The CMBS market waited with baited breath for Financial Accounting Standards Board's draft of responses (in question and answer form) addressing industry questions about the limitations imposed on servicer activities in CMBS transactions. This draft was the result of oral discussions between staff and board members held on May 16.

Though still disappointing, the draft provided some relief in the form of an ancillary provision (known as question no. 8). This provision allows security holders to transfer assets to an entity that is not a qualifying special purpose entity provided that the transferor has "no continuing involvement with the transferred assets." Experts believe that the transferee in this case can still exercise the functions of a special servicer.

"The draft offers an elegant compromise between the desire of FASB to clarify sales accounting for financial assets and the practical business of CMBS issuers," said Michael Youngblood, head of real estate research at Banc of America.

Youngblood believes that this provision would likely allow most CMBS conduits to enjoy the benefits of having a special servicer through the creation of a non-qualifying special purpose entity.

"However, participants must clarify that this non-qualifying SPE may engage a special servicer (agent) that has discretion that CMBS special servicers have come to enjoy since 1994," Youngblood said in a report.

Though some measure of success has been achieved, it is still not the perfect scenario that industry groups hoped for when they met with the FASB sometime last month.

Many issuers would still want to service the loans or own one or two classes of CMBS transactions, actions that are not consistent with the ancillary provision that specifically forbids continuing involvement with the transferred assets. Some life companies, for instance, would often issue CMBS but would retain one or more classes because of asset, liability and yield requirements.

"When you consider question 8 of the ruling, it still seems unfair because it likely hits the issuer's balance sheet when they either service loans or retain certificates. It might make more sense if sales treatment were attached to both the servicing and origination of loans being retained as opposed to just either one of them," said Darrell Wheeler, CMBS strategist at Salomon Smith Barney.

But even then he thought the treatment was unfair as many B-piece buyers have that same interest in CMBS transactions and are not assessed ownership of the entire transaction. In addition, Wheeler said that "while the ruling initially appeared to be an improvement, the more the market considered the answers the more uncertain people became as to whether the answers provided relief. Unfortunately for issuers, several issues still appear to require further clarification such as whether a minimum equity rule will apply. But I think FASB's process is working as the entire market is paying attention. Hopefully all issuers will submit the issues for clarification before the June 1st deadline. At this stage I expect issuers are looking for just little more clarification and an improvement in the fairness of the sales treatment."

Affected companies

Sources say that the FASB issue would likely affect deals from companies who have in-house origination and servicing capabilities -such as GMAC, First Union, Chase, Banc One - as well as in-house operations that actually hold B-pieces, though this would likely affect only 10-15% of the market. Most issuers originate the loans but have a third party service them and buy the B-pieces.

"Right now the deals that have come to market don't have this issue, a lot of these deals have shelf registration so are not affected (by this issue)," said a CMBS investor. "However, for companies who are originators, servicers and B-piece buyers, if I were them I'd draw up some argument saying that we have Chinese walls in our company."

Learning curve and

unanswered questions

"At this stage there is still some uncertainty in the market as to how to interpret the initial draft of FASB's questions and answers on FAS 140," SSB's Wheeler said.

He added that the market has to await the formal Q&A publication after clarifications to know what the final rule will involve. But if FASB's response to question eight is upheld, it would appear that the only issuers who would now be impacted by FAS 140 are people who don't sell all of their certificates or those who service their own transactions.

"That's not to say that is no longer an issue," said Wheeler. This is because several issuers like to service their own transactions to maintain their relationship with the borrowers and at the same time many floating-rate transactions in the past have been done in a structure that enable the issuer to keep the bottom certificates as opposed to having to sell them.

This is why several people may be concerned about that loss of flexibility. Indeed, the market is in doubt, and remains confused.

"Here is the part I really don't understand," said the investor. "Supposedly you have the big five accounting firms look at the language that is presented in preceding documents and they kind of bought on it. I can't understand why the big accounting firms would be okay with it while FASB would not be okay with it. I'm still trying to understand that myself."

Adverse market reaction

And as the market tries to absorb the implications of FASB's response, the possibility of adverse market reaction is there, especially with continuing doubts about the lack of servicer flexibility," sources said.

"I think perceptions could possibly go out of whack," noted the investor. "If you have B-piece buyers demanding spread on the subordinate tranches and rating agencies who are demanding subordination because of the lack servicer of flexibility, the economics may start to fall apart."

Michael Hoeh , a senior portfolio manager at Dreyfus Corp., said though the impact would be felt mostly by institutions doing in-house servicing of their commercial loans, FASB's reach is really going to be felt across the industry: it can decrease the amount of available liquidity in the market and shrink the size of the new issue market by making people lose interest in the special servicing business.

"You may see some organizations just decide not to confront this whole quagmire of issues and back away from the market," Hoeh said. "You also may see the appetite for special servicing decrease."

He added that this may result in the elimination of some of the players and make it more difficult to sell the first-loss piece. Typically, the special servicer also owns the first-loss piece, and there's a very small number of institutions that bid for it. The FASB issue might further shrink the market.

However, it is just time and some learning before things start to fall into place again, sources say.

"There's is still a need for a lot of education in the market place for people to understand what the FASB is going after, what is their end result," said the investor. "In the long run, I think it's going to be taken care of."

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