrades outnumbered upgrades on non-investment gradetranches. The upgrade/downgrade ratio for non-investment grade CMBS was0.7 to 1. This ratio was lower for non-investment grade floating rate CMBS(0.2 to 1).



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1Mezzanine CMBS includes AA+ through BBB-; Subordinate CMBS includes BB+ and below.

Rating Agency Upgrades Downgrades

Moody’s 198 156

S&P 348 91

Fitch 554 87

Total 1,100 334

2004 YTD1 RATING ACTIONS BY RATING AGENCYexhibit 11

1Through September 30, 2004.

Source: Morgan Stanley, Fitch, Moody’s, S&P

Fixed Rate CMBS Floating Rate CMBS All CMBS

Credit Class Upgrades Downgrades Upgrades Downgrades Upgrades Downgrades

Investment Grade 790 44 155 63 945 107

Non-Investment Grade 146 190 9 37 155 227

Total 936 234 164 100 1100 334

2004 YTD1 RATING CHANGES BY CREDIT CLASSexhibit 12



242

• The overall upgrade/downgrade ratio was positive for both fixed and floatingrate CMBS. Fixed rate classes experienced a 4.0 to 1 ratio, while floating rateclasses experienced a lower ratio of 1.6 to 1.

• In total, rating agencies upgraded 1,100 CMBS classes and downgraded 334,resulting in a 3.3 to 1 ratio. This is an improvement over the 1.8 to 1 ratio foryear-end 2003.

• The CMBS upgrade/downgrade ratio remains more favorable than the corpo-rate bond ratio over the same period. Through the third quarter, corporatebonds experienced an upgrade/downgrade ratio of 0.9 to 1.




HISTORICAL CMBSRATING ACTIONS

exhibit 13

• The 2000 cohort persists as the worst performing issuance year in terms ofrating actions, accounting for 24% of all CMBS downgrades (81) in 2004YTD.In 2003, about 14% of all tranches issued in 2000 were downgraded.Through 3Q2004, about 8% of tranches issued in 2000 were downgraded.

• While almost half of the downgrades on the 2000 cohort were on floatingrate classes and rake tranches in 2003, over 85% of the downgrades in2004YTD were due to deteriorating credit fundamentals on fixed rate classes.



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2004 YTD1 RATINGCHANGES BY

COHORT YEAR

exhibit 14

% of Total UniqueIssuance Year Tranches Downgraded

1998 3.0

1999 4.7

2000 7.9

2001 4.1

2002 3.9

2003 0.2

2004 YTD1 DOWNGRADES BY CMBS ISSUANCE YEARexhibit 15


Source: Morgan Stanley, Fitch, Moody’s, S&P, Commercial Mortgage Alert

245




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2004 YTD1 RATING CHANGES MATRIX FOR ALL CMBS

exhibit 16



AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BBAAA 0 7 0 0 0 3 0 0 0 0 0 0AA+ 71 0 1 0 0 1 0 1 0 0 0 0AA 154 49 0 3 3 2 0 0 1 0 0 0AA- 19 15 17 0 0 0 0 0 0 1 0 0A+ 27 13 11 21 1 0 2 1 0 0 1 0A 31 20 21 29 46 0 4 2 3 0 1 1A- 12 4 7 2 30 33 0 3 2 2 1 0BBB+ 11 2 7 3 11 16 22 0 4 3 2 0BBB 10 5 13 9 9 28 22 43 1 11 6 3BBB- 4 0 3 2 4 10 16 22 39 0 15 5BB+ 3 0 2 0 1 2 2 6 11 19 0 7BB 0 0 2 0 1 3 1 1 4 9 20 0BB- 0 0 0 0 0 1 2 1 0 0 9 8B+ 0 0 0 0 0 1 0 1 1 0 1 2B 0 0 0 0 0 0 1 0 2 0 5 1B- 0 0 0 0 0 0 0 0 0 0 1 2CCC+ 0 0 0 0 0 0 0 0 0 1 0 0CCC 0 0 0 0 0 0 0 0 0 0 2 0CCC- 0 0 0 0 0 0 0 0 0 0 0 0CC+ 0 0 0 0 0 0 0 0 0 0 0 0CC 0 0 0 0 0 0 0 0 0 0 0 0CC- 0 0 0 0 0 0 0 0 0 0 0 0C+ 0 0 0 0 0 0 0 0 0 0 0 0C 0 0 0 0 0 0 0 0 0 0 0 0C- 0 0 0 0 0 0 0 0 0 0 0 0D 0 0 0 0 0 0 0 0 0 0 0 0Total 342 115 84 69 106 100 72 81 68 46 64 29


BB- B+ B B- CCC+ CCC CCC- CC+ CC CC- C+ C C- D Total0 0 0 0 0 0 0 0 0 0 0 0 0 0 100 0 0 0 0 0 0 0 0 0 0 0 0 0 740 0 0 0 0 0 0 0 0 0 0 0 0 0 2120 0 0 0 0 0 0 0 0 0 0 0 0 0 520 0 0 0 0 0 0 0 0 0 0 0 0 0 770 0 0 0 0 0 0 0 0 0 0 0 0 0 1580 0 0 0 0 0 0 0 0 0 0 0 0 0 960 1 0 0 0 0 0 0 0 0 0 0 0 0 820 0 2 1 0 0 0 0 0 0 0 0 0 0 1636 0 0 2 0 0 0 0 0 0 0 0 0 0 1282 0 0 1 0 1 0 0 0 0 0 0 0 0 57

14 10 4 2 0 3 0 0 0 0 0 0 0 0 740 10 6 4 1 0 1 0 0 0 0 0 0 0 432 0 12 15 2 1 0 0 1 0 0 0 0 1 402 10 0 18 13 9 0 0 1 0 0 0 0 2 640 0 3 0 12 28 3 0 4 0 0 0 0 4 570 0 0 0 0 0 0 0 1 0 0 0 0 1 30 1 2 1 1 0 3 0 13 0 0 2 0 6 310 0 0 0 0 0 0 0 1 0 0 0 0 1 20 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 2 0 0 20 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 5 50 0 0 0 0 0 0 0 0 0 0 0 0 0 01 0 0 1 1 1 0 0 0 0 0 0 0 0 4

27 32 29 45 30 43 7 0 21 0 0 4 0 20 1434



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2004 YTD1 RATING CHANGES MATRIX FOR FIXED RATE CMBS TRANCHES

exhibit 17





BB- B+ B B- CCC+ CCC CCC- CC+ CC CC- C+ C C- D Total0 0 0 0 0 0 0 0 0 0 0 0 0 0 40 0 0 0 0 0 0 0 0 0 0 0 0 0 560 0 0 0 0 0 0 0 0 0 0 0 0 0 1720 0 0 0 0 0 0 0 0 0 0 0 0 0 370 0 0 0 0 0 0 0 0 0 0 0 0 0 630 0 0 0 0 0 0 0 0 0 0 0 0 0 1360 0 0 0 0 0 0 0 0 0 0 0 0 0 830 1 0 0 0 0 0 0 0 0 0 0 0 0 630 0 1 0 0 0 0 0 0 0 0 0 0 0 1271 0 0 0 0 0 0 0 0 0 0 0 0 0 930 0 0 0 0 0 0 0 0 0 0 0 0 0 50

12 6 3 1 0 3 0 0 0 0 0 0 0 0 630 9 5 2 0 0 0 0 0 0 0 0 0 0 372 0 11 14 1 1 0 0 0 0 0 0 0 0 342 10 0 17 11 7 0 0 1 0 0 0 0 1 570 0 3 0 12 25 2 0 3 0 0 0 0 2 490 0 0 0 0 0 0 0 1 0 0 0 0 1 30 1 2 1 1 0 3 0 13 0 0 2 0 6 310 0 0 0 0 0 0 0 1 0 0 0 0 1 20 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 1 0 0 10 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 5 50 0 0 0 0 0 0 0 0 0 0 0 0 0 01 0 0 1 1 1 0 0 0 0 0 0 0 0 4

18 27 25 36 26 37 5 0 19 0 0 3 0 16 1170



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2004 YTD1 RATING CHANGES MATRIX FOR FLOATING RATE CMBS TRANCHES

exhibit 18





BB- B+ B B- CCC+ CCC CCC- CC+ CC CC- C+ C C- D Total0 0 0 0 0 0 0 0 0 0 0 0 0 0 60 0 0 0 0 0 0 0 0 0 0 0 0 0 180 0 0 0 0 0 0 0 0 0 0 0 0 0 400 0 0 0 0 0 0 0 0 0 0 0 0 0 150 0 0 0 0 0 0 0 0 0 0 0 0 0 140 0 0 0 0 0 0 0 0 0 0 0 0 0 220 0 0 0 0 0 0 0 0 0 0 0 0 0 130 0 0 0 0 0 0 0 0 0 0 0 0 0 190 0 1 1 0 0 0 0 0 0 0 0 0 0 365 0 0 2 0 0 0 0 0 0 0 0 0 0 352 0 0 1 0 1 0 0 0 0 0 0 0 0 72 4 1 1 0 0 0 0 0 0 0 0 0 0 110 1 1 2 1 0 1 0 0 0 0 0 0 0 60 0 1 1 1 0 0 0 1 0 0 0 0 1 60 0 0 1 2 2 0 0 0 0 0 0 0 1 70 0 0 0 0 3 1 0 1 0 0 0 0 2 80 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 1 0 0 10 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 09 5 4 9 4 6 2 0 2 0 0 1 0 4 264



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Section V. Originator DelinquenciesWe revisited our periodic report examining the credit performance of various CMBSloan originators using September remittance report data.

Delinquencies on the CMBS universe that we examined declined 29 bp to 1.38% ofcurrent balances since we last analyzed the data (January 2004 remittance reports).Cumulative losses on CMBS remained low, rising 7 bp since our last report to 37 bp.

When we examined the data by originator type, as we have done in the past, wefound each originator type posted delinquencies and cumulative losses fairly close tothe mean (Exhibit 19).

CREDIT CCOORDINATES MMATRIX

In order to provide a visual representation encompassing more variables (delinquen-cies, cumulative losses, origination year, and originator), we applied the credit coordi-nates matrix developed by our ABS home equity research team to this study.

The average cumulative loss rate and delinquency rate for a given sample of dataprovide the boundary point separating the quadrants within the graphic. The lowerleft hand quadrant is the most desirable or “sweet spot”, with cumulative losses anddelinquencies below the average. The upper right hand quadrant is the least desir-able with losses and delinquencies above the average.

In order to put all of the originators on the same playing field in terms of loan sea-soning, we produced a matrix for each origination year.

We focused our analysis on originations that occurred between 1995 and 2002, sinceCMBS issuance was limited prior to 1995, and loans originated after 2002 have lowdelinquencies and no cumulative losses. We also limited our analysis to the mostactive originators based on current balances outstanding1.

DELINQUENCIES AND CUMULATIVE LOSSES BY INSTITUTION TYPE

exhibit 19


Number of Original Current % 30 Originator Type Issuers Balance ($MM) Balance ($MM) Days Del

Commercial Bank 22 91,563.9 74,441.3 0.26

Finance Company 29 79,366.7 59,229.2 0.27

Investment Bank 28 249,928.2 189,848.4 0.19

Insurance Company 20 25,628.6 18,819.1 0.04

Total/Weighted Average 99 446,487.2 342,338.0 0.21

1For investment bank, commercial bank and finance company originators we used a $3 billion outstanding bal-ance cut off. Since life company collateral accounts for only $18.8 billion in current balances, we used a $1billion cut off.


