Banking law facilitates securitization of r.e. loans.

Banking legislation signed into law September 23 by President Clinton should facilitate expansion of the secondary market for commercial and multi-family real estate mortgage loans by helping to reduce securitization transaction costs, expand investor markets, and aid banks' entry into the secondary market through subordination transactions.

As Treasury Secretary Lloyd Bentsen said in remarks delivered at the bill signing ceremony, with this legislation "we're helping our small businesses and those who help provide our businesses with commercial real estate by removing the barriers to backing securities with small business or commercial real estate loans."

In the view of the National Realty Committee, the new law "represents a positive, welcome step toward expansion of the secondary market for commercial and multi-family real estate loans," according to NRC Chairman James J. Didion, who is chairman and chief executive officer of Los Angeles-based CB Commercial Real Estate Group.

"With this action, policy-makers in Washington continue to demonstrate their recognition of the need for, and their support for, policy reforms that should help provide real estate market liquidity."

As a result of the new law, Didion added, "people and companies that rely on real estate as collateral for capital and credit will be in a better position to secure financing for all kinds of businesses."

Specifically, the Riegle Community Development and Regulatory Improvement Act of 1994 extends to commercial and multi-family real estate securities the same benefits enjoyed by residential mortgage-backed securities under the Secondary Mortgage Market Enhancement Act (SMMEA). Enacted in 1984, SMMEA removed a number of legal impediments to the development of a private, mortgage-backed securities market for residential mortgage pools. These steps included the preemption of state blue-sky laws, favorable margin rules and eligibility for "shelf" registration.

The net effect of this new policy change will be to reduce the cost of a public offering by allowing issuers of commercial mortgage-backed securities to bypass state securities registration laws and instead issue the securities through a single, federal application process. Also, the state law legal investment preemption will allow state-chartered or state-regulated entities such as banks, thrifts, credit unions, insurance companies and others to invest in commercial mortgage-backed securities as long as the securities are in the top two ratings tiers of at least one nationally recognized ratings agency.

Until now, risk-based bank capital rules required that a bank maintain at least eight percent of capital against the entirety of a commercial real estate loan pool, even if the bank had sold a senior interest in the loan pool and retained only a junior interest, with no ongoing credit support for the senior interest sold. The new law directs regulators to promulgate (within 180 days) capital rules under which depository institutions would not be required to hold capital in reserve to the extent that it exceeds "the contractual maximum amount of the recourse obligation." Although the same reserve ratios will continue to be applied to the entirety of commercial real estate loan pools, the reserve requirement now will be capped at the amount equal to the bank's retained recourse, or junior interest remaining.

Both of the real estate securitization measures included in the new law originally were contained in the Commercial Mortgage Capital Availability Act, introduced last year by Representatives Barney Frank (D-MA), Richard H. Baker (R-LA) and James P. Moran (D-VA), and by Senators Richard H. Bryan (D-NV) and Pete V. Domenici (R-NM). This legislation also would have removed an unnecessary Employment Retirement Income Security Act impediment to pension fund investment in rated commercial real estate securities. NRC, along with its partners in The Capital Consortium, a coalition effort aimed at expanding the secondary market through public and private-sector initiatives, is preparing a formal application to the Labor Department for such a policy modification.

NRC President Steven A. Wechsler "By facilitating the securitization of commercial and multi-family real estate loans, this legislation should help broaden some opportunities for investors, make the mortgage market more efficient and liquid, and provide safer investments through greater information disclosure, investment diversification and risk-sharing."

Wechsler explained that by helping to even out real estate capital and credit flows throughout the economic cycle, an expanded secondary market also would reduce significantly the likelihood of another liquidity crisis, the severity of which was experienced in the late 1980s and early 1990s.

Didion said the impact of enhanced real estate market liquidity - for refinancing, restructuring and other normal business activities - will be felt far beyond the real estate sector itself.

"As liquidity continues to return to real estate markets and real estate asset values stabilize, as they have now in much of the country, local tax bases will continue to be solidified, financial institutions will be healthier and in a better position to make all kinds of commercial and consumer loans, and taxpayers and savers will be affected beneficially," Didion said.