Browse Tag: dodd-frank

If Trump Targets Dodd-Frank, What Are the Commercial Real Estate Impacts?

While we find ourselves in the early, frenetic days of the Trump administration, it’s far from clear exactly what to expect from a White House that has single-mindedly pursued its own private list of policies without much concern for fallout or for some campaign promises. In what appears to be a intentional pattern of confusion, some of the President’s campaign promises have been confusingly dropped by the Oval Office, only to picked back up within hours. The very latest example of this pattern over the past 24 hours being his pledge to negotiate with the pharma industry to achieve lower drug prices.  This was a promise apparently dropped only to be picked back up hours later the same day.

So when the President announced yesterday that he intended to “do a big number” on the Wall Street reform package called Dodd-Frank, we got a warning something might (or might not) happen to key regulations on risk retention that deeply affect the commercial real estate industry.

Regulation, Risk and Reminders

President Trump severely criticized the Dodd-Frank law yesterday, calling it a “disaster” and promising to “do a big number” on the law soon. If the President does actually follow through with gutting Dodd-Frank, what could change for commercial real estate?  Whatever changes that stick will affect at least one of these areas:

  • The Credit Risk Retention Rule – Forces issuers of bonds comprised of performing commercial real estate properties to hold a percentage of the offering.  Affects CMBS marketplace significantly, as written about here.
  • Credit Rating Agency Reform – Rules that prevent the complicity of risk ratings agencies (Moody’s, Fitch, S&P) in mislabeling bond offerings to obscure systemic risk.  Affects CMBS and REIT share markets as well as the wider debt market transparency.
  • Legislative proposals to wind down the Government Sponsored Entities such as Freddie Mac that originate a great deal of capital for apartment building projects
  • The Volker Rule – Prevents banks from engaging in trading in certain kinds of investments. Affects: proprietary trading, disallows banks from owning or investing in hedge funds or private equity funds. If struck down, may increase availability of capital from banks to exotic or alternative financing vehicles serving the CRE industry.

Unclear (Still)

Guessing at impact is tough, because Dodd-Frank rules are a moving target — rules are still being designed and implemented with a time schedule that reaches into 2019 and beyond.  While the President signed an executive order this week compelling the elimination of two regulations for every one invoked, a move that tends to support speculation that the President sees regulations as intrinsically bad things, nobody should claim to know exactly what’s on the Donald’s mind before a) he announces it himself  and b) we wait a little bit for the dust to settle.

Risk Retention: The New CMBS Rules

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The Wall Street Reform and Consumer Protection Act (also known as Dodd-Frank) was written in part to address the 2007-08 systemic risk crisis in credit markets caused by the mispackaging and mislabeling of bonds made up of collections of mostly residential mortgages that went bust. The banks that performed the packaging, regulators reason, each contributed greatly to the giant and hidden risks by routinely selling off the bonds they packaged. These were sold in their entirety, meaning the bank’s risk was effectively zero if it happened that the contents of the bond were found later to be in default.

Risk Retention

What if, instead of being allowed to ship off truckloads of possibly mislabeled product, the packager was compelled by law to  own a percentage of each package (bond) themselves? The systemic risk of the bond — and of the mortgage-backed bond business generally, regulators reason, would then have a built-in limit by forcing the packaging bank to “have skin in the game” themselves.

Enter a provision of the 2010 Dodd-Frank law called “risk retention” set to come online December of this year that does just that by requiring the issuing bank to “eat its own dog food” — requiring 5% of the resulting bond to be held by the bank, so that default risk aftermarket is shared by the bank.

CMBS Exemption

What might be news in the commercial real estate space is that the commercial equivalent to residential mortgage-backed securities, called, unsurprisingly enough, commercial MBS (CMBS), has an exemption from the above kind of risk retention under Dodd-Frank.  This is detailed well in today’s Bloomberg piece by Sarah Mulholland “Wall Street Girds For Real Estate Debt It Must Invest In”:

The new requirement, dubbed risk retention, applies to all types of securitization, the process by which debt is pooled together and sliced into bonds of varying risk and reward. Such offerings backed by home loans were ground zero for the financial crisis.

The changes are creating an opportunity for real estate investors. Industry lobbyists won a concession from lawmakers to create an exemption for the CMBS market, allowing a third party to take on the risk on behalf of lenders as long as they agree not to sell their investment for at least five years. Banks will be held legally accountable if the firm they sell to violates the rules.

The CMBS market has a built-in cohort, called B-piece buyers, that buys the riskiest portions, absorbing losses first in exchange for a hefty yield. Firms including Ellington, DoubleLine Capital and KKR & Co. have entered the space in recent years, which was dominated by a handful of specialists prior to the financial crisis. Several B-piece buyers are seeking to raise funds to step in for the banks, though it may be difficult to find investors willing to lock up their cash for five years or more, said Warren Friend, an executive managing director at Situs, a commercial real estate consulting firm.

Securitization of real estate debt on the commercial side may never present the kind of systemic risk that brought us a giant recession, in part due to the underlying illiquidity that commercial properties tend to represent. That said, CRE investors living in the world of Dodd-Frank face a different landscape than before, hopefully not one where risk pitfalls are more hidden.

Photo Credit: Wikipedia