Reuters IFR: Deutsche Bank launches US$609m large-loan CMBS; Also recap of GSMS GC5

NEW YORK, Sept 28 (IFR) -  Sole book-runner and lead manager Deutsche Bank is marketing a US$609.1m commercial mortgage-backed security this week backed by seven large floating-rate loans for 52 commercial real estate (CRE) properties.

The transaction, dubbed COMM 2011-FL1, was announced today and is expected to price sometime next week.

The collateral is comprised of 80% hotel and 20% "mixed use" properties, which could be a combination of both office and retail loans.

The largest loan backing the transaction is a US$225m loan for the Hotel del Coronado, a 757-room luxury hotel occupying1.5 miles of beachfront property located just west of downtown San Diego.

The second largest loan in the pool, at US$113m, is for The Standard Hotel in downtown Manhattan, which opened in 2008. The 18-story, 337-room hotel is in the trendy Meatpacking District and straddles the High Line, an unused elevated rail structure located on Manhattan's west side that has been transformed to a 1.5 mile long pedestrian walkway.

The industry refers to this type of offering as a "large-loan" CMBS, because it comprises fewer, larger loans, and hence offers less diversification than the typical so-called "conduit" CMBS, which consists of many more CRE loans, typically culled from a broader range of geographical areas.

Even during less volatile times, therefore, rating agencies have demanded more credit enhancement to protect the Triple A slices of large-loan CMBS, compared to their conduit CMBS counterparts. Less diversification means that a delinquency on one loan can have a more devastating effect on a transaction's performance, so rating agencies rate large-loans more conservatively.

That trend is even more exaggerated now, given the current global volatility that has recently driven issuers to offer risk-averse investors spread concessions in order to appease them and get deals done.

The COMM 2011-FL1 deal, for instance, is structured with a whopping 41.5% credit enhancement supporting the US$356.295m Triple A rated piece. That's even more conservative then the 30% credit enhancement that has become a recent requirement on conduit offerings.

Moody's, Fitch, and Kroll rated the transaction.

"The rating agencies have always required more subordination for large-loan CMBS, and given recent global volatility, I expect that they will require even more subordination now," said Marc Peterson, a senior CMBS portfolio manager at Principal Global Investors in Des Moines, Iowa. "I expect that this volatility will keep commercial real estate originations slow for the remainder of the year."

The advantage of a large-loan CMBS pool is that investors can more easily conduct due diligence on the underlying properties. Given how well known some of the hotel properties are, some investors view the COMM 2011-FL1 loans as relatively low-leverage and high quality.

Additionally, some buy-siders view a floating-rate, short-duration CMBS as an attractive alternative to the typical fixed-rate, longer-maturity conduits that have been more common in the market, according to securitization specialists.

Only a handful of deals are expected for the remainder of the year, according to market participants.
A conduit from Wells Fargo and Royal Bank of Scotland is likely to surface soon, as well as the second standalone deal from Cantor Fitzgerald.

A fourth-quarter CMBS from Deutsche Bank and UBS is expected as well.

GOOD DEMAND FOR SENIOR BONDS ONLY

Last week, co-lead managers and joint bookrunners Goldman Sachs and Citigroup revived and restructured a US CMBS conduit that the banks had originally pulled from the market, post-pricing, in late July. The deal was withdrawn after an S&P ratings glitch hit the CMBS market.

Some loans from the original offering were dropped and different ones were added, ultimately increasing the size of the new deal, GSMS 2011-GC5, to US$1.75bn from the original US$1.5bn. The July conduit was dubbed GSMS 2011-GC4.

Spreads on several Triple A tranches of the reconstituted offering tightened at pricing last Thursday. For example, the 9.55-year Triple A piece printed 15bp inside guidance at swaps plus 170bp.

In fact, the equivalent tranche of GC4 priced slightly wider at swaps plus 175bp on July 22 – although that deal featured 20% credit enhancement protecting the Triple As, whereas GC5 boasted the now-standard 30% protection.

The snug pricing illustrated investors’ increasing demand for the Triple A part of the sector. CMBS fell out of favor in August amid an aversion to spread product due to uncertainty surrounding the European debt crisis and S&P's downgrade of the US sovereign credit rating.

