One of the readers of our blog, Commercial Real Estate Loan Tips, asked, "What is a B-piece buyer?" (You are encouraged to send an email to us with your commercial real estate loan questions.)
When commercial real estate loans are securitized, the individuals commercial mortgage loans are put in a trust. The trust then issues bonds secured by the commercial real estate mortgages in the trust; i.e., the bonds are backed by the commercial mortgages. Hence the expression, commercial mortgage-backed securities (CMBS).
These bonds are then sold off in layers, known as tranches. Each tranche enjoys a different priority of payment.
The highest rated tranche, typically a AAA-rated tranche, is the first to be paid its interest and principal. The second highest rated tranche, usually the AA-rate tranche, is the second group of bonds to be paid, if the trust brought in enough money that month. Then there is the A-rated tranche, followed by the BBB-rated tranche.
These top four tranches are known as investment grade. Many banks, insurance companies, public trusts (example: Carpententer's Union Pension Trust) and private trusts (example: a trust set up by some industrial baron for his kids) are only allowed to invest in investment grade bonds. An investment grade bond is one that is rated BBB or better by Moody's or Standard & Poors.
Obviously bond investors will accept a lower yield on AAA-rated bonds than AA-rated bonds, and so on, because they are less risky.
Below the BBB-rated bonds are the BB-rated bonds, the B-rated bonds, and the bonds that are so risky that they are unrated. Collectively the bonds below investment grade (below BBB) are known as the B-piece.
It is the B-piece buyer who takes the most risk in a CMBS auction. The B-piece buyer is exposed to the first risk of loss. If anybody is going take a financial haircut, a loss of principal, it will be the B-piece buyer. Therefore the B-piece buyer is afforded great rights.
One of the rights afforded to the B-piece buyer is the right to kick loans out of a proposed pool of loans. "Hey, we're not going to buy the B-piece if you put THAT stinky loan in the pool." And if there is no one to buy the B-piece, the securitization fails. As a result, the B-piece buyer has a lot of power.
Once the loans in the pool are securitized (sold off to bond buyers as mortgage-backed securities), the B-piece buyer has a lot of say in how the loans are serviced (how the are payments collected). If a loan goes into default, it will be the B-piece buyer who instructs the special servicer on how to foreclose or how to arrive at a workout. The special servicer is a loan servicing company that specializes in handling loans in default. A workout is some sort of compromise between the lender and the borrower, short of foreclosure, that is intended to get the loan back to making regular monthly payments.
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