CMBS structure and governance : an empirical analysis of security design and the role of the special servicer

Abstract

The CMBS market has experienced tremendous recent growth. Issuances in 1998 are anticipated to double 1997 levels of approximately $44 billion. At this point in the development of the market, most participants have a good understanding of the basic investment characteristics of commercial mortgage-backed securities. However, as the CMBS market continues to evolve and as innovations occur in security design and structuring and in security governance, participants should be cognizant of the impact of these elements on subordination levels, as set by the rating agencies, and on security pricing, as set by investors. This thesis empirically examines the determinants of CMBS security pricing and subordination levels, focusing on the influences of security design and governance as it pertains to special servicing. For security design, we examine whether rating agencies and investors recognize complexity. With respect to special servicing, we examine the contrasting theories of the conflict of interest between the AAA-rated classes and the Special Servicer, and of the efficiency of the Special Servicer governance mechanism. Regression analysis is performed on 125 AAA-rated securities derived from 70 CMBS issuances between 1994 and 1996. The results of our analyses show that complexity is costly, as rating agencies increase subordination levels and investors increase security yield spreads in response to complexity issues in security design and structuring. In addition, regarding the role of the Special Servicer, our findings suggest that rating agencies and investors recognize the conflict of interest theory over the efficiency theory. Furthermore, rating agencies and investors appear to adjust subordination levels and prices in response to the presence of certain Special Services.