7.3.17: Gross Profit Margins Now Transparent for CMBS Issues

Risk-retention rules have made the accurate calculation of gross profit margins for CMBS issues possible. Although the results do not include transaction expenses, the gross profit indications are more accurate than previous methods to “reverse engineer” the pricing results of the public bonds and estimates for the pricing of the non-public bonds.

Risk-retention regulations require new disclosures that make the gross profit margin calculation relatively simple for deals that utilize two of the three options under risk-retention rules – the “horizontal strip” structure and the “L-shaped strip” structure. Under these two structures, the issuer must disclose the amount of bonds retained, and this allows for the calculation of the gross profit margin. For example, if an issuer sells $1 billion of CMBS for $40 million more than the $1-billion face amount, the gross profit margin would be 4% ($40 million divided by $1 billion).

The determination of net profit margin is trickier. Deal expenses need to be subtracted from the gross profit margin. These expenses include fees paid to service providers, including legal fees and fees paid to rating agencies. Some loan contributors are required to pay fees to have bonds distributed to investors. In general, it is estimated that these fees will total roughly 0.5% of the deal amount. In addition, it is even harder to determine the cost of any hedging efforts.

Excluding any hedging impact and assuming transaction costs of 0.5%, estimated net profit margin for deals that utilized the “horizontal strip” structure and the “L-shaped strip” structure ranged from 2.04% to 6.10% for the first half of 2017, well in excess of the target margin of 2.0% expected by issuers.

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This entry was posted in CMBS, CMBS Securities, Commercial Mortgage-Backed Securities, Michael D. Sneden, News & Recent Closings, The Banker's Mortgage Conduit, Valuexpress and tagged , . Bookmark the permalink.

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