CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Notwithstanding, the overall tenor of the conference seemed to be a determined optimism projected against the overarching blanket of volatility.  European instability, a jobless recovery, a newly normalized, lumbering pace of economic growth and a constantly evolving regulatory framework continue to make uncertainty the only sure bet.  As one might expect, a number of clients we spoke with last week are adopting a cautiously optimistic demeanor for 2012 and plan to tread the market’s murky waters slowly.

Will CMBS rebound (or continue to rebound)?  Will the life co's and other non CMBS lenders be able to fill the void?  How will regulatory reform be implemented?  These questions are so 2010, and yet they stay with us.  Depending on who you believe, CMBS output in 2012 is estimated to be anywhere from $25 billion to $45 billion (compared to approximately $28 billion in 2011).  And even if the portfolio lenders have a gangbuster 2012 (which is, in fact, likely), they won't be able to bridge the void left by $360 billion of maturing debt this year.  As for Washington, we can’t even determine a cogent agenda for regulatory reform at this point, much less predict what the rules of the game will look like.

Perhaps we’ll have answers (or at least a lessened degree of uncertainty) by the mid-year in June.  

By:  Matthew Clark and Stewart McQueen

A year ago, hundreds of CMBS industry professional spent hundreds of hours of time wrapping our brains around AB 2.0, which in the SEC’s own words was a proposed rule that would “address the problems . . . by giving investors the tools they need to accurately assess risk and by better aligning the interests of the issuer with those of the investor.”   We worked with CREFC and MBA to provide comments, which I think were thoughtful and constructive.  I had hoped, perhaps naively, that this should have formed the basis of an ongoing dialogue between regulators and market participants to address what everyone agreed were problems in the structured finance environment. And then…nothing. Crickets.  The comment disappeared in the Stygian opacity of the SEC regulatory process and dialogue never happened.  We waited.

Now the SEC has spoken again, delivering up a number of wholly new concepts around shelf-eligibility through a “Re-proposal” of part of AB 2.0.

As far as CMBS is concerned, the Re-proposal does the following:

• Eliminates investment grade rating criteria for shelf registration;
• Re-structures the new CEO certification regarding securitized assets and the design of securitization;
• Requires the appointment in the transaction documents of a “credit risk manager” to review performance when certain trigger events occur;
• Inserts a required dispute resolution mechanic for requests of the issuer to re-purchase assets;
• Bakes into the transaction documents the mechanics to allow investors to address other investors in the transaction about deal concerns; and
• Requires all final transaction documents to be filed five days before pricing.

The Re-proposal strikes from Reg AB the risk retention provisions in light of the (soon?) to be issued joint regulatory risk retention regulations and, blessedly, punts the waterfall computer program provision (the notorious Python program requirement) to a subsequent re-proposal initiative.

Some of these might be good ideas and others are susceptible to becoming good ideas through a robust and open industry dialogue (OK, and some are just plain bad).  Off the top:

• No more investment grade rating test.  Who cares?
• The CEO certification seems a bad idea.  We have all the liability provisions of the existing securities laws to enforce good and transparent disclosure.  This seems just another opportunity for gotcha (and a big incentive not to be a business line CEO!).  What will this really do to improve disclosure?  I don’t think much.
• The credit risk manager seems a little like a part of what CMBS 2.0 operating advisors or trust advisors do today.  The Re-proposal ties the credit manager investigatory duties to certain trigger events, which are really not particularly relevant to CMBS.  But if the market is getting to a place which satisfies investors, why impose a new regulatory regime?
• I don’t think the investors will like the new resolution mechanic, and I don’t like it either.
• Providing a mechanic for investors to talk to each other is not the worst idea in the world, but the industry is already doing this with voluntary registration systems for investor communication.
• Providing transaction documents prior to the time of sale will be a nuisance.   Frankly, I don’t think investors get any benefit from it, but the world will not end if that has to become part of the game.

