A Guide to the Law of Securitisation in Australia - Clayton Utz

13 Commercial mortgage–backedsecurities13.1 Overview of CMBSA commercial mortgage–backed securities transaction typicallyinvolves an issue of debt securities, cash flows in respect ofwhich are underpinned by the rental income of pooled assetsconsisting of a cross-collateralised or cross-defaulted portfolio ofreal estate. The pooled assets are secured for the benefit ofholders of the debt securities.Payments are limited to the proceeds from the underlying assets.The secured assets are isolated from other operations of theentity through the creation of a special purpose entity (SPE) orthe use of managed investment schemes.The security pool may comprise the same property type ordifferent types of real estate such as commercial, industrial and/or retail properties.The rating agencies play a critical role in the CMBS market. Therating agencies examine the characteristics of the underlyingloan pool such as the debt service coverage ratio (DSCR); theloan-to-value ratio (LVR); the quality and diversity of the pool ofproperties supporting a particular CMBS; the level ofcollateralisation provided; credit quality of the tenant(s); thegeographical concentration; and the weighed average leasematurity of the collateralised pool.CMBS may provide a lower cost of funding the underlyingproperties, as compared to more traditional bank debt, dependingon the market for CMBS at the time.13.2 Structural featuresStructural features of a typical CMBS include:13.2.1 Further indebtednessThe SPE may be allowed to raise additional debt by issuingfurther debt securities secured by the collateralised pool ofproperties provided that the further issue of debt securities willnot have an adverse effect on the existing debt securities. Theratings agencies will consider the strengths and weakness of anynewly-acquired properties which are proposed to be added to thesecurity pool as well as the nature of the proposed furtherindebtedness.13.2.2 Amortisation and refinancingUnlike residential mortgages that are fully amortised over a longtime period, issued CMBS are usually interest only with noamortisation of principal until a scheduled maturity date. Ifrefinance is not available at the scheduled maturity date, withthe consequence that the CMBS are not redeemed, thetransaction moves into a refinancing period during which theunderlying properties may be sold under the security trustee’sdirection.Typically, if the CMBS are not fully repaid on the scheduledmaturity date then a default is taken not to have occurred.However, the SPE may be required to initiate the sale of theunderlying properties and utilise the proceeds from the sale toredeem the notes. The refinancing period is the term betweenthe scheduled maturity date and the final maturity date, at whichpoint the principal of the CMBS must be repaid in full.During the refinancing period, the coupon on the CMBS willtypically increase by a pre-agreed “step-up margin”.CMBS documentation often allows the security trustee to waivecompliance with the sale process if the security trustee issatisfied that:• the issuer has a proposal in place which will enable animminent refinancing of the CMBS; and• if that proposed financing were to fall over, there would besufficient time remaining prior to the final maturity date toundertake an asset sale sufficient to realise enough funds tofully repay holders of the CMBS.13.2.3 Cross-collateralisationDiversification of the underlying collateral is one way of reducingdefault risk. Another way to reduce default risk is to use crosscollateralisation.In cross-collateralisation or cross-defaultedpools of properties, the cash flow from each property jointlysupports the entire pool, a default on one property triggers adefault on the entire pool and the total liquidation proceeds fromeach and all of the properties are available to repay the debt.This will usually not be available in a multi-borrower CMBSwhere the underlying properties are ultimately owned by nonrelatedparties or different management investment schemes.13.2.4 Right to deal in propertiesA transaction can be structured to allow the SPE to both acquirefurther properties as well as dispose of existing properties, eitherwithin agreed criteria prior to the scheduled maturity date orsubject to confirmation from the rating agency that there will beno adverse impact to the rating of the Notes.Further acquisitions may be funded through the issuance offurther rated securities, subject to rating agency confirmation.71