Opportunities for Lenders: How the New Banking Legislation Will Affect Commercial Real Estate Lending
Freundlich, Alisa J., Journal of Commercial Lending
Securitization is the process of packaging pools of loans that act as collateral for the issuance of bonds or securities. Commercial mortgage-backed securities may be secured by commercial mortgages on any type of income-producing property, including apartments or other multifamily dwellings, office buildings, retail centers, restaurants, hospitals, hotels, warehouses, and industrial properties.
The Resolution Trust Corporation (RTC), through the bailout of the savings and loan industry, facilitated the creation and expansion of a viable commercial mortgage-backed securities market. The RTC set the precedent for future transactions by establishing standard procedures and ratings criteria with rating agencies to liquidate the mostly nonperforming commercial loans held by failed financial institutions. Investment bankers also worked with the rating agencies to develop underwriting standards, valuation techniques, and deal structures. Over time, a number of creative and entrepreneurial players (including investment bankers and the emerging real estate conduits) have significantly expanded the range of transactions beyond RTC securitizations and have developed a structure to securitize performing loans and sell them in the secondary market on an ongoing basis.
Historically, the commercial mortgage-backed securities market was slow to evolve because of four factors:
1. Lack of sponsorship of a secondary securities market by the federal government.
2. Abundance of alternative sources of capital.
3. Uniqueness of commercial loans and loan documents.
4. Poor historical performance of commercial mortgages.
Today, the secondary market for commercial mortgages has the power to overcome these obstacles for the following reasons:
* The market has devised many alternatives for credit enhancement, including the senior/subordinated debt structure, the absorption of first-loss positions by the issuer, and third-party credit enhancements.
* Demand for commercial loans remains strong, but financing is still difficult for some to obtain.
* Notwithstanding the uniqueness of loans, loan documents and transactions can be standardized. Many lenders have created express-style programs using standardized documents and terms.
* Mortgage performance is a function of underwriting and geographic conditions--the pooling of loans decreases the risk of loss.
The adoption of the Riegle Community Development and Regulatory Improvement Act of 1994 affects and facilitates the secondary market for loans secured by commercial property. Section 347 of the act expands the definition of a mortgage-related security to include securities backed by commercial real estate assets. As a result, qualifying commercial mortgage-related securities will have benefits similar to other securities specified by the Secondary Mortgage Market Enhancement Act (SMMEA). One of these benefits is the removal of impediments to trading and investing in commercial real estate mortgage-backed securities, including the easing of margin requirements under federal securities laws and the ability of insured banks to purchase commercial mortgage-backed securities, pursuant to bank regulations. Although the legislation specifically references "one or more parcels of real estate upon which is located one or more commercial structures," commentary provided in the conference report states that the definition also includes multifamily properties.
Before this legislation was adopted, banks were "penalized" for holding performing commercial real estate loans or related securities by the imposition of an 8% risk-based capital requirement. In comparison, performing residential loans and residential mortgage backed-securities qualifying under SMMEA did not require a capital reserve. By extending SMMEA treatment to commercial mortgage-backed securities, banks will be able to buy and hold rated, mortgage-backed securities similar to the way in which they invest in government securities. …