Regardless of the origination year, the “sweet spot” was not dominated by one origi-nator type over time. Investment banks, commercial banks, finance companies andlife companies were all represented in the lower left hand quadrant during each year.

Very few originators were located in the least desirable quadrant (upper right); how-ever, between 1995 and 1999, investment banks accounted for 8 out of the 11 origi-nators in that quadrant.

Although these graphics provide a quick view of five important variables, other fac-tors outside the scope of this analysis will affect the performance of a particulartransaction. Subordination levels, structure and collateral mix will also play a role inthe performance of bonds within specific deals.


High losses and lowdelinquencies

High losses and Highdelinquencies

Low losses and low delinquencies

"Sweet Spot"Low losses and

high delinquencies

Delinquencies

Average

Cum

ula

tive

Loss

es

CREDITCOORDINATES

MATRIX

exhibit 20

Change% 60 % 90 % % Total Since % Cum

Days Del Days Del Foreclosure % REO Del 01/04 Loss

0.04 0.34 0.12 0.42 1.17 0.09 0.30

0.09 0.77 0.15 0.41 1.68 -0.29 0.48

0.07 0.41 0.15 0.56 1.38 -0.52 0.35

0.20 0.66 0.10 0.23 1.23 0.54 0.48

0.07 0.47 0.14 0.48 1.38 -0.29 0.37



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chapter 13

Most transactions are comprised of collateral from several different originators.Therefore, the loan performance of a single loan contributor should not be used todetermine the credit quality of a particular transaction. Investors need to assess theperformance of all originators that contribute to a transaction.

For example, TOP transactions contain collateral originated by five originators: BearStearns, John Hancock, Morgan Stanley, Principal, and Wells Fargo. Examining theloans of any one of these entities is not necessarily an indicator of how the TOPprogram will fare over time. Examining the long term loan performance of all theoriginators contributing to TOP transactions should be a good benchmark for thecredit quality within the deals. In addition to contributing collateral to TOP transac-tions each of these originators also contributes to other dealer programs.

In the eight years of data examined, loans from these originators delivered solidcredit performance. Bear Stearns appeared in the lower left hand quadrant in alleight years, Morgan Stanley, Principal, and Wells Fargo appeared in six out of eightyears, while John Hancock appeared in four years.

The credit coordinate matrices for 1995-2002 are contained in Exhibits 26 through33 at the end of this piece.

ORIGINATION YYEAR PPERFORMANCEInvestors are often interested in how particular loan vintages perform over time. Weexamined CMBS loan origination years between 1986 and 2004 and found no origi-nation year with cumulative losses over 1.06%. Although subordination levels havebeen declining over time, cumulative losses of each vintage year remain well belowthe 5% credit enhancement on BBB CMBS issued in 2004.

The 1995 vintage experienced the highest cumulative loss rate (1.06%).Approximately one-quarter of the cumulative losses on 1995 collateral were due tothe $23.0 million Columbia Mall loan liquidation in DLJMA 1995-CF2 and the $17.3million Perimeter Square Shopping Center loan in MLMI 1995-C2.

Vintages with at least $20 billion of collateral outstanding followed a seasoningcurve with cumulative losses rising each year between 1997 and 2004.

However, vintages prior to 1997 do not follow this trend. For example, 1996 collat-eral had cumulative losses of 0.63% while 1997 collateral had cumulative losses of1.00%. This may be explained by small original balances in years prior to 1997 sinceCMBS was in its infancy.



CUMULATIVE LOSSES BY

ORIGINATION YEAR(%)

exhibit 21

Original CurrentOriginal Balance Balance % Total % Cum Year ($MM) ($MM) Del Loss

Pre-1986 1,832.7 211.4 0.16 0.10

1986 752.3 27.2 0.00 0.30

1987 1,099.3 145.4 2.26 1.01

1988 1,046.1 99.5 0.00 0.29

1989 1,201.2 148.4 0.00 0.77

1990 1,202.2 244.4 15.60 0.37

1991 945.5 83.4 0.00 0.80

1992 2,054.9 217.3 0.03 0.32

1993 5,347.5 546.0 1.51 0.32

1994 9,239.7 805.2 3.40 0.67

1995 11,252.5 3,372.0 3.82 1.06

1996 21,924.5 9,923.6 1.91 0.63

1997 48,154.4 29,418.8 3.28 1.00

1998 81,813.9 58,709.3 2.00 0.57

1999 49,198.6 35,046.5 2.50 0.42

2000 47,407.6 33,892.5 2.03 0.28

2001 69,041.0 53,291.1 0.97 0.07

2002 58,111.7 50,566.9 0.32 0.02

2003 86,370.3 82,974.9 0.06 0.00

2004 21,309.8 21,188.7 0.00 0.00

Total/Weighted 519,305.7 380,912.5 1.27 0.33Average*

DELINQUENCIES AND CUMULATIVE LOSSES BY ORIGINATION YEAR

exhibit 22

*Total and Weighted Average of the entire universe. See the methodology section for more detail.


PROPERTY TTYPEFinally, we examined cumulative losses by property type to assess the effect on anoriginator’s delinquency and cumulative loss performance. For example, if an origi-nator type had an above average concentration in unconventional property types itmight explain the originator’s higher than average cumulative loss rate.

To evaluate how an originator’s average cumulative loss rate is influenced by proper-ty type, we calculated property type concentrations for each originator type.

Our data support the conventional wisdom that life insurance companies tend to bemore conservative by lending less often to non-conventional property types whileinvestment banks are more active in non-conventional property types.

Life companies originate more retail loans (37%) than the average and fewer hotelloans (4%) than the average. Investment banks issue the greatest percentage ofhotel loans (10%) and the lowest percentage of multifamily loans (15%).

In addition to property type concentrations, we examined originator cumulative lossrates by property type. Investment bank collateral had cumulative loss rates belowthe average for all property types except multifamily. Finance company loans hadcumulative loss rates above the average for office, hotel, and other collateral.

Hotel collateral experienced the highest cumulative loss rate by property type(1.19%), but comprised only 8% of the CMBS universe we examined.

METHODOLOGYThis analysis of CMBS collateral was based on the Intex database, which contains$519.3 billion in original balances from 796 transactions. In the previous version ofthis study, our data did not contain paid down transactions within Intex, limiting ouranalysis to outstanding deals. In this update, we added data from paid down dealsand provided cumulative loss information by originator.



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Commercial Finance Investment InsuranceBank Company Bank Company Average

Office 23 22 28 25 26

Hotel 5 7 10 4 8

Retail 30 25 33 37 31

Multifamily 26 21 15 15 19

Other1 15 25 14 19 17

Total 100 100 100 100 100

PROPERTY TYPE CONCENTRATION BY ORIGINATOR GROUP (%)(BY ORIGINAL BALANCE)

exhibit 23

1Other includes industrial, self storage, senior housing, and mixed use.


For the purposes of this study, we analyzed all originators with more than $100 mil-lion in original balances outstanding. After eliminating the smaller originators, ouruniverse contained $446.5 billion in original balances from 99 different originators.All CMBS collateral was analyzed including large loans and floating rate loans.

Delinquencies and cumulative losses were evaluated at the loan level. If several orig-inators contributed to one transaction, delinquencies for each loan were assigned tothe respective originator. Over the past several years, some originators have merged,so certain entities such as DLJ no longer exist.

For this study, we do not combine data for originators that have merged overtime. Maintaining the original underwriter’s name allows investors to benchmarktheir portfolios.

We also grouped the collateral by originator type (commercial bank, financecompany, investment bank or insurance company). Within the insurance com-pany category, 18 of the 20 originators are life insurance companies. Theother two originators (Nationwide and State Farm) predominantly providecasualty insurance.

In addition to analyzing CMBS collateral performance by originator, we assessedcollateral performance by origination year. We included the entire Intex universefor this analysis. Since the data is evaluated at the loan level, the origination yearprovided is the year in which the loan was originated, not the year in which theCMBS transaction was issued.

The overall delinquency rate we provided includes 30-day delinquencies.However, it is important to note that loans often move in and out of the 30-daybucket due to timing of payments rather than fundamental deterioration.

Secore is a temporary shelf used by originators that are not registered in a par-ticular state where the property is located. For our analysis, we only had suffi-cient data to assign Secore originated loans to Morgan Stanley where appropri-ate. We did not have sufficient information on the remaining Secore collateral toassign them to their respective originators.


Commercial Finance Investment InsuranceBank Company Bank Company Average

Office 0.19 0.25 0.20 0.30 0.21

Hotel 1.98 1.54 1.01 0.22 1.19

Retail 0.24 0.28 0.31 0.95 0.34

Multifamily 0.16 0.20 0.25 0.08 0.21

Other1 0.23 0.83 0.32 0.18 0.43

Total 0.30 0.48 0.35 0.48 0.37

CUMULATIVE LOSSES BY INSTITUTION AND PROPERTY TYPE (%)

exhibit 24

1Other includes industrial, self storage, senior housing, and mixed use.




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LOANS ORIGINATED IN 1995: CUMULATIVE LOSSES AND CURRENT DELINQUENCIES

exhibit 25

*Inactive originators




exhibit 26





260

chapter 13


exhibit 27





exhibit 28





262

chapter 13


exhibit 29



Cumulative Losses (%)

ArchonBank of America

Bear Stearns

CIBC

Column

CSFBGACC

GE Capital

GMAC

Goldman Sachs

Greenwich

John Hancock

Keybank

Lasalle

Lehman

Merrill Lynch

Morgan Stanley

Nomura Conduit*

Salomon Brothers

Secore

TIAA(Total Delinquencies =0.00,Cumulative Losses =4.08)

UBS

Wachovia

Wells Fargo

Chase*

First Union*

Morgan Guaranty*

NomuraNationsBank

PrincipalPrudential

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

0.0 2.0 4.0 6.0 8.0 10.0 12.0Total Delinquencies (%)

Investment Bank -- Plain TextCommercial Bank -- Italic Text

Finance Company -- Gray Text Insurance Company -- Gray Italic Text



exhibit 30





264

chapter 13


exhibit 31





exhibit 32



266




European CMBS

Chapter 14


European CMBS

268

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Poised for Growth• CMBS poised for growth in Europe.

• European CMBS remain attractive.

• The CMBS advantage could close further.

• Move up in rating and pick up spread.

EUROPEAN MMARKET PPOISED FFOR GGROWTHGrowth in the European CMBS market picked up in 2004, and most analysts proj-ect that the sector is entering a period of steady increases in issuance volumes.The market saw $23 billion in issuance in 2004, a 50% increase from 2003. Theslowdown in 2003 resulted from a number of factors including the ramping up ofseveral new conduits, the delay of a large Italian deal, and a downturn in the U.K.office market.

In terms of issuance, the European CMBS market is nine to ten years behindthe U.S. The pattern of issuance growth in Europe between 1999 and 2003 par-allels U.S. growth from 1990-1994.

