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CRE Finance World, Winter 2012

Mixed Implications of the Super-Senior Structure; Public Deals Face Uncertain Compliance Costs However, as Moody’s pointed out in an earlier report, the structure signaled that the market is seeing public CMBS issuance sooner leads to less motivation for investors to discriminate among deals, rather than later, the SEC’s re-proposal underscored that much of leading to less pressure on originators to rein in the easing of the regulatory framework for such public deals is still in flux. underwriting.1 We’ve previously noted that in a highly competitive market, the participant to exert the most influence over underwriting Recent Developments Could Mean Fewer would likely be the B-piece buyer, rather than the rating agencies, Regulatory Roadblocks… regulators, or investment grade buyers.2 Yet, the investment grade Several aspects of the Reg AB II re-proposal are reassuring. buyers have shown that they can alter the dynamics of a structure. Importantly, the re-proposal drops risk retention from the shelf However, with a 30% subordinated class, and perhaps a broader eligibility requirements for asset-backed securities. It also waters array of investors, we wonder if this group may become a bit less down a bit the required CEO certification regarding the underlying vocal in pressuring collateral trends. collateral. The SEC also mentioned that it plans to separately re-propose in the future the “waterfall” computer program, which A residual effect of carving out the super-senior is that the remaining has received much industry criticism. junior triple-A is left as a much thinner class. While the likelihood of loss is a function of the subordination level, severity of loss given In the same vein, other separate developments suggest public default is related to tranche thickness. So although the agencies deals could face fewer regulatory roadblocks. In particular, the required the junior triple-A’s subordination to be increased to 20.875% House Financial Services Committee approved in late July an from the original 18.875%, the class is still exposed to higher loss act that would repeal the repeal (no slip of the pen here) of Rule severity than if a single triple-A was left intact. 436(g). Recall that a Dodd-Frank bill provision which repealed Rule 436(g), and assigned liability to rating agencies if the rating Structuring Move Could Potentially Bifurcate the Market is published in the prospectus, caused new ABS supply freeze The investors who took risk in coming back earlier in the CMBS last year. The act approved in the HFSC would rectify this issue. 2.0 market, comforted by the conservative underwriting metrics despite the 17–22% subordination levels (significantly lower than …But the Cost of Doing a Public Deal is Likely to Rise that of legacy dupers), may now be impacted by this structural re- Still, with the government’s comprehensive securitization reform, new lapse. Their earlier bonds with similar and likely superior underlying regulatory requirements would clearly add to the cost of issuing a credit characteristics may now potentially trade behind the bonds public deal. Such additional costs would naturally somewhat offset with the artificially boosted triple-A enhancement. the benefits of a public issuance. Among the new requirements public deals would need to comply with we can list the following. While the CMBS 2.0 product is still evolving in many ways, including changes yet to come based on regulatory outcomes, it must •Reg AB II reform. The SEC re-proposal still contains three new achieve more stability to remain vibrant. Investors need to fully shelf eligibility requirements that would replace the existing understand the risks they are being compensated to take while sole requirement of having investment-grade securities. CMBS borrowers need to be offered competitive coupons and proceeds. issuance is almost always done through the shelf registration Unfortunately, on top of the spread volatility the market has process. As such, future public deals would need to comply with experienced, investors have now experienced closing risk (arising a new, potentially costly, set of requirements. from the pulled ratings) and structure evolution risk. Additionally, we estimate the move to a super-senior structure increases all-in •Issuer collateral due diligence. The SEC finalized in January Rule borrowing costs by approximately 20bp. 193, which requires issuers to perform a review of the underlying collateral in a registered transaction. This SEC rule implements Public Deals Face Uncertain Compliance Costs Dodd-Frank section 945, and becomes effective on January 1, The need to comply with an expanding, and still-changing set of 2012. Again, this new set of rules could increase public issuance regulatory requirements for registered deals, is likely to remain cost. In fact, the SEC states that for CMBS it may be appropriate an important factor influencing how quickly, and to what extent, for the issuer to review every pool asset (as opposed to a sample CMBS new deals shift from the private to the public market. The of assets, the likely requirement for RMBS deals). issuance of the first CMBS 2.0 public deal on August 11 happened shortly after the SEC re-proposed Reg AB II. The two developments •Risk Retention. Although the SEC dropped risk retention from its are most likely unrelated. But as the DBUBS 2011-LC3 deal proposed shelf eligibility requirements, the regulator mentioned A publication of Winter issue 2012 sponsored by CRE Finance World Winter 2012 55


CRE Finance World, Winter 2012
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