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New Opportunities Open Up in Capital Markets Amid Dodd-Frank Rollbacks

As a result of this regulatory change, some borrowers could secure more competitive terms for their commercial real estate loans.

This spring, President Trump signed the Economic Growth, Regulatory Relief, and Consumer Protection Act (‘Economic Growth Act’) into law. This scaled back many of the provisions of the Dodd-Frank Wall Street Reform Act, which was originally implemented in response to the 2008 financial crisis.

This regulatory reduction is not unprecedented, as it follows a pattern seen throughout the nation’s history: tightening lending standards during a recession and relaxing them when the economy is thriving.

Many in the industry view these rollbacks as a strong win for commercial real estate because they provide certain lenders more incentive to originate certain types of loans and grow their real estate loan portfolios—resulting in the potential for increased activity and lower rates for borrowers.

These changes do present borrowers with additional funding sources and more competitive terms for higher risk loans like development and construction, providing some relief from the trend of more conservative underwriting amid rising interest rates.

That said, relaxing Dodd-Frank restrictions is part of maintaining a healthy economy and thriving lending environment, and we do not anticipate significant changes in the lending climate overall for the remainder of 2018.

Increased opportunity for higher-risk projects

The Economic Growth Act implemented a revision that could make it easier for some borrowers to obtain loans for acquisition, development or construction real estate projects that are considered to carry the most risk—“High Volatility Commercial Real Estate,” or HVCRE loans.

HVCRE loans have a heightened, 150 percent risk weight, meaning banks are required to reserve more capital—increasing the cost of financing for both the banks and, ultimately, the borrowers.

Due to this, under Dodd-Frank, some banks had been more conservative in their underwriting for these types of projects, or even exited the space altogether.

The new rules proposed do not lower the capital reserves required for HVCRE loans, but rather provide more clarification and opportunity for what would have been considered an HVCRE loan to be re-classified, so that the same loans now require less capital.

Because of the thriving economy and commercial real estate market, capital has for the most part remained available to developers and investors via other sources like private equity, albeit at higher rates.

As a result of this regulatory change, some borrowers could secure more competitive terms for their commercial real estate loans because banks could become more active in, or re-enter, the lending space for acquisition, development and construction.

That said, it is important that developers and investors work with a finance partner with a deep understanding of their project or business plan in order to weigh all options for funding sources based on borrower goals and requirements.

Some mid-size banks more aggressive for deals

Also included in the Economic Growth Act is a revision that significantly raises the threshold at which banks are considered systematically important financial institutions, and thus are required to face increased regulations and undergo annual ‘stress tests,”—from $50 billion to $250 billion.

This allows dozens of institutions to be less stringent than they have been under Dodd-Frank and save both money and time on satisfying compliance. As a result, some banks could be more aggressive in their loan originations, opening up more funding for developers and investors.

Further, this change could result in several banks, primarily those with assets currently in the $30 or $40 million range, being hungrier for growth, and thus more aggressive for deals, because they are no longer concerned about having to face increased regulations.

This could potentially change lending landscape in the long term, as there could be an increase in mergers and acquisitions.

Forward-thinking investors should not necessarily change their strategies for securing financing due to these changes, but remain aware of bank activity and where it could open up funding opportunities down the line.   

Sustaining healthy growth and securing competitive terms

While these regulatory relaxations do present more sources of funding and the potential for more competitive terms for borrowers, especially for riskier investments, it is unlikely to cause significant changes to the lending landscape this year.  

That said, we do believe that the rollbacks will help the capital markets maintain a strong, competitive pace and potentially counteract some of the slowdown we have seen due to recent interest rate rises and lender hesitancy due to the lengthening real estate cycle.

For example, increasing interest rates have led to most lenders offering lower leverage across the board. While commercial loans are still being originated at healthy levels and are not likely to decline, lenders continue to reduce leverage from the 70-percent range to 65-percent range.

Recent regulatory changes could help maintain these numbers and provide circumstances where it is possible to secure more competitive leverage for certain transactions.  

The Dodd-Frank rollbacks and clarifications do provide benefits to borrowers looking to secure competitive financing in some cases. This new act also suggests that borrowers can expect a similar lending environment in the upcoming year. Origination is unlikely to decline and will remain consistent with the current market.

While other economic factors keep these changes from offering a large boost in the economy, this new bill will assist in counteracting lender caution seen from continued rising interest rates and any slow down we have seen this year.

Ultimately, the rollback of regulations, in addition to other factors such as rising interest rates, reflects confidence in the strength of the current growth of the economy, strong labor markets and target inflation. 

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