CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Despite the general optimism, panelists at the forums agreed that 2013 will not be without challenges.  Many panelists believe that the biggest risk to the capital markets for 2013 will be the implementation of Dodd-Frank and the possibility that the regulations will impose risk retention and holding period requirements on CMBS sponsors and B-Piece buyers. 

If the morning forums did not dampen the expectations of many attendees, Monday’s featured speaker, David Malpass, threw a bucket of cold water on it with his outlook for the world economy over the next year.  Among the risks that David sees to the capital markets in 2013 are rising interest rates, over-regulation by the government, the threat of congressional grid-lock and the fiscal cliff, central bank policies that David views as contractionary, a slowing global economy (in particular, the threat of recession in Europe) and the possibility that the euro crises will return in the fourth quarter of 2013.  According to David, quantitative easing and other central bank policies are creating an artificial environment of low interest rates, and as the federal reserve pulls back on quantitative easing, rising interest rates will likely lead to a decline in real GDP growth through 2013. 

The sobering outlook delivered by David Malpass left many of us feeling the need for a drink, and over 380 other attendees who enjoyed Dechert’s reception at the SLS hotel on Monday night seemed to agree.  Day 2 of CREFC will bring more lively discussion and debate over the future of commercial real estate, but for now, the good food and drinks and great friends are helping us to forget our worries for one more night. 

By: Ken Hackman and Matt Ginsburg

In its interpretive letter, the CFTC acknowledged that certain securitization vehicles are likely not commodity pools and provided an explicit exclusion for securitizations that meet the following criteria:

1. the issuer of the asset-backed securities is operated consistent with conditions of SEC Regulation AB or SEC Rule 3a-7 of the Investment Company Act of 1940;
2. the entity’s activities are limited to passively owning or holding a pool of receivables or other financial assets that by their terms convert to cash within a finite period of time;
3. the entity’s use of derivatives is limited to the use of derivatives permitted under Regulation AB;
4. the issuer makes payments to securities holders only from cash flow generated by its pool assets and other assets, and not from changes to value in the entity’s equity assets; and
5. the issuer may not acquire additional assets or dispose of assets for the primary purpose of realizing gain or minimizing loss due to changing values of the vehicle’s assets.

Traditional CMBS and RMBS transactions should fall within the criteria for exclusion, but most CLOs and CDOs do not.  Instead, these vehicles will need to consider other avenues for exclusion or exception, such as CFTC Rule 4.13(a)(3) which exempts commodity pool operators from registration and regulation who engage only in de minimis pool trading.  Patrick Dolan, Holland West, Cynthia Williams and Ava Jacobi provide a comprehensive breakdown of the CFTC’s interpretive letter in a  recent Dechert On-Point, which can be found here.     

By: Stewart McQueen

Still pending are regulations that could likely have the consequence of restricting credit, such as the Consumer Financial Protection Bureau’s (the “CFPB”) ability-to-repay regulations incorporating the “Qualified Mortgage” (“QM”) standard which we have written about frequently including here and here as well as the interagency “Qualified Residential Mortgage” (“QRM”) exception to the risk retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which we have also written about here and here. In addition, revised capital rules may mean that holding mortgage loans other than what regulators deem low-risk mortgage loans will trigger increased capital requirements for certain financial institutions. These developments may significantly reduce lender interest in originating non-traditional loans, which, in turn, may trigger disparate impact claims. Fitch Ratings said last week that “nontraditional mortgages, viewed as high risk by regulators, may be effectively eliminated from broad availability at regulated banks.”

This topic was just addressed in a Webinar presented by Dechert partners Ralph Mazzeo, Bob Ledig, Tom Vartanian and Ben Rosenberg titled “Living With the Consumer Financial Protection Bureau.” Nearly 200 people registered for the Webinar that covered such topics as: Understanding the CFPB: rulemaking vs. enforcement; Who does the CFPB have jurisdiction over?; CFPB and the mortgage industry; CFPB and fair lending; and CFPB enforcement considerations, including relationships with state attorneys general.

A quick tutorial on three theories of liability related to discrimination in lending:

1. Liability for overt discrimination in lending exists when a lender overtly discriminates on a prohibited basis (e.g., lender offers potential borrowers Mortgage Products X, Y and Z but offers a protected class of borrowers only Mortgage Product Y).

