First Public Deal of CMBS 2.0 Highlights Disclosure Issues

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The CMBS deal recently priced by Deutsche Bank and UBS was the first deal since the market crash to include publicly registered bonds (all other post crash securitizations issued private bonds using the 144A Rule).

This is a big deal. Most people agree that for the CMBS market to truly recover, we have to issue public bonds — because so many potential investors are limited to only buying publically registered bonds.

The Deutsche-UBS deal issued public bonds for the top 70% of the deal and private 144A bonds for the bottom 30%. While the deal reportedly found good demand for both the public and private bonds, the structure of the deal highlighted the fact asset-level disclosures were different for the public bonds versus the private bonds.

Since the crash and because all deals were 144A, the investors have been allowed to see and review sufficient asset level data to re-underwrite the underlying loans. This data has included appraisals, rent rolls, historical financial information, and issuers’ underwriting models. However, since the investors were typically operating under a confidentiality provision that is typical in private deals, the issuers were not worried about disclosing the information and conducting specific Q&A sessions with potential investors to answer asset-specific questions.

Issuing public bonds carries a much higher liability standard for issuers when it comes to disclosures. Information must be disclosed uniformly to all investors at the same time, and there is no ability for one investor to learn more about the assets than other investors. Also, if any information the issuer supplies to investors in a public deal turns out to be wrong or misleading, even if the information came from sources other than the issuer, the issuer can be held liable.

Since the Deutsche–UBS deal had both public and private bonds, the question came up whether an investor could buy both the public and private bonds. The answer was no. The reason is the investor who bought the 144A private bonds would have had more access to deal information than the public bond buyers. The concern is they could “use” that private 144A information to make a better decision on the public bonds. Since other investors who were buying only public bonds could not see the 144A information, that information advantage is illegal and is effectively insider trading.

Presumably this did not occur on the subject deal, and it is up to the investors and the issuers to police themselves to make sure the rules are followed. However, with this potentially serious conflict relating to disclosures, it seems like the structure used in the Deutsche–UBS should be improved on. Since at least some investors are demanding full disclosure, and we need the investor depth that the public markets can provide, something has to give.

Hopefully, the new Reg AB II rules that the SEC is working on will require the right disclosures for investors of all bonds but also protect the issuers against lawsuits regarding unreasonable disclosure liability. Also, there should be a few more public deals this year, so it will be interesting to see how other issuers address this potential conflict.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

Reg AB II Movement

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The SEC recently “re-proposed” for public comment proposed new rules for asset backed securitization eligibility that has come to be known as Reg AB II. These proposed rules suggest changes to the current securitization regulations and cover multiple reforms on everything from asset-level disclosures on both public and private deals, to the role of the rating agencies, to adding a risk retention requirement, and several other steps that would be required for issuers to sell asset backed securities (including CMBS).

The SEC initially proposed these changes back in April 2010. The two major trade groups (the MBA and CREFC) spent the summer of 2010 preparing a regulatory response that was submitted on August 2, 2010.

Since that time, the SEC has stayed basically silent on this issue. The only reports I heard were they wanted to wait until after the risk retention rules are finalized to implement the rest of the securitization changes.  In the “re-proposal” the SEC made it clear it was sticking with asset-level disclosures, but they also stated  no final decision has been made regarding the specific data elements that will be disclosed.

Responses to the “re-proposed” rules are due to the SEC by October 4, 2011. Both the MBA and CREFC plan to submit responses. However, since the “re-proposal” does not specifically ask many new questions regarding CMBS, both trade groups are basically just re-submitting what they stated last August.

It looks like the risk retention issues will be finalized this fall, and the SEC wants to be ready to release the remaining securitization changes shortly thereafter. The fact that they have “re-proposed” their rules suggests that we may finally get clarity on the SEC’s vision of CMBS 2.0.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

C-MISMO survives coup attempt

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The leadership at C-MISMO (which I am a part of) has been trying to decide the next steps to promote standards adoption. Toward that end, we hosted a “MISMO Summit” in May to seek support. At the meeting, it was clear a group of people wanted to put the entire effort into a hibernation mode.

These people argue C-MISMO should be shut down because there is no interest in implementing common, industry-wide standards. Most of the existing industry players (especially mortgage bankers) are satisfied with the status quo. I’ve known they don’t want standardization, but I was surprised when they actually tried to kill it.