Personally, I’ve got to tell you, I don’t have time for this right now.  Don’t we collectively have enough on our plates to deal with?  It’s not so much the content of the Re-proposal which annoys me, but just the notion that we actually have to pay attention to another set of rules which will change the game yet again.  On the other hand, maybe since the original proposal was so flawed, this could be a net improvement, and the willingness of the SEC to re-propose here perhaps suggests the commencement of a positive dialogue.

We are going to re-launch a public CMBS market.  This week, in fact. Public deals will broaden the investor base (albeit diminishing the quality and scope of information available to IG investors).  As CMBS re-enters the public marketplace, the matters addressed by the original AB 2.0 and this new Re-proposal (and further promised re-proposals) will become increasingly relevant.

OK, so I’ll stop whining.   We need to get this public market right, and this is another chance to engage with the regulatory community to see if we can push it in that direction.  Another set of rules, another 60 days to comment.  Off we go!
 

By Rick Jones.

Indeed, the theme for the affair - On the Road Again - was apt and matched the overarching zeitgeist present in the lobby of the Waldorf. With perhaps $50b in insurance company lending and $40b in expected CMBS issuance expected by year's end, the industry is back to work in earnest. While eager issuers looked to a return of larger deals, cautious investors expressed some concern of perceived weakening in underwriting standards. Participants discussed the impact of this past spring's roll-out of CREFC's CMBS 2.0 market standards - a comprehensive initiative to provide consensus on Annex A, a standardized framework for loan underwriting principals, an expanded investor reporting package, a model set of CMBS representations and warranties and an efficient, workable model for dispute resolution when the reps go bad. (One particularly frequent topic of discussion was when (and if) issuers would widely adopt the form reps and warrants).

As could be expected, continuing regulatory developments commanded significant attention. Forefront on the minds of the industry, of course, are risk retention, rating agency reform, the status of covered bond legislation and what can be done with the GSE’s. Conversations on Premium Recapture divided investors and issuers – while issuers view the concept as a doomsday device with existential consequences for the CMBS market, investors take the view that it represents an effective risk-retention tool that has precedent in other structured-finance spheres (auto, credit card, etc.). All could agree, however, that the concept, as laid out in the NPR, requires significant refinement.

Day two continued with discussions of the return of a market for floating rate deals as fixed rate competition heats up. As I tweeted, more than a few participants discussed the re-invention of the CRE CDO as a viable financing model (yes, someone will find a way to get a CRE CDO done, and no, it will not be called a “CDO”). We at Crunchedcredit.com concluded the business end of the Conference with dinner and cocktails with close to 200 of our friends and clients at Quality Meats. The food was good and the room was full – very full – a physical manifestation of a market back at work. We were overjoyed with the size of the turnout and the opportunity to rub shoulders (literally) with so many of those we work with throughout the year.

By: Matt Clark

Having closed on the acquisition of several A/B structures in past months, I’m wondering if, as our recovery continues, it could be time for a form A/B Colender? The basic architecture of the A/B Colender is already largely understood and could be effectively reduced to a widely-accepted formula. The waterfall, absent any deal-specific fee sharing arrangement, is pretty standard (pre-triggering event, Servicer fees, A interest, B interest and pro-rata fees; post-triggering event, Servicer, A interest, A principal, A costs and then to the B). Cure rights and purchase options could be standardized without necessarily limiting a B Note holder’s ability to negotiate changes from deal-to-deal. (That said, I’ve never quite understood how a B Note holder cures a non-monetary event of default, and in the past few years I think the A would be more than happy to accept a par pay-out on a defaulted loan regardless of whether the requirements of the Colender had been fulfilled). Limitations on transfers of interests in the B Note (more than 49% only to a Qualified Transferee) and the rights of the B Note holder to pledge or finance its interest are, again, largely standard across deals.

