The commercial real estate industry secured a significant victory when the Senate voted to amend the risk-retention requirements in the financial regulatory reform bill (S 3217). Both the House and Senate versions of the legislation include new “skin-in-the-game” provisions that require originators and issuers of asset-backed (mortgage) securities (ABS) to retain 5 percent on their books.
NAA/NMHC and others successfully argued that commercial mortgage-backed securities (CMBS) should be treated differently than other ABS because they have subordinate investors (B-piece buyers) who underwrite the investment and purchase the first-loss position.
Because subordinate investors in CMBS are experts in commercial and multifamily housing real estate with knowledge and understanding of real estate assets and because they conduct due diligence and often establish requirements for loan performance and servicing and asset disposition, among other provisions prior to the bond issuance, they are effectively retaining risk or have “skin-in-the-game.”
Unlike other asset-backed securities (car loans, student loans, etc.) CMBS subordinate investors make their investments not on the rating or third-party assessment, but based on their own evaluations of assets in the CMBS pool based on the property financials, loan underwriting, asset quality and condition and the strength and weakness of the borrower or sponsor. In some cases they may even require select assets be removed from the CMBS pool prior to issuance to improve the overall quality and investment quality.
As originally written, the Senate bill did not allow for different assets to be treated differently. However, during floor debate the bill was successfully amended to allow regulators the flexibility to structure the skin-in-the-game mandate in several ways and instructs them to consider allowing a third-party investor to satisfy the risk retention requirement.
Without this change, CMBS lenders would have been required to increase their capital set asides, which would have increased the cost of and reduced access to CMBS capital. Based on the level of mortgage credit issued in 2009 (the lowest level in 20 years), applying the risk retention requirements to CMBS would cause an estimated reduction in $125 billion in credit.
The House measure allows the B-piece buyers of CMBS to meet the requirement, making it more likely that the amendment will survive House-Senate negotiations on a final compromise bill.