Coup Attempt

In late June there were both formal and informal efforts by certain members of the MBA to kill C-MISMO by shutting it down. A proposal letter was drafted and circulated through the MBA that stated “it is not a good use of resources at this time to continue to create new standards.” The letter recommended “the development of new standards by Commercial MISMO be halted.” The effort to kill C-MISMO was pursued all the way to the Board of Directors of the MBA, where it was formally discussed.

Fortunately, the recommendation to hibernate C-MISMO was rejected by MBA leadership. We have been given the green light to keep going and, from what I understand, the firms pushing for the C-MISMO shut-down have backed down.

Origination Standard

When the governance of C-MISMO found out about the proposal to kill our efforts, we initially laughed because we felt like we were being fired from volunteer jobs. But then we started to get annoyed. It is offensive that people would actively oppose open standards. So instead of shutting down shop, we are going on the offensive.

Yesterday, C-MISMO leadership voted to create a new standard we are calling the Origination Standard. This data standard will contain all the information needed to re-underwrite and make a commercial real estate loan. We are purposefully focused on the front end data package needed to make a loan versus the back end investor reporting package. While the goal is big, the existing C-MISMO data schema is complete enough that this should be a manageable effort. We are going to get started in September.

We also agreed to create a GSE MISMO Adoption Task Force, and we are going to pursue a Rating Agency Data Standard.

So much for going into hibernation.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

CREFC Cautious

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I attended the CREFC Annual Conference last week in New York, which was also attended by about 1,000 people representing all the different segments of the CMBS industry (Issuers, Investors, Servicers, and Professionals).

I would describe the mood as cautious due to recent spread widening, a perception that CMBS underwriting standards have already deteriorated and a widespread belief that the “reforms” implemented for CMBS 2.0 don’t amount to much.

What struck me most during the conference was the growing number of people calling for transparency. While not a majority yet, I would characterize the movement as a vocal minority (as opposed to a few individuals just last year) evidenced by:

1) Investor Demands

All the securitizations that have been done since the crash have been fully transparent on the initial loan level disclosures to the investors (Annex A data). These disclosures have included rent rolls, issuer underwriting models and appraisals. The investors have gotten used to this level of disclosure. Now they demand it.

The problem is all the recent securitizations have been private deals done under SEC Rule 144a, not publicly registered bonds. Since the deals were private, the issuers have been willing to share the information through password-protected Web sites, but the issuers are not yet willing to disclose the same level of data for public deals.

Most folks believe we have to get back to public deals for CMBS to truly recover, but when we asked investors if they are willing to trade public registration for the increased data they would receive up front, they all said no. They would live with the restrictions of 144A Bonds before they would go back to the old, insufficient upfront data disclosures. The folks at CRE Direct wrote a great article on this topic if you are interested.

2) IRP Committee

Since the CREFC put a stop to any changes to the IRP in 2007, there has been a lot of talk about the industry increasing disclosures on its own, but there has been very limited action.

This year hopefully signaled the start of CREFC allowing additional fields to be disclosed in the IRP. The IRP committee stated they would be forming work groups to recommend additional disclosures. While I am pessimistic that true disclosure will actually happen through this effort (I believe regulatory action is the only thing that will work), at least there is a committee being formed to consider new additions.

The best line came when an IRP committee member (not me) said something like “the industry will lose the support of the regulators if we do not show progress in making the IRP dynamic. The fact that the IRP has not changed much in years does not support the statements that CMBS has a dynamic and complete set of disclosures already in place.” Well said.

3) Regulatory Reform

While most of the discussion on regulatory reform was based on risk retention and the roll of the operating advisor, I heard more than one person state risk retention was a side show compared to the upcoming Reg AB changes that will determine the level and format of the disclosures that will be required for public bonds (aka Annex A and IRP in CMBS and Schedule L and LD in Reg AB). If the regulators get it right, the required transparency will be more meaningful than risk retention.

4) New CREFC Leadership

Every year the trade group gets a new president. This year the job goes to Jack Cohen, a successful, long-time industry player from Chicago who made his money in the mortgage banking business. He has a different perspective than most, and his acceptance speech during the conference suggested he believes all industry participants must cooperate at an increased level for the good of the whole industry — not only for our individual firms’ short term interests.

Another potentially significant change is the hiring of Steve Renna as the new CEO of CREFC. He seems like a practical guy, and the fact that he has an office in DC suggests he may take a leadership role in the regulatory process.

I think the spread widening and the cautious attitude might be helpful to the recovery of CMBS. We are an industry that only has a six-month memory, so reminding everyone that spreads do not always tighten should be helpful in promoting the need for transparency and, most importantly, prudent and profitable deal making at appropriate risk adjusted spreads.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

MISMO, Risk Retention and OBL

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Lots going on this week, including a MISMO Data Summit, federal risk retention proposals and the end of Osama Bin Laden.

