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CMA
January 19, 2018  

Rialto, KKR Led Shuffled B-Piece Market in '17

Risk retention shook up the ranks of conduit B-piece buyers last year.

While Rialto Capital remained the most-active buyer, three other shops — KKR, Silverpeak Argentic and Prime Group — surged up the league table.

Meanwhile, Eightfold Real Estate, Torchlight Investors and C-III Capital — which had finished 2-3-4 in 2016 — slid down or off the table.

In a separate ranking of special servicers, Midland Loan Services reclaimed the top spot, supplanting Rialto (see rankings and a list of B-piece yields on Pages 15-17).

Rialto and KKR dominated the B-piece activity, jointly accounting for nearly half of last year’s purchases. Rialto acquired the subordinate portions of 14 transactions totaling $12.9 billion, or 26.6% of the $48.5 billion aggregate conduit volume.

KKR took down 12 B-pieces from transactions totaling $10.9 billion, for a 22.5% market share. That was almost 11 times higher than its tally in 2016, when KKR acquired the B-piece of a single $1 billion offering.

Silverpeak, which is backed by hedge fund shop Elliott Management of New York, stormed into the sector last year and captured third place, grabbing B-pieces from seven deals totaling $6.3 billion, or 12.9% of the total. Prime Group came next, climbing to fourth place from eighth in 2016. Its $4.7 billion of volume was more than double the year-earlier total. Rounding out the top five was Eightfold, which slipped from second place in 2016. Eightfold’s volume was $4.4 billion, down 46% from $8.1 billion.

The B-piece market has always been concentrated, but grew even more so last year. The top three shops snapped up 62% of the business, up almost 10 percentage points from 2016’s top three.

Besides jumbling the playing field, risk retention also created a bifurcated market — of tradable and non-tradable B-pieces. The regulations, which went into effect at the end of 2016, require issuers to retain long-term exposure to 5% of securitizations and give them three deal-structuring options for complying. They can retain a vertical strip of bonds (5% of each class), a horizontal strip (the bottom 5% of the deal structure) or an L-shape strip (a combination of the two other options, such as a 2% vertical strip and a 3% horizontal strip). An issuer can also pass off all or part of the retention requirement to an unaffiliated B-piece investor, which can take down a horizontal strip or the horizontal portion of an L-shape strip.

If an issuer uses the vertical-strip structure, 95% of each bond class — including the junior tranches — is not subject to any hold requirements and can be sold at any time. So the B-pieces of those deals are tradable (except for the 5% portion retained by the issuer).

On the other hand, when the horizontal-strip or L-shape-strip options are employed, the junior classes are subject to long-term holds, effectively for the 10-year lives of conduit deals. So those B-pieces can’t be traded.

Last year, 64.5% of conduit issuance had non-tradable B-pieces, while the remaining 35.5% had tradable junior portions.

KKR was the most-active buyer of the non-tradable variety. All 12 of its purchases were from deals using either the horizontal-strip or L-shape-strip options. Those transactions totaled $10.9 billion, or 35% of the non-tradable total. Rialto was second, with six purchases from issues totaling $5.7 billion, followed by Silverpeak (five acquisitions from deals totaling $5 billion).

Rialto was the top buyer of tradable B-pieces, taking down eight from deals totaling $7.2 billion, or 42% of the tradable total. Prime Group was second (three purchases from deals totaling $2.7 billion), followed by Eightfold (two purchases from deals totaling $2.4 billion).

Risk retention introduced a long period of price discovery, as buyers had to gauge new market levels for both tradable and non-tradable B-pieces. That contributed to an inflow and outflow of investors. In addition to Silverpeak, three other shops that had not acquired any B-pieces in 2016 jumped into the market last year: MassMutual (two deals), Colony NorthStar (one) and Resource Capital (one).

But seven third-party purchasers dropped out: Torchlight, Ellington Management, Och-Ziff Capital, Seer Capital, Basis Investment, World Class Capital and Raith Capital.

Why the mass evacuation? Some investors said yields were too low for both types of B-pieces: Non-tradable bonds were not providing high enough returns to compensate for the illiquidity, and tradable bonds drew enough competition to push yields down to unacceptable levels.

Some market pros expressed concern about the highly concentrated field of buyers in the non-tradable sector. Last year, the top-three buyers accounted for 69% of the non-tradable activity, and only six different shops bought at least two non-tradable B-pieces.

“Right now, issuers have a three-bid market for most deals, and that works fine,” said one industry veteran. “But if it goes down to a two-bid market, that would be very different” because buyers would have more clout to reject specific loans in collateral pools and negotiate lower prices.

“The dealers have a fallback position, which is to retain the bonds themselves, and that gives them some breathing room,” the veteran said. “But that may change over time — some banks may get resistance internally to taking on those bonds.”

Risk retention has created varied and confusing ways of tracking the B-piece market. This ranking, as it has traditionally, gives buyers credit for the full amount of transactions, not for the face amount of acquired bonds — a figure that cannot be determined across all transactions. The proportion of purchased bonds is not equal across deals and has become even more varied under risk retention. The buyer of the horizontal portion of an L-shape strip might take down only the unrated and single-B classes of a conduit deal, while the buyer of a horizontal strip might buy all of the classes from unrated up to triple-B-minus.

On Jan. 5, Commercial Mortgage Alert published a ranking of the parties that took down risk-retention bonds last year, based on the face amount of the bonds. That ranking included both senior and junior bonds. Firms that took down the B-pieces of horizontal-strip and L-shape-strip deals led the way. KKR topped the ranking with $948.8 million of retained bonds, followed by Rialto ($562.3 million) and Silverpeak ($516 million).

Separately, Midland won the most special-servicing contracts last year, taking back the annual crown from Rialto. Midland had an 18.9% market share, followed by KeyBank (13.7%), Aegon USA Realty (13.5%), Rialto (13%) and Wells Fargo (12.7%).

The special-servicer and B-piece rankings are related, because B-piece buyers control the appointment of special servicers. Some B-piece buyers, including Rialto, steer the servicing contracts to their own special-servicing platforms. Buyers that don’t operate such platforms hire third-party special servicers — and that was key to Midland’s strong performance. The PNC unit’s business included servicing contracts on conduit deals from two active buyers, KKR and Eightfold.

KeyBank’s second-place showing stemmed largely from its contracts on single-borrower offerings.