A capital markets mortgage: A ratable model for Main Street and Wall Street

Real Property, Probate and Trust Journal, Fall 1996 by Joseph Philip Forte

Addressing the specific requirements of the various credit rating agencies in drafting the CMM, the Consortium required the borrower, in certain cases, to make certain representations and warranties as well as specific covenants regarding its SPE/bankruptcy remote status.37 In certain other cases, the borrower may be required to make warranties and covenants promulgated by the various credit rating agencies with respect to its principal's SPE/bankruptcy remote status, although the mortgage provision does not set forth any detailed representations and warranties beyond a mere cursory listing and intentionally does not set forth or sanction the credit rating agencies' "wish list."38 The CMM, however, does contain a specific default provision for the borrower's failure to maintain its SPE status.39 In the same vein, the CMM provides that a lender's consent to any transfer under the due-on-sale provisions may be conditioned upon, among other things, confirmation by the credit rating agency that "the transfer would not cause a downgrade, withdrawal or qualification of any Securities then rated."40 The provision assumes that any permitted transferee would have to be an SPE entity similar to the borrower. Regarding secondary financing, the CMM reflects the current credit rating agency preference for an absolute prohibition against any secondary financing.41 The CMM also expressly provides more detailed and specific requirements for the borrower's obligations to provide the lender with certain types of insurance regarding the property including minimum insurable amounts, limitations on deductibles, and special endorsements for such policies.42 Finally, the CMM imposes certain minimum credit rating agency standards for acceptable insurers.43

Access to and disclosure of information in the capital markets is critical to the securitization process. A growing appetite for property and borrower-specific information spawned by the losses accrued in the most recent national real estate depression, coupled with the continuing development of sophisticated computer data collection and retrieval systems in loan servicing, has fueled a feeding frenzy for information in commercial real estate finance.6

The development of the CMBS market has further accelerated the process of modernizing the information infrastructure with respect to the quantity, quality, scope, and type of information requested.46 The increased availability of such information, has caused the number of parties gathering and reviewing information to grow. In addition to the traditional participants, credit rating agencies, secondary market investors (senior, mezzanine, and subordinate), trustees and custodians, due diligence contractors and their respective attorneys, accountants, and other agents are involved in various stages of the process, whether the transaction deals with a whole loan, bulk sale, or sale of CMBS in a public offering or a private placement. Noninvestment grade investors, especially holders of the first loss position (the "B" piece buyer47), will have an even greater need for critical information regarding borrowers and properties.48 Without the comfort of an investment grade rating, noninvestment grade investors or their due diligence agents are compelled to review the borrower's credit and collateral to assure themselves of the prudence of their investments. Because of the inherent risk of the subordinate creditor position, the due diligence that they undertake may be greater than that of a primary mortgage market lender and similar to that of a junior mortgagee. This need for information does not cease after the loan is initially underwritten, closed, and funded. A CMBS, by definition, is designed to trade both the senior (the "A" piece buyer) and the B piece buyer. Current information is critical for prudent trading to occur.