Mortgage Banking

Making sense of commercial real estate finance.

Teaching a 6 year old about CMBS loans

Posted by Jordan Crouch on October 25, 2007

I don’t know why anyone would want to teach a six- year old about commercial mortgage backed securities (CMBS), but this is how I would do it. This is INCREDIBLY simplified. For this example, our six year old will be named Lucy.

First, let’s go to the grocery store. Have Lucy grab a basket. We’re headed for the produce section. Let’s grab a banana, an apple, an orange, and a tomato and put each in the basket. Good job Lucy! Quickly pay for the items and head home.

Now the fun begins. As the adult (young kids shouldn’t handle knifes), I’ll cut each of the items into halves. While I’m doing this, Lucy calls her two best friends (Anna and Bill) and has them come over to the house. She reminds them to bring their piggy banks.

While we wait for Anna and Bill to show up, we place one half of each of the fruit in a bag. We mark a big “A” on it. We put the rest of the fruit in another bag and label it “B”. About this time, Anna and Bill arrive. Lucy gives Bag A to Anna. In exchange Anna gives Lucy 200 pennies. Now Anna has a half of the banana, the apple, the orange, and the tomato and Lucy has $2. Next Lucy gives Bag B to Bill and gets 200 pennies in return. Everyone is happy and Lucy’s friends go home.

Lucy is out of fruit but now has $4. She takes $1 and puts it in her piggy bank and gives the other $3 to me. We hop in the car and head to the grocery store to buy some more fruit. And that is how to teach a 6 year old about CMBS loans!

Here’s the translation:

“Lucy” is not a six-year old but actually a conduit lender. There are thousands of “Lucys” in the world (Artesia, BofA, Goldman Sachs, PNC to name a few). Each of the “fruit” represents a loan the conduit lender makes. After the lender has made enough loans, it bundles the loans together (i.e. puts them in the basket). Once the loans are bundled, the lender slices the bundle into several tranches (for our story putting the halved fruit in Bag A and Bag B).

Next the lender will go to the market (call her two best friends) and sell the tranches (in this case for $2 each. In reality, each tranche will be priced differently.) Who buys the tranches? Pension funds, hedge funds, large banks, insurance companies, anyone who can write a very large check. After selling all of the tranches, the conduit lender will keep some of the profit ($1 in the piggy bank) and then go out and make more loans on other property (going back to the grocery store). The conduit lenders have perfected this cycle and repeat it several times year.

I said it was incredibly simplified. If you want a better explanation of what a CMBS is, check out here.

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7 Responses to “Teaching a 6 year old about CMBS loans”

  1. […] Teaching a 6 year old about CMBS loansEach of the fruit represents a loan the conduit lender makes. After the lender has made enough loans, it bundles the loans together (ie puts them in the basket). Once the loans are bundled, the lender slices the bundle into several … […]

  2. […] Jordan Crouch placed an interesting blog post on Teaching a 6 year old about CMBS loans.Here’s a brief overview:Each of the “fruit” represents a loan the conduit lender makes. After the lender has made enough loans, it bundles the loans together (ie puts them in the basket). Once the loans are bundled, the lender slices the bundle into several … […]

  3. […] use the example from the post about Lucy, imagine we sliced Bag A and Bag B in half and put half of each in a third bag called Bag C. Lucy […]

  4. Ron Jones said

    I always like reading your blog! Another good solid article and a great help to many people!

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