In the News

Known as The Preserving Access to CRE Capital Act of 2016, a new bill recently approved by the House Financial Services Committee in March could have major implications for low-risk CMBS lending. The bill includes modifications for the Securities Exchange Act of 1934 and exempts certain CRE loans from risk retention rules scheduled to go in effect by December 2016. According to Arkansas Congressman French Hill who championed the bill, the Capital Act intends to “help ensure continued liquidity and affordable financing options for commercial real estate borrowers.”

Risk-y Business

Currently, Dodd-Frank’s risk retention rules require borrowers of CMBS and other asset-backed securities to retain a 5% interest in the securitized transaction. The provision was designed to hold CMBS sponsors to more accountable for their investment decisions by maintaining more “skin in the game.” The retention requirement can be held as either an eligible horizontal residual interest (EHRI), an eligible vertical interest (EVI), or a combination of the two as each reflect different ways of calculating the interest level. If the level of interest is determined using the horizontal interest approach, CMBS sponsors have the option to satisfy all or a share of the requirement with investments from one or two third-party B-piece buyers. When two B-piece buyers are involved, the horizontal interest must be split equally between both parties on a pari passu basis. The securities also cannot be hedged or transferred to an outside party for at least 5 years and must be purchased in cash.

While the proposed legislation does not increase the cap of two B-piece buyers per CMBS transaction for this purpose, the Capital Act would give sponsors the choice of using either a pari passu structure or a senior/subordinate structure for the third-party purchaser option. B-piece buyers are sold non-rated and below-investment grade securities that generally only constitute 2-3% of their fair value for EHRI under the present rules. As a result, additional lower-yielding investment grade assets must be sold to meet the 5% risk retention minimum, an offering that has less appeal to B-piece buyers. Under the new amendment, the option to use a senior/subordinate structure enables sponsors to attract a larger pool of investors with varying levels of risk tolerance and yield requirements.

Qualifying Events

At the moment, the risk retention rules apply to all CMBS deal types including conduit and single-asset/single-borrower (SASB) transactions. Market participants argue that single-asset/single-borrower CMBS should be treated differently since they typically do not pose the same risks as other asset types and have much more difficulty garnering B-piece buy-in. The Capital Act creates an exemption for SASB loans as many feel they provide more detailed disclosure information and are easier to assess.

Under the final rules, qualifying commercial real estate (QCRE) loans are exempt from the risk retention clause if they meet a set of restrictive requirements. QCRE loans also reduce the required risk retention percentage by an amount proportional to the share of QCRE loans in the entire pool by up to 50%. The bill under review expands the list of QCRE loans, which is estimated to include a very small percentage of all CMBS loans, to comprise loans with interest-only structures and longer amortization schedules. Current QCRE loans must pay both monthly principal and interest and have an amortization schedule that is at least 10 years long but is shorter than 25 (or 30 for certain multifamily cases) years. Another proposal of the bill removes the lower LTV cutoff imposed on CMBS properties with cap rates less than 300 basis points above the 10-year Treasury rate.

Not "Just a Bill" Anymore?

According to an article from The Real Deal, the bill gained approval from the House Financial Services Committee, a committee overseeing the financial services industry formed by members of the House of Representatives. The bill passed with a vote of 39-18 but still needs a majority vote from the House of Representatives. Other challenges could lie ahead depending on its timing in the election year, but at least this bill has gotten farther than the one just sitting on Capitol Hill in that famous episode of Schoolhouse Rock.

Passage of the Capital Act could greatly enhance market liquidity and provide more financing options for investors interested in utilizing CMBS as a source of funding. The Act removes many of the term and structural restrictions that bar loans from meeting QCRE qualifications and softens the rules governing the B-piece buyer option. Even though the changes would increase the exemptions to current risk retention rules, the bill does not address the industry’s main concern. Many are still doubtful about B-piece buyer compliance and the risks associated with the EHRI holding period. Although there is no clear fix for these issues, the Capital Act certainly presents more selection and eases the headache in the transition to the new rules.