The gestation of CMBS 2.0 continues apace. A slow pace. The bulk of the deals look an awful lot like CMBS 1.0, but at least one, the Goldman/Citi deal, seemed to come right out of the playbook of the activist investment grade ad hoc committee that has been fulminating for fundamental change in the structure of CMBS. The Goldman/Citi deal saw a B buyer without customary rights to terminate the special servicer, bondholder voting mechanics to remove the special servicer, a consulting ombudsman for the investment grade classes, and constrained special servicer compensation. To say the least, the industry’s notion of what CMBS 2.0 ought to look like has not gelled and will probably continue to see innovation and tinkering for some time to come. Certainly, the industry has yet to absorb whatever risk retention FinReg will bring us as well as possible changes in the structure of representations and warranties and perhaps something to reflect enhanced underwriting.

The talk on the street is that the investment grade buyers responded very well to the Goldman/Citi structure. At the end of the day the structure will follow the money.

So it’s a good time to pause for a minute on the rush to the new structure. Is the new structure, so adamantly pursued by segments of the investment grade marketplace, really an unalloyed good?

We’ve beaten to death the nexus of conflict between a B buyer with termination rights and a special servicer intent on doing its bidding. Done. Agreed. What we got in return may be a special servicer that is incredibly hard to replace and is perhaps insensitive to bondholder concerns. In the Goldman/Citi deal, seventy-five percent of the bondholders must vote to replace the special servicer. Seventy-five percent! While the deal created the infrastructure for a voluntary bondholder register, it is unclear whether it will work at all. My bet is it doesn’t. My bet is bondholder removal initiatives will make hen’s teeth seem common.

So we have a special servicer for life and a fairly toothless B buyer who will have substantially less tools at hand to hold the special servicers’ feet to the fire. Is that a reasonable price to avoid the conflict? For those around in the early days of the business, we saw a full and robust debate over whether the B buyer at the bottom of the capital stack with the unfettered right to remove the special servicer was good or bad and the conclusion was that it was good. To borrow from Mr. Churchill, it was the worst possible system for enforcing the rights of various bondholders as a collective whole, except for all of the others.

And then you have an ombudsman. An ombudsman is essentially limited to cajoling and jawboning. Will that really improve the performance of the servicer? I doubt it. Will it create more transactional friction in the system that is already not exactly a paradigm of German engineering? For sure. Will it generate emails and correspondence which will potentially be grist for the mill of aggrieved borrowers who don’t like any particular decision of the special servicer and are looking to attack it? Certainly. Will this really move the ball forward? I think the question is on the table.

Finally, at least finally for purposes of this brief piece, special servicing compensation has been suppressed. Competition is certainly a wonderful thing and it can generate efficiency and enhance performance. On the other hand, if you pay peanuts sometimes you get monkeys. Is there enough compensation here to motivate the special servicer throughout the term of this long term relationship? Is the compensation competitive enough here to attract a replacement in the event the bondholders somehow get to the point they wish to remove the special servicer. I don’t know the answer, but I think the debate on these issues have been short of full and robust.

Standby. I don’t think we’re at the end of the experimentation that will ultimately stabilize into a CMBS 2.0 – no one should jump to conclusions in these early days.

By Rick Jones