Test Deal Gives Issuer Watchdog Role
The issuers of the first conduit offering designed to comply with risk-retention rules have awarded themselves a new power: the right to consult with the special servicer about its decisions on working out troubled loans.
The terms of the $871 million offering, which priced yesterday, authorize lead issuer Wells Fargo to consult with Rialto Capital if the special servicer proposes “certain material servicing actions.” But while Rialto would be required to meet with Wells, any recommendations by the bank wouldn’t be binding.
It’s presumed that Wells and its issuing partners on the deal — Bank of America and Morgan Stanley — created the role of “risk retention consultation party” mainly to protect their own interests, since they will retain a total of 5% of each tranche for the 10-year life of the deal.
“If I were them, I would certainly want to be kept informed of what the special servicer is doing,” said one rating-agency analyst.
Special servicers, which are appointed by B-piece holders, are notoriously stingy about sharing information about troubled mortgages and loan-workout strategies with investors. Even though the consultation party has no binding authority, it figures to have influence on special servicers, especially when the issuer is a major player like Wells.
The reason: Big issuers have tremendous clout in the industry, including the power to decide who wins B-pieces. “If, for some reason, Rialto wanted to service a loan in a fashion that Wells, BofA and Morgan Stanley didn’t like, the issuers could express their displeasure” by bypassing Rialto on B-piece offerings for future deals, one CMBS investor said.
He and other buysiders lauded issuers for carving out the consultation provision, which they figure could constrain special servicers from acting in their own self-interest at the expense of bondholders. But one special servicer played down the potential impact, emphasizing the provision’s nonbinding status.
After the market crashed in 2008, special servicers found themselves under intense scrutiny over potential conflicts of interest in loan workouts. Special servicers are required to represent the interests of all bondholders, but senior investors charged that their wide discretion to work out loans sometimes resulted in decisions that favored B-piece holders or the servicing operations themselves. A number of reforms were adopted to address those concerns, including the establishment of “trust advisors” to oversee special servicers. The creation of a consultation party sets up another watchdog of sorts.
The consultation provision, which industry pros expect to become standard when issuers retain a 5% vertical strip, may also help issuers win more-favorable treatment from regulators for capital set-asides. Under risk-based capital rules, banks must keep significantly larger amounts of capital in reserve against bonds than against loans. Issuers are contending that retained vertical strips should be treated as loan participations, instead of as bond exposures.
Since loan-participation agreements usually spell out the consultation rights for each lender, it appears Wells, BofA and Morgan Stanley have “constructed something consistent with their argument for the risk-based capital treatment they want,” said a CMBS attorney who isn’t connected to the deal.
The three dealers launched the conduit offering (WFCM 2016-BNK1) in advance of the Dec. 24 implementation of risk-retention rules as a test aimed at getting early feedback from regulators about the capital treatment.
Wells, BofA and Morgan Stanley retained $43.4 million of paper, split according to their relative collateral contributions. So Wells retained $17.1 million, or 39.4%, BofA kept $15.4 million, or 35.5%, and Morgan Stanley held $11 million, or 25.2% (see article on Page 1 and Initial Pricings on Page 9).
The impending risk-retention guidelines, mandated by the Dodd-Frank Act, are aimed at forcing lenders to maintain credit quality by requiring them to keep “skin in the game.”