Monty Python Dead Parrot? Risk Retention and the Third Party Purchaser

John Cleese, one of the great classic philosophers of the mid-twentieth century, made that inauspicious (from the perspective of the Shop Keeper) observation, “This parrot is dead!”  To which Michael Palin responded that it was merely resting.  (It’s better in drag and with the East Ender accent, but you get the idea.)

The Parrot skit [I wish I could link you to YouTube here, it is really very funny, but the damn lawyers here won’t let me.] came to mind recently as I attempted to negotiate yet another Third Party Purchaser (TPP) Agreement in risk retention land.  As everyone knows and is heartily sick of hearing, all securitization transactions now require the sponsor, or in commercial real estate deals, a third party purchaser, to hold risk retention securities in accordance with the breathtakingly vacuous Risk Retention Rule.  At Dechert, we did one of the pre-effective date pretend risk retention deals and, our TPP agreement was a weighty six pages long.  Since the Rule became real, TPP agreements have metastasized into much longer, more complex documents raising numerous dauntingly trying questions.

I have begun to wonder whether the risk retention TPP agreement is already near its death bed just some brief months following its birth.

The TPP construct struggles to bridge the anxieties of a securitization’s sponsor which remains liable for breach of the Risk Retention Rule, even though it has placed the risk retention securities with a TPP; on the other hand, with the disinclination of the TPP to devote capital, assume significant indemnification liabilities and assume intrusive contractual undertakings for a relatively small investment.

Making matters worse, the Rule is woefully inadequate as a guide book for compliance with massive white space, periodically interrupted by Delphically obscure bubbles of facial clarity.  Unclear rules and potentially existential liability and not the stuff of a deal easily made.

Of course, we’ve known all this since the final Rule was promulgated when the government apparently got tired of talking with industry about all this complexity and just excreted a final rule without any closure with industry experts around its meaning, function or utility.  Now as we actually apply it to real deals the old military adage comes to mind, “Battle plans rarely survive contact with the enemy.”

Examples of dysfunction in the Rule are simply too numerous to recount, but for example, what the hell does “full recourse” mean?  Did anyone notice the weirdness of getting to an L-shaped structure by adding 5% of vertical OPB and 5% of horizontal fair value?  Apples and oranges anyone?  Are there real issues around internal or external management for the TPP when it exercises credit judgment over purchasing a risk retention security?  Does the two pari passu TPP limitation impact the organizational structure of fund or investment vehicles with multiple owners?  Can a TPP hold disparate portions of the risk retention securities in difference MOAs?  What happens if those MOAs have different minority owners?  Does the provision that limits TPP financing from deal parties include every single, nominal party to the transaction?  Does it include borrowers?  Does the prohibition upon affiliation with deal parties really apply after the initial credit decision is made and continue for the life of the transaction?  What happens if affiliation is created when a deal party buys an equity stake in the TPP?  How about deal parties themselves engage in an organic M&A transaction?  There’s plenty more.

Staring into the abyss of risk retention chaos, we beaver away endeavoring to create certainty where no certainty exists.  For sponsors, the line between what’s ok and what’s not ok is obscured at best.  So, what does one do?  Push out the guardrails beyond the risk retention event horizon where liability clearly lives, right?  Wide guardrails; good for sponsors, not so good for the proposed TPP investor who sees enhanced obligations, reporting, capital at risk and liabilities.

Like one of those Venn diagrams in sixth grade math, the circle representing sponsor needs and the circle representing buyer tolerance are diverging and they may get to the point where they do not intersect at all.  It’s clear that as sponsors press for more certainty, fewer potential TPP dollars are going to find the investment worth the candle.

Now, not to overstate this, there are TPP dollars that will continue to find these trades attractive and of course one should never forget the ameliorative impact on perceived risk of added yield, but for an industry that needs an industrializable scale for a risk retention solution, this is problematic.  With limited money available for risk retention in the TPP universe to start with, the El Dorado-like search for certainty by deal parties will only diminish the supply.

If we are left with only sponsor-held solutions, is that enough?  Are there enough banks willing to hold verticals?  Do they have enough capital they are willing to devote to this business?  Are there enough non-bank sponsors willing and able to take up the slack and will the investors respond well to those structures?  The lack of risk retention capital and perhaps even the need to increase the price of risk retention capital will become another headwind for an industry that is already staring at marginalization.

So is the parrot dead, or just resting?  As the shopkeeper averred, “Remarkable bird, the Norwegian Blue…e’s stunned!”

Is the business model stunned?  Maybe we’ll get a fix either from our august elected representatives, or from the regulators who could certainly, even without actually changing the Rule, be enormously helpful by providing just some clarity through FAQs or the like on many of the unknowns in the Rule.  Maybe I’m just being overly pessimistic and maybe there’s enough yield on the table or enough risk appetite to square the circle, but heads up, this is a real problem.

