Risk-Retention Measure Could Help Heal CMBS

A financial risk-retention provision that could contribute substantially to recovery in the commercial mortgage-backed securities (CMBS) market has been approved by the U.S. House Financial Services Committee.

The provision falls under the broad set of legislative measures known as the Financial Stability Improvement Act of 2009 (H.R.3996), which is currently receiving a wave of attention and criticism for its recently approved amendment that would give the federal government power to dismantle ‘too big to fail’ firms.

The risk-retention provision, proposed by Walt Minnick, D-Idaho, and Melissa Bean, D-Ill., would cut the maximum retention requirement from 10% to 5% for the CMBS market. It also includes language that would ‘customize retention provisions to reflect the unique nature’ of CMBS, according to Commercial Mortgage Securities Association (CMSA), which applauded the amendment's passage.

Noting that unlike some other markets, CMBS involves a third-party investor that purchases the first-position and re-underwrites loans prior to securities' issuance, CMSA said it has long lobbied policy-makers to custom-tailor risk provisions accordingly. Doing so, the association says, helps to ‘maintain and strengthen the safeguards that exist in the CMBS market by explicitly recognizing the important role of third-party investors who purchase the first-loss position and perform due diligence.’

In addition, the Minnick provision would allow third-party investors to fulfill the risk-retention requirement, provided that the third party retains the associated first-loss risk. CMSA stated it is ‘strongly encouraged’ by this language in the provision.

‘Considering the challenges facing commercial real estate, these reforms must provide certainty and confidence for all market participants to help kick-start the lending markets,’ Patrick C. Sargent, CMSA president, noted in the association's statement of approval. ‘Tailoring retention language to support, rather than impede, the CMBS market is absolutely critical to recovery efforts in commercial real estate and our overall economy.’

In a September 2009 white paper, CMSA stressed the particular importance of proper risk-transfer rules for a well-functioning CMBS market.

‘The Treasury's reform proposal includes an originator/sponsor five-percent risk-retention requirement, but it also would provide the authority to grant exceptions or adjustments to the retention requirement in certain cases,’ the association wrote. ‘Given the unique structure of CMBS, the exception authority should be crafted to allow structured finance vehicles that include investors akin to the CMBS B-piece buyers to qualify, subject to the appropriate transfer of such risk.’

Minnick's provision earned bipartisan support, winning approval from both House Financial Services Committee Chairman Barney Frank and Ranking Member Spencer Bachus, a Marketwatch article notes.

Minnick explained to Marketwatch that his provision provides regulators overall flexibility to determine the extent of a stake that originators of securitized products, such as CMBS, should be required to retain.

‘If the securitizer is packaging high-risk junk bonds, the bank regulator may want to have the originator boost the amount they need to hold onto from five percent to 10 percent,’ he said. ‘If it is a plain-vanilla or low-risk product, such as a corporation offering a credit enhanced short-term note, the regulator could have the authority to say that there would not be any risk retention by the originator.’

CMSA also commended Reps. John Adler, D-N.J.; John Campbell, R.-Calif.; Dennis Moore, D-Kan.; and Gary Miller, R-Calif.; for their work on the Minnick provision. The Financial Stability Improvement Act of 2009 is expected to be presented to the House next month.


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