While we do not expect the same surge in European CMBS growth thatoccurred in the U.S. in 1998, we expect steady growth over the next five years.European CMBS has the potential to grow to a market with $40-50 billion ofannual issuance within a few years. Two forces that could lead to substantialgrowth are the implementation of the Basel II accords in 2006 and the passageof a “true sale initiative” in Germany that would ease the process of securitiza-tion in Europe’s largest economy.

1Forecast by Morgan Stanley Research; SCIP is an Italian government mixed residential and commercialmortgage transaction.

Source: Morgan Stanley and Commercial Mortgage Alert (CMA)

EUROPEAN CMBSISSUANCE

(IN BILLIONS OFU.S. DOLLARS)

exhibit 1


Historically, half or more of all European CMBS issuance has been out of thethe U.K. Recently, deals have been issued in several other countries, includingFrance, Italy, Sweden, and Poland. There has also been a proliferation of “pan-European” deals with collateral from several countries.

RELATIVE VVALUE: EEUROPEAN CCMBS RREMAINS AATTRACTIVEVERSUS CCORPORATESFloating-rate European CMBS spreads source moved to historically tight levelsin 2004, yet remain wider than corporate and some U.S. alternative investments.For example, as of December 2004, 5-year AAA floating-rate European CMBS

1Estimate by Morgan Stanley Research. F=Forecast by Morgan Stanley Research.


EUROPEAN CMBSMARKET…THE

NEXT U.S.?

exhibit 2


2003 EUROPEANCMBS ISSUANCE

BREAKDOWN (BYCOUNTRY)

exhibit 3


European CMBS

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traded at LIBOR + 20 bp, 40 bp tighter than at the start of the year. Spreadshave also tightened further down the credit curve.

With the investor base for European CMBS increasing, the gap between CMBSand European corporates has narrowed by 40-100 bp in 2004 and could closefurther, in our view. In addition, the increasing amount of information onEuropean CMBS should be another force pushing in bid-ask spreads.

RATING AADVANTAGE FFOR EEUROPEAN CCMBSIn addition to the spread advantage over corporate bonds, European CMBS arerated more conservatively than both European corporates and U.S. CMBS.European AAA subordination levels are at 20-30%, close to the U.S. levels ofseveral years ago and substantially higher than today’s U.S. AAA levels of 12% to 18%.


AAA FLOATING-RATE CMBS

SPREADS, DEC.1999- DEC 2004

(bp)

exhibit 4

(%) AAA AA A BBB BB B

AAA 100.00 0 0 0 0 0

AA 3.33 95.00 1.67 0 0 0

A 0 5.08 93.22 1.69 0 0

BBB 0 1.82 1.82 94.55 1.82 0

BB 0 0 0 0 100.00 0

B 0 0 0 0 0 0

CCC-C 0 0 0 0 0 0

WESTERN EUROPE – 1-YEAR RATING TRANSITION MATRIX,1993-2002

exhibit 5

Source: Fitch


European CMBS have been one of the best performing asset classes in terms ofthe ratio of upgrades to downgrades. Exhibit 5 shows that in the period 1993-2002, for example, twice as many BBB CMBS (2 x 1.82%) were upgraded asdowngraded.

CMBS RRISK AAND TTRANSACTION SSTRUCTURESWe outline below some of the key features of transaction structures and associ-ated risks that need to be considered by investors when considering investmentin CMBS. Although the description is based heavily on our experience of U.K.transactions, the general principles are applicable to all real estate markets,although legal processes will vary between jurisdictions.

TRANSACTION SSTRUCTURESExhibit 6 sets out in a simplified schematic form some of the key relationshipsthat commonly feature in CMBS transactions.


TYPICAL CMBSISSUANCE

STRUCTURE

exhibit 6

1 See “Commercial Mortgage Defaults: An Update” in Real Estate Finance (Spring 1999).


European CMBS

272

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The following table highlights the common structural features of transactions.

Legal SStructureExhibit 6 describes a simplified typical structure and can be used to illustrateboth single-asset/single corporate sponsor and conduit-style transactions.

Single asset/corporate transactionsAn issuing vehicle will make a loan of bond proceeds to one or more borrow-ers, who in turn will be property-owning subsidiaries within a company groupstructure (Borrowers A and B) ultimately owned by a holding company. Theseborrowers will in turn be the owners of specific properties that will be leasedto underlying lessees. The leases generate the rental flows to the borrowersthat in turn will enable the borrowers to service the loans from the issuer. Theissuing SPV can be included within the corporate structure with the same ulti-mate holding company owner as borrowers A and B.

Conduit transactionsConduit transactions are broadly similar except that Borrowers A and B will beunconnected and the loans to these borrowers will instead usually have beenoriginated by a commercial lender prior to being assigned to the issuer at thetime of the bond issue. The assets of Borrowers A and B will be owned prop-erty assets leased to end-users.

For both single asset and conduit transactions, Borrowers A and B will nor-mally be limited or special purpose companies with contractually limited otheractivities. These borrowers will fulfill no material role other than to borrowfrom the issuer (or intermediate borrower) and to own and lease the relevantproperty and to enter the asset pledge and collateral agreements.

Cross-CCollateralizationAn important distinction between conduit and non-conduit transactions isthat, in the case of conduit transactions, the underlying borrowers are notnormally part of the same corporate entity and therefore underlying prop-erties cannot be cross-collateralized.

However, excess interest on the pool of loans (in simple terms the differ-ence between the interest earned on the loans and the interest costs of thebonds) can be used to help absorb losses in those conduit transactions thatare not cross-collateralized.

Although the absence of cross-collateralization may be a negative feature inconduit transactions, compensating features usually include borrower andproperty diversity

KEY STRUCTURAL FEATURES OF CMBS TRANSACTIONSexhibit 7


Asset SSalesParticularly in the case of corporate transactions, borrowers may want topreserve the option of selling specific assets from the portfolio. Structurescan permit this, but for concentrated portfolios there is normally a require-ment for proceeds to be generated to the extent that they raise 115%-130%of the underlying financing allocated to that property which is then used topay down the financing. This technique avoids the potential negativeadverse selection through the cherry-picking of properties and reduces theLTV of the remaining financing. Clearly, this mechanism will not apply tonon cross-collateralized conduit transactions.

Liquidity SSupportAlthough legal structures of U.K. transactions are arranged in the expecta-tion that underlying loans will not become embroiled in extended insolven-cy proceedings, liquidity facilities from highly-rated banks provide supportfor timely payment of interest and principal in the event of borrower insol-vency or temporary disruptions to cash flows due to re-tenanting. Liquidityfacility providers are ultimately senior to bond investors, and such facilitiesusually contain restrictions on how much liquidity can be advanced to sup-port junior classes.Liquidity facilities also normally contain borrowing baserestrictions which require underlying assets to provide minimum coveragelevels for liquidity drawings.

Interest RRate HHedgingBond marketing considerations may require at least partial issuance in float-ing rate instruments. Underlying lease cash flows are by their nature fixedflows and cash flows on underlying conduit loans can be fixed. This mis-match is covered by interest rate hedging with bank counterparties.

Cash CControlRentals due on underlying leases are ideally directed to special trusteeaccounts to avoid commingling and associated corporate bankruptcy riskswhere applicable.

Reserve AAccountsReserve accounts are funded (at the expense of the equity holder in thetransaction) for various reasons. These may typically include reservesrequired if specified debt service coverage levels are breached or specialreserves that may be required, for example, if a defined share of underlyingleases are due to terminate within a certain period prior to a refinancingdate. Debt service reserves are alternatively seen pending achievement ofcertain rental levels in lease-up situations.

The following table describes the key credit risk concerns in CMBS transactionsand some of the ways in which bondholder protection is structured to overcomethe credit issues.

Tenant QQualityThe credit quality of transactions will benefit from a preponderance ofinvestment grade tenants. This is a rare feature outside of ‘trophy’-type securi-tizations. The value of higher rated tenants is that they are less likely todefault on leases in times of economic stress, which will reduce the exposureof the transaction to re-leasing on tenant default with associated cash flowlosses arising from both the time taken to re-lease the property and the asso-ciated potential cash flow losses that might arise from the need to re-lease theproperty at lower rental rates in difficult economic circumstances.

Tenant DDiversityHigh tenant quality is frequently combined with limited tenant diversity. Thisis a feature of city office developments but less conspicuous with large-scaleretail developments, where the tenant base is usually more widely spread,although the tenants may be in the same industry and retail operators mayeach suffer similar business stresses at the same time. Risk to transactions cantherefore become concentrated: a single lessee default can cause material dis-ruption. For example, in the Canary Wharf II transaction 65% of closingrentals was derived from 2 tenants – yet in ELoC 4 there are 440 separate ten-ants with a maximum rental of 4% from a single tenant.

Lease MMaturitiesLong lease terms at the outset - in excess of 15 years - are a strong supportto a transaction as they improve the relative assuredness of cash flows.

Similarly, the existence of average remaining lease terms exceeding 10 yearsat the point of any assumed refinancing also helps to provide confidencethat debt can be refinanced.

Lease BBreak CClauses aand MMaturities

Key analytical assumptions when reviewing real estate financings involve taking account of the pattern of lease maturities and break clauses within leases.Transactions are assessed according to how well they may perform if lease ter-mination (or lessee default) coincides with recessionary conditions, which requirematerial discounts in rentals or rent-free periods to entice new tenants.Transactions are required to withstand progressively higher levels of discount inline with higher desired ratings on underlying securities. Rental decline assumedin recessions may range from 20-35% depending on the credit rating desired.

An even distribution of lease maturities is preferable to bunching as thisreduces the risk of lease maturities coinciding with economic stresses.


European CMBS

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KEY CREDIT RISKS OF CMBS TRANSACTIONSexhibit 8


Generally, the assumptions for rated transactions are that 65% of maturingleases are renewed by tenants, with the balance re-leased, after an interval,at lower rental levels.

Re-LLeasing PPeriodsAssumptions for time periods required for re-leasing vacated properties or findingnew lessees post default will depend upon the desired rating of the underlyingbonds with assumed periods normally between 15 and 18 months.

The nature of real estate collateral is also key here as the assumed re-leasing periodsmay be lower in the case of high quality leading city developments or retail park sitesthat are multi-tenanted rather than isolated, specialized, single tenant sites.

Macro-perceptions on the durability of certain underlying industries may alsoaffect views on re-leasing prospects. For example, long-term perceptions concern-ing the viability of London as a financial centre will affect views on City office re-lettings, whereas views as to the threat to retail locations from home/internetshopping could impact perceptions of the Trafford Centre transaction.

ValuationsValuations at closing are obtained from leading valuation companies and trans-actions have been able to support the issuance of BBB securities at LTVs of70.2% (Canary Wharf Finance II), 73.1% (MS Mortgage Finance (Broadgate))and 69.3% (Trafford Centre).

The ELoC conduit transactions have been able to issue variously at BBB-levels at LTVs of 70%, BBB at 78%, BB at 76%. The underlying structureand nature of the assets will impact these levels.

For example, at the BBB level Canary Wharf Finance II had an initial DSC of1.14X (interest only) – but this was forecast to rise to 1.39x in Year 2 as dis-counted rents expired – whereas initial interest cover for similarly-rated tranch-es on the ELoC transactions ranged between 1.18x and 1.64x.

