Rules requiring “skin in the game” of securitizations caused a lot of hand wringing in the commercial mortgage bond market last year. Participants fretted that a requirement to hold 5% of the risk in deals would increase funding costs, causing them to lose market share to other kinds of lenders, such as commercial banks and insurance companies.
Turns out commercial mortgage bond investors are big fans.
Investors think that risk retention will encourage tighter underwriting of commercial mortgages, something they believe is sorely needed.
“Anything that aligns the interest with investors is better,” said James Grady, a managing director and head of structured finance at Deutsche Asset Management, a panelist at the Structured Finance Industry Group’s annual conference. “I’d like 10%, but I’ll take 5%.”
Bob Behal, a principal and co-head of ABS and CMBS investments for Vanguard Group, agrees. “It’s helping stabilize market fundamentals and dynamics,” he said. “It’s slowed down some of the trends we were seeing and worrying about.”
The CMBS market certainly dragged its feet in coming to grips with risk retention, which took effect at the end of December. The first deal designed to be compliant was not completed until August.
And issuance is off to a slow start this year: So far there have been just four deals.
Yet all four have been very well received by investors.
There was some discussion at the panel of the relative merits of various methods for complying with skin in the game rules. Wells Fargo opted to hold a “vertical” in its first conduit offering of the year, the $634.9 million WFCMT 2017-RC1: It is retaining 5% of each class of securities to be issued, from the senior tranche to the most subordinate.
CMBS issuers also have the option of retaining a “horizontal” position consisting entirely of the riskiest securities. Behal noted that this provides a better longer-term “value-at-risk” metric for issuers, though it also involves higher initial costs. So far, no sponsor has been willing to hold this kind of a stake, though there has been one deal where a third party held a horizontal interest on behalf of the sponsor.