CMBX Indices: Understanding Commercial Mortgage-Backed Securities

What Are CMBX Indices?

CMBX Indices are a group of financial indexes that track the commercial mortgage-backed securities (CMBS) market. These indexes represent 25 tranches of CMBS, each with a different a credit rating. Because mortgage-backed securities are illiquid and non-standardized in the over-the-counter (OTC) market, they often lack the transparency and regulation of listed securities. These indexes help provide liquidity and transparency.

These indexes enable investors to gauge the market and take long or short positions via credit default swaps, which put specific interest rate spreads on each risk class. The pricing is based on the spreads themselves rather than on a pricing mechanism.

Key Takeaways

• The CMBX are indices that track the prices of a basket of tranches in commercial mortgage-backed securities.
• Commercial mortgage-backed securities (CMBS) are fixed-income investment products that are backed by mortgages on commercial properties rather than residential real estate.
• Because CMBS trade over-the-counter. they tend to be opaque, illiquid, and unregulated. The CMBX provides a way to track CMBS prices and provide transparency and accountability.
• CMBX also gives investors and speculators a way to trade the CMBS market.

Understanding CMBX Indexes

Commercial mortgage-backed securities are a pool of loans typically contained within a trust, and they can be highly diversified in their terms, property types, and amounts. The underlying loans that are securitized into CMBS include loans for properties such as apartment buildings and complexes, factories, hotels, office buildings, office parks, and shopping malls, often within the same trust.

There are five separate CMBX indexes for ratings ranging from "AAA" to "BBB-" based on a basket of 25 CDSs, which reference CMBS securities.

The CMBX indexes are reconstituted every six months to bring in new securities and thereby continuously reflect the current health of the CMBS market. Daily trading involves cash settlements between the two parties to any transaction.

This "pay as you go" settlement process considers three events in the underlying securities as "credit events": principal writedowns, principal shortfalls (failures to pay on an underlying mortgage), and interest shortfalls (when current cash flows pay less than the CMBX coupon).

Special Considerations

The introduction of indexes like the CMBX has led to massive growth in the structured finance market, which includes credit default swaps, commercial mortgage-backed securities, collateralized debt obligations, and other collateralized securities.

Trading in the CMBX tranches is done over the counter, and liquidity is provided by a syndicate of large investment banks. While the average investor cannot participate in the CMBX indexes directly, they can view current spreads for a given risk class to assess how the market is digesting current market conditions, making it a potentially valuable research tool.

The CMBX indexes are issued by the CDS Index Company and administered by Markit. For these indexes to work, they must have sufficient liquidity. Therefore, the issuer has commitments from the largest dealers (large investment banks) to provide liquidity in the market.