Dodd-Frank And CMBS – Lenders Will Soon Be Required To ‘Eat Their Own Cooking’!

By | February 18, 2016

CMBS,securitization,Dodd-Frank

What’s better for a lender than underwriting a commercial mortgage loan, packaging it with other loans and then selling it to investors?

Any inherent risk of loan default, after the time it may take to sell the security off course, would be passed off to the investor that buys it.

What we saw during the financial crisis was that this business model can lead to abuses such as an underwriter potentially taking shortcuts, or overlooking some nicks or cuts that may be present in a specific loan scenario, in order to make as many securitized loans as they believe they can sell.

As of December 2016, however, all of this will change as a provision of the 2010 Dodd-Frank law that requires lenders to hold in reserves a percentage of the dollar amount of a securitized loan they originate, is scheduled to kick-in (this will be the case across all forms of securitized debt).

For lenders this increase in risk will likely reduce the amount of loans they are willing to make which in turn would reduce the liquidity available for real estate development.

But, For Every Change In A Market, Opportunity Presents Itself!

From an article at BloombergBusiness, ‘Wall Street Girds for Real Estate Debt It Must Invest In’…

‘Wall Street firms are readying themselves for new rules aimed at requiring them to eat what they cook.

A provision of the 2010 Dodd-Frank law that takes effect in December forces banks to keep a stake in the commercial-property loans they package into securities and sell off to investors. The rule is intended to deter the type of risky lending that helped fuel the last decade’s boom and bust. Under the current business model, banks are encouraged to issue as many loans as they think they can securitize and sell, with underwriting standards sometimes falling by the wayside, said Lea Overby, a debt analyst at Nomura Holdings Inc.

“Originators know their product better than anyone, and they are less likely to underwrite really bad stuff if they have to hold it,” Overby said in an interview.
The biggest players in the $550 billion market for commercial mortgage-backed securities, such as Wells Fargo & Co., Deutsche Bank AG and JPMorgan Chase & Co., are juggling multiple scenarios as they prepare for the new rule, according to bankers with knowledge of the deliberations. Banks may be required to hold as much as $50 million in capital for a $1 billion deal, a tough prospect to stomach with banks under pressure to keep their balance sheets in check. The rule also creates an opportunity for investors to team up with banks on the debt.

Turmoil in global markets is exacerbating the uncertainty surrounding how lenders will adjust to the new regulations. The CMBS market is already on shaky ground as the rout in oil prices, slowing growth in China and uncertainty over the Federal Reserve’s course on interest rates spook investors in stocks and bonds around the world.

The extra yield buyers demand to own commercial-mortgage bonds relative to benchmark interest rates has surged to the highest since 2011, meaning investors view the securities as increasingly risky, according to Morgan Stanley. Since January, the spread between the benchmark and CMBS rated BBB-minus, the lowest investment-grade ranking, has jumped 240 basis points, or 2.4 percentage point, the bank’s data show. Morgan Stanley analysts led by Richard Hill cut their 2016 CMBS sales forecast to $70 billion from $100 billion as lenders pull back.

Dealers are struggling to sell CMBS deals that have been in the pipeline for months, according to Leo Huang, who oversees commercial real estate debt at Ellington Management Group.

“Money is being lost in amounts that hasn’t been seen in years,” Huang said. “This should remind people there is substantial risk in this business.”…’

Read the rest of the article at BloombergBusiness here.

Michael Haltman is President of Hallmark Abstract Service in New York. He can be reached at mhaltman@hallmarkabstractllc.com

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