The formation of the Commercial Real Estate Finance Council’s CMBS 2.0 Committee reflects the industry’s wish to modernise in preparation for a return of CMBS new issuance in Europe. As a first step, January’s implementation of the Capital Requirements Directive (CRD) article 122a provided much-needed regulatory clarity to the securitisation market. The CRD goes some way to re-align originators’ and investors’ interests and to correct perceived structural weaknesses in the market; the CREFC Committee aims to put practical flesh on the regulatory bones.
Article 122a requires originators to: retain at least 5% of issues (as a vertical slice or first-loss piece); ensure all relevant due diligence informa-tion is properly disclosed; and to provide all the information investors need to conduct stress tests on cashflows and collateral values. Investors must show their regulator that they fully understand each investment; have monitoring processes for them; and have undertaken adequate due diligence.
The 5% retention rule will assuage investors’ previous fears that originators set up CMBS conduits to sell off loans’ downside while retaining some of the upside through servicing mandates and excess spread arrangements. But further realignment is needed. For example, the role of class X notes must be revised; their senior ranking and right to receive excess spread when there may be interest shortfalls on junior classes should not feature in CMBS 2.0.
Losses have been blamed on complex US and European CMBS structures, but while a strength-ening of structures may mitigate loss, it cannot compensate for investors’ poor underwriting. The CRD emphasizes due diligence in its broadest sense, but we would look for the fullest disclosure from borrowers and originators on underlying property data, cashflows and legal documentation, with regular dialogue and public updates required.
Alignment of interest should also extend to the servicer, issuer and trustee. CMBS investors are often frustrated by poor communication from servicers, intransigent trustees and uninterested borrowers. The exercise of investors’ rights can be costly and time consuming: in future issues, the right to appoint an operating adviser or change a special servicer should be quick, inexpensive and require limited legal involve-ment; the introduction of standard meeting notice templates would help.
As CMBS 2.0 evolves, the nature and extent of these rights will be much discussed. For example, most existing deals have an operating adviser, which is an important role; but its actual rights, responsibilities and indemnification need overhauling, and the appointing class (or classes) should be able to remunerate their appointee via the borrower or the deal’s cashflows.
Servicers have also been constrained by their liability concerns in some default and restructuring situations. It would be beneficial if they could engage more openly with investors and be empowered to take action with reduced trustee involvement. Whether this would require different voting processes, lower quorum requirements, an overhaul of the servicing standard, investor registers or the adoption of more traditional facility agent arrangements is open for discussion.
There is much work to be done before the CMBS 2.0 Committee’s guidelines are published later in the year. CMBS 2.0 won’t be a wholesale reconstruction of CMBS 1.0: we should remember that predictions of disaster over the past three years have thus far proved unfounded. What will be key for CMBS 2.0 is that it provides the confidence to begin rebuilding an investor base, while at the same time providing structures that borrowers find attractive. This also requires the market to be confident that the real estate market has got pricing right. New guidelines aren’t going to lead to a sudden broad resurgence of demand for CMBS. But it is right to invest now in preparing the conditions for that revival as it emerges.