The CMBS deal recently priced by Deutsche Bank and UBS was the first deal since the market crash to include publicly registered bonds (all other post crash securitizations issued private bonds using the 144A Rule).
This is a big deal. Most people agree that for the CMBS market to truly recover, we have to issue public bonds — because so many potential investors are limited to only buying publically registered bonds.
The Deutsche-UBS deal issued public bonds for the top 70% of the deal and private 144A bonds for the bottom 30%. While the deal reportedly found good demand for both the public and private bonds, the structure of the deal highlighted the fact asset-level disclosures were different for the public bonds versus the private bonds.
Since the crash and because all deals were 144A, the investors have been allowed to see and review sufficient asset level data to re-underwrite the underlying loans. This data has included appraisals, rent rolls, historical financial information, and issuers’ underwriting models. However, since the investors were typically operating under a confidentiality provision that is typical in private deals, the issuers were not worried about disclosing the information and conducting specific Q&A sessions with potential investors to answer asset-specific questions.
Issuing public bonds carries a much higher liability standard for issuers when it comes to disclosures. Information must be disclosed uniformly to all investors at the same time, and there is no ability for one investor to learn more about the assets than other investors. Also, if any information the issuer supplies to investors in a public deal turns out to be wrong or misleading, even if the information came from sources other than the issuer, the issuer can be held liable.
Since the Deutsche–UBS deal had both public and private bonds, the question came up whether an investor could buy both the public and private bonds. The answer was no. The reason is the investor who bought the 144A private bonds would have had more access to deal information than the public bond buyers. The concern is they could “use” that private 144A information to make a better decision on the public bonds. Since other investors who were buying only public bonds could not see the 144A information, that information advantage is illegal and is effectively insider trading.
Presumably this did not occur on the subject deal, and it is up to the investors and the issuers to police themselves to make sure the rules are followed. However, with this potentially serious conflict relating to disclosures, it seems like the structure used in the Deutsche–UBS should be improved on. Since at least some investors are demanding full disclosure, and we need the investor depth that the public markets can provide, something has to give.
Hopefully, the new Reg AB II rules that the SEC is working on will require the right disclosures for investors of all bonds but also protect the issuers against lawsuits regarding unreasonable disclosure liability. Also, there should be a few more public deals this year, so it will be interesting to see how other issuers address this potential conflict.
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Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.