Have Yourself a Very Trumpy Tax Plan

Well, we’ve had the big reveal and the administration’s new tax plan is out.  This plan, announced with a great deal of fanfare, feels more like a campaign promise than an actual executable plan.  At two hundred forty-six words from end to end (four different typesets, three different fonts, three colors, weird spacing and a sad little dash at the top), anyone who was hoping for clarity and a plan to go to the bank on, is either disappointed… or perhaps relieved.

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New Accounting Rules Regarding AUPs Taking Effect May 1, 2017:  More Fun for a Battered Industry

The Auditing Standards Board (the “ASB”) of the American Institute of Certified Public Accountants recently released new standards as part of the “Attestation Clarity Project” with the goal of redrafting all its standards “in clarity format” (what format were they in before?  And, while we’re at it, can we try to use English here?  Clarity format?).  This Project will require compliance by bankers and issuers with very specific disclosure obligations (reps?) before the auditors will issue an Agreed Upon Procedures Letter (AUPs) for securitizations.  Some of this formalized existing practice, but the changes go further and are far more prescriptive.  A “new letter of representation” from the party who hires the auditors (the “Engaging Party”) is required as well as similar letters from the parties providing the data that the auditors are reviewing (each, a “Responsible Party”).  These new rules will become effective on May 1, 2017.  Any AUP that is issued after May 1 will be subject to the new rules.

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The Dilemma of the Really Annoyed Borrower

Since my earliest days in the CRE capital markets biz, there has always been a drumbeat of grumbling from the borrower community about the annoying complexity, expense and delay of having one’s loan serviced in a capital markets transaction.  It’s been going on forever.  Like noise, like listening to Brits complaining about their weather; it’s ubiquitous, apparently personally gratifying, but largely inconsequential for outcomes.  The business goes on.  Data indicates that as many as 60% of all new CMBS loans come from refinancing non-CMBS loans, so it’s  not like a structured finance ghetto here.  The sell side takes comfort from the old saw that no sensible borrower would go to the CMBS window except as a last resort… like, three basis points or five bucks in extra proceeds.  Ok, that’s a tad too harsh and dismissive.  But going to the capital markets window for lower rates, more proceeds or less recourse is entirely rational.  On the other hand, the narrative about the pain through servicing in the capital markets is also real. Continue Reading

Dechert LLP and Richard D. Jones Recognized for Industry Leadership

It is awards season and we here at Crunched Credit have much to celebrate!

Dechert LLP named “Law Firm of the Year” by PDI, PEI and PERE

Dechert LLP was recently honored in five “Law Firm of the Year” awards across Europe, the Americas, and Asia by Private Debt Investor (PDI), Private Equity International (PEI) and Private Equity Real Estate (PERE), respectively. The PDI Awards 2016 named Dechert “Law firm of the Year in the Americas,” for the second consecutive year. Dechert was also honored as a finalist in Europe. PDI award winners are nominated and voted upon entirely by industry participants and service providers.

Dechert’s Representation of Private Investment Funds Recognized

Dechert finished in second place in the PEI Awards 2016 for the Asia-Pacific Region, in connection with which it was lauded for its outstanding work representing private investment funds, particularly in matters involving fund formation, and also placed second in the “Law Firm of the Year in Asia-Pacific (Secondaries)” category. The PEI Award winners are nominated by the publication itself based on feedback from a broad swath of industry participants; nominees are then voted upon by PEI’s readership.

Dechert’s significant representations and achievements in fund formation garnered it recognition as a finalist in the PERE Global Awards 2016, which honor leading industry participants in the private real estate markets and are also decided by industry vote.

Richard D. Jones named Top Investment Management Author

Crunched Credit’s blogger-in-chief, Richard D. Jones, has been recognized as a Top Author in the Investment Management industry category in JD Supra’s 2017 Readers Choice Awards. Readers of Crunched Credit know Rick as a thought leader with a style of writing all his own (just last week he mused, “our business will continue to grind along in a kind of middling trailer trash Goldilocks sort of way”), so please join us in congratulating Rick on this achievement.

This is the second year that JD Supra has given these awards, which acknowledge top authors and firms for their excellent reach with readers in a specific industry or for thought leadership writing on a key, cross-industry topic. The awards are tallied based upon the total number of reads an author had over the course of 2016; and we are thrilled that Rick was named among the top 10 out of 6,000+ in the investment management category! From all of us here at Crunched Credit, thank you to the readers who voted for Rick’s work and we look forward to another year of blogging about the black and/or orange swans on Crunched Credit.

We would like to offer our sincere and humble thanks to those who participated in the voting for these awards.

Reading the Financial Tea Leaves: CREFC Market Outlook Survey 2017

CREFC has surveyed some of its attendees—all major participants in the commercial real estate finance industry—at the 2017 CRE Finance Council January Conference in Miami.  CREFC’s 2017 market outlook survey confirmed what we observed at the conference this year, that for the most part survey respondents were cautiously optimistic in the face of the Trump Administration, Risk Retention and movement near the peak of the real estate cycle.  We decided to dig a little deeper to see how this year’s survey responses differed from last year’s. Armed with the benefit of a little hindsight, let’s consider the year we had, the year we expected, and the year we’ve just begun.

