Reversing The Risk Retention Rule For CMBS Could Improve Commercial Lending

By | Bond Market, Commercial mortgages, Financial Markets, Lenders, Regulation

There are several key bank regulations in the Dodd-Frank Act which if loosened could improve bank lending. One important one, is the risk retention rule for asset-backed securities including commercial mortgage-backed securities (CMBS). Reversing the risk retention rule, Section 941 of Dodd-Frank could help improve the CMBS market. The rule became effective December 24, 2015 and gave CMBS an additional year to comply which has caused lower CMBS loan origination volumes over the past year as CMBS lenders prepared to comply. It caused some smaller CMBS lenders to withdraw from CMBS lending altogether.

The risk retention rule problem

The main issue causing problems with the rule is that the CMBS issuers must have “skin in the game” by retaining 5% of the aggregate credit risk of the commercial mortgage loans that it adds to a securitization. Typically, a transaction goes like this. A lender originates a commercial mortgage and either holds on to it or sells it to a larger CMBS issuer. The CMBS issuer is an investment bank who pools other commercial mortgages from various lenders as collateral to support the CMBS. The CMBS issuer does its own homework on the loan before it purchases it.

So a lender will only sell loans that it feels would be accepted by the CMBS issuer. To do otherwise, risks the lender’s reputation with the CMBS issuer. There is already a lot of risk reduction going on before they get to the risk retention rule of holding 5%. That was not the case before the crisis for residential mortgages leading to the risk retention rule.

With the rule, the CMBS issuer, not originating lender has to hold a 5 percent interest in each mortgage they sell to a CMBS issuer. This causes issues both with the originating lender and with the CMBS issuer because the CMBS issuer must really know the lender’s origination and underwriting practices to have the assurance when purchasing loans from a lender. The bottom line is lower margins for all, higher interest rates and higher requirements for loans stemming from another rule that restricts lending. Loans that need to be refinanced and could be before the rule, now might struggle to get refinanced.

Additional issues occurring

A recent Wall Street Journal article expresses some of these issues.

“Pressures have been mounting on these firms for more than a year as volatility and risk have increased in the commercial mortgage-backed securities market.

Profit margins have narrowed in the past few months and are likely to be squeezed further as new rules take effect that require issuers of commercial mortgage-backed securities to keep at least 5% of the bonds they create.”

Some of the smaller lenders have left the business because of the new rules. Other lenders are having to increase their interest rates due to added cost of holding the 5 percent retention piece.

What to expect if you’re in the market for a commercial mortgage

CMBS lenders have, in the normal course of business, also been faced with increasing delinquency and default. As a result, according to another Wall Street Journal article more stress on CMBS lenders is causing additional requirements for commercial real estate borrowers. Some of the cautious steps lenders are taking to reduce their risk include the following. If you haven’t been in the market for a commercial mortgage recently, these are some things  you can expect.

  1. Lenders are keenly focused on their fundamentals of lending. Other than the top markets, commercial real estate geographic markets, lenders are really doing their homework and reviewing everything they can about the property in question. They are looking at the strength of the tenants, the lease terms, the net cash flow and looking closely at the sponsor’s liquidity globally not just on the subject property for example.
  2. The new risk retention rule has made borrowing more costly and complicated. Some property owners will not be able to refinance loans obtained prior to the financial crisis, or if they are able to it will be at a higher interest rate.
  3. Construction lending by banks (while not a CMBS product) has become more strict– with some of the big banks out of the business for certain property types. Part of this is the supply of new commercial properties, the other part is less permanent lending options available with CMBS. There are other non-bank lenders making construction loans, however. Some property types that remain strong candidates include industrial and multifamily.
  4. Increasing interest rates are causing lenders to underwrite commercial mortgages to higher interest rates than the current market rates -called a phantom rate. Note, a phantom rate is not the contractual rate– think of it as a stress test rate. By using a higher phantom rate, prospective borrowers will find that they are being approved, but at a loan amount lower than what they requested. So be ready to add additional cash to get a deal funded.

