Securitization Group Addresses Risk Retention in Regulatory Reform

[Update 2: Corrects statements made by CMSA on proposed regulatory reforms; an earlier story had incorrectly stated that the CMSA was supporting a Treasury proposal for 5% risk retention requirements, when the CMSA is not supporting such a requirement.] The commercial real estate market — and specifically the commercial mortgage-backed securities (CMBS) market — is experiencing its worst liquidity crisis since the early ’90s, according to the Commercial Mortgage Securities Association (CMSA). The association hosted a Webcast late Tuesday to discuss a “looming” crisis in the commercial real estate and mortgage market and to discuss the administration’s regulatory reform plan. The CMSA addressed five “utmost” concerns in the plan. The first issue deals with risk retention, which “is an important component regardless of who ultimately retains the risk: the broker/originator, the issuer or the first-loss buyer,” CMSA said in its paper on regulatory reform–but the group stopped short of endorsing a risk retention proposal being floated by Administration officials. The Treasury Department is urging a 5% risk retention ratio, with the idea that this would encourage originators to make loans of the highest quality. Under any 5% risk retention requirement by the Treasury, the CMSA said an exception authority should be crafted to allow certain structured finance vehicles to qualify for an exception to the requirement, “subject to the appropriate transfer of such risk.” But if originators are required to retain a portion of risk, they should be allowed to hedge certain risks, the CMSA said, as leaving such positions unhedged places the financial stability of the originator at risk. “Since there is no way to ensure that any hedge protects 100% of an investment from loss,” CMSA’s reform plan reads, “loan originators and sponsors will continue to carry significant credit risk exposure that reinforces the economic tie between the originator and the issued CMBS.” The CMSA also addressed the Treasury Department’s proposed changes to certain rules that allow originators to immediately recognize “gain on sale” and instead require such gains to be realized over a longer time period. “[W]hile aligning compensation with long-term performance of securitized assets would appear to be appropriate,” the CMSA’s plan reads, in part, “it is very difficult to determine if a future loan default is due to poor underwriting at origination, changes in market conditions, or poor business practices by the borrower and/or tenants.” Another issue generating discussion — a ratings differentiation for structured finance products — would be unhelpful, the CMSA claims, confusing some investors and prohibiting others from buying bonds until their investment policies are revised for the new ratings system. “This could significantly delay the positive impact of government initiatives to reinvigorate commercial mortgage lending,” CMSA said. In a Webcast late Tuesday, a CMSA panel discussed current government initiatives, including the Federal Reserve‘s Term Asset-Backed Loan Facility (TALF). Panel member Lisa Pendergast, who serves as managing director of Jeffries & Co., said commercial mortgage lending remains challenged along with the TALF’s slow start among CMBS. She noted the delinquency rate among commercial mortgages, currently around 3%, may top as much as 9% in a worst-case scenario. Another panel member, Chris Hoeffel — managing director of Investcorp International — noted the government’s expansion of TALF in May to consider certain CMBS as eligible collateral under the program. The deadlines within the program, however, must be extended if the CMBS side of TALF is to have any significant effect, Hoeffel said. Rick Jones, a partner at Dechert and fellow panel member, called the current time frames “relatively ludicrous.” It might be why the Fed received no bids at all for its first CMBS facility in June. It did receive almost $669m in applications for its July legacy CMBS facility. “The Fed’s heart is in the right place” as it tries to help bring liquidity to the market, Jones said. The legacy CMBS side of TALF is likely to have a positive impact on the business, and Jones expects the Fed to see more subscriptions for its next CMBS facility in August. Write to Diana Golobay.