If you want to get something done right, do it yourself.
Impending rules allow sponsors of commercial mortgage bonds to satisfy a requirement to keep "skin in the game" of their deals by selling the risk of first loss to a designated third party. It's an unusual concession by regulators that recognizes the important role played by so-called B-piece buyers. These investors can use their clout as holders of most subordinate classes of CMBS to reject loans they view as too risky to be used as collateral.
Yet the first CMBS intended to comply with U.S. risk retention relies on a different strategy: the three banks contributing the most collateral for the bonds, Wells Fargo, Bank of America and Morgan Stanley, will collectively retain 5% of the face value of securities to be issued, or approximately $43.5 million, according to Fitch Ratings and Kroll Bond Rating Agency.
The $870.6 million transaction, dubbed Wells Fargo Commercial Mortgage Trust 2016-BNK1, is backed by 39 commercial mortgage loans secured by 46 properties.
It may prove more cost-effective for the three sponsors to retain 5% of each class of securities issued by the trust (known as the vertical option) than to sell the most subordinate tranches to one of two B-piece buyers (known as the horizontal option).
For one thing, the 5% threshold is much higher than what B-piece buyers typically purchase from a deal, which is around 2.5%, according to a report published by Manus Clancy, senior managing director at Trepp, back in January. And this new threshold is based on deal proceeds instead of notional balances, essentially market value instead of par value.
That means B-piece buyers would be required to buy as high up in the credit stack as single A, rather than just bonds below BBB-. And it would be hard for these investors to achieve their targeted returns holding such highly rated, low yielding securities.
The upshot: B-piece buyers would either need to find a way to raise investment funds more cheaply, or they would demand higher compensation on the mortgage bonds, which would raise funding costs for buyers of commercial property and make it harder for CMBS conduits to compete with other lenders, such as commercial banks and insurance companies.
In an email last week, Clancy said it's still too early to know which option for meeting the risk retention requirement will take root.
"Originally we thought the horizontal would be the winner, because it mimics what has been the norm since CMBS began," he said. "But there has been a lot of talk of issuers trying the vertical…so we will see."
Risk retention rules, which take effect for CMBS on Dec. 24, were designed to provide sponsors with an incentive to improve underwriting by exposing them to credit risk associated with their originations. Conduit lenders have been slow to prepare, given the lead time in getting deals to market. In its presale report, Kroll called WFCNT 2916-BNK1 "a landmark securitization" that will "provide the marketplace with a much needed structural example and also provide adequate time for feedback from market constituents, as well as regulators."
A notable feature is that it allows for the creation of a "risk retention consultation party." Wells, B of A and Morgan Stanley may collectively appoint an entity that will be entitled to "consult" with the special servicer on certain material serving actions, according to Fitch's presale report. The servicer will not be bound by this consultation, however.
In terms of collateral, the three sponsors are playing it safe, at least by recent standards.
The deal is less highly leveraged than the average conduit rated this year by Fitch. It has a debt service coverage ratio (DSCR) of 1.22x and a loan-to-value ratio of 107.5%. (Ratings agencies calculated leverage statistics using what the view as an average value of the underlying properties at different stages of the credit cycle; this figure tends to be lower than current valuations.)
Like many recent transactions, the conduit's overall leverage is lowered by the inclusion of a few high-quality loans. In this case they are the two largest loans in the pool; one is backed by The Shops at Crystals (9.2% of the pool) and the other by Vertex Pharmaceutical's headquarters (9.2% of the pool). The two loans have a weighted average DSCR and Fitch LTV of 1.41x and 62.7%, as measured by Fitch, respectively.
The loans used as collateral will also experience more amortization over their life than recent deals rated by Fitch. The pool is scheduled to repay 11.3% of principal, while deals rated so far this year by Fitch will repay just 10%, on average.
As with any conduit, the composition of the collateral pool could change before closing, based on feedback from investors or ratings agencies.
"The intent of this deal is to test the market, so the structure could evolve," said Lauren Cerda, one of the Fitch analysts rating the transaction.
The trust will issue 19 classes of certificates, of which eleven classes are entitled to principal and interest, six classes receive interest-only, one class that is entitled solely to excess interest and one class is a residual interest.
Fitch and KBRA both expect to assign triple-A ratings to the super senior classes of certificates, which benefit from 30% credit enhancement, as well as to the senior class, which benefits from 21.875% credit enhancement.
The deal is also intended to comply with European risk retention rules, which are already in force. There are provisions to ensure that a sufficient amount of the underlying collateral was either originated or seasoned by the mortgage loan sellers or their affiliates.