Comment: No magic bullet, but CREFC has a careful shot at overhauling CMBS

Understanding the complexities that virtually no one else does, embedded in the structures of CMBS loans, is the stock in trade of members of the Commercial Real Estate Finance Council, who on 24 July put out proposals to improve CMBS loans – the so-called CMBS 2.0.

To have expected a trade association to simplify its main product so that it evolves into something different would be expecting the proverbial turkeys to vote for Christmas.

So it shouldn’t be a surprise that though the working group’s chairman, Nassar Hussain, said at the launch that the new guidelines “promote simple structures, transparency and increased  confidence among investors”, there is not much sign of simplification.

Take just one confusing aspect, the array of parties with roles in managing CMBS deals: issuer, cash manager, servicer, note trustee, special servicer, operating adviser… Far from cutting them back, the guidelines add a new one, ‘forum co-ordinator’, albeit with a useful role previously lacking – monitoring who the investors are.

In that sense, it is not a radical document. But it is a very thorough and detailed examination of the many weaknesses exposed in past CMBS structures, such as poor information for investors about deals they invest in, arranger banks being paid ahead of investors when deals default, and controversy about who has – or should have – controlling party rights. There are many good ideas and on some issues the working party has reached clear conclusions about the changes needed.

One is class X notes, the structure banks invented to capture the ‘excess spread’ (the interest from CMBS loans that exceeds the interest on CMBS notes). The notes appeared in many issues and ranked above all the other investors. The recommendation is that the way banks “extract revenue” should be disclosed and should stop after original maturity date or in default.

In other key areas it was tougher to balance competing interests – the guidelines acknowledge that full disclosure of loan and hedging documentation for investors requires the co-operation of borrowers, who were not much represented on the working group. The working group couldn’t reach consensus on what happens to controlling party rights on default, so sets out a range of options rather than a preferred option.

Unfortunately, the guidance can’t be put into practice where it would be most useful now; retrospectively, to deals in work-out. The recommended best practice is intended to help rebuild confidence in CMBS and the guidance should be incorporated in any new deals. On the prospects for the real estate capital markets opening up again, the panel that launched the document was realistic. As one said, a document like this is not the “magic bullet”.

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