But issuers have had to offer a whole new paradigm -- referred to by some as "CMBS 3.0" --  to attract investors back to the asset class. CMBS 2.0 was the moniker given to the new breed of deals issued as the US CMBS market revived after the 2008 financial crisis.

In addition to the apparently bulletproof 30% Triple A credit enhancement, GC5 was also segregated into publicly and privately offered securities. This new structural template, designed to appease risk-averse investors, started with the Deutsche Bank/UBS US$1.3bn DBUBS 2011-LC3 transaction, which was priced on August 11.

The increased credit enhancement in the new format and the publicly registered classes have opened the securities to a much larger account base. All previous so-called CMBS 2.0 offerings were issued in the private market.

"Judging from the market’s demand for the new 30% Triple A public paper, we think this structure is here to stay and will hopefully become the standard for what we have been calling CMBS 3.0," wrote Harris Trifon, head of CMBS research at Deutsche Bank, in a recent article.

A majority of the collateral in GC5 was originally scheduled to be included in GC4. That deal was scuppered when S&P's shocking July 27 criteria review sent the CMBS market into a tailspin. It led the firm to withdraw ratings on two deals and suspend the assignment of all new-issue CMBS ratings. A grim global economic outlook compounded the uncertainty in the market, causing a third deal to be pulled from the new-issue market in August.

S&P's ratings review occurred because it discovered its new-issue ratings and surveillance teams used "conflicting methods" of determining debt service coverage ratios for rating CMBS deals.

Even before S&P's announcement, the beleaguered GSMS 2011-GC4 offering was controversial as investors lobbied the arrangers to increase the credit enhancement to 20% from the paltry initial layer of 14.5%. They got their wish, but it made no difference after the deal was pulled.

However, S&P staged a drastic U-turn several days later, saying that based on an initial criteria review, it would resume assigning ratings to new conduit/fusion CMBS transactions. It also found that its ratings teams actually used consistent methods.

Still, Goldman and Citigroup, not surprisingly, did not hire S&P to rate last week's current transaction. Fitch, Moody's and Morningstar rated it.

Lower-rated portions of deals have not fared as well. A US$243.2m privately placed portion of a larger JP Morgan CMBS conduit that surfaced in mid-September is still struggling to sell, despite the fact that the arrangers have revised price guidance wider two times.

adam.tempkin@thomsonreuters.com

Reuters/IFR: SEC conflict-of-interest ABS rule confuses more than clarifies

by Adam Tempkin
NEW YORK, Sept 26 (IFR) - A rule proposed by the SEC last week to prohibit the conflict of interest between deal arrangers and investors such as the one in Goldman Sachs' infamous Abacus CDO raises more questions than answers about what securitization arrangements will ultimately be permissible under the law, market participants say.
 
"The SEC has acknowledged that this is a grey area," said a managing director in the structured finance department of a rating agency, who requested anonymity since the SEC is involved.
 
"Distinguishing between the most egregious abuses of 'conflicts of interest', which is what the SEC is going after, and what is considered 'normal' risk-mitigating activities in the securitization markets, is an extremely difficult task."
 
The SEC nearly admits as much.
 
For most of the 118-page proposed rule now out for 90-day comment, the regulator asks for guidance from the market via detailed and open-ended questions.
 
"Are certain types of ABS more susceptible to conflicts of interest?" the SEC queries market participants.
"What are the key features of the securitization process that bear on the existence or significance of conflicts of interest between participants in that process and investors in the ABS?"
 
The SEC voted unanimously last Monday to propose a rule intended to prohibit certain "material conflicts of interest" between those who package and sell ABS and those who invest in them.
 
It is designed to ensure that those who create and sell ABS cannot profit by betting against those same securities at the expense of those who buy them.
 
One problem: The SEC refuses to define a "material conflict of interest".
 
"We preliminarily believe that any attempt to precisely define this term in the text of the proposed rule might be both over- and under-inclusive in terms of identifying those types of material conflicts of interest arising as a result of or in connection with a securitization transaction .. especially given the complex and evolving nature of the securitization markets, the range of participants involved, and the various activities performed by those participants," the SEC writes.
 
