On Feb. 3rd, President Trump signed an executive order directing the Treasaury secretary to conduct a broad review of The Dodd-Frank Wall Street Reform and Consumer Protection Act that was enacted in 2010.
At the time, Trump said “we expect to be cutting a lot out of Dodd-Frank because frankly, I have so many people, friends of mine that had nice businesses, they can’t borrow money.”
The order doesn’t call for any specific changes, but lays out “key principles” that regulators should focus on. Those include the health and vibrancy of the nation’s financial markets in addition to limiting risk and consumer harm.
Separately, House Republicans plan to reintroduce an amended Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs (CHOICE) Act that would reform parts of the Dodd-Frank Act. It was originally brought to Congress last year.
NREI spoke with CRE Finance Council Executive Director Lisa A. Pendergast to gain some insights on what might be ahead for financial reform and the broader implications for commercial real estate lending.
This interview has been edited for length and clarity.
NREI: Do you think the fact that President Trump is addressing financial regulation so early is a telling sign that this is a top priority for the new administration?
Lisa A. Pendergast: He said he was going to focus on issues such as tax reform, infrastructure and deregulation, not only as it applies to financial markets, but as we have already seen, certain energy markets and the like.
As it relates to Dodd-Frank, President Trump’s executive order early in February directed the Treasury Secretary, Steven Mnuchin, to confer with regulators and report back in 120 days on potential changes to banking and financial rules. The focus is on unearthing those rules with unintended consequences that may unnecessarily impede the flow of capital and services important to job creation.
We also have Jeb Hensarling (R-Texas) in the House Financial Services Committee who is planning to reintroduce the CHOICE Act in early March. It’s really tough to triage these issues, but I do believe that financial regulation is certainly a top three.
NREI: What is going to be included in the CHOICE Act that will impact CRE lending specifically?
Lisa A. Pendergast: The first version of the CHOICE Act was introduced in 2016, but it failed to get sufficient traction. Version two is expected to look very similar to version one. CHOICE 2.0 focuses on rolling back portions of the Dodd-Frank Act, honing in on the role of the [Consumer Financial Protection Bureau] and what many view as excessive capital constraints on mid- to small-sized banking institutions.
As it relates to CRE finance, CHOICE Act 2.0 is likely to focus on risk retention, changes in the oversight of credit rating agencies, repeal of the Volcker rule, and a deeper dive into the options for ending the conservatorship of Fannie Mae and Freddie Mac, who provide significant amounts of debt capital to multifamily borrowers and see tremendous demand from bond investors in their multifamily loan securitizations.
NREI: And to the second part of that question, how will that impact CRE?
Lisa A. Pendergast: The issue of risk retention is an interesting one for the CMBS marketplace. Dodd-Frank was enacted in 2010 and yet CMBS risk-retention rules only took effect on December 24, 2016. The market has had quite a bit of time to prepare and yet there are mixed emotions surrounding talk of rolling back retention.
My discussions with investors suggest that they would very much like to see risk retention remain in place, while issuers’ views are more mixed. The fact is that CMBS underwriting grew far more conservative coming out of the Great Recession, so some see retention as overkill. We are in the process of polling our members to determine how the CRE Finance Council will advocate on these issues.
CHOICE also will take another look at the credit rating agencies, basically looking at provisions in place that may not serve the public interest or are not consistent with what investors would like to see.
On the Volcker Rule, our initial reading is that all of our members … are of the view that the rule serves to prohibit or significantly penalize proprietary trading desks, with the net result being a significant decrease in secondary-market liquidity. That negatively affects the CMBS holdings of pension funds, asset managers, banks and life companies.
Historically, those proprietary trading desks have served as buyers of last resort during periods of macro-market volatility. Holders of these securities could generally count on there being a bid for their bonds. It may not have been one you loved, but if you had to sell, there was someone there to buy. The alternative is to attempt to sell bonds into a bottomless pit, where there may be no bid at all during times of extreme volatility.
And the Fannie Mae and Freddie Mac component is very important to multifamily debt finance. The Republican side of the bench would like to see Fannie and Freddie come out of conservatorship and either work as independent, non-guaranteed entities or with some sort of guarantee, but outside of conservatorship.
NREI: At this stage, do we have any kind of roadmap on what the process might be if President Trump does want to make changes to existing regulations and legislation?
Lisa A. Pendergast: When you have a new administration in the White House, the president has the ability to change the leadership at the regulatory agencies. To the extent that happens, the new appointees will most likely be more aligned with the president’s agenda. So rollbacks, refinements and/or clarifications are likely for certain regulations that are deemed by the president to be over-reaching, or difficult to manage and understand for that matter.
Change can also come through legislation, via rollbacks of current legislation or the enactment of new legislation.
