Pooling benefits are increasingly being removed from European CMBS as arrangers split pools into A/B portions or rake structure, with the A portion going to the CMBS issuer and the B portion sold as B-notes to parties outside the CMBS transaction. According to a report published by Standard & Poor's last week, this can have a negative effect on CMBS noteholders.
The absence of subordination adjustments within these A/B portions provide lower leverage within the CMBS transaction, which can have an adverse effect on noteholders. A traditional European CMBS transaction involves a pool of loans sliced into risk-weighted tranches. Each investor is exposed to risks of the combined pool of loans, with junior noteholders taking on greater risk.
Under a rake structure, if there is an exceptional loss on one loan and all of the remaining loans perform, the triple-B would suffer materially compared to zero loss in a traditional CMBS structure under a similar loss scenario. Any unexpected costs would also directly hit investment-grade notes in a rake structure.
Rating agency concern
S&P is concerned that under the intercreditor agreements legal costs or other shortfalls could short investment-grade notes in rake transactions. "The losses would not short the investment-grade notes in a conventional structure and, of course, as conventional structures do not have A/B splits, the risk of legal disputes in this area is largely eliminated," the S&P report explained. "We consider that the European CMBS market will show increased signs of maturity when the fad for cutting off European CMBS multiborrower transactions at BBB' passes."
The rating agency analysts added that these structures are simply not sustainable if investment-grade notes suffer downgrades and loss severity risks in the event that loan defaults start to rise.
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