due diligence mortgage-backed securities

Due Diligence in Commercial Mortgage-Backed Securities

The due diligence process needed for evaluating commercial mortgage-backed securities is particularly intensive, both in terms of time and resources. Can artificial intelligence document review help? 

Commercial mortgage-backed securities (CMBS) are fixed-income investment products that are backed by mortgages on commercial properties. A fairly sophisticated product, they are heavily regulated to ensure transparency of the product itself and the underlying assets. Due diligence becomes a pivotal moment in the creation and assessment of CMBS and can be carried out in the phase that precedes the creation of the bond, or later when it’s time to evaluate the investment in existing securities. 

The Issues with Manual Due Diligence

The due diligence process consists of a review of the mortgages, debtors, and underlying properties that make up the asset pool backed in the securitisation; it can also include assessing the reliability of the originator of the CMBS.

Due diligence becomes essential to ensure transparency and provide the market with confidence in the investments being offered. 

A Granular Process

Due diligence must be performed at a very granular level and includes reviewing the loan documents of the mortgages, together with the collateral documents related to the property, as well as  all other documents that can help assess the integrity of the originator.

As any due diligence process, it suffers from 3 major setbacks

  • It is time consuming – as each and every agreement needs to be reviewed manually, looking for key clauses, highlighting them, and extracting them in a separate document for easy access.
  • It is resource heavy – several lawyers need to be involved in the process, which in turn, means the expense linked to the due diligence can be substantial.
  • It’s risky – substantial risks can be missed or underestimated. On the one hand, repetitive activities are generally error-prone. In addition to the inevitability of human error, the due diligence process never takes into consideration all of the underlying assets, but usually focuses on a limited sample of the overall pool of contracts. 

No manual due diligence process can be said to be 100% accurate and risk-free when it comes to evaluating sensitive investment vehicles like CMBS. 

 

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How AI-Powered Document Review Comes to the Rescue

Since due diligence for CMBS must be performed at a very granular level, the entity that carries out the analysis focuses on 4 main areas underlying the security: loan agreements, borrowers, originators, properties. 

AI-powered tools like Cognitiv+ are able to automate the process and substantially enhance the review and data retrieval for each and every phase.

Loan due diligence involves looking for key clauses and provisions in loan agreements. AI Document review can identify and extract key clauses like: 

  • Prepayment rights
  • Prohibition of subordinate security (ie. second and third mortgages)
  • Due-on-sale due-on-encumbrance
  • Limited recourse clauses
  • Cross-defaults
  • Assignability by the lender
  • Term of loan

The collateral due diligence (collateral audit), focuses on the property, and the underlying real estate agreement. Cognitiv+ lease abstraction technology has been trained to identify and extract relevant data from property and lease agreements, such as:

  • Property address
  • Property tenure
  • Valuation (amount and date)
  • Signature

Finally, if due diligence on the originator is required, Cognitiv+ document review technology can also analyse additional legal documents like constitutional documents, annual reports, membership rights, circulars, prospectuses, and servicing agreements.

AI-powered document review for the due diligence process for CMBS has become the gold standard for high-quality, efficient extraction of insight from contract data. Cognitiv+ versatility allows for efficient analysis of different types of contracts, including loan agreements, service agreements, shareholder agreements, while the Lease Abstraction technology has been developed for property agreements.

Cognitiv+ artificial intelligence technology resulted in customer-reported time savings of 30–70% during due diligence processes.

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