WASHINGTON, DC—The credit risk retention rules mandated by the Dodd-Frank Act and then the subject of fierce debate over the last two years by regulators and the industry as they were being written are now finalized. These rules will shape a number of financial products and lending activities, from mortgages to highly-leveraged corporate bonds to commercial mortgage-backed securities going forward.

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The changes will be significant for the CMBS market, starting with higher pricing that could range from an additional 25 basis points (according to estimates by regulators) to between 35 to 50 basis points (according to industry associations). The new rules are also expected to limit capacity, as well.

Still, these final rules--adopted by the Office of the Comptroller of the Currency, the Department of Treasury, the Federal Reserve Bank, the Federal Deposit Insurance Corp., the US Securities and Exchange Commission, the Federal Housing Finance Agency and the Department of Housing and Urban Development—are not as bad as the industry originally feared.

"The whole process has been an evolution," CREFC president and CEO Steve Renna tells GlobeSt.com. Over time this 'evolution' moved considerably more in direction that CREFC and other industry associations had advocated, he says.

Briefly, for the CMBS industry, the final rules eliminated the Premium Capture Cash Reserve Account that had been proposed in the earlier risk retention proposal. This onerous requirement, which would have required all issuer profits to be placed in a first-loss position, had been tentatively dismissed about a year ago, but to have it jettisoned from the final rules is a relief. Also gone from the final rules are cumbersome cash flow requirements.

The heart of the rules — a doubling of the amount of risk that has to be retained to 5% stayed in place — but further negotiations with regulators made this rule far more flexible to implement, Renna says.

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The bottom line is that B piece buyers have a lot of flexibility in figuring out the best way to raise capital they need for the additional retention. In addition, the retention can be divvied up between the issuer and B piece buyer. "We asked for flexibility and optionality in fulfilling the risk retention rule and the regulators provided that," Renna says. "They also originally said the B piece would have to retain the risk for ten years. We said five and they agreed."

Unfortunately, they wouldn't budge on the single-asset loan criteria, he says.

CREFC had been lobbying to keep certain loans that were conservatively underwritten—namely securitizations based on a single asset such as one building or a single credit—exempt from the risk retention rules. "No lenders want to keep that big of a loan on its balance sheet and it wasn't necessary, from an investor protection standpoint, to apply risk retention to these loans," Renna says.

The regulators didn't agree and Renna believes the consequence will be that these loans will be pushed into the cheaper – and less transparent -- corporate bond market.

"The regulators didn't make a strong case for why they decided this," he says. "These loans don't belong under risk retention."

Instant Insights /

Risk Retention Rules Approved; Higher Pricing, Less Capacity for CMBS

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