The Commercial Real Estate Finance Council (CREFC) will urge regulators on the Senate Banking Subcommittee this morning to pass the Preserving Access to CRE Capital Act of 2016, also known as H.R. 4620.
The House bill, which passed the Financial Services Committee in March, would mitigate the impacts of risk retention rules that CREFC believes will not only further disrupt the struggling CMBS market but also the commercial real estate finance industry more broadly.
“Now that the CMBS market is exhibiting severe distress, and there is evidence of a negative feedback loop between poor liquidity conditions, lending rates and capital raising, the effects of regulation must be addressed, and done so quickly,” said Drew Fung, head of the Debt Investment Group at Clarion Partners and a member of the CREFC Executive Committee, in prepared remarks to be presented this morning to the Senate.
H.R. 4620 makes three adjustments to the risk retention rules: to provide an exemption for single-asset/borrower deals, liberalize the Qualified Commercial Real Estate (QCRE) parameters to allow roughly 15 percent of the best quality loans to qualify, and add flexibility in the structuring of B-pieces to accommodate a capital raising required to meet risk retention.
Fung noted that “CMBS is experiencing severe pricing volatility, a marked contraction in issuance and reduction in capacity,” warning that CMBS “represents a core source of capital that cannot easily be replaced.”
Risk retention have been particularly unsettling to CMBS lenders who are already finding it difficult to compete after a months-long lull. As we’ve reported, Morgan Stanley lowered its issuance estimate earlier this year from $100 billion to $70 billion, and Kroll Bond Rating Agency’s projection stands at just $60 billion, as addressed in our recent weekly column.
In 2009, CMBS issuance had collapsed to almost $0 from a height of $231 billion in 2007, but issuance rebounded to roughly $100 billion in the private label market last year. But if projections (which continue to decline) pan out, the industry could see as little as half that amount in 2016.
“When new issuance is halved in a single year, especially one in which there are significant refinance needs, it is realistic to expect a broader market disruption,” Fung said.
Many bank lenders are reporting intentions to maintain instead of grow loan levels, “which means that any reduction in the CMBS market should represent a reduction in capital availability across the sector,” he added.
In further defense of H.R. 4620, Fung noted that SASB transactions performed better in the depths of the crisis than most fixed income markets perform under efficient market conditions, noting an all-time cumulative loss rate of just 0.25 percent compared to 2.79 percent for conduit transactions (1997-2013).
Also, only a small percentage of CMBS loans would currently be considered as QCRE loans and exempt from the risk retention requirements. As the rules currently stand, “nearly all of today’s RMBS loans would qualify for an exemption,” yet “the qualifying conditions are so onerous that only 3-8 percent of all CMBS conduit loans written since 1997 would qualify for an exemption” from the core 5 percent risk retention requirement.
“This has little sense of proportion or compelling rationale,” Fung said.
Lastly, under risk retention rules, there are special rules for CMBS that allow a third party investor to purchase the B-piece. The risk retention rule allows up to two third-party investors to share the 5 percent burden, but requires them to hold their positions pari passu (horizontally). The proposed legislation would allow third-party purchasers to share the retention obligation pari passu or in a senior-subordinate (vertical) structure.
Up until now, US regulators responsible for risk retention have “[seemed] unwilling to meaningfully investigate the role that regulation is playing in the fracturing of markets, fund flows and the global slowdown,” Fung said. But a passage of the bill in the Senate could free up more capital during an already vulnerable and volatile period in the industry that CREFC believes will have impacts well beyond CMBS.
“Market participants are unanimous in their belief that regulation is driving much of the present strategic decisions, and the effects of that regulation are causing the market to grow thinner and more fragile,” Fung said.
Parts of the statement will be read during an open session to the Committee on Banking, Housing, and Urban Affairs Subcommittee On Securities, Insurance, and Investment during a hearing on “Improving Communities’ and Businesses’ Access to Capital and Economic Development.”