MISMO Data Summit

Plans are full steam ahead for a C-MISMO data “Summit” May 16 at the MBA Servicing and Technology Conference in Chicago. About 75 individuals from 30 companies got personal invitations.

The Board of Governors and the MBA grouped the companies into six types: issuers, investors, rating agencies, servicers, GSEs and vendors. We split up the lists. My list consists of issuers and investors including Bank of America, Wells Fargo, JPMorgan, CWCapital, PNC, MetLife and New York Life.

The invite’s opening paragraph says:

“For the last several years, participation in, and funding for, Commercial MISMO (C-MISMO) has declined. Yet today our industry finds itself at a point where Commercial MISMO will be most needed, with the development of more standardized reporting systems and detailed regulatory oversight. Decisions need to be made regarding our industry’s belief in and support for C-MISMO. To strategically assess how C-MISMO should move forward, and to determine its direction, the Mortgage Bankers Association and MISMO’s Commercial Governance Committee would like to personally invite you to a MISMO Summit at this year’s Commercial/Multifamily Servicing and Technology Conference in Chicago.”

The Summit will either bring industry agreement on a common data standard with buy-in and commitment from the group, or it will be sparsely attended and/or bog down in debate with no clear agreement. I’ll report back after the conference on attendance and results.

Risk Retention

The federal regulators issued their joint proposals for risk retention a few weeks ago. They took a hard line with CMBS. While the rules do not go into effect until April 2013, and they might change after the comment period, they include three provisions that are unexpected and problematic:

  1. Premium Capture Reserve Account – The regulators introduced the concept that issuers must not monetize and book the profits from a securitization until after all the bonds have been repaid instead of when they are issued upfront. This provision is a big change and a big deal.
  2. Operating Advisor – The third party B Piece buyer will only satisfy the risk retention requirement if there is an “Operating Advisor” overseeing the asset management decisions of the special servicer / B Piece buyer.
  3. Exempt Loan Test Too High – The regulators put such low LTV and high DSCR requirements that very few CMBS loans would qualify as being “exempt” from risk retention.

If the regulators take as hard a line on disclosure as they did on risk retention, adopting XML will be inevitable — after all, that’s what they intended from the beginning.

That being said, I think getting the disclosure requirements right is much more important than the risk retention rules. I would be happy if the regulators gave a bit on retention as long as they get the disclosure right. Hopefully the feds do as good a job on securitization reform as they did on taking out Osama.

OBL

I was as happy as anyone that we took out Osama Bin Laden. We were all touched by 9-11, and I chronicled my story in my first blog post.

The Navy Seal raid was amazing, and I am glad justice was delivered on the spot. I was in New York this week and went by ground zero to pay respects and see the progress of the Freedom Tower. Finally, the building is coming out of the ground.

The Freedom Tower!

The Freedom Tower!

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

CREFC Releases Market Standards for CMBS 2.0

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The industry trade group that controls the reporting standards for CMBS reporting, the CRE Finance Council, released the consensus version of the new reporting requirements for CMBS 2.0. The trade group spent over a year with investors, issuers and servicers trying to reach consensus on best practices and disclosure levels.

Standardized Annex A

The biggest part of the release is standardization of investor disclosures when initially selling CMBS bonds. In the past, each issuer would define what they would disclose in the initial prospectus, with the actual data fields being defined in Annex A to the prospectus. While there were plenty of similarities in the Annex A disclosures from one issuer to the next, they were not standardized. The new disclosures (see attached) made good progress on standardizing and requiring data disclosure related to:

1) The data needed to model the debt both within and outside the trust (the entire capital stack)

2) More details on historical operating statements (income and expenses)

3) Better data on escrows and reserves

Download pdf: CREFC Standardized Annex A – December 2010

CREFC also addressed standardization of the “typical” Reps and Warranties issuers make to bond investors, as well as the repurchase language/process the parties go through if there is a breach claim. Definitely an important step.

Effort Falls Short

In my view, despite the progress, the consensus disclosure standard falls short, specifically as it relates to disclosing the in place rent on the collateral (full rent rolls). Instead of agreeing to disclose this critical data, the “consensus” was to add information on two additional tenants so investors will now get information on the top 5 tenants in each property instead of just the top 3.

