Editor's note: This is the second in a series of 10 articles revisiting some of our most-read stories of the year. The first can be found here.

Risk-retention and other regulations under the Dodd-Frank Act have led to subtle but significant changes in the way commercial properties are financed in the securitization market.

Large trophy office buildings, shopping malls and hotels are typically funded in this market because the exposure would be too big for any one bank or insurance company. Their size dictates that these mortgages either serve as collateral for a single bond offering or be split into multiple notes collateralizing two or more transactions on a pari passu, or equal-footing, basis.

But the Dodd-Frank rules forced a number of CMBS loan originators to exit the market, resulting in a decline in the average size of CMBS deals backed by multiple loans, known as conduits. As a result, even some not-so-large loans are being carved up into smaller, bite-size pieces.

“It used to be there was no problem putting a $100 million loan into a conduit,” said Erin Stafford, a managing director at DBRS. “But the average conduit transaction is now around $1 billion,” limiting the size of loans that can be used as collateral without increasing concentration risk of a given pool.

General Motors Building
Bloomberg News

One problem with the trend of pari passu issuance is that when these loans go bad, as some surely will, workouts will inevitably be more complicated than they would be for a whole loan.

In the meantime, pari passu loans have become so endemic that investors putting money to work in more than one CMBS conduit need to pay close attention, lest they end up placing bigger bets than they want.

In one example, a $325 million mortgage on the Fresno Fashion Fair Mall, in Fresno, Calif., was split into six notes, ranging in size from $39 million to $80 million, placed in as many conduits between October 2016 and March 2017, according to DBRS. The loan, which the property owner Macerich Co. obtained from JPMorgan Chase and Societe Generale, is backed by 536,093 square feet of the 957,944-square-foot shopping center.

Very large loans, those over $250 million, can still be securitized on their own. Goldman Sachs completed a number of these transactions, which are known as single-asset, single-borrower CMBS, including a $465 million mortgage backed a portfolio of 10 office properties in Houston (in April) and a $350 million mortgage on 485 Lexington Avenue, a 32-story office building in midtown Manhattan (in February).

In some cases, however, lenders are breaking off relatively small pieces of these large loans to be used as collateral in one or more conduits. In June 2017, real estate investment trust Boston Properties obtained a $2.3 billion mortgage on 767 Fifth Avenue in New York, an iconic property better known as the General Motors Building, from a group of four banks. A $1.35 billion portion of this loan was used as collateral for a single-asset securitization; smaller portions have been used as collateral in at least three conduit transactions.

There’s another reason for investors to be aware of pari passu loans in conduits: These loans, which typically have relatively low leverage, can be used to offset much higher leverage in other loans in the collateral pool, keeping headline loan-to-value ratios down – a practice known as credit barbelling.

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