The 'Unintended Consequence' Of Dodd-Frank And The Impact Of Trump’s Deregulation Plans On CRE Lending

President Donald Trump has called for a reworking of the 2010 Dodd-Frank Act, which could significantly change the residential mortgage market. But thanks to a rapid adaptation in the commercial real estate world, there may be little impact on the capital available for commercial projects.

Though there has been some tightening from banks since the financial crisis — which was exacerbated last year as new risk retention rules took effect, requiring lenders to keep more capital on the books — debt, foreign investment and rising interest from institutional investors have kept a flood of funding in the market.

Dodd-Frank was enacted by a Democrat-dominated Congress in 2010 to prevent another financial crisis, but many have criticized the law, claiming it unnecessarily burdens lenders, limits consumers’ options for funding, and hurts business and economic growth.

Even the law’s co-author, Barney Frank, is advocating a reworking of the law. He said a complete dismantling would be a disaster that leads to another Wall Street meltdown, but a tightening of the rules here and there is justified.

"Any comprehensive legislation needs some changes," Frank told CNBC. "If the Republicans hadn't taken over the House in 2011, with an avowed purpose to get rid of the whole thing, we would have made the changes."

The Republican-dominated Congress is advocating for multiple amendments to Dodd-Frank. One change likely to take effect is raising the $50B asset threshold that identifies banks as too big to fail; banks that large are subject to tougher restrictions. Discussions are underway to raise that threshold to $250B, which would include the top 10 banks in the U.S., including Citigroup, J.P. Morgan, Wells Fargo, Bank of America, Goldman Sachs and Morgan Stanley.

Overall, the market has adjusted to Dodd-Frank without much of a blip, and the same may happen if it's changed.

The Unintended Consequence

"The unintended consequence of being strict about commercial lending at smaller banks is that business turns away from those banks," Mission Capital Advisors principal David Tobin said. Other capital sources simply fill the gap and keep real estate deals happening.

Though enacted in 2010, the law was held up in Congress for six years, so banks didn’t really begin to feel the impact of Dodd-Frank until Dec. 24, 2016, when the new risk retention rules took effect.

The new regulations require lenders to keep 5% of the value of any loan on their balance sheets, rather than selling it entirely in the form of bonds. In some cases, these rules have made CMBS loans less profitable to issue and have required CRE sponsors to put up more capital to see a deal through. That hasn't stymied deals, though.

“The dynamism of the commercial real estate finance market continues to be impressive, with CMBS issuers adjusting to new risk-retention requirements that took effect on Dec. 24, 2016, and portfolio lenders, private equity and a new generation of other lenders stepping in to fill gaps and enable opportunity in the investment marketplace,” CRE Finance Council executive director Lisa Pendergast said.

Though banks are still the primary source of corporate lending, traditional investment firms have ramped up their commercial lending in recent years, putting added pressure on banks. The firms typically receive large cash flows from clients that allow them to make these loans available.

“That’s also an important trend that comes about very often from regulation,” Tobin said. “Investors around the country are [increasingly] forced to go to non-bank lenders like Blackstone, Oak Tree and Colony Capital. They come in as alternative capital providers that are not restrained by [banks'] rules.”

Residential Lenders Hit Hardest

Trump’s claims that Dodd-Frank regulations have restricted borrowers from pursuing the American dream is not far-fetched. Tobin said residential lenders have been far more affected by the risk-retention rules than commercial lenders.

During the subprime market crash in 2008, private lending dried up and the government was forced to bail out free-falling assets. The Federal Reserve grabbed hundreds of billions worth of mortgaged-backed securities as a result. Today, it has $1.75 trillion worth.

The enactment of tough financial regulations through laws like Dodd-Frank have nearly taken private lenders out of the game, placing most residential mortgage lending firmly into the hands of the government through programs from the Federal Housing Administration, the U.S. Department of Veterans Affairs, Fannie Mae and Freddie Mac — the last two of which remain under government control (though the Trump administration is pushing to privatize the two mortgage behemoths once again).

“Candidly speaking, the private label RMBS market never came back following the great financial recession,” Tobin said. “On the one hand you’ve got Dodd-Frank implementing risk retention and that restricts residential lending … on the other hand, the only loan programs that remain are government-backed and loan programs. The government is basically driving borrowers into their arms because banks can’t make those loans.”

Tobin said the lack of lending for potential owners is felt most in the smaller markets throughout the country that were hit hardest during the crisis, with major drops in job gains and overall economic growth. 

Updating Dodd-Frank could bring the bond market back to normalcy, with business and consumer lending picking up. “You’ll have more business lending and you’ll have more consumer lending and mortgage availability throughout the whole banking system,” Tobin said.