I think the two areas where some disagreement could arise would be the servicing transfer mechanic (from interim to PSA) and Controlling Holder control rights. Generally, the loan is administered by a servicer acting on behalf of the A Note - initially, pursuant to an interim servicing agreement; post securitization, pursuant to the PSA. The transition mechanic between interim and PSA can vary from deal-to-deal. Sometimes, the B note holder will have a chance to review and comment on the PSA, sometimes the parties will agree to a form of PSA (something much easier in the days when issuers had form PSA’s to attach), and sometimes, the Colender will limit changes to certain material terms or definitions (control appraisal events, for instance). With CREFC spearheading an effort to produce a form PSA (presumably containing market-standard provisions that adequately protect the holders of non-pooled components), at least some of the heartburn felt by issuers (“I can’t have the B Note holder holding me up!”) and B note holders ("I’m not getting jammed with a terrible PSA!") could be averted.

Controlling Holder control rights are probably among the most negotiated portions of these agreements - the list of consent and consultation rights ranging widely from deal-to-deal. In practice, however, it's not always clear that a long litany of controlling holder rights beyond the basics (i.e. rights that put the Controlling Holder at the nexus of a proposed workout) are necessarily that helpful when things hit the fan. And, of course, these rights could easily be negotiated on a deal-by-deal basis – why not start from a form? In addition, a form would allow for a more streamlined control appraisal mechanism (including standard rights for additional appraisals and threshold collateral) – especially if a form PSA should gain traction.

Like a lot of us, my experience with Colenders during the Crunched Credit era often followed a similar pattern - debt syndicated on co-lending arrangements that anticipated - no, needed - the A to be securitized; the servicing arrangements outside of the predicted PSA left vague, ill-defined (or, in some cases, just broken). And then the music died. (This is all more than somewhat understandable - few clients found it worthwhile to commission robust, fully-textured interim servicing agreements to administer freshly-minted mortgage loans during the months between origination and securitization. It's just that loose interim servicing arrangements and co-lenders dependent on a future PSA only work until they don't).

To be clear – I’m not suggesting each deal could be spit out on a standard form or that there isn’t significant value in thoughtful, zealous negotiation between parties on these points (I mean, I’ve spent the better part of my career having these conversations). But as CMBS 2.0 loans continue to be originated and sold, a model Colender could contribute to a more efficient market with reduced transaction costs.

By: Matt Clark

The discussion began with a summary of where we stand. Pace for domestic CMBS issuance is around $40b in 2011. Obviously, a small fraction of 2004 – 07, but still a big jump from 2010 (let's let '09 alone). Nine US deals have priced so far this year that I’m aware of, and the pipeline is equally encouraging, with reports of six more deals slated for May and June. It's important to note that this activity is occurring at a time of relatively significant uncertainty - no one is quite sure what the landscape will look like when the regulators finally declare victory (especially as it regards risk retention (see also here), and we're still waiting to see how 2.0 best practices will work their way into deals (for instance, whether issuers will adopt the form reps developed by CREFC). Meanwhile, the life companies, as a group, seem to have been the most obvious beneficiaries of the (heretofore) sluggish recovery of CMBS lending – they will essentially match CMBS lending this year and are similarly in-line with bank portfolio lending.

The presentation asked the panel to discuss their approach to a series of hypothetical properties – the stabilized, suburban office complex, the un-stabilized downtown office tower, the grocery-anchored retail development, the urban boutique hotel - and to explain their strategies for hitting the bid. The similarities among the panelists analysis was striking as each walked through their concerns on the underlying fundamentals (location, tenant mix, sponsorship, recourse). The major differences? Surprisingly (or maybe not surprisingly) not nearly as pronounced. At this point in the cycle, the Life Co's and Banks are competing (more or less) for the same deals as the CMBS lenders (albeit, it seems these days, the Life Co's are winning). There was some concern expressed that this may drive CMBS lenders to lowering underwriting standards. I’m less cynical on this point – from what I can tell, CMBS lenders - for these past four years cast as the Azazel of all that is poor underwriting - are looking at the same fundamentals as everyone else.

After the event, I joined some colleagues for dinner with clients … clients that were delayed a full hour at the office. More green shoots, I suppose. It will be a really good sign when industry "After-Work" seminars don't get rolling until at least 8:30.

By Matthew Clark.