Amortization SStructuresArrangements vary, although it is common for transactions to require bal-loon refinancing even at the end of extended debt tenors – Canary WharfII features a £100m (21% of original principal) refinancing requirementafter 30 years. The assumption is, notwithstanding the extended maturity,that the real estate can be comfortably re-financed at these levels. TraffordCentre, however, is scheduled to amortize fully over its 22-year life.

In contrast, the ELoC transactions are much shorter term with final matu-rities not exceeding 9 years. Amortization reducing the underlying loanLTVs compared to LTVs at closing of approximately 10% occurs in alltransactions and it is assumed that due to the high degree of interim amor-tization (principal is paid down faster for the transaction life than would berequired under a 30 year mortgage-style amortization profile), and also withthe benefit of projected strong interest cover levels at the refinancing date,then refinancing opportunities for the underlying loans would be available.

276




Japanese CMBS

Chapter 15

278

chapter 15

A JPY 25 Trillion Market?The Japanese commercial mortgage-backed securities market is still in the earlystages of development. In 2004, issuers brought close to US$7 billion inJapanese CMBS to market, roughly the size of the U.S. market in 1991. Doesthe Japanese CMBS market have the potential to grow at the rate of the U.S.market over the past decade? What are the risks and opportunities for investorsin this relatively new fixed-income product?

Our main findings are:

Growth PPotential• The Japanese CMBS market has the potential to grow over the next decade

to a market cap of JPY 25 trillion (US$200 billion) or more.

Conduit MMarket• If a conduit market develops, annual issuance could reach JPY 3 trillion

(US$25 billion) over the next 4 to 6 years.

Japanese EEconomy• Long term growth in the Japanese CMBS market is dependent on the recov-

ery in the Japanese economy and stabilization or growth in real estate values.

Expanding IInvestor BBase• Growth of a Japanese CMBS conduit market will likely lead to an expansion

of the investor base and greater liquidity.

In the next section, we first review the historical development of the JapaneseCMBS market. We then discuss the current structural features of JapaneseCMBS and rating agency methodology. Following is a section on pricing ofJapanese CMBS and relative value. Then we present data on recent JapaneseCMBS and the Japanese real estate market and end with the questions aninvestor should ask before buying a Japanese CMBS.

REASONS FFOR JJAPANESE CCMBS EEMERGENCEMuch as in the U.S. CMBS market, Japanese CMBS are evolving out of dis-tressed conditions for commercial real estate in Japan. The steep real estaterecession of the late 1980s and early 1990s in the U.S. was the worst since theDepression of the 1930s. Prices of commercial real estate fell by 50% or morein some areas and delinquency rates on loans soared to all-time highs. Japan inthe 1990s has seen real estate values fall as much as 90% after the bubble periodof the 1980s.


Japanese CMBS


Before the mid-1990s the U.S. real estate business was predominately a privatemarket. Lending was dominated by a handful of banks, life insurance companies,and pension funds. Losses on commercial loan portfolios led to the exit of manytraditional lenders from the commercial mortgage market. Regulators and ratingagencies turned more negative on commercial mortgage holdings, so that theremaining lenders became less willing to extend credit. As the chart belowshows, thrifts and insurance companies went from supplying over $40 billion incommercial and multifamily loans in 1985 to decreasing their holdings by $46billion by 1992.

In Japan, we could see a similar process growing out of the current downturn.Many banks and insurance companies are in financial distress and are less will-ing to extend long-term credit to real estate borrowers. As in the U.S., theJapanese CMBS market is a natural substitute for traditional originators of com-mercial mortgages.

A BBRIEF HHISTORY OOF CCMBS: UU.S. AAND EEUROPEIn the U.S., investment banks started to apply securitization legal structures, andtechnology developed during the 1970s and 1980s for residential mortgagebacked securities to commercial mortgages. In the mid- to late-1980s, issuerssecuritized a few loans on single properties into CMBS.

Packaging of diversified pools of mortgages into CMBS developed in the U.S. inthe early 1990s when the Resolution Trust Corporation (RTC) pooled nonper-forming loans from failed institutions. Some transactions exceeded $1 billion andled to the growth in the investor base for CMBS. After the success of the RTCtransactions, CMBS gained wider acceptance with investors and nongovernment,or “private-label conduit,” issuers.

Source: Federal Reserve Board, Flow-of-Funds

NET SUPPLY BYINSURANCE

COMPANIES ANDTHRIFT

INSTITUTIONS TOTHE U.S.

COMMERCIAL/MULTIFAMILY

MORTGAGEMARKET

(IN BILLIONS OF $)

exhibit 1

1Moody’s Investors Service, “Japanese Securitization Market: 2001 Year in Review and 2002 Outlook,”May 9, 2002.


Japanese CMBS

280

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Issuance of CMBS in the U.S. grew rapidly in the mid-1990s, reaching $78 bil-lion in 1998. In Europe, CMBS has also taken hold as a financing vehicle, with$13 billion issued in 2001. Most of the transactions are out of the UnitedKingdom, but deals have been done in several other countries.

The SSecond SStageAs the table below shows, we believe that the Japanese CMBS market is current-ly in the second stage of development, comparable to the early 1990s in the U.S.This phase comes at the end of a period of distress for real estate. This periodlasted for about five years in the U.S. – in Japan it could go on for longer.Toward the middle or end of this period we would expect to see the growth ofconduit deals and a decrease in CMBS backed by distressed deals.

Japanese CCMBS: JJPY 225 TTrillion?In its next phase, we believe that the Japanese CMBS market has the potential togrow in the next decade to a market capitalization of JPY 25 trillion (US$200billion) or more. In order for this growth to occur, in our view, a Japanese ver-sion of the U.S. conduit market must develop. A conduit originates loans solelyfor the purpose of securitization and not for portfolio holding.

The development of CMBS conduits spurred growth of the U.S. CMBS market.Conduit originations account for more than half of all CMBS collateral in theU.S. In Europe as well, conduits have been a main contributor to the growth ofthe CMBS market.

United States Japan

Non-

Year RTC RTC Total Year Total

Stage 1 – Early Development

1989 0 4.1 4.1 1998 0.0

1990 0 3.4 3.4 1999 1.1

Stage 2 – Distressed Assets

1991 2.7 5.0 7.6 2000 5.2

1992 8.8 5.2 14.0 2001 4.9

1993 3.1 14.1 17.2 2002p 9.0

1994 3.0 14.4 17.4 2003 TBD

1995 1.2 16.7 17.8 2004 TBD

Stage 3 – Conduit Growth

1996 0.0 28.8 28.8 2005 TBD

1997 0.0 40.4 40.4 2006 TBD

1998 0.0 77.7 77.7 2007 TBD

CMBS GROWTH: U.S. AND JAPAN (BILLIONS OF U.S. $)

exhibit 2

p= Morgan Stanley Forecast; TBD= to be determined



Conduits do not want to hold collateral for a long period. They therefore tend tooriginate standardized pools of mortgages since this speeds the securitizationprocess. This standardization attracts money managers who are not real estateexperts. These investors do not have to spend a lot of time analyzing a pool andare attracted by the commodity-like nature of conduit pools. The broadenedinvestor base has been one of the main factors behind the growth of the CMBSmarket in the U.S.

Although still in the early stages, conduits are starting to develop in Japan. It is ourbelief that conduits will not start to grow at a rapid pace until the Japanese econo-my begins a sustained recovery. In the U.S., conduit originations did not grow rap-idly until the real estate recovery was under way. In the initial stages of the market,growth in conduit originations depends on both a high level of real estate transac-tions and investor willingness to buy securities related to real estate. Anotherimportant element is the willingness of some investors to hold the unrated andlower-rated classes of CMBS, which are a levered real estate investment.

If the conduit market does eventually take off, we believe the Japanese CMBSmarket could eventually become as large a share of the mortgage market as inthe U.S. The size of the U.S. market is rapidly approaching $400 billion dollars,or about 20% of the value of all commercial and multifamily mortgages.

Although there are not exact numbers available, we estimate that there is thepotential for the commercial and multifamily mortgage market to grow to JPY125 trillion (US$1 trillion). This assumes a slightly lower mortgage to GDP ratiothan in the U.S. If we also assume that the Japanese mortgage market continuesto grow and the Japanese CMBS share of mortgages approaches the U.S. ratio,the size of the Japanese CMBS market has the potential to grow to JPY 25 tril-lion (US$200 billion). We think that annual issuance could approach JPY 3 tril-lion (US$25 billion). This would put the ratio of Japanese CMBS to JapaneseGDP roughly in line with the current ratio in the U.S.


RATIO OF CMBSISSUANCE TO GDP

exhibit 3

0.0

0.2

0.4

0.6

0.8

1.0

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

% of GDP

Japan

US

US:

Japan: 1998 1999 2000 2001 2002


Japanese CMBS

282

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STRUCTURAL FFEATURESCMBS have very simple structures compared to their residential mortgage coun-terparts. Bonds are almost always sequential pay, with amortization, prepayments,and default recoveries paid to the most senior remaining class. The lowest ratedremaining class absorbs losses, after equity and reserves are reduced to zero. Inthe U.S., commercial mortgages almost always have some form of prepaymentpenalty, so credit analysis plays a more important role than prepayment analysis.In Japan, call protection has not become a standard feature yet, but we believethat this is necessary for a conduit market to develop.

CMBS are static pools of commercial real estate loans divided into tranches withvarying subordination levels and credit ratings. In the U.S., a typical transactionhas about 90% investment grade bonds, concentrated in AAA securities, with theremaining 10% noninvestment grade. Interest only (IO) bonds can be strippedoff all or part of the structure.

A typical structure consists of sequential pay, fixed rate bonds. The AAA bondsare time-tranched with a 5-year AAA bond ahead of a 10-year AAA bond. Thesubordination level for a AAA conduit deal ranges from 15% to 25%.

In Japan, since the market is still in its early stages, no standard structure has yetdeveloped. Most performing loan deals, however, have the sequential structuredescribed above. The tranches are typically 5 to 7 year bullets, with an additional2 to 3 years until the legal final maturity. The extra time until the legal final is toallow for workouts of loans that default at the bullet payment date.

CALL PPROTECTION, SSERVICING, AAND OOTHER FFEATURESCall protection on Japanese CMBS is not as strong as in the U.S, where defea-sance is the most common form of prepayment penalty. For a defeased loan, theprepaying borrower must place Treasury securities into the trust to generate cashflow that matches the mortgage payments. For European CMBS, fixed-rate loansusually have call protection. Most floating-rate loans in Europe have weak or nocall protection. In Japan, defeasance is rarely used, although some loans haveprepayment penalties.

The Trustee, Master Servicer and Special Servicer each play an ongoing role inthe transaction. The Pooling and Servicing Agreement, Prospectus, and otherlegal documents outline each party’s responsibilities and fees. Typically, theTrustee is responsible for reporting monthly payments and collateral perform-ance data to certificate holders. The Master Servicer is responsible for servicingall performing loans and monitoring loan document requirements. The SpecialServicer resolves defaulted or delinquent loan issues.

In both Japan and the U.S., in addition to the mortgage collateral, credit enhance-ments may be in the form of reserve funds, guarantees, letters of credit, cross-col-lateralization and cross-default provisions. Loans within the pool may have certaincash control provisions such as a “lock box” that requires payments from tenantsto go directly to the trust instead of through the borrower if certain default trig-gers occur. Virtually all loans within CMBS are bankruptcy remote.


