Pat Sargent, partner in Alston & Bird’s Finance Practice, offers his thoughts on the new Dodd-Frank credit risk retention rules, their effect on the CMBS market and what they will mean to lenders. Pat will be a featured panelist at the upcoming Financial 411 webinar on February 12th.
How are financial institutions preparing for risk retention?
The good news is that we finally have guidelines and instruction, so institutions are no longer in the dark as we have been for four years. The bad news is that securitization will cost more and be more complex. Institutions and trade groups (such as CREFC) are working to prepare for compliance with the rules that will take effect in the fall of 2016, so we have some time to work on the structural, reporting and disclosure changes.
Do financial institutions see the cost of credit increasing due to the changes they have to make?
Yes, and it seems to favor the large institutions that have the capital. The higher cost will take the form of increased transaction expenses as well as credit cost now that the B-piece buyer(s) will have to acquire a larger portion of the stack—i.e., 5 percent of the fair value of the deal rather than 5 percent of the par amount of the bonds. That means they must buy 7-9 percent of the bottom, and there will be an economic impact to securitizers. However, it will likely be passed on so that borrowers can expect to pay the estimated 20-40 bp increase in rates for the cost associated with compliance.
Do they think that there will be a contraction in the B-piece buying market as a result?
With the higher capital demand per deal for the B-piece buyers, the likely result is that only well-capitalized B-piece buyers will remain—a smaller group. The rules do allow two B-piece buyers to team up so long as they buy a pari passu (rather than senior/subordinate) ownership interest, but they must hold their position for five years. The rule also requires disclosure of the name of the B-piece buyer, its experience, the price paid and material terms.
How likely is it that financial institutions will start making qualifying real estate commercial loans given that the parameters are so far off where the current market is in CMBS world?
Not likely. The painful irony of the rule is that the residential sector, which clearly caused and bore the brunt of the crisis due to lax underwriting, bears no responsibility in the purported resolution under the Qualified Residential Mortgage (QRM) definition. The commercial side, in contrast, was mandated Qualified Commercial Real Estate Loan (QCRE) parameters that do not comport with current market standards, even those that most credit conscious lenders and investors would embrace, and thus will not attract many borrowers. Remember, CMBS lenders still must compete with life companies, banks and other balance sheet lenders that are not so constrained.
With single asset securitizations expressly excluded from a safe harbor, will the market go away for these given the lack of "B-piece" buyers? Will the use of mezzanine debt as an end-around come into play?
The failure to exclude investment grade, low leverage single borrower/single credit (SBSC) deals is perplexing and frustrating. But it is unlikely they will go away altogether since there is a strong demand for the product and 2014 saw a greater number of these deals than we’ve seen before. There could be more large loans split and spread among multiple pools (this is occurring already) but we may just see the SBSC loan amount increase so there is a below-investment-grade class—a number of recent deals have B-pieces. In any event, the lenders and capital markets professionals are sharp and will no doubt figure out a way to continue to finance commercial real estate even in this new environment of regulatory change and intrusion that bears little relation to the intended goal or the real problem.