Why CMBS Risk Retention Rules Are Reducing The Amount of Conduit Lenders
While conduit loan issuances have risen steeply in the last few years, the amount of lenders has actually fallen slightly— and experts believe that’s a direct result of a new federal risk retention rule that took effect in Dec. 2016. Before the market crash of 2008, the CMBS market was incredibly hot, and lenders were quite liberal with who they provided loans to— especially because they knew they could transfer 100% of the risk to CMBS bondholders.
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While conduit loan issuances have risen steeply in the last few years, the amount of lenders has actually fallen slightly— and experts believe that’s a direct result of new federal risk retention rules that took effect in Dec. 2016. Before the market crash of 2008, the CMBS market was incredibly hot, and lenders were quite liberal with who they provided loans to— especially because they knew they could transfer 100% of the risk to CMBS bondholders.
Two years after the crash, congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which, among other things, was intended to insure that banks had more skin in the game when it came to CMBS loan transactions. To do that, Dodd-Frank mandated that lenders keep 5 percent of the risk for at least 5 years. While Dodd-Frank was passed back in 2010, the rule was issued with a 6-year waiting period, which is why it didn’t go into effect until late 2016.
While these rules may be good for investors, they aren’t the greatest for CMBS borrowers. Since banks and other conduit lenders can now suffer direct losses as a result of CMBS loan defaults, they are likely to tighten underwriting standards, issue less interest-only CMBS loans, and perhaps issue less conduit loans to riskier asset classes, such as student housing properties.
Related Questions
What is CMBS risk retention?
CMBS risk retention is a rule instituted by the Dodd-Frank Act of 2010 and first enforced in 2016. It dictates that lenders must hold onto at least 5% of the commercial mortgage-backed securities they issue, including a portion of the B-piece tranches. This rule was implemented to ensure that CMBS lenders' interests remain aligned with the interests of the investors, and to effectively steer them away from offering loans to investors who may turn out to be unable to pay them back.
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How do CMBS risk retention rules affect conduit lenders?
CMBS risk retention rules, instituted by the Dodd-Frank Act of 2010 and first enforced in 2016, require lenders to keep at least 5% of the risk for at least 5 years. This means that conduit lenders can suffer direct losses as a result of CMBS loan defaults, so they are likely to tighten underwriting standards, issue less interest-only CMBS loans, and perhaps issue less conduit loans to riskier asset classes, such as student housing properties.
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What are the benefits of CMBS risk retention rules?
The CMBS risk retention rules instituted by the Dodd-Frank Act of 2010 and first enforced in 2016 have several benefits. These rules dictate that lenders must hold onto at least 5% of the commercial mortgage-backed securities they issue, including a portion of the B-piece tranches. This ensures that CMBS lenders' interests remain aligned with the interests of the investors, and effectively steers them away from offering loans to investors who may turn out to be unable to pay them back. This helps to reduce the risk of a CMBS market crisis, like the one that occurred in 2008-2010.
The rules also require that B-piece buyers hold onto their investment for a minimum of 5 years, which means that hedge funds and other players who were actively trading B-piece securities can no longer do so. This helps to reduce the amount of conduit lenders, as they can now suffer direct losses as a result of CMBS loan defaults.
What are the drawbacks of CMBS risk retention rules?
The major drawback of CMBS risk retention rules is that they require lenders to keep at least 5% of the commercial mortgage-backed securities they issue, including a portion of the B-piece tranches. This means that lenders have more skin in the game when it comes to CMBS loan transactions, and as a result, they are likely to tighten underwriting standards, issue less interest-only CMBS loans, and perhaps issue less conduit loans to riskier asset classes, such as student housing properties. Additionally, CMBS loans typically do not permit secondary/supplemental financing, as this is seen to increase the risk for CMBS investors. Finally, most CMBS loans require borrowers to have reserves, including replacement reserves, and money set aside for insurance, taxes, and other essential purposes.
How can borrowers benefit from CMBS risk retention rules?
Borrowers can benefit from CMBS risk retention rules by having lenders' interests remain aligned with the interests of the investors. This helps to ensure that CMBS lenders are not offering loans to investors who may turn out to be unable to pay them back. Additionally, the rules require lenders to keep at least 5% of the commercial mortgage-backed securities they issue, including a portion of the B-piece tranches, on their balance sheets. This helps to reduce the amount of conduit lenders, as they can suffer direct losses as a result of CMBS loan defaults.
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