CMBS Market Developments

The emergence of the commercial mortgage-backed securities (CMBS) market during the 1990s is rapidly changing how commercial real estate is financed. The CMBS issuance activity level has experienced nearly a ninefold increase from $5 billion in 1990 to $44 billion in 1997. However, despite the recent growth, unnecessary barriers to the development of the CMBS market have not been eliminated completely.

To address these barriers, the Capital Consortium was formed in 1992 to promote a broader-based secondary market. The consortium comprises the National Association of Realtors, the National Realty Committee, and the Mortgage Bankers Association of America. During first quarter 1998, it made three submittals to regulatory agencies that address several issues.

Class Exemption
Over the past three years, the consortium has worked with the Department of Labor (DOL) to obtain a class exemption to allow pension funds to purchase investment-grade (AAA, AA, A, and BBB) CMBS. Currently, pension funds only can purchase the highest-rated tranche from issuers that have received an exemption from the DOL to market these securities to pension funds. In the vast majority of issues, the highest-rated CMBS tranche is a AAA rating. However, the stringent CMBS restrictions are not present for investment-grade corporate bonds. Consequently, pension funds are able to purchase AA, A, and BBB corporate bonds, but not similarly rated CMBS. The consortium maintains that this represents unequal treatment of CMBS because ratings are intended to be consistent among all investment categories. Consequently, the risk of default for a BBB-grade CMBS is identical to a BBB corporate bond. In January 1998, the consortium sent a letter to the DOL that addressed these concerns and is optimistic that a class exemption will be granted by mid- to late 1998.

Capital Standards
In February 1998, the consortium presented proposed risk-based capital standards for CMBS to the bank regulatory agencies, including the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve, and the Office of Thrift Supervision. The consortium endorsed the concept of reducing the risk weighting of a AAA-grade CMBS. However, it recommended a 10 percent risk weighting versus the agencies’ proposed 20 percent standard. For AA, A, and BBB-grade CMBS, the consortium opposed the modified gross-up approach presented in the proposed rule because it would require risk-based capital reserves far in excess of current requirements. Instead, the consortium recommended the escalating face value approach, which uses the AAA rating as the benchmark for assessing risk-based capital. Under this approach, the reserve requirement is determined by the decreasing level of credit enhancement that is required for non-AAA investment-grade securities. A final rule is not expected to be released until late this year.

Appraisal Requirements
In January 1998, the consortium submitted a letter to the FDIC supporting a proposed rule to eliminate cumbersome appraisal requirements for CMBS properties for bank holding companies and wholly owned subsidiaries. The proposal did not address banks. The rule is likely to be adopted by mid-1998.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.