The conflict-of-interest proposal, therefore, is clearly just a starting point for the SEC, securitization specialists say. The agency is expecting a hearty response from industry lawyers.
 
MAKING EXCEPTIONS
 
The regulator also carved out exceptions to the rule, such as if parties to a transaction participate in risk-mitigating hedging activities, liquidity commitments, or "bona-fide market-making".
 
The new rule could prohibit a firm from allowing a third party to help assemble an ABS in a way that creates an opportunity for the third party to profit from its failure.
 
Although the SEC never mentions the Abacus CDO by name in the 118 pages, this aspect of the rule seems like a clear attempt to ban Abacus-like trades.
 
Goldman Sachs GS.N agreed to pay $550 million in July 2010 to settle civil fraud charges relating to its marketing of the Abacus 2007-AC1 CDO. Although the bank did not admit or deny any wrongdoing, it did acknowledge that it was a mistake for the marketing materials not to disclose the role of hedge fund Paulson & Co. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors.
 
Paulson was not charged at all.
 
"The SEC rule is reasonably well crafted to reduce this type of conflict of interest," said Darrell Duffie, a professor at Stanford University graduate school of business.
 
"By ruling out these types of conflicts of interest, however, it is also ruling out what some investors may want to do with bona-fide reasons, completely open-eyed. It's not a cost-free improvement in the law, and it may reduce the liquidity of the securitization market. The SEC itself mentions this tradeoff."
 
Indeed, the regulator acknowledges that there are a number of conflicts of interest inherent in, and possibly essential to, the securitization process. It refers to one commenter wholisted more than 20 categories of potential conflicts of interest that may be inherent in the ordinary course of securitization but, in the commenter's view, should not be prohibited by the SEC.
 
Examples include the basic risk transfer that occurs in structuring a securitization; the tranching of debt; risk retention; and providing financing through a warehouse line of credit.
 
MORE CLARITY NEEDED
 
Some say the SEC may be walking a fine line as it attempts to differentiate between transactions that have a clear conflict of interest and were designed to fail, and others that represent the desire of a fully knowledgeable party to take a point of view on a trade.
 
"Generically, our concern is that a general definition of 'material conflict of interest' may be hard to apply to specific areas of the market," said Tom Deutsch, the executive director of the American Securitization Forum.
 
"There are many potential conflicts in individual situations that we don't think should be prohibited under these rules without additional clarity.
 
"The devil is in the details."
 
One pressing concern is that a broad interpretation of "material conflicts of interest" could prohibit mortgage servicers from pursuing customary servicing activities, including loss mitigation efforts such as loan modifications under the Home Affordable Modification Program (HAMP), he said.
 
If a loan servicer holds a subordinate tranche of a securitization, for example, this can be construed as an inherent conflict of interest.
 
In a statement released on Friday, Fitch Ratings said that it is concerned for the potential for confusion among market participants between true conflicts and certain normal hedging or risk management practices.
 
"The securitization market's recovery remains fragile," said Ian Linnell, group managing director of Fitch's structured finance group. "There remains the risk that multiple layers of regulation may become burdensome for certain market participants."
 
Moreover, Stanford University's Duffie suggested that this rule, by itself, may ironically not apply to Goldman's specific role in the Abacus CDO, since the bank was actually on the long side of the trade, and did ultimately take some losses.
 
Every example cited by the SEC in its proposal references situations where a party shorts a transaction. Paulson & Co shorted the Abacus CDO, yet was not sued by the SEC; Goldman was not directly involved in the short side of the deal -- unless one makes the argument that it received a fee associated with Paulson's participation.
 
Some market participants will likely also demand more concrete examples of what it means to be a "liquidity provider" or "market maker" in a transaction -- two statuses that exempt deal participants from the rule.
 
As a theoretical example, had Goldman Sachs merely taken a position on a trade in order to allow the deal to go ahead and meet the needs of a client -- in a liquidity provider role, for instance -- the bank may actually be protected under this new rule, Professor Duffie said.
 
"The rule might actually serve to protect intermediaries in situations where it can be shown that they are just providing liquidity services," he noted.
 
(Reporting by IFR senior analyst Adam Tempkin)