Under new accounting rules issued by the Japan Association of Certified PublicAccountants, an originator cannot move a securitized asset off balance sheetunless its holding of the subordinate class is less than 5%. The impact of thischange has been minimized by the development of a sub-investment gradeinvestor base.

THE MMYCAL CCHALLENGEIn 2001, the Japanese corporation Mycal, a major retailer, went into bankruptcy.A bankruptcy court administrator challenged the bankruptcy-remoteness of thecollateral in two CMBS backed by shopping centers leased by Mycal.

Although the specific case is still being negotiated, most observers believe that itshould not have any negative long-term effects on securitization in Japan. Ratingagencies have downgraded some classes of the deals because of collateral per-formance, but have not taken any negative rating actions because of the case.They also have not changed rating criteria.

In June 2002, Emeritus Professor Shindo of Tokyo University published an arti-cle supporting the position of investors in the Mycal CMBS case. The opinionwas a counter-argument to the opinion of Professor Yamamoto of KyotoUniversity, which Mycal’s administrator made public in May. Shindo believes thatreceivables in a securitization should not be part of bankruptcy reorganizationunder the Japanese Corporate Rehabilitation Law.

In Japan, the rating agencies have published limited credit enhancement guide-lines for CMBS deals. We believe, however, that the rating agencies will apply asimilar methodology to the rating of Japanese conduit CMBS. The table belowshows Standard and Poor’s published criteria for Japanese CMBS.

Early on, some rating agencies looked at the volatility of real estate values com-pared to the U.S. as a basis for Japanese CMBS ratings criteria. Recently, however,most have used a cash flow approach to evaluating credit risk. This methodologytends to lead to more stable valuations than using individual property appraisals.

JAPANESE CMBS BASE-CASE CMBS RATING CRITERIAexhibit 4

Source: Standard and Poor’s

Rating DSCR LTV (in %)

AAA 2.25-2.5 35-40

AA 2.0-2.25 40-47.5

A 1.8-2.0 47.5-55

BBB 1.6-1.8 55-60

BB 1.4-1.6 60-65

B 1.2-1.4 65-75


Japanese CMBS

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MONITORINGAfter a transaction is issued, rating agencies monitor deals for changes in creditrisk. As the Japanese CMBS market is relatively new and many deals are private,it is often difficult for investors to receive detailed monthly monitoring reports.In the more developed U.S. market, private vendors such as Trepp, RealPoint,and Conquest provide loan level monitoring details on every transaction.

As the Japanese CMBS market develops, we expect to see a growth in thenumber of readily available monitoring reports and the amount of detail ineach report. Improvement in monitoring systems will help the investor basefor Japanese CMBS to grow, as less time will be needed to keep track ofinvestments in the sector.

LACK OOF JJAPANESE DDEFAULT DDATAIn Japan there is scant default data and not enough deals or history to evaluaterating changes. How, then, can we assess the expected default rates on JapaneseCMBS? The short answer is we can’t, at least to the degree of confidence as inthe U.S.

What we can do, though, is look at what sort of scenario it would take to causedefault on a AAA Japanese CMBS. We can then attempt to judge the probabilityof such an event occurring. We estimate that the combination of subordinationand equity in current Japanese CMBS exceeds 50% and can be as much as 65%on performing loan deals. Rating agencies (and originators) also usually reduceor “haircut” the current cash flows of a property in their underwriting.

Given these assumptions, we estimate that it would take a fall in current propertyvalues of 70% or more to expose the AAA-rated classes to losses. BBB classescould withstand a fall of prices in excess of 40% in most cases.

PRICES DDOWN 553%The Japan Real Estate Institute (JREI) has the longest time series of propertyvalues in Japan. The JREI publishes a commercial land price index for urbanareas that dates back to the mid-1950s. In Japan, a high percentage of propertyvalue is in land since there is a limited amount of space for development. Thenational commercial land price index has fallen 53% from March 1990 through

Source: JREI

0

20

40

60

80

100

120

Mar-55 Oct-66 Jun-78 Feb-90 Sep-01

Nationwide6 Largest Cities

COMMERCIALLAND PRICES IN

JAPAN

exhibit 5


March 2002. This is by far the worst period of decline in the 47-year history ofthe index. In large cities, prices have fallen even more. The commercial index forlarge cities has fallen by 84% from 1990 to 2002.

While it’s possible that the index could decline further, a drop of the magnitudeto threaten AAA CMBS seems unlikely. A further 70% fall in the land priceindex would put its value in nominal terms close to the level in March 1967. Inreal terms, the fall in prices would put values close to the level of the early1960s, or almost 90% below the peak value in 1990.

In large cities, an additional drop of 60% would put values at less than 5% ofthe peak. A similar percentage drop in another bubble market, the NASDAQ,equates to a decline from the peak of 5000 to 250, less than 20% of its value asof June 2002.

INSULATIONIn the U.S. CMBS market, the high subordination levels for investment gradeCMBS insulated those securities from the recent downturn in U.S. real estatemarkets. In 2001 and 2002, vacancies in many areas of the U.S. were moving todouble-digit levels as real estate markets declined, yet investment grade CMBSspreads were flat to tighter. Subordination had the effect of removing much ofthe direct real estate risk from the higher-rated classes of CMBS.

In Japan, it is too early to say whether subordination levels are of the samedegree of conservatism as in the early days of U.S. CMBS. Under current ratingcriteria, however, the Japanese real estate market could undergo further signifi-cant declines without causing defaults on investment grade Japanese CMBS. Thesevere downturn of the past ten years could be repeated without causing adefault of most AAA-rated Japanese CMBS. Since most Japanese CMBS have amaturity of 5 to 7 years, the decline would also have to occur in a much shortertime frame than the current downturn to affect investment grade bonds.


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Case Studies: Selected Japanese CMBS

EAST RREALTYCO., LLTD.Issuer East Realty Kabushiki KaishaAmount JPY 83.9 billion (US$670 million)Issue ddate March 2002Final mmaturity 2009 Expected maturity: 2007Collateral Tobu Dept. Store (Ikebukuro) and adjacent buildings; Tobu

Dept. Store (Funabishi) and adjacent buildings; land in Harajuku.Ratings Standard and Poor’s, Fitch

RATING AAGENCY PPOSITIVES• Location of stores• Prime location of Harajuku land• Geographical diversification• High alternative use• Tobu as creditworthy tenant• Liquidity facility• Strong trustee (Yasuda Trust)

STRUCTURE/PRICINGAmount Spread to LIBOR

Class Rating (Bil. of JPY) (in bp) Coupon

A AAA 44.1 60 FixedB AA 10.2 80 FixedC A 10.4 100 FixedD BBB 11.2 160 FixedE BB+ 8.0 350 Fixed

LTV AND DSC RATIOS

Class Rating S&P LTV Fitch LTV S&P DSC Fitch DSC

A AAA 36 35.8 2.77 2.53B AA 44 44.1 2.25 2.05C A 52 52.6 1.89 1.72D BBB 61 61.7 1.61 1.47E BB+ 68 68.2 1.46 1.33

Source: S&P Presale Report, 2/18/2002; Fitch New Issue Report, 3/26/2002

RATING AAGENCY CCONCERNS• Concentration risk in Ikebukuro store• Single tenant risk• Outlook for domestic retail• Illiquid property types (railway facilities

and department stores)• Balloon risk (nonamortizing loans)

Reserves JPY 3 billion capital expenditure reserve; JPY $1.5 billion operational expense reserve; JPY 4.2 billion security reserve

Payments Semi-annual

Underwriter Mizuho Securities (lead), Daiwa, Kokusai

Property Manager Tobu Railway

Trustee Yasuda Trust

Rating Analyst Contact S&P: Tomoyoshi Omuro 3593-8584; Fitch: Masaaki Kudo 3288-2830

Source: S&P and Fitch Presale Reports


J-CCMBS-11 LLTD.Issuer J-CMBS-1 Ltd.Amount JPY 21 billion (US$171 million)Issue ddate May 2000Final mmaturity 2007 Expected maturity: 2004Collateral 13 properties in central Tokyo. Largest loan: Akasaka 1, an

office building (27%) Ratings Standard and Poor’s/Moody’s/Fitch

RATING AAGENCY PPOSITIVES• Cross-collateralized portfolio• Location in central Tokyo• Diversified tenant base• Conservatively underwritten cash flow• Cash trap trigger at DSCR of 1.50x• Well capitalized sponsors

STRUCTURE/PRICING

LTV AND DSC RATIOS

Class Rating S&P LTV Fitch LTV S&P DSC Fitch DSC

A AAA 36 2.6B AA 43 2.1C BBB 50 1.9D BBB 58 1.6X AAA NA 1.46

Source: S&P Presale Report, 5/26/00

RATING AAGENCY CCONCERNS• Low occupancies in some

buildings• Supply concerns in Tokyo

office market• No amortization

Reserves Holdback of JPY 3 billion for 6 months

Payments Semi-annual

Underwriter Salomon Brothers

Property Manager Mitsui Fudosan

Trustee Cititrust

Servicer GMAC Commercial Mortgage

Rating Analyst Contact S&P: Kenji Kondo 3593-8590

Rating Amount Spread to LIBOR Class (Moody’s/ S&P/Fitch) (Bil. of JPY) (in bp) Coupon

A Aaa/AAA/AAA 13.0 30 FloatingB Aa2/AA/AA 2.5 45 FloatingC A2/A/A 2.5 70 FloatingD Baa2/BBB/BBB 3.0 130 FloatingX Aaa/AAA/AAA N/a N/a Floating

Source: S&P Presale Report


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JLOC 22001-III LLTD.Issuer Centennial FundingAmount JPY 71 billion (US$590 million)Issue ddate November 2001Final mmaturity 2008 Expected maturity: 2006Collateral 20 trust certificates backed by 313 properties (80% office)Ratings Moody’s/Standard and Poor’s/Fitch

RATING AAGENCY PPOSITIVES• Geographical diversity• Property locations in central business

districts• Asset manager has established disposition plan• Completed liquidation of some assets • Assets formerly owned by Daihyaku Mutual

Life• Fast-pay triggers dependent on debt

service coverage• Asset manager experience

Other: Interest and principal payments dependent on cash flow from buildings andproceeds from sale of properties. Proceeds from sale of properties used to paydown classes sequentially, starting with the AAA class. No scheduled amortization.

STRUCTURE/PRICING

Rating Amount Spread to LIBOR Class (Moody’s/ S&P/Fitch) (Bil. of JPY) (in bp) Coupon

A Aaa/AAA/AAA 50.0 35 FloatingB Aa2/AA/AA 8.0 55 FloatingC A2/A/A 7.0 80 FloatingD Baa2/BBB/BBB 6.0 125 Floating

RATING AAGENCY CCONCERNS• Potential volatility of prices in

small cities• Office concentration• 10% concentration in one

office building• Higher vacancy rates than

market

Reserves Cash reserves of JPY 4.4 billion

Payments Quarterly

Underwriter Morgan Stanley

Property Manager Nomura Real Estate Development Co., MF Building, Sumitomo Real Estate, Pacific Development

Trustee Bankers Trust

Asset Manager Morgan Stanley Properties, Japan

Source: Moody’s/S&P/Fitch Presale Reports


The Japanese Real Estate MarketIt has long been my contention that spreads on investment-grade CMBS (in theU.S. market) have little correlation with real estate fundamentals. In 1998, theU.S. commercial real estate market was booming, but spreads on CMBS movedto the widest level ever after the Russian default and Long Term Capital failure.In 2002, spreads tightened 20 bp or more for all investment-grade conduit rat-ings even though the real estate market was weakening and office vacanciesexceeded 20% in many cities.

