US market view: What next for Dodd-Frank?

CRE lenders in the US are yet to brace themselves for a Dodd-Frank roll-back, writes Meghan Morris, the New York-based reporter of sister title PERE

US President Donald Trump has spoken candidly about his views on financial regulation: “Dodd-Frank is a disaster,” he said in February.

The policy implications of such sweeping statements, however, are less clear. Three months into the 45th president’s term, the real estate industry is still grappling with potential wide-ranging changes from immigration to tax reform. Yet, at the top of many investors’ minds, specifically those in the investment banking space, is
Dodd-Frank.

The Dodd-Frank Wall Street Reform and Consumer Protection Act 2010, was written by former US congressman Barney Frank and former US senator Chris Dodd in a bid to rectify the ills that US politicians and others identified as contributing to
the collapse of the financial industry in 2008.

Among the bill’s 390 rulemaking requirements and the regulations written off the back of them, many have contributed to more conservative commercial real estate lending practices at the top investment banks.

While Trump, a real estate entrepreneur himself, has occasionally touched on financial reform in broad terms, he and members of his staff have offered few clues about the future of the law. He signed an executive order in February ordering regulators to review Dodd-Frank, but since then little time in Washington has been spent on financial details, commercial real estate executives with ties to the capital say.

Nevertheless, expect that change is coming. The president is surrounded by Dodd-Frank critics, including Blackstone founder Steve Schwarzman and JPMorgan chief executive Jamie Dimon, who sit on Trump’s economic advisory council. Treasury secretary Steven Mnuchin, a former Goldman Sachs executive, has said Dodd-Frank is “too complicated”, and although he cannot repeal the law, as the leader of the Financial Stability Oversight Council, he has significant power over the group’s agenda in the future.

But for now, both political parties are paying closer attention to the more politically sensitive areas of healthcare, immigration and infrastructure than financial regulation reform.

Even previous attempts at reform are being tabled, at least for the time being. Texas representative Jeb Hensarling, the chairman of the House Financial Services Committee, introduced the Financial CHOICE Act of 2016 in June that would roll back many parts of Dodd-Frank. The legislation is said to have been shelved for now, with the committee taking on the issue of flood insurance instead.

“All of those topics are highly controversial and slow-moving,” says Lisa Pendergast, the executive director of industry group the Commercial Real Estate Finance Council.

“While we’re all preparing for important legislative and regulatory issues to make their way through the system over the course of the year, most have taken a step back with a growing understanding that none of this [financial reform] will happen as quickly as some might like.”

CREFC itself has not yet taken a position on Dodd-Frank reform. The group is currently surveying its members about how they want CREFC to advocate and is waiting to publish a policy agenda or approach lawmakers when results come back.

Focus on risk retention

Industry insiders say a likely area of change within the Dodd-Frank regulation relates to risk retention rules. Currently, any sponsor of an asset-backed security is required to hold 5 percent of the fair value of securities offered by an issuer, a rule which took effect in late December. William Stern, a partner at international law firm Goodwin, says risk retention rules do not directly limit commercial real estate lending, but rather constrains the extent to which banks can package loans in securitisations. The rules are intended to ensure that sponsors of securitisations, including CMBS, retain some ‘skin in the game’ and that the credit risk is not simply sold on to investors.

Some non-bank lenders play down the impact of risk retention requirements on their lending activities. Boyd Fellows, a co-founder of San Francisco-based private debt firm Acore Capital, said most firms keep significantly more than 5 percent of a loan in any event.

“With respect to the risk retention guidelines, in the vast majority of the cases of our investments, Acore retains approximately 30 percent of any loans we originate, which is well above any risk retention requirements,” Fellows says.

After more than three months in place, the risk retention regulations do not appear to have led to a pullback in debt issuance for the investment banks, CREFC’s Pendergast says. In fact, credit quality has actually improved as a result, she suggests.

“The concern always was that risk retention would drive up borrowing costs and that could make CMBS issuers less competitive and drive borrowers more toward portfolio or alternative lenders.

“What we’re learning is the strong demand for the bonds and therefore the sound pricing level for these bonds is translating into only a marginal increase in coupons for commercial real estate and multifamily borrowers. I think that’s a positive development for all of commercial real estate because it doesn’t exclude the investment banks from the list of lenders that commercial and multifamily real estate owners who borrow in the US go to.”

One small potential area for change, Pendergast highlights, is allowing an exemption from the risk retention requirement for single-borrower CMBS deals secured by large trophy properties underwritten by low leverage.

Basel looms

While Trump’s rhetoric surrounding Dodd-Frank has focused the attention for some real estate practitioners, others point to looming regulation from the Switzerland-based Basel Committee on Banking Supervision as likely to have a bigger impact on lenders.

Introduced in December 2010 and staggered into implementation in the years following, the Basel accords have been responsible for regulating capital requirements with full implementation of the latest revisions – known as Basel IV – expected in 2019.

The rules force banks to hold more cash reserves to account for anything that falls into the ‘high volatility commercial real estate category’.

Having to keep this extra risk retention capital has limited the real estate lending capacity of some of the property sector’s most historically ensconced lenders and given opportunity to a new order of loan issuers.

Goodwin’s Stern argues that Dodd-Frank does not explicitly limit commercial property lending, per se. The focus, Stern argues, is more on asset quality and capital retention: “There are a lot of provisions in Dodd-Frank that the financial services industry in general would like to see rolled back or that were expensive and disruptive to have to comply with, but I don’t know that they directly affect commercial real estate lending.”

In any event, repealing or rolling back Dodd-Frank, which requires a congressional vote, would be challenging at best, says one unnamed chief executive, who lobbied to shape Dodd-Frank.

Likewise, John Klopp, who heads Morgan Stanley’s real assets division, told the 500-plus audience at the PERE Asia Summit in February that he did not expect US reforms, including Dodd-Frank, to greatly impact the private real estate sector in the
short term.

“Is [Trump] going to vaporise regulation overnight?” Klopp asked. “I don’t think so. I just don’t anticipate everything created post-global financial crisis will be repealed. I just can’t see that.”

As such, if, against most predictions, the Trump administration does tackle Dodd-Frank in the coming months, resulting legislation may not change investment banks’ lending behaviour.

The stricter internal controls many investment banks have adopted voluntarily post-global financial crisis will continue to keep many of the players who were burned by risky loans during the GFC out of the space, some argue. With no shortage of private equity real estate debt funds and boutique debt providers popping up in recent years that provide plenty of sources of financing, borrowers have little reason to worry, either.

As Stern says: “Even if certain aspects of Dodd-Frank are rolled back, the genie’s out of the bottle. We’ve put in place these new and improved rules and just because they’re magically taken away, it’s hard for people to say we’ll go back 100 percent to how we were doing before. Many people think Dodd-Frank went too far, but to some extent they recognise that something needed to be done.”

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