Last Wednesday, Laura Swihart and I attended CREFC’s after-work seminar on the new model set of representations and warranties, which the group is set to release in coming weeks. The model set is the product of a patchwork committee of 50-odd individuals representing the full gamut of industry types – securitization issuers, bond investors, rating agencies, servicers, wall street banks, life insurance companies, law firms, third-party providers and other interested parties. As a member of the committee, I’ll second CEO John D’Amico’s statement applauding the hard work of the committee. It takes a special group of people to stay energized through 90 minutes of heated discussion on the phrasing of property insurance requirements; the enthusiasm so many of my fellow committee members brought to each meeting and conference call was astounding.
The initiative is, in large part, a response to the SEC’s new Exchange Act Rule 17g-7 (initially proposed last October and final rule released in January), which, among other things, requires that the rating agencies identify, on a deal-by-deal basis, deviations from industry-standard reps and warrants. CREFC hopes that the model set will serve as the basis upon which all deals will be judged. It’s not necessarily clear whether the model reps will be widely utilized by the market, or how the SEC rules will be implemented – deals have obviously been selling for over a year without industry-wide agreement on a form of reps and warrants.
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.