How to Break into Commercial Mortgage-Backed Securities (CMBS) at a Bulge-Bracket Bank
Is it possible to win an offer at a bulge-bracket bank if you start out in retail sales?
Yes – but more so if you aim for groups outside of investment banking, such as commercial mortgage-backed securities (CMBS).
It’s one group where deal experience and real-world results matter more than GPA, prestige, or pedigree.
When I first heard the story of a reader who moved from retail into CMBS, it seemed unbelievable.
So, naturally, I had to sit down with him to get the full version:
From Retail to Bond Sales: Getting In
Q: Your story is incredible. Can you tell it to us?
A: I graduated from a semi-target school on the West Coast of the U.S. and had no idea what I wanted to do.
Like every liberal-arts major, I thought about going to law school, but I wanted to take some time off after graduation and consider my options.
So, I took a temporary job doing retail sales while I was studying for the LSAT.
One of my clients was the head of acquisitions/finance for a “hospitality private equity fund.”
“Hospitality private equity” just meant that he and a few other billionaire friends joined together to acquire, renovate, and flip hotels.
I mentioned that I was thinking about law school, and he got me a job with the in-house attorney at his firm.
I quickly realized that I hated law, so I went back to this client, said his job seemed more interesting, and proposed working for him.
He said, “OK, but you have to do all the work and teach yourself everything. Run the numbers, put together the memos, and so on. I’ll talk to people, and you’ll do the work.”
I worked at his firm for about two years but eventually got bored of hotel turnarounds, and I thought about pursuing an MBA.
The day I had made up my mind to get an MBA, a bulge-bracket MD in the CMBS group came in to pitch a debt offering.
I called him after the meeting, said I wanted to work on real estate deals, and asked him if I should do an MBA.
He asked what I wanted to do, and I answered, “See more and bigger deals.”
He said it would be easier to do that at a bank and offered me an interview for an entry-level Analyst role.
Another Analyst had just left the team, and they needed someone ASAP.
The interview was very informal and mostly about fit; they just wanted to verify that I understood the real estate pro-forma and how to evaluate deals.
Your real estate financial modeling course helped with both of those.
I won the role, advanced to the Associate level, and have been here for a few years now.
Q: That might be my favorite “breaking in from a random background” story ever.
What types of candidates are CMBS groups at large banks usually seeking?
A: We do a lot of recruiting at schools that are known for real estate – the UCs, USC, Wisconsin, and Wharton, for example.
On the West Coast, Stanford, Berkeley, UCLA, and USC are the biggest sources for candidates, but in New York, it is more diversified.
In the field offices, we receive stacks of resumes each year, and we look at pretty much anyone with “real estate” on their resume.
In the first round of interviews, we determine whether the person is normal, not crazy, and capable of working long hours.
The second round gets more technical, and we ask about Cap Rates, debt yield, what real estate operating statements look like, and the trade-offs of multifamily vs. hotel investments (for example).
Most candidates, even ones from the “top” real estate programs, know almost nothing.
It is very rare for someone out of school to truly understand the complexities of a lease, let alone the possible risks of a poorly staggered rent roll.
As a result, we often hire experienced candidates, and typically we look for people who have had training, experience, or time at a commercial real estate brokerage firm, life insurance company (the CRE lending arms), or a Balance Sheet lender (i.e., a lender that does not securitize the loans).
Knowledge of real estate market analysis helps a lot, which is also why we prefer these candidates with RE backgrounds.
Q: So, networking your way in sounds plausible.
A: Yes! Do not overestimate the competition. Particularly in smaller and regional offices, the candidate pool is not that great.
If you’re aggressive, you’ve taken the time to learn real estate, and you put in the effort, you can win offers even at the biggest banks.
On the Job in CMBS
Q: OK, thanks for explaining that.
What do you do in commercial mortgage-backed securities?
Pretend that I know nothing about this topic.
A: Broadly speaking, we pool real estate loans together, put them into a holding vehicle (trust), and sell the bonds of that vehicle into the capital markets.
We might work with loans ranging from $10 million up to $1-2 billion in size, and we use three methods to securitize from a loan (“exits”):
- We might pool the loan with many other loans in a trust and sell the bonds of that trust; this is typically called “conduit.” The typical loan size here can range from $10 to $90 million.
- We might put an entire loan into a trust and sell the bonds of that trust; this is generally called “stand alone.” Loans in this category need to be at least $250 million – anything below that doesn’t make economic sense – and also tend to be low leverage (low loan-to-value). Typically, only the largest banks take part in this type of financing.