2. Disparate treatment liability results when a lender treats a minority applicant differently than a similarly situated majority applicant (e.g., lender denies or charges minority applicants more for mortgage products than similarly situated majority applicants).

3. Disparate impact liability can be triggered when a seemingly facially neutral policy or practice that is applied equally to all applicants disproportionately excludes or burdens certain persons on a prohibited basis (e.g., lender requires applicants to meet certain loan qualification criteria such as a minimum downpayment).

The law on disparate impact as it applies to lending discrimination is subject to continuing dispute and may ultimately require a Supreme Court ruling. What we know is that, under the view of federal regulators, evidence of discriminatory intent is not necessary to establish that a lender’s policy or practice that has a disparate impact is in violation of the Fair Housing Act or the ECOA. And we know that a policy or practice that has a disparate impact is not, by itself, proof of a violation because such policy or practice may be justified by “business necessity.” However, even with a business necessity justification, such policy or practice may still be a violation if some alternative policy or practice could serve the same purpose with less of a discriminatory effect.

This month, the DOJ entered into a proposed settlement with Luther Burbank Savings (“Burbank”) to resolve discrimination claims under the Fair Housing Act and ECOA after the DOJ alleged that Burbank’s minimum loan amount (generally $400,000) for single-family residential mortgage loans had a disparate impact on African-American and Hispanic borrowers that was not justified by business necessity.  Such settlements are not binding court precedent but they certainly have an effect on the policies of lending institutions. Another effect of such settlements may be that regulators and the CFPB may be more inclined to pursue disparate impact fair lending claims. See the recent “U.S. Department of Justice Turns Spotlight on Disparate Impact Discrimination Claims.”

Government actions that encourage or mandate restrictive lending standards have the potential to have a disparate impact on certain minority borrowers. Regulators may have to reconcile competing directives to lenders to maintain strict credit standards while avoiding or limiting policies that have a disparate impact. Institutions may find themselves in a difficult position between these two government objectives.

Lenders should carefully review their business justifications for lending policies that may have a disparate impact and consider whether there are acceptable alternatives that could have less of a disparate impact.

By Laurie Nelson

As you can see, I’m pretty good at questions. The trouble is that, when you run a business, you’ve got to come up with some answers. As I’ve said to my colleagues around here, we need to have a view. Not taking a view is taking a view and no matter how daunting the prognostication game can be, you gotta do it.

So, with that said, this is what I think.

·         No deep recession for the United States (if there is, ignore everything below).

·         The job situation will continue to steadily improve, but the new normal of structural unemployment will be 6-7%, not 4-5%. The new normal of full employment notwithstanding, this will lead to continued firming of the demand for commercial real estate space.

·         Private deleveraging will continue, housing will finally make a bottom, and CRE markets will modestly expand.

·         Here in the U.S., we won’t fix the debt problem anytime soon. I hope Keynes was right about aggregate demand and government spending, but I doubt it.

·         EU banks will sell U.S. and EU assets

·         U.S. banks will sell assets in a less panicky way – portfolios will be balanced

·         The EU crisis will have its own “trading range”. The EU will not collapse, no one will leave, but it will not get healthy, either. No European economic growth for the foreseeable future, or until they finally learn high taxation, protectionism and a massive regulatory apparatus is not a recipe for growth.

·         EU countries will not let national champion banks fail, period.

·         There will be a global tightening of credit and U.S. banks will have a material competitive advantage, if our own regulators don’t do more stupid things.

·         Kicking the can down the road on bad loans is getting closer to its final denouement. More loans will get resolved, loan sales, real restructurings and rescue capital trades will accelerate

·         Structured finance will be used broadly to facilitate disintermediation. Liquidating trusts, seasoned low leverage CMBS, and CRE CDOs will all be broadly used.

·         There will be a CMBS business. Modestly better than 2011. What’s broken will trend toward being fixed – bid/ask spreads will come in. Rating agency models will migrate to levels at which capital formation can occur, and the gap between the CMBS bid and the portfolio bid will come in as the portfolio bid will simply be insufficient to deliver all the capital required by a modestly growing CRE sector.

·         Further, regulatory action will continue to be characterized by unintended consequences being markedly more costly than the value of the intended good. This will continue to threaten the recovery and all of the good stuff above.

