The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama in 2010 is considered the most sweeping change in U.S. financial regulations since the Great Depression.
Many of those regulatory changes will become effective beginning January 1, 2012. If you’ve listened for any length of time to the Republican presidential debates one of the re-occurring themes that is bandied about by several of the candidates is that Dodd-Frank should be repealed. They consider this legislation a quintessential example of government red tape that is crippling our economy. Hmm… Is that really true?
I freely admit I’m no expert on the subject of the Dodd-Frank bill which totaled over 2,300 pages in length and most likely neither are you. So let’s begin by doing a quick overview of what was in the bill and how it impacts commercial real estate.
1. Banks are required to have 5% “skin in the game” for every loan that they approve. No longer can they approve a risky loan and then sell it to some unsuspecting investor by passing it off as a quality investment. This means that lenders are now scrutinizing and documenting real estate loans more carefully. Anyone in the mortgage lending business will tell you that it takes much longer and requires much more paperwork today than it did three years ago. You can thank this 5% rule for the reason why loan processing has become so much more cumbersome.
2. Banks are required to carry more capital reserves. They now have to prove they have the correct amount of reserves, and based on recent default rates and delinquencies, they have had to increase capital reserves significantly over what they were required only a few years ago. This has resulted in decreasing the overall amount of lending capacity in the market in addition to decreasing significantly the number of lenders lending. Pre-2008 lenders were tripping all over themselves competing for loans.
3. Rating agencies now bear more risk and liability under Dodd-Frank. Gone are the days when credit agencies were fearful of losing lucrative business if they came down too conservatively on risky loan pools. As a result CMBS issues today are much more conservative, with lower LTVs and higher debt coverage ratios. It is no surprise that the CMBS market is a shadow of its former self. In 2007 there was $228 billion in the CMBS market compared to a measly $12 billion in 2010. There are several reasons for this downturn but the rating agency reform in the Dodd-Frank bill is certainly one of them.
I would be the first to admit that the Dodd-Frank bill is having a huge adverse impact on the banking system in the short term. But would you prefer to go back to where the banking regulations were prior to the sub-prime loan debacle? I don’t think so. Yes it’s painful and it certainly makes a good sound bite on the campaign trail to rail against the Dodd Frank bill. But all three of these changes are just plain common sense. They are needed in order to slowly repair a battered banking system that has lost all the respect that it once had. If you disagree, I welcome your comments.
Source: Regulatory Reform: What Impact Will It Have On Commercial Real Estate?, CoStar Group Real Estate Information, Randyl Drummer, July 28, 2010.