Legislative Update
Vijay Yadlapati, NATIONAL ASSOCIATION OF REALTORS® Associate
Commercial Policy Representative
Risk Retention Regulatory
Impact on Commercial
Real Estate
Since the peak of the financial crisis, there have been a number of
regulatory proposals and actions such as Basel III bank capital standards that could be harmful for the commercial real estate market
recovery. However, one regulatory issue in particular that could
have an even more damaging impact on the industry is a credit risk
retention or “skin-in-the-game” proposed rule by U.S. regulators.
The proposed rule is a result of the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Act), signed into law last
year, which tasked six U.S. banking agencies to establish rules that
would require any entities that securitize mortgage loans to retain an
economic interest in a portion of the credit risk. The Act generally
requires 5 percent risk retention for most asset classes; however, the
law gives federal agencies broad authority to identify the acceptable
types, forms, and amounts of risk retention for “low credit risk”
commercial and multifamily mortgages.
The agencies’ proposed rule outlines low credit risk underwriting standards that would permit asset-backed securities backed
exclusively by commercial and multifamily loans to qualify for less
than 5 percent risk retention. Specifically, the agencies have proposed zero percent risk retention for commercial mortgage-backed
securities (CMBS) issuances that meet a series of underwriting
standards. Moreover, a qualifying commercial real estate loan must
meet over 30 different underwriting conditions in order to forgo
the agencies’ risk retention requirement. The underwriting requirements are so narrowly focused that virtually no CMBS loans could
qualify. Accordingly, Morgan Stanley estimates that if just three
of these requirements are applied (Loan-to-Value of 65 percent,
Debt Service Coverage Ratio of 1.7x or higher, and an amortization period of 20 years or less at securitization), approximately 0.4
percent of the $671 billion conduit loans that have been securitized
since the creation of the CMBS market would have qualified.
In an August 2011 letter to bank regulators, NAR stressed its
concern that the proposed thresholds for loans to be exempt from
risk retention are too restrictive to apply to the majority of commercial and multifamily loans. This would effectively reduce the
number of CMBS issuances – increasing borrowing costs, severely
diminishing the amount of financing available to the commercial
and multifamily sector, and exacerbating the current commercial
real estate lending crisis.
In the past, the CMBS market has been able to meet the refinancing needs of property owners when the banking sector failed
to meet demand from commercial borrowers. The CMBS market
currently represents nearly 26 percent of the outstanding balance of
commercial and multifamily mortgages. This is down from nearly
50 percent in 2007, when the CMBS market provided approximately $240 billion in financing. In contrast, the CMBS market
provided less than $13 billion in issuances in 2008 and $2 billion
in 2009, despite strong credit performance and huge demand from
borrowers. Although the CMBS market is showing some signs of
a recovery, with $12.3 billion in new issuances in 2010, prolonged
weak economic fundamentals continue to limit the CMBS market’s
capacity to refinance commercial loans. In fact, the inability to
secure refinancing will result in increased defaults and foreclosures,
and the forced sale of many properties at greatly depressed prices,
creating a ripple effect of financial losses and more job layoffs,
threatening our nation’s economic recovery.
