Commercial Lending Update: Mid-Year Review and Regulatory Impact
Commercial lending is regulated by various federal laws such as the Dodd-Frank Wall Street Reform and Consumer Protection Act. As these regulations begin to take effect, life companies continue with business as usual while banks and CMBS lenders work to implement the new changes. The Dodd-Frank Reform and Protection Act was signed into federal law in 2010 as a response to the 2008/09 recession in order to regulate Wall Street. Different lenders have different regulatory requirements, which can have a major impact on a borrower’s bottom line and funding timeline. Here’s what you need to know about the three major commercial lending segments right now.
Most life companies have maintained or increased their asset allocation for commercial mortgages—which are traditionally a small portion of their overall investment portfolio. Yields on commercial mortgages remain attractive relative to safe investments such as investment grade bonds. Life companies are currently offering 10-year fixed rates in the 3.25-4.5% range.
Over the past nine months, many smaller CMBS firms have become dormant while larger money center banks plan how they will retain 5% of transactions for at least five years amidst a general feeling of cautious optimism. During this time, CMBS has remained active but volatile. CMBS spreads have come down as large lenders finalize adoption of new industry regulations and the beginning of CMBS 3.0. According to Commercial Mortgage Alert, “the spate of well-received bond offerings in recent weeks is giving conduit originators the flexibility—and the courage—to offer loan rates that are more competitive with those of balance-sheet lenders.” From now until the end of the year, the CMBS market should strengthen and terms offered to borrowers should improve. This segment has stabilized due to increased bond buyer demand, a decreased supply of CMBS bond offerings, and stabilization of the international financial markets over the past six months.
With new Basel III rules in place, some banks are starting to pull back loan amounts and LTVs on construction lending due to regulations for High Volatility Commercial Real Estate loans (HVCRE). Some banks are tightening construction lending in order to avoid a 50 percent increase in cash reserves to account for anything that falls into the HVCRE category. Due to Frank Dodd laws, banks are increasing the head count of their respective compliance departments as the level of due diligence required for each borrower/sponsor/entity has increased significantly. This makes documenting loans a hassle for more complex entity structures as the additional documentation requests can be endless. With that said, while the CMBS market was disjointed, some banks stepped up term lending to pick up market share. Banks will continue to pump the brakes by increasing or decreasing interest rate spreads based on their risk appetite and ability to implement regulatory compliance.