- Finally, if the loan is sizeable – above $90 million – it might be split into two or more pieces (“notes”). The exit options here are to sprinkle the notes into multiple conduit trusts, or if the loan is large enough, to put the bulk of the notes into a “stand alone” and place the other notes into conduit trusts. Again, only the larger banks typically do this.
Banks and other lenders like CMBS because they provide liquidity for the loans and, until recently, they provided a quick and cheap way to generate returns.
Traditional lending requires a lender to retain the loan for the entire term, which limits the capital they can lend and forces them to charge higher interest rates to compensate for that risk.
But larger CMBS lenders typically do not hold loans on their Balance Sheets for more than 60-90 days, so there’s a huge difference.
Investors like CMBS because they can diversify their loans across different asset classes and invest in real estate in the most secure position (CMBS loans are senior loans and, as a result, take a loss last). There is also liquidity in the bonds.
The industry itself is split into origination/underwriting and the pooling and selling of CMBS (often called “Securitization” or “Capital Markets”).
“Originators” drum up business from real estate investors who need loans to acquire properties. They typically get historical operating statements, market information, rent rolls, and other property information from mortgage brokers or borrowers (real estate investors).
After reviewing the materials, the originator will issue a term sheet at the loan amount, interest rate, and high-level loan structure acceptable to the lender based on that information.
After winning the loan – a process that may involve heavy negotiations, and which requires the borrower to pick the bank and sign the term sheet – the originators send the deal to the underwriters to review the property’s information.
We review the leases and operating statements and perform other due diligence on the property’s value and risk factors. This process includes reviewing an appraisal, engineering report, environmental report, tenant information, market data, and site inspection.
If the numbers (historical and stressed) check out and meet the requirements of the term sheet, and a credit committee approves the loan, we’ll fund the loan. This entire process is called “Underwriting” and is what most junior team members perform.
Then, depending on the loan’s size, the Capital Markets team will bundle it up with other loans or split it into smaller loan notes.
They will prepare the marketing materials with the underwriter’s help, liaise with the rating agencies and “B-Buyers,” and market the trusts. Ultimately, bonds salespeople will sell it to pension funds, life insurance companies, or hedge funds.
A mortgage broker typically sits between the originator and the borrower; some of the big ones in the U.S. are Eastdil Secured, Jones Lang LaSalle (JLL), HFF, CBRE, and Cushman & Wakefield.
Of those, Eastdil Secured is the closest to a real bank, and it has a great reputation as a “real estate investment bank” as well.
Q: OK. Can you explain the mechanics of pooling loans together?
And who are the normal buyers of these pooled loans?
A: We put the loans in a trust, and then we sell bonds on behalf of that trust.
The bonds are backed by the interest on the underlying loans, and we make money because the interest paid by the bonds is less than the interest paid on the loans. We create a bond that is backed purely by the excess interest of the loans, and this is where banks make their money.
The bonds are graded from AAA down to “junk bond” territory; ~80% of CMBS are rated AAA.
Pension funds and insurance firms are the typical buyers for AAA issuances.
Hedge funds, private equity funds, and specialized credit funds tend to buy the junk bonds.
This non-investment-grade portion is typically called the “B-Piece,” and so these buyers are called the “B-Buyers.”
These lower tranches of bonds are the first-loss bonds; as a result, the buyers get the ability to review all the loans in a trust and can often shape the trust as well.
The investors who know the most about real estate often buy the B-Piece since they can better evaluate the risk. Industry knowledge isn’t as important with AAA bonds.
Typically, the banks do not keep any of the bonds after the trust is securitized, but following regulatory changes that began in December 2016, lenders must pay to keep some of the bonds (“skin in the game”) or pay someone to retain the bonds for at least five years.
The largest banks (Citi, MS, DB, WF, BAML) have been doing this, but smaller banks and firms will have to do so at some point as well.
Q: I see. How do you decide which loans to pool together?
Is it based on the industry, the credit rating, or something else?
A: In theory, our job is to build a pool of loans where no single asset class dominates.
So, for example, we might build a pool where 30-40% of the loans are for retail properties, 30-40% are for offices, and the rest are for multifamily, hospitality, and self-storage.
We can’t do more multifamily than that because Fannie Mae and Freddie Mac dominate that market in the U.S.
Unofficially, we package together whatever loans we have.
For example, if 50% of our pending loans are for offices, we’re not going to stop the securitization process and say, “Sorry! Too many offices. We need to wait for more diverse property types first.”