Still, the bad boy guaranty (together with amendments to the Bankruptcy Code rendering single-asset bankruptcies less attractive to borrowers) did, in fact, work to reduce the number of bankruptcy filings during this most recent downturn and provided lenders with a measure of dry powder when seated at the negotiating table. A warm-body guarantor is often thought of as the gold-standard of behavior modification – no one wants to explain to their children how their college fund was paid over to a CMBS trust. Of course, a high-net worth entity can be equally as effective – so long as its assets extend beyond the subject real estate. Lenders’ confidence should be bolstered by the recent Empire State decision, which is in line with the majority of legal precedent on this issue:

● Blue Hills Office Park LLC v. J.P. Morgan Chase Bank  - Massachusetts court applies plain language of guaranty to uphold claim arising from misapplication of settlement proceeds;

● CSFB 2001-C-4 Princeton Park Corporate Center, LLC v. SB Rental I, LLC – New Jersey court rejects argument that recourse guaranty constituted an unenforceable liquidated damages provision;

● GCCFC 2006-GG7 Westheimer Mall, LLC v. Edward H. Okun - New York court finds guarantor liable for full amount of the loan after voluntary bankruptcy petition; and

● Diamond Point Plaza L.P. v. Wells Fargo Bank, N.A. – Maryland court holds guarantor responsible for full amount of loan after misapplication of rents and failure to maintain SPE status.

Recent vintage loans are, generally, including expanded carve-outs that are supported by stronger credit (indeed, the CREFC model representations and warranties include a specific representation on the presence of a recourse guaranty). Moreover, there has been a significant push by 2.0 issuers and rating agencies to require foreclosing mezzanine lenders to provide a substitute guaranty from credit-worthy entities - in some cases, that meet objective asset and shareholder equity thresholds - as a condition precedent to foreclosure (whether or not the existing guarantor is released).

Alternatively, sophisticated borrowers – themselves weary from the battles of the past half-decade – are now insisting that mortgage loan guaranties burn-off after they’ve been removed from control as a result of mezz foreclosure. Telling the kiddies that the tuition is gone because your mezz lender filed the property into bankruptcy is a different conversation altogether.

By Matthew Clark
 

Nonetheless, the model reps are very instructive as to those issues that are weighing mostly heavily on the minds of CMBS investors as they look to allocate risk in CMBS 2.0 structures. And – while certainly not an investors’ wish-list by any means – the model reps do, in some ways, represent significant risk-shifting on many issues – particularly as it relates to underwriting practices. A game changer? Maybe, maybe not – but it will be interesting to see how investors (B-piece buyers in particular) use this set of reps and warrants to lever increased reps and warrants on a going-forward basis.

I’m in the process of comparing the model reps to the deals that have populated the 2.0 market thus far and will be preparing a more detailed review of the final rep package once it’s released. The following, however, is an (unscientific) preview of the features contained in the CREFC model that could been seen as new additions to traditional CMBS loan seller reps:

• Representations that the origination, due diligence and underwriting performed by the loan seller materially complied with its internal origination, due diligence, underwriting procedures, guidelines and standards for similar loans, as well as a representation that interim servicing was conducted in accordance with industry standards;
   
• Representation that the loan seller obtained a certified rent roll and operating history within 180 days of the date of origination of the loan;

• Representation that the loan seller obtained an organizational chart reflecting all equity owners of 10% or more of the equity in the property, as well as representations regarding know-your-client processes and credit-checks;

• Significantly expanded representations regarding lease estoppels for retail, office and industrial properties, including requirements that lease estoppels be requested of all commercial tenants and requirements that estoppels be received from tenants representing 65% of in-place rental within 90 days of the origination of the loan;

• Expanded representations regarding site visits, including representations that the property was inspected within 4 months of origination and 12 months of securitization, and that an engineering report was obtained within 12 months of securitization;

• New reps for hotel properties, including representations regarding the enforceability of franchise comfort letters;

• Substantial revision and clarification to common MLPA insurance reps that reflect the input from several CMBS-industry insurance consultants;

• Increased scrutiny of originator due-diligence with respect to the adequacy of licenses and permits required to operate the property; and

• Representation requiring recourse liability to guarantors that are natural persons or entities that have assets independent of equity in the property.