These and other lending rules have led to an increase in specialty finance sources to fill the gap that regulation has created with the big bank lenders. We are contacted almost daily by these lenders seeking deals to finance.

Reducing the regulatory burden

The Trump administration is working to reduce the regulatory burden that banks and financial markets are under. It could be a key step to improving the lending environment. Lenders were punished enough through their own mistaken lending practices to have the additional burden of more regulations imposed. Before any of the new regulations were written or became effective lenders had already learned their lessons. Lenders made the necessary changes to reduce their risk and make prudent loans. Banks don’t need post-crisis regulation to do it for them. Lenders are the practitioners, they know better than regulators what mistakes were made and how to correct them.

The regulatory backlash always happens after a crisis. A crisis happens, regulators point to the mistakes (that’s the easy part) and then write more rules to prevent the mistakes from occurring in the future (the hard part)– the problem is every crisis is different and rules don’t get repealed very often. Regulators have never predicted or stopped a financial crisis from occurring and it is not their mission. Even with prudent lending, lenders will have losses when the economy turns down and goes through a recession. If regulators wrote rules to prevent lenders from taking on risk and suffering losses, then there wouldn’t be any banks– because the rules would essentially prevent them from lending in the first place.

Finally, on a positive note, the economic outlook is strong and commercial real estate remains solid, and there are many lenders lending in a competitive environment so it’s still a great time for both lenders and commercial property owners.



Banks Get Increased Commercial Real Estate Oversight

By | Lenders, Regulation

U.S. Bank Regulator Toughens Commercial Real Estate Oversight

Credit risks have increased in U.S. commercial real estate as lenders more aggressively compete in a low-rate environment, according to the Office of the Comptroller of the Currency’s semiannual risk report. The report indicates that the Federal Reserve has held down interest rates for more than seven years to help the economy recover from the 2008 financial crisis, which is putting a damper on bank profits and increasing competition among lenders. However, that competitive pressure is increasing risk. Comptroller of the Currency Thomas Curry said, “It’s at this stage of the cycle that we also see strong loan growth combined with easing underwriting to result in increased credit risk.” The regulator also flagged risks in commercial and industrial loans and indicated that it is monitoring financial technology and marketplace lending.

via (Rueters)

Manage Cash Flow to Improve Your Business Credit Score

By | Commercial mortgages, Financial Markets, Lenders

By better managing cash flow in your business you can utilize both your capital and credit in a more efficient way– which will improve or maintain a strong business credit score. Cash flow becomes very important if you have a line of credit that you are drawing on. If you have a line of credit, it is to your advantage to show that you have the ability and capacity to repay the line on a consistent basis. Ideally, the balance should be paid down to zero for each billing cycle. If it is a commercial mortgage loan, whatever you do, don’t make a late payment and plan ahead for the balloon payment by seeking a replacement loan well in advance to give enough time to correct any weaknesses.

Here are some ways to improve cash flow and therefore improve your business credit score.

  • Know what your credit terms and conditions are and live by them. Do all you can to prevent violating those loan covenants.
  • Review your credit terms to ensure you are receiving competitive terms. Look at the whole relationship. Shop around find out what others are paying to give you leverage to negotiate better terms and fees.
  • Improve incoming cash by giving your customers incentives to pay you early.
  • Don’t out spend your growth by trying to grow too fast.
  • Control your costs associated with advertising, sales and administration.

At the end of the day, the more cash you report on your financial statements the better!