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Observations from SFIG Vegas 2017 Conference

SFIG Vegas 2017, which took place last week at Aria Resort & Casino, was the largest capital markets conference in the world, according to the Structured Finance Industry Group. With over 6,300 registered attendees, and I suspect thousands more who came to Vegas to attend meetings without registering for the conference, it’s hard to imagine that anyone in our industry wasn’t in Vegas last week. And while the weather in Vegas during the conference was unseasonably chilly, there was the warm glow of an industry feeling pretty good about its prospects inside the conference halls. The conference agenda was jam packed and the mood upbeat.

There was a lot to catchup on since our last industry-wide get together last September at the 22nd Annual ABS East conference. Donald Trump was elected President, an outcome that was uncertain at best five months ago. The Fed raised interest rates. Risk retention arrived (effective December 24, 2016) with seemingly little fanfare (although for those of us on the legal side, we appreciate all the legal work it created). The DOW set new records throughout January and February in its second-fastest rise in U.S. history. And Angelina Jolie filed for divorce from Brad Pitt. Four out of five of these topics were the focus of much discussion at the conference. I won’t say which one was left out.

Based on panels and side conversations:

The industry as a whole seems to have cleared the risk retention hurdle with limited disruption.

  • Although some industry players think there is a possibility of repeal of large portions of Dodd-Frank under the new administration, most seemed to think that a full repeal is improbable.
  • Spreads are expected to continue tightening while Treasury and LIBOR rates continue to creep upwards. All this seems consistent with steady growth ahead in the near term. Beyond that, if only I knew.
  • While some commentators believe we are nearing the end of this cycle, no one seems to be sounding alarm bells.

The conference sessions overall were lively and well attended. One of my favorites was keynote speaker Joe Scarborough, co-host of MSNBC’s Morning Joe and a former member of Congress, offering his perspective on the current political climate. He was careful not to offer any predictions. But in the end he assured us that “Americans can be trusted to do the right thing… once they have exhausted all [other] possibilities.”

Another highlight of the conference was “Blockchain University,” a series of sessions intended to give participants an understanding of the technology behind blockchain and how it can be utilized in capital markets. For those of you who are not particularly sure what blockchain is all about (no need to be embarrassed, let’s be honest), I am probably not the right person to explain it, but I get the impression that blockchain today may be similar to what the internet was 25 years ago – we have a sense that it’s important, but few can yet explain what it is.

And thus another conference drew to an end. After four days of meetings and learning, it’s good to get back to work to find inboxes full of email and offices abuzz with activity. Certainly feels like 2017 is off to a good start. See you all at the next one!

New Year! New Administration! Same EB-5 Dilemma!

Since 2015, we here at Crunched Credit have tracked, followed and discussed the developments (or lack thereof) concerning the Immigration Investor Program, more commonly known as the “EB-5 Visa Program.” Throughout the past year, we’ve witnessed the approval of several extensions of the EB-5 Visa Program and in each instance, no substantive changes were included—these extensions were solely put in place in order to prevent the expiration of one of the most successful investment programs. Continue Reading

Alternative Facts? A World Without Dodd-Frank and Basel III

What if Dodd-Frank and Basel III were to largely go away? Eliminating Dodd-Frank has been a hobbyhorse of Representative Hensarling, the chair of the House Services Committee, for several years and has figured prominently in President Trump’s campaign talking points. But the conventional wisdom has been that any sort of transformational uprooting of the Dodd-Frank and Basel III thicket was unlikely.

That’s what I thought, too. In fact, I have bloviated to that point in the press and on podiums many times. From the moment when everyone’s thinking was refocused that November 9th morning, I had thought that while major disruptions of many things were in the cards, Dodd-Frank and the Basel III architecture really weren’t on the menu. Now I’m starting to wonder. Sure, I still think major retrenchment is not going to happen, but my conviction that it’s impossible is what now gives me pause. Let’s face it, while rarely in doubt, I’m wrong a lot.

So just in case I am wrong, yet again, and some version of repeal or replace happens for Dodd-Frank and Basel III is rejected or slow-walked to death, what might that mean? It’s time to start planning for alternative facts. Continue Reading

Substantive Consolidation: It’s Alive and Well (or Maybe Just Alive)

The doctrine of substantive consolidation (generally- the power of a bankruptcy court to consolidate the assets and liabilities of affiliated entities in bankruptcy) is a recognized remedy exercised by bankruptcy courts – one that strikes fear into the hearts of many lenders. Justifiably so. The doctrine can be employed to order the substantive consolidation of related-debtor entities in bankruptcy and it can also be employed to substantively consolidate the assets of a debtor in bankruptcy with those of a related entity that is not a debtor in bankruptcy. Picture this: A parent entity files for bankruptcy and all the goodies are in a series of subsidiaries and the companies have never respected corporate niceties. The bankruptcy court presiding over the bankruptcy of the debtor-parent entity orders that the non-bankrupt SPE borrower will be dragged into bankruptcy and its assets used to satisfy the creditors of both the SPE borrower and the parent. Ta da. Continue Reading

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