Shopping the B-piece is an integral part of structuring a CMBS transaction. However, with more than a few of the more traditional B-piece investors exiting the market in the last down cycle, B-piece buying became more opportunistic. As CMBS market fundamentals improve, the sector is bound to see the return of the more traditional mezzanine investors, sources said.
Traditional B-piece buyers underwrite lower tranches in CMBS transactions. They are capable of working out loans that go into special servicing for the best recovery value. "As a controlling class, they have the right and skills to work out the loans for the best outcome," said Ron D'Vari, co-founder and CEO at New Oak Capital.
However, last year much of the mezzanine appetite came from the more opportunistic players that have been attracted to the newly originated mezzanine loans underwritten based on today's valuations and stabilized net operating incomes.
According to Barclays Capital analysts, most B-pieces from 2010 conduit deals have been absorbed by a few buyers - BlackRock, Elliott Management, and H/2 Capital Partners. The analysts said that there was only one known instance so far where special servicer Rialto Capital Management - a newcomer in the special servicing industry - acquired the B-piece.
"They also consider mid to lower tranches of specific CMBS to both achieve reasonable interest-only yield with the upside option to become controlling class and have access to the special-serviced loans," said D'Vari.
In January, BlackRock reportedly acquired the non-investment-grade tranche of the $2.9 billion commercial mortgage-backed securities deal from Deutsche Bank Securities, UBS and Ladder Capital. The B-piece made up 6% of the deal, or about $174 million.
Barclays analysts said it is critical that more of these traditional B-piece buyers associated with special servicers re-enter the market. At the moment, however, these special servicers are handling, according to analysts' estimates, about 50%, or $60 billion, of the loans transferred for special servicing. They estimated that this is the case for the six largest special servicers in the conduit universe - this includes LNR, CWCapital, C-III Asset Management, Berkadia Commercial Mortgage, Midland Loan Services and JER Partners.
D'Vari said that as the CMBS market recovers, it is likely that more traditional B-piece and B-note buyers will begin to invest in the new B-pieces and mid-tranches of CMBS transactions, although at a lower implied leverage level. "A bottoming in fundamentals, lower loss estimates and an accommodative [Federal Reserve] justifies going down in credit to mezzanine classes across a wider swathe of mezzanine bonds, in our view," wrote Bank of America Merrill Lynch analysts in a report.
Some of the recently launched commercial mortgage REITs that might sponsor CMBS deals and take down B-pieces could include Starwood Property Trust, Colony Financial, CreXus Investment Corp. and Apollo Commercial Real Estate Finance. "It's important to note that some of the new names we may see in this space aren't really new kids on the block, just new outfits worn by veterans who really understand this segment of CMBS," D'Vari said.
The return of these more traditional buyers will help support the growing CMBS volumes in 2011. BofA Merrill has predicted that issuance will fall within the range of $30 billion to $40 billion in 2011, and Moody's Investors Service said last week that it projected a $37 billion market.
There is a tremendous amount of capital to take on these mezzanine positions in loans, said Greta Guggenheim, co-founder and president of Ladder Capital, at the Urban Land Institute forum on capital markets in January. In originating high-LTV loans, Ladder will go up to 80% LTV. "We will securitize the first mortgage," Guggenheim said, and sell the remaining 15% to 20% LTV piece to mezzanine investors.
D'Vari said that 2011 should prove to be a busy year for CMBS origination as it has been slated to be one of the highest refinance years as a result of the maturing CMBS loans.
According to BofA Merrill, the balance of (non-defeased) CMBS loans set to mature in 2011 is approximately $55 billion across all deal types, up from $50 billion of 2010 maturities.
"If the machine doesn't open up, the market as whole could be in trouble," D'Vari said. "And in most cases we will see better loans with more stable properties. The pools will have much less single-use and secondary or tertiary zone loans and more corporate-like lease structures with longer lease terms, hence more stable cash flows."
