Deutsche, Citi Testing Risk-Retention Rules
Commercial MBS issuers continue to conduct trial runs of the new risk-retention rules in advance of their implementation.
Deutsche Bank is shopping the first single-borrower deal structured to comply with the regulations, which take effect on Christmas Eve. Meanwhile, the team of Deutsche and Citigroup asked investors bidding on the B-piece of an upcoming conduit deal to submit three separate bids, based on the different options for addressing risk retention.
The first risk-compliant deal was floated in August, when the team of Wells Fargo, Bank of America and Morgan Stanley retained a 5% vertical strip of an $870.6 million conduit offering (WFCM 2016-BNK1). Also, as previously reported, J.P. Morgan and Deutsche are working on the first conduit offering that will be structured with a 5% horizontal strip at the bottom of the deal structure, which BlackRock will take down.
The activity reflects the fact that issuers want to be sure they are ready to handle risk-retention rules, which aim to boost the quality of securitized loans by requiring lenders or B-piece buyers to keep “skin in the game” by retaining bonds for the long term. Some major issuers also see a competitive advantage to being first.
Under the rules, mandated by the Dodd-Frank Act that was passed following the market crash, issuers can retain a vertical strip encompassing 5% of every tranche in a securitization, a horizontal 5% strip at the bottom of the capital stack, or an L-shaped strip that combines the first two options. Issuers can also pass off all or part of the retention responsibility to B-piece buyers, which must hold a horizontal strip. The rules stipulate that conduit bonds must be retained for at least five years and in most cases for the full 10-year life of transactions.
The first single-borrower deal compliant with the rules will be backed by a $214 million portion of a $254 million fixed-rate loan with a 10-year term that Deutsche originated last month on 667 Madison Avenue, a 274,000-square-foot office building in Midtown Manhattan that’s owned by Hartz Mountain Industries of Secaucus, N.J.
Prima Capital has agreed to buy the $12.6 million junior tranche, which will serve as the “risk-retention piece.” The balance of that class equals slightly more than 5% of the deal’s proceeds, as required by the rules, sources said. Prima is committing to hold the securities for the 10-year life of the deal.
Deutsche jumped the gun on the regulation’s Dec. 24 implementation date for two reasons, according to people familiar with the transaction. First, it wanted to make sure it had the proper paperwork in place. “They want to practice getting the documentation right, and this deal lets them do it when they are not under extreme time pressure,” said one source. “It’s complicated, because the lawyers have to sign off on the documents, and so do the servicers and all the other parties that are involved in these deals.”
The second motivation was price discovery — getting a gauge on how much investors are willing to pay for bonds when risk retention is employed.
The Hartz Mountain deal, backed by a relatively small, prestigious building in a high-end district, also presented Deutsche with a low-risk opportunity to run a pricing exercise. Investor appetite for the bonds is likely to be strong, so the downside risk to the dealer is low.
Separately, Deutsche and Citi conducted a different kind of pricing experiment with an upcoming conduit offering (CD 2016-CD2). They asked a handful of investors to bid on the subordinate portion in three different ways: as a traditional B-piece; as a 5% horizontal strip compliant with risk retention; and as the 95% portion of subordinate bonds that would remain if the issuers retained a 5% vertical strip. In the last option, the holder of the 95% portion would be free to sell the bonds at any time.
Deutsche and Citi conducted the experiment because “they thought it would give them a clearer picture of the pricing variables if they got a whole set of numbers from several different players,” said one source.
Deutsche and Citi ultimately awarded the B-piece to Och-Ziff Capital. It’s unknown which of the three options will be employed. It’s also unknown if Deutsche and Citi were actually willing to retain a vertical strip or were simply testing pricing.