Banks Are Far Better Prepared For Next Downturn

By | Economy, Financial Markets, Lenders

In a recent interview with American Banker, Comptroller of the Currency Thomas Curry acknowledged the challenges facing the banking industry but said recent reforms have made the U.S. banking system more resilient. “I do think that this is an unsettled environment currently,” Curry remarked. “I think our focus as prudential regulators is really on making sure that our supervised entities are prepared for all environments. … Whatever happens with the economy, we have a much stronger banking industry.” He cited higher industrywide capital levels, improved liquidity, and more robust loss provisioning as reasons to be confident that the industry is better prepared for the next downturn. Curry also discussed efforts by the Office of the Comptroller of the Currency to warn about asset classes where banks are weakening their standards, such as subprime auto loans. He added that cybersecurity is a “constant worry,” indicating that a massive enough security breach could threaten the solvency of a smaller bank, and incidents at major banks could undermine confidence in the entire banking industry. “The first step is to have the banks be the first line of defense,” Curry said. “Then the value of the regulatory system, at least in the banking sector, is to be able to supplement that and get a horizontal view of what’s going on in the entire industry.”

From “OCC’s Curry: Banks Are Far Better Prepared for Next Downturn”
American Banker (02/11/16) Wack, Kevin

Commercial mortgage loans less available as Bank mergers increase

By | Commercial mortgages, Commercial Real Estate, Lenders, Regulation

One in Six Banks Will Have to Merge: CBA Chief Hunt

Thanks to the Dodd Frank Act bank mergers and consolidation in the banking industry continues. The reasons cited below certainly are driving the trend at an accelerating rate. The impact to commercial property owners is that they will not have as many commercial mortgage loans choices among traditional banks. As a result, it could be harder for commercial property owners to obtain the financing that best meets their needs. The American Banker article summary below explains the probable cause for this trend.

In a recent interview, Consumer Bankers Association President and CEO Richard Hunt said consolidation will keep community banking viable in the face of such persistent threats as the economy, technology, and regulation. He expects mergers and acquisitions to pick up among banks with $10 billion to $100 billion in assets. “We have been saying for some time there are three great disruptors in the marketplace today — the economy, the evolution of technology, and the burdensome new regulatory environment,” he said. “Any one of those would have a dramatic effect on banking, but to have all three happen simultaneously creates the perfect storm. We expect more [mergers] to continue throughout 2016 and years beyond.” Hunt said there are more than 6,000 banks currently, and even if 1,000 to 1,500 were lost, the industry would still be competitive. However, he noted that “the definition of competition will become greatly different. You don’t have to have a branch in a hometown in order to be competitive because of the Internet.” Hunt said consolidations ultimately will benefit consumers because “by combining forces and achieving the economies of scale, the technological platforms will be better.”  From “One in Six Banks Will Have to Merge: CBA Chief Hunt” American Banker (02/12/16) Stewart, Jackie

We have many lender relationships outside of traditional banking that are actively funding commercial mortgage loans. We have established relationship with wholesale lenders, private equity firms, conduit lenders or life insurance companies that rely upon third parties to introduce borrowers to their commercial lending products. The bottom line is we have lender relationships that the typical commercial property owner does not have access to or possibly even knows that such lenders exist. If your local bank is not able to provide the commercial mortgage loan that you need, we would be happy to work with you and our lender network to find the commercial mortgage that fits you and your property.

Third Quarter Commercial & Multifamily Mortgage Originations Up 12 Percent Year-over-Year

By | Commercial mortgages, Commercial Real Estate, Lenders, Multifamily housing

WASHINGTON, D.C. (November 10, 2015) – According to the Mortgage Bankers Association’s (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations, third quarter 2015 commercial and multifamily mortgage loan originations were 12 percent higher than during the same period last year and three percent higher than the second quarter of 2015.

“Commercial mortgage borrowing and lending continued to grow during the third quarter,” said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research. “Every major investor group and property type except one has seen increases in year-to-date lending volumes, and we expect year-end numbers to continue that trend.”

Increases in originations for retail and office properties led the overall increase in commercial/multifamily lending volumes when compared to the third quarter of 2015. The increase included a 39 percent increase in the dollar volume of loans for retail properties, a 17 percent increase for office properties, an 11 percent increase for multifamily properties, a 10 percent increase for industrial properties, a nine percent decrease in hotel property loans, and health care property loans decreased 30 percent year-over-year.

