Issuers, investors, rating agencies and other industry participants continue to wrestle with the fundamental changes that will come to define CMBS 2.0. Among the (many) issues raised in the "Best Practices" guidelines issued by CREFC during June’s get-together was a proposal for market-wide, programmatic change to the package of representations and warranties given by securitization issuers. Specifically, investors are calling for the formulation of a market standard list of reps and warrants, and for a standard procedure for receiving any deviations on a deal-by-deal basis. One would hope this would sate the appetite of the investing community – a community ravenous after being starved of ground lease exceptions and knowledge qualifiers during the lean years.
What exactly will be included in the CMBS 2.0 rep package is being debated by market constituents. One overriding issue being driven by the investor community is the inclusion of some derivation of representations regarding underwriting practices. Investors will push hard for reps that underwriting procedures were generally in-line with “market standards”, or that the underwriting of a loan complied with the originator’s own best practices. We could also see a push for issuers to stand behind their underwriting on a more granular level – including representations regarding the issuer’s receipt and review of current rents rolls and historical operating statements. These representations will be the source of stress for issuers; good underwriting – always more of an art than a science – is difficult to shoehorn into a clear representative statement.
Will the model reps catch on? Perhaps not – as highlighted in this blog, deals are getting done in advance of any widespread agreement on rep and warranty expansion. And practically, while CMBS 1.0 reps and warrants were never quite “fixed”, there was a pervasive understanding of the universe of statements given from deal-to-deal. I also might suggest that the real effects of any deterioration of reps during the boom years (if there really was any) have been overplayed – in the vast majority of circumstances, the contributing causes of widespread loan failures would not have been resolved by greater representation or disclosure, no matter how robust.
However, if a new rep package is widely adopted, lenders will need to be very careful to ensure that their form loan documents include the appropriate provisions in order to stand behind the reps they will be expected to deliver.