A U.S. government proposal to curb the type of lending that contributed to the financial crisis needs to be reworked to avoid shutting down the $700 billion commercial-mortgage bond market, according to Deutsche Bank AG.
Firms packaging property loans into securities would need to set aside certain cash that is typically collected upfront, under rules released by the Federal Deposit Insurance Corp. and Federal Reserve for public comment on March 29. The requirement effectively precludes originators from making money until the bond is paid off, reducing the incentive to issue securities backed by commercial mortgages, Deutsche Bank analysts led by Harris Trifon in New York wrote in a report yesterday.
“The proposed rules are a negative with a large number of unintended consequences,” Trifon said in a telephone interview. “There is a need to address some of the excesses of the previous cycle. With a few tweak and changes, the proposed rules should result in a satisfactory outcome.”
Policy makers are designing the rules to align financial institutions’ incentives with those of investors to prevent lenders from writing shoddy loans they would not make for their own books.
A provision related to lenders retaining 5 percent of the risk of the transaction may increase borrowing costs, the analysts said in the report. Regulators may calculate this amount on the market value of the securities instead of the face value, potentially increasing the amount of the deal the holder of the risk needs to retain, the analysts said.
Relative yields on debt ranked BBB may widen by 300 to 500 basis points, increasing financing costs to borrowers by as much as $8 billion over a 10-year period, they said. A basis point is 0.01 percentage point.
Sales of commercial mortgage-backed securities are set to climb to $45 billion this year, according to JPMorgan Chase & Co. Banks arranged $11.5 billion of the debt in 2010 compared with a record $234 billion in 2007, according to data compiled by Bloomberg. Issuance plummeted to $3.4 billion in 2009 as credit markets froze, choking off funding to borrowers with maturing loans.