Many of the reps obviously represent a significant departure from the reps and warrants we were accustomed to, and, inevitably, many could become susceptible to litigation abuse. But in light of what was being pushed by investor groups last summer, it’s clearly a heavily-negotiated product. Perhaps perfectly so – a set of reps and warrants that makes everyone unhappy.

After the seminar, we had dinner with a client (from one of the larger CMBS investors) in TriBeCa – the place where if you don’t call De Niro “Bobby” they’ll know you’re from Boston. Over appetizers, I asked him whether, after having attended the seminar, he’d push to stretch issuers on reps going forward. But as Jimmy Conway would say, “never rat on your friends and keep your mouth shut” .

By Matt Clark.

Also not news: there remains substantial anxiety. Is there sufficient loan demand? The girls have decided to have a dance, have hired the hall, put up the bunting and blown up the balloons, the band is tuning up. No guys. Or not enough. What happens, that little voice natters on, if we re-built this sell-side edifice, put expensive rumps in seats, and the buy-side don’t come to the dance? That’s simply not acceptable. To a man with a hammer, everything looks like a nail. A rebuilt, robust sell side will lend or die trying. And what might that do to heretofore heartfelt pledges of discipline?

On fundamentals, the consensus was pretty positive.

Jamie Woodwells, MBA’s brilliant commercial real estate economist, said at the conference in his state of the union:

• We should see good GDP growth for the next several quarters, in the 3% range.
• Interest rates are still benign and, even if the long end of the curve creeps up 100-200 bps, risk spreads will come in, keeping coupons at acceptable levels. LIBOR will also be benign.
• Employment will remain anemic but grow.
• Housing will continue to “grow more affordable” (nice way of saying prices continue to decline) at a slower rate and slowly but surely the shadow inventory will be absorbed.
• There’s been precious little new stock built in any of the major real estate food groups in years.
• There is a modest but a growing sustainable demand for mortgage credit. Plenty of refis to do.

That’s all basically good.

On the other hand, there does seem to be too much retail, too much multifamily, and Corporate America really doesn’t even need the space it has. And, on employment, there’s precious little evidence of real growth yet. (Is the new normal 8% structural unemployment? If so, what’s that going to do to us?) QE3 is on the runway, deficits continue to balloon, the consumer is still overburdened with debt, housing is doing a double dip, 30% of homeowners are under water on their biggest investment. Oops, there I go, going negative again. Don’t worry, it will somehow all work out.

And maybe that’s the headline both for CREFC and CREF. Somehow, it will all work out. After three wrenching years of retrenchment and loss, growth simply must be back. Somehow it will all work out! I kinda think so too.

By: Rick Jones.
 

Last night Dechert welcomed over a hundred clients to DC Coast for dinner and cocktails - the room was filled with participants from every corner of the industry. The general atmosphere of the event was certainly more optimistic than in previous years - there's a definite sense that the industry is getting back to work.

Today's events rounded out with a forum on Financial Reform and Legislative Proposals (Rick was among the panelists) and a brief speech from Senator Chuck Schumer. These programs were well attended - the Government's regulatory framework - Dodd Frank, GSE reform, covered bond legislation - were the central topics of interest this year. The clear takeaway from this session is that we are no closer to a cogent regulatory scheme than we were last year (and may be further away given the recent power shift in Congress).

By:  Matt Clark.

