Hi guys,

I have been working on sizing loans. While I work on comps, cash flows, pre lim underwriting, I dont get to work on structuring/pricing a loan. So, I am trying to learn how CMBS loans get priced.

We have a break even spread in our model. Right now, its 180-185 bps for a lot of my loans sized. I get that it is market driven, but can anybody ELI5 the math behind how that is derived? or even what the break even spread is actually is? I am assuming this varies across product types?

Secondly, based on the break even spread of say 180-185, I think my structuring team comes up with the all in spread of 210-220 bps. I also see references to a "15 bps per point". I dont know what this is, but I think this helps the team come up with the 210-220 bps.

If somebody can walk me through the math behind this, I would really appreciate it, thank you!

Our break even spread is based on the latest spread (agency cmbs/cmbs)
For example if we priced a floater deal today at +29, then we will use that to establish the break even spread for floating rate loans

Break even spread is the number you need to not lose money on the issuance, then we have many pricing grids based on product type and DCR/LTV to add on top of the break even

Thank you!, so say break even for a loan is 185 bps, thats how much we are expecting the loan will be sold for? and that is based on what a similar loan is being sold for today?

So, a very basic and newbie q- say a loan is getting sold for 185 bps, what does that really mean? Like the originator gets paid 1.85% of the loan amount for the loan?

No, that 185 is referring to +185 above treasury, so if treasury is 3%, then +185 means the borrower have to pay 4.85% note rate

Can you dumb it down and explain what the +29 means? Thats the yield the investor is getting for investing in that particular bond class (is it AAA?). So, how you use that +29 info in order to get info on pricing your loan? Thank you!

Deal level spread is set by the market

When you go price a deal, you would "announce" the deal to everyone by blasting it in Bloomberg, and you would give an initial pricing, say +40. Then investors would come back to you and subscribe to the deal. If the deal is heavily oversubscribed, you can tighten the spread to maybe +38, and vice versus you widen the spread if the deal is undersubscribed

Initial pricing is based on recently settled deal pricing and market mood, there isn't any math to it

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Isn't the "all-in" rate accounting for project-specific risk factors? Like a risk premium on top of the break even amount?

Wouldn't "what you can sell it for" be the fee that is added onto the amount of debt that ends up being originated? Like a commission or fixed amount that isn't included in pricing the premium bps on the debt? Like what debt brokers charge to go out and find funds.

Broker make money 3 ways from us
1. Primary services fee, I think it's 13 bps
2. Buy up for the loan, which is not much
3. Incentive for bringing us loans that we can securitize, we pay this to brokers quarterly after loans are sold in agency cmbs market

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To add to what some others have said, in CMBS business, Break-Even spread helps calculate the loan coupon at which the bank will neither make nor lose money after securitizing the loan. Most CMBS loans are 10 year loans these days. So the spread is a spread over 10 year swap rates. If 10 year swap rate is 3.00%, a break-even spread of 185 means that if teh bank makes a loan at 4.85% (3.00% + 1.85%), it will not make or lose money. If it makes the loan at a higher spread, it will make money. For 10 year loans, generally 14 basis points results in profit of 1 point or 1% on the loan amount. So, if the bank prices a 10 year loan at a spread of 213, it will make a profit of 2% (i.e. (213-185)/14). 7 year and 5 year loans are less common. For 7 year loans, 20 bps is 1%, and for 5 year loans 25 bps is one point.

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What's the math behind that? On a 10 year, 14 bps = 1 point?

10 year amortizing loans in a securitization have a duration of approximately 7.1. So 100 bps is 7.1%, which means for 1%, you need 100/7.1 or approx 14 bps.

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this is correct. dif. shops have slightly dif. numbers, but thats besides the point...

To price a loan/debt with pass-through structure, the method proposed by David Lee has been widely used. You need to estimate a Hazard Rate Function and use it to derive the survival function, then simulate default and prepayment time.

The risk of default and prepayment will be well incorporated into the spread data in an efficient market, that's for sure. But it's been less welcomed to price MBS cash flow and a "macro" or aggregate level since the 2008 crisis. Both industry and academics have been making progress to model the cash flow at loan level, which requires tons of advanced math stuff.

CMBS is not that complicated, we have prepayment penalty on fixed rate deal so generally you don't have to worry about prepayment on fixed rate deal

I can't agree with you on this. The math is actually beyond 99.99% people's capability. There are very smart PhDs behind the models and data. I talked to Intex and they are well aware the models in the Intex system is only at very basic level and barely used by quants in big banks. Even the models in Intex can make most people rubbing head for days to understand. If you think MBS is easy, you're way behind time bro. As a CDO manager, I can say with confidence, you'll need a master's in physics to understand the newest models.

I am really shocked no one has said this.

To simplest way to learn the break even structure of any CMBS loan is looking at the SASB capital structure. This is usually provided in the CMA or Bloomberg terminal.

The Break Even math is nothing more than a weighted average of the bonds the loan gets tranche out into. Most conduit CMBS loans get tranche out between AAA all the way down to non-rated. Find the spreads on each bond class and do a weighted average of the entire capital stack, and then you're done pretty close to the break even for a loan. Anything above that break even gets securitized in the X classes of the trust. This is the profit for that trust.

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I am surprised nobody mentioned rating agency constraints i.e. Fitch Stresses Losses (for conduits) or S&P/Moodys/Fitch Tranching (for SASB and securitized floaters).

While a lot of the information above is accurate, at the end of the day it is the rating agency treatment of the loan that determines how profitable it will be. For SASB deals it is mostly S&P as the major rating agency (for non-trophy assets) and Fitch for conduits (it used to be Moodys until a few years ago).

A loan could look really good on paper (e.g. super low cap rate/DY NYC property) but due to the often silly rating agency criteria, it could really not be that profitable due to punitive rating agency treatment.

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