CMBS Risk Retention Rules
In anticipation of the impending rollout of risk retention rules for commercial mortgage-backed securities issuers under the Dodd-Frank Wall Street Reform and Consumer Protection Act by years-end, a new bill has been put forth. This bill, called the the Preserving Access to CRE Capital Act of 2016, aims to help ease some of the regulatory restrictions CMBS issuers feel may constrict, or even destroy, the market.
“Many have seen the disappointing CMBS issuance number over the year as a bad sign.”
An economic cooling
Under Dodd-Frank, risk retention for all classes – including CMBS – requires sponsors to hold 5 percent of the risk of any deal brought to the market, with the bill taking full effect on December 24, 2016. The bill is designed to discourage the risky lending that led to the housing crisis by forcing issuers to retain interest in bonds. Simultaneously, this has created an economic cooling where loan volume has fallen and interest rates remain high. Many have seen the disappointing CMBS issuance number over the years as a sign that lenders are afraid to trifle with the product in anticipation of the legislative change.
This slowdown has had serious global consequences. Dramatic fluctuation in the global bond markets and the shuttering of mid-sized CMBS lender Redwood has many economists and industry experts concerned about the health of the CMBS market.
“We have concluded that the challenging market conditions our CMBS conduit has faced over the past few quarters are worsening and are not likely to improve for the foreseeable future,” wrote Redwood CEO Marty Hughes when the lender closed its doors in February. Other voices have been spreading a less dire, more perplexed sentiment.
“It’s definitely a big topic. Even as early as December of 2015 people started to express their concerns over it,” Sean Barrie of CMBS research company Trepp told The Real Deal. “It will make CMBS lending a more tricky outlet.” He added that smaller issuers are likely to be hit hardest by the new rules.
The Preserving Access to CRE Capital Act was introduced by Arkansas Republican Congressman French Hill, who insists the purpose is to “help ensure continued liquidity and affordable financing options for CRE borrowers.” Specifically, the bill targets compliance for single-asset/single-borrower (SASB) CMBS and allows them exemption from the rule taking effect in December.
“The bill aims to enable more CRE loans to become qualified.”
“The bill would exempt SASB from the 5 percent risk retention requirements altogether,” Richard Jones, partner at Dechert, told SCi. “The retention rules don’t have such an exemption right now, but these loans are high quality with low LTVs, often cut at investment grade. There’s not the sort of risk in this type of loan to justify a 5 percent risk retention.”
SCi asserts that Jones’ statement rings true for S&P who claims no single-borrower class has taken a material loss since 2009. With softening criteria for qualification, the bill aims to enable more CRE loans to become qualified and allow certain interest-only loans to qualify for exemption, as well as allowing loans with amortisation schedules of 30 years or more. Finally, it would allow B-piece buyers to hold their retention interest at 5 percent via a senior/subordinate structure with a more senior investor.
“The B-piece market is robust in the US and so it doesn’t need the disruption,” said Jones. “But the issue is that the current buyers will not get the yield their business requires when the 5 percent almost certainly requires them to pick up an investment grade piece. At least with the option to tranche the risk retention piece, we get the government’s retention goals met in a transaction structure the market will fund.”
The bill has currently reached the Senate, with Congressman Hill letting SCi it has received “a positive response, with strong bipartisan support.”