Instead of complying with Dodd-Frank and disclosing enough information to allow the investors/rating agencies to recreate their own underwriting models by disclosing the full rent roll, CREFC issued a 33-page “Principals Based Underwriting Template” in an effort to describe a “good” underwriting.

With all due respect, people in the business know how to underwrite, and a 33 page manual is a complete waste. Instead, the counterparties to the securitizations need the data to recreate an underwriting and make their own conclusions. Having an issuer state they “followed the manual” is nowhere near the same as disclosing the data to allow all parties to reach their own conclusions. The investors agreed and initially asked for full rent rolls but were not able to reach “consensus” on this issue so, instead, we are left with limited information on the “top 5.”

Active Few Weeks

I think the timing of these market standards indicates the “rules” from the SEC/regulators will soon be released. Later this week the regulators will release their conclusions on risk retention, and there is a rumor the SEC will be issuing its rules on Reg AB reform in the next few weeks/months. We will see if the regulators step up and require additional rent data or if CMBS 2.0 is really a lot more like CMBS 1.5.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

MBA not as upbeat as CREFC

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Last week’s MBA CREF conference was more subdued than January’s CMBS-centric CREFC conference. While the mood was cautiously optimistic — and definitely better than last year — the MBA CREF conference lacked the jubilation expressed at CREFC.

That’s because CMBS was absolutely dead last year. Opening the coffin on the asset class has put most players in a celebratory mood, and that showed at the CREFC conference.

The people that go to the MBA CREF conference represent companies from a broader part of the real estate lending business, not just CMBS. To put it into perspective: Attendance was about 2,500 — about twice that of the CREFC conference.

These companies have been hurting for sure, but they were not put into the grave like CMBS was. The agency business (Fannie/Freddie/HUD) has actually been thriving, the life companies beat the CMBS market back in, and the FDIC is liquidating banks providing at least some deal flow.

Despite complaints about lack of funding for smaller deals, I would describe the MBA CREF mood as being cautiously optimistic but not yet jubilant.

2012 CREF in Atlanta
The biggest buzz at the conference was the MBA’s announcement that the 2012 MBA CREF conference will be in Atlanta.

There has been a history of the conference switching every year between a west coast city (San Diego) and a east coast city (Orlando).

Last year they tried Las Vegas, which was fun but a disaster for networking: Vegas swallows up a conference of only 2,500 people; you never saw anyone. But at least it was Vegas.

Needless to say, no one I spoke with was happy about going to Atlanta next February.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

Upbeat mood at CREFC conference

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I attended the annual CREFC CMBS Investor conference in Washington DC last week, where the mood was definitely upbeat. So positive, in fact, that some people were already warning about slipping underwriting standards!

Headed back to South Beach

Perhaps the biggest sign that the market is back was the announcement that the 2012 conference will move back to South Beach from Washington DC. The conference had been in Miami for years. but moved to DC after the crash for two reasons:

1) to be closer to the policy makers and

2) to avoid the appearance that bailed out banks were sending their people to a party in Miami Beach. Now that everything is back, South Beach is back on the agenda.

The White House.

The White House

Dinner with the CREFC president

My personal highlight of the trip was a dinner where I sat next to John D’Amico, the acting CEO of CREFC and the president elect for 2011–2012.

My friend Jim Cooke, who is a lawyer at Ballard Spahr and chair of Commercial MISMO, invited me to his firm’s dinner where he had John sitting between the two of us. We spent the dinner talking about the disclosure of rent rolls to all investors and the value of XML.

John was a B Piece buyer pre 2009 and certainly has a good understanding of credit. When he was buying below investment grade bonds, they always had access to the rent rolls, so he was sympathetic to sharing the same data with the investment grade bond buyers.

By comparing XML to a “tab” in a Word document, he was able to understand the essence of XML versus Excel and understood how XML would be needed to move rent rolls.

We also talked about the value MISMO standards could bring in that process. While I think we, at some level, converted John to XML based disclosure, the fact is he does not have that much control over CREFC final policy. Nonetheless, he is a key person to get on board, and the dinner was fun.

Snow at Reagan Airport.

Snow at Reagan Airport.

Other highlights from the conference

2011 Volume
The “pros” were projecting CMBS originations to triple or quadruple from $10 billion in 2010 to $30 or $40 billion in 2011. While the overall mood was positive, some worry there are too many lenders back in the market, and that competition for good loans is creating a “race to the bottom” in underwriting standards.

Privately, there was talk that 2011 might not be as robust as everyone thought (maybe $20 to $30 billion) but, overall, folks were upbeat and positive on 2011 prospects.

