CMBS are static pools of commercial real estate loans that are divided into classes with different ratings and varying levels of subordination that generally follow sequential pay structures. The most senior tranches of a CMBS pool are typically rated investment grade by rating agencies. B-pieces are the subordinate tranches of a CMBS issuance that have below investment grade ratings and, have historically comprised of 3%-7% of the transaction. The size of B-Pieces will increase in the future.
CMBS is held by a wide range of global fixed-income investors. Historically, investment grade CMBS bonds were typically purchased by a large number of insurance companies, pension funds, money managers and other institutional investors. Recently, due to the mark dislocation, more non-traditional CMBS investors have entered the market for investment grade CMBS. In contrast, there are a limited number of investors for subordinate tranches of CMBS.
The current real estate downturn requires extremely careful expertise, analysis and due diligence. The analysis of the subordinate tranches can require detailed due diligence on hundreds of loans within a few weeks. The holder of the B-piece faces the first loss in a CMBS transaction up to the face amount of its investment. In order to mitigate potential losses that could adversely affect returns, the subordinate investor must have an effective process in place to analyze every potential loan in the CMBS pool. This is especially true in today’s economic environment.
A subordinate investor’s reputation serves as a formidable barrier for entry into the B-piece acquisition market. This reputation is built up over years by successfully analyzing commercial real estate fundamentals and closing transactions. CMBS issuers typically transact with a limited number of partners that have over time demonstrated their capacity to analyze and close transactions efficiently and in a timely manner. CMBS issuers require certainty of execution for the disposition of these tranches. The B-piece represents a small but critical component of the securitization. A transaction’s AAA rated pieces cannot be sold without an in-place B-piece buyer. Therefore, the presence of an established B-Piece buyer will hasten the revival of commercial real estate securitization.