Of course, the mix still has to fall within the realm of reason; no capital markets team in their right mind would cobble together a trust with 80% offices or hotels.
Speed is essential, especially when interest rates are rising.
After we put together the loans, we take the package to the credit rating agencies (Moody’s, Fitch, and S&P). Of the entire trust’s bonds, approximately 80% are rated “AAA.”
Not to get too nuanced, but even within the “AAA” category, there are further credit enhancements that will result in a “super senior” rating, essentially making a bond the last one to take a loss.
Roughly the next 5% get rated “AA,” and beyond that, many issuances are in “medium grade” (A and BBB-) and “junk” territory (BB, B-, and non-rated).
The rating agencies look at the merits of each loan (operating history, market conditions, lease expirations, tenant quality, leverage and coverage ratios, etc.); they effectively “re-underwrite” the loan and stress-test the cash flows their own way.
Then, they also look at the entire trust to see if there’s too much concentration in any asset class or geography.
In theory, they should assign lower ratings to pools with too much concentration or very aggressive loans, but in practice, the subordination levels rarely differ substantially between different trusts and loan originators for the most senior bonds.
For example, you’ll never see a conduit loan trust get only 50% of its bonds rated “AAA.”
Q: That’s kind of scary to hear… but let’s move on.
You mentioned that the bulge-bracket banks are heavily involved in this market, but who else participates?
A: There’s a much broader set of banks/funds on the origination side – there are around 40 lenders of all sizes there, but that number may decline in future years due to Dodd-Frank.
Participants include everyone from the largest banks, like DB, Goldman, and UBS, to middle-market banks, such as Cantor and Jefferies, to funds such as Rialto and Starwood.
On the pooling & sales side, Deutsche Bank, JP Morgan, and Wells Fargo issue the most bonds, followed by the rest of the bulge brackets: Morgan Stanley, Goldman Sachs, Credit Suisse, BAML, and Citi.
Note that not every bank does pooling and sales, and many smaller lenders will securitize their loans with the larger banks.
A few middle-market and In-Between-a-Banks also operate in this market (e.g., Cantor, Jefferies, Société Générale, and Scotiabank).
The Culture, the Compensation, and the Exits
Q: Thanks for explaining all that. What are the hours and work culture like?
A: Overall, the hours are closer to the ones in sales & trading: 60-70 hours per week for Analysts and Associates.
If you’re working on a complex or time-pressured deal, you might pull a 100-hour week, but that’s not too common.
I’ve slept in the office and pulled all-nighters before, but it’s very rare. Usually, I’m busy all day on weekdays and free on weekends.
The hours are sometimes more unpredictable in regional offices because they have fewer resources than NYC offices, and you spend more time tracking people down in the home office or reviewing legal documents.
It’s less stressful than investment banking, but you’re still under pressure because bond investors, traders, credit rating agencies, and other parties scrutinize every document.
Q: I hope you’re well-compensated for all this…
A: An Analyst just out of undergraduate would earn $65K – $85K USD for a base salary, with bonuses ranging from 45% of that up to 100-150% of it depending on the year.
If the year is a bloodbath for fixed income, bonuses will be closer to the “45%” level.
At the Associate level, the base salary is $100K – $130K USD, and bonuses are 50-100% of that. So, you’ll earn between $150K and $250K USD all-in if you perform at a large bank.
(NOTE: Compensation figures as of 2016-2017.)
Q: The hours sound decent, and the compensation is fairly generous.
Do most people in your group stay in this role for the long term?
A: Most people want to go to the equity side and join REITs or real estate private equity funds.
Whether or not that happens is a different story; if you stay here too long, you get pigeonholed into CMBS lending.
Some people also become mortgage brokers, but “mortgage broker” has become a much more loosely defined term. Almost anyone can set up a one-man shop and become a “mortgage broker,” so it’s not as popular anymore
It’s more common for originators to go that route because they already have large client bases to draw business from.
I enjoy doing deals, so I plan to stay here for the long term. I might crash and burn one day, but I’m happy with my current path.
Q: Great. Is there anything else you want to add?
A: CMBS groups are great “back doors” into finance at large banks since they care less about grades and prestige and far more about your deal experience and knowledge of real estate.
With that said, if your real interest is RE PE, generalist private equity, or investment banking, you should move over as soon as possible (i.e., when you’re still an Analyst or Associate).
There’s a perception that CMBS people are not as strong in real estate analysis because we straddle bonds and real estate – and it’s tough to overcome that perception once you’ve been in the group too long.
Q: Thanks for adding that, and for your time.
A: My pleasure.
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