Deutsche Bank and JP Morgan stripped out non-bank collateral on their latest commercial mortgage bond issue before it was sold to investors, winning favour with the simpler structure in a market scarred by volatility and regulatory pressures.
The two banks dropped collateral from at least one non-bank lender by the time the US$818m deal was offered to investors last week, two sources with direct knowledge of the trade told IFR.
It was rebranded as a bank-only deal comprised exclusively of loans originated by the two banks, after the final line up of loans were signed off and headed for securitisation, sources said.
“It was not bank-only from the get-go,” said one of the sources.
The move marked a U-turn for an industry that until recently relied heavily on a swell of smaller, non-bank lenders to pad out their bond deals.
Behind the scenes battles have been brewing in the US$600bn CMBS market for months as high volatility and new reforms have put pressure on existing lending alliances between banks and non-banks.
Deutsche Bank’s prior deal in February, for example, included 19% loans from a single non-bank lender.
But this time around, pressure from B-piece buyers forced Deutsche Bank and JP Morgan to exclude any loans not lent by them, one of the sources said.
B-piece buyers purchase a deal’s bottom speculative grade securities in a bidding round that occurs before a pool of loans are finalised and securitised.
“I would say things began to change in the fall of last year,” said Warren Friend, an executive managing director at Situs, a commercial real estate loan servicer that analyses loan pools before they are securitised.
That was when a new reform rule called Regulation AB II took hold, which has since touched off a storm for non-bank lenders whose loans have faced heightened scrutiny by CMBS issuers.
New, non-bank lenders have proliferated in the past four years, as private equity and hedge funds chased fatter returns by making loans that big banks avoided in dicey areas of the property market. This saw the amount of loans from non-bank lenders packaged in CMBS transactions soar.
But the new rule, notably, for the first time put bond issuers on the hook if any information about a deal ends up being untrue.
“It made people start to think about where loans were being originated,” Friend said of the reforms.
In recent months, B-piece buyers have been dramatically shaping pools by liberally kicking out loans they deem too risky.
“In a few deals our loan rejection rate was more than 30%,” a B-piece buyer told IFR.
Simplicity wins
The simple structure chalked up a win for the banks involved as they were able to lower the pricing benchmark for CMBS after a painful period of relentless spread widening.
The biggest class of Triple A rated securities – the US$247.7m A4 notes – cleared at swaps plus 129bp, or 44bp tighter than Deutsche’s deal last month with non-bank loans, which pushed out pricing to new multi-year wides, according to IFR data.
The new CMBS was priced tighter than whispers across its tranches, making it the tightest print this year.
The A4 notes were talked at the swaps plus 132bp area, for example. Even its riskier US$38.9m piece of BBB–/BBB(low) rated securities was priced at the tight end of the swaps plus 600bp–625bp talk. This compared with an eyewatering 825bp spread on Deutsche Bank’s prior CMBS print.
Some said the absence of non-bank loans drove demand for the deal. The issue pooled 33 loans, of which Deutsche Bank contributed 81.4% and JP Morgan originated 18.6%, according to a Moody’s report.
Its positive outcome was a rare bright spot in a market struggling to find its feet.
“We think about eight more conduit deals may come to market through May,” Credit Suisse research analysts Roger Lehman wrote on Thursday.
“From then, however, we may not see any conduit transactions, through the end of the second quarter.”
Volumes for newly completed deals are being forecast at just US$40bn–$60bn this year, a major drop from the US$100bn annual output seen in the past few years.
Start of a shift
The significance of two major investment banks standing by the sector through tough times was not lost on investors.
“Big banks are making a statement that they are standing by deals and coming to market despite volatility,” said one portfolio manager. “That certainly doesn’t hurt.”
The trade is expected to be the first in a new series of CMBS that JP Morgan and Deutsche Bank plan to jointly sell of entirely their own collateral.
The next “from scratch” deal from this pair of investment banks is likely to be some four weeks away before it comes to market, one of the sources said.
Even while the sector is back to basics with this new bank-only deal, it may not cure the ailing market, the B-piece buyer said. “Believe me, banks make crappy loans too.”
