Minimum 05CR

Understanding Minimum 05CR (Risk Retention)

The term Minimum 05CR refers to the 5% Credit Risk Retention requirement established under the Dodd-Frank Wall Street Reform and Consumer Protection Act. In the commercial mortgage industry, specifically regarding Commercial Mortgage-Backed Securities (CMBS), this rule mandates that the sponsors of a securitization transaction retain at least 5% of the credit risk of the assets they are securitizing.

Detailed Description of 05CR

Commonly known as the "skin in the game" rule, the Minimum 05CR mandate was designed to improve the quality of commercial mortgage underwriting. By requiring the securitizer to maintain a financial interest in the performance of the loans, the regulation ensures that the interests of the loan originators are aligned with the interests of the long-term investors. This prevents the "originate-to-distribute" model that was prevalent prior to the 2008 financial crisis, where lenders could issue high-risk loans and immediately sell them off without consequence.

There are three primary structures used to satisfy the Minimum 05CR requirement in commercial mortgage transactions:

• Vertical Retention: The sponsor retains 5% of the face value of each class of bonds issued in the CMBS transaction.
• Horizontal Retention: The sponsor (or a qualified third-party "B-piece buyer") retains the most subordinate (riskiest) class of bonds, representing at least 5% of the fair value of all interests issued.
• L-Shaped Retention: A hybrid approach where a combination of both vertical and horizontal slices is used to meet the total 5% requirement.

For a commercial mortgage borrower, the 05CR rule often results in stricter underwriting standards and more rigorous property inspections. Because the entity holding the 5% risk cannot hedge or transfer that risk for a specified period (typically five years for commercial mortgages), they are highly motivated to ensure that only high-quality, sustainable properties are included in the loan pool.

Ultimately, the Minimum 05CR serves as a regulatory safeguard. It provides a buffer for investors and stabilizes the commercial real estate market by ensuring that the parties responsible for creating commercial mortgage products are financially exposed to the potential default of those underlying loans.