Regulatory Reform
With no word from the SEC on the securitization reform known as Reg AB (rules expected soon), the focus was on GSE reform and what the future of Fannie, Freddie and HUD might be.

Most agreed there would not be meaningful GSE reform until after the next presidential election. That being said, two distinct views of the future were offered by two guest speakers (Senator Charles Schumer, a NY Democrat and a Rep Scott Garrett, a NJ Republican).

Senator Schumer spoke about the importance of the GSEs. He believes they serve a critical function for both residential and apartments, and they should remain in place with the full backing of the U.S. government.

Representative Scott Garrett (R-NJ) went the other way with it and stated the Republicans favor privatizing the GSE and getting the government out of the housing business altogether. Not a lot of common ground there.

Parties
The parties were back! Lots of different lenders/servicers had parties and dinners, the bars were open and the buffets were full of shrimp and other good food. Last year, there were far fewer parties — another sign of the good mood this year.

Attendance
Conference attendance was up with over 1,200 people attending compared to a low of 700 people in 2009 and a high of the 1,600 people at the height of the market in January 2007.

Speakers
The keynote speaker was Tucker Carlson from Fox News. Being from San Francisco, I do not usually watch Fox News but he gave a great talk. Funny and poking fun of everyone from the left and the right. He talked mostly about politics and predicted that Chris Christie, the governor of New Jersey, would be the Republican nominee for president.

Travel
Another good reason to move the conference back to South Beach is the weather. I tried to leave DC on Wednesday but got caught up in one of the many East Coast snow storms. After hours at the airport, a missed meeting in Minneapolis, and a full day of traveling the next day, I got back to sunny California.

I am off to the MBA conference in San Diego next week and will report back after that conference.

Back home. The view from Mt. Tamalpais.

Back home. The view from Mt. Tamalpais.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

2010: Industry makes progress while waiting on the SEC

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I expected the SEC to release the final Reg AB language before the end of the year, but that did not happen. So, for a final post of the year, I thought I’d highlight steps the industry has taken on its own to improve transparency and investor protections, as well as define CMBS 2.0.

Upon reflection, there has been pretty good progress. 2010 CMBS deals saw four positive trends:

Servicer oversight

A major theme was reducing the conflict between the special servicer and the B Piece bond investor. Most of the 2010 deals had provisions limiting the B Piece owner’s ability to pick the Special Servicer by the introduction of the Senior Trust Advisor. These are third party consulting firms that oversee the Special Servicer and provide information to the investors. The Senior Trust Advisors have the authority to remove the special servicer and really do give the senior investors an oversight position on resolution strategies.

Projected vs. actual loss to pick special servicer

In CMBS 1.0, the controlling class that would pick the special servicer was determined by actual loss, not projected loss. Since the controlling class (the B Piece buyer) was also the special servicer in most cases, the potential for conflict in resolution strategies was apparent.

The 2010 CMBS deals all had the provision that losses and therefore control be determined by projected loss (appraised value) instead of actual loss. Specifically, the special servicer can be replaced by majority vote of remaining bond holders if appraised losses — as opposed to actual losses — exceed 75 percent of the most junior bond balance.

Transparency

The 2010 CMBS deals record on increased transparency is mixed put there were definite positive trends.

On the negative side, none of the deals increase any additional “public” disclosure (all based on IRP 5 without rent rolls and underwritings) and, in fact, actually limited disclosure because they were all 144 A Private deals.

On the positive side, the issuers reportedly did share underwriting models and full assumptions with known investors as part of the investor “road shows.” So, if you were actually buying these bonds, the word is the issuers shared all. Other positive events include the CREFC increasing modification reporting with the release of IRP 5.1. Also CREFC are making proposals to standardize Annex A disclosures, Reps and Warranties and underwriting. While still missing some critical data, there was no doubt progress.

New B Piece Buyers

Attracting capital to buy below-investment-grade CMBS is key to CMBS 2.0. 2010 saw new entrants (most run by old players) to the B Piece market. Of the six deals done in 2010, the B Pieces were bought by four different firms:

Black Rock: three deals
H/2 Capital: one deal
Rialto Capital: one deal
Elliott Capital: one deal

So, with those positive thoughts, Happy New Year and I hope 2011 gives you more than 2010.

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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

CREFC mini conference: some good, some not

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I attended a CREFC mini-conference in New York this week titled “2010 Market Initiatives: Overview and Updates.”

The half-day session provided an update on financial regulatory reform and CREFC’s efforts to improve transparency outside SEC directives by creating industry consensus.

Some of the results are good, some are not good.

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