·         The election matters, hugely. If the market concludes that Mr. Obama will remain in the White House and the Democrats may get more seats in the House and Senate, much of the good news above is materially trumped.

·         Macro/global tail risks are at an all time high. Really bad stuff could completely shuffle the deck.

So what does all this mean for planning? We will see increased transactional activity in the CRE and structured finance space. Our clients are likely to be busy. There will be a premium on ingenuity, and innovation and scale will be rewarded.

So, here’s my plan: Go all in.  We’ll grow. We’ll invest in innovation and deliver scale. When the risk/reward traffic lights are flashing green and the downside risks, while pretty catastrophic, still look tailish, it’s an easy call.

I’m looking forward to 2012; I think.

An issuer has strict liability for misstatements and omissions in a public deal. So what’s really added here?  An issuer can now be liable for bad disclosure about the nature of its diligence process or if its diligence failed to provide “reasonable assurance” that the disclosures were “correct”.  Now that’s new and different!  I don’t know what “reasonable assurance” means, but I suspect if we round up the usual suspects at the trial bar, they will tell us it means something, by God!  One more count in every complaint!

This only applies to registered deals and in the CMBS space registered deals are beginning to look like the dodo.  But the SEC staff mused in the preamble to the Rule that a similar regulatory regime for the 144A market might be appropriate and they’re a fixin’ to think about it.  Joy. 

Also one should not discount the argument that, as the SEC has concluded that this information needs to be provided to meet its standards for adequate disclosure, mischief could be concocted by our usual suspects right now.  If this disclosure is appropriate in 2012, why not now?

Another new rule, Rule 15Ga-1 (release here (pdf)), is more straightforwardly and more immediately problematic.  Rule 15Ga-1 requires an issuer to disclose, in a very complex and burdensome way, its past history of demands for the repurchase of assets -- successful, unsuccessful or otherwise -- for breaches of representations and warranties on pool assets.  The SEC is also requiring, in Rule 17g-7 (released with Rule 15Ga-1 above), that rating agencies include in their reports a description of the issuer's reps, the enforcement mechanisms to address breaches and how each differs from such provisions in "similar securities".

All this kicks in by the first quarter of 2012 as well, and it applies to all securitizations, public and private. SIFMA, in its comment letters on these rules (available here and here) stressed how burdensome this was, how little actual probative information it would deliver to investors, by giving investors data about unrelated asset classes and unsuccessful or even unpursued claims, and how, at least in CMBS, put-backs were really extraordinarily rare in any event.  And what in the world do rating agencies do with a "similar securities" standard?

All for naught.  We’re now going to have to learn to live with this.  Note how extraordinary it is that issuers of private 144A deals will now have to make public filings.  If that doesn’t blur the distinction between the public and private markets (which I sort of think is what the SEC has in mind), what does?

While Rule 15Ga-1 doesn’t kick in for a year, this will cause issuers a very substantial amount of work, starting now, to get ready for next year.  Below the Rule's headlines, a lot of detailed compliance and mechanics questions will need to be answered in the process.  How comforting that the Rule contains an analysis by the SEC of its expectations of the cost of compliance.  And here’s the headline: the compliance costs won’t be bad at all!  It makes risible reading.

Beyond the additional costs, extra work and potential liability imposed by these Rules, which are bad enough, this first batch of Dodd-Frank regulations tells us that complying with the fullness of Dodd-Frank is going to be a lot worse.  In a significant way, Dodd-Frank was built on the basis of unsupported conjecture, received wisdom and ideological certitudes.  Dodd-Frank booted much, if not most, of the actual sausage-making to the reconciliation and launched dozens of regulatory processes. 

The regulatory handcuffs will magnify the underlying subtext of Dodd-Frank - that we have insufficient regulatory restraints on the behavior of market participants and we need more to avoid a return to the edge of apocalypse.  Regulators will regulate.  Close calls and unclear, skeletal legislative direction will be settled in favor of more, not less. 

Consequently, the industry faces a daunting rear guard action in the 112th Congress to try to mediate what will likely be excessively burdensome and intrusive rules.  No matter how well this goes, capital formation will get harder and more expensive.  Will all of this really help investors and prevent irrational exuberance and excess?  

At least in CMBS, I think not. It’ll make some trial lawyers happy, though.

By Rick Jones.