On October 22, 2014, the federal regulatory agencies responsible for implementing regulations under Dodd-Frank finalized the risk retention rule for asset-backed securities (the “Risk Retention Rule”). For the securitization of multifamily loans, compliance with this rule is required beginning December 24, 2016. Securitizations for multifamily loans created before December 24, 2016 do not need to comply with the Risk Retention Rule requirements. While we will only discuss multifamily loans here, please note that the Risk Retention Rule applies to the securitization of residential (single family) mortgages beginning December 24, 2015. Also note loans originated through a state Housing Finance Agency (“HFA”) are exempt from the Risk Retention Rule.
On and after December 24, 2016, Section .7 of the Risk Retention Rule gives commercial mortgage-backed securities (“CMBS”) sponsors the option to satisfy their risk retention obligation by exercising the third-party purchaser option, which allows up to two third-party purchasers (“B-Piece Buyers”) to hold a pari passu portion of eligible horizontal residual interest (“B-Piece”). Below is a list of the requirements necessary if exercising this option:
- Each B-Piece Buyer must perform an independent review of the credit risk of each securitized asset, pay for the B-Pieces in cash at closing, without financing, and must not be affiliated with any party to the securitization transaction, other than the Special Servicer, investors, and originators of less than 10% of the unpaid principal balance of the securitized assets in the transaction.
- An unaffiliated “Operating Advisor” must be appointed, whose responsibility is to consult with the Special Servicer on any material decisions after the principal balance of the B-Piece has been reduced by principal payments, realized losses, and appraisal reduction amounts to a principal balance of 25% or less of its initial principal balance. The Operating Advisor is required to act in the best interest of the investors as a whole and has the authority to recommend that the Special Servicer be replaced.
- Sponsors must make certain disclosures to potential investors, including the name and form of organization of each B-Piece Buyer, a description of each B-Piece Buyer’s experience in investing in CMBS; a description of potential conflicts; the fair value of each B-Piece, the dollar amount to be acquired by the B-Piece Buyer, the purchase price paid for the CMBS interest, and other material information.
A B-Piece Buyer must comply with the Risk Retention Rule’s requirements concerning hedging of interest as if it were the retaining sponsor and may not transfer its B-Piece for 5 years following closing of the securitized transaction. After 5 years, the B-Piece may be transferred to a different B-Piece Buyer, who complies with the requirements of B-Piece Buyers generally. All subsequent B-Piece Buyers must comply with the transfer restrictions. When all mortgage loans in a CMBS transaction have been fully defeased, the risk retention obligation is terminated.