Among investor types, the dollar volume of loans originated for commercial bank portfolio loans increased by 93 percent from last year’s third quarter. There was an 18 percent increase for life insurance company loans, a three percent decrease for Government Sponsored Enterprises (GSEs – Fannie Mae and Freddie Mac) loans, and an eight percent decrease in dollar volume for Commercial Mortgage Backed Securities (CMBS) loans.

Third quarter 2015 originations for office properties increased 37 percent compared to the second quarter 2015. There was a 27 percent increase in originations for retail properties, a five percent increase for health care properties, a one percent decrease for industrial properties, an eight percent decrease for multifamily properties, and a 29 percent decrease for hotel properties from the second quarter 2015.

Among investor types, between the second and third quarter of 2015, the dollar volume of loans for CMBS increased 22 percent, loans for life insurance companies increased 13 percent, originations for commercial bank portfolios increased nine percent, and loans for GSEs decreased by 28 percent.

via (MBA)

More “TIC’ Loans Showing Up in CMBS Deals

By | Commercial mortgages, Commercial Real Estate, Financial Markets, Lenders

Commercial MBS lenders are increasingly securitizing mortgages on properties that have a complex form of ownership, creating a fresh credit-quality concern for bond buyers.

The ownership structure, called “tenants in common” or TIC, permits up to 35 investors to take passive, undivided interests in a property. The fear is that such an unwieldy ownership group can complicate workouts if a mortgage runs into trouble.

While TIC loans were securitized with some frequency before the market crash, issuers largely avoided them when the conduit sector started to revive in 2010. But such loans have turned up more often recently, as fierce competition for business has made conduit originators more receptive to such borrowers.

Loans to TICs accounted for 8% of the collective collateral pool of conduit deals that closed in the third quarter, up from 5% a year earlier, according to Moody’s.

“It’s a real demonstrable increase,” said Dan Rubock, a senior vice president at the rating agency. “Tenants-in-common are becoming more common once again, and they need to be handled with care. I’ve noticed analysts coming by my desk more often to ask me how to deal with these.”

Among the last 20 conduit deals rated by Kroll, the percentage of TIC loans ranged from 0.5% to 16.2% of the collateral balance, with the level topping 7% in 12 deals, said managing director Robin Regan.

Before the crash, some securitized TIC loans had as many as 20-25 borrowers. But over the past few years, the number of borrowers has generally been limited to five. For example, there were typically only 2-4 TIC borrowers per loan in the recent Kroll deals. That is a key factor, because there’s less risk with fewer borrowers, Regan said. But word has it that some recent TIC loans have had 10-15 borrowers, increasing the potential for problems.

While TIC loans weren’t a major source of woes during the downturn, CMBS investors and servicers are wary of them because each owner has to sign off on workouts — meaning that a single TIC investor could potentially derail an agreement. They also worry about the possibility that individual investors in a TIC could block foreclosure by organizing “serial bankruptcies” — that is, filing successive bankruptcy claims to trigger a series of automatic stays on a property seizure.

Legal protections can be built into loan terms to curb the risks. For example, lenders usually insist that a single TIC investor be designated as the loan sponsor and take responsibility for dealing with servicers, with any workout agreement binding on the other TIC owners. Likewise, a recourse provision can discourage bankruptcy filings by making each TIC owner personally responsible for repaying his share of the loan. Another option is to set up the CMBS collateral as a financeable lease, making it easier to take control of the property in case of a default.

“If you properly structure these loans, you can make them close to credit-neutral,” said Gerard Keegan, a partner at law firm Alston & Bird.

But, he added, there’s still inherent risk in dealing with multiple direct owners of a property because there is nothing to stop those owners — who are often unsophisticated mom-and-pop investors — from seeking to block workouts or file for bankruptcy regardless of the protections.

It takes considerable time and effort by originators, their attorneys, the rating agencies and bond buyers to vet TIC loans and make sure all of the necessary bondholder protections are in place. For that reason, CMBS issuers steered clear of such loans when the market revived, because they had plenty of alternative lending opportunities. But as the number of lenders competing for assignments has grown, CMBS programs have become more willing to write loans to TICs.