I believe that in Japan, CMBS spreads will similarly be detached from real estatefundamentals. I think that this will be especially true for diversified conduit deals.Rating agencies have required high levels of subordination for investment-graderated CMBS, providing insulation from further moderate declines in real estate.Despite this insulation, it is nonetheless instructive to examine the current state ofthe Japanese real estate market. Lower-rated CMBS could be affected by real estatetrends and even highly rated-classes might feel the impact of a sharp downturn.

Ten-YYear DDeclineThe Japanese real estate market has been in almost steady decline for the lastdecade. After the bubble period of the 1990s, prices have declined in everyregion in Japan.

On a nominal basis, land prices in Tokyo and Osaka have declined to near thepre-bubble levels of the early 1980s. In real terms, or as measured as a ration toGDP, prices have fallen even further.

Source: JREI

40

60

80

100

120

140

160

Mar-85 Mar-89 Mar-93 Mar-97 Mar-01

Kanto (Tokyo)

Tohoku (Sendai)Chubu- Tok (Nagoya)Kinki (Osaka)

Kyushu (Fukuoka)

REGIONAL LANDPRICES

exhibit 6


Japanese CMBS

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Source: JREI

RATIO OF LANDPRICE INDEX TO

GDP

exhibit 7



Factors to Consider Before Investing in CMBS

Chapter 16


Factors to Consider BeforeInvesting in CMBS

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ECONOMIC/INTEREST RRATE OOUTLOOKInvestors should be aware of the growth outlook for the U.S. economy.Investment-grade bonds tend to do well on a total return basis when GDPgrowth is slow and the Federal Reserve is in an easing mode. Credit spreads,however, might widen and defaults rise during an extended slowdown.

SWAP SSPREADSInvestment-grade CMBS and swap spreads are highly correlated. The swapspread represents the price of exchanging a fixed-rate cash flow for a floating-rate one. Swap spreads are also a proxy for overall credit risk.

A ten-year swap spread of Treasuries + 80 bp means that one party must paythe 10-year U.S. Treasury (UST) yield plus 80 bp to the counterparty to receive afloating-rate (LIBOR) cash flow. If a CMBS has a yield of the UST + 130 bpand the swap spread is 80 bp, then the CMBS is said to trade at Swaps + 50 bp.That is, the purchaser of the CMBS receives UST +130 bp, can pay out UST +80 bp, and receive Libor plus the 50 bp difference between 130 bp and 80 bp.

Investors should be aware of the historical trading ranges of CMBS to swaps foreach rating category. CMBS buyers should put current spreads in the context ofhistorical data and be able to explain circumstances that might drive spreads out-side of trading ranges.

GLOBAL RRISKCMBS investors should also have a view of the global economy and potentialeffects of global credit risk on U.S. fixed-income markets. In 1998, the Russiandebt crisis had a major impact on U.S. markets, including CMBS.

REAL EESTATE FFACTORS

Real eestate ccycleHigh subordination levels insulate most investment-grade CMBS investorsagainst default during real estate downturns of the magnitude experienced overthe past 30 years. Non-investment grade buyers are more vulnerable to weaken-ing real estate conditions. All investors, however, should monitor changes inmacro real estate trends to judge if spread widening could occur versusTreasuries, swaps, or other sectors.

Real eestate ddataThere are a myriad of sources from which to obtain data on real estate condi-tions. Providers include:

• American Council of Life Insurers (commercial mortgage delinquencies andoriginations).

• Federal Reserve Board (Beige Book on regional economic conditions; flow-of-funds data on commercial and multifamily originations).

• U.S. Census bureau (construction).

• Torto Wheaton Research (vacancy data by property type and market).


• CB Commercial (vacancies and rents).

• F.W. Dodge (construction).

• REIS (property market overviews).

• PricewaterhouseCoopers (property market overviews).

• Smith Travel Research (hotel occupancies and room rates).

• Moody’s, Standard & Poor’s, Fitch (periodic reports on real estate and CMBS).

RELATIVE VVALUEInvestors use several benchmarks for CMBS spreads:

• Single-A bank and finance – Formerly used as a benchmark for AAA CMBS;now used for both AAAs, AAs, and single-As.

• Unsecured REITs – Benchmark for BBBs and BBB- CMBS.

• Single-A corporate industrials – Benchmark for investment-grade CMBS.

• Mortgage pass-through OAS – Comparison for AAAs.

• ABS – Benchmark for short AAAs.

CMBS investors examine the historical relationships among CMBS spreads andthose from each of these sectors. “Relative value” analysis involves judgingwhether the divergence of spreads represents a buying opportunity.



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BOND-SSPECIFICIn analyzing a specific class of CMBS, an investor should consider the following factors:

RatingsMost CMBS have at least two ratings. The rating agencies in the U.S. market areMoody’s, Standard and Poor’s (S&P), and Fitch. Some investors require thateither Moody’s or S&P rate the bond. A potential investor should check if bondpurchased in the secondary market is on ratings watch. Rating agencies state thatthey continually monitor outstanding ratings. Fitch and S&P conduct annualreviews and are more likely to change a rating at that time.

Rating agency analysts are available to answer credit questions about new issuesor bonds in the secondary market. With a new issue, it is sometimes valuable tocall the rating agency that has not rated the bond, since that agency is likely tohave analyzed the credit more conservatively.

Subordination llevels

An investor should compare the subordination level of the bond in question toothers in the market and to older transactions. Lower subordination is not neces-sarily an indication of lesser credit quality. Issuers with highest quality collateralobtain the lowest credit enhancement levels, and will often have the lowest delin-quency rates.

Subordination levels have trended down over time. An investor should be com-fortable that the current enhancement levels are appropriate for the expectedfuture default rates.

Issuer qqualitySpreads in the CMBS market have tiered based on the perceived quality of theissuer’s collateral. As a general rule, bank and insurance companies are viewed ashaving the highest credit quality mortgages.

Investors should consider the possibility that an issuer will exit the CMBS busi-ness. Even though CMBS are bankruptcy remote, the failure of an issuer mightlead to spread widening because a market perception of reduced liquidity.

One quantitative check on the quality of an issuer’s collateral is the performanceof seasoned transactions. Morgan Stanley and other dealers publish delinquencyrates by issuer.

Cash fflowsInvestors can model simple cash flows on Bloomberg for almost all CMBS.More detailed modeling services include Trepp LLC and Conquest. Theseservices allow for loan-by-loan default modeling and also provide detailedmonitoring information.

LiquidityInvestors should try to determine how many dealers make a market in a particu-lar CMBS. If only one or two dealers trade a bond, the market will place a liq-uidity premium on the security.

Property/Regional cconcentrationConcentrations of various property types or within regions are important factorsin analyzing CMBS. Property type or regional concentrations above 40% of apool may raise a warning flag. Non-standard property types such as cold storage,health care, or manufactured housing communities also draw increased scrutiny.This is not to say that these property types should be avoided. Instead, aninvestor should make sure that the rating agencies have made proper adjustmentsand that the pricing reflects any potential risk.

Deals with high (greater than 30%) concentrations of multifamily loans are oftenviewed favorable, since Federal agencies are more likely to purchase these deals.

ERISA-eeligibility

Effective August 23, 2001, the Dept. of Labor ruled that CMBS rated as low asBBB- are eligible as pension fund amendments under ERISA. For most dealsclosed before that date, the issuer needs to amend the original documents toachieve ERISA-eligibility for bonds rated less than AAA. As of August 2001,Morgan Stanley, Nomura, and Bank of America had amended deals issued fromtheir shelves before the effective date.

Remittance rreportsFor seasoned transactions, an investor should obtain the most current remittancereport and special servicing report. Every month, the trustee compiles thereport, which details distributions and loan delinquencies. Special servicingreports highlight loans transferred from the servicer to the special servicer.

Total delinquency rates of less than 2% are usually not a concern for AAAinvestors. Thirty-day delinquency rates are of lesser concern than 60 day+ rates.


CREDIT ENHANCEMENTPNCMA 2001-C1 A2

exhibit 1

Current At Issuance CreditClass Balance Cpn Type Rating Enhancement

A1 141,114 5.91 Fixed Rate AAA/Aaa 19.75%

A2 560,781 6.36 Fixed Rate AAA/Aaa 19.75%

B 33,060 6.58 Fixed Rate AA/Aa2 16.00%

C1 18,856 6.80 Fixed Rate A/A2 12.50%

C2 12,000 2.57 Fixed Rate A/A2 12.50%

C2X 12,000 — IO, Other Non-Fi A/A2 —

D 11,020 6.93 Fixed Rate A–/A3 11.25%

E 8,816 — WAC/Pass Thru BBB+/Baa1 10.25%

F 13,224 — WAC/Pass Thru BBB+/Baa2 8.75%

G 7,714 — WAC/Pass Thru BBB–/Baa3 7.88%

H 16,530 5.91 Fixed Rate BB+/Ba1 6.00%

J 14,326 5.91 Fixed Rate BB/Ba2 4.38%

K 5,510 5.91 Fixed Rate BB–/Ba3 3.75%

L 8,816 5.91 Fixed Rate B+/B1 2.75%

The sources for exhibits 1-6 are cash flow runs on Trepp LLC analytics on Bloomberg.

Price/Yield ttablesThe following tables show details for a new issue conduit transaction, PNCMA2001-C1. The deal represents an average CMBS transaction. The tables show theresilient nature of both AAA and BBB bonds under a number of default andprepayment scenarios.

The first table shows the capital structure of the transaction, with credit supportand ratings. The AAA bond has 19.75% subordination and the BBB 8.75%. Theselevels were close to the average for conduit transactions as of August 2001.

The following table shows the types of call protection on the loans for each year afterissuance. In the first year, 97.42% of the loans have defeasance or are locked-out (LO).

The yield table below shows the effects of changing prepayments on the yield ofthe AAA bond, priced at 101-22 1/4. Note that the yield, average life, andspread are almost unchanged across a wide range of prepayments. CPR or some-times “CPY,” stands for the annual prepayment rate on loans not in lockout ordefeasance. Before year 10, no more than 8.83% (100% – 91.17% in the previ-ous table) of the loans are able to prepay. In addition, the 5-year AAA class isabsorbing the effects of prepayments.



