Will B-Piece Buyers Save CMBS Next Year?

Hyatt Regency Orlando

ORLANDO—It’s been “understood” that the B piece buyers will be able to navigate the complicated, strict and occasionally conflicting risk retention rules under the Dodd-Frank Act. Somehow, people in the industry think, these investors will find a way to keep the commercial mortgage-backed securities market going. But what if they can’t — or just don’t want to? Those were some of the more sobering questions posed by a panel at the Mortgage Bankers Association annual convention in Orlando, Fla., which is ending today. The panelists were Katie Schwarting, managing partner with Bryan Cave, and Paul Vanderslice, managing director of Citigroup Global Markets, and the moderator was Richard Jones, a partner at Dechert LLP. “The risk retention rule will create a new investment environment that the B piece never bought into and may not fit their credit and risk profiles,” Schwarting said. Perhaps more to the point, even if the B piece buyer is wiling to conform to this new landscape it might not be able to afford to. The rule does not permit financing for the B piece buyer. That, coupled with a long hold period depending on the amount of the loan means the B piece could run out of capital very quickly, Vanderslice said. “They will need to raise 10-year money every year to participate in these deals,” he said.

Onerous Rules

Briefly, the risk retention rule was adopted by several federal agencies in 2014 after the commercial real estate industry beat back the most onerous provisions that had been originally proposed in 2011. It goes into effect at the start of 2017. Broadly-speaking, the rule requires asset-backed loan originators to retain at least 5% of the credit risk relating to the assets that underlie the securities. For CMBS specifically there are two structures in which the risk can be retained. One is an “eligible vertical interest,” in which the sponsor retains 5% of the face value of each class of securities issued in the CMBS transaction. The other is an “eligible horizontal interest” — and the B piece buyer option is a form of this — in which the sponsor retains 5% of the most subordinate class of the “fair value” of all of the CMBS issued The rules don’t make it easy for the B piece buyer, though, the panelists said. Using fair value to satisfy the horizontal interest means the B piece must hold a larger portion of the transaction than it ordinarily would. Also the retained risk cannot be hedged against or sold for a period of five years. “No other asset has this length of a hold restriction,” Schwarting said There can be two B piece buyers for a transaction, but only two, and each must hold their interest in pari passu form – that is, they cannot hold it in junior or senior tranches. The B piece has to conduct an independent review of the loans’ risk. The B piece has to pay cash for its interest. No financing is allowed. The sponsor has to take ownership of the transaction anyway, monitoring the B piece for compliance. This could be problematic or at least irksome for the B piece if it and the sponsor has different risk profiles or appetites. In this respect, as well as others, the meaning of the rule is unclear, the panelists said. “The language about the penalties and reach is vague and uncertain,” one noted.  In other places, the “rule is rife with contradictions.” In many places the rules are uncertain, in fact. They suggest the B piece buyer can sell the retained risk after five years to another qualified B piece buyer but it is unclear if the clock starts again for that buyer. Essentially, the rule calls for the B piece buyer to fall on its sword, Schwarting said. Or to use another image, the industry is expecting the B piece to be the hero, she said. How much, if at all, they are willing to do so is still a mystery in the industry. And if they do — what price will they extract in return? alm