One remittance month on an illustrative $1,000M conduit, followed dollar by dollar from the loans to the bonds.
A CMBS waterfall runs three streams in three directions. Interest is paid down the stack, each class in order of seniority, after servicing and trustee fees, with the excess of the net mortgage rate over the senior coupons going to the interest-only class. Principal goes entirely to the most senior class outstanding. Losses are written off from the bottom. In one illustrative month on a $1,000M conduit, all $39.5M of principal retires Class A while a $12.0M loss cuts Class G from $30.0M to $18.0M, and Class D's credit enhancement falls from 7.50 to 6.64 per cent even though the senior bond was paid down.
Worked in full in CMBS and CRE CLOs by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
An illustrative fixed-rate conduit with a $1,000M pool, the same eight principal classes as the deal in how credit enhancement is calculated in CMBS, plus one interest-only class, X-A, whose notional follows Classes A and A-S. During the month one loan pays off at maturity, the pool amortises, and the special servicer completes the sale of one defaulted loan. Servicing and trustee fees are simplified into a single 0.10 per cent strip, and advances are assumed recovered in full.
| Item | Value |
|---|---|
| Pool balance | $1,000.0M |
| Weighted average mortgage rate | 5.40% |
| Servicing, trustee and advisor fees | 0.10% |
| Net weighted average coupon (net WAC) | 5.30% |
| Scheduled amortisation | $1.5M |
| Balloon repaid at maturity | $20.0M |
| Liquidated loan: balance / net recovery | $30.0M / $18.0M |
The loans pay a month's interest on the pool at the mortgage rate. Fees come off the top, before any bondholder is paid. What is left is available interest, and it is paid to the classes in order: A, then A-S, then B, and so on down to G. Classes A and A-S carry fixed coupons below the net WAC; B to G are WAC classes, paying the net WAC itself.
Gross interest = 1,000.0M × 5.40% / 12 = $4,500,000
Fees = 1,000.0M × 0.10% / 12 = $83,333
Available interest = 4,500,000 − 83,333 = $4,416,667
Excel, class interest due: =Balance*Coupon/12, then paid in order with =MIN(Due, Available - SUM(paid above))
| Class | Balance $M | Coupon | Interest $ |
|---|---|---|---|
| A | 700.0 | 4.80% | 2,800,000 |
| A-S | 87.5 | 5.10% | 371,875 |
| B | 45.0 | 5.30% | 198,750 |
| C | 40.0 | 5.30% | 176,667 |
| D | 52.5 | 5.30% | 231,875 |
| E | 25.0 | 5.30% | 110,417 |
| F | 20.0 | 5.30% | 88,333 |
| G | 30.0 | 5.30% | 132,500 |
| X-A (interest only) | 787.5 notional | 0.47% | 306,250 |
| Total | 4,416,667 |
The principal classes need $4,110,417. The remaining $306,250 is the X-A strip: the net WAC of 5.30 per cent less the 4.83 per cent weighted coupon of A and A-S, on their $787.5M. The IO class is paid pari passu with Class A, which is why it is rated as a senior bond despite having no principal.
Every dollar of principal collected in the month is pooled, whatever its source, and paid sequentially. Scheduled amortisation, the balloon and the recovery on the liquidated loan add up to $39.5M, and all of it goes to Class A, which falls from $700.0M to $660.5M. No junior class receives a cent of principal until every class above it has been retired.
Principal distributable = 1.5 + 20.0 + 18.0 = $39.5M, all to Class A
The liquidated loan had a $30.0M balance and recovered $18.0M: a $12.0M realised loss, a 40.0 per cent severity. The pool has shrunk by $51.5M (1.5 + 20.0 + 30.0) to $948.5M, but only $39.5M of bonds were repaid. The trustee closes the gap by writing down the certificate balance of the most junior class outstanding. Class G falls from $30.0M to $18.0M, and the bonds again add up to the pool: $948.5M.
| Class | Opening | Principal | Loss | Closing |
|---|---|---|---|---|
| A | 700.0 | 39.5 | 0.0 | 660.5 |
| A-S to F | 270.0 | 0.0 | 0.0 | 270.0 |
| G | 30.0 | 0.0 | 12.0 | 18.0 |
| Total | 1,000.0 | 39.5 | 12.0 | 948.5 |
The effect on protection is what investors watch. Class D's credit enhancement was 75.0 / 1,000.0 = 7.50 per cent. It is now (25.0 + 20.0 + 18.0) / 948.5 = 6.64 per cent. Class A's rose from 30.00 to 30.36 per cent, because the paydown more than offset the loss. Sequential pay protects the top of the stack at the expense of the middle.
When a loan is in special servicing, the servicer's fees, an appraisal reduction that cuts interest advances, or a non-recoverable advance can leave available interest short of what the classes are owed. Shortfalls run in the same direction as losses: from the bottom up.
| Shortfall $ | Classes paid nothing | Class partly short | Share of its interest lost |
|---|---|---|---|
| 50,000 | none | G | 38% |
| 200,000 | G | F | 76% |
| 600,000 | G, F, E, D | C | 21% |
| 900,000 | G, F, E, D, C | B | 81% |
The bottom four classes together earn $563,125 a month, so a shortfall of that size wipes out their interest entirely. That is a small number against a $1,000M pool: a few large loans in special servicing are enough to switch off the coupon on the investment-grade mezzanine.
Many conduits switch the senior classes from sequential to pro rata once the subordinate classes are written down to zero, and some pay principal pro rata from day one. The pooling and servicing agreement, not convention, decides.
The common mistake is modelling principal as if it were shared pro rata, as in a syndicated loan. Pro rata, the juniors B to G would have received $8.39M of this month's principal, Class A only $27.65M, and after the loss Class D's enhancement would be 6.33 per cent, not 6.64. Over ten years of amortisation and maturities the difference compounds: sequential pay is what builds subordination for the senior bonds. The second mistake is treating the recovery as the only principal from a liquidation. The recovery is principal; the shortfall is a loss; and before either is paid, the servicer recovers its advances, which is why realised severity runs above appraisal severity.
The book builds the full waterfall from a twenty-loan tape and a fourteen-class stack, with a ten-year cash reconciliation that closes to the cent, and the free workbook for this case lets you run your own remittances through it.
In a typical conduit, sequentially: every dollar of scheduled amortisation, balloon repayment and liquidation recovery goes to the most senior class outstanding until it is retired. In this example all $39.5M of the month's principal goes to Class A. Many deals switch the senior classes to pro rata once the subordinate classes have been written down to zero, so read the waterfall in the pooling and servicing agreement.
Shortfalls caused by appraisal reductions, special servicing fees or non-recoverable advances are allocated from the bottom of the stack, the same direction as losses. In this illustrative deal a $50,000 shortfall takes 38 per cent of Class G's monthly interest of $132,500, while a $600,000 shortfall wipes out the interest on G, F, E and D and cuts Class C's.
From the interest waterfall, not principal. The X-A class receives the net mortgage rate minus the weighted coupon of the classes it references, on their balance. Here the net rate is 5.30 per cent and A and A-S pay 4.83 per cent on average, so X-A earns a 0.47 per cent strip on $787.5M: $306,250 a month.
This article is one calculation from CMBS and CRE CLOs. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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