Another factor could be a rise in loan demand from TICs seeking to arrange financing before potential curbs on the ownership structure take effect. A bill proposed by Sen. Bernie Sanders (I-Vt.) and a companion measure sponsored in the House by Rep. Marcy Kaptur (D-Ohio) would effectively repeal Section 1031 of the Internal Revenue Code, which allows real estate owners to defer capital-gains taxes when selling a property if the proceeds are used to purchase another property of equal value within 180 days. The IRS started allowing those proceeds to be funneled into TICs in 2002.

via (cma)

Buck Stops Where? CMBS Shops Must Choose

By | Bond Market, Commercial mortgages, Financial Markets, Lenders, Regulation

Commercial MBS issuers will soon have to decide which executive at their operations will personally vouch that deal information supplied to investors is accurate.

Under an SEC rule that takes effect Nov. 24, a senior executive must sign a one-page form saying that he has personally reviewed the prospectus of a transaction being floated and is familiar “in all material aspects” with the collateral assets, the deal’s structure and “all material underlying transaction agreements.”

The form goes on to say that the signer certifies that the prospectus and supporting documents don’t contain untrue statements or omit material information.

Industry lobbyists last year tried to persuade the SEC to permit the signer to stipulate that he is relying on information provided by other parties, because a transaction’s collateral can be contributed by multiple lenders. But the regulator wouldn’t budge on the wording, which is outlined in the latest version of “Regulation AB,” the SEC’s sweeping set of disclosure rules for all types of securitizations.

The rule is intended to force issuers to more closely scrutinize collateral and raise their credit standards, following extraordinary losses on residential MBS transactions during the market crash. Violations of the certification carry no criminal liability, but could leave signers personally liable to civil lawsuits by investors or to SEC charges of civil violations of securities law.

The form must be signed by the chief executive of a securitization’s “depositor” — the entity that registers the transaction with the SEC and transfers collateral mortgages from the originators to the securitization trust.

While the depositor is essentially a paper entity, it has a board of directors made up of executives from the securitization’s lead bank. In the past, the chief executive was usually a CMBS executive, but sometimes has been a more-senior officer — such as the overall head of securitization or a risk officer. But going forward, because of the certification requirement, that post will have to be given to an executive working closely on the transaction. The most likely candidates are CMBS group heads or senior executives on their teams.

“Clearly, no one expects that Jamie Dimon will be signing the certification for J.P. Morgan deals,” said one industry attorney. “It will have to be somebody more familiar with the ins and outs of the actual deals.”

That will mean more time and effort for the selected executive and for other bankers delegated with performing some of the due diligence and briefing that person. “Signers of the CEO certification will need to consider what level of diligence will provide them with sufficient familiarity with the overall transaction to be comfortable making the required certifications,” said Janet Barbiere, a partner at law firm Orrick Herrington.

Some CMBS bankers are upset about the requirement, arguing that it’s unfair to subject them to personal liability for what should be a corporate responsibility.

“If something goes wrong in one of these deals — and you never really know everything that’s going to happen over the 10-year life of a loan — the SEC will come after you personally with all guns blazing,” said one group head at a major bank.

Another senior CMBS executive was less concerned, saying he assumed his employer will indemnify him against personal responsibility. What’s more, he added, “I have a high comfort that the descriptions of the loans we’re providing in the prospectus are accurate.”

The certification, required for public offerings, is one of a host of changes required under the Regulation AB amendments, which were finalized last year. Three conduit shops — Bank of America, Deutsche Bank and J.P. Morgan — participated in a pilot program with the SEC to devise model versions of shelf registrations that would comply with the changes. Those shelf registrations contain the boilerplate language to be used in the prospectus and the pooling and servicing agreement, with blank spaces to be filled in later with deal-specific information.