So, as I said earlier, a second version of the CHOICE Act will likely be put forth sometime in the next few weeks. The CHOICE Act version two focuses on the repeal or refinement of some of the existing Dodd-Frank regulations. When we talk about repeal and replace, it sounds a lot easier than it is. I think we are starting to see that with Affordable Care Act.
NREI: Do you think the intent of the Trump administration is to do a major overhaul or roll-back on Dodd-Frank, or are there certain issues in particular that are likely to be key targets, i.e. CMBS risk retention and high volatility commercial real estate (HVCRE) loans?
Lisa A. Pendergast: I don’t think we’ll know the full extent of the President’s intentions until he’s had the chance to hear recommendations from the report he required through his executive order. That seems like a logical approach to me.
I think his objective is to look at those rules that are overly burdensome, overly expensive and, most importantly, don’t serve the goals that they were initially set out to serve. I feel confident in saying that folks in the commercial real estate finance markets have concerns about HVCRE, the Volcker rule, and certain provisions within the Dodd-Frank as they relate to CMBS and hope that they receive thoughtful consideration from the President and the House and Senate.
NREI: When we talk about new requirements for HVCRE loans, which have been largely blamed for slowing construction lending at the larger banks, is that a Dodd-Frank issue or a Basel issue?
Lisa A. Pendergast: It is a Basel issue. HVCRE is defined as acquisition, development and construction loans, under the so-called Basel rules. Most would agree that construction loans require a higher level of governance than say an acquisition loan on a stabilized property or a development loan where a property owner/borrower is enhancing an existing property. Furthermore, there is a great deal of uncertainty in how to interpret the rule as to what is and is not an HVCRE loan, not only from a lending perspective, but also from a regulatory perspective. The HVCRE rule is overreaching and provides a sound example of the excesses embedded in the proposed new Basel IV rules.
NREI: What power would President Trump, Secretary of the Treasury Mnuchin or various agencies actually have to make changes, or would this require new legislation?
Lisa A. Pendergast: There are three pathways to change. The first is through leadership changes at the various regulatory agencies charged with rule-making. The second is through legislation, via rollbacks of current rules or new legislation. The third is the not often used Congressional Review Act (CRA), which allows Congress to disapprove more recent final rules.
NREI: Given the Republican majority, will the CHOICE Act have some good traction to move forward, or will there be some resistance in the House and/or Senate?
Lisa A. Pendergast: It’s really impossible to project how this bill will fare. But, suffice it to say that the current construct of a Republican in the White House, and both the Senate and House privy to Republican majorities suggest that CHOICE 2.0 is better positioned to move forward in some way than its predecessor.
It will no doubt face opposition from Democrats and remember that the Senate requires 60 votes to advance any legislation moving the dials on finance. It’s also noteworthy that Senator Crapo (R-ID), Chairman of the Senate Committee on Banking, Housing & Urban Development, has said that he would like to work with Democrats to find bipartisan solutions to reform. I think it would be premature to expect significant Dodd-Frank rollbacks.
NREI: What kind of time table are we talking about for change here?
Lisa A. Pendergast: Any legislative breakthroughs on health care and tax or significant rollbacks to Dodd-Frank likely will have the best chances of happening this year. Yet, the current momentum appears fragile and could easily shift from health care and tax reform over to banking and financial services should those efforts hit any potholes.
On GSE reform, we have some skepticism. We could see legislation this year and it possibly may even pass the Senate, but the House appears much less inclined to continue the government guarantee without fairly drastic reforms that may prove too much for the Senate to stomach.
NREI: Capital markets do not like uncertainty. Does this create more uncertainty and make people more conservative, or is it business as usual?
Lisa A. Pendergast: I think those in the capital markets have been operating on two plains. The first is to proceed as if what is in place today remains in place. The second is that if there are changes to come, as long as they don’t happen overnight, businesses will be able to adjust. To the extent that there is risk retention, many believe it enhances credit quality and acts as a governor for CMBS origination standards. Most in the markets have seen a significant improvement in underwriting. Also, keep in mind that many have raised new capital to put to work in the sector under the current constrict and they will continue to participate in the market until something changes.
NREI: What are the implications here for capital markets in general? Could these changes improve liquidity? What is the big takeaway here?
Lisa A. Pendergast: Knowing how our membership has responded to these potential changes to date, I think the one area that everyone seems to be in agreement on is capital and liquidity. The CMBS sector, for most of its existence, has enjoyed tremendous liquidity. Some would say it was a hallmark of the sector.
The fact that that liquidity has slowly been drained from the system over the last several years has truly had a negative effect on CMBS investor portfolios and everyone involved in the business. So, to the extent that we can do something with Volcker and push back on the adoption of Basel IV, markets should respond positively.