The late '90’s and early Oughts witnessed an explosion in the popularity of mezz debt in CMBS structures. Up until that point mezz debt was uniformly rare and rarely uniform. Mezz lender rights varied widely from deal to deal and included significant restrictions on mezz lenders’ rights to sell or finance their positions or to foreclose on their collateral (leading to high origination costs and uncertain securitization execution). The promulgation of rating agency criteria with respect to mezzanine debt (all things being equal, mezz debt generally garners only about a third of the leverage penalty attributed to a B Note) and the introduction by CREFC (then CMSA) of a standard form intercreditor provided a level playing field for lenders, investors and rating agencies. And, ignoring for the moment certain recent legal opinions (Stuy Town), the industry became very confident in their understanding of the basic architecture (in short: the right to cure, purchase, foreclose, transfer to a QUIL and a really, really complicated section on the right to amend). As we all know, by the middle of the last decade, stacked mezzanine loans (huge, stacked mezzanine loans) became the norm, each layer then being further syndicated among large numbers of participants, setting the stage for the many battles of the guerre des tranches we’ve fought these past years.

The current lending environment is primed for a resurgence in mezzanine lending for a number of reasons. Despite a stabilization (if not a rebound) in property values, a vast number of owners will not be in a position to refinance their properties at maturity given the levels mortgage lenders are willing to lend to; mezzanine debt can erect a portion of the bridge to higher loan-to-value ratios. And notwithstanding LIBOR, yields should be able to attract private equity dollars. Oddly (and, again, Stuy Town notwithstanding) the downturn may have, in some ways, bolstered mezz investors’ confidence in the structural integrity of mezzanine debt. The extended go-go-cycle from the nineties through ’07 deprived mezz lenders of a proper laboratory to vet the effectiveness of their remedies en masse. Recent history, however, has shown the UCC sale to be the tool of choice for many savvy investors looking to purchase distressed real estate (for instance, see these posts on the mezzanine foreclosure of the Hancock Tower).

Mezzanine debt will be an important, desirable aspect of lending in 2011. And, one note in closing, as this first week of ’11 draws to an end - I realize, strangely enough, the client was right. There will be no football in New England this weekend. Tommy Brady drew the first round bye.

By Matt Clark.

It is a curious state of affairs but the commercial side of MBA and CREFC, for many years, very effectively represented the commercial mortgage finance industry in a sort of sloppy, overlapping and certainly inefficient way. The trade organization version of what the psychologists call parallel play in children. Same sandbox, same toys, limited and suspicious interaction. MBA traditionally represented portfolio lenders and mortgage bankers; CREFC tended to the investors and sell-side bankers. Both claimed the affections of the servicers. (Both ignore the bulk of the commercial banks, but that’s another story). Both held solid, value added meetings and did important advocacy and education.

When things got bad and budgets got tight in 2008, everyone started thinking, “Wouldn’t it be great if we had one trade organization to represent the entire commercial finance industry; one set of dues to pay, one set of sponsorships, one set of annual meetings to attend?” As Samuel Johnson (pdf, page 285) said about the gallows, such a time of trouble focuses the mind most wonderfully. Collapsing membership revenues set both CREFC and MBA dreaming the dream of a global, galactic industry-spanning organization. So, both organizations during the “late unpleasantness” launched initiatives to broaden their remit, made organizational changes (a new name in the case of CREFC), adjusted their mission and started recruiting new members. After much huffing and puffing, there are indeed a couple of mortgage bankers in CREFC and a couple of investors who are members of the MBA. Both nominally have embraced strategic plans to be the one source trade organization for the CRE space.

Neither is going to win this mud wrestling match and, indeed, I think both are reconciled to that in their heart of hearts. Can you really see legions of mortgage bankers hanging with investment grade bond investors? Really?

Let’s face it, both organizations represent a unique value proposition and both are vitally important to the successful operation of the commercial finance market.

Several times over in the past couple of years, I was a fan of the one organization model. And perhaps, someday, we'll get there. But for the moment, it’s not happening. That train has left the station. We will continue to attend meetings of both the MBA and CREFC, and pay two sets of dues and sponsorships. Let’s all recognize this reality, waste no more energy on competition and get our trade organizations to stick to the knitting. CREFC has its hands full with the reflation of the capital markets. There is no shortage of important initiatives for the MBA to tend to.  These organizations which, after all, work for us (although sometimes it seems that we act as if they don't) need to move beyond competition and embrace cooperation.

By Rick Jones.