Your correspondent is fresh from the front-lines of the risk retention wars where great armies of lawyers, bankers and advisers are fixedly staring at each other, staring out of the redoubts of their respective defensive crouches in a complex, multidimensional chess game.  All are fervently hoping against hope that something or someone does something to create clarity and allow our business to pivot around this new set of rules so it can continue to thrive.  I think all of us in the finance world are justifiably proud of the fact that if we are given a set of rules, we’ll figure out how to conduct business.  But the uncertainty here is freezing everyone in place, a giant front court pick that we can’t seem to get around.  But one thing is certain and that is that Christmas Eve is coming and with it this Rule will become effective.  After having obsessed about the Risk Retention Rule for years now, we are broadly no closer to clarity about how one should play in the soon to be upon us risk retention world.

Based on our wide ranging conversations with industry participants and early days negotiation of real deal documents, here’s some of the things, consequential things, that we still don’t know:

• We don’t know which Banks can practically hold vertical retention at a sufficient scale to represent a meaningful potential solution to the risk retention problem.
• We don’t know how pricing will work for mortgage loan sellers selling into deals free of any risk retention obligation.
• We don’t know if sponsors and third party purchasers can get to terms on price. What is a market clearing price of a third party purchaser undertaking?  How is illiquidity actually priced?
• We don’t know if sponsors and third party purchasers or indeed multiple sponsors can get to terms on the allocation of liability. This Rule is so full of white space that there are many unanswered questions that are consequential.  When confronted by a regulatory apparatus that is either unable or unwilling to provide any material guidance, how does one price the unknown unknowns?
• Will there be new non-Bank, unregulated sponsors ready to come to market in January? March?  2018?  Will investors accept bonds off non-Bank shelfs?  Will they have adequate capital to really preserve the market?
• How will the CRE majority owned affiliate (MOA) structure (not to be confused with the C-MOA structure we wrote about for CLOs) really work? What will it look like? Is there a consensus on whether there can be multiple owners inside an MOA?  Is there a consensus on whether the non-sponsor or third-party purchaser which will hold equity in these MOAs trade these positions?  How does one discern what full recourse actually means?  If these questions can’t be answered, the industry may be starved for the equity required to provide necessary liquidity in the risk retention world.
• All in, is this just a pricing issue? If so, who actually pays it?  The borrowers?  Anyone think we actually have pricing power?
• How do mortgage loan sellers that are not shelf-equipped get comfortable that they have an exit for production into a risk retention environment? When might lenders, this fall, begin to flex price in order to accommodate the “tax” which is the ultimate bottom line of the risk retention regime?
• Who might just pack up their ball and bat and go home?
• And finally, does the election matter? Are the rules of the road likely to be affected by the installation of a new administration next year?

That’s a lot not known and we’re getting really close to when it will very much matter.  No answers right now.  Negotiations are beginning around real deals and they are not going terrifically well.  We will report back from the trenches as the engagement ensues.