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PREPAYMENT PENALTY MATRIXPNCMA 2001-C1 A2

exhibit 2

No. Date LO YM PP>=5% PP>=4% PP>=3% PP>=2% PP>=1% None

1 8/01 97.42% 2.58% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

2 8/02 96.51% 3.49% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

3 8/03 94.24% 5.76% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

4 8/04 92.85% 7.15% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

5 8/05 92.90% 5.88% 0.00% 0.00% 0.00% 0.00% 0.00% 1.22%

6 8/06 90.87% 7.41% 0.00% 0.00% 0.00% 0.00% 0.00% 1.72%

7 8/07 92.46% 7.17% 0.00% 0.00% 0.00% 0.00% 0.00% 0.37%

8 8/08 91.90% 6.39% 0.00% 0.00% 0.00% 0.00% 0.00% 1.71%

9 8/09 91.17% 6.48% 0.00% 0.00% 0.00% 0.00% 0.00% 2.35%

10 8/10 71.60% 2.40% 0.00% 0.00% 0.00% 0.00% 0.00% 26.01%

11 8/11 100.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

12 8/12 100.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

PRICE/YIELD TABLEPNCMA 2001-C1 A2

exhibit 3

CPR when PP <= X% 0.00 15.00 30.00 45.00 60.00

101-22¼ Price 6.172 6.172 6.172 6.171 6.171

WAL 9.35 9.34 9.33 9.31 9.30

Sprd Swaps +45.02 +45.06 +45.11 +45.17 +45.24

The yield table below shows the effects of changing prepayments on the yield ofthe BBB bond, priced at 101-1. As with the AAA, note that the yield, averagelife, and spread are almost unchanged across a wide range of prepayments.

The following yield table shows the effects of defaults on the AAA class. Thedefault rate is an annual default rate of the remaining balance, abbreviated asCDR. The yield changes very little up to 3% CDR, an extremely high default rateby historical standards. The change in yield at higher CDRs is caused by thereduction of the average life of a premium security.

The yield table below shows the effects of defaults on the BBB class. The yield is unchanged up to 2% CDR. At a default rate of 3% CDR, principal is notaffected, but the yield decreases slightly. The yield decrease is from the shorten-ing of a premium bond.


PRICE/YIELD TABLEPNCMA 2001-C1 F

exhibit 4

CPR when PP <= X% 0.00 15.00 30.00 45.00 60.00

100-1 Price 7.073 7.073 7.073 7.073 7.073

WAL 9.62 9.62 9.61 9.59 9.57

Sprd Swaps +131.98 +132.02 +132.10 +132.21 +132.33

PRICE/YIELD TABLEPNCMA 2001-C1 A2

exhibit 5

Default Rate 0.00 0.50 1.00 2.00 3.00

101-22¼ Price 6.172 6.171 6.170 6.166 6.162

WAL 9.35 9.31 9.25 9.10 8.91

Sprd Swaps +45.02 +45.19 +45.43 +46.06 +46.92

PRICE/YIELD TABLEPNCMA 2001-C1 F

exhibit 6

Default Rate 0.00 0.50 1.00 2.00 3.00

100-1 Price 7.070 7.070 7.070 7.070 7.159

WAL 9.62 9.62 9.62 9.62 14.13

Sprd Swaps +132.01 +132.01 +132.01 +132.02 +107.51

298




Glossary


Glossary

300

Anchor SStore A major grocery, discount retailer, or department store that attractsshoppers to the mall.

Anchored SStrip CCenter A shopping center with at least one anchor store. All elsebeing equal, an anchored strip center is more valuable than an unanchored stripbecause of the extra flow of shoppers.

ASERS ((Appraisal SSubordinate EEntitlement RReductions)/CVA ((Collateral VValuationAdjustments) Structural deal feature that estimates unrealized losses on defaultedloans and prevents payment of current interest on the estimated losses. Designedto prevent conflicts between the interests of subordinate and senior classes.

Assisted LLiving FFacilities A property type targeted to elderly needing assistance, butnot full time medical care. These facilities typically consist of apartment style unitswith a kitchenette. The operator of the facility provides three meals a day andassists residents with daily activities such as feeding, bathing, dressing, andmedication reminders.

Average DDaily RRate Total guest room revenue divided by total number ofoccupied rooms.

B-ppiece See Subordinated Tranche.

Call PProtection The main forms of call protection in CMBS loans are lockout,penalty points, yield maintenance and defeasance. The purpose of call protection isto protect the lender from borrower prepayment. Defeasance and lockout providefor the most stable cash flows. The only cash flow variability will be a result ofcredit events.

Capital EExpenditures ((Cap EEx) Extraordinary expense items necessary to maintainthe property. Examples would include repairing a roof, repaving a parking lot, orreplacing heating and air conditioning systems.

Capitalization RRate Rate of interest (or return) used to convert a series of propertycash flows into a building value. The higher the cap rate, the riskier the asset.

CDR Annualized default rate expressed as a percentage of the remaining poolbalance; a default is assumed to be a liquidation.

Class AA PProperties Trophy quality properties with higher quality finishes andprominent locations.

Class BB PProperties Generic real estate; 10-20 years old, well maintained, averagelocations, fewer amenities.

Class CC Properties Older properties needing renovation; uncertain future.

Community CCenter Over 100,000 - 275,000 square feet of space; multiple anchorsbut not enclosed.

Congregate SSenior HHousing These are independent living facilities that provide acommon dining facility and other services. Congregate senior housing has nomedical component, but may provide access to emergency medical care through callbuttons. Not licensed as a nursing home.

Continuing CCare RRetirement CCommunities These facilities offer the entire continuumof seniors housing from independent living to skilled nursing facilities. Residentsmove within the facility depending on the level of care required. Licensed operator.

Co-oop LLoans/Blanket LLoans Very low loan to value multifamily loans. Loans senior toco-op share loans.

Co-TTenancy PProvisions A provision in a retail lease which permits the tenant tocancel its lease if another major tenant closes.

CPR The constant rate of the outstanding collateral principal expected to beprepaid in a year. Also see Constant Prepayment Yield (CPY).

CPY A modified CPR that assumes prepayments to be zero until all yield maintenanceprovisions are expired. CMBS IOs are priced assuming a 100 CPY speed.

Credit TTenant LLease A type of retail lease. All payments guaranteed by credit oftenant (i.e., Wal-Mart).

Debt SService CConstant Annual Principal and Interest Payment/Original Loan Amount.

Debt SService CCoverage RRatio ((DSCR) Net Income/Annual Debt Service. An indica-tor of protection from cash flow volatility.

Defeasance Upon prepayment of the loan, the borrower is required to provide thelender with U.S. government securities in an amount such that the lender receivesthe same yield as if the borrower had not prepaid the loans. From the lender’s per-spective, a defeased loan is positive. The yield is the same, but there is a creditupgrade from commercial real estate credit to U.S. Government credit.

Distribution SSpace Structure in an industrial property. Principal use is distributionor light assembly. Minimal office space as a percentage of total space (typically0–10%). “Clear heights”, 24’ ceiling heights, are the minimum for modern distribu-tion buildings. Higher clear heights are more economical for the tenant as theystack goods vertically and rent fewer square feet.

Dollar PPrice The price at which bonds are currently trading, with a $100 dollar pric-ing being a par bond.

Double WWide/Single WWide Describes the size of manufactured home that a givenslab will support. The double wide segment has experienced the fastest growth dueto the growing acceptance of manufactured homes as a single family housing alter-native.

E-CCurve The front end of the swap curve is constructed with Eurodollar futures con-tracts, which are future contracts on 3-month LIBOR. Unlike the J-spread, which is aspread over the bond’s average life point on the Treasury curve, the E-spread is a sin-gle constant spread that is added to each relevant point on the Eurodollar futurescurve.

EAs ((Extension AAdvisor) Provides representation for the senior classes in a loan modi-fication process. Typically the transaction documents require the special servicer toget approval from the EA to grant any extensions to a loan beyond a certain date.

Fee SSimple Ownership of both land and building in perpetuity.



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FF&E Furniture, Fixtures, and Equipment; standard hotel underwriting includes adeduction as an operating for the ongoing replacement of FF&E, typically 4% to5% of gross revenue. This differentiates hotel underwriting from apartment under-writing where some of those same expenses are considered capital expendituresand are not an operating expense deducted from NOI. Typical hotel refurbishmentshould occur at least every 7 years.

Flex SSpace/Office WWarehouse Higher amount of office space as a percentage oftotal space. This results in higher tenant improvement costs necessary upon leaserenewals. These tenants are less sensitive to clear heights and more sensitive toaccessibility of qualified labor pools.

Franchise FFee Fee paid to hotel company that allows hotel owner to “fly the flag”of the hotel company (i.e., Marriott, Sheraton, etc). Fee ranges from 4% to 7% ofgross revenue.

Full SService HHotel A hotel that offers banquet and convention services; one or morefull service restaurants.

Fusion TTransaction Commercial Mortgage Alert defines a fusion deal as a transac-tion that has conduit style loans and either has one loan that is more than 10% ofthe pool balance or all loans of $50 million or more are at least 15% of the deal.Market participants often classify a deal as a fusion transaction if the top 10 loansaccount for at least 40% of the collateral.

Garden AApartments Multiple buildings; usually no more than 2-3 stories.

Go DDark PProvisions A provision in a retail lease. Prevents tenant from vacating thespace while continuing to pay rent; landlords like this because this vacant space is adetriment to other stores’ sales at the center.

Ground LLease Building owner leases land from land owner.

Haircut Difference between the loan underwriter cash flow and the cash flow usedby the rating agency to size the loan. Examples of haircuts given by the rating agen-cies include above market rents and apartment occupancies greater than 95%.

High RRise AApartments Over three stories; usually located in downtown areas.

I-CCurve Interpolated Treasury curve. Pricing a 9.5-year CMBS bond as a spread tothe I-Curve involves interpolating yields for the remaining maturities of the on-the-run 5-year and 10-year Treasury notes. If both notes were issued three months ago,the interpolation would involve 4.75 years as the starting point and 9.75 years as theending point. For more details, see pages 90-91.

Independent LLiving FFacilities Multifamily apartment complexes catering to seniorcitizens. They supply few services beyond building and ground maintenance.These facilities are unregulated.

In-LLine SStore Smaller store within a center (i.e.., Foot Locker or Hallmark Cardsstore).

Investment GGrade TTranches Tranches in a CMBS transaction that are rated betweenAAA and BBB-.


J-CCurve Interpolated nominal Treasury curve. Pricing a 9.5-year CMBS bond as aspread to the J-Curve involves interpolating yields for the original maturities of theon-the-run 5-year and 10-year Treasury notes. The J-Curve ignores any seasoningthat may have taken place in either issue. For more details, see pages 90-91.

Junior AAAA TTranches See Super Senior AAA Tranches.

LTV See Loan to Value.

Leasehold IInterest Building owner leases land. Lender wants ground lease term toexceed loan amortization period.

Leasing CCommissions Fees paid to brokers to bring tenants for office leases, typical-ly $2-4 per square foot at lease signings. Landlords bear this expense.

Levered IIO ((Interest OOnly) The Levered IO is stripped off of the senior and surbor-dinate classes of the CMBS structure. The levered IO has more exposure to collat-eral defaults than the PAC IO, which is stripped off of the mezzanine bonds in thecapital structure. The levered IO is AAA rated because of its top priority in receiv-ing cash flows.

Limited SService HHotel No food service other than continental breakfast, minimalpublic space and small staff.

Loan tto VValue ((LTV) Loan Amount/Appraised Value. A 70% LTV is the average forcommercial loans in CMBS transactions.

Lockout Borrower prohibited from prepaying; same as a non-call in corporate bonds.

Loss SSeverity Realized loan loss (in dollars)/remaining outstanding loan balance at themonth of write-off.

MAI ((Member, AAppraisal IInstitute) Designation given to certified appraisers.

