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CMBS "In the Money"


MBS Transitions

Was the CMBS 2.0 moniker simply a rebrand of CMBS 1.0 created to put a new spit shine on an old pair of worn out shoes? Post the 2008-2009 financial crisis, investors of CMBS bonds learned a few valuable lessons as CMBS loan defaults hit record levels and bondholders had to entrust special servicers to fairly adjudicate losses and recoveries in CMBS loan pools. Not completely satisfied with the process , many B-piece bondholders were reluctant to re-invest in these loan pools. Investors buying CMBS after 2009 were looking for CMBS issuances to be more pristine with tighter underwriting standards and stronger risk alignment. CMBS 2.0 was announced.

Extenders and Pretenders

CMBS 2.0 underwriting standards have certainly become more stringent over the last 5 to 7 years. Lenders have reduced LTV's, added more cash management agreements, originated fewer interest only loans and demanded more substantive escrows. In our opinion, however, the most impactful change in CMBS 2.0 targets the special servicers and the controlling class holders. CMBS 2.0 has tightened the reins on the "extend and pretend" plays orchestrated by controlling class holders. CMBS 2.0 forces appraisal reductions/ASER's (Appraisal Subordination Entitlement Reduction) to be taken on more of a spot basis forcing Lenders to mark to market their loans.

"In the Money"

In a typical CMBS transaction, the majority holder of the junior most bonds is designated as the controlling class representative and as such appoints the special servicer for the underlying loan pool. This arrangement works well in the early stages of the REMIC investment where Property values are generally stable and market fluctuations are minimal. The controlling class representative is perceived by the investors to have "skin in the game" and interests are generally aligned in maximizing trust asset recoveries. The CCR is "in the money" so to speak.

"Out of the Money"

CMBS mechanics do not always react quickly to a changing landscape such as the precipitous market decline and property devaluations experienced after 2007-2008. A special servicer could stall the appraisal valuation process for up to six months (allowed by contract) and hold the asset for 36 months (governed by the PSA specifically) in REO. Control holder status often took far too long to migrate up the capital stack under CMBS 1.o.

Special Servicer and the controlling class holders could avoid taking a "real-time" appraisal reduction even on severely over leveraged assets ensuring that the special servicer and CCR stay in tact. The results, at times, were resolutions that were dictated by an "out of the money" special servicer or CCR.

CMBS 2.0 takes a proactive approach to resolving the conflict of interest issues created when a servicer goes from "into" to "out of" the money in a CMBS transaction.

Focus on your niche and let us focus on ours. The principals at The Henley Group have been working with Special Servicers, CCR's and Bondholders since 1997. We specialize in proven solutions that Lenders and Bondholders accept.

David Goldfisher is principal and founder at The Henley Group.

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