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Risk Retention Re-proposal Trade Letter

November 1, 2013

On Oct. 30, real estate and finance industry groups, including NAR, sent a joint trade letter the agencies responsible for the QRM rules (the Federal Reserve, FDIC, HUD, SEC, Department of the Treasury, and the FHFA) regarding commercial real estate elements of the re-proposed rule on credit risk retention ("the Re-proposal"). The letter acknoweldges changes in the Re-proposal which are beneficial to Commercial Mortgage-Backed Securities (CMBS), but also points out the most critical problems in it, and provides recommendations on them. These problems are:

  • Proposed restriction on cash flows to eligible horizontal risk retention interest: This would severely limit cash flow to horizontal risk retention holders due to restrictions linking CMBS payments to principal repayment, which usually doesn’t occur for CMBS until the expiration of the securitization.  
  • Horizontal risk retention interests: This can only be shared on a pari passu basis. The signatories recommend that risk retention be able to be split into senior and subordinate positions, in addition to pari passu.
  • Qualified Commercial Real Estate (QCRE) Loans: Only 2.5 – 8% of current mortgages comprising conduit CMBS will qualify for zero risk retention, calling into question whether the underwriting characteristics of QCRE loans were fairly and optimally calibrated. Reconsidering the underwriting metrics for CMBS is strongly recommended.   
  • Single Borrower, Single Credit CMBS (SBSC): Despite much lower cumulative loss rates for SBSC compared to conduit CMBS, only minimal SBSC loans would have qualified for QCRE loan status. Agencies should reconsider the QCRE eligibility requirements for SBSC.
  • B-Piece Buyer Affiliations: the Re-proposal prohibits a third-party purchaser of the EHRI from affiliation with a lender that contributes more than 10% of the loans to the deal. There is no compelling support for this preclusion.
  • Five-percent quorum for replacing the special servicer: This could result in bond holders controlling only 2.51% of the CMBS outstanding principal replacing the special servicer. Existing market standards for establishing quorum requirement should be considered.

The agencies are urged to make every effort to understand the economic impact the Re-proposal could have, and to conduct a cost-benefit economic impact study prior to implementation.

Read the joint trade letter