08/20/2010

H/2 Snags B-Piece of JP Morgan Conduit Deal

High-yield investment shop H/2 Capital has circled the below-investment-grade portion of J.P. Morgan's upcoming $1.2 billion conduit deal.

While the Stamford, Conn., firm has made a number of opportunistic investments in commercial real estate debt since opening in 2004, this marks its first play in the B-piece arena.

H/2 agreed to take down the bonds at a price that will provide a yield in the mid- to high teens, market players said. The company, headed by former iStar Financial president Spencer Haber, operates private equity funds and hedge funds.

Since the new-issue commercial MBS market started to revive last November after a 17-month halt, only two other transactions have been structured with B-pieces. A debt fund operated by BlackRock acquired the B-piece of a $716.3 million multi-borrower offering that J.P. Morgan and Ladder Capital priced on June 11 (J.P. Morgan Chase Commercial Mortgage Securities Trust, 2010-C1). And hedge-fund shop Elliott Management won the bidding contest for the junior portion of a $788.5 million offering that Goldman Sachs, Citigroup and Starwood Property priced two weeks ago (GS Mortgage Securities Trust, 2010-C1).

J.P. Morgan's upcoming deal will resemble its June transaction in terms of loan-workout rights and other structural features, market players said. In the June transaction, the B-piece holder has control over the appointment of the special servicer - and therefore the workout of any loans that go sour - in line with market tradition. But some restrictions were added to placate senior investors.

For example, control of the special-servicing rights traditionally moved up the class structure as tranches were wiped out. But in the J.P. Morgan deal, once losses have eaten up through 75% of Class E, which is rated triple-B-minus, control wouldn't shift to Class D, but rather to a 75% majority of the remaining noteholders. The motive is to give senior holders more control. What's more, the impact of appraisal reductions must be factored in, not just actual loan losses, which was the previous market convention. The effect is that the controlling party can change long before losses are actually booked.

The Goldman-Citi-Starwood deal went much further in the direction that senior bondholders have urged by eliminating the B-piece buyer's authority to appoint and replace the special servicer (see article on Page 1).

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