Changes In The Structure of Commercial Mortgage Backed Securities Transactions

It was reported in Law 360 (May 6, 2014) that there have been some significant changes in the way CMBS transactions are structured.  In the hot CMBS market prior to 2008, standards and due diligence became, shall we say, a bit slipshod.

The United States CMBS market all but dried up in 2009 as issuance totaled less than $3 billion in 2009, down from more than $200 billion a couple of years earlier. Needless to say, investors had grown more cautious. Since that time issuance has grown steadily and the first quarter saw issuance of more than $20 billion according to the Pension Real Estate Association.

But things have changed materially. The structure of deals has become much more conservative. Some old methods are being redeployed to make the financing more secure. For examples, underwriters are requiring cash management accounts (CMA)  to control the flow of cash, less creativity is being employed in packaging the loans. Loan-to-value ratios are still a lower levels than was the case before the crash. But as the number of deals start to increase again, it remains to be seen as to whether the deal structuring teams will become more aggressive again.

Here follows some of the changes in deal structure that have, for the time being, survived more aggressive structures.

Lenders, in search of more security, have been insisting on CMAs to be associated with the loans. The concept is pretty simple, rather than the cash going directly to the borrowers (mortgage receipts, etc.), cash management accounts are the first stop. This “bullet proofs” the structure avoiding any third parties getting their hands on the cash before the lenders.  Nothing new here but in the “old days” these structures were deemed unnecessary and redundant.

“One thing that we’re seeing now that we did not see pre-2007 is cash management is required in almost every deal. On the biggest deals where you would sort of expect it, down to the smaller deals.,” said Stephen P. Lieske of Allen Matkins Leck Gamble Mallory & Natsis LLP.  “Virtually every CMBS deal is requiring cash management. Cash management seems to have become the norm. .. It’s lenders saying, “We want to maintain a bit more control over the money”.

Each deal will likely have a different cash management structure. In many cases, the lenders will not touch the funds in the CMA unless a certain triggering event occurs such as a covenant breach.

The lenders are looking for more control. The concept was called a “lock box” in past banking times (10 years ago). Th cash management structures will now be in favor of the lender, protecting them from loss as much as possible.

Lawyers have seen less creativity in deals. Less “pushing the envelope”. Lending guidelines are being more strictly followed. Structures are more conservative. With the caution comes closer examination of individual properties (a sound practice you would have thought for commercial real estate lenders). Clearly the underwriters have felt the pain associated with the underwriting standards in 2008 and prior,” Loeb & Loeb LLP’s Thomas F. Hanley said. “They are much more closely scrutinizing each loan transaction. It’s brought more sanity into the process.”


Another part of scrutinizing the individual transactions is doing more research on geographical markets. Although prior to the crash, such research wasn’t necessarily made a priority by any stretch. It’s now a more important part of lender due diligence.

“I’m seeing significantly more prudent underwriting,” said Matt Case of Madison Partners. “Much more emphasis on the market that the properties are in…I’m seeing much more diligence.” Unfortunately that was not the situation a few years ago. “Any underwriter could grab some figure. They never really dug into the nuance of the market,” Case said. “Whatever the case might be, as long as they could get a few data points, it wen through approval. ” “CMBS lenders are being smart, Lieske said. “CMBS lenders are being careful about what they are doing. What I’m seeing is an awful lot of thought going into each of the deals.”

Documentation has become more complex. In particular, the number of so-called bad boy carve-outs-exceptions to the non-recourse nature of the loans has grown considerably. This has trickled down to smaller loans.

And lastly, loan to value rations remain lower than pre-crash.  It now ranges around 70%. Some go to 80% but the deals are more complex. Mezzanine financing fills the gap. This was unnecessary prior to 2008.  Unfortunately greater competition for these deals seems to be swinging the pendulum back.

Hopefully we will not go back to the “not guts, no glory” days prior to 2008. But somehow I doubt it. We seldom learn and greed trumps caution. It comes back to the same issue, lenders need to be more prudent and exercise greater due diligence before pulling the trigger. The problem is that no one gets paid for saying no. No one has really satisfied me that at the “top of the house” doing deals is far more important than saying no. No bonuses and no promotions will come in the absence of booking deals. One issue that still needs to be looked at very carefully is whether the banks and investments banks not withstanding new rules and regulation have to much “lazy capital” above and beyond the regulatory capital requirements. I would venture to say that major financial institutions prior to 2008 were long capital and short investment opportunities. There is little reward for having low risk weighted low return assets on the books. No matter what happens the bills are never paid with prudent lending. The organizations all have bills to pay. Low return low risk assets may in many cases simply not generate enough cash to keep the lights on and feed all those that need to be fed.

Financial institutions in order to attract capital must generate ample returns on equity and returns on assets. Absent tat, CEOs will no be generously compensated for a falling or stable stock price. Let’s get real. We still live in a primarily capitalistic society with capitalistic imperatives. Growth. The problem has from time to time been growth at what cost. It all goes back to each organizations corporate strategy and mission statements. It would be useful to go back and look at what AIG’s and AIG Financial Products’ corporate strategies were. I would suspect that prudence was not high on the list. A discussion worth having at another time. Large financial institutions, especially those taking deposits, have a fiduciary responsibility to their depositors. Why was no one held accountable for the breach of those fiduciary responsibilities?

So stay tuned to this space and let’s see what happens in this robust stock market environment.  Will banks and investment banks be able to resist their old ways or will they find new (old) way to get where they need to go. I think that in the end we will go back to “too big to fail” to eventually save those who should not be saved. To this day, the perpetrators of the enormous losses suffered by investors have walked away “Scot Free” in almost all cases. In the absence of those who brought us there being forced to disgorge the fruits of their “labor” not much will change. Why should it?

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