August 4, 2016 / 9:11 PM / 2 years ago

Banks price US CMBS to test 'skin in the game' rules

NEW YORK (IFR) - Three major Wall Street banks on Thursday priced the first US CMBS designed to comply with tough new “skin in the game” risk retention requirements that take effect later this year.

Wells Fargo, Bank of America Merrill Lynch and Morgan Stanley priced the deal, which securitized a pool of $870.6 million commercial property loans.

Spreads were tightened on the benchmark 10-year Triple A class of bonds multiple times before finally landing at Swaps plus 94bp, bankers and investors told IFR.

The bonds were initially offered at 100bp, but pricing was pulled in to what is now the tightest spread for the asset class this year as investors vied for a slice of the landmark transaction.

“This deal looked pretty good for a transaction that would obviously gain a lot of attention,” said Christopher Sullivan, a portfolio manager at United Nations Federal Credit Union in New York.

“It’s an initial stab at complying with the risk retention requirements.”

Spreads were also dramatically trimmed on the deal’s bottom rung of Triple B minus securities. The D class priced at 425bp on Thursday, versus initial talk in the 500bp range.

That was 175bp inside of where Wells priced similar bonds in mid-July, according to Wells Fargo data.

FOOD FIGHT

Investors piled in partly because all three banks have agreed to share any downside. They each own a slice of each class from AAA to unrated, so if loans go bad and bonds take a loss - the three banks will also take a hit.

“In theory the banks will support the bonds, and you might see trading in blocks be much easier,” said one portfolio manager.

“But I think also (it was due to) a trend of more bank-originated collateral, rather than the potpourri of originators that throw whatever they have into the deal.”

Loan leverage was also more palatable to the buyside.

Kroll Bond Ratings pegged it at 91.7% - way under the record 118.6% ratio reported recently by Moody’s Investors Service for deals sold in the past two quarters.

Meanwhile, subdued CMBS issuance this year has left some investors with cash to put to work scrambling for paper. Deutsche Bank analysts said this week that they expect outstanding CMBS supply to dwindle by $46 billion in the next 12 months.

“That means the Fireman’s Recipe is at work,” the analysts wrote. “By the time everyone sits down to eat, they are so ravenous that whatever you made tastes great and will be devoured.”

BONUS STRUCTURE

Risk retention kicks in at the end of 2016 - but market players are still trying to find a workaround that will satisfy regulators and still make deals profitable for originators. The new CMBS trade is looking to provide a possible solution, and it’s not clear whether it will be given the nod of approval.

Regulators drafted the tougher rules in the wake of the financial crisis to better align Wall Street banks with investors who buy securities.

The rule will require banks originating CMBS to keep a 5% vertical strip of each new deal, an “L-shaped” portion or a horizontal slice of subordinate notes.

The horizontal 5% slice can also be sold to eligible investors, called B-piece buyers, that can hold the risk instead.

The Wells-led deal has banks keeping a 5 percent eligible vertical interest, according to Kroll. This structure was never the preferred option for banks, but has grown in popularity as B-piece buyers have struggled to raise funds to fill the void.

But the banks also included two additional safeguards that some bond investors have wanted for years.

One involves a new risk-retention “consultation party,” - in this case Wells Fargo - to consult with the servicer on any workouts of soured loans, another investor said.

“We finally have someone involved in those workout discussions that has some alignment with us,” he said.

The second enhancement will call on a deal’s trustee to order an independent “fair value” appraisal on a property if a servicer opts to sell a defaulted property out of the trust.

“Now all of the sudden they care about these things,” the investor said. “It makes sense, theoretically, now that have skin-in-the-game to make the change.”

Reporting by Joy Wiltermuth; Editing by Natalie Harrison, Marc Carnegie and Shankar Ramakrishnan

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