After three years of waiting, we now have our Risk Retention Rule.  All six of the Agencies responsible for the Rule – the FDIC, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Department of Housing and Urban Development, the Federal Housing Finance Agency and the SEC – have finally managed to agree, albeit with significant dissent at the FDIC and the SEC, on a Final Rule.  Note that Richard Cordray of the Congregation for the Doctrine of the Faith (in Progressive Causes) …er…the Consumer Financial Protection Bureau, apparently had a heavy finger on the scales, which is why there was material dissent at the FDIC and SEC.  So, after all those years of waiting, we have “it.”  “It” of course is another five hundred some odd pages of commentary and bloviating and a relatively few pages of actual Rule which, as we study it more, will inevitably have left much that will need to be subsequently clarified.  We have already found technical inconsistencies between the commentary and the Rule. 

Generally speaking, the commentariat appears to be relieved.  OK, I’ll admit I’m relieved, too.  Really?  How pitiful are we?  We are happy that the Rule didn’t get worse from the late lamented exposure draft?  We had a bunch of reasonable, common sense asks of the Agencies last time this creature surfaced from the black lagoon of the regulatory swamp and got little of note.  And yet we’re still sort of happy?  This is regulatory Stockholm Syndrome.  We are beaten and abused, but still drawing breath and therefore we thank our abusers for not making our plight worse?

There’s not much new here, at least as it applies to commercial mortgage finance.  Here are the highs and low points:

  • The existentially horrific premium recapture and/or closing date cash flow test (that would have restricted payments with respect to the B piece to the rate of amortization of the bonds as a whole) is gone.  That’s good. 
  • We can now have two B piece holders.  But they need to be pari.  As a benefit to the efficient operation of the capital markets, that’s teats on a boar. 
  • New, unpalatable B piece disclosure of many things, notably, including its acquisition price, a disclosure, to say the least, inconsistent with B buyer market strategies. 
  • It’s now not so easy for the operating advisor to boot out the Special Servicer and replace it with another Special Servicer.  Who told the regulatory apparatchiki that Operating Advisors are going to be good at picking Special Servicers?   That seems a curious faith based initiative. 
  • The commercial Qualified Mortgage definition was tweaked but remains an essentially unattainable and hence not a useful safe harbor in the real world. 
  • In a curious refusal to acknowledge the blindingly obvious, no exception was made for investment-grade-only standalones.  In what universe does a 50% LTV loan need the sponsor to hold risk?
  • The Rule does not require the calculation of fair value for eligible vertical interest (a distinction of almost no importance whatsoever).
  • There’s been no change in the originator retention provisions which allows an originator of at least 20% of the pools to become a risk retention party, but cunningly invites that originator to take that risk with respect to all of the loans in the pools, not just its own loans.  Who’s signing up for that?
  • A few tweaks to the Operating Advisor scope.  But when you get down to it, nothing transformational. 
  • The B piece buyer is now allowed to be an affiliate of the special servicer (yes, the sun does come up in the east), but for reasons which are obscure; the B piece buyer can be an affiliated only with an originator who produces less than 10% of the loans in the pool.  What’s this provision got to do with prudential lending?

That is it and it is essentially all noise.  What’s important is that for the most likely form of compliance, the horizontal strip, we still have 5% fair value risk retention.  That’s what’s important here.  We’ve started the 24 month clock on this odious piece of this regulatory mommy state intrusion between sophisticated sellers and buyers of commercial real estate risk.  I know it is in the statute.  I know.  But the regulators could have done much to align the legislative provisions on risk retention with current market practice and the efficient operation of the capital markets, yet they affirmatively elected not to do so.  In my judgment, they elected to align themselves with populist fearmongering and not thoughtful and competent public policy.  And to heap outrage upon the already intellectually unsupportable, the regulators abandoned principal in the face of powerful housing constituencies and gave the entire residential mortgage industry a complete pass on risk retention by effectively eliminating any down payment requirement from the QRM.  At the just concluded MBA Annual Conference, I had to listen politely to people saying, with what appeared to be straight faces (what price to their immortal souls did they pay to achieve that, I shudder to think), that risk retention in the residential mortgage industry would fatally damage the private securitization market.  Fatally damage?  The private securitization market?  As long as the GSEs continue to own the market, there is no material private securitization market.  If we eventually find the courage of our public policy conviction and begin to shrink the GSEs, I really need someone to explain to me how risk retention makes perfectly good sense in commercial finance but would be fatal to the health of the resi market.  Don’t get it.  Don’t get it, because it’s not true.  And in the last crisis, where were the problems of bad underwriting concentrated?  The commercial market?  Hah.  The subprime residential market.  Here we go again? 

So I’m torqued up at this point.  After years of uncertainty, we have an intrusive ill-thought through and in some fundamental way completely unproductive risk retention regime which is at odds with the existing structure of the commercial mortgage capital markets — which, by the way, seem to be working just fine, thank you, without this Rule.  The efficient functionality of that market is important to our economy.  Pay attention, people, this Rule extracts a real price and delivers… almost nothing. 

But as I tell my colleagues, we have a two year transition period and a lot can happen in two years.  I’m hoping now with this thing, having finally been retched up, we’ll all get over the fantasy that risk retention is the silver bullet of good underwriting and begin to engage, in an intelligent way, on what if anything is really needed or useful to make the commercial real estate capital markets better, safer and more efficient. 

Long before this odious regulatory sideshow becomes the law of the land, we need to get something better.