The templates, finalized in the past several weeks, followed months of discussions between the lenders and the SEC that clarified uncertainties about the changes and the exact wording to use. But there was virtually no discussion of the language for the certification, because the SEC had previously indicated it would not change the draft wording for the certification that it had unveiled last year.

via (CMA)

Demand for Commercial Real Estate Loans Increases

By | Commercial mortgages, Commercial Real Estate, Economy, Lenders

The Federal Reserve says demand for commercial, industrial, and commercial real estate loans rose in the second quarter, along with demand for home-purchase, auto, and credit card loans. The central bank’s survey of senior loan officers shows stronger home loan demand across most categories, including home equity lines of credit, and modest net fractions of banks eased underwriting standards, particularly for jumbo loans that comply with the Consumer Financial Protection Bureau’s qualified mortgage rules. However, most banks still do not give mortgages to subprime borrowers and have not eased lending standards for home equity lines of credit. Although residential real estate lending standards were “at least somewhat tighter” than the midpoints of the last decade’s ranges for all home-loan categories, a small number of banks tightened loan standards for credit cards or auto loans to subprime borrowers relative to midpoints for those loans over the same period. A “measured easing” of credit conditions for mortgages was seen mainly among GSE-eligible and government-insured mortgages.
via (wsj)

Why regulation is unhealthy

By | Lenders, Regulation

Regulated banks are under more and more pressure to comply with all the new regulations coming out of Washington, DC. The Dodd Frank Act was passed and signed into law by President Obama on July 21, 2010. It is a huge piece of legislation with over 2,300 pages and calling for 250 new rulemakings which have generated thousands and thousands of pages of new regulations.

For community banks, faced with this with massive burden, it literally creates fear in the local banker to, well, be a banker! It drains a Bank’s resources while trying to keep up with all the new regulations to comply. Banks end up worrying about the compliance aspects of the business and lose focus on what they do best—lending. Just as important, added regulation increases a bank’s cost to comply with more regulations, which in turn end up costing small businesses and consumers more. In addition, new regulations have restricted the availability of financial products and credit because banks are now so focused on complying with regulation it has become difficult to be innovative.

It can be argued that much of the new regulations are unnecessary to force upon community banks. Many of the new regulations do not protect consumers, or make the banking system any safer than before without the regulations. And in fact, just the opposite is occurring. Many smaller banks are being sold or merged with larger ones. Other banks are closing their residential mortgage operations. The banking industry is consolidating; the main street banker is forced to compete with the larger regional and national banks.

Unfortunately, perception is reality and the perception from the financial crisis is that more regulation is better. But is it smarter? How does it impact the commercial property owner? And what does it do for the local economy?

While there are no easy answers, the first one is, that our country has been based upon the freedom to choose. Increase regulatory burden, and you take away the freedom to choose. The freedom to run a business to meet the needs of your customers. If the banker is so restricted on what loans they can choose to make, it will have a negative impact on the commercial property owner and any small business looking for financing. When a small business cannot obtain the financing it needs to operate or grow, guess what, the community suffers. It suffers in terms of local employment, obtaining goods and services and generally economic activity is dampened.

Rather than more regulation, what is needs is regulation 2.0. Throw out the old and write new regulations; lessen the burden. Banks today are basically a government appendage. Bankers are subject not to their customers but to the government. While it appears the ultimate stakeholder is the government with their consumer protection agenda, the real stakeholder is the communities in which local banks operate.

According to American Banker,

 “…there are now 1,342 fewer community banks in the U.S. than there were in June 2010. The number of banks with assets below $100 million shrunk by 32%, while the number of banks with assets between $100 million and $1 billion fell by 11%.

Consequently, it should come as little surprise that since Dodd-Frank, the share of U.S. assets held by banks with assets above the $10 billion threshold has increased by 4%. By contrast, banks with assets below $100 million have seen their share of U.S. assets decline by 40%. Banks with assets between $100 million and $1 billion lost 21% market share during this time.”

You can read the full article here via American Banker