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CMA
October 28, 2016  

Ellington's CMBS Issuance Plan Takes Shape

Details about Ellington Management’s plan to become a commercial MBS issuer are beginning to surface as it seeks to raise $250 million of equity for a fund to pursue the strategy.

Ellington’s plan is to buy and warehouse loans and organize them into pools for securitization — the traditional functions of an issuer — so that it can qualify to be the “risk-retention holder” for conduit offerings. It would use a “vertical” structure for the risk-retention piece, taking 5% of each class of bonds.

The firm, which has been an active B-piece buyer, would also take down the remaining 95% of the below-investment-grade bonds in its transactions. It would be free to trade those high-yield bonds at any time.

The Old Greenwich, Conn., shop is soliciting capital for Ellington CMBS Sponsor Retention Fund, which would have a two-year investment period. Bonds could be held for 10 years, enabling Ellington to retain the risk-retention strips for the life of each deal.

By conducting transactions and taking down both the vertical slices and the first-loss pieces, Ellington projects a 12-14% return. The vehicle also would have the option of buying tradable B-pieces from deals in which other issuers hold the vertical piece.

The vertical structure is one of three options for complying with the risk-retention rules that take effect for CMBS on Dec. 24. The regulations alternatively allow issuers to hold — or sell to a B-piece buyer — a “horizontal” strip of bonds at the bottom of the capital stack, equivalent to 5% of the proceeds of the deal. That would be larger than traditional B-pieces, extending into investment-grade paper, and would have to be held long-term. Issuers also may use an “L-shape” hybrid of the two.

Ellington is telling potential investors that it expects the industry to move to a model in which investment managers, rather than banks, issue deals and retain the required 5%, using the vertical structure. The theory is that banks aren’t set up to hold bonds for long periods and don’t want the headaches of having to monitor a third-party holder.

The fund manager would charge a 1.5% management fee and would take a 20% cut of profits after investors get an 8% preferred return.

Senior portfolio manager Leo Huang runs the shop’s established B-piece business — and also has experience on the issuer side, having previously co-headed Goldman Sachs’s commercial real estate lending business. Real estate credit chief Wendy Pei works with him.