Manufactured HHousing CCommunities The land, streets, utilities, landscaping, andconcrete pads under the homes comprise a manufactured housing community. Thehomes are independently financed. Homeowners pay monthly rent for the pad tothe manufactured housing community owner.

Master SServicer Receives a 2-10 bp fee to collect monthly mortgage payments andreserve payments required by the loan documents.

Mezzanine DDebt Debt secured by borrower’s equity interest in the property.There is no lien on the property. Usually this refers to debt in addition to thefirst mortgage.

Mezzanine TTranches Typically the CMBS tranches rated between AA and BBB.They are not as senior as the AAA tranches, but are senior to the B-pieces.

NOI ((Net OOperating IIncome) Property revenues minus property expenses.

OA ((Operating AAdvisor) Majority owner of the first loss class controls certainaspects of the special servicing; generally preferred by rating agencies as anenhancement to credit.

OAS ((Option-AAdjusted SSpread) A measure of spread that adjusts for default and calloption costs.

Occupancy RRate Number of occupied units/total number of units.

PAC IO See Levered IO.

Pad Concrete slab that supports each manufactured home in a manufactured hous-ing community.

Pari PPassu LLoan Pari passu loans are created when an issuer splits a large loan intosmaller pieces. These smaller pieces are often securitized in separate transactionsand are paid monthly principal and interest simultaneously and on a pro-rata basis.

Power CCenter/Big BBox Predominantly anchor tenants and few small stores. Typicallybig discounters or mass retailers.

Prepayment PPenalty PPoints A prepayment penalty that is equal to a percentage ofthe remaining loan balance (i.e., 5%, 4%, 3%, etc). Generally, the least preferableform of call protection.

Recapture PProvisions A provision in a retail lease. Permits the owner to cancel alease and to regain control of space after a tenant closes its store.

Regional MMall Over 750,000 square feet with several department stores (2-3) asanchors.

REO ((Real EEstate OOwned) A property becomes REO upon foreclosure of the loan.The lender or trust now owns the property.

RevPAR ((Revenue PPer AAvailable RRoom) Average Daily Rate x Occupancy Rate.Used mainly for analyzing hotel/lodging properties.

Rollover Term used to describe expiration of a tenant lease in an office property.Lease terms are generally for 5-10 years; credit tenants may be longer. It is prefer-able not to have rollover concentrations, which would expose an owner to uncer-tain rental market or potentially reduce NOI below debt service.

Self-SStorage FFacility Commercial property that leases storage space to individuals orbusinesses on a month-to-month basis. The average self-storage facility hasbetween 40,000 and 10,000 square feet of rentable space divided among 400 to1,000 individual units.

Shadow AAnchored SStrip Similar to an anchored strip except that the shopping centerdoes not own the anchor store.

Shadow RRating A rating on an individual loan in a large loan pool given by the rat-ing agencies.


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Skilled NNursing FFacilities Independent nursing homes or a designated wing in a hos-pital. The facility provides full-time licensed skilled nursing, medical and rehabilita-tive services. Average length of stay can range from 2 months to 2 years, or more.24-hour care is provided, with doctors and registered nurses on call. Facilities arelicensed by the state; operator must obtain a certificate of need from the statebefore beginning operation.

Special SServicer Handles workout situations of delinquent or defaulted loans for a fee. Usually, the special servicer owns the most subordinate bonds in the transac-tion. Real estate expertise is key for special services.

Stressed DDSCR Rating Agency Adjusted Cash Flow/Debt Service Payment using anassumed debt service constant.

Sub SServicer A servicer who performs specialized tasks for the master or specialservicers. The master or special servicer that contracts out the work remains legallyresponsible.

Super RRegional MMall Over 1 million square feet with multiple department (4-5) storesas anchors.

Super SSenior AAAA TTranches The most senior tranches in a CMBS transaction. Theyare structured with higher credit support levels than the junior AAA class.

Tenant IImprovements Costs to build walls, ceilings, carpet for a new office tenant.Typically $5-40 per square foot. The landlord usually incurs this expense. In strongdemand markets the landlord can pass this expense through to the tenant in termsof a higher rental rate. In weak markets, landlords must take tenant improvementsout of net income, which reduces cash flow.

Tilt-UUp CConstruction This is the preferred construction type for industrial buildings.It includes pre-cast concrete panels that are “tilted-up” on a steel frame. Tilt-up ispreferable to corrugated metal exteriors for maintenance reasons.

Trailer PPark This is a lower-end asset class, often confused with manufactured hous-ing communities. Trailer parks are highly transient, dense communities of homeson wheels. Tenants are provided with no amenities other than simple utilityhookups. Not typically seen in conduit pools.

Triple NNet LLease A type of retail lease. Tenant pays rent, real estate taxes, expenses,and maintenance.

Trustee The trustee represents all investors in a CMBS transaction and acts as thetrust that holds the title to the collateral. The trustee is responsible for enforcingthe pooling and servicing agreement, supervising the master and special services,and distributing the monthly proceeds to the bond holders.


UCF ((Underwritten CCash FFlow) The cash flow number used by the lender to estab-lish a desired debt service coverage ratio. Typically includes a standardized deduc-tion from net operating income to account for expenses need to maintain the prop-erty. Net Operating Income less reserves.

Unanchored SStrip No major destination type tenant. Usually smaller local tenants.Location needs natural traffic to be successful. Properties perform best if they arelocated in a highly developed area with little vacant land.

WAC ((Weighted AAverage CCoupon) The higher the WAC, the greater the prepaymentrisk; the lower the WAC, the greater the extension risk.

WAL ((Weighted AAverage LLife) The average number of years until all mortgage prin-cipal is expected to be paid off, weighted by the dollar balance of the mortgages. Amore widely used measure than duration for CMBS.

Yield MMaintenance A prepayment penalty that requires a borrower to make a penal-ty payment to the lender if the lending rate at the time of prepayment is lower thanthe mortgage rate on the loan. Yield maintenance formulas vary, but generally, theydiscount the difference between the remaining contractual mortgage payments anda hypothetical mortgage payment at current market rates. Most yield maintenanceformulas use the Treasury rate as the discount rate to determine the present valueof the difference in the two payments. Using the Treasury rate is advantageous tothe lender, since the lender made the loan at the Treasury rate plus a spread, butrecovers the remaining cash flows at the Treasury rate. Yield maintenance is gener-ally assumed to equal lock-out in modeling CMBS transactions.

Z-SScore A calculation developed by Professor Edward Altman of NYU to assessfinancial risk of a company; based on data contained in the company’s financialstatements.Z-Score = 1.2* (Working Capital / Total Assets) +

1.4* (Retained Earnings / Total Assets) +3.3* (EBIT / Total Assets) +0.6* (Market Value of Equity / Liabilities) +1.0* (Sales / Total Assets)


Glossary

306



Disclosures


Disclosures

308

ANALYST RRATINGS DDEFINITIONSOverweight (O) Over the next 6 months, the fixed income instrument’s total return isexpected to exceed the average total return of the relevant benchmark, as described inthis report, on a risk adjusted basis.

Equal-weight (E) Over the next 6 months, the fixed income instrument’s total returnis expected to be in line with the average total return of the relevant benchmark, asdescribed in this report, on a risk adjusted basis.

Underweight (U) Over the next 6 months, the fixed income instrument’s total returnis expected to be below the average total return of the relevant benchmark, asdescribed in this report, on a risk adjusted basis.

More volatile (V) The analyst anticipates that this fixed income instrument is likely toexperience significant price or spread volatility in the short term.

Important DDisclosures oon SSubject CCompaniesThe information and opinions in this report were prepared by Morgan Stanley &Co. Incorporated and its affiliates (collectively, "Morgan Stanley") and theresearch analyst(s) named on page one of this report.

Morgan Stanley policy prohibits research analysts from investing insecurities/instruments in their MSCI sub industry. Analysts may neverthelessown such securities/instruments to the extent acquired under a prior policy or ina merger, fund distribution or other involuntary acquisition.

Morgan Stanley is involved in many businesses that may relate to companies orinstruments mentioned in this report. These businesses include market making,providing liquidity and specialized trading, risk arbitrage and other proprietarytrading, fund management, investment services and investment banking. MorganStanley trades as principal in the securities/instruments (or related derivatives)that are the subject of this report. Morgan Stanley may have a position in thedebt of the Company or instruments discussed in this report.

Other IImportant DDisclosuresThe securities/instruments discussed in this report may not be suitable for allinvestors. This report has been prepared and issued by Morgan Stanley primarilyfor distribution to market professionals and institutional investor clients.Recipients who are not market professionals or institutional investor clients ofMorgan Stanley should seek independent financial advice prior to making anyinvestment decision based on this report or for any necessary explanation of its

# of Ratings in % Total Fixed Income

Rating Coverage Universe Instrument Coverage

Overweight 193 22%

Equal-weight 466 54%

Underweight 210 24%

Total 869 100%

CREDIT PRODUCTS RATING DISTRIBUTION TABLE(AS OF DECEMBER 1, 2004)

Coverage includes all companies that we currently rate.


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Disclosures

310


CMBS Information

World Wide Web SourcesTRUSTEES

LaSalle www.etrustee.netStateStreet www.statestreet.comWells Fargo www.wellsfargo.com/com/comintro.jhtmlChase www.jpmorgan.com/absmbs

SERVICERS

Amresco www.amresco.comMidland www.midlandls.comGMAC www.gmaccm.com

RATING AGENCIES

Fitch www.fitchratings.comMoody’s www.moodys.comS&P www.standardandpoors.com

AGENCIES

Fannie Mae www.fanniemae.comGinnie Mae www.ginniemae.gov

ContactsU.S. CMBS TRADING/CAPITAL MARKETS

Jon Strain, [email protected] 212.761.2270Kara McShane, [email protected] 212.761.2164Scott Stelzer, [email protected] 212.761.2055Jahan Moslehi, [email protected] 212.761.2177Manwin Sidhu, [email protected] 212.761.2090Ahsim Khan, [email protected] 212.761.2106Jon Miller, [email protected] 212.761.1317

EUROPEAN CMBS RESEARCH

Howard Esaki, [email protected] 44.20.7677.7592Asim Qureshi, [email protected] 44.20.7677.8670

U.S. CMBS RESEARCH

Marielle Jan de Beur, [email protected] 212.761.1454Masumi Goldman, [email protected] 212.761.1080

U.S. PRODUCT SPECIALISTS

Bob Karner, [email protected] 212.761.1605Matt Salem, [email protected] 212.761.2040

This book is an overview of the CommercialMortgage-Backed Securities (CMBS) market.

The contents of this publication are over eightyears in the making and include excerpts ofresearch reports from as early as 1997. In thisfifth edition of our primer, we have reorganizedthe chapters to highlight the different investmentoptions within CMBS. New material since ourlast edition includes sections on the various typesof AAA CMBS classes, total rate of return swaps,floating rate large loan transactions, and anupdated version of the commercial mortgagedefault study.

We hope you find this book useful and welcomecomments so that we can improve future editions.

THE AMERICAS1585 BroadwayNew York, NY 10036-89293Tel: (1) 212-761-4000

EUROPE25 Cabot Square, Canary WharfLondon E14 4QA, EnglandTel: (44 20) 7425-8000

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AISA PACIFICThree Exchange SquareHong KongTel: (852) 2848-5200

© 2005 Morgan Stanley

cmbs primer 5th edition

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