Bracketed with its riskier RMBS cousin, the CMBS market has been hit by new risk retention rules. Al Barbarino explains how the effects may yet be mitigated.
Dodd-Frank risk retention rules set to come into effect later this year continue to cast a cloud of gloom over the stalling CMBS market, but there’s hope that, if passed, a new bill will lift some of the burden.
As part of the current rules, starting in late 2016 CMBS issuers will have to retain a 5 percent slice of every new deal they issue – or designate a B-piece buyer to take on that risk. This slice is much higher than what B-piece buyers typically purchase from a deal, which is around 2.5 percent.
The rules have led to uncertainty for CMBS lenders in structuring and pricing capital. B-piece buyers would be required to buy as high up in the credit stack as single A, making yield targets more difficult to achieve and ultimately leading to wider spreads on those additional bonds and forcing lenders to increase coupons, as Trepp senior managing director Manus Clancy recently noted.
The bill proposed in February by Congressman French Hill of Arizona, the Preserving Access to CRE Capital Act of 2016, would exclude single-asset, single-borrower (SASB) CMBS from the rule as well as all other “Qualified Commercial Real Estate” loans that are conservatively underwritten, modifying the criteria to allow roughly 15 percent of the best quality loans to qualify. It also allows B-piece buyers to use a senior/subordinate structure.
A brief from the CRE financial council states that QCRE loans have experienced superior historical performance and accuses regulators of taking a “one size fits all” approach, punishing CMBS for the shortcomings of its residential counterpart, RMBS.
“These loans have posed no threat to the system, with historical loss ratios as low as of one-half of one percent (0.5 percent),” CREFC states regarding SASB loans. “Due to the contentious nature of the rulemaking, [CMBS] were ‘caught up in the wash’ while the agencies’ focus was justifiably on residential mortgage-backed securities [RMBS].”
Currently, according to CREFC, more than 90 percent of residential loans would be deemed as QCRE, whereas only 3 to 8 percent of commercial loans would. The bill charges that risk retention regulators failed to properly analyse market data, wrongly assuming that longer duration meant a safer loan, that interest-only loans meant a riskier loan, and that amortisation was the key to loan performance.
“Despite empirical data demonstrating a stellar track record and unparalleled transparency, CMBS was treated more like a sub-prime, high-risk product than a proven, prime borrowing option,” according to CREFC.
The realities of risk retention have been particularly unsettling to CMBS lenders which are already finding it difficult to compete after a months-long lull. As we’ve previously 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.
In addition to CREFC, the Appraisal Institute, the National Association of Realtors, the International Council of Shopping Centers and the US Chamber of Commerce are all rallying behind the bill, sending a joint letter warning that without the bill “many smaller commercial markets across the country may not be able to finance projects that could spur development and create jobs in the areas that need it most”.
The House Financial Services Committee has voted in favour of the bill and Martin Schuh, CRE Finance Council’s VP of legislative and regulatory policy, said his organisation is now “actively seeking Senate support for the measure”.
It could be at least several months before the bill makes it to the Senate, especially during a particularly contentious election year – but if and when it is passed, it could inject some desperately needed energy into a CMBS market feeling the pain.